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Explaining Gift Tax: Exemptions and Rates

If you’ve considered making a sizeable gift to a child, extended family member, or friend, you might not realize that you may have to pay federal taxes on that gift. However, federal gift tax laws include many exemptions and exclusions that allow most taxpayers to avoid paying gift taxes during their lifetimes. Understanding the gift tax system can help you minimize unnecessary financial liability. 

Understanding Gift Tax

The Internal Revenue Code imposes taxes on certain transfers of money or property to persons or entities when the person transferring the money/property receives nothing or less than fair value in return. The person transferring the money/property, rather than the gift recipient, must pay any applicable gift tax. The amount of taxes owed on a taxable gift increases as the size of the gift increases. The gift tax does not apply to charitable donations to qualified non-profit entities, for which the gifter can claim a tax deduction. Individuals otherwise cannot deduct the value of gifts from their income tax.

The government has little interest in collecting taxes whenever you give someone an ordinary birthday or holiday gift. As a result, federal tax law includes annual and lifetime exclusions on gift-giving that exempts most gift-giving from taxation. When a person makes gifts that exceed their annual or lifetime giving limits, they must report the gift(s) on their annual tax returns. 

Gift Tax Exemptions

Federal gift tax law exempts specific categories of gifts from the scope of the law, including:

  • Gifts to a spouse
  • Tuition and other educational expenses paid on behalf of another person
  • Medical expenses paid on behalf of another person
  • Gifts to a political organization

People can continue making non-exempt gifts to individuals or organizations without incurring potential tax liability when the total value of those gifts does not exceed the gift-giver’s annual and lifetime exclusion limits. An individual has an annual exclusion limit for each gift recipient. For example, a parent has separate annual exclusion limits for each of their children rather than a single annual exclusion limit for all gifts they might make in a year. The annual exclusion limit resets at the start of a person’s tax year. As of 2024, a person has an annual exclusion per donee limit of $18,000. The annual exclusion limit usually increases yearly or every couple of years to reflect inflation. Married couples can combine their annual exclusion limits. 

Each person has a lifetime exclusion limit covering all the gifts they make during their lifetime and any assets they pass on after their death. As of 2024, each person has a lifetime exclusion limit of $13.61 million, although the law currently states that this limit will revert to the pre-2018 limit of $5 million (adjusted for inflation) in 2025.

Gift Tax Rates

Although taxpayers must file gift tax returns when they make gifts that exceed their annual exclusion limits, they typically only pay taxes once they exceed their lifetime exclusion amounts. As with income taxes, gift taxes use a progressive system, which breaks the taxable value of gifts into tranches. As of 2024, gift tax rates range from 18 to 40 percent. 

Common Gift Tax Mistakes

Some of the most frequent mistakes people make that can ultimately trigger gift tax liability include:

  • Not keeping track of gift-giving amounts or how much you have left on your annual/lifetime exclusion limits
  • Not taking advantage of special rules for large one-time gifts or combining annual/lifetime limits by married couples
  • Making interest-free loans to family members or friends or waiving repayment of a loan
  • Placing another family member as a joint accountholder on an already-funded bank account

Contact an Estate Planning Lawyer to Learn More About How Gift Tax May Affect You

When considering making a sizeable gift to a family member or friend, you need to know how federal gift tax laws might apply and whether you may owe federal taxes on your gift. Contact an experienced estate planning lawyer at Jones, Gregg, Creehan & Gerace for an initial consultation to learn more about gift tax exemptions and rates.