We all worry about the kids in our lives, and we want to make sure we do everything we can to safeguard their financial future.
A fantastic way to do that is to start building a nest egg today for the next generation to use tomorrow. However, there are some IRS tax rules you should know before you start gifting away assets.
The IRS gift tax is a tax law designed to make sure people aren’t unfairly dodging the estate tax — and it forces those gifting assets to pay taxes on those gifts.
The good news is that the IRS does allow each taxpayer to gift up to a certain amount each year (and over the course of their lifetime) without getting taxed on those gifts.
This guide explains what the gift tax is, the tax free gift limit for 2022, and who's eligible to use the IRS gift tax exemption.
What is the Gift Tax?
Before we break down your tax free gift limit and how it works, let’s talk about what the gift tax is.
The gift tax is a U.S. tax on the transfer of property from one person to another. But it only applies when the person giving the gift receives nothing — or less than the item’s full value — in return.
Keep in mind, the gift tax generally applies whether you mean for the property transfer to be a gift or not.
For example, let’s say you buy a brand-new Lamborghini for $200,000. Then, you turn around and sell that car to your little sister for $10,000. Because you’ve sold it for so far below the going fair market value for a high-end car like that, the gift tax would probably apply to this sale.
You should also note the gift tax applies to some interest-free loans or reduced-interest loans too. This can be a bit of a gray area — so, when in doubt, you should get in touch with the Internal Revenue Service (IRS) for guidance on loans.
Simply put: the gift tax applies to the transfer of all property types. That means cash, income from real-estate sales, property, stock shares, cars, bonds, and everything in between.
Why do you have to pay gift tax?
The U.S. Congress introduced the gift tax in the 1930s after realizing that donors were trying to dodge the federal estate tax by transferring all of their assets before they died.
Through the gift tax, the IRS can now prevent people from avoiding the estate tax — although you’re still allowed to gift individuals a certain amount without having to pay the tax.
This is what’s known as your gift tax exemption (or your “tax free gift limit”). But we’ll get to that in just a minute.
If you do give a gift that needs to be declared to the IRS, you need to report it as part of your annual tax return.
This is done by completing and submitting IRS Form 709 — which tells the IRS all about the taxable gifts you’ve made during your lifetime. It also allocates the lifetime use of your generation-skipping transfer tax exemption.
Despite all of that, there are a few exceptions in which you won’t be expected to pay gift tax.
The first gift tax exemption is if the gifts you’ve made don’t exceed your annual tax free gift limit for that calendar year. We’ll talk more about what that is in a bit.
But you can also avoid having to pay gift tax if the money or assets you’ve given are being used to pay directly for tuition or medical expenses. These exceptions are called the “educational exclusion” and the “medical exclusion,” respectively.
The same rule applies if you’re gifting assets to a political organization or a qualifying charity.
The final exemption relates to giving monetary gifts to your spouse. You can gift a spouse as much as you want to without having to pay the gift tax — but only as long as your spouse is a U.S. citizen.
If your spouse isn’t a U.S. citizen, you have a tax free gift limit of $164,000 for 2022 — which is much higher than the normal annual gift tax limit. But, there is no lifetime limit — so, if you gift your spouse anything over this amount, it will be subject to tax.
How Does the Gift Tax Limit Work?
The IRS gift tax covers a wide range of assets and gifts. But as we’ve already mentioned, the IRS doesn’t tax every single cent you’d like to gift to a loved one — instead, there is a tax free gift limit.
You’ll often hear people refer to the tax free gift limit as your “gift tax exemption,” “gift tax limit,” or "gift tax rate." But they all mean the same thing.
There are two two gift tax limits: an annual limit and a lifetime limit.
What is the annual gift tax limit?
The annual IRS gift tax limit enables you to give a certain amount of money to people every year without having to report that gift to the IRS.
In 2021, the annual gift tax exclusion was $15,000 per person per year.
Because the gift tax limit is per person, that means that you could give up to $15,000 per year to multiple people without paying the tax.
For example, in 2021, you could have given $15,000 to your daughter, $15,000 to your cousin, and $15,000 to your godson, without having to declare the gifts when you file your taxes in 2022 — and without paying a tax on those gifts.
It’s also important to note that the $15,000 annual exemption is for self-filers.
So, if you’re a married couple jointly filing your taxes in 2022, the 2021 gift tax limit is doubled to $30,000 per recipient.
That means you and your spouse could have given up to $30,000 to each of your children last year without having to report those gifts to the IRS.
What is the lifetime gift tax limit?
There’s also an IRS lifetime gift tax limit, which works a little bit differently.
In 2021, you were allowed to give a lifetime limit of $11.7 million to family, friends, or anybody else you’d like to gift to.
Unlike the annual tax free gift limit, your $11.7-million cap isn’t per person. It’s a cap on all the gifts you’ve made over your lifetime.
Here’s how it works: every time you give more than your annual gift tax limit, those gifts start to count against your $11.7 million lifetime limit.
All of those annual gifts that count against your lifetime exclusion are reported using Form 709, which is the gift tax return.
It’s important to note that this doesn’t necessarily mean you have to pay the gift tax. The IRS will decide that. It just means you need to report your gifts that go above annual or lifetime limits.
What is the Tax Free Gift Limit for 2022?
After four years of the federal gift tax limit remaining static at $15,000, it has now increased to $16,000 for 2022 — the highest it’s ever been. The iRS has reported that this increase is to help adjust for inflation.
The lifetime limit has also increased to account for inflation. In 2021, it was $11.6 million, but for 2022 it’s now $12.06 million.
Previously, the lifetime limit was set to be cut in half as of 2023, as a provision of the Build Back Better Act. That has now been delayed to 2026 — unless something else changes.
Under the current plans, the U.S. House Ways and Means Committee has recommended these changes would include a “no clawback” clause. That means any gifts you’ve already made before any impending gift tax limit reduction wouldn't be taxed retrospectively.
For example, let’s say you’ve already gifted $10m over your lifetime to your loved ones. But then Congress decides to enact this House proposal and lower the lifetime tax free gift limit to just $5m.
Even though the gifts you’ve made exceed the new lifetime gift tax limit, the IRS wouldn’t punish you for having already gifted above that amount. The previous gift tax limit will be honored on any gifts made before the new implementation date.
Who's Eligible for the Tax Free Gift Limit?
If you’d like to transfer property to a loved one, the good news is that all taxpayers are eligible to use the gift tax exemption.
The gift tax is applied to just about every gift to most taxpayers — so you’re allowed to gift up to your tax free gift limit on an annual or lifetime basis without having to pay taxes on those gifts.
The big exception to this eligibility rule is if you’re gifting cash to your spouse.
When you make a gift to a spouse, this is covered by a different tax-free deduction called the "unlimited marital deduction."
The unlimited marital deduction states you can gift as much as you want to your spouse (while living or after you’ve died) without having to pay the gift tax or the federal estate tax.
This applies to same-sex couples, too — but only as long as you’re legally married. Domestic partners or civil union partners of any gender aren’t eligible for the unlimited marital deduction.
If spouses aren't U.S. citizens, the rules are slightly different.
Non-U.S. spouses aren’t eligible for the marital deduction. Instead, you’ll be limited to an annual exclusion. But that annual exclusion is much larger than the ordinary annual gift tax limit.
You can gift up to $159,000 in 2021 and $164,000 in 2022 to a non-US citizen spouse without having to pay gift tax.
If you want to pass on your wealth to the people you care about, it’s critical you understand the rules around gifting — and that’s where the gift tax slides into the frame.
In 2022, you’re allowed to use a tax free gift limit of up to $16,000 per person per year without having to report that gift to the IRS. Meanwhile, you’re allowed to give up to $12.06 million to your loved ones during your lifetime.
Just make sure to keep your ear to the ground because change could be on the horizon.
So, are you ready to start gifting?
Download the EarlyBird app now and start gifting towards the financial futures of the kids in your life.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.