Supporting the little ones in our lives is important. And while time spent together may be the most valuable gift of all, financial gifts can help set children up for a more secure financial future.
Whether you’re a parent, family member, or close friend, providing a valuable gift for a child can have a profound impact — particularly if the gift is invested and allowed to grow over time.
But what about tax implications? Does Uncle Sam get a piece of the pie when it comes to gifts?
This comprehensive guide will teach you everything you need to know about tax on gifts to children — and how to maximize your gift's impact.
Is There Tax on Gifts to Children?
Gifts made to children may be subject to tax, but typically only if they are large gifts.
As of 2022, any gift under $16,000 isn’t typically subject to gift tax and doesn’t need to be reported to the IRS.
This is due to the annual gift tax exclusion. It was $15,000 in 2021, but has increased to $16,000 for 2022 — as it’s usually adjusted each year for inflation.
All types of gifts are subject to the appropriately named “gift tax.” The gift tax is a federal tax from the IRS that applies to gifts of cash, property, assets, and anything else of value.
When you give a gift to someone, the IRS bases any applicable gift taxes on the item’s fair market value on the day of the gift.
For example, the gift of a used car may be based on the current Kelly Blue Book value, regardless of how much the gifter originally paid for the car.
Fortunately, this tax has many exemptions that make it relatively easy to avoid gift tax (legally!).
- As of 2022, any gift of under $16,000 isn’t subject to gift tax and doesn’t need to be reported.
- Gifts of over $16,000 must be reported but likely won’t be subject to any gift tax due to generous lifetime exclusions (more on this below).
Plus, these limits are per person. For couples filing jointly, that means gifts of up to $32,000 are allowed with no gift tax return required.
These are the basics, but there’s a bit more to know about the gift tax.
Gift Tax Explained
Federal gift tax comes into play for certain larger gifts. All gifts under $16,000 are exempt, while all gifts over $16,000 are subject to the gift tax.
The gifter always pays the gift tax — the recipient won’t owe any tax (even for very large gifts).
The gift tax applies to situations where you give a gift and get nothing in return (or get less than the gift’s full value). This means that if you buy a $50,000 car and “sell” it to your friend for $1,000, this is still a gift in the eyes of the IRS.
For gift tax purposes, the IRS doesn’t care what the gift consists of — it could be a monetary gift, investment, car, house, or piece of artwork. As far as the IRS is concerned, the only relevant factor is the item’s “fair market value” — basically, how much the gift is worth.
Annual gift tax exclusions
Each year, there’s a set annual exclusion for gift tax. In 2021, it was $15,000 per person, and in 2022 it’s $16,000 per person. This applies both to each gifter and to each recipient.
For example, a single person could give $14,000 each to every person in their family, and they wouldn’t need to report any of the gifts (because each was under $16,000).
Likewise, a married couple could give up to $32,000 to every person in their friend circle in 2022 (because each gifter has their own individual $16,000 limit, for a combined limit of $32,000 each year).
If a gift exceeds these exclusion limits, then a gift tax return (IRS form 709) must be filed.
Lifetime gift tax exclusion
Separately, there’s a lifetime exclusion for each gift-giver. For 2022, this is $12,060,000 per person.
If you give a gift of over $16,000 to any individual, the amount over $16,000 will be deducted from your $12,060,000 lifetime exclusion. For instance, a single person gifting their friend $100,000 would require a gift tax return, and $84,000 would apply to the gifter’s lifetime exclusion.
This exclusion applies only to the gifter. This means that you can’t give three different people $10 million each without paying any gift tax — you can only gift a total of $12,060,000 without paying tax (in addition to the yearly exclusion discussed above).
However, married couples can double the lifetime exclusion to $24.12 million total.
Note: The $12,060,000 lifetime exclusion is tied to inflation, so this figure can change over time. (It was $11.7 million in 2021 and is $12.06 million in 2022).
However, the exemption is also temporary — it’s set to expire in 2025 unless Congress extends it. If Congress doesn’t act, the lifetime exemption will revert to its pre-2017 level of $5.6 million.
Exemptions for medical and educational gifts
The IRS allows “unlimited payments” to be paid directly to educational institutions or medical providers on behalf of others without incurring a taxable gift.
This means that a family friend could pay for a close friend’s $80,000 cancer treatment (by paying the medical provider directly), or a grandmother could pay for her grandson’s $50,000 college tuition (by paying the college directly).
In both of these situations, no gift tax return would need to be filed.
This exemption requires paying the provider or school directly, however. If money is instead transferred to the beneficiary, normal gift tax rules will apply.
Examples of the gift tax
Let’s walk through two examples of how gift tax works.
Terri wants to give her goddaughter a used car in 2022 with a fair market value of $8,000. Because the gift is under $16,000, it isn’t subject to gift tax, and no IRS tax form is required.
Keep in mind that there may be state-level taxes or registration costs applicable in this case due to the transfer of a vehicle.
Anika and Rishaan wish to give their grandchild Jay $50,000 worth of stock in order to help fund his future education expenses.
Combined, Anika and Rishaan have a yearly gift tax exemption of $32,000, as of 2022. This means only $18,000 of the $50,000 gift is subject to gift tax.
However, Anika and Rishaan also have the lifetime exemption of $12,060,000 each ($24,120,000 total).
So, the couple would need to file a gift tax return (IRS form 709) reporting the $50,000 gift. $18,000 of this gift would count against their $24.12 million lifetime gift tax exemption, but they wouldn’t owe any tax on the gift.
What about state gift tax?
All the information above relates to the federal gift tax. But do individual states have their own gift tax rules?
Most states do not have their own gift taxes. Currently, only Connecticut has a gift tax rule on the books.
However, many states have inheritance tax rules that may need to be considered in broader estate planning. Inheritance/estate taxes come into play when the individual has passed away, while gift taxes apply only to gifts given while the individual is alive.
Are Gifting Rules Different for Parents?
In general, no — parents gifting to their children have the same gift tax rules as anyone else.
Are Gifts to Children Tax-Deductible?
Gifts to individuals aren't typically tax-deductible. They have no effect on income tax for either the gifter or the recipient.
The only types of “gifts” that may be tax-deductible are gifts to charities and other qualifying nonprofit organizations.
The only case where actual gifts might be tax-deductible is if a business gives a qualifying gift to a client or customer. The IRS has special rules for these gifts — and they would almost never apply to a gift to a child.
“Lifetime Gifting” in the Estate Planning Process
For very high net-worth households, there are some estate tax considerations for passing wealth onto the next generation. The process is called estate planning. It essentially involves figuring out how you would like to distribute your assets and wealth to loved ones, charities, etc., when you pass away.
Similar rules apply to estates/inheritances as apply to general gifts. But inheritance tax applies to your estate after you pass away, while gift tax applies to gifts distributed throughout your life.
Most of us will pay little to no inheritance tax or estate tax — but for high net-worth households, that may not be the case.
So, the idea of “lifetime gifting” is worth learning about, even if you’ve yet to build a formal estate plan.
Essentially, some households choose to give smaller amounts of money to loved ones each year rather than gifting their entire estate upon death.
For instance, a married couple may gift each of their three children up to $32,000 each per year without triggering gift tax rules or using up any of their lifetime exclusion. Over a 20-year period, that’s $1.92 million transferred tax-free.
This could save the couple a lot in taxes if their entire estate ends up being more than the total lifetime gift tax exclusion.
It’s important to speak to a tax professional about estate tax planning — this section is merely a (very) brief introduction to the concept of lifetime gifting in the estate planning process.
Gifting Investments to Children
When gifting investments — stocks, bonds, mutual funds, ETFs, precious metals, cryptocurrency — the rules are the same as they are for cash gifts.
For 2022, gifts of under $16,000 per person per year won’t need to be reported and aren’t subject to gift tax. Gifts over $16,000 must be reported and will count towards your lifetime gift tax exclusion.
When it comes to gifting existing investments, there are a few things to keep in mind:
Fair market value
As discussed above, gift tax is based on the “fair market value” on the day of the gift. With something like a stock, this is simply the actual current value of the shares on the stock market (usually, the closing value of the shares on the day they are transferred).
For instance, imagine that you purchase $10,000 worth of ABC stock. Ten years later, it’s worth $20,000. You then give $20,000-worth of ABC stock to your nephew.
Even though you only paid $10,000, the fair market value — and therefore the amount subject to gift tax rules — is $20,000.
In this case, $4,000 would be deducted from your lifetime exclusion (assuming the annual limit is still $16,000 at the time you give the gift).
Here’s where it gets a little tricky. The original cost basis of the shares will transfer to the gift recipient. When the new owner eventually sells that investment, they will owe tax on the capital gain, defined as the difference between the sales price and the original cost basis.
Taking the same example from above, that means the cost basis would be $10,000 (what you originally paid).
If your nephew holds onto the investment for another five years and then sells it for $25,000, he would have to pay capital gains tax on $15,000 of profit ($25,000 - $10,000 original cost basis).
We discuss this more in our gifting stock guide.
Using EarlyBird to gift investments
If you’re thinking about investing for a little one’s future, a great way to do so is to set up an EarlyBird account on behalf of the child.
EarlyBird is a platform that makes it simple to set up an investment portfolio for a child. Here’s how it works:
- An adult sets up an EarlyBird custodial investment account for the child.
- A portfolio of ETFs is selected based on investment preferences (ranging from aggressive to conservative), and funds are invested in a mix of stocks and bonds.
- Anyone can contribute money through the EarlyBird platform, which will go directly to the child’s account and be invested.
- Gifts can grow over time, as every dollar is invested automatically.
- Once the child is a legal adult, they gain full control over the account and can use the money for any purpose.
In seeking to give gifts that matter, gifts that contribute to a child’s financial security are among the most impactful.
And in most situations, there’s typically no tax on gifts to children due to the generous gift tax exclusions.
As of 2022, you can gift any individual up to $16,000 per year without owing any gift tax or even having to file a gift tax return — and gifts in excess of this won’t be taxed until you hit the lifetime exclusion cap of $12,060,000 (although you will still need to file a gift tax return).
Want to learn more about giving meaningful gifts? Check out our complete guide to gifting.
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.