Many people don't realize that the federal government charges taxes on gifts. That's because of a provision that allows people to give up to a certain amount each year without any gift tax consequences at all. That annual gift-tax exclusion amount, which remains unchanged at $15,000 for 2021, keeps all but the most lavish gift givers from having to worry about the IRS with their typical holiday practices.
As you'll see below, though, even if you make a gift of more than $15,000, you usually won't have to pay any gift taxes right away. The system governing gift tax is tricky to understand, but below, we'll explain how it works and what you have to do to avoid it, if possible.
The ins and outs of gift taxes
The IRS has a combined system of taxation that governs both lifetime gifts and bequests you make at death. The idea is to make the timing of property transfers to family members or other loved ones less critical to how they get taxed.
However, tax officials didn't want people to have to account for every tiny gift they make. The $15,000 annual exclusion amount was the compromise to prevent all but the largest gifts from triggering any IRS requirements. The $15,000 is indexed to inflation, but low inflation rates have kept the amount unchanged since 2018.
That $15,000 applies per recipient. So someone could give $15,000 each to a dozen different people and still not have any gift-tax liability.
What if you give more than $15,000?
Some other exclusions and exemptions to the gift tax are also available. You therefore might not owe any tax, even if you make bigger gifts than $15,000.
You can make gifts in unlimited amounts for several purposes or to certain individuals. If your spouse is a U.S. citizen, there's no limit to tax-free gifts you can make. Similarly, outright gifts to charity are always unlimited.
In addition, you can make unlimited gifts to educational institutions to cover someone's tuition and qualified educational expenses. Similarly, unlimited gifts to medical facilities or other healthcare professionals are allowed gift-tax free to cover a person's medical expenses. It's important in these two cases, however, that you make the gifts directly to the educational or medical provider. Giving money to the student or patient takes away the exclusion and makes the gift potentially subject to tax.
What if no other exclusion applies?
Finally, even if none of the other provisions allows you to avoid gift tax, you have a lifetime exemption amount that will generally cover you. In 2021, that amount is $11.7 million.
Say you gave $15,000 each to nine friends in 2021 and $100,000 each to your spouse and your child. The nine gifts are all covered by the annual exclusion. For your spouse, the spousal exemption covers the entire amount. Only the child's gift is subject to tax, with the first $15,000 tax-free and the remaining $85,000 uncovered.
However, you're allowed to apply the $85,000 against your $11.7 million lifetime exemption amount. That would leave you $11,615,000 to use for future gifts or as your estate tax exemption at death.
The catch here, though, is that you have to file a gift-tax return on IRS Form 709 in order to claim the lifetime-exemption amount. With gifts subject to the annual, marital, charitable, educational, or medical exemptions, filing is rarely necessary.
Go ahead -- make your gifts
Once you hear about the gift tax, it can be easy to think that it'll be a nightmare. However, with so many exclusions, very few people have to deal with gift-tax liability at any point in their lifetime.