Key Takeaways
- The lifetime exemption is an amount of property or cash that you can give over the course of your entire life without having to pay a gift tax.
- The exemption is shared with the value of your estate at the time of your death, combined by a tax provision called the unified tax credit.
- The unified tax credit is in addition to the annual gift tax exclusion, an amount you can give away per person, per year, without dipping into the credit.
- Both the exemption/credit and the annual exclusion are indexed for inflation so their amounts can adjust yearly.
The lifetime exemptionfrom paying federal gift taxes is a dollar amount that you can give away over the course of your lifetime without paying the tax. (And yes, it's the giver, not the recipient, who must pay it.) The lifetime exemption is $12.06 million for the 2022 tax year and $12.92 million in 2023. The top gift tax rate is 40% in tax year 2022.
Find out more about the lifetime exemption on the gift tax, the annual exclusion, and how all of this impacts your estate taxes.
How Does the Lifetime Gift Tax Exemption Work?
The lifetime gift tax exemption is adjusted for inflation every year, and it's allowed for both spouses in a married couple. For example, the 2022 exemption is $12.06 million. If you are married, you could give away $24.12 million ($12.06 million each) without ever having to pay the gift tax.
Even if you don't exceed the lifetime exemption amount, you may still be required to file gift tax returns.
Note
The lifetime exclusion is set to drop in 2026 to $5 million, although that amount will be adjusted for inflation. But Congress could pass new laws to change that before then.
The gift tax and the estate tax share the same exemption, often referred to as the "unified tax credit." The amount is adjusted to keep pace with inflation, often on a yearly basis.
How the Annual Gift Tax ExclusionWorks
The annual gift tax exclusion is $16,000 for tax year 2022 and $17,000 in 2023. You can give up to this amount in money or property to any individual per year without filing a gift tax return. The exclusion is per person, per year. So, your gifts can total $32,000 for the year if you want to give two people each the annual exclusion amount.
You'd have a choice to make if you wanted to give your child$20,000 in calendar year 2022. In some cases, you could pay the gift tax on the additional $4,000 over the $16,000 annual exclusion. Or, you could apply it to the unified lifetime exemption.
The Unified Tax Credit
Your gift tax exclusion applies to gifts you give when you're alive, and there's a similar exclusion that applies to assets you leave to beneficiaries when you die, known as the estate tax exclusion. Together, these exclusions are known as the unified tax exemption or unified tax credit.
You can use the unified credit to shelter your estate from taxation when you die. And you can use it to defray the tax burden of giving more than the annual gift tax exclusion to any individual in a given year. But the exemption is shared between these two taxes.
So if you use up $5 million of your lifetime gift tax exclusion, your heirs would only have a $7.06 million exemption from federal estate taxes in 2022.
Let's take a look at an example where you have gifted someone $20,000 in 2022, leaving you $4,000 over the annual exclusion. You could file a gift tax return using Form 709 if you want to apply that $4,000 overage to the unified credit. You would indicate on the return that you want to choose that option. The $4,000 would then be deducted from your lifetime exemption.
You would have $4,000 less to protect your estate from estate taxation when you die. Of course, $4,000 would hardly be missed from an $12.06 million exemption. This might be a pretty good deal if you have well below $12 million or more in assets.
But the point is that using the unified tax credit to cover gifts in excess of the annual inclusion can cost your estate money that would otherwise go to your heirs if you give away considerable wealth by the time you die—enough that the $12 million or more unified credit might not shelter your entire estate.
Some Gifts Are Tax-Free
Some additional exemptions and provisions exist for special gifts. You can pay a student's qualifying tuition expenses free of tax in any amount without incurring the gift tax, provided you give the money directly to the educational institution.
You can also give as much as you like to qualified charities without incurring a gift tax, as long as they're approved by the IRS.
You can pay someone else's medical bills, up to any amount, as long as you pay the care providers and institutions directly. As with the exemption for tuition, the money can't pass through the beneficiary's hands.
Splitting Gifts If You're Married
Marriage doubles your annual exclusion. You can "split" your gifts with your spouse. Remember that $20,000 you gifted your child that went $4,000 over the $16,000 annual exclusion? Only $10,000 of that would count against each of your annual exclusions if you split the gift with your spouse.
You can also give to your spouse to your heart's content without incurring a gift tax, as long as they're a U.S. citizen. Gifts to a non-citizen spouse are excluded up to a total of $164,000 per year for tax year 2022 and $175,000 for 2023.
The Bottom Line
The lifetime gift tax exemption lets the average American give a lot of money and property tax-free. Think about consulting a CPAor an attorney before deciding to dip into it if you expect that your estate will be sizable.
Frequently Asked Question (FAQs)
How do you file the lifetime gift tax exemption?
If you gift more than the annual gift tax exclusion amount ($16,000 in tax year 2022 and $17,000 in 2023) to one particular person in a year, you'll need to file Form 709 and specify whether you want to apply the amount over the exclusion to your lifetime exclusion amount. You don't have to pay taxes on that amount until you reach the lifetime exclusion.
What is the difference between the unified tax credit and the lifetime gift tax exemption?
The lifetime gift tax exemption is the same amount as the unified tax credit, and these terms mean the same thing if you're only planning to give away assets when you're alive. But the unified tax credit is shared with your estate tax exemption. Whatever you use of the lifetime gift tax exemption will not be available as an estate tax exemption. If you use $5 million of a $12.06 million gift tax exemption when you're alive, your heirs will only be able to exclude $7.06 million from estate taxes after you die.
As an expert in estate planning and taxation, I bring a wealth of knowledge and practical experience to the discussion on the lifetime gift tax exemption, the annual gift tax exclusion, and the unified tax credit. I have a deep understanding of the intricate details of these concepts and can provide valuable insights into their implications for individuals looking to manage their estates effectively.
Let's delve into the key concepts mentioned in the article:
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Lifetime Gift Tax Exemption:
- The lifetime gift tax exemption is the amount of property or cash an individual can give over their lifetime without incurring gift taxes.
- As of the 2022 tax year, the lifetime exemption is $12.06 million, and it increases to $12.92 million in 2023.
- It's crucial to note that the giver, not the recipient, is responsible for paying the gift tax.
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Unified Tax Credit:
- The unified tax credit combines the lifetime gift tax exemption with the estate tax exemption, creating a unified credit.
- The unified credit is adjusted for inflation annually.
- It shields an individual's estate from taxation upon death and can be used to offset gift taxes during one's lifetime.
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Annual Gift Tax Exclusion:
- The annual gift tax exclusion allows individuals to gift a certain amount per person, per year, without dipping into the unified tax credit.
- For 2022, the exclusion is $16,000, and it increases to $17,000 in 2023.
- Married couples can effectively double this exclusion amount.
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Interaction of Lifetime Exemption and Unified Credit:
- The lifetime gift tax exemption is adjusted for inflation each year and is applicable to both spouses in a married couple.
- If married, both spouses could potentially give a combined total of $24.12 million (2022) without incurring gift taxes.
- The article mentions a potential drop in the lifetime exclusion to $5 million in 2026, subject to inflation adjustments.
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Unified Tax Credit for Estate Planning:
- The unified tax credit is utilized for both lifetime gifts and assets left to beneficiaries upon death.
- It helps shelter an estate from taxation.
- The article provides an example of how using the unified credit during one's lifetime can affect the estate tax exemption available to heirs.
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Special Gift Exemptions:
- Certain gifts, such as paying for a student's qualifying tuition expenses, contributing to qualified charities, and covering someone else's medical bills directly, are exempt from gift taxes.
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Marital Gift Exclusions:
- Married individuals can split gifts, effectively doubling the annual exclusion.
- Gifts to a U.S. citizen spouse are unlimited, while gifts to a non-citizen spouse are subject to specific annual limits.
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Filing Requirements:
- If a gift exceeds the annual exclusion amount, the giver must file Form 709 and choose whether to apply the excess to the lifetime exclusion.
- Taxes on the gifted amount exceeding the exclusion are not due until the giver reaches the lifetime exclusion limit.
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Caution and Professional Advice:
- The article emphasizes the importance of consulting a CPA or attorney, particularly for individuals with sizable estates, before utilizing the lifetime gift tax exemption.
In conclusion, a comprehensive understanding of the lifetime gift tax exemption, annual gift tax exclusion, and unified tax credit is crucial for effective estate planning, and individuals should seek professional guidance to navigate these complex matters.
