Many people don’t realize that they can’t give money or other assets to other people beyond certain limits without a tax consequence. Federal gift tax rules may apply when you make gifts to anyone other than your spouse. However, this type of gift seldom leads to any tax payments.
In this post, we will discuss the annual gift tax exclusion, how the gift tax and estate tax work together, and the generation-skipping tax (GST) as it applies to gifts made to irrevocable trusts.
What is the Gift Tax?
The gift tax is a tax on wealth transfers to individuals and trusts beyond the annual exclusion. This tax is a separate tax from income taxes.
What Is the Annual Gift Tax Exclusion?
For 2024, you can give gifts of up to $18,000 per recipient without any tax consequences. This means you could provide $18,000 each year to each of your children or grandchildren without ever paying any tax or needing to file a gift tax return. This annual exclusion amount is adjusted each year for inflation.
If you exceed $18,000 in gifts to a single person, you are required to file a gift tax return with the IRS for that year.
In addition, a married couple may give $36,000 per year, but if they give it all from the same account at the same time, they need to file a gift tax return to gift-split and allocate their individual exemptions to the gift.
Gifts to others include not only outright gifts of cash but also the transfer of assets (such as stocks, bonds, real estate, or cars), loans without adequate interest rates, and paying for expenses (such as vacations or weddings). This is not an all-encompassing list.
Are Payments of Medical Expenses Considered Gifts?
Payments of medical expenses directly to the facility are not considered a gift. Reimbursing someone for a medical expense is a gift, and if the amount combined with all other gifts during the calendar year exceeds the annual gift tax exclusion, this could trigger a gift tax return to be filed and possibly will result in taxation.
Are Tuition or College Expenses Considered Gifts?
Grandparents, take note! Payments for tuition made directly to the educational institution are not considered a gift. Payments of room and board and other school expenses such as books and computers are gifts to non-dependents, however, and if the amount combined with all other gifts during the calendar year exceeds the annual gift tax exclusion, this will trigger a gift tax return to be filed. It is rare for a taxable gift to result in taxes, but it can happen if your assets at death plus recent gifts exceed the unified federal gift and estate tax exemption (currently over $13 million per person).
Who Pays the Gift Tax?
The donor files a gift tax return when necessary and pays any gift taxes due.
How Do the Gift Tax and Estate Tax Work Together?
Filing a gift tax return does not automatically mean that you pay any gift tax. Any gifts over $18,000 per year simply reduce your lifetime gift and estate tax exemption.
In 2024, this lifetime exemption is $13.61 million. If you pass away with assets valued at over $13.61 million, your estate may owe taxes on the amount exceeding the exemption.
Let’s look at a couple of examples.
Example 1: You pass away with $15 million worth of assets and never gave any gifts over the annual exclusion. This means your estate owes taxes on $1.39 million — the difference between your total assets and the lifetime exemption.
Example 2: You pass away with $13 million worth of assets, but in the year before you died, you gifted your child $1.018 million. Since this amount exceeds the $18,000 annual exclusion by $1 million, your lifetime exemption was reduced by $1 million. Your lifetime exemption is now $12.61 million, and your estate owes taxes on $390,000 at the time of your death.
What About the Generation-Skipping Tax?
The GST is an additional tax that applies when you make gifts to beneficiaries who are two or more generations below you or are more than 37.5 years younger than you, such as your grandchildren or great-grandchildren. This tax is meant to prevent wealthy individuals from avoiding estate taxes by transferring assets directly to younger generations.
Like the gift tax, everyone currently receives a $13.61 million exemption from the GST, as well as a $18,000 per-year per-person exemption. When you are filing a gift tax return, it is essential to consider the GST implications, as the exemptions and rules differ slightly from the gift tax rules.
It is important to realize that the GST is in addition to any gift or estate taxes.
Are Contributions to 529 Plans Considered Gifts?
Contributions to a custodial (often called UTMA) account or a 529 college savings account are considered gifts to the child who either owns the custodial account or is the beneficiary of the 529 account. So any contributions over $18,000 will reduce your lifetime exemption, and you will need to file a gift tax return.
One exception to this rule is the ability to “superfund” a 529 plan. The IRS allows you to contribute a lump sum of up to five times the annual exclusion ($90,000 for 2024) to a 529 plan in a single year. The gift is considered as having been made evenly over five years and does not reduce your lifetime exemption. But if you do contribute the full $90,000 allowed, you cannot make any additional gifts to that child until the five-year period has ended. Additionally, to receive this tax treatment, you must file a gift tax return in the year the gift is made.
Does Changing Beneficiaries on a 529 Plan Result in a Gift?
Gifts to a 529 are considered completed gifts, belonging to the beneficiary. If you change the beneficiary to any family member who is two generations or more below the original beneficiary, the GST may apply. If the original beneficiary is your child, and if the beneficiary is then changed to a great-grandchild, your child would need to file a gift tax return and the amount in excess of the annual exclusion would be subject to the GST.
The lesson is to always open the account in the name of the child, not the parent (the parent still owns the account), to keep the assets compounding gift- and GST-free for as long as possible.
Do Gifts to Trusts Follow the Same Rules?
You might think that you can also make gifts up to $18,000 per person per year into an irrevocable trust where that person is a beneficiary. However, the beneficiary must have a “present interest” for the gift to qualify for the exemption. Specific language must be included in the trust document to meet this rule. Otherwise, the gift will reduce your lifetime exclusion.
Does the GST Apply to Gifts to Irrevocable Trusts?
When you make gifts to irrevocable trusts, the generation-skipping tax may apply if the trust beneficiaries are considered to be more than one generation younger than you. To avoid the tax, the trust must be structured to comply with specific GST rules.
One strategy to avoid the GST is to establish a “dynasty trust” designed to last for multiple generations. With proper planning, assets in a dynasty trust can be transferred to future generations without incurring GSTs. However, this strategy requires careful legal and tax planning to ensure compliance with complex tax rules.
Conclusion
For most people, the gift tax rules will never result in any actual tax being paid. However, it is crucial to be aware of the annual exclusion limits and how gifts to irrevocable trusts may affect the GST due, so you can accurately report any gifts that will reduce your lifetime exemption. By understanding these tax implications, you can make more informed decisions when it comes to gifting and estate planning and pass your wealth down to future generations as efficiently as possible.
If you need help with your estate planning or financial planning in general, please reach out to our team. You can also learn about our team here.
Disclaimer: This is not to be considered investment, tax, or financial advice. Please review your personal situation with your tax and/or financial advisor. Milestone Financial Planning, LLC (Milestone) is a fee-only financial planning firm and registered investment advisor in Bedford, NH. Milestone works with clients on a long-term, ongoing basis. Our fees are based on the assets that we manage and may include an annual financial planning subscription fee. Clients receive financial planning, tax planning, retirement planning, and investment management services and have unlimited access to our advisors. We receive no commissions or referral fees. We put our client’s interests first. If you need assistance with your investments or financial planning, please reach out to one of our fee-only advisors. Advisory services are only offered to clients or prospective clients where Milestone and its representatives are properly licensed or exempt from licensure.