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What Are Gift Tax Returns and Who Needs to File Them?

Sometimes, the name given to certain federal tax laws disguises the full scope of the laws and the impact the laws may have on you individually. For example, the gift tax laws not only apply to formal gifts from one person to another, but they also apply to transfers whenever the donor shifts assets without receiving something of equal value in return.

Essentially, the gift tax laws and reporting requirements affect transfers when the value transferred is greater than certain amounts (often referred to as the annual exclusion amount) or when the donor transfers assets that are subject to restrictions (such as transfers made in a trust).

Additionally, gift tax returns serve to report transfers that are subject to the Generation-Skipping Transfer (“GST”) Tax – which applies to transfers made to or for the benefit of individuals who are more than one generation removed from the donor. The GST Tax is a confusing set of laws that can further complicate your gifting, so if you are considering making significant transfers to or for the benefit of your grandchildren, please consider speaking to an estate planning attorney or financial advisor before taking further steps.

Consider the following before you decide whether the transfer of high-value assets or property is currently right for you.

Current and Future Exclusions

For individuals, the current gift tax annual exclusion is $16,000 per recipient. To be clear, the exemption is not $16,000 per gift, but the cumulative total value transferred from one individual to another within a calendar year. So, if you made gifts of $10,000 to each of your two children, you would not need to report anything on a gift tax return even though your total gifts for the year would be $20,000. However, if you paid rent of $1,500 a month on behalf of a child for an entire year, you would report total gifts of $18,000 to that child.

For married couples, the exclusion doubles to $32,000 for 2022. And, if you and your spouse made gifts to a child and his or her spouse, you can transfer a total of $64,000 in 2022 without the need to file any gift tax return.

Another important exclusion is that transfers of property or other assets between spouses are generally exempt from gift tax reporting so long as you and your spouse are both US citizens. If your spouse is not a US citizen, the marital exclusion is currently $164,000.

While we do not yet know the annual exclusion for 2023 and beyond, the general trend since 2000 has been that the annual exclusion amount increases by $1,000 every three to five years.

Lifetime Exemptions

While you are required to report gifts that exceed your annual exclusion, you may still avoid paying gift taxes to the extent that you have a lifetime gift tax exemption. This lifetime exemption is sometimes referred to as your “unified lifetime exemption” as it not only impacts lifetime transfers made and reported on gift tax returns but also transfers made at death and reported on any federal estate tax return.

In 2022, the current lifetime exemption for individuals is $12.06 million meaning that an individual can transfer significant wealth during their lifetime without triggering any gift tax. Any gifts which exceed the annual exclusion amount will reduce this $12.06 million of lifetime exemption. Each year’s gift tax return keeps track of the lifetime exclusion used up to and through the end of that calendar year.

Much like the annual exclusion, the lifetime exemption amount effectively doubles for married couples to $24.12 million as of 2022. Should you make gifts that exceed these thresholds, the excess is taxed at the federal gift tax rate of 40%.

Even if you do not anticipate exceeding your lifetime exemption, you are required to file gift tax returns for transfers exceeding the annual exclusion amounts in order to report the lifetime exemption used as well as reporting the allocation of your GST exemption (if any).

Statistically, due to the current lifetime exemptions, most Americans will not ever need to worry about paying a gift tax on lifetime transfers much like most Americans will not be subject to federal estate taxes.

Because the federal gift tax and the federal estate tax are intrinsically linked, these lifetime exemptions are scheduled to increase each year through 2025 due to inflation. In 2026, the federal exemption is scheduled to decrease automatically to around half of its current value. Luckily, if you take advantage of the elevated lifetime exemption before the sunset, the federal government is less likely to penalize individuals with any kind of “look back” recalculation on transfers made prior to 2026.

For those whose wealth exceeds the lifetime exemption, bear in mind that your estate will be subject to federal estate taxes to the extent your estate exceeds any remaining lifetime exemption.

Donations Exempt From Gift Tax

Under current federal tax laws, there are four types of “gift” transfers that are not subject to the gift tax. These transfers include payments made to political and civic organizations, payments that qualify for education if made directly to the institution, payments made for another’s medical expenses, and gifts to certain qualifying charitable organizations (so long as the transfer is of a complete, present interest).

The education exclusion applies to payments made directly for an individual’s tuition to the institution. Payments made in reimbursement of tuition or those payments for supplemental material such as textbooks, room and board, and other school supplies do not qualify for this education exclusion.

The medical exclusion applies to payments made directly to providers for an individual’s healthcare or medical treatment – in general, this means diagnosis, cure, mitigation, and treatment. The medical exclusion also applies to payments made to a health insurance provider to provide coverage for the individual. However, if any medical expenses are later reimbursed by health insurance to the individual, a gift would have been made to that individual which would be subject to the annual exclusion and any lifetime exemption.

Additionally, keep in mind that if you are required to file a gift tax return, you are required to report gifts made to charitable organizations on that return, even though it does not generate any gift tax or use any lifetime exemption.

Considerations for Different States

There is no gift tax under Maryland law. Maryland residents are subject to an estate tax of 16% for decedent’s estates which exceed the state exemption and may be subject to an inheritance tax of 10% of the value received if the inheritor is not a direct family member of the decedent. Currently, the Maryland estate tax exemption is $5 million.

Currently, the only state in the US with a gift tax is Connecticut. Connecticut’s gift tax operates similarly to the federal gift tax, although the applicable lifetime exemption is lower.

Where to Find More Help and Information

If you are unsure as to how the federal gift tax may affect you and your family, you can start by contacting a financial advisor or your accountant. A qualified estate planning attorney can also help you determine how gift tax laws may affect your estate plan and advise you on strategies for transferring wealth with an eye to making use of your lifetime exemption.

Federal tax laws are subject to changes resulting from the politics in Washington and the economy as a whole. More information on federal gift taxes can be found on the IRS website.

Before you begin any significant gifting or transfers of assets, we recommend further research and seeking professional advice. At Sessa & Dorsey, we strive to update our clients on any forthcoming changes to federal and state tax laws to ensure their specific estate plans continue to represent their wishes and protect their interests.

At Sessa & Dorsey, we consider the bigger picture at hand and advise our clients on the best estates and trusts for their specific needs and desires. If you have questions, please contact us at (443) 589-5600.

Related blog posts:

3 Benefits of a Donor-Advised Fund as a Charitable Giving Strategy
When to Consider Using a Qualified Charitable Distribution (QCD) to Reduce Taxes
5 Things You Should Do Now to Prepare for Possible Estate Tax Law Changes
Revocable vs. Irrevocable Trusts: Which is Right for Me?
Best Practices for Irrevocable Trusts