Basics of the Federal Gift Tax
You may know that estate tax laws apply to transfers of your assets at death. However, you may not be aware of the fact that gift tax laws apply to gifts of money or property you make during your lifetime. Although Indiana does not have a tax on lifetime gifts, there are some states that impose gift taxes. There is also a gift tax that applies at the federal level.
The federal gift tax is a tax on the transfer of property by one individual to another where the transferor receives either nothing or less than full value in return for what was given away. Therefore, whether you intend to do so or not, you are making a gift when you give away property or when you give away the use of, or income from, property without receiving something of at least equal value in return. You are also making a gift if you sell something for less than its full value. The general rule is that any gift is a taxable gift unless (or to the extent) it falls within one of the following specific exceptions:
Gifts each calendar year that are not more than the annual exclusion amount for that year. In 2022, the annual exclusion allows you to give up to $16,000 to as many people as you wish during the year (generally, married couples can together give up to $32,000 per donee through “gift-splitting”).
Tuition or medical expenses in unlimited amounts that you pay on someone else’s behalf directly to the educational or medical institution.
Gifts to your spouse in unlimited amounts.
Gifts in unlimited amounts to certain political organizations for their use.
Gifts to qualified charities in unlimited amounts.
Of course, each of these exceptions has its own set of rules that must be complied with for the gift to be excluded from the gift tax. To the extent that you make a gift that does not fall within one of these exceptions, the gift must be reported on a federal gift tax return, which is required to be filed on or before April 15th of the year following the year in which you made the gift. Currently, the federal gift tax rate is a hefty 40%, and the payment of the federal gift tax is your responsibility as the donor (the one making the gift). However, because the federal gift and estate taxes are administered under a unified system, you will not actually pay any federal gift tax until the sum of your lifetime taxable gifts exceeds the then applicable federal estate tax exemption amount (which is $12,060,000 in 2022). Instead, the value of your taxable gifts simply reduces the value of assets that you may transfer free of federal estate tax at your death. Once your total lifetime taxable gifts exceed the federal estate tax exemption amount, your taxable gifts in excess of the estate tax exemption will be subject to gift tax (currently, at the rate of 40%).
Note that this description of the federal gift tax is a simplified version and there are nuances that further complicate gift-making. When you are considering making a gift, it is important that you consult with your legal and tax advisors who can help you consider and better understand the complexities and potential unintended consequences of gifting and the federal gift tax.