Taxpayers can transfer substantial amounts free of gift taxes to their children or other donee each year per person through the proper use of the annual gift exclusion. The current year exclusion amount is $16,000 and rises to $17,000 in 2023.
Even gifts that are not covered by the annual exclusion, that may be considered taxable, could be allowed a credit against the tax liability based on the donor’s current year exclusion ($12,060,000 for 2022 and rises to $12,920,000 in 2023). However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.
The annual exclusion covers gifts an individual makes to each donee each year. For example, a taxpayer with three children can transfer a total of $48,000 to his or her children every year free of federal gift taxes. If the only gifts made during a year are excludable, there is no need to file a federal gift tax return. If an annual gift to a donee exceeds $16,000, the exclusion covers the first $16,000 and only the excess is taxable. Even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below). (Note, this discussion is not relevant to gifts made by a donor to his or her spouse because these gifts are gift tax-free under separate marital deduction rules.)
Gift-splitting by married taxpayers: If the donor of the gift is married, gifts to each donee made during a year can be treated as split between the spouses, even if the cash or gift property is given to a donee by only one of them. By gift-splitting, $32,000 a year can be transferred to each donee by a married couple. For example, assuming the taxpayer from above is married with three children, they can gift $32,000 to each child for a total of $64,000. If the children are married, their spouses each can be gifted up to the exclusion as well.
Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return(s) each spouse files. IRS prefers that both spouses indicate their consent on each return filed. Because more than $16,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $32,000 exclusion covers total gifts.
The “present interest” requirement: For a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” This means the donee’s enjoyment of the gift cannot be postponed into the future. For example, if you put cash into a trust and provide that donee A is to receive the income from it while they are alive and donee B is to receive the principal at A’s death, B’s interest is a “future interest.” Special valuation tables are consulted to determine the value of the separate interests you set up for each donee. The gift of the income interest qualifies for the annual exclusion because enjoyment of it is not deferred, so the first $16,000 of its total value will not be taxed. However, the gift of the other interest (called a “remainder” interest) is a taxable gift in its entirety.
Exception to present interest rule: If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he or she reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available, and the present interest rule will not apply. These arrangements are called Code Sec. 2503(c) trusts because of the section in the Internal Revenue Code that permits parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.
Please contact our office regarding the preparation of gift tax return (or returns), if more than $16,000 is being given to a single donee in any year.
As always, we encourage you to contact us with any questions you may have.