If you’re preparing to give a large sum of money to a loved one, follow these five simple steps to avoid paying the gift tax.
The Internal Revenue Service keeps track of practically all forms of revenue to collect the correct amount of taxes. It only makes it reasonable that a federal gift tax regulates income received in the form of a gift, as bothersome as it may be. But, if presents are subject to a federal tax, why don’t you have to record your birthday money every year?
Because there are various typical ways to avoid paying the gift tax, this is the case. Many Americans avoid paying them throughout their lives due to the permissible maximum. However, there are some circumstances in which a gift tax may apply. The following guide will explain why a gift tax is necessary and help you through the process of avoiding gift taxes where possible.
5 Ways to Save Money on Gift Taxes
Large gifts may be subject to the federal gift tax, although this is not always the case. Consider the following options for avoiding the gift tax:
Keep the gift tax limit in mind.
Staying below the IRS’s gift tax limit is the most effective approach to avoid paying the tax. So, what is the gift tax exemption amount? The maximum was $15,000 per recipient for the 2020 tax year. However, it usually increases annually in line with inflation.
In other words, you can give $15,000 presents to as many people as you like without paying the gift tax. However, as soon as you give that money to any recipient, you will be subject to tax. (It’s also worth noting an $11.5 million lifetime gift tax exception to consider.)
Knowing what counts toward the $15,000 gift tax exemption is crucial. Gifts can be anything of value, and there is no restriction on money. Assets, investments, and recurring income will be classified as “gifts” by the IRS for no apparent reason. A few situations may allow you to go beyond this limit.
Spread out gifts over several years.
Another strategy to minimize the gift tax is to spread out gifts over several years, avoiding giving more than $15,000 in a single tax year. This method can help you maximize the amount you contribute while also reducing the overall taxes on your present by spreading it out over time.
Let’s say Sarah wants to present a gift of $25,000 to her niece Lisa. Sarah might give Lisa $12,500 for her birthday in 2022 to avoid paying the gift tax. Sarah might then defer the remaining $12,500 until Lisa’s next birthday in 2023, avoiding the gift tax entirely.
Provide a gift to help with medical costs.
Money set aside for medical expenditures is one of the most significant exclusions to the gift tax limit. The gift, however, must be made to the medical facility or insurance company directly. The gift tax limit will still apply to gifts made directly to the recipient to support medical expenses.
For example, if you wanted to pay for your grandparent’s nursing home stay, you’d have to engage directly with the facility’s billing department. This would allow you to pay for medical expenses regularly without worrying about surpassing the annual donation limit.
Provide a gift for education expenses
Educational gifts are donated directly to an institution. Just like medical expenses, they can avoid the gift tax limit. Pay tuition and other qualifying expenditures with money given to the school or university rather than the student. Gifts made to pay the cost of books or supplies, however, do not count toward the education exclusion and instead count against the yearly gift limit.
Leverage marriage when it comes to gift-giving.
Surprisingly, married couples are treated differently regarding the gift tax limit. This means that regardless of whether the couple files joint taxes or not, gifts given or received by one spouse will be classed separately from those given or received by the other spouse.
There are two parameters to this exclusion. First, you and your spouse can give up to $15,000 to each beneficiary in a single year (as long as the gifts are from the joint property). This effectively allows married couples to donate each recipient up to $30,000 per year.
Gifting to married couples is the second option to take advantage of this provision. You can give up to $15,000 per spouse without exceeding the annual gift tax limit. As previously stated, regardless of how many assets are merged or divided, couples are handled differently regarding the yearly limit.
In extreme cases, you and your spouse may give up to $60,000 to another married couple without exceeding the gift tax limit. Let’s say you gift $15,000 to a buddy and another $15,000 to their spouse; in addition to your present, your spouse can contribute up to $15,000 to your friend and their spouse.
Final Thoughts
Compared to other standard taxes like income or sales tax, the gift tax receives far less attention. This is because of the large number of exclusions. Many people can avoid paying gift taxes for the rest of their lives if they follow the advice above.
Consider a tax-forward estate planning strategy if you want to give money or high-value assets to your loved ones. This allows you to provide specific gifts to family and friends while reducing the amount of money you must pay in taxes.
