The gift tax is a federal transfer tax similar to the estate tax, but dealing with gifts you give to someone during your lifetime, rather than at your passing. The tax is also charged to the giver, and such gifts are not income taxable to the recipient(s).
The federal gift tax currently follows the same rate and bracket structure as the federal estate tax, topping out at 40% for any giving beyond $1 million in any one year.
There is an escape valve for the gift tax: the “annual exclusion amount.” This is the amount you’re allowed to give to any individual recipient in any given year without filing a gift tax form (IRS Form 709), and as of this writing, stands at $19,000 per recipient per year.
Even if your gift to someone totals more than the annual exclusion amount, rather than paying the tax, the amount you would have owed simply reduces the amount of “lifetime exclusion amount” you have available to you in the year you eventually pass away.
It’s important to consult with an attorney or tax accountant competent in this subject before you start substantial giving during your life in order to avoid unfortunate surprises.
If you are weighing between giving substantial lifetime gifts or waiting until you pass away so that the gift goes out as an inheritance, there are two additional topics you need to consider and explore:
- The income tax “step-up in basis,” and how it’s preserved or lost, and
- The fact that the estate tax is “tax inclusive,” meaning that the tax comes out of the inheritance given, versus the gift tax, which is “tax exclusive,” meaning that the giver pays the transfer tax owing as a separate payment, which actually can sharply reduce the transfer tax burden to get a set dollar amount into little Jimmy’s hands.
One of the two approaches will leave you with a lower net tax owed, so structure wisely.