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There are actually three types of gifts you can make that may effect your taxes.
The Annual Gift while you are living
Each taxpayer has an “annual gift exclusion” that allows them to give $14,000 per year to any number of individuals, without paying any gift tax. That means parents can collectively give each of their children $28,000 each per year ($14,000 per taxpayer). So long as you stay under this amount each year there are no IRS gift reporting requirements. This used to be a very important tax avoidance strategy when the inheritance tax exclusion was much lower than it is in 2021. However, as you will learn below, the current inheritance tax exemption is very generous, making the necessity of annual gifting a non-issue for most families.
What if I want to give more than $15,000 to a person in a given year?
Gifts above $15,000 per year begin to apply to your “lifetime exclusion”. In 2021 the lifetime exclusion is $11,700,000 per taxpayer. So if you make a gift above $15,000, you must report to the IRS using a gift tax return when you made the gift and the amount of the gift so it will be applied towards your lifetime exclusion.
The Inheritance Tax Exemption and the Unlimited Marital Deduction
A married couple has a combined federal inheritance tax exemption of $23,400,000 ($11,700,000 each spouse in 2021). However, there is an IRS rule called the Unlimited Marital Deduction. This rule allows the surviving spouse to pay no inheritance tax until he or she finally passes away, no matter how large the couples estate. While this seems like a simple estate planning strategy, it may cause the estate to pay more inheritance taxes than necessary when the final spouse passes on. Most trusts drafted today by competent estate planning attorneys help the client preserve the maximum inheritance tax available to each taxpayer.
The most common form of tax free gift remains the charitable gift. Although many rules apply to gifts to non-profit “charitable” organizations and causes, the general rule is that the gift is not part of the total inheritance tax exemption, thus exempting the gift from inheritance tax if it would otherwise apply. Always check with your tax advisor when planning to make a substantial charitable contribution.
Confused? You needn’t be. A knowledgeable estate planning attorney can explain the rules and guide you to an informed decision.