What is the Gift Tax and How Does it Work?

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November 22, 2021

Last week, I provided a brief overview of the gift tax in a vlog.  You can view the vlog here.  In this blog post, I’ll expand on basic gift tax concepts, just in time to make your holiday gifts.

What is the gift tax?  Basically, the gift tax is a tax imposed on the gratuitous transfer of property during your lifetime.

Wisconsin does not impose gift tax, but some other states impose gift taxes and other related taxes, like inheritance taxes.  Gift taxes are imposed on the donor of a gift, whereas inheritance taxes are imposed on the recipient of a gift.  Therefore, if you are a Wisconsin resident, you do not need to worry about state gift taxes because Wisconsin does not impose gift tax; however, if you make a gift to an individual who is a resident of a state that imposes inheritance taxes, the recipient may be subject to inheritance tax on your gift.

The federal government imposes a gift tax.  Here’s how it works.  Each year, you can make gifts of a certain amount per person to as many different individuals as you want.  These gifts are called “annual exclusion gifts,” and they are not subject to gift tax.  In 2021, the annual exclusion gift amount is $15,000 per person.  The amount is scheduled to increase to $16,000 per person in 2022.

If you make gifts that exceed the annual exclusion gift amount, it’s possible your gifts still may not be subject to gift tax.  Over the course of your lifetime, you can transfer a certain amount of assets without paying any gift tax.  This amount is called the “gift tax exemption amount.”  In 2021, the gift tax exemption amount is $11,700,000. The amount is scheduled to increase to $12,060,000 in 2022.

If your lifetime gifts exceed the annual exclusion gift amount and you have depleted your gift tax exemption amount, your gifts will be subject to a 40% gift tax on every dollar over those amounts.

Let’s use an example to illustrate the gift tax concepts described in this blog post:

  • In 2021, Peter makes a gift to Paul in the amount of $15,000, and he makes a gift in the amount of $10,000 to Mary. Both gifts are not subject to gift tax because they qualify as annual exclusion gifts.  Peter also makes a gift to a trust for the benefit of John in the amount of $11,700,000.  Assuming Peter has not made any prior taxable gifts, this gift is shielded from the gift tax by Peter’s gift tax exemption.  At the end of 2021, Peter has used his entire gift tax exemption, and he cannot make any gifts that do not qualify as annual exclusion gifts unless he is willing to pay a 40% gift tax.
  • In 2022, the gift tax exemption amount increases to $12,060,000, so Peter has $360,000 remaining gift tax exemption that he may use without paying any gift tax. Peter makes gifts in the amount of $10,000 to each of Paul and Mary.  These gifts are not subject to gift tax because they qualify as annual exclusion gifts.  Peter also makes a gift to Jane in the amount of $500,000.  A portion of this gift – $16,000 – qualifies as an annual exclusion gift, but the remaining $484,000 is a taxable gift.  Since Peter’s remaining gift tax exemption amount is $360,000, he will pay gift tax equal to 40% of $124,000, which is $49,600.

Please keep in mind this explanation of the gift tax is very simplified, and there may be nuances to the gift tax laws that apply to you.  If you have questions regarding the gift tax, please feel free to contact any attorney on Ruder Ware’s Estate Planning Team.

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