Understanding the gift tax

Key takeaways about the gift tax

• The gift tax is not really a tax on gifts. It is a tax that makes it impossible to circumvent estate taxes by gifting all of one’s assets.

• Gifts under a certain annual threshold ($15K in 2021) to any given person are not taxed.

• Any gift to a given person in a given year over the threshold counts towards the giver's lifetime limit.

• Amounts over the limit are added into the taxable estate even though the person no longer owned them.

You or a member of your family might have received gifts from your loved one before they passed away. In fact, they may have gifted you assets from their estate as a way to better plan for your future and handle any tax responsibilities after they died. While it may feel challenging to delve into these issues while you are still grieving, this is part of how your loved one hoped to take care of you after they were gone. And it is important to understand the impact that receiving gifts can have on estate taxes.

What is the gift tax?

The United States Gift Tax refers to a federal tax on any transfer of money or property to another individual. These transfers are not transactional; they are considered gifts if you do not get anything in return. 

As a rule, the following types of gifts are not taxable: 

• Tuition or medical expenses that you pay directly to the educational or medical provider for someone else

• Gifts to a spouse who is a United States citizen

• Gifts to charities or political organizations

Any gift will be tax-free if it does not exceed your gifting limits.

Gift tax limits for individuals

As of 2021, the gift tax only comes into play for the giver when the amounts gifted to any individual over $15,000 in a given year add up to a lifetime limit of $11.7 million. Your loved one may therefore have given you and any other beneficiaries each up to $15,000 per year in the years preceding their death, tax-free. And, anything over this amount would only have been taxed after their lifetime limit was reached. (As we will see below, if your loved one was married, they may actually have given you $30,000 tax-free on behalf of them both, a practice referred to as gift splitting.)

This $15,000 does not have to be exclusively in the form of cash. For example, you could receive $5,000 cash and $10,000 in stocks. Or $15,000 worth of land or any other type of asset.

The gift tax is designed to make sure no one entirely bypasses estate taxes through gifting most of their assets to their heirs during their lifetime. Therefore it is the giver, not the receiver, of a gift that is primarily responsible for paying the tax.

The gifting limit allows for gifts of reasonable size to be given, while making it possible to monitor large gifts. 

If your loved one gave you more than $15,000 in assets or cash in a year, they needed to file a gift tax return, using IRS Form 709, to declare the gift. This effectively allows the IRS to track how much cash or assets one has gifted throughout one’s lifetime. In 2021, individuals get an $11.7 million lifetime exclusion.

In other words, the $15,000 per year is a measure of whether any given gift is counted toward this threshold. One could give $14,000 each per year to several people without it ever counting toward the lifetime limit. Only amounts exceeding the annual exclusion count toward the limit; any annual gift to a single person that exceeds $15,000 will be added to the calculation.

So, if your loved one gifted you $40,000 in a given year (assuming there was no gift splitting), the first $15,000 of that gift is tax-free. The other $25,000 would have been added to the total toward their lifetime exclusion. Once all those amounts over $15,000 totaled $11.7 million, any future gifts they gave over $15,000 would have been subject to the gift tax, which they would have paid each year along with their income taxes.

The gift tax and estate taxes

The exclusion for the gift tax is the same threshold as that of the federal estate tax, and they are added together. In other words, if the value of your loved one’s estate exceeds $11.7 million in 2021, then it will be subject to federal estate tax. But if they gave gifts that were over the yearly limit during their lifetime, the threshold for whether the estate will pay estate taxes will be lowered by the total amount that was over that limit.

Thus, if your loved one gifted you $115,000 every year for 10 years (and gave no other large gifts), they would have gifted a total of $1 million during their lifetime. If they passed away in 2021, their estate would be subject to federal estate taxes not at the threshold of $11.7 million, but rather at $10.7 million, and any amount that was over that $10.7 million would be taxed. 

If someone gave enough gifts during their lifetime that they went over the threshold and were paying gift taxes on all subsequent gifts over $15,000, then after they pass away, their estate begins paying federal estate taxes at the very first dollar, as it is already considered to be over the threshold.

Although 12 states have their own state estate tax, only a few have their own state-level exclusion limit for gifts.

Gift tax limits for couples

If your loved one was married, the couple could have gifted twice as much from any shared assets they had without going over the gift tax limit, or up to $30,000 per person per year. The same applies to a couple’s lifetime deduction. In 2021, for example, the lifetime gift deduction for a married couple is $23.4 million.

Giving to a minor

If your loved one left significant assets or property to a minor, they most likely set up a plan identifying who will be in charge of these assets until they are of age. To do so, they might have opened irrevocable children’s trusts or a custodianship authorized by state law, either of which may not be considered in the same taxable category as a gift. 

Your responsibilities as a beneficiary

Assets you receive as a gift (or as inheritance) are not considered income and are not subject to federal income taxes. Keep in mind that if these assets produce income down the line, you will need to pay taxes on that income when the time comes. This may include dividends or interest on any money or securities, or rent that you earn from gifted property.

Moreover, if your loved one gave you assets that appreciate in value, you will need to pay capital gains tax if you ever sell them, based on how much the value of the asset increased from the moment you received the gift until its sale.

Consider speaking with an accountant or a lawyer for advice on how to best prepare yourself for receiving gifts that could produce income down the line. 

Understanding inheritance tax

You may receive a gift as a bequest in your loved one’s will or inherit part of their estate. While this kind of gift may not be subject to an estate tax at the federal or state level, you may owe another type of tax on it called the inheritance tax, depending on where your loved one lived and your relationship to them. 

Only people receiving money from estates based in Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have to pay inheritance tax. What you pay in inheritance tax varies by state law, which will take into account the size of the inheritance, your relationship to the person who passed away, and in some cases, the size of their total estate.

In Maryland, the estate is subject to estate tax, and the estate’s beneficiaries are also subject to an inheritance tax. In other words, Maryland residents have to pay taxes on both sides of the mirror. 

Spouses are never subject to inheritance taxes; children are typically exempt as well, but this is not always the case. Speak with a lawyer or accountant to determine whether the state in question allows direct relatives to bypass the inheritance tax. 

Understanding how a gift your loved one gave you functions on a tax level can help you determine whether you or your loved one’s estate will incur significant taxes. If you are the executor of the estate or a beneficiary, get in touch with an accountant to go over the situation, determine whether your loved one exceeded their limit, and figure out what that means for the estate and any bequests.

You may be eligible for free bereavement support. Empathy can help with everything from funeral planning to estate administration, with step-by-step guidance and real-time expert support. Many people get free premium access to Empathy as a benefit with their life insurance claim. We partner with New York Life, Guardian Life Insurance Company, Bestow, Lemonade, and other leading carriers. When you make your life insurance claim, talk to your representative about whether Empathy is a benefit they offer.