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All About Gift Tax: Do I have to Pay Tax on Gifts From Parents?

All About Gift Tax: Do I have to Pay Tax on Gifts From Parents?

Don't worry about gift tax if you recently received a large gift from your mother and/or father. The IRS generally holds the donor liable for taxes. And if the person doesn't donate a small fortune, they won't have to pay gift tax either.

But if your parents are magnanimous, you might want to know how the IRS views the transfer of money. This article will help you understand everything about the gift tax, but since the rules for calculating gift tax can be complicated, your parents should seek financial advice if their gift may result in a tax bill.

For the 2021 tax year, a person can donate up to $15,000 per person without notifying old Uncle Sam. In 2022, this threshold will increase to $16,000. But even if your parents exceed the annual exclusion threshold, they may only need to submit a few documents. Usually, your parents won't owe an out-of-pocket tax payment unless the gifts in the year exceed the lifetime gift tax exclusion threshold, which is $12.06 million for the first fiscal year of 2022 ($11.7M in 2021).


What is the gift tax?

The IRS can impose a gift tax on someone who transfers money or property to another person without receiving anything in return of at least equal value. However, this action is quantity dependent. The IRS virtually ignores gifts that do not violate the annual gift tax exclusion.

For 2022 fiscal year, the annual gift tax exclusion is $16,000 ($32,000 for joint filers). This is an increase of $15,000 in 2021 ($30,000 for joint filers).

That means your parents could give you and anyone else $16,000 in 2022 tax-free. But suppose they give you $20,000 after, say, your wedding. At this point, they've made a taxable donation. But that doesn't necessarily mean they have to write a check to the IRS that year for a gift. However, they must file a tax return and complete IRS Form 709.

The government requires you to keep track of your parents' tax-free life gifts. A lot of people here get confused. But the rules are quite simple. Let's analyze it.


How does the lifetime gift tax exemption work?

For the 2021 tax year (which you will pay this year, 2022), the lifetime gift tax exemption was $11.7 million for individuals and $23.4 million for couples filing together.

You can consider the annual gift tax exclusion as an addition to the lifetime gift tax exclusion. So let's say your father gave you a total of $25,000 in cash in 2021. He needs to file IRS Form 709 to file the gift because he used the $15,000 annual exclusion for the year. But he probably won't have to pay taxes for this gift. The surplus amount ($25,000 - $15,000 = $10,000) reduces the value of the lifetime gift tax exclusion.

This translates to $11.7m - $10,000 = $11.6m. So he can still give gifts and only worry about additional documents. He is free unless he intends to give beyond the lifetime tax exclusion limit.


What is the 2022 gift tax exclusion?

The Internal Revenue recently announced that the annual gift tax exemption for the fiscal year 2022 would increase to $16,000 for single filers and $32,000 for couples filing together. Excluding the lifetime tax on donations also increases to $12.06 million ($24.12 million for couples filing jointly).

However, it is vital to note that the tax exclusion of lifetime gifts has not always been so high. It has increased significantly since the Tax Cuts and Jobs Act (TCJA). Often referred to as Trump's budget plan, these tax cuts will expire by 2025. However, some lawmakers are working to make them permanent. Nonetheless, political changes could affect the provisions of this important tax reform by then. Therefore, it is important to seek and enlist the help of a financial adviser or gift tax specialist.


What doesn't count as gift tax?

The IRS never taxes certain transfers of money or property, regardless of the amount. You can avoid gift tax by donating to:

  • Spouse

  • Political organizations

  • Medical and Tuition expenses on behalf of someone else

When paying someone's medical expenses or bills, it's best to send those payments directly to the institution to avoid problems with the IRS. So if you have a school account and your parents want to cover it, let them send the money to the school. If they send it to you first, they may have to complete additional paperwork. They can also reduce the lifetime gift tax exclusion, which they can easily avoid.


Who pays the gift tax?

If a gift generates an actual tax bill, the individual responsible for payment would be the donor. The IRS may impose a gift tax on the recipient if the donor chooses not to pay it in rare cases.

However, there are several ways for the wealthy to avoid gift tax. This includes careful planning of real estate strategies, using the right trust, and using exclusions of giving money to students. This can be especially useful if your parents invest in a 529 college savings plan for you.


How much is the Gift Tax?

If your parents owe gift tax to the IRS, the rate typically ranges from 18% to 40%. However, the IRS sets specific rules and allows certain exceptions when it comes to gift taxes and handling them. Your parents can understand how this affects their specific situation by talking to a tax expert or reviewing the instructions on IRS Form 709.


How to avoid gift tax?

If your parents are investing in an educational 529 plan to fund your college tuition, they can take advantage of these savings vehicles' unique gift tax exemptions.

As long as they make special elections, they can make a one-time contribution to a 529 plan up to five times more than the annual gift tax exclusion and avoid gift tax. This limit is $80,000 ($160,000 if married with a joint return) for the 2022 tax year. The special election implies that your parents are asking Uncle Sam to treat this contribution as if they had made it evenly throughout a five years period.

So let's say your single parent contributes $80,000 to your 529 plan in 2022. This triggers gift tax. But since it was made for a 529 plan, the IRS can treat it as $16,000 in five years. Therefore, your parent avoids violating the annual gift tax exemption. As a result, the plan contribution of $80,000 to 529 will not reduce the lifetime gift tax exclusion. The one condition is that they do not contribute to the plan for the next five years.

They can request it on a federal tax return.

However, if your parent dies during these five years, the IRS considers the remaining rates part of the parent's gross federal assets for tax purposes.

So suppose your parents chose the special five-year rule but died in the second year. The first two installments of the total contribution of $80,000 ($16,000 x 2 = $32,000) will not count towards your parents' estate, however the remainder ($48,000) will. Additionally, some states have their own private property tax rules.

If your parents need help with gift tax relief for 529 plans, Abundant Wealth Planning, LLC. can help.


Bottom Line

You probably won't have to pay taxes for a gift your parents give you. Your parents may have to file a tax return depending on the amount. If they give you or anyone more than $32,000 in 2022 ($16,000 per parent), they will be required to file some documentation.


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