What does the word ‘gift’ mean to you? For most of us, the term likely conjures up images of a birthday party with wrapped presents or perhaps a birthday card with some cash in it. The term also implies that it is free. Free for you to give and free for the recipient to receive. Unfortunately, Uncle Sam may not feel the same way. In fact, he may feel quite entitled to a portion of that gift plus a significant amount of your estate when it’s doled out to your beneficiaries upon your passing – if you don’t optimize your gift-giving strategy.
With the Tax-Cut and Job Act (TCJA) of 2018 in place, tax-free giftable amounts are currently more generous. However, with TCJA set to expire in 2025 and these amounts nearly halving, it’s essential to know exactly how much you can give away each year and throughout your life. In this article, we’ll look at the nuances of gifting on an annual and lifetime basis and help you figure out how much you can give away before TCJA-era exclusion limits go away.
Understanding the Basics of Gifting
As we hinted in the above section, there are essentially two categories of gifting as they pertain to exclusion limits – annual and lifetime.
Annual Exclusion Limits
Each year, the IRS sets a threshold amount that individuals can gift to others without incurring any federal gift tax, known as the annual exclusion limit. For 2023, this limit is set at $17,000 for individuals, meaning an individual can gift up to this amount to as many recipients as they like during the year, all without attracting any gift tax. Married couples can combine their individual allowances, allowing them to gift up to $34,000 to a single recipient.
There are a few important nuances to keep in mind, though. First of all, unlike some other aspects of investing and taxation, you can’t roll over any unused portions to the following year. Basically, if you don’t use it, you lose it.
Also, when you gift something, that’s it; it’s no longer yours. All ownership, rights, and earned interest associated with the gifted asset must also be transferred. The recipient must have full and unrestricted access to the gift for it to be considered valid under the watchful eyes of the IRS.
Lifetime Gift Tax Exemption Limits
On top of your annual gift limit, you also have an unrelated lifetime limit, which is much larger. For 2023, the individual lifetime exclusion amount stands at a staggering $12.92 million. This means an individual can gift this cumulative amount over their entire lifetime without incurring any federal gift tax.
For married couples, the possibilities are even more significant. When both spouses take advantage of their individual limits, they can jointly gift up to $25.84 million tax-free over their lifetimes. If one spouse passes away before the other without having ‘filled up’ their lifetime exclusion amount, the remaining spouse can take the difference and add it to their own limit.
For instance, if one spouse only used $5 million of their $12.92 million limit before passing away, the surviving spouse could potentially add the remaining $7.92 million to their own lifetime limit. This provision ensures that couples can maximize their gifting potential, even if one spouse didn’t fully utilize their limit.
Estate Tax Exemption vs Lifetime Gift Tax Exemption
The lifetime gift tax exclusion is directly connected to estate taxes upon one’s death. Basically, the gifts you make during your lifetime count against the estate tax exemption amount available when you pass away. For example, suppose an individual gifted $5 million during their lifetime (above and beyond any gifts included in the annual gift exclusion). In that case, they’d only have $7.92 million left of their estate tax exemption. Unfortunately, the government isn’t going to let you benefit from both the estate tax exemption and the lifetime gift tax exemption.
What’s on the Horizon for 2026
As the TCJA-era tax cuts approach their 2026 sunset date, it’s unlikely Congress will extend them – though possible. However, despite the potential for legislative changes, the prudent thing to do is to prepare for the current $12.92 million estate exemption to be reduced to $6.46 million, a change that will dramatically impact estate and gifting strategies.
Once your assets have exceeded the exclusion limit, they will face up to a 40% tax. To put this in perspective, on an estate or gift over $1 million, which would mean a potential tax liability of $400,000! If your net worth doesn’t currently exceed the upcoming 2026 exemption limit, don’t forget that your estate may be growing via dividends, interest, rents, or other passive income sources.
Sheltering Strategies
If your current net worth exceeds the upcoming limit but doesn’t exceed the current limit, it would behoove you to consider reducing your taxable estate to below that level before TCJA expires. Alternatively, if you have a very sizeable estate, you can ‘fill up’ your current lifetime exclusion to get you below the future limit.
Annual Gifting
One of the most straightforward paths is giving away at least up to your annual gift limit. In 2023, the yearly gift limit is $17,000 for individuals or $34,000 for couples.
Let’s imagine you and your spouse have two adult children, each with a spouse, and you donate the maximum amount of $34,000 to each individual. There’s $136,000 successfully transferred away from your estate.
But you also have five grandchildren, so you gift each of them $34,000. In total, you’ve already gifted $306,000 – before cutting into your lifetime exemption. Over three years, you can give away $918,000, potentially pushing you below the future exclusion limit.
If you have other loved ones or friends you’d like to give a gift to, you’re free to do so as well. In fact, there is no limit to how many individual donations you can provide – you could gift 100 people $34,000 if you wanted to, though that probably wouldn’t align with your estate planning goals!
Additionally, you’re not limited to only $34,000 per individual. Just because you exceed that limit doesn’t mean you’ll have to cut the IRS a check for the tax bill. Instead, you can exclude the excess from your lifetime exemption. You’re not limited to cash either. You can just as easily donate an appreciated asset, though the recipient will eventually owe capital gains tax based on its original value.
Alternative Tax-Free Gifting Strategies
Other ways to give gifts to your loved ones and friends without dipping into either your annual or lifetime exemptions include tuition and medical bills. The most important factor is that the funds go directly to the education or medical provider – don’t give your grandkids cash to go pay the bill for you.
With tuition and medical costs being what they are, you’re sure to notice a sizable chunk gone before even delving into exclusions and exemptions!
In Conclusion
The methods we’ve mentioned thus far are only a few potential solutions to diminishing your taxable estate. And since it’s the season of giving, our next article will examine strategies that utilize your feelings of goodwill to reduce your estate as much as possible before TCJA sunrises. After all, wouldn’t you rather contribute to charity than pay Uncle Sam? Especially when you’re facing down the barrel of a 40% estate tax?
If you’d like to explore these and other strategies to reduce your taxable estate before TCJA expires, click the button below!
