“You can’t take it with you.” “It’s better to give than receive.”
There are many clichés about generosity, but it turns out your well-being and your financial plan may benefit if you share your wealth with your loved ones now rather than passing it on through your estate.
One way you can do so with no adverse tax consequences is through something called the annual gift tax exclusion.
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What Is the Annual Exclusion?
The annual exclusion is the amount of money one person may transfer to another each year without incurring a gift tax. In 2022, the amount is $16,000 per gift – in other words, this year you can give up to $16,000 to as many people as you want without you or the recipient(s) owing taxes.
If you are married, your spouse can give the same amount. A married couple could potentially give a child, grandchild, or friend up to $32,000 this year and neither the giver nor the recipient would owe taxes on the amount.
Other Ways to Give Tax-Free Gifts
Even though there’s an annual exclusion limit on cash gifts to individuals, there’s no limit on the amount of gifts for qualified medical or educational purposes. The gifts can be made on behalf of any individual, regardless of their relationship to you.
The catch is that the amounts must be paid directly to the educational institution or medical provider and can’t be paid to an individual as a “reimbursement” for expenses.
How Can the Exclusion Help You?
Gifting while you are alive reduces the size of your estate. Once you’ve exhausted the annual exclusion amount and the tax-free medical/educational gifts, any further gifts you make go against your lifetime estate and gift tax exemption amount.
The current federal estate tax exemption is $12.06 million for individuals, $24.12 million for a married couple. That sounds like a huge sum, and it’s true that only a small percentage of Americans die with an estate valued this high.
However, the exemption amount is expected to drop to $5 million (plus an adjustment for inflation) in 2026 when the current tax laws sunset. And there are proposals in Congress to drop it even further. If an estate is valued above the exclusion, much of the estate’s value is taxed at a steep 40% rate.
And even if your estate isn’t large enough to trigger the federal tax, there are 12 states and the District of Columbia that impose their own estate or inheritance tax, and some states like Massachusetts and Oregon have an exemption of only $1 million.
Tax planning is an important aspect of estate planning. It’s best to seek the advice of a tax professional when it comes to creating a comprehensive estate plan.