We’ve officially entered perhaps the highest spending month of the year!
In fact, Christmas celebrations are expected to cost 17% more this year when compared to 2019 (you can thank COVID-19 and inflation for that lump of coal).
Despite being “the happiest time of the year,” gifters should beware of another type of Grinch, the gift tax.
Giving to others doesn’t have to result in paying extra for your generosity, but how do you give without needing to pay extra to the IRS?
Let’s go over what the gift tax is all about.
The Basics of the Gift Tax
You know the sentiment of giving without expecting anything in return? That’s the gift tax in a nutshell.
The IRS imposes a gift tax on the transfer of money, property, or assets from one person to another while not receiving a thing. But fear not, the IRS isn’t likely to audit your holiday shopping list.
Many people won’t have to worry about being taxed on regular gifts throughout the year due to the annual gift tax exclusion, rising from $15,000 in 2021 to $16,000 in 2022. If you’re married filing jointly, that figure doubles to $30,000 and $32,000, respectively.
The good news?
The gift tax operates individually, so you can give $15,000 this year to your child, co-worker, best friend, etc., without the government batting an eye. But once a gift exceeds that limit for one person, you’ll need to start thinking about taxes.
If you have the desire and means to give over the annual limit, you can alternatively start chipping away at your lifetime exclusion. The lifetime limit has grown from $11.7 million in 2021 to a historic high of $12.06 million in 2022. Exceed those limits, and you’re looking at paying anywhere from 18% to 40% depending on the value of your estate.
But these numbers are far from set in stone; economic impacts, leadership, and more can cause these limits to fluctuate over time.
You may be exempt from the gift tax in the following ways:
- Gifting below the annual gift tax exclusion for individuals or spouses
- Utilizing the lifetime exclusion limit
- Giving between spouses
- Contributing to medical or education institutions
- Donating to charitable and political organizations
Now that we’ve covered the general rules and regulations of the gift tax, here are five creative ways to avoid paying it altogether.
1. Pay for Medical & Tuition Costs Directly
Hospital and medical fees are often significant burdens on families during the holiday season. Whether you want to contribute to your daughter’s child delivery, your parent’s surgery bill, or your friend’s treatment, you can avoid the gift tax by paying the medical facility directly.
If you have children or grandchildren in higher education, contributing to their tuition is one of the most valuable gifts you can give. However, writing them a hefty check could be subject to significant gift taxes.
If you’re planning to give over $16,000 to an individual (with either a lump sum or cumulative contributions) in 2022, you can instead pay their tuition directly through the university to keep the gift tax at bay.
2. Spread Gifts Over Multiple Years or Tap Into the Lifetime Gift Amount
If you’re reading this now intending to cover your child’s wedding expenses, gifting your grandchild a new car, or providing your parents with their dream home, don’t worry!
You can either split sums over a few years, so you aren’t giving more than the annual limit or, if you can’t help exceeding it, you may also start tapping into your lifetime limit instead.
Keep in mind that the lifetime exemption never resets and only counts per donor, not per recipient.
You can start utilizing your overall lifetime limit by filing IRS Form 709 every year along with your other usual tax return paperwork. This form acts as a record of any taxable gifts you have given to a recipient, subtracting the amount that went over the annual limit from the lifetime limit.
For example, if you’re single and gift your grandchild a vehicle in the new year that costs you $30,000, the $14,000 that went over the $16,000 annual limit will then be subtracted from 2022’s lifetime limit of $12.06 million. Clear as mud, right?
Don’t forget to note that lifetime exclusion limits could change. While it may be at a historical high in 2022, it could decrease to a fraction of what it was in the upcoming years. If you plan to give away an estate or property, work with your financial team to create the best plan for you.
3. Create A Trust
Trusts aren’t just lucrative estate planning vehicles; they can also help you structure giving and transferring wealth in a strategic and tax-friendly way.
A trust is a legal arrangement between three parties (the grantor, beneficiary, and trustee) that guarantees a grantor’s assets will go to a beneficiary of their choice.
To avoid the gift tax, you can consider a Crummey Trust. A Crummey Trust is a tool that helps maximize lifetime gifts by enabling families to consistently give assets into a protected fund for the beneficiary’s benefit, so long as the gift falls below the annual exclusion. Another advantage of this vehicle is that the grantor can establish specific limitations and rules around when and why a recipient can access the money.
A Crummey Trust is far from your only option. Trusts can be excellent tools to help you transfer wealth, and there are several different types to consider based on your beneficiaries, goals, and estate’s value.
Can a trust benefit your estate plan? Review your options with your trusted financial team.
4. Look at Your 529 Plan
Considering modern tuition costs, making a significant contribution towards your child or grandchild’s 529 Plan is bound to happen.
Luckily, you can prepay a lump sum of up to five years worth of annual gift tax exclusions. So, you can stash away $75,000 in 2021, that figure jumps to $80,000 in 2022 in one lump sum. If you’re married filing jointly, go ahead and double those amounts to $150,000 and $160,000 respectively.
Keep in mind that your IRS Form 709 must reflect your option to take the five-year election.
Here’s a key caveat: Since you’ve paid in advance, you won’t be able to make any additional contributions or gift any other resources within those five years. Filing Form 709 will document each gift beyond the tuition contribution and will start subtracting from your lifetime limit.
This option could be good for families with kids about to go to school or later on in the college saving journey.
5. Donate to Charity
Consider contributing to someone else’s life by donating to a charity or organization this holiday season. Due to the pandemic, there are now more people than ever whose lives would be more accessible if given needed resources.
By donating even just a fraction of what you’d normally spend on presents under the tree, you’d be teaching a valuable lesson to the younger members of your family, providing resources to those who need it most, and influencing your family and friends to give too.
The gift tax can’t touch contributions made to charitable organizations, so the sky’s the limit when considering what sum to donate. If charitable giving sounds like a tradition you’d like to establish in your family this new year, reference this helpful blog post on our website.
‘Tis the Season to Give
Giving is one of the many ways to celebrate the season. Let us help guide your spending and make your money work for you without limiting your holiday shopping for your family and friends.
Talk to Chladek Wealth if you plan to give a large gift to help you determine the best strategies to avoid the gift tax. Schedule an appointment to organize your holiday giving arrangements today.
The contents of this article are for general information and educational purposes and should not be construed as specific investment, financial planning, tax, accounting, or legal advice. Please consult with a professional advisor before taking any action based on the contents of this article. All investment and financial planning strategies involve risk of loss that you should be prepared to bear. We cannot guarantee any investment performance whatsoever, and past performance is not indicative of potential future returns.