Receiving a cash gift or inheritance can be a welcome financial boost. You might use the money to pay down debt, build your savings, invest for the future, or cover a major expense. Whatever your plans, it's smart to understand the tax rules before the money changes hands.
The good news is that most people who receive a gift or inheritance won't owe federal income tax on it. However, gift and estate tax rules can affect the person giving the gift or the estate distributing the inheritance.
Who Pays the Gift Tax?
One of the most common misconceptions about gift taxes is that the recipient has to pay them. In most cases, that's not true.
If you receive a monetary gift, you generally do not owe federal income tax on the amount received. The responsibility for gift tax reporting, when required, falls on the person making the gift.
An individual can give up to $19,000 per recipient per year without needing to file a federal gift tax return. If you give more than $19,000 to a single person during the year, you may need to report the gift to the IRS. However, reporting a gift does not automatically mean you'll owe gift tax.
Married couples can often take advantage of a strategy called "gift splitting." If both spouses agree, they may effectively combine their annual exclusions and give up to $38,000 to a single recipient without reducing their lifetime exemption.
Understanding the Lifetime Gift and Estate Tax Exemption
Many people assume that gifts above the annual exclusion are immediately taxable. In reality, most taxpayers never pay federal gift tax because of the lifetime gift and estate tax exemption.
The federal lifetime exemption is $15 million per individual. This amount applies to both lifetime taxable gifts and assets transferred through an estate after death.
Here's how it works:
- Gifts up to the annual exclusion amount generally require no reporting.
- Gifts above the annual exclusion may need to be reported on a gift tax return.
- The amount exceeding the annual exclusion typically reduces your lifetime exemption.
- Gift tax generally isn't owed until your cumulative taxable gifts exceed your available lifetime exemption.
As a result, very few taxpayers ever pay federal gift tax.
How Gift Taxes and Estate Taxes Work Together
Gift taxes and estate taxes are connected through the same lifetime exemption.
When you make taxable gifts during your lifetime, those gifts can reduce the exemption available to your estate later. That means a larger portion of your estate could become subject to federal estate tax if you've significantly reduced your lifetime exemption through prior taxable gifts.
For families with substantial assets, strategic gifting can be part of a broader estate planning strategy. For example, parents may make annual gifts that stay within the exclusion amount, transferring wealth to children or grandchildren without affecting their lifetime exemption.
Because annual exclusion gifts do not reduce the lifetime exemption, this strategy can help lower the size of a taxable estate over time.
Are Inheritances Taxable?
In most situations, inherited money and property are not subject to federal income tax when received.
However, there are a few important exceptions:
- Income earned from inherited assets after you receive them may be taxable.
- Withdrawals from inherited retirement accounts may be taxable, depending on the type of account and your relationship to the original owner.
- Some states impose inheritance or estate taxes, even when no federal tax applies.
If you've recently received an inheritance, it's worth reviewing the specific type of asset involved so you understand any future tax consequences.
What Gifts Are Exempt From Gift Tax Rules?
Certain transfers are excluded from gift tax reporting requirements altogether. These gifts generally do not count against the annual exclusion or the lifetime exemption.
Common examples include:
- Gifts made to your U.S. citizen spouse
- Donations to qualified charitable organizations
- Tuition payments made directly to an educational institution on someone else's behalf
- Medical expenses paid directly to a healthcare provider for another person
- Certain gifts to political organizations
These exceptions can provide valuable opportunities to help family members and support causes you care about without triggering gift tax concerns.
How Do You Report a Taxable Gift?
If you make a gift that exceeds the annual exclusion amount, you may need to file IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
A Form 709 filing may be required even if you don't owe any gift tax. The IRS uses the form to track how much of your lifetime exemption has been used.
Generally, Form 709 is due on the same date as your federal individual income tax return, including extensions.
Our software does not support the filing of Form 709 returns.