So, you’re only allowed to give away $16,000 a year to each recipient, right?

No, wrong. But it might nevertheless be a good rule of thumb.

Like many of our clients, you may be under the misconception that you are limited in making gifts to $16,000 per recipient per year. This is because $16,000 is the current gift tax exclusion figure – the amount that you may give away without having to file a gift tax return. (Many people also believe that the limit is $15,000 because that was the level of the exclusion for many years, until it was indexed to the inflation rate.) In fact, this limit is irrelevant to almost everyone because of the combined estate and gift tax threshold (or unified credit equivalent if you want the technical term) of $12.06 million (in 2022).

Here’s how it works: If you give away more than $16,000 to an individual in a year, you are supposed to report the excess. Every dollar over $16,000 uses up part of the $12.06 million you may give away tax free. So, for instance, if you give someone $116,000, you will have used up $100,000 of your $12.06 million credit, so you can give away only $11.9 million tax free at death. So, as you can see, the $16,000 exclusion is not really a limit for most people. It was much more significant when the federal estate tax threshold was $600,000 as recently as 1997 and $1 million as recently as 2003.

Even though the estate and gift tax system affects very few people, it’s still on the books and everyone is required to report gifts in excess of $16,000 per individual per year. But what happens if you don’t report your gift of $16,000? Nothing. The penalty for not filing a gift tax return is a percentage of the gift tax owed. Since you won’t owe any gift tax until you give away $12.06 million, it’s quite unlikely that you’ll ever pay a penalty for not filing your gift tax return. That said, $16,000 (or $32,000 for a couple since they can both give $16,000 a year) may be a pretty good limit on how much anyone should give anyone else during a calendar year absent unusual need. You probably don’t want your children and grandchildren depending on your largess for their basic living expenses.

Some Exceptions

A few more fun gift tax facts:

•  There’s no gift tax reporting requirement for gifts made to people you are obligated to support. So, there’s no limit on what you give or spend for your children under age 18. In addition, gifts to your spouse during life or at death are exempt from both gift and estate taxes (unless he’s not a US citizen).
• There’s no limit or reporting requirement for payments for education or health care. You just need to make the payments directly to the education facility or health care provider. In addition, you can, in effect, prepay gifts into a 529 plan, putting in up to $75,000 at once for five years of gifts ($150,000 for a couple).
• The gift tax exclusion has nothing to do with Medicaid planning. A gift of even as little as $15,000 must be reported on a Medicaid application if made within the prior five years and may cause a period of ineligibility for benefits.
• Gift taxes are payable by the giver. The recipient of a gift doesn’t have to report it to the IRS and the gift is not taxable income.
• Both a husband and wife can give up to $15,000 a year and a spouse can consent to the use of her exclusion. This means that either spouse may give up to $32,000 a year to a particular individual if the other spouse agrees.

While we’ve never had a client who has had to pay a gift tax, we did have one who received a taxable gift. Our client was a childhood friend of a man who became a very successful Hollywood star. (You’ve definitely heard of him.) He was also very generous and bought our client a condominium. Since he had already surpassed the gift tax threshold, which was much lower then, in making the gift to our client, he also had to pay a substantial gift tax of 45 percent of what he gifted. Unfortunately, in facilitating the arrangement, we didn’t get to talk with the star himself, just his tax accountants.

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