You worked hard and saved for decades. Now it's time for the most rewarding part— sharing your money with the people you love.
You can pass on your wealth through gifting, giving away assets during your lifetime. Another option is leaving an inheritance for heirs when you die. Both methods come with tax implications.
Understanding gift tax vs. inheritance tax and how these
What is inheritance tax?
An inheritance tax is a state-level tax imposed on the transfer of property from one person to another upon death. The purpose of inheritance tax is to generate revenue for the state where the decedent resided or owned property. Unlike estate taxes, which are levied on a deceased person's estate, inheritance taxes are levied on recipients.
There is no federal inheritance tax. Currently,
If you live or own property in a state with an inheritance tax and want to avoid having taxes chip away at the value of your loved ones' inheritance, you can consider gifting assets during your lifetime instead—just be aware of potential gift tax consequences.
What is gift tax?
A gift tax is a tax imposed on the transfer of property from one person to another. The purpose of the gift tax is to prevent people from avoiding paying estate and inheritance taxes by giving assets away during their lifetime.
How much money can be gifted tax-free? You can leverage two exclusions to avoid paying the gift tax: the annual exclusion and the lifetime exclusion.
The annual exclusion allows you to give up to a certain amount per year to any number of recipients without triggering a gift tax return filing requirement.
For 2022, the
For married couples, each spouse is entitled to their own annual exclusion amount. This means a married couple could give up to $96,000 ($16,000 x 6) to their three children in 2022 without filing a gift tax return.
For 2023, the annual exclusion rises to $17,000 per recipient.
Keep in mind that filing a gift tax return doesn't necessarily mean you need to pay taxes on the gift—unless your total reported gifts exceed the lifetime exclusion.
The lifetime exclusion allows you to give away up to a certain amount during your lifetime without triggering gift or estate taxes.
For 2022, the
The lifetime exclusion applies to both gift and estate taxes combined, so any portion of the exemption you use for gifting reduces the amount you can use for the estate tax.
How the gift and estate tax exemption works
Here's an example of how annual and lifetime exclusions work together: Say you're unmarried and give $100,000 to your adult child in 2022. Because that gift is more than the annual exclusion, you must file a gift tax return using
Now, say you pass away in 2023. At that point, up to $12,836,000 of the value of your estate is excluded from estate taxes. That's the lifetime exemption amount that applies in 2023 ($12,920,000) minus the $84,000 you used up with your gift in 2022.
Note that the current lifetime exemption, while generous, is only temporary. Unless Congress makes the existing exemption limit permanent, it may revert to $5.49 million (adjusted for inflation) after 2025. That impermanence makes gifting assets to your loved ones now more appealing. Doing so effectively "locks in" your exemption, since there's no telling what the lifetime exemption amount may be in the future.
Gift tax considerations
Gifting within the annual exclusion amount can be a way to
Medicare and Medicare supplemental insurance don't cover most long-term care, so your sources for paying for long-term care are limited to:
- Your own money. Make sure that you have enough saved up before giving away your assets.
- Long-term care insurance. This can help pay for the cost of
long-term care services.
- Medicaid. Medicaid is a government program that helps people pay for medical expenses, including long-term care. To be eligible for Medicaid, you must meet certain requirements, such as having a low income and few assets.
While there are strategies for meeting Medicaid's income and asset requirements, including using trusts, gifting assets can create a penalty for you (or your spouse) because of Medicaid's five-year look-back period.
The five-year look-back period means that if you or your spouse move to a long-term care facility or nursing home and apply for Medicaid, the state looks back at the past 60 months to make sure you didn't transfer any assets for less than their fair market value. Those transfers can include gifts and items sold for less than they're worth. Even payments to a caregiver can violate the look-back period if there isn't a written agreement in place.
There are some exceptions to this rule, including some transfers to spouses, children with disabilities, siblings, adult children caregivers and debt payments. However, transferring assets is complicated, so discuss your plans with your financial advisor first.
Partial payment gifts
Another popular approaching to passing down assets is a partial payment gift, where the recipient pays for a portion of their gift but not its full value.
For example, say your home is worth $1 million, but you sell it to your adult child for $750,000. The $250,000 difference between the home's value and the purchase price is considered a gift. As a result, you need to file a gift tax return, and your lifetime exemption is reduced.
Get professional guidance
When it comes down to gift tax vs. inheritance tax, it's crucial to understand how both taxes work and how they might affect your beneficiaries. With proper planning, you can minimize or even avoid these taxes altogether. Connect with a