Gift Tax Complexity: Helping Family Isn’t Always Simple

In the world of financial planning and managing wealth, the U.S. gift tax can be a puzzling yet vital consideration. Imagine you want to lend a helping hand to a family member by giving them money. It seems straightforward, right? But understanding the ins and outs of the gift tax is crucial if you want to engage in acts of generosity without running into unexpected tax issues.

What is the U.S. gift tax?

The gift tax is a federal tax on giving money or property that’s worth more than a set amount each year, known as the annual exclusion. If you give someone something they can use and enjoy now, it’s called a “present interest,” and is gift tax-free up to that year’s annual exclusion. However, gifts that provide the right to enjoy something in the future are subject to gift tax and not eligible for exclusion.

Currently, the annual exclusion allows each person to give up to $18,000 to each recipient each year without worrying about the tax.¹ This means you can give this much to as many people as you want every year without owing any gift tax. Should you end up owing gift tax, the rate ranges from 18% to 40% in 2024, depending on your cumulative lifetime gift amount.

Example 1: Sam gives his brother $10,000 in cash to help him through a job loss. Since the cash gift is a present interest, it qualifies for the annual exclusion. Furthermore, since the amount is below $18,000, it will not be subject to gift tax.

Example 2: Reba gifts $10,000 into a trust for the benefit of her child in 40 years when she turns 65. Since this gift is a future interest, it does not qualify for the annual exclusion and the full $10,000 would be subject to gift tax.

Apart from the annual exclusion, there’s a lifetime gift tax exemption that lets individuals give away a certain amount over their lifetime without paying gift tax. For 2024, this exemption is $13.61 million per person, adjusted each year for inflation. If the tax laws stay the same, this exemption is expected to halve in 2026, still leaving a substantial $6.8 million exemption. It’s crucial to understand that this exemption covers all gifts given throughout your life, beyond the annual exclusion. Also, any amount you use from this exemption reduces the remaining exemption you have for your estate when you pass away.

Example 3: Continuing with Example 2 above, while the $10,000 is subject to gift tax, Reba will not actually owe any tax provided she has gift tax exemption remaining. If she has not dipped into her gift tax exemption yet, her lifetime exemption would drop by $10,000 from $13,610,000 to $13,600,000.

If your gifts are under the annual exclusion limit, you do not need to report them to the IRS. Alternatively, if you give more than the yearly limit, you need to report it to the IRS by completing Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return. You usually need to submit this form by April 15 of the year after you made the gift.

Strategic planning

Since the tax rules allow you to use certain strategies for savings and payments that take advantage of the annual and lifetime exclusions, it is important to know about the ones that might be most useful to you. For instance, the 529 plan helps you save for future education expenses while giving you tax benefits. “529 frontloading”, also known as “529 superfunding”, lets you contribute a one-time lump sum to the plan that can be averaged over five years to meet the annual exclusion amount. There are also “excludible gifts” that do not incur a gift tax but are often overlooked, such as payments made directly to an educational institution or medical provider instead of made to the individuals they benefit.

529 frontloading

The 529 plans are run by states, state agencies, or educational institutions and provide diverse ways to invest your money. Depending on where you live, your 529 plan contributions may garner a deduction on your state income taxes. Contributions to the plan grow tax deferred and withdrawals used for qualified education expenses are typically tax-free.

Contributions to a 529 by anyone other than the beneficiary are considered gifts for gift tax purposes. Although the gift is of a future interest, the law permits the use of the annual exclusion. In addition, up to 5-years’ worth of gift tax annual exclusions can be utilized in one year, known as 529 frontloading.² For 2024, this permits a gift of $90,000 without consuming any lifetime exemption. However, the donor has used up the annual exclusion for that beneficiary for the following four years, so any additional gifts to that beneficiary may create a taxable gift situation.

Example 4: Regina just received a large inheritance from her father who recently passed away. She decides to put $90,000 into a 529 for her daughter in 2024. The full $90,000 will be gift tax-free if she files the Form 709 to elect 529 frontloading.

Example 5: Continuing with Example 4, Regina decides to gift $18,000 to her daughter in 2025 by funding a custodial investment account. The full $18,000 will be subject to gift tax in 2025 because the annual exclusion for 2024 through 2028 has already been utilized with the 529 frontloading gift.

Even though gift tax will not be owed on the 5-year frontloading, a gift tax return must be filed to make the election.

Excludible gifts

Excludible gifts refer to certain types of gifts that are not subject to the federal gift tax and include education and medical expenses, gifts to U.S. citizen spouses, charitable contributions, political organizations, and costs of care for a minor.³

If tuition payments go directly to the educational institution or medical expenses are paid directly to the provider, it’s not subject to gift tax. These payments can be of any amount and won’t affect the annual exclusion for the beneficiary or the donor’s lifetime exemption. The key is that the payment must go directly to the educational or medical provider. If the money goes to the beneficiary who then pays the expenses, it counts as a gift. However, gifts between spouses are generally exempt from gift tax, except if one spouse is a non-U.S. citizen. In that case, there’s a “super” annual exclusion of $185,000 for 2024 to prevent estate taxes on assets if the non-U.S. citizen spouse leaves the country.⁴

Example 6: Sam’s uncle has an ongoing medical condition that has incurred expenses beyond his medical benefits, which he cannot afford. Sam contacted the medical provider and arranged to pay $25,000 of his uncle’s medical bill directly. The full $25,000 is excludible from gift tax in 2025 because Sam sent his payment to the doctor directly.

Our complete financial planning offering for individuals and families includes gift tax strategies when it fits into your goals. When in doubt, speak with your wealth advisor. If you are not a Mercer Advisors client and want to learn more, let’s talk.

1.”What is the Gift Tax Exclusion for 2024?”, Kiplinger, June 3, 2024.

2.”How grandparents can help fund education,” Fidelity, March 13, 2023.

3.”What Gifts Are Not Subject to the Gift Tax?”, The Balance, Nov. 7, 2022.

4.“Frequently Asked Questions on Gift Taxes for Nonresidents not Citizens of the United States,” IRS.