Gift, Inheritance & Estate Taxes: What you need to know

Last week, we discussed personal and business gift tax deductions. This week, we'll look at the ins and outs of inheritance and estate taxes.
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As mentioned in our recent blog “Gifts, Taxes, and Deductions: What You Need to Know Before Giving”, personal gifts are not tax deductible. Also, if your gift exceeds the Annual Gift Tax Exclusion of $16,000 per recipient for 2022 ($17,000 for 2023 at the writing of this article), you will have to report and pay tax on the amount.

Before we get into explaining Gift & Inheritance Taxes, we should first define what exactly a gift is.

The IRS has specific rules regarding the following types of gifts:

  • Business Gifts – Something (money, property, or another valuable asset) given “in the course of your trade or business” without an exchange of goods or services for this item

  • Personal Gifts – Something (money, property, or another valuable asset) given to another person without getting anything in return (or you get something of lesser market value)

  • Inherited Gift – Something (money, property, or another valuable asset) bequeathed to you upon someone’s death.

  • Charitable Gifts – donations of money or valuable property a Person or Business gives to recognized non-profit organizations.

In this article, we’ll take a closer look at the tax ramifications of Gift & Estate Taxes so that you can understand your reporting requirements. (Learn more about Charitable Gifts or Business & Personal Gifts here.)

The “Gift Tax” – Inherited Gifts

You might give another person a financial gift. Or you may be on the receiving end. Did Mom and Dad give you a down payment for a house? Did you give your newly graduated neighbor a car?

The IRS considers a gift when you transfer money or property to another person without getting anything in return (or you get something of lesser value). Money or property bequeathed to you upon someone’s death is an inherited gift. This is also not the same as charitable contributions, which are donations of money or property a person or business makes to recognized non-profit organizations.

Learn more about the ins and outs of gift taxes here.

I gave one person over the annual exclusion what now?

Some types of personal gifts are not taxable, regardless of the amount. These include money you spend to pay someone’s medical or tuition expenses, spousal gifts, and gifts to a political organization.

The person who receives a personal gift from you does not need to report it or pay tax. However, suppose you exceed the annual or lifetime exclusion limits noted above. In that case, you may have to report the gift and pay tax on the value (unless it is applied to the Lifetime Gift Exclusion, see below). The tax form to report Gifts above the annual exclusion is IRS Form 709.

Example: If you gifted a car worth $16,950 to someone, you would need to report the amount of $950 on the annual Gift Tax Return (IRS Tax Form 709). If you gave the same person a $5,000 check, you would have to report $5,950 on the Gift Tax Return. However, if you gave the car to one spouse and the check to the other spouse, only the $950 would need to be reported.

So, can I just keep going over the annual gift tax exclusion limit each year?

No, there is also a lifetime exclusion per recipient. That amount is $12.06 million for 2022 ($24.12M for married couples), but the figure will drop significantly in 2026 (to $5M at the writing of this article). This is the accumulated total you can give away “tax-free” throughout your life without paying the Gift Tax. So if you total every Form 709 over your lifetime and it exceed the Lifetime Exclusion Limit, you will have to pay Gift tax.

The Gift Tax Rate in 2022 is 18-40%, so it’s worth researching before writing that check or giving away your property.

You’ll want proof

Naturally, the IRS expects you to keep records of all your transactions. You may want to record the following:

  • What you gifted, if not money
  • What the item(s) market value is, if not money
  • When you gifted it
  • The recipient’s full legal name
  • The recipient’s relationship with you

Is Gift Tax and Inheritance (Estate) Tax the same thing?

No, they are not. Gift taxes are applied to transfers made during a taxpayer’s lifetime, whereas inheritance (estate) tax applies to transfers made after the taxpayer’s death.

The “Inheritance Tax”

What about an Inherited Gift? Whether you’ve received an inheritance or you’re considering leaving an inheritance, it’s important to understand the basics.

First, some good news – the IRS does not tax inheritance property (woohoo!). However, subsequent earnings from inheritance property would be subject to income tax (such as dividends earned on inherited stocks)

Now, the not-so-great news – several states still have an inheritance tax on the value of property a taxpayer receives from someone who has passed away. (Currently, Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania at the time of this article). This will be based on where the “giver” lives and pays state taxes.

Further, retirement accounts and real estate received might also be subject to other types of tax.

Each state is different, and tax law is complicated and often changes, so it’s a good idea to check tax laws in your state, or better yet, talk to a tax pro!

Is there a difference between Inheritance Tax and Estate Tax?

Yes, and it is based on who pays the tax.

Estate taxes are collected FROM the estate before any assets are distributed. The estate is, therefore, responsible for paying the Estate Tax. However, the person receiving an inheritance is responsible for paying the Inheritance Tax (again, at the state level).

The estate will pay taxes and pay off/down debts before giving out the inheritance to the beneficiaries. Currency (in 2022) the IRS only taxes estates worth more than $11.7 million ($23.4 for married couples). This is why the IRS does not collect Inheritance Tax once it’s passed to the recipient; it’s already been taxed in most cases!

Pro Tip: Do not DIY, hire a qualified estate planner and tax pro to plan your end-of-life gift-giving.

Have Questions? Let ProAdvisor CPA be your Gift Giving Guide

Gift-giving is noble and generous, but it’s best to give in a way that benefits everybody without causing unwanted tax implications. At ProAdvisor CPA, we understand that it’s complicated. We’re here to guide you so you can be confident you’re not only doing the right thing, you’re doing it the right way. Contact us here to chat with one of our ProAdvisors. 

This publication is designed to provide information on federal tax and accounting laws and/or regulations. It is presented with the understanding that the author is not rendering legal or accounting services.

This text is not intended to address every situation that arises or provide specific, strategic tax and/or accounting planning advice. This text should not be used solely to answer tax and/or accounting questions and you should consult additional sources of information, as needed, to determine the solution to tax and/or accounting questions.

This text has been prepared with due diligence. However, the possibility of mechanical or human error does exist and the author accepts no responsibility or liability regarding this material and its use. This text is not intended or written by the practitioner to be used and cannot be used by a taxpayer or tax return preparer, for the purpose of avoiding penalties that may be imposed.

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