Understanding the Lifetime Gift Tax

Gifting allows you to transfer wealth to your loved ones during your lifetime, enabling them to enjoy financial security. By taking advantage of the tax exclusion for gifts, you can ensure that your family's financial future is safeguarded.

The Tax Cuts and Jobs Act of 2017 (TCJA) effectively doubled the gift and estate tax exclusion and generation-skipping transfer tax exclusion, allowing individuals to gift without owing gift tax. By gifting assets, you can reduce the size of your taxable estate, potentially lowering the estate tax your estate will have to pay upon your death. This is crucial if you have a substantial estate that could be subject to estate tax.

As of 2023, the lifetime gift and estate tax exclusion stands at $12.92 million per person. This exclusion is projected to increase to $13.61 million per person in 2024. However, come January 1, 2026, the exclusion is set to decrease by nearly 50%, settling at approximately $7 million per person. Given this reduction, it is prudent to gift between now and 2026 to take advantage of the higher exclusion.

However, not all gifts are created equal. When deciding what to gift before January 1, 2026, consider the basis of the assets being transferred. Think of the basis as a figurative apple-the Internal Revenue Service (IRS) only takes a single "bite" of it. For example, suppose you purchased a house in 1992 for $200,000 using income from your paycheck, which was subject to tax withholdings. Over time, the house's value has appreciated, and it's now valued at $1 million. When you sell the house, you'll be liable for taxes on $800,000 of the gain since the IRS has already taken a "bite" of the initial $200,000 investment.

However, when an asset goes through probate, it gets a "basis step-up." Using the same house example, let's say you paid $200,000 for the house and lived in it for the rest of your life. When the house becomes a part of your estate, your heirs can sell the house for $1 million, and they will not be expected to pay tax on the $800,000 gain because the house received a "basis step-up" to the fair market value.

Deciding what to gift can be a balancing act, but by planning ahead and consulting with tax professionals you can make the most of the current gift tax exclusion and secure your family's financial future.