The Federal Gift Tax

Saving for our children’s futures is an intimidating topic. The cost of everything continues to rise year after year and if you are like me, you are constantly thinking of ways to put away more dollars into savings or investments. Fortunately for many of us, we are blessed to have family members that are willing to help us on our financial journeys. Grandparents, aunts, uncles, cousins, and other extended friends and family are often sending gifts for birthdays or Christmas to our children, but what if a relative is financially able and willing to provide more? Maybe it’s your single uncle that has no children and wants to buy your child a car on their 16th birthday. Or perhaps it’s your parents that want to financially contribute to the costs of tuition for private schooling for your child. Like everything related to money in life, there are usually tax consequences of large gifts and it’s important that your loved ones know the implications of these gifts before they give them. In this post, I am going to break down the basics of the federal gift tax and hopefully provide some helpful ways that your family can work together to set your children up for long-term financial prosperity. 

FAQ #1: What is the federal gift tax? 

The federal gift tax is a levy on the transfer of money or property to another person while receiving nothing or less than full value in return. 

FAQ #2: What are the annual limits? 

For an individual the limit is up to $19K per year per recipient. This would mean that a single grandparent with three grandchildren could give a total of $57K in a tax year, with $19K going to each child and avoid recording these gifted amounts as taxable income for estate tax purposes. 

For a married couple, the limit is increased to $38K per year per recipient. 

There is a lifetime exemption of $15M per donor in 2026. For very wealthy individuals this could come into play quickly as a means of transferring wealth to the next generation tax-free, which is why the lifetime exemption exists. 

FAQ #3: What happens if an individual gifts more than the annual limit in a given year? 

If the annual exclusion amount is exceeded, the gifting individual must report the gift to the IRS using IRS Form 709. Federal gift tax rates range from 18-40% depending on the size of the taxable gift and whether or not the individual has met their lifetime gift tax exclusion. However, it is important to note that you may not actually owe any gift tax in a year where you give over the $19K limit so long as your lifetime gift limit has not been exceeded as a donor. 

FAQ #4: Why do individuals use the annual gift tax exclusion?

Annual gift tax exclusions are helpful for individuals that want to avoid or limit paying federal estate taxes upon their death. It is a way to essentially transfer wealth gradually to future generations while the individual gifting the money is still alive. As noted in FAQ #2 above, high net-worth individuals use this tactic to transfer their wealth over their lifetime tax-free. 

For example, if your grandparents have $15M in cash savings and they are in their 80’s, they may consider gifting $38K per year to you and any of their other grandchildren while they are still alive so that the $15M does not get taxed as part of their estate upon their death. This helps keep that $15M in the family rather than giving a portion of it back to the federal government in way of taxes. 

FAQ #5: Can “gifts” be contributed to a 529 educational savings plan? 

Yes - there are no restrictions on where the gifted money can go. This means that a grandparent wishing to contribute to a 529 plan for their grandchild can do so each year up to the federal limits and not pay any tax upon that transfer. A donor may also elect to front-load up to 5 years of annual exclusions into a 529 plan at one time by filing Form 709. 

However, it may be more beneficial for the gifting individual to use the intended gift amount to pay your child’s school directly. Educational payments like school tuition are not subject to the gift tax limits and therefore this is a way to bypass the limits all together and allow your relative to contribute these funds to your child’s education directly. For example, a grandma could give $19K to her grandchild’s savings account and on top of that pay her grandchild’s school tuition for the year. The payment to the school would not count towards the $19K gift tax exclusion limit in that year. Note that room and board is not eligible, just tuition paid directly to the school or institution. 

FAQ #6: Does the gift tax exclusion limit apply to physical assets (i.e. a car)? 

Yes - physical assets are included in these limits. 

FAQ #7: Are any types of transfers entirely exempt from the gift tax and do not count toward your lifetime or annual limits? 

Yes - gifts to a spouse (must be US residents) or an IRS approved tax-exempt charity are not subject to the gift tax limits. Educational payments, medical expenses and certain political contributions are also not subject to the gift tax limits.

FAQ #8: Is the receipt of the gift taxable to the individual that is receiving the gift as income? 

No - you or your child are not taxed on that money. Under the IRS rules, the recipient of a gift does not have to pay federal gift tax on the amount, nor do they need to report it on their tax return. The federal gift tax is at the sole responsibility of the giver. 

Appendix: 

1. IRS Website - Gift Tax: https://www.irs.gov/businesses/small-businesses-self-employed/gift-tax

2. Vanguard Guide to Gift Tax: https://investor.vanguard.com/investor-resources-education/taxes/gift-taxes

3. H&R Block Gift Tax Information Center: https://www.hrblock.com/tax-center/income/other-income/do-i-have-to-pay-taxes-on-a-gift/?srsltid=AfmBOor4VuunZxpFeYWEr3wQDG_zqDxCIwUMjvmcJl8V9VxbcQKF-qri