Article Highlights:Annual Gift Tax ExemptionGift SplittingLifetime Estate Tax ExemptionEducation ExceptionMedical ExceptionQualified Tuition Plan ContributionsSpouse’s Unused Estate Tax ExclusionStates With Estate TaxesWhy Should You Be Concerned?Gift & Estate Tax RatesGift and estate taxes are both part of the federal transfer tax system and are interconnected.Gift tax applies to transfers of wealth during a person's lifetime. If a person gives another person a gift that exceeds the annual gift tax exclusion ($17,000 in 2023), the giver (also referred to as the donor) may have to pay gift tax. However, there is also a lifetime gift tax exemption ($12.92 million in 2023), which means that a person can give away up to that amount over their lifetime without paying gift tax. When the amount given to another person during any year exceeds the annual exclusion for that year, the donor is required to file a Gift Tax Return (IRS Form 709), even if no gift tax is owed because the donor’s lifetime exemption hasn’t been exceeded. The IRS requires this filing so that they can keep track of how much of the donor’s lifetime exclusion has been used up.Estate tax, on the other hand, applies to transfers of wealth after a person's death. The value of the deceased person's estate is calculated, and if it exceeds the estate tax exemption $12,920,000 in 2023), the estate may owe estate tax.The interaction between gift and estate taxes comes into play because the lifetime gift tax exemption and the estate tax exemption are coordinated. This means that any portion of the lifetime gift tax exemption that is used reduces the amount available for the estate tax exemption. For example, if a person gives away $1 million over the annual exclusions during their lifetime and dies in 2023, their estate tax exemption would be reduced to $11.92 million.Annual Gift Tax Exemption– As of 2024, the annual gift tax exemption is $18,000 per recipient (up from $17,000 in 2023). This means that in 2024 you can give up to $18,000 to as many individuals as you want in a single year without incurring a gift tax or reducing your lifetime estate exemption. If you give more than $18,000 in 2024 to a single individual, the excess amount is subject to gift tax. Thus, for example, let’s say you have 4 children. You can gift each of them an amount equal to the annual gift tax exemption without triggering any gift tax or gift tax reporting requirements or reducing the lifetime estate tax exemption. Gifts to be counted are cash and property, including birthday and holiday gifts.Gift Splitting - A husband and wife can each make annual exclusion gifts, thereby increasing the exclusion from $17,000 to $34,000 per year (based upon 2023 amounts). However, only one of the spouses may have available property to give. IRC Section 2513 allows the spouses to elect (on a Form 709) to treat a gift made by one spouse as being made by both spouses.Example - Gift Splitting - John and Jane are married and have two children. In 2023 when the annual exclusion limit is $17,000, they would like to exclude $68,000 ($17,000 x 2 donors x 2 donees) in gifts. Jane received a large inheritance some years back; John has only a modest estate. Jane gives the children $34,000 each. Then the couple elects to gift split so that the $34,000 gift is treated as given one-half by Jane and one-half by John (or $17,000 each). The gifts all qualify for the annual exclusion.Lifetime Estate Tax Exemption – As previously discussed, the lifetime gift and estate tax exemption are coordinated, meaning they apply to both gifts given during your lifetime more than the annual exception and assets left at your death. So, if you use part of the exemption for lifetime gifts, only the remaining amount is available to shield your estate from estate tax when you die. However, the lifetime estate exemption is only reduced by gifts you made during your lifetime that exceed the annual gift tax exemption. To keep track of that amount, the IRS requires Form 709, Gift Tax Return, to be filed when gifts exceed the annual exception.Medical and Education Exceptions – In addition to the annual gift tax exception there are also medical and education exceptions included in the U.S. tax code that allow individuals to make certain types of payments on behalf of others without those payments being subject to the gift tax. They include:Education Exception: Any payments made directly to an educational institution for someone's tuition are not considered taxable gifts, regardless of the amount. This means you could pay for a child's, grandchild's, or even a friend's tuition costs without incurring the gift tax. However, this exception only applies to tuition costs. Other expenses, such as books, supplies, or room and board, are not covered by this exception. Contributions to a Sec 529 plan don’t count for this exception but have their own rules (see below).Medical Exception: Like the education exception, any payments made directly to a medical care provider for someone's medical expenses are not considered taxable gifts. This includes payments for procedures, treatments, and hospital stays. In both cases, it's important to note that the payments must be made directly to the institution or provider. If you give the money to the individual for them to pay the expenses, it will not qualify for the exception.