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Stefanie A. Gallo:

Giving to loved ones can be fun and gratifying. But it's important to understand how gifts are taxed. To explore this topic, let's follow Dana. Dana has done well for herself.

She's got more than she needs. And now she'd like to give some gifts to family and friends. For one thing, she wants to pay rent for her son, Evan. She'd also like to sell her vintage Jaguar convertible to her best friend Mary.

Mary always mentions how much she likes it and would buy it if she ever decided to sell. But to be nice to her friend, Dana wants to sell it for much less than it's worth. And then there's Doug, her brother. He's going back to college again.

And she'd like to help him out with his tuition. So Dana's first question is, what exactly is a gift? Generally, when you give something of value to another person without receiving something of equal value in return, that's a gift. That could be cash, stock, artwork, cars, or a ton of other things.

Expenses Dana pays on behalf of another person are also gifts, like paying Evan's rent. A gift can be something sold for less than its full fair value. So when Dana sells her $50,000 Jag to Mary for $5,000, it counts as a gift. When Dana gives these gifts, she may owe gift taxes on them.

For 2023, for federal gift tax purposes, donors like Dana can exclude up to $17,000 per person from their taxable gift calculation. This is known as the annual gift tax exclusion. And it gets adjusted for inflation every year. If Dana was married, she could give double that amount with the consent of her spouse.

So when Dana writes checks adding up to $17,000 for Evan's rent, the annual exclusion applies. And the full amount would not be subject to gift taxes. The Jaguar is a bit more complicated. The car is worth $50,000.

And she only received $5,000 for it. So that brings the gift's value to $45,000. She can also deduct the $17,000 annual exclusion amount. So she's left with a gift of $28,000 and a really grateful Mary.

There are some exceptions to what is generally a taxable gift. First, if Dana wants to pay qualified medical expenses or tuition for someone, that gift amount is excluded from her annual limit. But she must pay the health care provider or educational institution directly. That's good news for Dana and her brother Doug.

If she pays qualified tuition directly to his school, she can cover the full amount without worrying about gift tax. Second, if Dana makes a gift to a qualified charity, it's excluded from gift tax. And finally, if Dana's married to a U.S. citizen, there's no limit on the value of gifts they can give to each other outright. OK.

But that's not the end of the story. Let's go back to Mary and the Jaguar. Remember, Dana has made a $28,000 gift to Mary. She'll have to file a gift tax return.

But she still might not owe taxes on it. That's because each person also has a lifetime gift tax exemption. Dana can exclude up to $12.92 million during her lifetime before she starts incurring gift tax.

This is above and beyond the amount of any annual exclusion gifts, since they don't count toward the lifetime exemption. Married couples can exclude $25.84 million if they each fully utilize their own exemption. So with regard to Dana's $28,000 taxable gift to Mary, she would apply the balance to her lifetime exemption and owe no gift tax.

That's good for Dana. But there's more to say about the lifetime exemption. So let's say Dana has never used any of her lifetime exemption apart from the gift of the Jaguar to Mary. She decides to use the rest of her exemption in one grand gesture.

She gives $12.92 million to Evan. Remember Evan? Actually, she gives him slightly less, $28,000 less to be exact, to account for the gift to Mary.

But Evan is still really happy. The taxable bill amount on her gifts, zero. The lifetime exemption is especially relevant now because the current $12.92 million limit is set to drop by about half at the end of 2025.

If you're ready to start giving gifts, remember, a gift is something of monetary value that you give to another person without getting something of equal value in return. You can typically gift tax free up to a certain limit each year. This is known as the annual gift tax exclusion. Separate from the annual exclusion, you also have a lifetime gift tax exemption.

When in doubt, speak with a tax professional to understand if your gift is taxable and should be reported.

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