How Can Proposed Gift Tax Exemption Affect Your Family in 2022

In the Revenue Procedure 2021-45, published on November 8, 2021, and effective January 1, 2022, the Internal Revenue Service (IRS) announced the new inflation-adjusted numbers. The adjustments refer to more than 60 tax provisions to be used by individual taxpayers on their 2021 returns - meaning the returns that are generally filed in 2022. 

When it comes to the gift tax - a federal tax levied on a taxpayer who gives money or property to someone else - the annual exclusion from gift tax will increase. The annual exclusion is defined as the aggregate amount of present interest gifts that can be given without using lifetime gift tax exemption. Taxpayers and their advisors should pay attention to these potential developments as they may affect their present estate plan.

Here’s everything you need to know about how the proposed gift tax exemption can affect your family in 2022.

Tax Exemption

The current federal gift and estate tax exemption stands at $11.7 million, and under the new IRS inflation-adjusted number, it climbs up to $12.6 million. Moreover, under the new law, the gift tax annual exclusion amount is increased to $16,000 for 2022, up from $15,000 where it’s been since 2018. 

On the biggest estates, the estate tax is 40%. This means that the rich can avoid the estate tax by transferring wealth to their heirs early. Usually, it’s done by making significant gifts which typically are counted in millions of dollars and total more than the $12.6 million exemption amount. Often they also resort to making lots of $16,000 annual exclusion gifts that don’t end up beaching the $12.6 million-rule.

The numbers above essentially mean that the wealthy taxpayers can transfer a lot more to their heirs tax-free during life or at death. In 2022, an individual can leave $12.6 million to heirs without paying federal or estate gift taxes. Married couples can leave up to $24.12 million, while for those couples who already happened to max out lifetime gifts, a new higher exemption gives them room to give away another $720,000 in 2022.

If you’re interested in making a large lifetime gift, it might be a better idea to do it now rather than wait to pass it in your will after your death. However, suppose you want to wait and use the exemption at your death, or you’re expecting to inherit a large gift. In that case, you might also be interested in learning about probate and understanding probate process.

Tax Brackets

When talking about the tax brackets, it’s essential to remember that the U.S. has a progressive tax system, where rates increase with income. People with higher income are subjected to higher taxes, while people with lower income pay lower taxes. It’s the government that decides how much tax you owe by dividing your taxable income into chunks (called tax brackets). Then, each chunk is taxed at its corresponding rate. The most appealing thing about this system is that you won’t pay the tax rate on your whole income no matter what bracket you’re in. 

There are seven federal tax brackets for the 2021 tax year, and they stand at: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Your bracket depends on the amount of taxable income that you own and your filing status. The good news to the taxpayers is that the 2022 brackets do not change.

Because of this, in 2022, it will take higher income to become subject to each of the six higher tax brackets. They differ from one taxpayer to another, and essentially everything depends on the amount of taxable income each person has. The brackets can also vary depending on who they apply to, meaning that they’ll be different whether you’re a single individual taxpayer or part of a married couple. To stay informed about the changes in the tax brackets that apply to you, you can consult this guide.

Your taxable income can be reduced by credits and deductions. Credits don’t affect the tax bracket you’re in, and they directly reduce the sum of tax you owe. Deductions lower your taxable income by the percentage of your highest federal income tax bracket. It might be in good sense to take all the tax deductions you can because they can reduce the amount of your taxable income and put you in a lower bracket. As a result, you might pay a lower tax rate.

General Rules

There are a few general rules that you should be aware of when it comes to gift taxes:

1. The donor is usually the person responsible for paying the tax gift. However, special agreements may be arranged, and the donee may agree to pay the taxes. To make such an arrangement, you should consult your tax advisor.

2. According to the IRA, every transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return, is considered a gift. It’s usually agreed that any gift is taxable, but there are some exceptions to this rule. Additionally, gifts to qualified (recognized as tax-exempt) charities are deductible from the value of the gifts made.

3. The value of the gifts that you make can’t be deducted from (except gifts that are deductible charitable contributions).

4. The gift tax limit isn't a cap on the total sum of all your gifts for the year. Effective January 1, 2022, you can make individual $16,000 gifts to as many people as you want. You just cannot gift any recipient more than $16,000 within one year.

5. If you and your spouse want to give away property that you own together, each of you is entitled to the annual exclusion amount on the gift. From January 1, 2022, the total amount will stand at $32,000. What is more, for federal tax purposes, the terms “spouse,” “husband,” and “wife” also includes individuals of the same sex who were lawfully married and who remain married.

Final Thoughts

One of the main reasons why the annual exclusion is being increased is to catch up with inflation. If you are thinking about giving away a large amount of money or property, you must consider the newly released information, especially when planning for your family’s future.

In light of the new changes, try discussing your plans with a tax before making any financial decision. For other inflation adjustments that may affect your income taxes, don’t hesitate to see Revenue Procedure 2021-45.