Learn more about how the federal gift tax works and whether it applies to your gifts.

How Does the Federal Gift Tax Work?

The federal gift tax applies to valuable financial gifts that one party gives to another one. It isn’t meant to regulate everyday gifts. Because it’s meant to keep people from avoiding estate taxes after their death, the gift tax is payable by the donor, not the recipient of a gift. It also doesn’t apply to all gifts made during the donor’s lifetime.

Annual and Lifetime Allowances

Individuals are free to give money or property away in relatively small increments. The federal government allows you to give the amount of the annual exclusion tax-free. The annual exclusion for tax year 2022 was $16,000, and for tax year 2023 it’s $17,000. Even if you go over that amount, you can apply the tax to your lifetime exemption, which was $12.06 million for 2022 and $12.92 million for 2023. If you send your grandkids a check for a few hundred—or even a few thousand—dollars, that isn’t subject to the gift tax, as long as you give each less than the annual exclusion for the year. Likewise, if you pay for a friend or relative to go on a trip with you, that won’t trigger the gift tax either, unless it’s worth more than the annual exclusion. You can even give certain gifts of more significant value because they’re exceptions to the usual rules (more on that below). Instead, the gift tax applies to very large financial gifts. These can be cash gifts or items that would otherwise cost a tens of thousands or hundreds of thousands of dollars, such as a new car or a house.

The Timing of Taxable Gifts

Gifts are taxable in the year that you give them. For example, if you wrote a $25,000 check for your son in December of 2022, you have to report it on your 2022 tax return (filed in 2023) no matter when he deposits it. If he didn’t deposit it until January 2023, the taxable portion of the gift is still taxed in 2022.

Loans and Cancelled Debts

Part of that $25,000 check is still taxable if you gave it as a loan but didn’t charge the applicable federal interest rate (the minimum rate the IRS requires for loans between family members). In that case, the “gift” is the difference between the rate you do charge—if any—and the federal rate in place at that time. This difference is called “imputed interest.” This rule only applies to loans of more than $10,000 unless you “forgive” the debt and decline repayment. In that case, the portion of the $25,000 that doesn’t qualify for exemptions or exclusions becomes taxable.

What Counts As a Gift for Tax Purposes?

It can be complicated to figure out what does and doesn’t count as a gift for tax purposes. Whether a gift is taxable depends on four factors:

Who receives itThe type of giftIts fair market valueWhether it was a present interest gift or a future interest gift

The Gift’s Recipient

Certain recipients fall into exempt categories, meaning you don’t have to pay taxes on gifts that you give them. For individual recipients, this is based on their relationship to you. For organizations you give gifts to, it depends on the tax status of the organization. All gifts made to your spouse are exempt from the federal gift tax, provided that your spouse is a U.S. citizen. The federal unlimited marital deduction allows spouses to give property to each other without taxation either before or after death. Gifts to political organizations and qualifying charities are fully exempt as well, although certain rules do apply. For example, gifts made to political organizations must be for the organization’s own use. While gifts to your spouse are exempt, gifts to your children, grandchildren, other relatives, or friends are not.

Gift Type

If the recipient is not one of the exceptions listed above, gift taxes apply to all types of financial transfers and purchases except two: medical expenses and tuition. You can pay someone’s medical bills or school tuition with no limit and without incurring a gift tax. To do so, however, you must make the payments directly to the care provider or educational institution. It’s considered a taxable gift if you give your friend or relative a check or pay their credit card bill for them, even if the money is meant to cover medical or education expenses.

Fair Market Value

A gift is anything you give without receiving fair market value in return. The Internal Revenue Service (IRS) defines fair market value as what would be paid for an item or asset if neither the buyer nor the seller were under any duress to complete the transaction. The value of a gift is clear if you give cash. You’ve made a $10,000 gift if you give someone $10,000 and receive nothing in return. But you’re considered to have given a gift of $150,000 if you sell someone a $300,000 home for $150,000. That’s because you didn’t receive anything in exchange for half the property’s value, which is the remaining $150,000. Fair market value is typically a gift’s appraised value or a value comparable to other similar items sold at the same point in time and in the same condition. 

Present Interest vs. Future Interest

Only present interest gifts are eligible for the annual exclusion. A gift of present interest is one that the recipient is free to use, enjoy, and benefit from immediately. It comes with no strings attached. Future interest gifts are taxable and must be reported to the IRS on Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return. It’s a future interest gift if the recipient doesn’t have complete use and enjoyment of it until some future point in time. Common examples of future-interest gifts are a life estate in real estate or money put into a trust. In either case, your beneficiary typically doesn’t become the full and vested owner until your death.

How Much Can I Gift Tax-Free? 

As mentioned earlier, federal law exempts the first $17,000 you give per recipient in 2023. That’s the amount of the annual exclusion. It was $16,000 for tax year 2022. Only the balance of the gift’s value over the annual exclusion amount is taxable. You can apply it to gifts made to anyone other than your spouse, such as your children. For example, if you make a one-time gift of $117,000 to your child for the purchase of a home in 2023, $17,000 of the gift would be free and clear of the federal gift tax. The remaining $100,000 would be considered a taxable gift. If you give your child $17,000 in December and another $34,000 in January, you would only pay tax on $17,000 of your gift. The $17,000 from December would be exempt, as would half of the amount you gave in January. This limit only applies per recipient. So if your child is married, you could give them and their spouse each $17,000. This would allow you to give twice as much without incurring a gift tax on either amount. And if you are married, you and your spouse could each give $17,000 to each person. This would allow you to give a total of $68,000 tax-free to your child and their partner.

Using the Lifetime Exemption

The lifetime exemption is another legal way to get out of paying gift taxes, but it’s shared with the estate tax. This lifetime exclusion is sometimes referred to as the “unified tax credit” because it covers both taxes. You can either pay the gift tax on the balance of a gift over the $17,000 annual exclusion or apply the balance to this lifetime credit. No gift tax would be due, but the amount of a gift is subtracted from the lifetime exemption each time you do that. This leaves less to shelter your estate from any applicable taxes at the time of your death. Only very sizable estates should be affected by this rule, though.