Cash Gift Vs. Inheritance: Which Is Better and Why?
If you know you plan to bequeath any amount of money to your loved ones upon your death, you may wonder, should you gift the money to them now or should you leave it to them as an inheritance? While there is a lot to be said for the inheritance route — such as that it gives you more financial leeway in your retirement and grants you more control over how and when your loved ones receive the funds — the cash gift option almost always makes more sense. This is true for one main reason: taxes.
The Federal Government Offers Considerable Leniency When It Comes to Gift Taxes
When U.S. residents pass away, their earthly possessions are subject to two types of death taxes: estate taxes and inheritance taxes. Estate taxes are the responsibility of individuals who own the estate, meaning the departed. Inheritance taxes, on the other hand, become the responsibility of the person who inherits assets or money.
Each type of death tax is further broken up by the level of government that collects them: federal and state. Most states adhere to the federal government’s rules for gift taxes. The good news is that the federal government’s gift tax laws are extremely lenient.
As of 2022, the federal government gift tax exemption is $16,000 per person. What this means is that you can gift up to $16,000 to as many individuals as you like each year before your death. If you have a spouse, your annual exemption doubles to $32,000.
If you keep your gifts at $16,000 or under, you do not have to file any paperwork and nor do you have to file any taxes. However, say you gift more than $16,000 to the same individual in a single year. Will you have to pay taxes on the amount that exceeds the exemption?
Contrary to popular belief, the answer is “unlikely.” Though you will have to file Form 709 with the IRS if an annual cash gift exceeds the limit, it is highly unlikely you will have to pay taxes on it. This is because, in addition to an annual gift tax exemption, the government offers a lifetime exemption. As of 2022, the lifetime gift tax exemption is a whopping $12.06 million for individuals, and $24.12 million for married couples.
Not only is the lifetime exemption high but also, it does not kick in until you have already used up your annual exemptions. For instance, say you gifted your grandson $50,000. Technically, the taxable amount would be $36,000, which is the gift amount less the $16,000 annual exemption. However, you still have your lifetime exemption to consider. Assuming this is the first gift you made over the annual exemption, your remaining lifetime exemption would be $12,024,000 — or, $12.06 million less $36,000.
The bottom line is, your cash gifts are very unlikely to ever trigger taxes. While there is a bit of paperwork involved when you exceed the annual amount, you can give away as much as you like without facing financial repercussions.
Inheritance Tax Laws
In addition to having lenient gift tax laws, the federal government does not have inheritance tax laws. That said, it does charge taxes on any income derived from an inheritance, such as a home, investment property or stock option. Moreover, six states do maintain inheritance tax laws. Those six states are as follows:
- New Jersey
If you live in one of these six states, it is important that you familiarize yourself with tax rates and exemption amounts.
While you or your loved ones will unlikely ever have to pay taxes on a cash gift or inheritance, going the cash gift route is typically easier. You do not have to leave instructions for your executor, you can gift money as you see fit and you can gift a massive amount without ever having to do much more than file some paperwork. If you have money to give, consider gifting it during your lifetime.