The Annual Gift Tax Exclusion
The Internal Revenue Code imposes a gift tax on property or cash you give to any one person or entity, but it also provides a couple of ways to avoid the tax. One option is the annual gift tax exclusion. Only the value of a gift that exceeds this threshold can be taxed.
You can give away the amount of the exclusion each year without incurring a gift tax. The donor of the gift is responsible for paying the tax when and if it comes due, not the recipient of the gift.
The Tax Definition of a Gift
The IRS defines a "gift" as anything for which you don't receive full consideration in return. You've given a gift of $100,000 if you sell a piece of property to your niece for $100,000, but the property had a fair market value of $200,000.
Fair market value is defined as what someone would pay for an item in a reasonable exchange when neither the buyer nor the seller are under pressure to pay too much or sell for too little.
Cash is a dollar-for-dollar value against the exclusion.
The Annual Gift Tax Exclusion
The annual gift tax exclusion was indexed for inflation as part of the Tax Relief Act of 1997, so the amount can increase from year to year to keep pace with the economy, but only in increments of $1,000. The exclusion has remained steady for several spans of years, increasing in 2002, 2006, 2009, 2013, and 2018.
|Year||Annual Exclusion Amount|
How the Annual Exclusion Works
You can give any individual up to $15,000 in 2021 without paying a gift tax. The "annual" part of the exclusion means you could gift $15,000 on December 31 and another $15,000 on January 1 without incurring a tax because the gifts occurred in two separate years.
The gift doesn't have to be made in one lump sum. The tax will also come due if you cumulatively exceed the exclusion amount, such as if you give someone $2,000 a month for 12 months. You'd owe the gift tax on the balance of $9,000, the difference between $24,000 and the $15,000 exclusion.
Exceptions to the Rules
These rules don't apply to everything and everyone. You can make unlimited gifts in the form of tuition, other qualified educational expenses, and medical expenses if you pay the learning institution or the care provider directly. They're not gifts and they don't count against the exclusion amount if you pay schooling or doctor bills on someone's behalf.
You can make unlimited gifts to political organizations and to your spouse as well, provided your spouse is a U.S. citizen.
Gifts to non-citizen spouses are capped at $157,000 annually in 2020, increasing to $159,000 in 2021. Similar to the annual exclusion for everyone else, you can give your non-citizen this much per year without incurring a gift tax.
The Lifetime Exemption
The gift tax must be paid one way or another if you exceed the annual exclusion, but this doesn't necessarily mean that you must hand over cold, hard cash to the IRS. The U.S. tax code also provides for a lifetime exemption that allows you to effectively bump the tax over to another exclusion.
This exemption is sometimes referred to as the "unified credit" because it shares its cap with the estate tax. The government gives you an $11.7 million exemption as of 2021, allowing you to transfer this much money or property tax-free to other individuals either as gifts during your lifetime or from your estate at your death.
You can effectively assign any gifts that exceed the annual exclusion to this unified credit if you decide you don't want to pay the gift tax in the year you go over the exclusion. If you gave someone $700,000 in one year, $11 million of the exemption—plus the annual exclusion amount—would remain to shield other gifts you give over the annual exclusion and your estate at the time of your death.
IRS. "Publication 561 (02/2020), Determining the Value of Donated Property." Accessed Nov. 7, 2020.
IRS. "IRS provides tax inflation adjustments for tax year 2021." Accessed Nov. 7, 2020.
IRS. "Estate Tax." Accessed Nov. 7, 2020.