An annual exclusion gift is one that is below a certain dollar amount, so that qualifies it to be excluded from federal gift taxes in a given year. For the 2021 tax year, the limit is $15,000 per person, and in 2022 it rises to $16,000. The person who gives the gift is responsible for paying the gift tax, meaning you can give away this much in cash or property value each year without incurring a gift tax and without it counting toward your lifetime gift tax exclusion (called your "lifetime exemption").
Gift Tax Exclusions and ATRA
The gift tax is designed to prevent individuals from giving away their wealth during their lifetimes in order to avoid estate taxes when transferring money and assets to beneficiaries after their deaths. It's been around for a while, but the American Taxpayer Relief Act of 2012—commonly known as ATRA—increased the top tax rate on estate assets from 35% to 40%.
ATRA also indexed the lifetime gift tax exclusion for inflation, so it increases periodically. The lifetime exclusion is $11.7 million as of 2021 and $12.06 million in 2022. If you go over the annual exclusion amount, you can either apply this lifetime exclusion to the balance or pay the gift tax.
The annual exclusion is also indexed for inflation, but it can only increase in $1,000 increments. It doesn't do so every year.
How the Annual Exclusion Works
If your daughter needs $25,000 for a down payment on a house and you give her that amount, you will owe the gift tax on $10,000—the balance over the $15,000 annual exclusion in 2021. On the surface, it's that simple, but a couple of wrinkles can work to your advantage.
Maybe your daughter asks you for the money in December, and she's planning to close on the property in January. In this case, you can give her the money tax-free: $15,000 in December in one calendar year and $10,000 on January 1 of the next calendar year. The exclusion is literally annual, and it rolls over when the calendar does.
You can even give your daughter the entire $25,000 in January—or any other month of the year—if you're married.
How the Annual Exclusion Works for Spouses
Spouses can combine their annual gift tax exclusion amounts and give a total of $30,000 per person per year without incurring any gift tax liability. They must file gift tax returns for the year, however, reporting this to the IRS: Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
Spouses must file separate Forms 709, even if they file a joint income tax return.
Other Gift Tax Exclusions
In addition to the annual exclusion gift, there are other forms of gifts that are not subject to the federal gift tax. A few more common examples include:
- You can pay unlimited tuition or medical costs for an individual.
- Donations or gifts to political organizations are fully tax-exempt.
- Gifts made from one spouse to another (if the spouse is a U.S. citizen) are exempt from gift taxes due to the unlimited marital deduction.
Gifts made to a spouse who is not a U.S. citizen are treated as any other and subject to taxation above the annual gift exclusion amount. They are also subject to their own lifetime exclusion amount, set at $159,000 in 2021.
- An annual exclusion gift is one that is below a threshold that qualifies it to be excluded from federal taxes in a given year.
- In addition to a yearly gift exclusion, there is also a lifetime gift tax exclusion which shifts periodically for inflation.
- Spouses can combine their annual exclusion gift to double the threshold limit before taxes kick in.
Frequently Asked Questions (FAQs)
Why are gifts taxed in the first place?
The IRS imposes a tax on gifts to discourage people from skirting estate taxes by giving away their money during their lifetimes.
How much money can I give my child before I'm taxed on it?
In the 2021 tax year, you can give up to $15,000, and in 2022, you can give $16,000 without having to pay taxes on the gift. To avoid paying taxes on gifts to your child, be sure to stay under the threshold amount each year and also under the lifetime exclusion limit.
Can I deduct gifts on my tax return?
Generally, gifts given to individuals do not typically affect your income tax liability. However, if you made a gift to a qualifying charity, it may be deductible. If your estate or gift-giving situation is highly complex, you may wish to consult a CPA or tax professional for detailed and personalized advice.