An annual exclusion gift is one that qualifies for the $15,000 per person per year exclusion from federal gift taxes for 2021 and $16,000 for 2022. Because the person giving the gift is responsible for the gift tax, you can give away this much in cash or property value each year without incurring a gift tax and without it counting towards 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 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. 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 Jan. 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 June—or any other month of the year—if you're married. 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
Gifts made to a spouse who 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 have their own annual exclusion amount: $159,000 in 2021. You can pay unlimited tuition or medical costs for an individual, and gifts to political organizations are also totally exempt. This exclusion is also indexed for inflation.
State and local laws change frequently and the above information may not reflect the most recent changes. For current tax advice, please consult with an accountant. The information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.