What Is an Annual Exclusion Gift?

Annual Exclusion Gifts Can Reduce the Value of Your Taxable Estate

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At the end of each year, I get calls from clients who are ready to make their year-end "estate planning" gifts to their loved ones. This will usually include gifts of cash, stocks, bonds, portions of real estate, or forgiving debt on a family loan in an amount that doesn't exceed the annual gift tax exclusion. But what exactly is an annual exclusion gift?

Definition of Annual Exclusion Gift

An annual exclusion gift is simply a gift that qualifies for the annual exclusion from federal gift taxes. This amount is set each year by the IRS through a revenue procedure and is usually published in early November for the following year. For 2012 the federal exclusion from gift taxes was $13,000, for 2013 the exclusion increased to $14,000, and the exclusion will remain at $14,000 for 2014.

How Annual Exclusion Gifting Works

So how does annual exclusion gifting work? Each person is given their own separate annual exclusion amount to gift and they can give this amount to an unlimited number of people (family members and non-family members alike) during the course of the year. Married couples can combine their annual exclusion amounts, but any gifts split between the husband and wife must be reported to the IRS on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.

In addition, gifts made to a spouse who is a U.S. citizen are exempt from gift taxes altogether due to the unlimited marital deduction, while gifts made to a spouse who is not a U.S. citizen have their own annual exclusion amount which was $134,000 for 2010, $136,000 for 2011, $139,000 for 2012, $143,000 for 2013 and $145,000 for 2014.

Annual Exclusion Gift Example

An example should help to explain how annual exclusion gifting works:

Let's say that during the course of 2014 you and your spouse, who are both U.S. citizens, make the following gifts:

  1. You give $5,000 to your son, Bob, in March and then another $5,000 in December.
  2. Your spouse gives $10,000 to her daughter, Betty, in March and then another $10,000 in December.
  3. You give $2,000 to your niece, Susie, in June.
  4. You give your spouse a diamond ring worth $50,000 in December.
  5. Your spouse gives you a bottle of rare wine worth $50,000 in December.

So where do you and your spouse stand on your annual exclusion gifts for 2014?

You have made total gifts of $62,000 in 2014, but fortunately for you all of them qualify as either annual exclusion gifts or the unlimited marital deduction: A total of $10,000 to Bob qualifies for the annual exclusion, a total of $2,000 to Susie qualifies for the annual exclusion, and a total of $50,000 to your spouse qualifies for the unlimited marital deduction.

On the other hand, your spouse has made total gifts of $70,000 in 2014 that may or may not qualify as annual exclusion gifts: A total of $20,000 to Betty exceeds the $14,000 annual exclusion limit, while a total of $50,000 to you qualifies for the unlimited marital deduction.

So what about the $20,000 to Betty? Will $6,000 of the $20,000 given to her be considered a taxable gift or not? This will depend on two factors - (1) how the account(s) where the money came from were titled, and (2) whether or not you agree to split the gifts with your spouse.

If the gifts to Betty came from a joint account titled in the names of you and your spouse, then since each of you can give Betty $14,000 the gifts won't be taxable. If on the other hand the gifts to Betty came from an account in your spouse's sole name, then you and your spouse will have to decide if you want to split the gift to Betty or not. If you agree to split Betty's gift, then the total $20,000 will qualify as an annual exclusion gift, but you and your spouse will need to report the split gift to the IRS using Form 709 as discussed above. If you do not agree to split Betty's gift with your spouse, then your spouse will need to report a $6,000 taxable gift to the IRS using Form 709.

How to Determine if You Have Made Taxable Gifts

The bottom line - if you're not sure whether or not you made any taxable gifts during the course of the year, then consult with your accountant and/or tax or estate planning attorney to be sure.