Definition and Examples of an Annual Exclusion Gift
An annual exclusion gift is a gift that can be included in the donor's yearly exclusion. The annual exclusion is a tax benefit that taxpayers can use when giving a gift that exceeds the exclusion amount.
Annual exclusion gifts are usually in the forms 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. The federal government sets the allowable limits for tax-free giving each year.
For the 2021 tax year, the federal exclusion from gift taxes is $15,000, and the limit for 2022 is $16,000.
The IRS usually publishes the allowable annual exclusion from federal gift taxes each November for the following year. Sometimes, the amount remains the same.
How Annual Exclusion Gifting Works
When you give someone a gift with a value of less than the exclusion limit, you don't need to pay taxes on it. However, if your gift is over the limit, you'll need to report the amount that exceeded the limit on IRS Form 709.
Each person is given a separate annual exclusion amount to gift under U.S. tax law. They can give this amount to an unlimited number of people (family members and non-family members alike) during the year. For example, you can give any number of people a gift of $16,000 in 2022 without incurring any tax penalties.
Married couples can combine their annual exclusion amounts, but gifts split between the husband and wife must be reported to the IRS on Form 709 (U.S. Gift and Generation-Skipping Transfer Tax Return).
Gifts made to a spouse who is a U.S. citizen are exempt from gift taxes because of the unlimited marital deduction. Gifts made to a spouse who is not a U.S. citizen have an annual exclusion amount of $159,000 for 2021 and $164,000 in 2022.
When to Report Annual Exclusion Gifts
Suppose that during 2022, you and your spouse, who are both U.S. citizens, make the following gifts:
- You give $5,000 to your son, Bob, in March and then another $5,000 in December.
- Your spouse gives $10,000 to her daughter, Betty, in March and then another $10,000 in December.
- You give $2,000 to your niece, Susie, in June.
- You give your spouse a diamond ring worth $50,000 in December.
- Your spouse gives you a bottle of rare wine worth $50,000 in December.
Gifts That Don't Require Reporting
You have made total gifts of $62,000 in 2022, but fortunately for you, all of them qualify as annual exclusion gifts or are not taxable per the unlimited marital deduction: The $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 according to the unlimited marital deduction.
You don't need to report any of the $50,000 you've gifted for the year.
Gifts That Require Reporting
On the other hand, your spouse has made total gifts of $70,000 in 2022 that may or may not qualify as annual exclusion gifts: A total of $20,000 to Betty exceeds the $16,000 annual exclusion limit, while a total of $50,000 to you qualifies for the unlimited marital deduction.
What about the $20,000 to Betty? Will $4,000 of the $20,000 given to her be considered a taxable gift or not? This will depend on two factors:
- How the account(s) where the money came from was(were) titled, and
- Whether or not you agree to split the gifts with your spouse.
If the gifts to Betty came from a joint account titled in your and your spouse's names, the gifts are not taxable, because each of you can give Betty $16,000.
If the gifts to Betty came from an account in your spouse's name, you and your spouse would have to decide whether you want to split Betty's gift. The total $20,000 will qualify as an annual exclusion gift, but you and your spouse must report the split gift to the IRS using Form 709.
If you do not agree to split the exemption on Betty's gift with your spouse, your spouse will need to report a $4,000 taxable gift to the IRS using Form 709.
- An annual exclusion gift falls within the limit and is tax-free.
- The tax-free limit for 2021 is $15,000 and $16,000 for 2022.
- Spouses have an unlimited threshold of tax-free gift giving if the donee is a U.S. citizen.
- Married couples can double their tax-free giving to an individual by combining their limits.
- Any gifts split between a husband and wife must be reported on IRS Form 709.