An annual exclusion gift is a gift that qualifies for the annual exclusion from federal gift taxes.
What Is an Annual Exclusion Gift?
An annual exclusion gift usually involves 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.
The IRS usually publishes the allowable annual exclusion from federal gift taxes each November for the following year. Sometimes the amount remains the same.
For 2020, the federal exclusion from gift taxes was $15,000.
How Annual Exclusion Gifting Works
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 (U.S. Gift and Generation-Skipping Transfer Tax Return).
Types of Annual Exclusion Gifting
Suppose that during the course of 2020, 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.
You have made total gifts of $62,000 in 2020, but fortunately for you, all of them qualify as annual exclusion gifts or are not taxable per 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 according to the unlimited marital deduction.
On the other hand, your spouse has made total gifts of $70,000 in 2020 that may or may not qualify as annual exclusion gifts: A total of $20,000 to Betty exceeds the $15,000 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 5,000 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 $15,000, 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 whether 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. If you do not agree to split the exemption on Betty's gift with your spouse, then your spouse will need to report a $5,000 taxable gift to the IRS using Form 709.
- An annual exclusion gift falls within the government's limits and is tax-free.
- The tax-free limit for 2021 is $15,000.
- Spouses have an unlimited threshold of tax-free gift giving.
- Married couples can double their tax-free giving to an individual by combining their limits.