What Is It?
The gift tax annual exclusion is a planning tool that individuals can use to reduce the size of their gross estates by giving gifts during their lifetime. The amount that may be given free of gift tax to any one person is subject to a limit that is indexed annually for inflation. However, there’s no limit on the number of people who may receive such gifts.
How Does It Work?
Every year, individuals may give up to the annual exclusion—to as many people as they want. The gross estate is then reduced by the total amount of these gifts.
For example, a man giving $14,000 to one person reduces his estate by $14,000. A woman who gives $14,000 each to five different people reduces her estate by $70,000 using the annual exclusion.
If the gift exceeds the annual exclusion amount, the donor can use their unified credit to shelter up to the currently allowed exclusion amount for taxable lifetime gifts or taxable estate transfers. Your Turtle Creek insurance specialist can help you determine the lifetime gift tax exclusion.
Gift-splitting permits married couples to elect to split a gift that is made from the separate property of either spouse. This allows them to double the annual exclusion available for the gift. For example, if Oliver wants to give his son $28,000 and the annual exclusion is $14,000, he and his wife Hannah could elect to split the gift so each can use their $14,000 annual exclusion. This scenario could be repeated in future years.
What Constitutes a Gift?
To qualify for the gift tax annual exclusion, the property being transferred must be considered a completed gift. This means that the transfer must meet three specific requirements.
- It must be gratuitous. The donor can’t receive consideration in return because it would then be considered a sale, not a gift.
- It must be complete. The donor may not retain any control over the property, such as retaining actual possession. Nor can the donor retain any power to revoke the gift.
- It must be voluntary. Giving the gift must be a voluntary act, not one that occurs only because a court of law or other legal authority requires the transfer, or because the transfer satisfies a legal obligation.
In addition, qualifying gifts must be of a “present interest.” This means that the person receiving the gift must have the right to enjoy the property immediately after the gift is made.
The gift tax annual exclusion can’t be used if the recipient’s enjoyment is delayed until sometime in the future, or by the need to get someone else’s agreement in order to exercise rights of ownership.
There’s an important exception: gifts to a 2503(c) trust for a minor qualify for the annual exclusion even though the minor beneficiary has a future interest.
What Are the Benefits?
The gift tax annual exclusion benefits both donors and recipients. The donor can reduce the size of the gross estate while avoiding the payment of the federal gift tax and ultimately, other taxes and costs associated with administering the estate. At the same time, the recipient receives money or other property that might otherwise not be available until after the donor’s death. And—with the single exception of a transfer made by way of a 2503(c) trust created for a minor—the recipient has immediate use of the gift.
Summing Up
The federal gift tax annual exclusion gives individuals and couples a tax-advantaged way to transfer property during their lifetimes to people who would likely be the ultimate recipients anyway. The donees can enjoy the property sooner, and the donors can reduce federal estate taxes.