Annual Exclusion

The annual exclusion is the amount of property the IRS allows a person to gift to another person during a calendar year before a gift tax is assessed and/or a gift tax return must be filed. The amount increases periodically, and as of 2018, it is set at $15,000. It raises along with the Consumer Price Index, but only jumps in increments of $1,000, so it will be a few years before there is another increase.

There is no limit to the number of people you can give gifts to which qualify for the annual exclusion. To qualify for the annual exclusion, the gift must be one that a recipient can enjoy immediately and have full control over.

The word “give” is a key word. Transfers to an irrevocable trust are generally considered a “gift” and the value of the gift is subject to the gift tax laws. You can give the annual exclusion amount without paying a gift tax. Anything above that will be taxed and eat away at your lifetime exemption amount (approx. $11 million as of 2018). When the exemption amount was a lot lower, the gift tax was a big deal for many folks. Now it isn’t a big deal for most folks. Except for Connecticut, states don’t have any type of gift tax.

I know some of you are thinking “the gift tax will never apply to me!”  Most folks are not giving away over $14,000 a year to anyone. However, you can get into a gift tax situation fairly innocently. For example, if you are helping your divorced daughter and her children by paying the house payments, insurance, and food bills, all those helps are “gifts” in the eyes of the IRS. If you put someone’s name on a deed, that’s a gift of the proportionate value of the property. For example, if you and your spouse are on the deed and you put a child’s name on the deed, that’s a gift of a third of the value of the property. You need to think like the IRS and see gifts the way they do.

In estate planning, giving large gifts could make a difference in the estate tax outcome. Some of us have given or received large gifts to make house down payments, so it is important that we understand the gift tax. Using a trust is an ideal way to “give” property to your heirs and yet not let them “have” it.  Once property has been irrevocably and completely removed from your asset structure, it is, of course, no longer considered a part of your estate. By making annual gifts to the trust, each under the yearly limit, you can give a lot of property to your heirs and still remain within the “annual exclusion limits.”  Thus, in many cases, a taxable estate can be moved to the position of a non-taxable estate by gifting into a children’s trust.

If you are trying to distribute parts of your estate so that there will be less of a tax on it after you die (see my article on unified taxes), remember that you can give the $15,000 to as many individuals as you want. Your spouse can also give $15,000 to as many folks as he or she wants. The $15,000 is just ignored for tax purposes. The person receiving the gift doesn’t report it. It certainly isn’t income to them. The person giving the gift just ignores it for tax purposes.

Technically, if a husband and wife each make a gift and the total is over $15,000, the couple needs to file a gift tax return that year and basically tell the IRS that they have made a “split gift.” The IRS may think that one person made a $30,000 gift rather than the real intention of each spouse making a $15,000 gift.

If you go over the $15,000, the amount above the $15,000 eats away at the $11 million you can pass under the estate tax laws. Gift and estate taxes are “unified,” so you’ve got a total of the $11 million to give away in life or at death. This tax will not be paid immediately; the lifetime exemption kicks in. IF you have less than $11 million in your total estate, it is very doubtful the IRS will ever come after you for whatever you do. When you exceed that annual exclusion amount, then you owe gift tax to the government, or at least the gift should be reported and some of your unified credit will be used to “pay” the gift tax. There are also exceptions for college education and some health care expenses. So, provided that you file a gift tax return, you will not actually have to pay gift taxes until you (or you and your spouse both) use up your unified credit lifetime exemption.