Annual Gift Tax Exclusion

Congress wanted to tax the transfer of only sizable gifts, so it created an exclusion for smaller ones. Gifts that do not exceed the amount of the exclusion are never taxable.

The gift tax annual exclusion is a dollar amount, which can be adjusted annually for inflation. For 2011, the exclusion is $13,000. The exclusion applies per recipient per year, so that you can give your child, your best friend, your cousin, or a stranger on the street up to $13,000 in cash and/or property in 2007 with no gift tax concerns. (Property’s value on the date of the gift, not what you paid for it, determines the amount of the gift.) There is no limit on the number of exclusion gifts you can make each year or during your lifetime.

Example: You have three grandchildren, two of whom are married. You can give away $65,000 to them in 2011 ($13,000 for each grandchild, plus $13,000 for each of the grandchildren’s spouses).

If you give money to a 529 college savings or prepaid tuition plan on behalf of someone else, this is viewed as a gift. However, under a special rule solely for this purpose, you can opt to make a gift up to five times the annual exclusion without any current gift tax. The gift is treated as if you’d made five equal annual gifts.

Example: In 2011, you give $60,000 to your grandchild’s state tuition plan. You are treated as having made five $13,000 gifts covering years 2011 through 2015.

The annual exclusion applies only to gifts of “present interests.” This means cash and property that recipients can immediately enjoy. Gifts of future interest, such as interests held in trust for a recipient for a future time, cannot be sheltered by the exclusion.

Married couples can each use an exclusion. If one spouse, however, has money and property in his/her own name, the other spouse can consent to make a joint gift, allowing the spouse with the assets to effectively obtain a double exclusion. Say you have $26,000 in a bank CD that you want to give to your grandchild. If your spouse consents to the gift, each of you is treated as having made a $13,000 gift to the grandchild, sheltering the entire transfer.

Generally, gifts fully covered by the annual gift tax exclusion do not have to be reported to the IRS. However, joint gifts must be reported on an annual gift tax return, Form 709, even though they may be tax free.