The Benefits and Applications of Annual Exclusion Gifts
We frequently receive questions from clients about the best ways to provide financial assistance to adult children and other relations. Our answer almost always starts with a discussion about if and how the client is taking advantage of annual exclusion gifts.
What Are Annual Exclusion Gifts?
An annual exclusion refers to the sum of money the IRS allows individuals to give to another person without triggering a gift tax. Currently, that amount is up to $18,000 per recipient, or $36,000 from a couple, within a 12-month time frame. This sum can be given to as many people you like. As long as you stay at or below that maximum amount, the giver does not need to file a gift tax return and the recipient does not have to report the gift as income and owes no tax on it. Additionally, these gifts do not count towards your lifetime federal estate tax exclusion which right now stands $13.61M per individual ($27.22M per couple).
Let’s look at an example to illustrate the wealth transfer benefits of this option:
Bob and Sarah have two children, both of whom are married, and three grandchildren. As a couple they can give each of their children, their children’s spouses and their grandchildren up to $36,000 a year ($18,000 per-person-per-year from Bob and the same from Sarah). This is a total of $252,000 of tax-free gifting per year across the seven recipients.
What qualifies as an annual exclusion gift?
To qualify as an annual exclusion, a gift must be what the IRS deems, “present interest in property.” In other words, it has to be in a form that the recipient can access and utilize immediately. A check or cash deposit of course qualifies but so do things like cars, land, stock or other assets. For example, if you want to give your adult child a car, the IRS will consider the fair-market value of the car (i.e., Kelly Blue Book value). If the car is worth less than $18,000, you (the giver) won’t need to disclose the gift. If it is worth more than $18,000 you will need to file a gift tax return (IRS Form 709) and the value in excess would count against your lifetime federal estate tax exclusion.
Contributions to 529 college savings accounts also count towards the annual exclusion. If you plan to contribute more than $18,000 in a single year, you may want to do what is known as “super funding.” This allows a giver to fund up to five times the annual exclusion gift max all in one year. You will still need to file an IRS Form 709 but there will be no gift tax consequences unless you exceed the annual maximum times five. This also means you cannot make additional annual exclusion gifts to that individual (or their 529 account) for a five-year period.
Be mindful that the value of ALL gifts made in a 12-month timeframe to any single individual count towards the $18,000 total. So, if you plan to contribute to a child’s 529 account and give gifts on their birthday and holidays all in the same year, you may want to keep monetary gifts well below $18,000 so that you don’t exceed the annual limit.
Additional considerations/things to know:
- Each person in a couple should write their own check to each recipient. While a married couple can gift a combined $36,000 per recipient/year, each spouse needs to write his/her own check for no more than $18,000. Taking this approach, as opposed to writing one combined check, prevents the giver from having to report this as a spousal “splitting” gift and thus file a gift tax return.
- If you are looking to help a child or relative more significantly, such as with the down payment of a house, you may want to consider structuring an intra-family loan. You can find more information about these private loans on our website here.
- Unlimited payments made directly to medical providers or educational institutions on behalf of others for qualified expenses are excluded from federal tax and do not count against your annual gift exclusion or your lifetime gift and estate exemption. For example, if you wanted to pay your granddaughter’s $40,000 college tuition, you could pay the university directly for her tuition and still give her an additional $18,000 tax-free. There are some restrictions so be sure to check with your accountant before proceeding.
- Gifts to qualified non-profit organizations are considered charitable donations so the annual exclusion maximum does not apply.
- In some cases, gifts to trusts set up for grandchildren and later generations could trigger the generation-skipping transfer tax (GSTT). Check with your estate attorney to make sure you structure gifts in a way that avoids this outcome.
- Annual exclusion gifts are not deductible on your income tax return.
State your intentions for the gift.
Gifts of money can lead to misunderstandings. Often the giver has preferences for how the money should be used that the receiver may not realize. To prevent confusion, gifts of money, particularly substantial sums, should come with a letter that outlines the hopes and intentions of the gift. It does not have to be extensive or overly restrictive but if your expectation is that this money, or at least a portion of it, will be set aside for savings or used for a specific purpose, say so. If the money truly is for your child or grandchild to allocate in any way they like, say that as well and then refrain from criticizing whatever choice is made.
Annual exclusion gifts enable parents and grandparents to provide limited but meaningful financial assistance. We welcome questions from clients about how to utilize this option in your own family.
The material shown is for educational purposes only and should not be construed as accounting, investment, legal or tax advice. Please see Altair Advisers’ Form ADV Part 2A and Form CRS at https://altairadvisers.com/disclosures/ for additional information about Altair Advisers’ business practices and conflicts identified. All investments are subject to the risk of loss.