DEFINITION of Annual Exclusion

Annual exclusion is the amount of money that one person may transfer to another as a gift without incurring a gift tax or affecting the unified credit. This amount can be transferred in the form of cash or other assets.

BREAKING DOWN Annual Exclusion

The annual exclusion applies to each gift made. For example, if grandparents gift several thousand dollars to each of their grandchildren, each amount will be considered for an annual exclusion separately. For 2018, the Internal Revenue Service (IRS) announced the annual exclusion as $15,000. This is up from $14,000 in 2014, 2015, 2016 and 2017. While any gift is generally a taxable gift, exceptions do exist. For example, the following gifts are not taxable:

  • Gifts that are less than the year’s annual exclusion
  • Tuition or medical expenses
  • Gifts to a spouse
  • Gifts to a political organization

Gifts to qualifying charities are also deductible from the value of the gift(s) made. Otherwise, taxpayers cannot deduct the value of gifts they make. IRS Publication 559, Survivors, Executors, and Administrators lays out the specifics in this regard.

To be approved for an annual exclusion, taxpayers must submit copies of appraisals, copies of relevant documents regarding the transfer, and any documentation of unusual items shown on the return (such as partially-gifted assets).

Annual Exclusion and Estate Tax Exemption

While the annual exclusion applies to gifts among living parties, estate tax exemption is what you are allowed to pass on to heirs or beneficiaries after you die. In 2018, the estate tax exemption is $5.6 million per individual, up from $5.49 million in 2017. For a married couple, the threshold is $11.2 million.

Annual Exclusion and Wealth Management

Annual exclusion and estate tax exemption are often considered as part of a larger wealth management plan or estate plan. A high net worth individual (HNW), for example, could enlist the support of a wealth management firm or independent financial advisor to determine how best to allocate financial and other assets via gifts or in a will in order to avoid heavy tax penalties.

A will is a legal document that provides clear instructions on how an individual’s property and custody of minor children, if any, should be handled after death. In a will, an individual expresses her wishes and names a trustee or executor to fulfill the stated intentions. The will can also indicate whether a trust should be created after death. If a will includes instructions on gifts, this section will determine any tax liabilities for the estate or beneficiaries.