Every year, the IRS sets an amount of money that a gift-giver can give to a recipient free from taxes. That amount is called the annual exclusion.
In 2018, the annual exclusion will be $15,000 (in 2017 it is $14,000).
Contributions to 529 plans, Coverdell ESAs and UGMA / UTMAs are all treated as gifts, subject to annual exclusion amounts. If you’re not sure which college savings account is right for you, our interactive college savings guide will walk you through the best options for families like yours.
Example: Two parents give $30,000 to each of their children in 2018 ($15,000 annual exclusion * 2 gift-givers = $30,000 per recipient).
If you want to keep your tax & financial life simple, you can just never exceed the annual exclusion amount with your gifts, and you'll have no gift taxes due and no extra paperwork to complete.
What happens if you gift more than the annual exclusion?
When you gift more than than annual exclusion, you need to file Form 709: United States Gift (and Generation-Skipping Transfer) Tax Return.
There are a number of different reasons you might file a Form 709 and we won't get into all the detail here - we highly recommend consulting a professional tax advisor if you're contemplating potentially taxable gifts or filing a Form 709.
We'll highlight one particular use of Form 709: when you accelerate up to 5 years' worth of gifts to a 529 plan.
Example: Two parents contribute $150,000 to their child's 529 plan under this 5 year option. (2 gift-givers * $15,000 annual exclusion * 5 year acceleration)
If you're not availing yourself of a particular tax strategy, such as the 5-year accelerated gift to a 529 plan, you'll have the option to start "using up" a different type of exclusion: the basic exclusion amount. The basic exclusion amount is the amount of your estate that you can pass to others without incurring estate tax.
In 2018, the basic exclusion will be $11,200,000 (in 2017 it is $5,490,000 - note that the new 2017 tax law increased it). Remember that this is per individual (not per couple). (Note that current tax bills contemplate abolishing or nearly doubling this amount, but the new rules are not yet agreed upon or finalized.)
The basic idea is that the IRS will look at your would-be taxable gifts (the amount by which you exceeded applicable annual exclusion amounts), but then allow you to apply your basic exclusion amount and "use up" a portion of that amount.
For most people, that means that they will not actually owe tax. (Because net worth is less than the basic exclusion amount.)
There are other strategies requiring a Form 709 where you do intend to pay gift tax to affect a particular transaction, but those are topics for future posts!
There's obviously a ton of detail to the Form 709 that we're glossing over in the interest of illuminating basic concepts, but the instructions for Form 709 will take you through all the (gory!) detail, if you want it!
As always, we highly recommend consulting a qualified tax advisor!