What happens if a donor exceeds the annual exclusion limit?

When a donor exceeds the annual exclusion limit, the correct interpretation is that only the excess amount over the annual exclusion is subject to donor's tax. The annual exclusion allows donors to give up to a specific amount to as many recipients as they choose within a given year without incurring a gift tax or needing to file a return. If the total gifts to an individual exceed this limit, it is only the portion above that threshold that incurs tax liability.

For example, if the annual exclusion is $15,000 and a donor gives $20,000 to one recipient, the first $15,000 is excluded from gift tax considerations, while the remaining $5,000 is taxable and must be reported. This structure allows individuals to gift substantial amounts without immediate tax implications, only activating the donor's tax for amounts that go beyond the allowable limits.

Understanding this aspect of gift taxation is crucial for effective estate and financial planning, as it helps donors take full advantage of allowable exemptions without incurring unnecessary tax liabilities.