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Gifting Money to Family Members while Reducing the Tax Implications
For many clients, an important aspiration is supporting their families financially, however, doing so may have unexpected tax implications for them. This blog offers a few remedies so you can keep your clients on the path to supporting their families while not creating a huge tax burden.
By Angie M. Stephenson, CPA, PFS, CFP
For many clients, an important aspiration is supporting their families financially, however, doing so may have unexpected tax implications for them. The Internal Revenue Code (IRC) imposes an annual limit for making tax free gifts to individuals, and going above this exclusion may create gift tax consequences and count against a client’s lifetime gift and estate exemption. This blog offers a few remedies so you can keep your clients on the path to supporting their families while not creating a huge tax burden in doing so.
Annual Gift Exclusion
For 2022, an individual could give away up to $16,000 directly to any individual free of gift tax consequences. The number of individuals one may gift to is unlimited. If a client is married, the couple together may give away up to $32,000 per individual recipient. The receipt of a gift is not taxable for income tax purposes by the recipient, nor is it tax deductible for income tax purposes by the donor.
Many people think the gift tax exclusion only applies to family members, but this gifting limit applies to anyone: a friend, coworker, or someone from church. For example, if a client is a married couple who wants to gift the maximum under the annual exclusion to a married son, daughter-in-law, and friend, they could gift a total of $96,000 ($16,000 from each member of the couple to each of the three recipients) free of any gift taxes.
According to the IRC, to qualify as a gift that is eligible for the annual exclusion, it must be “of present interest” – that means not for a later use, not with conditions or strings attached, etc. It must be an outright gift. If in a trust, the trust must contain certain conditions for the gift to be deemed one of a present interest.
There are two ways to reduce gift tax implications if gifting above the annual exclusion amount while also not using any of a client’s lifetime gift or estate tax exemption.
Qualified Tuition
One way for clients to support family or loved ones is to help pay for educational costs.
The IRC allows for any payment directly made to a qualified educational institution to be a qualified tuition exclusion over and above the annual gift exclusion. Qualified educational institutions could include private schools, colleges, and technical schools. A client cannot write a check to an individual family member or friend to qualify, but he or she can pay the amount directly to the institution with no effect on the client’s annual gift exclusion. This applies to tuition only, however, not the additional expenses often paired with pursuing education such as books, additional fees, or room and board.
Qualified Medical Expenses
Another way to support the important needs of loved ones is by helping them defray medical costs.
Those costs could be from any number of providers: dental, orthodontia, mental health, medical specialties, and rehabilitation needs, for example, would all qualify. Similar to the qualified tuition exclusion, all payments must be made directly to the medical provider or organization, and not to the individual. If this is done, payments on behalf of another individual directly to the health care provider will not reduce the annual gift exclusion for the individual or otherwise use the client’s lifetime gift and estate exclusion.
Large or Small
These techniques don’t have to be used for major dollar amounts, either. Even small needs can be met via the direct-payment method without affecting the client’s annual exclusion.
If clients decide to gift amounts over the annual exclusion limit in a calendar year, it will use up their lifetime gift and estate tax exemption. For 2022, the gift and estate tax exemptions are a combined $12.06 million per person. Congress may dramatically decrease this exemption amount, potentially by half, in the near future. If an individual were to go over this gift or estate tax exemption amount, the gift will be deemed taxable at a federal rate of 40% (or higher depending on future law changes) on dollars gifted above the lifetime exemption limit.
Angie M. Stephenson, CPA, PFS, CFP, is partner, chief operating officer, and senior wealth adviser for Domani Wealth in Lancaster, Pa. She can be reached at angie.stephenson@domaniwealth.com.
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