Most of us with grandchildren love spoiling them with gifts. I know I do. Unfortunately, the government puts limitations on how much we can give our children and grandchildren. The vast majority of people I meet for the first time have no idea that there are limitations as to how much you can gift to another individual without having to report it and/or potentially pay taxes on it. We see people who gift their children and grandchildren cars, houses, and cash with no thought as to the potential tax consequences. You might want to be aware of these limitations as well as know something about how to accomplish what you are trying to do without accidentally racking up adverse tax consequences to you or your heirs.
Gifts that are not taxable:
- Annual Exclusion Gifts: In most cases, you may gift up to $14,000 per year to any individual without filing a gift tax return or paying any tax. If you split gifts with your spouse, the amount is effectively increased to $28,000; however, in the case of split gifts, the IRS requires you to file a gift tax return. (Remember, it is not only cash that would be considered a gift; it could be property such as a car or a valuable piece of jewelry)
- Normal Support: When you provide support to a minor child, it is not treated as a taxable gift if you have an obligation to provide this support under state law. This might include minor children, college-aged children, and special needs children.
- Qualified Tuition Programs: In the case of a qualified tuition program, such as a 529 plan, the annual exclusion of $14,000 can be effectively increased to five times that amount (i.e. $70,000 or $140,000 if you split gifts with your spouse). Keep in mind, this amount is not in addition to the annual exclusion limitation of $14,000 but allows parents or grandparents to make lump sum contributions, instead of having to spread them out over a longer period of time. Remember: if you choose to “front load” a 529 plan, you cannot also make annual exclusion gifts for the next four years without filing a gift tax return.
- Qualified Educational Expenses: You can make unlimited gifts for tuition purposes without gift taxes, as long as you write the check directly to the institution. You should not write the check to your child or grandchild and then have them pay their tuition bill; any amount over $14,000 (or if gift splitting with a spouse $28,000) would be considered a gift to the child for gift tax purposes. Also, things like books, fees, and board are not considered qualified educational expenses so the amount of those expenses would be considered a gift for tax purposes.
- Qualified Medical Expenses: You can make unlimited gifts for medical care, provided that the gifts are made directly to the medical care provider.
Income Tax Consequences
When you give a gift to your child or grandchild, the gift is not considered taxable income to the person receiving the gift. However, if you gift property and there is income produced by the property, there are potential income tax consequences. Or, if the property is sold by the child at a subsequent date, then there are potential tax consequences that should be considered:
- Income for support. If you gift income-producing property to your child, the income produced from that property will be taxed to you if that income was used to fulfill your legal obligation to provide support.
- Kiddie tax. If a child earns too much money from investment income, their earnings could be taxed at their parent’s income tax rate, rather than at their own rate. Children subject to the “kiddie tax” is generally taxed at their parent’s tax rate on any unearned income over a certain amount. For 2014, this amount is $2,000 (the first $1,000 is tax-free and the next $1,000 is taxed at the child’s rate). The kiddie tax rules apply to (1) those under age 18, (2) those age 18 whose earned income doesn’t exceed one-half of their support, and (3) those ages 19 to 23 who are full-time students and whose earned income doesn’t exceed one-half of their support.
Obviously, this rule came about to avoid parents gifting large sums of investment property to their children to avoid paying taxes as the parents’ tax rate. Keep in mind, if the child’s investment income would be taxed at the parents’ high tax rates, it may make sense to invest in ways that can produce nontaxable income (e.g., tax-exempt bonds) or defer taxation (e.g., Series EE bonds) until after the kiddie tax period.
- Cost Basis. When you make a gift, the person receiving the gift generally takes an income tax basis equal to your basis in the gift. (This is often referred to as a “carryover” or “transferred” basis.) The carried-over basis can be increased–but not above fair market value (FMV)–by any gift tax paid that is attributable to appreciation in the value of the gift (appreciation is equal to the excess of FMV over your basis in the gift immediately before the gift). The income tax basis is generally used to determine the amount of taxable gain if the child then sells the property. However, for purpose of determining loss on a subsequent sale, the carried-over basis cannot exceed the FMV of the property at the time of the gift.
- Taking Losses Before Transferring Property: If you have a property that would produce a loss if sold, you might consider selling the property, claiming the loss, and then transferring the proceeds to the child, rather than transferring the property to the child who would not be able to claim the loss.
As Mother Teresa said, “It’s not how much we give but how much love we put into giving.”