From time to time a Millennial client will tell me that their parents want to give them money to buy a home or pay off student loans. After I congratulate them on having generous parents, we dive into the conversation of tax planning. They often wonder if the monetary gifts taxable to them or if the receiver of a gift pays taxes on it. This leads us down the road of talking about the gift tax. It is wonderful to be generous if you can afford it, but always be aware of the tax rules.
Here are the top 5 questions I get about the gift tax:
- What is gift tax?
Good question and great place to start! The gift tax is a tax on the transfer of tangible or intangible property (including money) from one person to another. - Do I have to pay taxes on a gift?
Generally, as the receiver you do not have to pay taxes on a gift. - So, who pays gift tax?
The giver generally pays the gift tax but it depends on how much is being given and when. However, they may only have to pay if they exceed the annual gift exclusion or lifetime exclusion which leads us to question 4. - What is the annual gift exclusion and lifetime exclusion?
The gift tax annual exclusion is the amount you can give to someone in a year and not have to worry about IRS paperwork. The IRS gifting tax rules state that for 2018, that amount is $15,000 per recipient. So if you give one person more than that you or your accountant will have to fill out a form. However, you can give $15,000 to each of your family members and close friends (can I be your friend?) and not have to deal with the forms.Also, if each of your parents want to give you $15,000 then they can do that as well because it is $15,000 per person not per couple or joint tax filers.The lifetime gift tax exclusion is the amount that you can give away during your lifetime or by your estate after you die before having to pay taxes. So each time you give away more than $15,000 to someone each year, that amount above $15,000 counts towards the lifetime amount of $11,180,000 for 2018. Basically you can give away a lot of money in your life without having to pay taxes if you do a little each year. But if you start giving away large chunks then you need to watch out for the gift tax. - What is the gift tax rate?
So if you are fortunate enough to have given away over $11 million then you may have to pay gift tax. Generally this happens as part of settling your estate after you die because the IRS then adds up everything you have given away during your lifetime plus the value of your estate. At this point, if you have to deal with estate and gift taxes you or your estate’s executor should just go find a good accountant. It gets messy fast. Would you expect less from the IRS?Let’s look at an example because the nuances here can be complicated. For the home purchase example, Matt and Stacy want to buy a home and need $150,000 for a down payment. Matt’s parents want to give them money for it. Mom and Dad could each give $15,000 to both Matt and Stacy for a total of $60,000 without hitting the annual gift tax exclusion. However, if they give more than $60,000 total to Matt and Stacy in one year, then the amount above that applies to their lifetime exclusion.
Other Special Gift Tax Rules
There is a special rule that allows the giver of the gift to spread it across 5 tax years. So if Matt’s dad just gave him $75,000 in one year, he could spread it over 5 years of gift tax returns so that he doesn’t hit his annual exclusion amount. But, that also means if he gives Matt any more money in those 5 years, it will count against his lifetime exclusion.
One creative way that families can help if they want to gift but not deal with gift tax issues is to pay for things directly like college tuition or medical bills. By paying the institutions directly, that does not count as a gift. A spouse can also gift money to their spouse without incurring gift tax as well.
Say your parents want to loan your money for a down payment on a house instead. They think that this will get around the gift tax rules. Well, not so fast because the IRS considers interest-free loans as a gift. Lending money to someone may not be the best idea because you get to deal with the IRS if they have questions about that loan.
That covers the basics of the rules surrounding gifting money to family members or others. If your parents or grandparents do want to give you money or you want to give someone a large gift, be aware of how much you can gift tax free. And know that most people can give to others without having to worry about gift taxes of the receiver of a gift paying taxes.
As always, having a good financial advisor and accountant team in your arsenal can make sure you don’t overlook any potential issues when gifting money to others. Never underestimate the value of a professional.