When a family member or friend is in financial need, and you have the means to do something about it, it can be hard to resist reaching for the checkbook. The impulse is a noble one, but it can lead to unintended and unnecessary tax consequences. If you make your gift using your head as your heart, you can benefit your loved one without harming yourself.
Here are some suggestions for structuring gifts in a way that will not incur gift tax or, down the road, expose your estate to estate tax.
As you probably know, you can gift a certain amount of value to another person without incurring federal gift tax. As of 2016, that amount is $14,000 annually. Gifts to all individuals are subject to gift tax laws, which means that even if your gift is to an adult child, you have to be mindful of gift tax.
What if, for example, your child wants to buy a home with their spouse, and you want to give them $50,000 for a down payment? There are a number of things you can do. You might make a gift to your child and another, separately, to your child's spouse. Your own spouse can do the same. As a couple, you are able to double your maximum gift without triggering gift tax. Thus, making separate gifts to each individual, you and your spouse could give them $56,000.
If the year is drawing to a close and you haven't made gifts totaling $14,000 to your child during that calendar year, you could also make one gift in late December, and another in early January for the next year.
What happens if you do make a gift that exceeds your gift tax exclusion amount? It's likely you won't receive a tax bill, but you will need to fill out a gift tax return, and the gift will be applied to your lifetime exclusion from federal estate and gift tax (currently $5.45 million per U.S. resident).
You've been watching your adult child scrimp to put their children through private school, or your sister struggle to pay both her mortgage and her medical bills. Is there any way you can help without triggering gift tax? Fortunately, yes.
If you gift anything other than cash, such as stocks or real estate, you should first talk to a CPA or attorney about the potential adverse capital gains tax consequences to your child when they sell the asset.
So long as you make payments directly to a qualifying educational organization or medical care provider on behalf of your loved one, you can make as large a gift as you need to without gift tax coming into play. You can also place money into a 529 plan for the educational benefit of a loved one, but there are rules specific to the use of such plans with which you should be familiar first. If you give your loved one cash instead, even if they immediately use it to pay their medical or tuition bill, that gift may be taxable.
If you gift anything other than cash, such as stocks or real estate, you should first talk to a CPA or attorney about the potential adverse capital gains tax consequences to your child when they sell the asset received by way of lifetime gift.
Avoiding gift tax is not the only issue you should consider when making a gift. If you or your spouse might need Medicaid to pay for long-term care, or want to qualify for Veterans' Administration pension benefits, you should be aware of those programs' "look-back periods." The look-back period is five years for Medicaid benefits and three years for VA benefits.
In a nutshell, in order to qualify for benefits, the agencies administering these benefits will look back at transfers made for a period of time prior to the application for benefits. If, during this time, you or your spouse have transferred away significant assets without receiving fair market value in exchange for them, the transfer may disqualify you from receiving benefits.
The transfers, regardless of your intent in making them, may be seen as an effort to reduce your net worth so that you will qualify for benefits. Unless you can prove otherwise by clear and convincing evidence—a high standard to meet—you may face a penalty period of up to 10 years during which you are ineligible for benefits. Annual exclusion gifts are counted by Medicaid in the look-back period, so don't assume that just because a gift isn't taxable, making it will not have a negative impact on you.
To learn more about how to protect yourself, your benefits, and your assets, request one of our free informational guides or contact an experienced Michigan estate planning attorney to discuss the wisest way to help loved ones financially.