Be Generous and Smart

Tax-Free Family Gifts

Do you have someone in your family who could use some financial help? Are you able and willing to provide it? Don’t get out your checkbook without first considering the most tax-advantaged way to help. Without research and planning, your generosity could cause you unnecessary taxation. While estate taxes govern taxation on assets after your death, gift taxes govern what you can give away during your lifetime. Let’s examine ways you can help your family without hurting your own finances.

Exclusions and Exemptions
Within current guidelines, you can still give to your family and friends without facing gift taxes—as long as you keep an eye on exclusions and exemptions.

Gift Tax Annual Exclusion – The federal tax law allows you to give up to $13,000 annually (per recipient in 2011) to an unlimited number of individuals—with no tax or reporting obligations.

Gift Splitting – Married couples can gift up to $26,000 (per recipient in 2011) each year using their gift tax annual exclusions.

Lifetime Exemption – The tax law also provides a lifetime gift tax exemption ($5 million in 2011). This allows you to give away as much as a total of $5 million to family and friends over your lifetime without owing any federal gift tax. If you are married, you and your spouse each are entitled to a separate credit. You can use any or all of the credit to offset taxes on gifts, and the amount you have used will not be available to offset taxes on your estate.

This means that gifts made under the $13,000 exclusion will not use up any of your lifetime gift tax exemption. However, any gifts you make over the $13,000 limit per individual, per year, will reduce your lifetime exemption.

Other Options
Beyond those exclusions and exemptions, there are other tax-free ways to help:

Education Savings
Another possibility might be to make tax-free contributions to the 529 college savings plan of a beneficiary. In one year, you may invest as much as $65,000 ($130,000 if you split the gift with your spouse) in a 529 plan. However, that $65,000 will be treated as if it were a series of $13,000 gifts made over five years. As a result, you won’t be able to make any other tax-free gifts to that person during that five-year period.

College Tuition and Medical Expenses
There are no limits on the amount of these expenses you can pay, as long as you give the money directly to the medical provider or the educational institution where the expenses were incurred.

Loans
You can loan money to family members at a lower interest rate than they would have to pay a bank. To avoid gift taxes, it’s important that you follow the required processes and impose the stated interest rate.

Homes
It’s unclear whether letting someone live rent-free in a home you own is considered a “gift” by the IRS, and therefore subject to gift taxes. You could avoid the issue by making them a part-owner in the home.

When to File a Gift Tax Return
A return is generally needed only when you make a gift of more than $13,000 to any person (other than your spouse) in one year. Your gifts can be cash, securities or other property, but as long as their combined value is $13,000 or less per year, per recipient, no federal gift tax applies and you don’t have to file a gift tax return.

Under current law, you won’t have to pay federal gift tax until all taxable gifts made during your lifetime exceed $5 million. You may want to file a gift tax return for a hard-to-value gift, even when a return is not required. Why? If the transfer is adequately disclosed, the IRS has only three years to challenge the valuation. Without the gift tax return, the IRS could dispute the valuation later when your estate tax return is filed (and justification is much more difficult), potentially forcing your family to pay substantial back taxes.

Generous and Smart

Making gifts while you’re still alive can help your family when they need it most—and if you plan wisely it can also help you avoid or minimize future estate taxes. Your financial advisor can help you make smart decisions to benefit your family and friends, while also keeping your own financial goals and taxes in mind.