No doubt you want the best for your children; however, exactly what is the best way to gift money to them? In this post, we discuss the ins and outs of gifting money to your children while minimizing taxes.
There are many factors to consider before transferring your wealth to one or more of your children. To help you better understand the process, we spoke with GW & Wade Principal Darren M. Norton, JD, and a former estate planning and probate litigation attorney.
Annual & Lifetime Gifting Limitations
According to Norton, the first step is to understand the basic maximums you’re allowed to gift to your children without having to pay taxes. Currently, you’re allowed to gift $14,000 annually to each of your children tax free. This is your annual exclusion amount which is periodically increased by the IRS. Keep in mind that if you’re gifting as a married couple, then you’re allowed to gift up to $28,000 annually to each of your children, or to anyone for that matter.
If you wanted to help your son and daughter-in-law purchase a home, you can gift your son $28,000 and his wife another $28,000, annually.
Ultimately, you won’t need to pay gift taxes until you’ve reached what the IRS refers to as your lifetime exemption. Presently, it’s approximately $5.4 million per individual. If you’re married, your spouse can also gift up to $5.4 million over the course of his or her life without paying a gift tax.
Keep in mind that it’s only the amount over $14,000 annually that applies to your lifetime exemption, e.g., if you gift your child $15,000 cash this year, only the additional $1,000 applies toward your lifetime exemption.
Remember to File Form 709
Norton said, “whenever you gift more than $14,000 in any given year, you must report this gift by filing IRS Form 709.” You won’t owe taxes on your gifts until you’ve surpassed your lifetime gifting limit, yet you still must file this form with your annual tax return.
What can be excluded from gifts?
According to the IRS, the general rule is that any gift is a taxable gift1. However, there are many exceptions to this rule.
Generally, the following gifts are not taxable gifts:
- Gifts that are not more than the annual exclusion for the calendar year.
- Tuition or medical expenses you pay for someone (the educational and medical exclusions).
- Gifts to your spouse.
- Gifts to a political organization for its use.
- Gifts to qualifying charities are deductible from the value of the gift(s) made.
According to Norton, a recipient (also known as the donee) of your cash gifts never has to pay taxes on such gifts, nor is there a limit to the amount of cash gifts a recipient can receive.
Additional Gifting Considerations
If you’re looking to reduce the amount of income to report on your income taxes this year, Norton suggests gifting some of your appreciated securities to your children, specifically to one in a lower tax bracket, such as a child in college.
Even though your child will still need to pay capital gains when they sell the stock, they’ll likely pay a much lower tax given their lower tax bracket.
Front Load 529 Education Plans
According to Investopedia2, the IRS allows you to get around the $14,000 annual gifting limit once, by front loading a 529 plan for up to five years with no gift tax consequences. For instance, instead of contributing $14,000 per child per year, contribute $70,000 per child in the first year and treat it as if you gave $14,000 per year for each of five consecutive years.
Why do this?
Investopedia gives the following logic: Front loading $70,000 would compound to $168,463 at 5% over 18 years (compounded annually). However, if you contributed the same $70,000 over 18 years in annual installments of $3,889, the total would be just $114,877.
That’s $53,586 in lost earnings on your contribution.
Furthermore, if you were looking to reduce your estate tax obligation, front loading 529 plans is one way to go about it, added Norton.
Gifting Real Estate through Trusts & LLCs
Sometimes parents prefer gifting real estate to their children. However, this process isn’t as straightforward as giving your child $14,000 in cash annually. In instances when parents want to gift real estate, Norton will sometimes recommend that parents first establish a real estate trust or LLC, naming themselves and their children as members.
Then, the parents can gift a percentage of their ownership each year to their children. Parents often prefer this approach because they remain in control of the property for a longer period of time, as compared to just signing the deed over, said Norton.
As an aside, many older retirees will attempt to sign the deed over to their children in order to avoid Medicare consequences. However, this approach is not comprehensive, since it doesn’t take into account tax consequences, said Norton.
Emotions Surrounding Gifting
The large majority of parents try to be fair when gifting to their children, with the goal of having each child receiving the same amount of money. However, this isn’t always possible, said Norton. Instead, some children are more financially independent than others. In these instances, Norton will sometimes recommend that parents rebalance gifting within their will, leaving more to their children who require less financial support today.
“Some parents aren’t always comfortable gifting money to their children”, said Norton. For example, one of his client’s children needed help with a down payment for their home. The recently retired couple didn’t feel confident simply giving money to their child. Instead, they offered a short-term loan.
In this instance, the loan is usually for a term of five to seven years, and must require interest at no less than the IRS’s Applicable Federal Rate3. Otherwise, it’s considered a gift if there is no interest charged, ultimately impacting your lifetime gifting limit, said Norton.
Many investors are not impacted by the gift tax simply because of the large lifetime limit. Yet, there are many other factors surrounding gifting money to your children that need to be taken into consideration, such as how the gift impacts your overall financial and estate plans.
What’s more, the emotional makeup and age of your children should be taken into consideration, prompting the questions: Should I give a gift now while I’m alive so that I can see the impact of my gift? If I do, how many controls should I place on this gift? Or, should I simply leave an inheritance?
Clearly there are many issues to consider when contemplating gifts to children, regardless of their ages. If you have questions regarding gifting to your children or questions pertaining to any element of your financial life, please contact us.
The information provided above is general in nature and is not intended to represent specific investment or professional advice. Any results cited do not necessarily represent the experience of other GW & Wade clients. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship.
Clients of the firm who have specific questions should contact their GW & Wade Counselor. All other inquiries, including a potential advisory relationship with GW & Wade, should be directed to:
Laurie Gerber, Client Development
GW & Wade, LLC