Americans are notoriously generous, both with their money and their time. Our government recognizes two basic forms of gifts: gifts to Qualified Charities and gifts to individuals. The former may provide some tax incentives, but care must be taken to ensure compliance with the Tax Code. IRS publishes a list of Qualified Charities in Publication 526, available on the IRS website. Tax deductions are allowed for gifts to those charities, subject to the gift givers’ tax status, which is explained on the IRS website.
The second form of gift-giving takes place between individuals. In every personal gift transaction, there are two sides—the giver and the recipient. From a tax standpoint, the recipient is the winner, as gifts are not considered taxable income under the U.S. Tax Code. Any and all tax liability falls on the gift giver. Note that we are discussing gifts made in lifetime, rather than inheritance.
Under the Tax Code, any real person can give any other real person (this simply means that entities such as trusts do not qualify) a certain amount of money in any calendar year, tax-free. This annual limit is indexed for inflation, and currently stands at $18,000. These gifts will likely not ever be challenged, although the giver should keep complete and thorough records.
Gifts to an individual in excess of the annual limit are allowable, but to avoid the giver being taxed, a Gift Tax Return must be filed (IRS Form 709), which will credit the giver’s lifetime exclusion amount, currently $13.61 Million. Other gift-giving methods are available, and some are important when the recipient is a minor. One of our favorites is 529 College Savings Programs, which are available in various states to all Americans, regardless of residence.
Contributions are limited by the annual non-taxable gift tax maximum, although up to 5 years of contributions may be made upon account opening. Further contributions may then be resumed starting in year 6. Used correctly, the 529 will supply tax-free payments for qualified higher education expenses for the beneficiary. Keep in mind, however, that contributions to a 529 Plan (or other Educational Funding Plan) are not federally tax-deductible.
Far more complex options for personal gifting exist, but they generally involve attorneys creating trusts, for which fees will be charged. Again, neither the contributions nor the attorney’s fees are tax-deductible. Maintaining control of funds in the account is the main highlight of this method of giving, aside from obvious financial benefits to the recipient.
In short, there are no perfect giving options, meaning that if taxes are involved, any tax will only affect the giver. Therefore, when considering making gifts, it is wise to have a thorough discussion with a knowledgeable planner and/or attorney. We recommend a fee-only Certified Financial Planner®.
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