As a rule, the IRS treats any transfer of money or property you make to another person (vs. to a charity or to a political organization) as a taxable gift – unless an exclusion applies.
Three typical exclusions that may apply are:
- Gifts to a spouse, which are subject to an unlimited marital deduction unless the spouse is not a U.S. citizen;
- Tuition or medical expenses paid directly to an institution on another person’s behalf; and
- Gifts to an individual who is not a spouse (for example, a child) that do not exceed the “annual exclusion” amount available in that calendar year.
The annual exclusion – the threshold below which a gift to an individual who is not a spouse is not taxable – is $14,000 per gift recipient (“donee”) in 2017 and will increase to $15,000 per donee in 2018. A couple can effectively combine their gifts to give a child $28,000 in 2017 ($14,000 each) and $30,000 in 2018 ($15,000 each).
With additional planning, these exclusions can be used to increase the immediate impact of a gift without the person making the gift (“donor”) incurring gift taxes or reducing his or her lifetime estate and gift tax “exemption equivalency amount.” For example, parents of a married child can effectively give the couple $56,000 in 2017 ($14,000 by each parent to the child, $14,000 by each parent to the child’s spouse). Parents or grandparents can “super fund” a child’s 529 college savings account by each depositing up to 5 years’ worth of annual exclusion amounts – a sum of $140,000 in 2017 ($14,000 exclusion x 5 years x 2 donors). Certain requirements apply, so check with your advisors first.
If parents want to help an adult child buy a home or start a business with less debt, even larger gifts can be made by using a promissory note to repay the debt and forgiving certain portions of the debt each year. Done correctly, the parents incur no gift taxes and do not reduce their exemption equivalency amounts. However, we do not recommend you try this strategy without help from your lawyer and accountant.