Most gifts of money or valuable assets to another are considered by the IRS to be taxable to the person making the gift.
Under current IRS rules there are four ways to make tax free gifts that are not taxable to the person making the gift:
- Annual gifts capped at $14,000 (indexed for inflation)
- Lifetime gift exclusion ($5.45 million in 2016 indexed for inflation)
- Payments directly to an educational institution for the benefit of a student
- Payments to any person who provides medical care to another person
Gift Tax Exclusion
Section 2503 of the Internal Revenue Code of 1986 discusses gift taxes:
- A donor may give tax free gifts to any person without incurring gift taxes in any calendar year so long as the amount of the gift falls below the annual gift tax exclusion.
- The annual tax free gift exclusion is $14,000 in 2016 and is indexed for inflation.
- If the transfer exceeds the annual gift tax exclusion, the donor may elect to use part of the donor's lifetime gift tax exclusion ($5.45 million in 2016) instead of paying gift taxes.
- The gift tax exclusion is per donor, so a couple can together give twice the annual gift tax exclusion ($28,000) without incurring any gift tax liability.
- Any gift made in a calendar year which exceeds the annual gift tax exclusion must be reported to the IRS using Form 709.
Gifts In The Form Of Direct Payments To Educational Institutions
Under current IRS rules, a payment made directly to an educational institution to pay for the tuition of a student does not count as a gift to the student for gift tax purposes. For example, a grandparent can avoid gift taxes by writing a check to the college for their grandchild's tuition instead of giving the money to the student or the student's parents. But, such a payment may result in a significant reduction in the student's eligibility for need-based financial aid.
Accordingly, this strategy should be avoided if the student expects to qualify for need-based financial aid. In such a circumstance, a better strategy is to contribute the money to the student's 529 college savings plan. One could also wait until after the student graduates from college and help the student pay down his or her student loans as a graduation gift.
A side note related to contributions to a 529 college savings plan is that you are permitted to “bundle” five (5) years worth of annual gift exclusions in single lump sum contributions, which may be done every five (5) years without incurring gift tax. This means a single individual may contribute up to $70,000 ($14,000 x 5) into a 529 college savings plan for as many students as you choose. Married couples, therefore, may contribute up to $140,000 in a single contribution to a 529 every five (5) years. There are no gift taxes imposed on these gifts and you are not required to file a gift tax return.
Gifts In The Form Of Direct Payments for Another's Medical Care
You may also make unlimited tax free gift payments to any person providing medical care for another, as payment for the medical care received.
In certain cases, a transfer for the benefit of another person will not be considered a gift even if it exceeds the annual gift tax exclusion.
Exclusion For Certain Transfers For Educational Expenses Or Medical Expenses (Section 2503(e))
- In general, any qualified transfer shall not be treated as a transfer of property by gift for purposes of this chapter.
- Qualified transfer for purposes of this subsection, the term “qualified transfer” means any amount paid on behalf of an individual.
- as tuition to an educational organization described in section 170(b)(1)(A)(ii) for the education or training of such individual, or
- to any person who provides medical care (as defined in section 213(d)) with respect to such individual as payment for such medical care.