Occasionally a client will discover that they really do have more money than they are likely to need during their lifetime. Often they will want to help their kids who might have incurred education, medical or other debts. Most clients know that they can give some amount each year and not have to pay any gift tax. How much is that? In 2013 the annual exclusion from gift tax is $14,000 per person. That means you can give $14,000 gifts to as many people as you want and still not have to pay any gift tax in 2013.
Well that is fine if your children’s debts are small enough. But what if they are larger? Do you just give them $14,000 each year until the debt is paid off? Yes, you can do that. And if you are married both you and your wife can make gifts, so you could give $28,000 each year. Or if your child is married, you and your wife could give $28,000 to each of them for a total to the family of $56,000. But there is another alternative. That is to use your lifetime gift tax exclusion. As of 2013 the lifetime gift tax exclusion is $5.25 million per person. In this case the “per person” means the person making the gifts. But this exclusion does not include any gifts you make each year to people at a level below the annual exclusion gift tax amount.
The one key thing to remember when making a larger gift is that the IRS expects you to keep a running tally of gifts applied against this exclusion and report these gifts on a gift tax return (Form 706) so it will know how much has already been used up when you die. So if your children have $100,000 of debt, you can give them $100,000 gift in one year, but you will have to file a gift tax return that year so that you can advise the IRS that you are using some of your lifetime gift tax exclusion. Remember, having to file a gift tax return doesn’t mean you have to pay the tax; this is just a reporting requirement.
A few cautions:
- Make sure kids are not simply going to run those debts up again. If the debts your kids have are the result of routine shopping and use of credit cards, you may want to ensure they have a “credit abuse” recovery program in place before you make your gift.
- Government benefit program problems. If you need to apply for government assistance within a few short years (five or sometimes fewer), those gifts may still be considered as part of your resources even though you no longer have them.
- Reduction in estate tax exclusion. In addition to a lifetime exclusion from gift tax, there is also lifetime exclusion for estate tax. Both of these exclusions are $5.25 million in 2013. But when you use up part of your lifetime gift tax exclusion it also will reduce the lifetime estate tax exclusion. For example, if you have used $1 million of the gift tax exclusion to make taxable lifetime gifts, the unused exclusion if you die in 2013 will be $4.25 million, rather than $5.25 million.