By default, high-priced gifts are taxable under the IRS rules. However, there are exemptions to this rule.
Now, you can spoil your loved ones and even people you don’t know with lavish gifts without tipping the gift tax radar.
How? Pay tuition or medical expenses. The recipient can be your grandchildren, the children of your grandchildren, a friend, or a total stranger.
First, let’s have a rundown of the tax exclusions for gift and estate tax.
For the year 2020, the maximum amount for tax-free gifts is $15,000 annually and $11.58M for a lifetime exclusion under the Tax Cuts and Jobs Act of 2017. The number of persons is unlimited.
Additionally, spouses can give a gift to the same person, effectively increasing their tax exclusions to $30,000 annually. The lifetime exclusion is also doubled, which amounts to $23.16M.
No Gift Tax Liability on Tuition Payments
You can pay tuition without paying a gift tax to another person in one condition. You must pay the check directly to the educational institution on behalf of your benefactor.
These payments are limited to tuition. Gifts made to pay for books and other miscellaneous educational fees are still tax-free. The amount must not exceed the maximum amount.
College tuition payments for your children aren’t gifts. But, they may be treated as tax credits under the Lifetime Learning Credit or education-related tax credits.
Scenario. Grandma Amanda writes a check to her grandchildren, Bethany, Chloe, and Dexter, annually for their tuition. The check amounts to $20,000 for each child.
The $15,000 is tax-free. The remaining $5,000 is either non-taxable or taxable under the gift tax rate. It’s non-taxable if you opt to charge the amount to your lifetime exclusion. If you do, the amount decreases by $5,000.
Qualified Educational Institution
An educational institution can either be a primary, secondary, college, or university. A foreign university is also an accepted educational organization.
Will gift payments to a martial arts school, yoga school, or any other similar schools qualify as tax-free transactions?
According to IRS, an educational institution must have the following features to qualify as such:
- a regular curriculum
- a regular faculty
- regular attendance of classes of enrolled students
So, yes. A martial arts school or a yoga school is considered an educational institution if it possesses all the characteristics above. You can always consult an expert opinion on the matter if you’re not sure.
Gift in Trust
Some grandparents gift their grandchildren with a trust fund for their education expenses. This gift in trust for tuition payments is acceptable and can also qualify as a tax exclusion.
Scenario. Now, Grandma Amanda wants to avoid tax liability but still wants to spoil her grandchildren with gifts. To achieve a tax-free year for gift-giving, she must write the check directly to the educational institution.
The IRS doesn’t specify a limit. Thus, she can write a check as high as a hundred thousand dollars in the name of the school.
If Grandma wants, she can still give her grandchildren gifts amounting to $15,000, tax-free. Moreover, she can also bestow a gift in trust or Crummey Trust for her grandchildren. This amount is still tax-exempt.
The 529 Gift
Another way to bequeath gifts without paying liability is to enroll for a 529 contribution plan. This plan is an excellent way to prepare for the college tuition of your grandchildren (or children for that matter).
You can opt for a 5-year election for a lump sum contribution, which allows you to distribute the amount over the years. In case your original beneficiary doesn’t pursue college, you can name another beneficiary.
Scenario. Instead, Grandma Amanda avails of a 529 contribution plan for her grandchildren. She doesn’t pay the gift tax if the plan is up to $75,000, lump-sum payment.
Why? Because she can opt for a 5-year distribution. Each year, she can claim $15,000 (75,000 divided by 5 years) as gift and estate tax exclusions.
If she gets a plan for each grandchild, she can avail $45,000 ($15,000 multiply by 3 grandchildren) as tax exclusions for all her grandchildren.
No Tax Liability on Medical Payments
Aside from tuition payments, you can gift someone through his or her medical expenses. For a tax-free gift, pay the amount directly to the medical care provider or the insurance company. The amount is unlimited.
Scenario. One of the grandchildren of Grandma Amanda, Bethany, got sick and was confined to a private hospital. Bethany’s parents incurred $75,000 in medical expenses.
Since Grandma Amanda is generous, she pays for the medical expenses directly to the hospital. To avoid undue medical expenses, Grandma paid insurance of $15,000 for her grandchild, Bethany.
For tax purposes, Grandma can avail of the payments to the medical institution and insurance provider as tax exclusions.
Qualified Medical Expenses
A medical expense is considered a tax exclusion if it meets any of the three criteria:
- The expense is for diagnosis, treatment, mitigation, or prevention of disease.
- When the expense aims to affect function or structure in your body.
- The expense is for medical care, such as transportation and lodging.
For specific details, you can check the qualified medical expenses used for an income tax deduction. The list is the same.
Reimbursed medical expenses from an insurance company disqualify a gift as tax exclusion up to the amount reimbursed. When the benefactor receives an insurance reimbursement, he or she must return the equivalent amount. Otherwise, the amount is subject to tax, net of the exclusion if applicable.
Scenario. The parents of Bethany received an insurance reimbursement, amounting to $20,000 after Grandma Amanda paid for the medical expenses. As a favor to Grandma’s generosity, they returned the money.
The difference of $55,000 is non-taxable since Grandma made the payment directly to the medical institution. The $20,000 is subject to the qualifying requirement for tax exclusions.
Since the maximum tax exclusion is $15,000, the remaining $5,000 is taxable if Grandma doesn’t want to charge the amount to her lifetime exclusion. Otherwise, it’s non-taxable.
How and When to File
Filing is necessary if the amount of gifts exceeds the maximum limit. For filing, the form is 709, and the due date is on or before April 15.
You and your spouse can’t file jointly, but you can “split” the amount, regardless of who gave the gift. When splitting the amount, your spouse must give consent to the arrangement.
Filing a return doesn’t necessarily mean you’re paying a tax liability. It means you’re telling the IRS to charge the excess amount to your lifetime exclusions or that you’re splitting the amount with your spouse.
Key Takeaways on the Gift Tax
A gift tax should never stop you from giving gifts because of the lucrative tax breaks. However, when you want to gift your loved ones and never want to pay liability, remember these important things.
One, gifts should be within the limit, which is $15,000. Any excess is charged to your lifetime exclusion.
Two, the gift and estate tax exclusion is an aggregate number. It is the same number used when the government computes your estate tax when you die. So, plan carefully.
Lastly, never underestimate the power of an expert opinion. Always consult a professional if you aren’t sure what to do.