Many of our clients are in the fortunate position to be providing an inheritance to their children and grandchildren. While there’s comfort in knowing you’ll ultimately be helping your loved ones financially, lifetime gifts can provide a psychological reward you’ll never experience if you wait until after you die to pass your money on.

When discussing lifetime gifts, parents and grandparents often ask me about the best way to provide financial assistance to children and grandchildren. In many instances, there is confusion regarding how much a person could give another without running afoul of the gift tax rules. While it’s true the tax code puts a limit on the how much money we may gift each year without incurring gift taxes, that’s only part of the story.

According to the IRS, the general rule is that any gift is a taxable gift. However, there are certain exclusions that apply.  For starters, the annual gift exclusion allows us to give up to $15,000 (up from $14,000 in 2017) per recipient per year. Married folks are entitled to an unlimited gift exclusion when giving to each other, and they may “gift split” and give twice as much ($30,000 total) to each recipient each year.

Payments you make on someone’s behalf for tuition and medical expenses will also be excluded if your payments are made directly to the qualifying educational institution or medical care provider. Amounts you pay directly to qualifying institutions do not count toward the annual gift exclusion either.

A contribution to a 529 plan is not considered direct payment of education expenses, but does qualify for the annual gift exclusion. This is important to remember if you plan on making other gifts to the 529 plan beneficiary in the same year. One nice benefit to 529 Plans, is a special rule that allows you to contribute 5 years’ worth of annual gift exclusions at one time. For example, you may contribute $75,000 ($150,000 for married couples) to a 529 plan for one beneficiary and elect to treat the contribution as if it were made over five calendar years.

Don’t fret if you give, or want to give, more than the annual gift exclusion amount. There is a lifetime gift tax exemption that will allow all but the very largest gifts to be transferred gift tax free. In 2017, the lifetime gift exemption was $5.49 million, but the recent passing of the Tax Cuts and Jobs Act (TCJA) increased the gift tax exemption to $11.8 million beginning in 2018.  When a gift exceeds the annual gift exclusion, it is a taxable gift, but you may elect to use your lifetime gift exclusion  to avoid gift taxes. Anytime you use your lifetime gift tax exemption, you also reduce your estate exemption, which is an amount you may use to shield assets you pass at death from estate taxes. The TCJA increased the estate exemption to $11.8 million per person as well.

Here’s how it works. Let’s say you would like to give your son $100,000 to use as a down payment to buy a home.  $15,000 of your gift will be covered by the annual gift exclusion, but the remaining $85,000 will be considered a taxable gift. You’ll be required to file a gift tax return (IRS Form 709), but rather than pay gift taxes, you may elect to use $85,000 of your lifetime gift exemption. By doing so, you will reduce both your lifetime gift exemption and your estate exemption by $85,000, leaving a mere $11,715,000 for future lifetime gifts and estate tax-free transfers.

When it comes time to make a gift, the default gifting method for most is to simply write a check to the recipient. Sometimes, however, it’s to the donor’s advantage to give appreciated investment assets, such as stocks or mutual funds, rather than cash. The donor’s cost basis in the asset carries over to the recipient, so when the asset is sold, the gain and any associated tax becomes the responsibility of the recipient. 

Depending on income, a taxpayer’s capital gains tax rate will be 0, 15, or 20 percent. There is also the 3.8 percent Medicare surtax to consider, which may add to these rates for taxpayers with income over $200,000 ($250,000 for couples filing jointly). If you plan on selling assets to raise cash for the gift, make sure you compare the tax liability if you sell or if you gift the investments and your gift recipient sells.

When choosing between a cash gift or gift of investment assets, keep in mind that inherited assets receive a step-up in basis to the fair market value as of the date of death. This means, if your gift recipient would otherwise inherit the asset at some point, they could sell when they inherit for no taxable gain. 

Gifting appreciated investment assets may not work if the recipient is a college-aged or younger child as the “kiddie tax” rules, which trigger taxes on unearned income over $2,100 at trust tax rates, apply to children under age 19 and full-time college students under the age of 24.

Despite common belief, gift and estate tax laws allow us to give far more than the annual gift exclusion each year. For more information, take a look at IRS Publication 559, Form 709, and the instructions for Form 709.  

Securities and Advisory Services offered through The Strategic Financial Alliance, Inc. (SFA) – Member FINRA, SIPC.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary.  The SFA does not provide tax or legal advice.