The holiday gift-giving season may be over, but that doesn’t mean that we are done giving — especially when it comes to our children. Keep in mind that giving gifts, even to kids, can have tax consequences.
I don’t know about you but my living room was a mess this holiday season. The floor was covered with toys and games and wrapping paper — remnants of a present spree brought on by friends and family.
But just because something doesn’t come with a bow on top doesn’t mean it’s not a gift. So far as the IRS is concerned, a gift is “[a]ny transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” In other words, anything that you give or sell for less than fair market value can be a gift.
This definition matters because gifts — even to children — can have tax consequences. While making a gift generally doesn’t affect the giver’s federal income tax (since gifts, other than charitable donations, are not deductible), there may be federal gift and estate tax consequences.
What’s considered a taxable gift?
For federal gift and estate tax purposes, the person making the gift is generally responsible for reporting the gift and paying any tax due. The basic rule is that any gift — no matter how big or small — can be considered a taxable gift. It’s easy to think that the gift tax won’t apply to you if you aren’t in the habit of writing big checks but don’t be fooled. Smaller gifts, like the Timex watch you just bought for Christmas or the football jersey you picked up for a birthday present, count toward the total, too. Additionally, consider money for college, funding a trip abroad, handing over the keys to a new car (even if it’s not new to you) and helping to furnish a home or apartment: It all adds up.
Each calendar year, the IRS allows you to make gifts, tax free, up to the exclusion amount. For 2013, the annual exclusion amount is $14,000 which means that you can gift that amount to as many people as you want without triggering tax, whether you give $14,000 to one person or $14,000 each to a thousand people. If you’re married, you can split gifts by combining your exemption amounts, allowing you to pass up to $28,000 per person per year.
Certain gifts don’t count toward the annual exclusion amount such as those to your U.S. citizen spouse or to charity. The exception also includes gifts for tuition or medical expenses so long as the institution is paid directly. This is a great option, in particular, for grandparents who want to help out with educational expenses. Assuming that the check is written directly to the school for tuition, the gift doesn’t count toward the total.
If you want to make a cash gift to a child now, Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts can be a good way to establish a bank or investment account for a child’s benefit. In most cases, those accounts can be funded with any amount of money. Depending on state law, money that is contributed to a UGMA/UTMA account is managed by an adult custodian on behalf of a child until the child is no longer a minor.
Saving for college
A 529 college savings plan is also a good way to invest now for the benefit of a child. Money which is gifted to a 529 college savings plan grows federal income tax free so long as the money, when actually withdrawn, is used for qualified higher education expenses. Plans also offer flexibility: If the child designated on the account decides not to go to college (or is the recipient of a scholarship and doesn’t need the money), you can use the account for another member of the family, including children, grandchildren, siblings, spouses, nieces, nephews, aunts, uncles, cousins and in-laws. The benefits of 529 plans vary by state and can include income tax benefits.
Finally, trusts can be a terrific way to put aside money for the benefit of a child. Trusts don’t have to be funded with millions of dollars; depending on the circumstances, they can be funded with any amount of money during lifetime or funded at the death of a parent or grandparent through a will or designation of beneficiary account (such as life insurance). It’s worth noting that you should exercise care when making gifts to trusts since, depending on the terms of the trust, those gifts may not count toward your annual exclusion amount.
We all love to make gifts, especially to our children and grandchildren. Since gift tax rules — and trust laws — can be complicated, and depending on the type of account, can differ from state to state, it’s a good idea to consult with a professional advisor before taking out your checkbook.