Rules On Gifting Money To Family Members You Must Know About
Rules on gifting money to family help the donor know about tax exclusion and other legal provisions. Up to $17000 can be gifted annually to avoid gift tax.
Humans have been helping each other out ever since the dawn of society. Exchanging gifts has been one of our primary traditions for thousands of years.
During the holiday season or any other festival, parents love giving gifts to their children as a way to reward them for being good. Money is considered a suitable item to gift to a beloved family member.
While in the past giving money during special occasions was frowned upon as it reflected the donor's unwillingness to give a thoughtful present. However, in recent years, gifting money has turned out to be an icebreaker. Gifting money directly removes you from making unnecessary assumptions about what the donee wants as the other person can buy anything they want with the cash.
So, why not gift money directly and save yourself from the hassle of having to come up with a unique idea? There are a few factors to be considered before gifting money to a loved one.
Rules To Remember Before Gifting Money To Family
Rules on gifting money to family include factors like legal tax provisions and the nature of gift.
An individual can give any amount of money to their loved ones from a few dollars to hundreds of thousands. However, we'll only be considering monetary gifts big enough to attract the attention of tax collectors.
As suspected, the Internal Revenue Service (IRS) will demand taxes on many types of gifts. Still, there are multiple legal provisions that exempt certain gifts from taxation.
Tax Exemption Allowed By Federal Tax Laws
In the US, the IRS is tasked with imposing various taxes, including gift tax. In the case of gifts, the tax rate ranges from 18% to 40% on the value of the present.
However, it doesn't mean all gifts are taxable. The federal government has provided various tax exemptions if the transaction falls under a certain category.
For instance, the IRS grants an annual tax exemption on monetary gifts of $17 thousand per person for an individual tax-payer in 2023. For example, if you are planning to gift money to four family members, you can give $68 thousand [$17 thousand to each] without paying a gift tax.
Even if the gift amount exceeds $17 thousand for a single person, the donor doesn't necessarily have to pay a tax. The IRS also grants a lifetime gift tax exclusion amount, which is $12.92 million in 2023.
If a person gives $20 thousand to a family member, $17 thousand is exempted due to the annual exclusion. Meanwhile, $3 thousand is deducted from the lifetime exclusion amount.
Similarly, if a couple is planning to provide a monetary present to the family, they can jointly file an annual exclusion amount of $34 thousand per recipient.
Under the marital deduction, you can give any amount of money to your spouse without paying a gift tax. But, the exemption is only allowed if your partner is a US citizen.
Gift Tax Law
The Gift Tax Law was introduced by the US Federal Government in 1924. It was originally implemented to tax rich families who were trying to skip estate taxes by transferring real estate to the next of kin.
The gift tax is not limited to money as various assets are also subjected to the law, including real estate, stock shares, bonds, trust funds, and/or other financial assets.
The tax doesn't distinguish between family members and non-family members. It is imposed if a transaction has taken place between two people who might or might not be family members.
IRS Estate Tax
The estate tax is levied when a property or money is transferred from a deceased person to the heir.
The tax is imposed on the decedent and must be paid from the assets of the deceased before the transfer. Meanwhile, the recipient could also agree to pay the tax.
In many cases, the recipient doesn't have to pay a single penny if certain conditions are fulfilled. If the deceased hadn't used the lifetime exclusion amount and the asset transferred didn't exceed the exemption amount, the recipient is not liable to pay estate tax.
Moreover, if the assets are worth less than the lifetime exclusion bracket, the remaining exemption amount can also be transferred but only to a spouse.
Estate tax exclusion can be claimed by personally filing the IRS Form 706.
The inheritance tax is levied by the state government and not by the IRS. As of 2023, the tax is only applicable in six states, including Kentucky, Maryland, Pennsylvania, Iowa, New Jersey, and Nebraska.
Unlike estate tax, inheritance tax is imposed on the beneficiary and is limited to the assets received by the recipient. Even in the above-mentioned six states, the beneficiary doesn't necessarily have to pay the tax if the property is subject to various exemptions.
For example, the surviving spouse of the deceased is totally exempt. Similarly, domestic partners are exempt in the state of New Jersey. The direct descendants of the deceased should pay inheritance tax in only Nebraska and Pennsylvania.
Moreover, in Iowa and Maryland, the inheritances are taxed only if the properties transferred exceed the value of $25 thousand and $50 thousand, respectively.
The rates of inheritance are up to 18%, depending on the value of inheritance and the relationship with the decedent. If you are an immediate family member of the deceased, the closer familial ties reportedly subject you to lower rates than other beneficiaries.
Capital Gains Tax
The capital gains tax is only imposed if you sell the inherited asset.
If the asset is sold within a year of inheritance, it will be taxed under the short-term capital gains. Meanwhile, if the asset is held for a year or more, it will be subject to long-term capital gains tax.
The short-term capital gains tax is the same rate as the basic income tax. On the other hand, long-term capital gains have three rates: 0%, 15%, or 20%. The rates are determined based on the taxable income of the individual. Higher incomes will subject a person to higher tax rates.
Payments Exempted From Taxation
If you want to help out a family member, pay for specific expenses that are excluded from taxes.
Expenses like tuition fees, dental charges, and medical bills often dent the financial well-being of the payer. Making a monetary contribution on behalf of a family member can be a great help to a person struggling to make ends meet.
The above-mentioned expenses are completely excluded from taxes. The gift doesn't get deducted from the annual or lifetime exclusion amount.
However, the money should be directly deposited to the institution providing the surface. It can't be deducted from the exclusion amount if the money was paid to the beneficiary as a way to reimburse them.
You Can Invest Money On Behalf Of Children As A Gift
Gifting money to children can be tricky as the easiest way might not be the best way. If the amount is a few dollars, you can directly hand away the cash.
But, if the amount is significant, the donor will want to know if the money is being spent in the right way.
Making long-term investments on behalf of a child is the best way to save up for the future and teach the value of money to a kid.
The donor can set up a custodial account or a trust fund to deposit the money. Until the child comes of age, the accounts are managed by the parents or a legal custodian.
A custodial account is created to deposit money by a benefactor. Additionally, the account also holds other assets like mutual funds, stocks, exchange-traded funds, and bonds.
The person setting up the account usually has the right of a custodian or they can name a third party to act as a custodian.
The custodian manages the funds as long as the beneficiary is a minor. Once the kid reaches the age of majority, he/she shall have the authority to control the money. The age of majority differs from state to state and ranges from 18 to 21 years old.
Similarly, custodial accounts are of two types: UGMA and UTMA. The two types of accounts only have a few differences.
Uniforms Gifts to Minor Act, simply called UGMA, accounts can store assets, including stocks, mutual funds, or other financial bonds. UGMA accounts are valid in all US states.
On the other hand, Uniform Transfers to Minors Act, also called UTMA, accounts hold intellectual property and fine arts in addition to the assets held by UGMA accounts. However, UTMA accounts are not legal in all US states and usually require a higher age to reach the majority.
A trust fund is similar to a custodial account; but, in this case, a neutral third party, also called the trustee, has the authority to manage the fund instead of a custodian.
Trust funds also hold different types of assets, including money, real estate, bond, and more. There are two types of funds under this category: revocable and irrevocable.
A revocable fund allows the person setting up the fund to make changes in the policy. The donor has the privilege of shutting down the fund if required.
Meanwhile, under the irrevocable fund, the grantor can't change the terms once the trust fund is set up. This type of fund gives a significant tax benefit to the donor as the property held by the fund can be written off for tax purposes.
Gifting Money To Adult Children
In the case of adult children set to soon depart for college, you can help by paying their college fees. Or, you can also help out by paying for their medical expenses.
Under US Code 529, also called a qualified tuition program (QTP), an individual can set up a college fund for loved ones. According to IRS, the money held under this program is tax-free, meaning any interest accrued is also automatically excluded from taxation.
Likewise, the money can be withdrawn without incurring any additional expenses. However, the amount must be used for covering the cost of education. If the money is used for any other purpose, tax exemption is not allowed.
Who Pays The Gift Tax?
The donor should pay the gift tax in regular situations. But, in many cases, the donee might agree to pay the tax.
Further, any money gifted during a fiscal year should be filed with the IRS, whether or not the gift is subject to a tax.
To disclose the gift, the individual must fill out the IRS Form 709 while filing the yearly tax return. If you are liable to a certain amount of money as gift tax, the IRS will communicate the taxable amount.
The tax can be then paid through various ways, including online payments, direct payments from a savings account, credit or debit card, cash payments, or online monthly installments with the IRS Online Payment method.
How To Avoid Gift Tax?
To avoid paying gift tax, you can follow a series of legal provisions that exempt the imposing of taxes on gifts. These include benefits like the annual and lifetime exclusion amount, paying for college or medical expenses, and more.
Most, if not all, donations made to a charitable/non-profit organization are also excluded from taxation.