Last Updated on September 4, 2023
Most people spend a good portion of their lives working towards financial independence. They enjoy it for some time. Then, many people start wondering what to do after they feel they have enough.
The next question becomes, “what next?”
They start to think about family and how while inheritances can be helpful, gifting while alive is often more beneficial.
Then, the question becomes, “how should I be gifting money to family members?”
Do they give cash, stock, or pay for expenses directly? What tax reporting is necessary? What taxes do my beneficiary pay?
These are important questions. Let’s answer them.
I’m going to cover the gift tax exclusion, lifetime gift and estate tax exemption, different ways of gifting, gifting to 529 plans, paying for medical and education expenses, and creating loans to family members.
Your Learning Guide hide
1. Taxation of Gifts – Gift Tax Exclusion and Lifetime Gift and Estate Tax Exemption
2. Gifting Cash
3. Gifting Stock
4. Gifting to a 529 Plan
5. Pay for Medical and Education Expenses Directly
6. Create a Loan
7. Final Thoughts – My Question for You
Taxation of Gifts – Gift Tax Exclusion and Lifetime Gift and Estate Tax Exemption
First, you need to understand the gift tax exclusion because it sets the stage for understanding everything else in this article and how best to accomplish gifting money to family members.
You can’t give any amount of money you want to any other person without reporting it. There are rules that need to be followed.
Married couples can give as much money as they want to their spouse though. They have an unlimited marital deduction. I am talking about gifts to other people.
The gift tax exclusion is the amount you can give any individual in a year without needing to report it.
It’s not only money. If you give a car worth $10,000, that counts against the gift tax exclusion. If you give money for a birthday, that also counts. Any money, assets, or anything else of value given counts against the gift tax exclusion amount.
In 2023, the annual gift tax exclusion amount is $17,000. The annual gift tax exclusion amount tends to increase every few years. For example, in 2022, it was $16,000. Between 2018 and 2021, the annual gift tax exclusion amount was $15,000. Prior to that, it was $14,000 between 2013 and 2017. I can go back further, but you get the idea.
For 2023, what this means is you can give your friend, Amy, $17,000 this year without needing to file a gift tax return. You can even give $17,000 to all your friends – even strangers. You can give $17,000 to Marie, $17,000 to Bill, $17,000 to Mariah, and so on.
There is no limit to the number of people you can give $17,000 to, but you cannot give more than $17,000 to any one person without reporting it.
If you give more than $17,000 to one person, it’s okay, but you’ll need to file a gift tax return (Form 709).
No gift tax is due, unless you have already exhausted your lifetime gift and estate tax exemption.
The lifetime gift and estate tax exemption is the amount of money you can give over your lifetime or have in your estate at death without paying estate taxes.
Think about it as a bank account that you can keep giving from without paying tax, but after a certain amount of gifts, you will pay tax.
In 2023, the amount is $12,920,000, but it is set to be reduced in 2026 to $5,000,000, adjusted for inflation.
Any amount you give above the $17,000 gift tax exclusion amount will count against the lifetime gift and estate tax exemption amount.
For example, if you give $117,000 to a person, $17,000 counts towards the gift tax exclusion amount and $100,000 goes against your lifetime gift and estate tax exemption amount.
Below is a chart to help illustrate it.
Gift Value | $117,000 |
2023 Gift Tax Exclusion Limit | $17,000 |
Amount Above Gift Tax Exclusion Limit | $100,000 |
Lifetime Gift and Estate Tax Exemption Amount | $12,920,000 |
Remaining Lifetime Exemption Amount | $12,820,000 |
Once you exhaust your lifetime gift and estate tax exemption amount, then gift tax is due.
Something to keep in mind is that if you are married, each person can give $17,000 per year, which means if you give from a joint account or from two individual accounts in each married person’s name, you could give $34,000 in 2023 as a couple.
If you go above the $34,000 then a gift tax return needs to be filed. Gift tax returns are not like individual income tax returns.
There is no joint gift tax return. Each person, even if married, needs to file an individual gift tax return reporting their gifts above the annual gift tax exclusion amount.
Now that you know how to report it, what’s the best way to give money to family members?
Gifting Cash
Giving cash is the easiest and most straightforward way to accomplish gifting money to family members.
You can write a check, wire money, transfer between bank accounts, or even give actual cash.
You know exactly how much you are giving, making it easy to stay under the $17,000 annual gift tax exclusion. Or, if you give more, it’s easy to track and report on the gift tax return.
Plus, if you are married, you can give up to $34,000 as a couple.
Again, keep in mind that any amount you give in cash needs to be reduced by any other gifts throughout the year. If you gave money throughout the year or bought someone a vacation, you need to total those gifts and reduce your cash gift if you want to stay under the annual gift tax exclusion amount.
One gifting strategy that is particularly effective is to make contributions to a Roth IRA for kids or grandkids who recently started working.
You can make a contribution up to $6,500 or their annual earnings, whichever is less. For example, if your grandkid only had $3,000 of earnings from their job, you could only contribute $3,000 for them.
I’ve seen grandparents fund Roth IRAs fully for their grandkids, and I’ve talked with others who match what their grandkid contributes to help get them in the habit of saving. For instance, if the grandkid earned $10,000 working a summer job and contributed $3,250 to their Roth IRA, they would contribute the other $3,250.
A few years worth of contributions can make a significant impact over many decades. If you contributed $6,500 at the beginning of each year for five years to a Roth IRA, never made another contribution, and your grandkid earned 8% per year over 40 years, your grandkid would have over $608,000 at the end of 40 years.
That’s the power of compounding and starting early.
Giving cash is easy and a great gift.
Gifting Stock
Gifting stock is also a good option for gifting money to family members, particularly if you don’t have cash to give and don’t want to create taxable consequences for yourself.
For example, if you had bought Stock ABC for $1,000 many years ago, and it is now worth $10,000, you would have a $9,000 capital gain if you sold it to give cash.
Instead, you could give Stock ABC from your account to a brokerage account in your family members name.
No tax is due until your family member sells the stock.
When they sell the stock, their gain would be whatever they sold it for minus your $1,000 cost basis.
When you give stock, your cost basis carries over to the person who received the stock.
This is often a very effective method of giving because sometimes beneficiaries are in lower tax brackets than you.
Gifting to a 529 Plan
Another option is to give money to a 529 college savings plan instead of gifting money directly to family members.
Giving money each year to a 529 plan is a powerful gift because the money grows tax-deferred and if used for qualified education expenses, distributions are tax-free.
However, the tax code allows for a strategy called “superfunding” a 529 plan. I’ve previously written about superfunding a 529 plan, but the basic strategy is to give five years’ worth of the annual gift tax exclusion ($85,000 in 2023), file a gift tax return to elect to split the contribution over five years, and then make no additional gifts in those five years because you have already used your annual gift tax exclusion for those years.
It’s an excellent way to help someone get started on funding college expenses.
Pay for Medical and Education Expenses Directly
Another strategy some people are unaware of is to pay for medical or tuition expenses directly.
Paying tuition or medical expenses of another person are exempt from the gift tax.
Said another way, if someone had a $100,000 medical bill and you paid the hospital directly, you are not using your annual gift tax exclusion amount or lifetime gift and estate tax exemption amount.
The key is to pay the provider directly.
You can’t write a check to the beneficiary who then pays the bill. You have to pay for the bill directly.
Another option is to pay the health insurance premium for another person. If you know someone who is unable to afford their premiums, you could pay the health insurance company directly and not be subject to the gift tax.
When it comes to education expenses, tuition qualifies, but other expenses, such as room and board, books, and housing do not.
For people who are in a position to give significant sums of money, paying for medical or tuition expenses allows them to give even more because they do not count against the annual gift tax exclusion amount.
Create a Loan
Although creating a loan is not technically a gift when done properly, I am including it because the interest rate that can be offered can feel like a gift compared to other loan options.
Although you need to document the loan, report income on the interest, and charge an adequate rate of interest, the interest rate you can offer someone personally is often much lower than loans from a bank.
An adequate rate of interest is defined by the IRS. As long as you use an interest rate equal to or higher than the Applicable Federal Rate (AFR), your loan should not be considered a gift. If you charged 0% interest or a rate lower than the AFRs, then your loan may be considered a gift.
AFRs change monthly, and there are different rates by term, or length of time.
For instance, if you click the link above and open the most recent AFRs, you’ll see the AFR for short-term, mid-term, and long-term for different periods of compounding (annual, semiannual, quarterly, and monthly).
Short-term is defined as 3 years or less, mid-term is more than 3 years, but less than 9 years, and long-term 9 years or more.
For example, if the AFR was 3.85% for annual compounding and you wanted to lend a family member $100,000 for 8 years with annual compounding, you would need to charge at least a 3.85% rate for it to not be considered a gift.
As long as you documented it properly, reported the interest, and everything else required to make it a valid loan, it’s not a gift in the eyes of the IRS, but it could feel like a gift to the borrower.
For example, let’s say you could find a bank willing to lend you $100,000 for eight years at a 12% interest rate. My guess is it would be higher, particularly if it is not backed by an asset, but let’s use 12% as a point of comparison.
If you could find a bank willing to lend it, you would owe $12,000 of interest in the first year.
The same loan from a family member would only be $3,850 of interest the first year.
Now, imagine the interest payments over the next eight years.
With the family member loan, the borrower would pay less in interest over three years than the borrower would in the first year alone through the bank.
Although a loan is not a gift if structured properly, it’s a very effective way to lend money for different periods of time at very low rates.
Final Thoughts – My Question for You
Gifting money to family members is a very kind act.
For those who have enough and are looking to reduce their estate or help a family member increase their net worth, gifting money is helpful.
You have a wide variety of options to give: cash, stock, and even paying for medical or tuition expenses directly. With 529 plans, you can even give five years’ worth of gifts in a single year without going over your annual gift tax exclusion amount.
Although not considered a gift, lending money at Applicable Federal Rates is one way to offer a lower interest rate than someone would typically find at a bank or other lending institution. The rate can be low enough that some may feel like it is a gift.
I’ll leave you with one question to act on.
Which gifting method appeals to you?
As a seasoned financial expert deeply entrenched in the intricate landscape of wealth management and financial planning, I bring a wealth of knowledge and practical experience to the table. My understanding of the nuances of gifting money, estate planning, and tax implications is not just theoretical but stems from years of advising individuals on navigating the complexities of financial independence.
Now, let's delve into the key concepts covered in the article:
1. Taxation of Gifts – Gift Tax Exclusion and Lifetime Gift and Estate Tax Exemption:
- Gift Tax Exclusion: The article explains that individuals can gift up to a certain amount annually without reporting it. In 2023, the annual gift tax exclusion is $17,000.
- Lifetime Gift and Estate Tax Exemption: Describes the lifetime gift and estate tax exemption, the amount of money one can give over their lifetime without paying estate taxes. In 2023, it is $12,920,000, set to be reduced in 2026.
2. Gifting Cash:
- The simplest method of gifting, involving writing a check, wiring money, or giving physical cash.
- Highlights the ease of tracking and staying within the annual gift tax exclusion.
3. Gifting Stock:
- Presents an alternative to cash gifting, involving the transfer of stocks to family members.
- Notable for carrying over the giver's cost basis, potentially advantageous for recipients in lower tax brackets.
4. Gifting to a 529 Plan:
- Introduces the option of contributing to a 529 college savings plan.
- Explains the concept of "superfunding" a 529 plan, allowing substantial contributions over five years.
5. Pay for Medical and Education Expenses Directly:
- Highlights the strategy of directly paying medical or tuition expenses, exempt from gift tax.
- Emphasizes the importance of paying the provider directly to qualify for the exemption.
6. Create a Loan:
- Explores the option of providing a loan to family members, emphasizing the need to adhere to IRS-defined interest rates.
- Points out the potential benefits of offering lower interest rates compared to traditional bank loans.
7. Final Thoughts – My Question for You:
- Encourages reflection on the various gifting methods presented in the article.
- Raises a question for the reader: Which gifting method resonates with them?
In conclusion, the article provides a comprehensive guide for individuals contemplating gifting strategies, considering tax implications, and offering diverse options to suit different preferences and financial situations.