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4 Rules for Giving Your Heirs Money While You’re Alive

Before making a gift, be sure you know these tax implications


Leaving money to heirs upon your death, by contrast, is a lot less taxing than you might expect. For inheritances, the 2015 federal estate tax exemption is $5.43 million per person. That means 99. 8 percent of people never have to pay an estate tax, because so few people have assets that exceed $5.43 million. However, if you want to give money to your children or grandchildren while you are still alive, you have options.

The goods news is that the estate tax exemption is a lifetime exemption that can also be used for gifts. Every dollar that you give as a gift today will just reduce the amount that you can transfer tax-free at the time of your death.

Tax planning is complicated and tax laws change frequently, so if you do want to give your kids or grandkids money soon, meet with your tax adviser to come up with a workable plan. You don’t want to overestimate your retirement income and become excessively generous with gifts you’ll later regret.

4 Tax Rules for Gifts to Your Heirs

If you do decide to provide gifts to your children or grandchildren while you’re still alive, you even have opportunities beyond the $5.43 lifetime exemption. Here are four considerations that you can discuss with your estate planner:

1. The amount of tax-free gifts is capped each year. The Internal Revenue Service (IRS) sets a maximum gift-tax exclusion annually. For 2015, it’s $14,000 per person. You can give that amount to as many people as you like, and each spouse has his or her own annual $14,000 limit.

You can make five years of contributions to a 529 plan at one time without triggering a gift tax.

So if you and your spouse have two grandchildren, both of you can gift $14,000 to each child for a total amount in tax-free gifts of $56,000. And remember, these are tax-free gifts above and beyond the $5.43 million exemption limit.

2. Medical, dental and tuition expenses can be excluded from that cap. If the reason you want to make a gift is for your child’s or grandchild’s medical or dental bills or tuition, this money can be exempt from the annual gift limitations. However, in order to ensure these gifts are tax-exempt, you have to pay the doctor, dentist or school directly.

Although tuition expenses are exempt, there’s no educational exclusion for books, supplies or room and board. And the medical exclusion doesn’t apply to amounts paid for medical care that are reimbursed by your insurance.

Be careful about making your grandchild’s tuition payments directly to a college if he or she has financial aid. A direct payment by anyone other than the parent will be counted as cash support, which will could reduce the amount of aid for the child.

3. You can give away more through a 529 college savings plan. Contributions to state-sponsored 529 plans are not exempt from the gift tax limit, but you can make five years of contributions at one time without triggering a gift tax. That means you could give $70,000 in one year without triggering the gift tax.

Most states let you deduct your donation from your state income tax return, up to their limit. (There is no federal tax deduction.) You can determine your state’s tax benefit on this calculator on Vanguard’s website.

Once your money is in a 529, the earnings will be deferred on federal and most state tax returns. And there is no tax due when taking the money out for qualified education expenses. The donation limits are high, and typically range between $300,000 and $400,000 per beneficiary.

One tip for grandparents: If you open a 529 for for your grandchild, he or she could end up losing a lot of financial aid. There is a workaround, though. Have your son or daughter open the 529 and then you can contribute to it.

4. Beware the “Kiddie Tax.” This law was created to make sure that parents didn’t give stocks to children under 24 in an attempt to avoid paying taxes themselves. If the amount of interest or dividends from the gifted shares exceeds $2,000, it will be taxable at the parents’ highest rate.

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