Generally speaking, the IRS considers any asset transfer from one individual to another for less than full and adequate consideration to be a "gift" for purposes of federal gift taxation.
However, many exceptions exist which allow transfers of value without gift tax resulting. Importantly, the current law allows an individual to make cumulative gifts during his or her lifetime of up to the "basic exclusion amount" (currently inflation adjusted to $12,060,000, per donor) without incurring gift tax, and to make annual gifts up to the annual donee exclusion limit (currently $16,000 per recipient) without reducing one's basic exclusion amount.
Deciding to gift creates a myriad of questions for the donor to consider, such as:
- Should the gift be outright or in trust?
- Is the gift over or under the annual donee exclusion limit?
- Is this gift over or under my lifetime exemption amount?
- Does generation-skipping tax apply to this transfer?
- Should I file a gift tax return?
Prior to making substantial gifts, it is advisable to confer with an attorney or tax advisor to take into account these and other considerations.
Fortunately, the tax law also allows individuals to give without "gifting," so to speak, by providing for certain lifetime transfers that are exempt from gift taxation and reporting requirements. The Internal Revenue Code and applicable law provide that the payment of tuition and medical expenses does not qualify as a gift, and therefore, does not have gift tax consequences or a reporting requirement as long as specific rules are followed:
There is not a gift when a person pays qualifying medical expenses on behalf of another person. The payment must be made directly to the medical provider and cannot be paid to the patient (or parent of the patient) to allow them to make the payment. Qualifying medical expenses can include amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, including health insurance premiums, but do not include payments for anything cosmetic.
If a person wants to contribute $25,000 to their neighbor's medical expenses for cancer treatment, they can make a payment directly to the medical provider. However, if they make the payment to their neighbor's Go Fund Me page, this amount typically will constitute a gift and will require consideration of the questions listed above.
Qualifying expenses may also include payments to an assisted living facility or for in-home care. Practically, payments may include a gift amount component (not medically necessary) and a gift exclusion amount component (medically necessary).
There is not a gift when a person pays tuition on another individual's behalf. In order to qualify under this gift exclusion, the tuition must be paid directly to the qualifying institution and not to the student or the parents of the student. The tuition could be paid for a full-time or part-time student.
In practice, we often find that a client is helping or planning to help financially with a grandchild's tuition expense. Typically, when a grandparent provides funding to or for the benefit of a grandchild, it must be structured in a specific way so as not to trigger the generation-skipping transfer tax. The generation-skipping transfer tax is separate from (and can be in addition to) the federal gift tax, and can be assessed at 40% of the total gift. However, since tuition does not constitute a gift, a grandparent can pay tuition directly to a University (or other qualified institution) for a grandchild without having to consider the generation-skipping rules. The tuition payment could be $10,000 or $100,000, and the gift exemption would still apply. The relevant Treasury Regulations do provide that the tuition exclusion applies only to direct tuition expenses, and not for books, supplies, dormitory fees, etc.
The IRS provides that an organization qualifies as an educational institution if the primary purpose is formal educational instruction. There are a number of factors that contribute to this primary purpose test, such as number of students, regular faculty, and type of educational instruction. In many instances, the IRS allows the grandparent to pay private school tuition for their elementary aged grandchildren and even preschool tuition for their younger grandchildren.
The ability to give without gifting is a useful tool for those interested in reducing their taxable estates without using their basic exclusion amount or looking to transfer assets without triggering a gift tax filing requirement. The analysis of what constitutes a qualified institution or what is a qualified medical expense is one of substance over form, and is something that our Trusts and Estates team would be happy to discuss as it applies to your particular situation.
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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.