Make Tax-Free Gifts to Your Children

There are several ways to make tax-free gifts to your loved ones.
There are several ways to make tax-free gifts to your children and other family members.

Do not let constant political and financial speculation prevent you from making tax-free gifts to your children or other family members. These can take the form of  what’s called “annual exclusion” gifts, or the payment of a child’s or grandchild’s medical expenses, or paying for their education.

Making Tax-Free Annual Exclusion Gifts

Annual exclusion gifts are transfers of money or property in an amount or value that does not exceed the annual gift tax exclusion. In 2021, the annual gift tax exclusion is $15,000 per recipient. Therefore, this year you can give up to $15,000 per person to as many individuals as you choose without having to report the gifts to the IRS. In other words, the IRS does not consider gifts that are equal to or less than the annual exclusion amount to be taxable gifts at all. You may need to file a gift tax return if your gifts either exceed or do not qualify for the annual exclusion amount. Your estate planning attorney or accountant can guide you.

Married couples can take double advantage of the annual exclusion and make tax-free gifts of $30,000 in 2021.

Making Tax-Free Gifts That Qualify for the Medical Exclusion

 A payment that qualifies for the medical exclusion is another type of tax-free gift you can make. Payments qualify for this exclusion if they are made on behalf of an individual to a person or an institution that provided medical care or medical insurance to the individual. In general, medical expenses that qualify for this exclusion are the same ones that are deductible for federal income tax purposes. Therefore, in 2021, you can pay the cost of your grandchild’s emergency appendectomy and, in the same year, give your grandchild an additional $15,000 without having to file any gift tax returns.

To qualify for the medical exclusion, a payment must meet two critical requirements.

  • You must make payment directly to the person or institution that provided the medical care or medical insurance. If you give the money to the individual who received the medical care or insurance benefit, even with explicit instructions that it be used to pay for the medical care, your payment will be considered a gift to the individual and not payment of a qualified medical expense.
  • The amount paid must not have been reimbursed by the individual’s insurance company. Any reimbursed amount is not eligible for the unlimited medical exclusion from the gift tax, and that amount will be treated as having been made on the date the individual received the reimbursement.

Making Tax-Free Gifts That Qualify for the Educational Exclusion

A payment that qualifies for the educational exclusion is another type of tax-free gift. For example, in 2021, in addition to paying for your grandchild’s emergency appendectomy and giving them $15,000 (see above), you can pay their college tuition costs without having to file any gift tax returns or pay any gift tax.

To qualify for the educational exclusion, a payment must meet two critical requirements.

  • You must make payment directly to the institution providing the education rather than to the individual receiving the education.
  • Your payment must be for tuition only, not for books, supplies, room and board, or other types of education-related expenses.

If your payment fails to meet either of these requirements, it will be considered a gift to the individual.

Giving gifts can be an effective way to provide financial assistance to your family members. An estate planning attorney can help with any questions you may have on how to make tax-free gifts of money or property to your family.

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Do You Need Power of Attorney If You Have a Joint Account?

Clients often, sometimes at the suggestion of their bankers, add names onto accounts to make money accessible upon the incapacity or death of a parent.  This often leads them to assume they don’t need a Power of Attorney (POA), and they don’t realize that Powers of Attorney are designed to permit access to accounts upon incapacity of a parent. There are some pros and cons of doing this in either way, as discussed in the article “POAs vs. joint ownership” from NWI.com.

The POA permits the agent to access their parent’s bank accounts, make deposits and write checks.  However, it doesn’t create any ownership interest in the bank accounts. It allows access and signing authority.  This is usually what individuals are thinking of when they create these accounts.

If the person’s parent wants to add them to the account, they become a joint owner of the account. When this happens, the person has the same authority as the parent, accessing the account and making deposits and withdrawals.

However, there are downsides. Once the person is added to the account as a joint owner, their relationship changes. As a POA, they are a fiduciary, which means they have a legally enforceable responsibility to put their parent’s benefits above their own.  As an owner, they can treat the accounts as if they were their own and there’s no requirement to be held to a higher standard of financial care.  You can see the following article for more on this point.  https://galligan-law.com/effect-of-adding-someone-to-your-bank-account/

Because the POA does not create an ownership interest in the account, when the owner dies, the account may pass to the surviving joint owners, Payable on Death (POD) beneficiaries or beneficiaries under the parent’s estate plan.

It also avoids the creation of a gift, which may have estate tax or Medicaid ramifications.

If the account is owned jointly, when one of the joint owners dies, the other person becomes the sole owner.

Another issue to consider is that becoming a joint owner means the account could be vulnerable to creditors for all owners. If the adult child has any debt issues, the parent’s account could be attached by creditors, before or after their passing.  I worked closing on a case with the opposite scenario, a creditor a parent collected money that otherwise would have gone to the children.

Most estate planning attorneys recommend the use of a POA rather than adding an owner to a joint account. If the intent of the owners is to give the child the proceeds of the bank account, they can name the child a POD on the account for when they pass and use a POA, so the child can access the account while they are living.

One last point: while the parent is still living, the child should contact the bank and provide them with a copy of the POA. This, allows the bank to enter the POA into the system and add the child as a signatory on the account. If there are any issues, they are best resolved before while the parent is still living.

Reference: NWI.com (Aug. 15, 2021) “POAs vs. joint ownership”

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Five IRA Rollover Mistakes to Avoid

Making a mistake when rolling your 401(k) to an IRA could result in unexpected taxes and possible penalties.
Making a mistake when rolling your 401(k) to an IRA could result in unexpected taxes and possible penalties.

Recent changes in the job market have led to an increase in IRA rollovers, but at the same time, people are making more mistakes when transferring their employer related retirement accounts to an IRA, reports The Wall Street Journal in a recent article, “The Biggest Mistake People Make With IRA Rollovers.” These IRA rollover mistakes may result in additional taxes and penalties.

Done properly, rolling funds from a 401(k) to a traditional IRA offers you more flexibility and control. A company retirement plan may limit you to a half-dozen or so investment choices; but, depending on the IRA custodian, the IRA owner may choose investment options ranging from stocks and bonds to mutual funds, exchange-traded funds, certificates of deposits or annuities.

However, if you are considering rolling over an employer related retirement plan to an IRA, make sure to avoid these common IRA rollover mistakes:

Mistake #1:  Taking a lump-sum distribution of the 401(k) funds instead of moving the funds directly to an IRA custodian. The clock starts ticking when you do what’s called an “indirect rollover.” Miss the 60-day deadline and the amount is considered a distribution, included as gross income and taxable. If you’re younger than 59½, you might also get hit with a 10% early withdrawal penalty.

There is an exception: if you are an employee with highly appreciated stock of the company that you are leaving in your 401(k), it’s considered a “Net Unrealized Appreciation,” or NUA. In this case, you may take the lump-sum distribution and pay taxes at the ordinary income-tax rate, but only on the cost basis, or the adjusted original value, of the stock. The difference between the cost basis and the current market value is the NUA, and you can defer the tax on the difference until you sell the stock.

Mistake #2:  Not realizing when you do an indirect rollover, your workplace plan administrator will usually withhold 20% of your account and send it to the IRS as pre-payment of federal income tax on the distribution. This will happen even if your plan is to immediately transfer the money into an IRA. If too much tax was withheld, you’ll get a refund from the IRS.

Mistake #3:  Rolling over funds from a 401(k) to an IRA before taking a Required Minimum Distribution or RMD. If you’re required to take an RMD for the year that you are receiving the distribution (age 72 and over), neglecting this will result in an excess contribution, which could be subject to a 6% penalty.

Mistake #4:   Rolling funds from a 401(k) to a Roth IRA and neglecting to pay taxes immediately. If you move money from a 401(k) to a Roth IRA, it’s a conversion and taxes are due when you make the transfer. However, if you have some after-tax dollars left in the 401(k), you can make a tax-free distribution of those funds to a Roth IRA.

Mistake #5:  Not knowing the limits when moving funds from one IRA to another, if you do a 60-day rollover. The general rule is this: you are allowed to do only one distribution from an IRA to another IRA within a 12-month period. Make more than one distribution and it’s considered taxable income. Tack on a 10% penalty, if you’re under 59½.

Reference: The Wall Street Journal (Oct. 1, 2021) “The Biggest Mistake People Make With IRA Rollovers”

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