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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Benefits of 529 Plans

529 Plans have benefits beyond tax-deferred earnings which make them attractive options for educational funding.

I’ve been discussing 529 plans, how they work and their benefits far more frequently with clients than I used to.  You might think that tax-deferred savings is the main benefit, along with tax-free withdrawals for qualifying higher education expenses in 529 plans. However, there are also state tax incentives, such as tax deductions, credits, grants, or exemption from financial aid consideration from in-state schools in certain states.  Forbes’ recent article entitled “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)” says there are many more advantages to the college savings programs than simple tax benefits.

1) Registered Apprenticeship Programs Qualify. You can make qualified withdrawals from a 529 plan for registered apprenticeship programs. These programs cover a wide range of areas with an average annual salary for those that complete their apprenticeship of $70,000.

2) International Schools Usually Qualify. More than 400 schools outside of the US are considered to be qualified higher education institutions. You can, therefore, make tax-free withdrawals from 529 plans for qualifying expenses at those colleges.

3) Gap Year and College Credit Classes for High School. Some gap year programs have partnered with higher education institutions to qualify for funding from 529 accounts. This includes some international and domestic gap year, outdoor education, study-abroad, wilderness survival, sustainable living trades and art programs. Primary school students over 14 can also use 529 plans for college credit classes, where available.

4) Get Your Money Back if Not Going to College. If your beneficiary meets certain criteria, it’s possible to avoid a 10% penalty and changing the plan from tax-free to tax-deferred. For this to happen, the beneficiary must:

  • Receive a tax-free scholarship or grant
  • Attend a US military academy
  • Die or become disabled; or
  • Get assistance through a qualifying employer-assisted college savings program.

Note that 529 plans are technically revocable. Therefore, you can rescind the gift and pull the assets back into the estate of the account owner. However, there are tax consequences, including tax on earnings plus a 10% penalty tax.

5) Private K–12 Tuition Is Qualified. 529 withdrawals can be used for up to $10,000 of tuition expenses at private K–12 schools. However, other expenses, such as computers, supplies, travel and other costs are not qualified.

6) Pay Off Your Student Loans. If you graduate with some money leftover in a 529 account, it can be used for up to $10,000 in certain student loan repayments.

7) Estate Planning. Contributions to a 529 plan are completed gifts to the beneficiary. These can be “superfunded” for up to $75,000 per beneficiary in a single year, effectively using five years’ worth of annual gift tax exemption up front. For retirees with significant RMDs (required minimum distributions) from qualified accounts, such as 401(k)s and traditional IRAs, the 529 plan offers high contribution limits across multiple beneficiaries, while retaining control of the assets during the lifetime of the account owner. Assets also pass by contract upon death, avoiding probate and estate tax.

7.5) Medicaid Benefit.  I’m going to cheat and add one more.  In Texas, transfers to 529 plans for CERTAIN beneficiaries are exempt as transactions for longterm Medicaid.  As with all Medicaid planning, you would want to do this at the advice of an attorney, but for situations where it fits, it is a very powerful spend down tool, especially where grandchildren are school age.

Reference: Forbes (July 15, 2021) “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)”

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Which Powers should a Power of Attorney Include?

Most clients have at least heard of powers of attorney (POA), and I find that many people with an existing estate plan have one.  However, I find the biggest problem with powers of attorney is not the lack of one, but having one without sufficient powers or provisions to work well for the client.  For that reason, you need to know powerful this document is and identify its limits. A recent article from Forbes titled “4 Power of Attorney Clauses You Need To Focus On” addresses many key provisions to consider in the power of attorney.

First, as a primer, the POA is a document that assigns decision making to another person during your life.  People often do this for when they become incapacitated in life, but also for convenience, such as a spouse having authority to interact with a bank, signing at a remote real estate closing and so on.

The agent acting under the authority of your POA only controls assets in your name. Assets in a trust are not owned by you, so your agent can’t access them. The trustee (you or a successor trustee, if you are incapacitated) appointed in your trust document would have control of the trust and its assets.  Also, POAs are for lifetime delegation of decision-making, so they cease to be effective when you die.

If you want more background on what they are, see this classic blog.  https://galligan-law.com/power-of-attorney-planning-for-incapacity/

With all of that said, here are three key provisions to consider within your POA to make it effective for your circumstances.

Determine gifting parameters. Will your agent be authorized to make gifts? Depending upon your estate, you may want your agent to be able to make gifts, which is useful if you want to reduce estate taxes or if you’ll need to apply for government benefits in the future. You can also give directions as to who gets gifts and how much.

In recent years I’ve discussed the possibility of extensive gifting quite a lot so that wealthier clients can consider making large gifts for estate tax purposes. In elder law cases this is one of the most key provisions in a POA as it provides options for long term care planning.

Can the POA agent change beneficiary designations? Chances are a lot of your assets will pass to loved ones through a beneficiary designation: life insurance, investment, retirement accounts, etc. Banks tend to build products that provide for this, which is good, but does raise issues within your estate plan.  Do you want your POA agent to have the ability to change these? In most states, Texas included, your POA needs to expressly provide for this power.  So, it is important to consider if you will need this power to adequately control assets in the future.

Can the POA create or amend a trust? Depending upon your circumstances, you may or may not want your POA to have the ability to create or make changes to trusts. This would allow the POA to change the terms of the trust, and potentially beneficiaries depending on the terms of the POA.  It is also worth considering this if you’ll need long term care in the future as these provisions assist with qualified income trusts which are helpful in Medicaid planning.

The POA is a more powerful document than people think, and that is especially true with powers crafted to fit your wishes and needs. Downloading a POA and hoping for the best can undo a lifetime of financial and estate planning. It’s best to have a POA created that is uniquely drafted for your family and your situation.

Reference: Forbes (July 19, 2021) “4 Power of Attorney Clauses You Need To Focus On”

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