It’s that time of year when new grads are taking that long walk across the stage to collect their degrees and first-time students are preparing to head off to college for the first time. From a parent’s perspective, both events can be financially draining, especially if you’re shouldering some of the cost of tuition or forking over a sizable amount of cash as a graduation present. To add insult to injury, your wallet could see even more of a strain if you have to pay a gift tax on your contribution.
When you give someone money that is a gift and you automatically become subject to the gift tax. Whether or not you actually have to pay the tax depends on the size of the gift and what it was used for. If you’re planning on giving your student money to help out with college expenses or as a reward for finishing their degree, here are a few things you’ll need to keep in mind.
What the Gift Tax Is
The gift tax is a special tax that applies when one person transfers property or money to someone else without receiving anything in return or receiving less than the gift’s full value. Giving someone a car, selling something for less than what it’s worth, forgiving an outstanding debt or offering someone an interest-free loan could all be considered a gift for tax purposes. The person who gives the gift is usually responsible for paying the tax, unless you make arrangements for the recipient to pay it.
Exclusion Limits on Gifts
The IRS allows you to gift a certain amount of money or property to someone before the gift tax kicks in. For 2014, the annual exclusion limit is $14,000 per person. That means you can give your student up to that amount directly without having to worry about paying the gift tax. If you have more than one child, you’re allowed to gift each of them up to that same amount.
Married couples also have the advantage of being able to split their gifts. This basically means that you can double up on the amount you give to your student without incurring the gift tax. For instance, let’s say you gift $11,000 to your child at graduation. None of it would be taxable since you’re not over the annual exclusion limit. Your spouse, on the other hand, decides to chip in an additional $17,000 for a total of $28,000. Ordinarily, $3,000 of their contribution would be taxable but if you decide to split the gift equally no tax is owed.
Gifting Money for Tuition
Aside from the annual exclusion limit, the IRS also waives the tax for gifts that are used to pay tuition expenses. There’s no limit on how much you can pay but you have to give the money directly to your student’s school. Otherwise, any amount over the annual exclusion limit is subject to the gift tax. There is one potential drawback, however, since any money you pay on your student’s behalf may be viewed as untaxed income for the purposes of determining their federal financial aid eligibility.
529 Plan Contributions
If college is still a few years off, funding a 529 plan is one of the easiest ways to plan ahead for tuition costs. When it comes to the gift tax, parents are still subject to the annual exclusion limits and the gift-splitting rule for contributions but there is an exception for lump-sum contributions.
For 2014, parents could put in up to $70,000 in a 529 plan at one time without having to pay the gift tax. Married couples who agree to split their gifts can contribute up to $140,000. If you choose to go this route, remember that any additional contributions you make during the five-year period would be subject to the gift tax.
Navigating your way around the gift tax can be tricky and you may want to seek professional advice before you hand over the cash. Even though your gift is motivated by good intentions, it could end up causing more financial harm than good if you’re not careful.
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Photo Credit: Shannon Elrod