Giving money to friends and family can involve gifts or loans that can carry emotional baggage and ignite tax concerns. But there are ways to give significant money that address both issues.
“Often these arrangements are informal and emotions play an outsized role,” said Michael Garry, founder of Yardley Wealth Management in Yardley, Pa., and author of "The Smart Person’s Guide to Financial Planning & Investments."
“With gifts you don’t need any formality, though gift tax returns may be required to be filed—and they rarely are." he said. “They usually know there is a gift tax but don’t know what the current annual exclusion amount is or what it means."
This year, individuals can give up to $16,000 using their annual exclusion without gift tax consequences. The lifetime gift tax exclusion is $12.06 million. Both the annual and lifetime exclusions are double for married couples who file taxes jointly.
What advisors and clients need to be acutely aware of, said Craig Richards, managing director and director of Tax Services at Fiduciary Trust International, “When a family member or friend asks for money and it’s given to them, if not discussed and agreed to explicitly, the question becomes, ‘Gift or loan?’"
If giving a loan, the lender must make sure that it is properly structured to ensure that isn't perceived as a gift by the IRS, advisors note.
“Loans between individuals generally should be in writing, stating the terms of the loan, and interest should be charged minimally at a rate published by the IRS,” he said. “If this minimal amount of interest is not charged, the loan could be considered a gift loan and have gift tax consequences.”
Exceptions, he added, include de minimis loans of up to $10,000 between individuals.
“In most cases, the gift tax return just reduces the taxpayer’s lifelong exemption and no tax is due,” said Rob Seltzer, a CPA at Seltzer Business Management in Los Angeles. He also added noted that paying tuition or medical expenses are not considered reportable gifts.”
Some clients understand gifting rules well, as it’s part of their annual gifting and estate planning strategy. “Others are not as aware,” Richards said. “Initially, many individuals may be taken aback by these rules and cannot conceive why they can’t give without having to worry about filing a gift tax return or be concerned about having to pay gift tax. The need to charge a specific interest on a loan to a family member or dear friend may also seem unconscionable to some folks.”