When your children were young, you probably enjoyed watching them open the gifts from you as much as they enjoyed unwrapping them. Their happy faces automatically triggered the same expression on your face. Now that your children are grown, your choice of gifts has shifted to match their adult wants and needs, which often includes the always-appreciated gift of money. Giving money to children during your lifetime – instead of leaving all of it as an inheritance to them – is a way for you to witness the joy it brings them, just as you did when they were little. Whether your gift of money celebrates your children’s adult birthdays or helps get them through challenging financial times, you may be pleasantly surprised at the IRS tax requirements.
Parents can give pre-inheritance gifts of money to their children without paying a gift tax as long as the monetary sums fall within IRS limits.
IRS Definition of Gift
The IRS establishes its broad definition of a gift as "any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth), is not received in return." That's a mouthful that covers a fairly diverse list of potential gifts. And although you may think of a gift as more along the lines of a piece of jewelry or a household item, money is also categorized as a gift under this definition. One stipulation in the IRS definition is that the gift cannot be exchanged for something of equal value, such as goods or services.
Gifting Money to Children
Your gifts of money to your children carry the same tax liability as your gifts of money to friends or any other nonrelated persons. Children are not covered by any exclusive tax law that results in a greater or lesser tax benefit for the monetary gifts you give. So you won't have to pore over IRS guidelines for the legal definition of a qualifying child or an eligible dependent to determine if your child is your "legal" child for gift-giving purposes. A gift is a gift, regardless of who the recipient is.
Are Gifts of Money Taxable?
The short answer is yes. But before you worry that the money you give your children will result in a higher tax liability for you, know that the IRS sets the tax-exempt bar pretty high for the gifts you give. These tax-exempt limits are called exclusions because these gifts are excluded from your tax liability. In plain English, this means that as long as you stay within the IRS tax-exempt gift limits, you will owe zero in gift taxes. These limits are so high that the overwhelming majority of taxpayers will never reach the upper limits of the exclusions, allowing parents to be quite generous when gifting their children. The IRS establishes three gift-tax thresholds: the annual exclusion, a lifetime exclusion and unlimited exclusions.
Annual Gift Tax Limit
As of 2018, you may give each of your children (or other recipients) a tax-free gift of money up to $15,000 during the tax year. You don’t have to give the money in one lump sum, but the total amount must not exceed $15,000 to qualify for the annual exclusion. And if you’re married, each child may receive up to $30,000 – $15,000 from each parent. You don’t have to pay tax on this gift, and you don’t even have to report it on your tax return. If you give a child more than $15,000 during the tax year, you’ll have to report only the overage amount on IRS Tax Form 709 – “United States Gift and Generation-Skipping Transfer Tax Return.” For example, if you gave your child $20,000, you only have to report $5,000 on Form 709. But even then, you won’t have to pay tax on the excess amount unless you also exceed your lifetime gift limit.
Lifetime Gift Tax Limit
2018 tax law allows you to give each of your children (or other recipients) a tax-free gift of money up to a whopping $5.6 million during your lifetime. And if you’re married, this figure is doubled – each child may receive up to $11.2 million over the lifetime of both parents ($5.6 million from each parent) without the parents having to pay taxes on their gifts. It’s only if you give more than this in your lifetime that you’ll have to pay taxes – and only on the overage. But another resounding perk of this lifetime amount is that it only kicks in after you’ve gifted $15,000 per person for the annual limit. For example, if you give $20,000 to a child during the tax year, $5,000 – the amount you’ll report on Form 709 – goes toward your lifetime exclusion of $5.6 million. And you’ll only owe a gift tax if the sum of all the overages from all your annual limits exceeds this $5.6 million.
Unlimited Gift Tax Limit
The IRS allows two important unlimited tax-free gift exceptions for your adult children or other persons, which you do not have to include in either your annual or lifetime exclusion limits – medical payments and tuition costs. Even though you’d probably consider these payments as gifts to your children, the IRS does not classify them as gifts for income-tax purposes. You do not have to file Form 709 to report these payments. Even if you're filing Form 709 to report any overages for your annual exclusion, you do not have to list medical and education costs on Schedule A of Form 709.
- Medical payments. When you make medical payments on behalf of your adult children to an individual or a facility that provided medical care, the gift tax does not apply. The medical care and the provider must meet the requirements in IRS Publication 709, Section 213(d) to qualify as eligible costs. Eligible medical costs include diagnosis, treatment or prevention of illness or disease. You can also include payments you make for medical insurance on behalf of your child. But if the insurance carrier reimburses you for any eligible medical expenses, you cannot include the reimbursed amount in your medical exclusion.
- Tuition. If you pay for your adult child’s tuition, you do not have to include this cost in your gift-tax exclusion limits. The school must be a qualifying educational organization as defined in IRS Publication
- Broadly speaking, the school must have a faculty, curriculum and a place for regularly scheduled educational activities. The facility must also have pupils or students who are regularly enrolled in a course of study. You cannot include any costs other than tuition, for example, books, supplies or room and board. And you’ll have to make the tuition payments directly to the school.
Recipient's Gift-Tax Liability
Even though you will not have to pay a gift tax on the money you give your children (as long as you stay within IRS gift exclusion amounts), what about your children's tax liability on your gift? If you’re concerned that your adult children may not be able to keep 100 percent of the money you give them because part of it will go toward taxes they would have to pay on it, you can rest easy. Your children will not be saddled with a gift-tax liability simply by receiving your gift of money, regardless of the amount you give. The IRS doesn't require gift recipients to pay taxes on the gifts they receive.
Reporting Your Gift of Money
Spouses must file separate gift tax returns (Form 709); they cannot combine their gifts on a joint gift tax return. Each spouse reports only the amount that exceeds his or her annual exclusion of $15,000 on the corresponding Form 709. If you make multiple gifts of money throughout a tax year, you’ll only submit one Form 709 when you file your annual tax return, which includes only the overages for each gift. The filing deadline for Form 709 is April 15 in the year following the year that you made any gifts of money that exceeded your annual exclusion limit. If April 15 falls on a weekend or a legal holiday, the filing deadline is extended to the next business day.
If you request a filing extension for your annual tax return, the same extension is automatically applied to your Form 709. File IRS Form 4868 ("Application for Automatic Extension of Time to File U.S. Individual Income Tax Return") or Form 2350 ("Application for Extension of Time to File U.S. Income Tax Return"). If you do not request a filing extension for your regular tax return but you want an extension only for your Form 709, file Form 8892 ("Application for Automatic Extension of Time to File Form 709 and/or Payment of Gift/Generation-Skipping Transfer Tax"). This will give you an automatic 6-month extension to file your gift tax return separately from your regular tax return.
Free and Clear Gift Money
Any amount of money that you give to your adult children as a tax-exempt gift must be immediately accessible to them. This is called “present interest,” which is different than “future interest.” A gift of money with future interest means that your children do not have immediate access to the funds; they must wait until a future date when the funds are available to them. You cannot place conditions or restrictions on the availability of the funds.
Joint Bank Account Rule
If you open a joint bank account for yourself and your adult child into which you make deposits, your deposits are not considered gifts to your child simply because the account also bears your child's name. But if your child withdraws money from the account to benefit themselves, the money then becomes a gift. The withdrawal must not be considered a loan from you; it must be a free and clear gift without any obligation to repay the money to you.
Charitable Deduction Guidelines
Your gifts of money to children are tax-exempt if they fall within IRS exclusion limits, but they are not also tax-deductible. If your adult child works for a qualifying charitable organization as defined in IRS Publication 526 (Charitable Contributions), your gift of money is only tax-deductible if you give the donation directly to the charity and not as a gift to your child. For example, if your daughter works for the American Red Cross and you want to make a contribution for disaster relief, you must make the donation directly to the charity, and you must itemize the deduction on Schedule A of your Form 1040 tax return. This is not a gift that you report on Form 709 for gift-tax exclusions. However, if you give the money to your child as a gift, and she decides to donate the money to the Red Cross, she takes the deduction on her income tax return.