The Internal Revenue Service casts a wide net when it comes to what counts as a gift for tax purposes. If you give anything away – even to a third party such as a credit card company on someone else's behalf – it's a gift, assuming you don't expect the cardholder to repay you. That means taxes could potentially come due – collectible from you, not the person you helped out.
When you pay a friend or family member's credit card bill without any expectation of being paid back, the IRS considers it a gift.
Loans versus Gifts
Technically, the IRS says a gift is anything you transfer to someone else without receiving full value for it in exchange. In the case of cash, such as if you write a check to pay off someone's credit card debt, receiving full value means you'll get the money back eventually – it's a loan.
But the IRS is picky about loans as well. Repayment must include interest. You can't charge nominal interest either – it must be equal to the federal rate. If you're collecting interest on a loan, it’s taxable income and you have to report it. If you’re not collecting interest on the loan, this means it's a gift. One exception is that you don't have to charge interest on loans under $10,000, so if you pay the creditor less than this, you're probably in the clear. Additionally, if you pay $10,000 or less, you won't have to worry about being repaid at all, because this amount falls within the annual exclusion for gift tax purposes.
Gifts to Friends and Family
As of 2018, the IRS allows you to give away up to $15,000 per person each year per person without paying taxes on the gifts. If you pay off someone's credit card to the tune of $15,000, it's a nontaxable event. Interest is no longer an issue because you don't have to ask the individual to pay you back. Otherwise, you might have to pay a gift tax on any portion of the money that exceeds the annual $15,000 exclusion. Unless you've given away millions in gifts, though, you can choose not to pay, because the IRS also offers an $11.18 million lifetime exclusion as of 2018.
Unfortunately, this same $11.18 million exclusion also covers estate taxes when you die. Your estate doesn't pay taxes on the first $11.18 million of your assets' value, but if you begin snipping away at this lifetime exclusion by using it to avoid paying gift taxes during your lifetime, your estate can only use what remains. Paying one credit card off for someone won’t make much of a difference, but it can add up if you exceed the annual exclusion regularly.
If you pay off your spouse's credit card, it's not a gift, no matter how much the bill is. You can give anything you like to your spouse tax-free. Paying someone's medical bills or college costs is also exempt from taxation, but there's a catch. You must make the payments directly to the care provider or the learning institution. If someone charges these bills on a credit card, then you pay off the credit card, the transaction becomes a taxable gift – assuming you pay more than $15,000.
When to File
If you exceed the annual exclusion, the IRS doesn't want to wait to hear about it until you die. It likes to keep a running tab of what you owe. Therefore, even if you decide not to pay the gift tax and use a portion of your exclusion, you must file a gift tax return, Form 709. The IRS keeps a total of all the times you've exceeded the annual exclusion limit so it knows the amount that remains for your estate.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.