Avoiding the Grinch: gift tax exclusions

Steve Merrell |

Q: I have been making some gifts to my children and grandchildren and my accountant keeps warning me about gift taxes. On the other hand, I hear that some gifts are not taxable. Which are taxable and which are not?

A: I remember when I first heard about gift taxes. I was just a kid, but I was incredulous. It sounded like the Grinch trying to steal Christmas. I still don’t like it, but at least I understand it better. If you are making significant gifts to your children and grandchildren, I’m glad to hear that your accountant is raising the gift tax warning flag. There is nothing that prevents you from making the gifts. However, if your gifts exceed the annual exclusion amount, you will need to file a gift tax return (IRS form 709) for the year in which you made the gift. The IRS also requires this form if you and your spouse split gifts, regardless of the amount of the gift.

On the positive side, there are several types of gifts that are not subject to gift tax. These include all gifts below the annual exclusion amount, gifts to spouses, payments made directly to a qualifying institution for the education of an individual, and payments made directly to a medical institution for the benefit of an individual. In addition, gifts made to certain political organizations and other exempt organizations are excluded from gift tax, but these are beyond the scope of today’s column.

Many people are aware of the annual gift tax exclusion rule. This rule says that any gift below the exclusion amount is not subject to gift tax nor does it count against an individual’s lifetime gift tax exclusion. In 2021, the annual gift tax exclusion is $15,000 per recipient. In addition, spouses can split their gifts, meaning that their combined annual gift tax exclusion is $30,000 per recipient.

Gifts to spouses are covered by something called the unlimited marital deduction. As the name implies, gifts of any amount can be made between spouses without incurring gift tax—unless the spouse receiving the gift is not a U.S. citizen. In that case, the annual limit in 2021 is $159,000. Gifts above that amount go against the giver’s lifetime exclusion.

Payments made directly to a school for someone’s tuition are not considered gifts for gift tax purposes. However, if the payment goes toward books, supplies, room and board or other non-tuition expenses, it would be considered a gift to the individual, To the extent your total gifts to that individual exceed the annual exclusion amount, those payments would be subject to gift tax.

Direct tuition payments can be a very effective way to help someone pay for college. Given the limits on the educational exclusion and the high cost of college education, you may find it beneficial to consider a combination of 529 plan contributions and direct tuition payments. You should also be aware that direct tuition payments might complicate the student’s eligibility for financial aid, so check with the school to better understand the potential impact.

Medical expenses paid directly to a care provider on behalf of another individual are also excluded from gift tax. The IRS specifically defines medical care as payments made for “the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.” It also includes the amounts paid for medical insurance on behalf of any individual. If the person receiving the medical care gets reimbursed for the cost of that care by an insurance company, the payment is considered a gift to the recipient of the care.

Two final points: First, the educational and medical exclusions are available regardless of the relationship between the giver and the recipient. Second, in the event gift tax is incurred, it is generally the giver of a gift that is held liable for any gift tax owed. However, if the giver does not pay, the IRS will seek payment from the receiver of the gift.



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.