Open up any newspaper or magazine across the county and likely you will read an article about the difficulties facing young adult looking for their first jobs. More and more young adults are turning to their parents for financial assistance. How can parents help their children? And what are the gift tax implications of such assistance?
Each individual has the ability to gift $14,000 a year to each person without using up any of his or her lifetime exclusion. A married couple can then gift $28,000 to an adult child without any gift tax impact at all. However, you must keep in mind that this $14,000 amount is inclusive of all gifts. You cannot give $14,000 directly to your child and then give them additional withdrawal rights under a trust.
In addition, you may also pay your adult child’s college or graduate school tuition directly to the educational organization or pay expenses for your child’s medical care directly to the provider of the care. The Internal Revenue Code has specific provisions which exclude these types of transfers from the definition of a gift.
If this is not sufficient and your adult child still requires financial assistance, you may transfer additional sums to him or her. In 2015 every individual has a $5,430,000 lifetime exclusion amount. Gifts you make to your children over the $14,000 annual exclusion can count against this total lifetime amount.
As an alternative you can lend your child money. Such intra family loans should be carefully documented. A written loan agreement or promissory note spelling out your child’s obligation should be in place. In order for this to be treated as a loan and not a gift by the IRS, interest must be charged at least at the Applicable Federal Rate published by the IRS each month. Different rates are used depending on the length of the loan, short term (where all principal is due back within 3 year), midterm (where all principal is due back after 3 years but before 9 years) and long term (where the principal is due after 9 years). Interest rates are currently fairly low. The November 2015 rates range from .49% for a short term loan to 2.57% for a long term loan.
If you decide to lend money to a child and circumstances evolve such that he or she cannot pay back interest or principal as it becomes due, you can then forgive some or all of the note. That note forgiveness will be treated as a gift which can then utilize some or all of both you and your spouse’s $14,000 annual gift exclusion amount or your respective $5,430,000 lifetime gift exclusion amounts.
There are several ways you can help your children financially. However, it is important to always keep in mind the tax implications of such help.