The season of giving is upon us, and it's time to make those year-end gifts… not just the ones you make to charities, but it’s often this time of year that many of us find ourselves also giving to family members. 

While gifting money to loved ones may seem like an easy choice, it can sometimes have relational, spiritual, and tax implications. The annual gift tax limit for 2022 is $16,000 per recipient for a single person or $32,000 for a married couple (for 2023 these numbers increased to $17k and $34k). Any gifts you give to loved ones over this amount may be subject to federal and, depending on where you live, state taxes. 

How can you maximize your generosity while protecting your assets from taxation? Let's take a look at the tax implications of personal giving during the holidays.

Counting the Cost of Giving to Adult Children

Besides spiritual discipline and benefits, giving in general can offer a tremendous psychological reward. Giving just feels good. It's different from making a loan or even offering to help someone. By definition, gifts come with no strings attached. 

Although gift-giving can be extremely fulfilling, it can require discernment and discretion. Just because you can give someone a generous gift doesn't necessarily mean you should give it. Generosity often requires wisdom, even when you give to your own family. 

When you give to a non-profit, you likely consider the organization's mission, operations, impact, and how they will use those funds. Similarly, when gifting to adult children, you might want to consider the impact that gift might have on them and their family. 

Consider the financial and relational aspects of giving, including the potential taxation. 

What Are Gift Taxes?

Gift taxes limit the amount of tax-free gifts one person can give to another. These taxes exist to prevent people from avoiding taxes by giving away their assets to family members.

There are two limits: an annual limit and a lifetime one.

Under IRS rules, gifts to loved ones outside of a spouse are generally considered “taxable” if they total more than the annual gift tax exemption. In 2022, that exemption stands at $16,000 for a single filer and $32,000 for a married couple per recipient. In other words, a single grandparent could give up to $16,000 to each adult child or grandchild without having to report these gifts to the federal government. - (These numbers increased to $17,000 and $34,000 for 2023.)

Gifts exceeding the annual exemption amount may require you to file a gift tax return with your federal tax forms and pay any applicable taxes.

There are, however, many exceptions to this rule (including the lifetime gift tax exemption), which we’ll touch on later.

Federal Tax Implications of Giving to Family

For the IRS, it's not just the amount you give that matters but also whom you give to. If you're giving to your spouse or a qualified charity, for example, there are no limits on the amount you can donate tax-free. 

Gifts to adult children, though, may trigger the need to file a gift tax return if they exceed the annual exclusion amount. You cannot circumvent the exclusion by making a non-cash contribution such as real estate, stocks, or bonds. 

Just because a gift is taxable, though, doesn't mean you'll actually pay gift taxes on it. And even if you need to file a notice of your gift with your tax return, the IRS has created loopholes to help you out. We'll come back to these.

State Tax Implications of Giving to Family

Some states may charge gift taxes, but others, including California, do not. Regardless of your state, though, be sure to talk with your tax preparer about any significant gifts you plan to make during the holidays.

The state or federal tax implications could depend on whether you give to a minor, an adult child, a legal spouse, a trust, or a custodial account.

When Do You Have to Report Family Gifts to the IRS?

The federal government considers money or property a gift when it is transferred to another person and an item of equal value is not exchanged in return. Most of us give or receive gifts regularly without ever reporting them to the IRS, so when is it essential to file and pay gift taxes?

Fortunately, most Americans will never have to pay gift taxes. These taxes are generally levied only on the wealthiest citizens. However, you do need to file your gift with the IRS if you make a gift to an individual that is valued at more than the annual gift tax exemption amount. In certain cases, you don't have to file the gift forms with your taxes. 

The following gifts are entirely exempt from the gift tax:

• Gifts to spouses 

• Charitable donations to a qualifying charity

• Medical expenses

• School tuition and education expenses

• Political contributions

In addition to these exemptions, two other policies help limit gift taxes — the annual gift tax exemption and the lifetime gift tax exemption. The annual gift tax exemption determines how much you can give to a single recipient in a single year. The lifetime gift tax exemption establishes how much a taxpayer can give away over the course of their lifetime, including at death. For 2022, the lifetime tax exemption stands at $12.06 million in assets or property (this increased to roughly $12.9 million in 2023).

So gifts that are given in a calendar year that are not more than the annual gift tax exemption do not have to be reported. When you give more than the annual exemption, you must file a notice of your gift with the IRS. The amount given is then deducted from the your lifetime tax exemption. And no taxes are likely owed.

Consider this example using 2022 exemption numbers:

A woman buys her grandson a $30,000 car as a college graduation gift. Grandma's present exceeds the annual $16,000 exclusion limit per gift by $14,000. Consequently, she will have to report the gift to the IRS using Form 709. The $14,000 is subtracted from her $12.06 million lifetime exemption. Grandma will owe no extra taxes on the gift, and she can still give away up to $12,046,000 without paying a gift tax.

Creative Ways to Give Assets to Your Family This Season

If you find yourself knocking at the door of the lifetime exemption amount, there may be a good reason for gifting your assets now vs. later. More in-depth estate and tax planning will likely be beneficial to you. Call your financial advisor and estate attorney to learn more. 

In any case, for financial, tax, or personal reasons, you may find yourself not wanting to give cash, property, or easy-to-liquidate collectibles to your kids. If this is you, you can still share your assets with your family in creative ways, however.

It's easy to help cover the cost of medical bills or college tuition. You can pay the healthcare provider or university directly, and you may never have to report those gifts on your taxes. There are caveats, though - as of the time of this article, tuition payment support could impact student financial aid, for example. Other ways to help your loved ones might include opening investment accounts for them or giving to an existing account such as a Roth IRA or 529 plan (assuming they qualify). While doing so may require you to report the gift with your taxes, other benefits may outweigh the hassle of the extra tax form.

Funding Roth IRAs for Adult Children

Funding a Roth IRA for a young adult is almost always a smart move. Can you contribute to a Roth IRA for a child, though?

Absolutely! In fact, a retirement account may be one of the best gifts you can give. And while they may not realize it at first, wait until compounding interest starts to take off. When funding a Roth IRA for a young adult, all earnings grow tax-free until withdrawal at retirement age (subject to some limitations). Unlike a gift to someone who might spend the funds on anything but retirement savings, you know your gift will likely go towards building up a nest egg for their future. 

Thanks to compounding interest, the money you invest today can grow exponentially over the coming decades and be available at critical moments in life. In most cases, your family member can withdraw funds tax-free and penalty-free to help pay for college, $10,000 for a first-time home purchase, or their retirement.

If your child is under 18, the account must be a custodial account. For children over age 18, the account owner must be the child, and you can continue to make contributions, up to the annual limit, to their Roth IRA provided that they qualify and have received taxable income for the year in which the contribution was made. Check with your child and your wealth management advisor before making a contribution, as Roth IRAs have annual limits and phaseouts.

529 Plans

A 529 plan is a state-run college savings account. Many people feel that 529 plans are a great way to provide for their loved ones. And they can be! In most cases, money held in a 529 plan will not widely limit access to federal financial aid. In addition, the account owner maintains control over how the money is invested. 

That said, you have limited flexibility on how the money can be spent. Eventually, the account must be liquidated, and the owner could face tax implications if the funds are not used for qualifying education expenses. . Check with your tax preparer or wealth management professional about any tax laws you should be aware of if you decide to contribute to a 529 plan as a gift. 

When Giving Assets to Adult Children Doesn't Make Sense

Sometimes, giving assets to your children is not a good idea. For example, a house is usually best left in an estate. If you directly give your family member a house while you are still alive, they may owe a large tax bill for its appreciation for the time you owned the house.

Gifts that may come in the way of a relationship, including a relationship with God, may also be worth reconsidering. Such gifts generally require forethought and prayer before being made.

For most assets, the IRS does not care if you give them when you are alive or after you pass away. They do, however, require proper reporting. Except for the wealthiest Americans, gift and estate taxes will likely not be a concern. 

That's good because 65% of people over age 55 say they want to share with their heirs while they're still alive. However, you likely want to avoid over-giving now and then have to rely on your children for help in later life. For this reason, consider discussing significant gifts with your wealth management professional before you make them. They can help you evaluate its impact on your overall financial plan, taxes, and legacy. 

To make an appointment with a Cooke Wealth Management advisor, give us a call today. We'd be glad to discuss your family's financial future together.