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Best Options To Give Financial Help to Family and Friends

Client Alert - September 18, 2013

By: Wayne Buckwalter

Many people are feeling pretty pessimistic about their finances and are wondering how they're going to pay their bills. Their situation may be due to layoffs or stock market fluctuations among other things.

If you have family and friends that are experiencing financial difficulties, and you are  fortunate enough to be able to help, you need to know how the IRS regulates your good intent. Generous, well-meaning assistance is considered a lifetime gift unless it's for someone whom you are legally obligated to support, such as a spouse or child.

The IRS is not concerned with noble motives. The same rules apply to any other lifetime transfers, including those made for the sole purpose of gift and estate tax planning. Gifts may count against your $5 million lifetime exclusion from gift tax and your $5.25 million exclusion from estate tax for 2013. If you exceed that limit, you could wind up owing gift tax of up to 35% on the excess. Gifts below the limit may reduce your estate tax limit. Failure to follow the rules may result in unnecessary tax or even interest and penalties. There are strategies for helping family and friends that minimize these consequences.

The simplest way is by using the annual gift exclusion, which in 2014 allows you to gift up to $14,000 each to as many individuals (not limited to family) as you want. Spouses can combine their annual exclusions to gift up to $28,000. For example, a married couple with a child who is married and has two children could make a joint cash gift of $28,000 to the adult child, the child's spouse and each grandchild providing the family with a total of $112,000 without the gifts counting against the $5 million ($10 million for married couples) lifetime gift exclusion.

Loans require the same documentation as a bank loan with a dramatically lower interest rate. These loans require a minimum rate of interest set each month by the Treasury, the applicable federal rate (AFR), to avoid potential gift tax and income tax consequences. For July 2013, the AFR was 2.80%. That is significantly less than the cost of a bank loan, assuming the borrower could obtain one, but more than you could earn from CDs or money market accounts.

Without using your annual exclusion or your gift and estate tax exclusion, you can pay the tuition, dental and medical expenses of anyone you want. Note that you must make the payments directly to the providers of those services. Do not reimburse the person you are assisting. If someone is temporarily out of work and loses health insurance coverage, you could directly pay the premium for that person and or that person's family.

You may employ family members or friends. They must provide a service (bookkeeping, real estate management and child care are examples) and the compensation must be reasonable (the same as you would pay someone independent). Overcompensating may make you personally liable for gift tax on the excess and you may not be able to deduct the full salary.

You may purchase a residence or allow someone to live in yours rent-free, so long as the fair market value of the rent comes within the annual exclusion amount.

You may fund Section 529 education savings plans for family members. This reduces the need to save for college at a time when they may be overwhelmed with current expenses. While contributions to a 529 account are considered gifts, these accounts grow tax-free and can be withdrawn tax-free, provided the withdrawals go to pay for college, a graduate, vocational or another accredited school, or for related expenses. This may affect the student’s financial aid.

For more information please contract Wayne Buckwalter, Chair of the Wealth Preservation Group at 215.564.1700 or