How to avoid taxes when giving money

Your Money


Imagine your grandparents slipping you some spending money, as grandparents so often do. But instead of $5, it's a check to cover your college tuition or the down payment on a first home.

It may seem like the privilege of a few wealthy elite, but today's grandparents, on the whole, have amassed more financial assets than previous generations. In fact, it's estimated they'll pass on $25 trillion over the next couple of decades.

And many want some of that wealth to benefit you, their grandchildren.

"Grandparents have more time and a little more money to distribute," said Dr. Arthur Kornhaber, founder of the Foundation for Grandparenting and author of The Grandparent Guide: The Definitive Guide to Coping with the Challenges of Modern Grandparenting (McGraw-Hill, $16.95). "They also see the financial demands placed on families today."

Making the down payment on a home, however, is not as effortless as handing over a few dollar bills. You need a few strategies to minimize the taxes that otherwise would significantly shrink your grandparents' legacy.

Each year, Uncle Sam allows you to make a tax-free gift to any number of people as long as the gift doesn't exceed $12,000 per person.

Anything more could be subject to a double tax: the gift tax and the generation-skipping transfer tax, each as high as 46 percent. Though you don't pay these taxes, it's deducted from your grandparents' estate if they give more than $2 million to an individual over their lifetime, reducing the overall amount that they can pass on. (Under current law, the lifetime limit will increase and tax rates decrease through 2010. In 2011, they switch to $1 million and 55 percent, respectively.)

"The best and easiest way to move money is under the $12,000-a-year exemption," said Diahann Lassus, a certified financial planner in New Providence, N.J.

Plus, if your grandparents are paying for tuition bills or medical expenses, there's no ceiling. They can give beyond $12,000, as long as they pay the money directly to the institution, not to you.

When it comes to the down payment for a home, $12,000 probably won't suffice. But if your grandparents have the financial means to give more, there are some ways around the cap.

First, both grandma and grandpa can make a tax-free gift, totaling $24,000. Have a spouse? They can give $24,000 to him or her too. You also could time the purchase of a home for early in the year and receive one gift in December and another in January - again, all tax-free.

Finally, your grandparents could lend you the money. To convince the IRS that the loan really isn't a gift, you have to follow some rules: Draw up a contract that states how and when the loan will be repaid as well as apply an interest rate that's comparable to what banks charge.

Still, the interest rate can be competitive, and your grandparents may even forgive your interest payments each year as a gift - up to $12,000.

Carolyn Bigda writes for Tribune Media Services.

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