Around the world, countless people are facing unexpected illness and unemployment, and this crisis is hitting many U.S. families close to home. While donating to charity is tax free (and may even qualify for a tax deduction), gifts to family members do not benefit from this preferred treatment. Indeed, these gifts can be a trap for the unwary. Currently, gifts to family and other noncharitable beneficiaries are subject to a 40% gift tax. For those who want to help family during this time, consider taking advantage of the many exemptions and exclusions from the gift tax in order to achieve your goals without unnecessary tax and complexity.
Pay medical bills or take over tuition payments.
Job loss can mean loss of medical benefits and decreased liquidity to make tuition payments. Transfers to qualified medical and educational institutions, regardless of the size of the payments, are excluded from gift tax as long as the payments are made directly to the service provider. One of the simplest options for family members looking to help is to take over medical or educational bills for a period of time. Health insurance premium payments also qualify for this treatment and may be particularly impactful for those who have lost jobs and employer-subsidized benefits. In order to qualify for the exclusion from gift tax, be sure to make the payments directly to the school, insurance company or medical provider and not to the family member.
Give cash, but not too much.
The IRS acknowledges that family members and friends exchange “small” gifts too frequently to track. If we filed a gift tax return for every birthday, wedding and baby shower, the amount of paperwork would overwhelm the system. For this reason, each year, the IRS sets a dollar amount under which it doesn’t want to hear about the gifts. This “annual exclusion” from the gift tax is currently $15,000 per person. Practically, this means that you can write a check to any person for $15,000 and not worry about gift tax. If there are three family members you want to help, you can write a $15,000 check to each of them. If your spouse wants to contribute as well, you can each give $15,000 for a total of $30,000 per person. If your spouse has the desire to give but not the means, you can “split gifts” and make the $30,000 transfer from your account, but you would have to file a gift tax return to report the split (this is just a reporting requirement to qualify to split gifts; no gift tax would be owed).
In practice, this means that if a family member is in need, you and your spouse can transfer $30,000 to them. If that family member is married, you can transfer $30,000 to the spouse as well. If they have children, $30,000 can be transferred to each child, too. This is on top of any tuition or medical payments you make on behalf of the family as described above. If the need exceeds this amount, you can make an identical transfer on January 1, 2021, when the annual exclusion resets and/or make larger gifts (described below) or loans.
Give more, but understand the tax implications and reporting requirements.
If you give a family member more than the annual exclusion amount, you have made a taxable gift. The good news is that under current federal tax laws, every U.S. citizen can make gifts of up to $11.58 million before the transfer is subject to the 40% gift tax. This is what is known as the gift tax exemption amount. These gifts are not “excluded” from the gift tax, as are those described above, but they are exempt until they cross over the $11.58 million threshold. This means that you can step in and provide significant financial assistance to family through simple outright transfers of assets, and those gifts are not subject to gift tax until they total more than $11.58 million (doubled if you split gifts with your spouse). For purposes of this exemption, the amount does not reset every year as it does for the annual exclusion, and it is not per person as with the annual exclusion. Instead, it refers to how much you can give to all noncharitable beneficiaries during your life. If you do not “use up” the exemption during life by making gifts, you can apply the balance to the value of your estate at death.
If you are able to stomach a little more complexity, it may make sense to transfer the assets to family in trust rather than outright.
Revisit existing trusts and other structures and re-underwrite their purpose.
For trusts that have already been formed and funded, it may make sense to review the distribution provisions and see if trust assets can and should be used to provide relief. A trustee has a fiduciary duty to oversee assets for the benefit of the beneficiaries of the trust, and most are given broad discretion to make distributions to beneficiaries to provide for their maintenance, education, support and health.
Beneficiaries who have fallen ill, been furloughed from or lost a job or had a business close or seriously curtailed by the pandemic should communicate their circumstances to their trustee so that discussions regarding potential distributions can begin. It is precisely as a precaution against these types of unforeseen circumstances that trusts are set up to benefit future generations. A trustee should be considered a trusted advisor who can look at the big picture and help chart a way through this change in circumstances. Even if you are working with a non-BBH trustee, we are happy to review the trust terms and provide suggestions on making existing trusts flex to help address needs of today.
Help in other ways: invest in family.
If your goal is not to simply give, in addition to loans, you can also address financial need through a direct investment.
Suppose a family member has built a business in leased space that has been affected by current events. The family certainly could take over the rent for the business, but another approach could be to contact the landlord or building owner to see if they would entertain selling the building outright to the family. Many residences were acquired by banks in the 2008 financial crisis, and banks and landlords might be convinced to sell to avoid the costs, labor and financial uncertainty of having to evict a bankrupt family business and upfit and release the space when the pandemic ends and the economy improves.
A family member or family-controlled entity can be a more patient landlord in allowing the business to regain its footing without sacrificing the capital and efforts put into building the business. This approach also appeals to parents who want to help a family member without disadvantaging others, as the building may be seen as a long-term investment for the entire family.
Whether through a gift, loan or investment, if you are struggling with how to help family during these challenging times, please reach out to your BBH relationship team so we can discuss your goals and how we might best help you achieve them.