How to Make Tax-Free Gifts to Your Children (Even If They're Adults)

You've reached that wonderful time in life when your children are grown, perhaps having their own children, and you have the financial means to make their lives better and easier. There are many ways to make gifts to your children, but you want to be sure that those gifts will not result in a negative tax consequence to you.

Fortunately, there are many ways to help your children financially without harming yourself or causing unintended financial consequences for them. Let's take a look at the basics of making tax-free gifts to your children.

Understand the Gift Tax Exclusion

Federal law allows you to give assets valued up to a certain amount to an adult child (or other person) without incurring federal gift tax. As of this writing, that amount is $14,000 per year from one individual to another per year. If you are married, you and your spouse can each give your child $14,000 without triggering a gift tax issue. These gift tax rules now apply to same-sex married couples as well as opposite-sex couples. And if your child is also married, you and your spouse can each give your child and their spouse $14,000, for a total of $56,000.

Another option, if it's close to the end of the calendar year and you have not given your child a gift in the current year, is to make one gift at the end of the current year, and another at the beginning of the next year. This strategy may be useful if your child needs a large sum of money for a one-time expense, say, a down payment on a house or an investment in a business.

Of course, you can always give your child a gift in an amount greater than that of your annual exclusion. You likely won't have to pay tax on the excess amount, but you will need to complete and file a federal gift tax return. You have a lifetime exclusion from federal estate and gift tax, and the excess gift will be applied to that amount ($5.45 million per individual as of this writing). Thus, the gift may reduce the amount of assets you can pass tax-free upon your death.

Educational, Medical, and Dental Exclusions

You may also make payments directly to a medical care provider or qualifying educational organization on behalf of your child or grandchild without triggering any gift tax issues. If your son has a large medical bill following emergency surgery, or your daughter is working two jobs trying to put her kids through private school, these exclusions can be a tremendous help. By paying the school or medical provider directly, you can make as large a payment as you like. Be aware that if you give the gift to your child, even if they turn right around and use it for the medical, dental, or educational expense, the gift does not qualify for the exclusion.

Beware of Unintended Financial Consequences

Using these strategies, you may successfully avoid a gift tax issue, but that doesn't mean you're out of the woods. If there is a chance that you or your spouse may need to qualify for government benefits, a gift you make to your child could be viewed as an attempt to lower your personal net worth so that you will qualify sooner.

Medicaid has a five year "look-back" period. You may not think you would ever qualify for Medicaid, or need to, but if you or your spouse need long-term nursing care, expenses will mount rapidly. Many people eventually require Medicaid assistance to pay for ongoing care, and to qualify, they must have assets valued at less than a certain amount. Medicaid will look back at transfers within the five years prior to your application for benefits. If you have transferred away assets during this span of time without having received fair market value for them, the gift may derail your qualification for benefits.

This is true even if it's a perfectly understandable gift to a child, and even if you had no intent to defraud Medicaid. And while annual exclusion gifts do not trigger gift tax, they are still taken into account by Medicaid if made during the five-year "look back" period.

The wisest course of action if contemplating a gift of significant value to a child is to contact an attorney who is experienced in estate planning, tax law, and elder law. Your attorney will help you to avoid not just negative tax consequences, but other unintended financial consequences as well.