Hello, I'm Jean Carter, an ACTEC Fellow from Raleigh, North Carolina, and with me is Toni Ann Kruse, an ACTEC Fellow from New York City, New York. And our topic today is a special kind of gift tax exception, the direct payment of medical and tuition items. Well, let's start at the beginning. What are gifts?
Sure, thanks so much, Jean. A gift is a transfer to an individual directly or indirectly that is for less than adequate consideration. So essentially, that's giving someone money for something, and you're not getting anything in return. There is one important distinction I want to make here, and that is a payment by parents for something for a child that would be a support obligation, so for any major needs of a child, of course, if you're paying that as a parent on behalf of your child, that's not a gift.
Certainly, that makes sense. And how are gifts taxed?
Gifts that are not subject to specific exemptions or exclusions are taxed at a current federal gift tax rate of 40 percent. The gifts are reportable and due from the person who actually made the gift, not the person who received it. The person who made the gift is what we refer to as the donor.
You said there are some exceptions from these gift tax rules. What are those?
Right, every individual, every US person, has an exemption of 11.7 million dollars from lifetime gifts or estate tax on death. This lifetime exemption has been discussed in a separate video in this series, so I'm not going to go into it in great detail, but any gifts that go above the $11.7 million are taxable unless a specific exclusion applies, and there are some exclusions that we'll talk about today and others that exist as well. Let me give you a couple of examples. So you may have heard of the annual exclusions - that's the ability to give $15,000 to anyone that you want to, and that's not subject to gift tax. In addition, there are some powerful exclusions that we're going to discuss today - the tuition and medical payment exclusions.
Well, can those payments for tuition and medical we made for anyone?
They can. It's not that you can only make them on behalf of a spouse or child, or other relatives. You can make tuition and medical expense payments on behalf of anyone you wish.
And to whom do you make these kinds of tuition and medical payments?
This is a really important detail to pay attention to. When you are paying for medical expenses or tuition for another person, you do need to pay those directly to the medical provider or educational institution. You cannot, for example, give money to a child and say, "Hey, want you to use this for my grandchild’s private school payments this year." You need to pay it directly to the school for the exclusion to apply.
Makes sense. When you say "tuition," what is included as tuition?
So, tuition is narrowly defined by the Code. It's really a payment directly to an educational institution at any grade level, college-level, higher ed, private-school for younger grades, but it does not include things like a tutor; it doesn't include summer camp. It wouldn't include daycare or payments to a nanny or au pair, and it does not include living expenses, any payments towards a dorm or books.
Well, you said the other exception is for medical expenses, direct payment of them. What qualifies as medical expenses?
Right, so the exclusion for the payment of medical expenses really only applies to deductible medical costs. So that would include payments for medical insurance, prescription drugs, or payments directly to a provider for medical care. It doesn't include things like a gym membership or other sort of health adjacent needs.
Well, if someone does make these kinds of direct payments of medical and tuition, do they have to file and gift tax return?
Actually, they do not. These transfers are not part of the definition of "gifts" as that term is used on the gift tax return, which is also referred to as a Form 709. In the instructions to the 709, it makes it fairly clear that you do not need to report direct payments of tuition or medical expenses.
That's great. Can you give us some practical examples of how people have used these exclusions?
Sure., So one that I see often is where a client comes to me who's a grandparent and says, "I set up these trust for Johnny and Sally a number of years ago, I've been funding them and they are about to enter college and I thought maybe, ‘hey we can use those trusts to pay for their college expenses.’" And I say, "Let's not do that. Why don't we think about this and instead of paying all of their expenses while they're in college from the trust, why don't you pay for tuition directly. In that case, you won't be eating into the trust that you may have used some of your exemption to fund and you're going to be getting more assets out of your estate without any gift tax implications whatsoever." It's a good way to kind of use this exclusion. Another example is where you know a grandparent or family member wants to pay for orthodontic work for a child or grandchild. That, again, is a thing that it can get pricey. It's something that may be very helpful or maybe paying medical insurance for an adult child -like a parent who their child doesn't have a job that provides medical insurance, so they want to pay for that. Those are those are some examples. One creative way that we'll sometimes look at is a grandparent, especially if they're elderly or ill, will decide to prepay tuition payment for a number of years for a grandchild just so that it's all done, and they don't need to worry about it anymore.
This sounds like it could be a very, very good exclusion on the gift tax. Let's just put it all together. It sounds like in a year you could make a great many gifts within these various exceptions.
Yeah, and it really adds up. If you, as an individual, decide that you're going to pay for the tuition for everyone in your family who's in any kind of educational institution that you love, and you want to go ahead and do that. Maybe you also say, ”Any medical expenses, please tell me about it, and I'll pay those directly too.” You can really add up to over $100,000 a year very quickly.
That's great. Thank you so much for your time this today.
Thanks for having me. I hope this is helpful.