01 Oct Will the IRS know if I gift money to my grandchildren?

Q. I know there are limits on what you can gift without tax consequences. But really, if I gave smaller amounts to my grandkids even if it adds up to a lot, how would the IRS ever know?
— Grandparent

A. Gifting assets, often, is done on the honor system.

Federal and state tax authorities have no direct way of knowing how much is being gifted. The system relies on taxpayers self-reporting gifts.

However, the tax authorities may find out if you or the recipient is audited by matching transactions reported for certain assets, or because banks are required to report cash transfers in excess of $10,000, said Andrew Novick, a certified financial planner and estate planning attorney with The Investment Connection and Brookner Law Offices in Bridgewater.

“Since it is relatively easy to avoid paying gift tax, it doesn’t seem worth the risk of getting caught for flouting the rules,” he said. “Understanding the gift tax is the best way to avoid problems.”

The IRS states that a gift is “the transfer of property by one individual to another while receiving nothing, or less than full value, in return.”

Gifts are never taxable to the recipient, so only the person making the gift has to deal with the gift tax, Novick said.

The amount you can give will not be subject to gift tax if the gift amounts fall below annual and lifetime exemptions. Both exemptions have changed over the years.

“Currently, the annual gift exemption is $15,000 per recipient,” he said. “This means that you can give up to $15,000 each year to an unlimited number of people with no reporting requirement at all.”

The lifetime exemption is currently $11.4 million and only applies to gifts in excess of the annual gift exclusion, Novick said. Remember that these amounts are doubled if you are married.

Novick said only a small number of taxpayers have to worry about exceeding the lifetime exemption. However, many taxpayers exceed the annual gift tax exemption.

Examples include helping a relative or friend buy a car, make a down payment on a home, or pay for college. In this case, you are supposed to complete a U.S. Gift Tax Return (IRS Form 709), but don’t panic. Although you should file a gift tax return, it is highly unlikely any gift tax will be due, Novick said.

“The reason is that gifts in excess of the annual exemption offset your lifetime exemption before any gift tax is due,” he said. “For example, if you make an annual gift of $315,000 to a grandchild, the first $15,000 is exempt due to the annual gift exemption and while $300,000 needs to be reported as a taxable gift, no gift tax is due because it just reduces your lifetime exemption to $11.1 million.”

Until you use up your entire lifetime exemption, no gift taxes are due, Novick said.

Note that the IRS can impose penalties if you they discover that you failed to file a gift tax return even if no gift tax was due.

It’s also important to realize that the gift tax is integrated with the estate tax, which applies to amounts transferred upon your death in excess of your remaining lifetime exemption.

“Assuming there were no other lifetime gifts in my example above, estate tax would only be due on amounts transferred at your death in excess of your remaining $11.1 exemption,” he said. “Therefore, I suspect that you can make any gifts during your lifetime that you desire, file a gift tax return if applicable with no gift tax due, and still not have to worry about estate taxes at your death.”

On the other hand, if your net worth is very high, you should consult with a qualified professional to help you determine an appropriate gift and estate tax strategy, he said.

Novick also wants to point out that if you are planning on making a gift to help pay another’s college costs or medical expenses, it may be better to make the payment directly to the educational or healthcare institution because such a payment isn’t even considered a gift.

Also don’t forget that while New Jersey does not have a gift tax or an estate tax, it still has an inheritance tax.

“Gifts made within three years of death are considered part of the decedent’s estate and subject to the inheritance tax,” he said. “The New Jersey inheritance tax does not apply to transfers made to Class A beneficiaries, which include a spouse, domestic or civil union partner, parent, grandparent, child, stepchild or grandchild.”

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This story was originally published on Oct. 1, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.