The unintended tax consequences of generosity
Whether it is helping a friend raise money for unexpected medical costs, giving large financial gifts to friends or family, sharing a child’s tax benefits with a partner or former spouse or leaving money to loved ones in a will, many acts of kindness can cost more than expected. The real kicker is when it isn’t the benefactor but the recipient who is stuck with an unexpected tax bill.
Nathan Rigney, lead tax research analyst at The Tax Institute at H&R Block says taxpayers should be careful when considering one of these four good deeds. In some cases, careful tax planning can reduce or eliminate negative tax effects.
Beware of rewards when crowdfunding
Online crowdfunding is an accessible way for people to help friends and family in need. But it is best to keep the fundraiser as simple as possible to avoid tax consequences for the recipients.
Recipients will not have to pay taxes on the amount raised if the givers do not receive something for their contributions. Trading something of value for a donation would mean the recipient of the funds could have to pay taxes on the amount raised, because that transaction resembles a sale instead of a simple donation.
Even if they don’t have to pay taxes, the recipient may still receive a 1099-K reporting the funds paid if the campaign had more than 200 contributors and raised more than $20,000. Because the IRS will have this information, it will likely send a notice asking about “underreported income.”
“That does not mean you need to pay taxes on the amount, but you should have documents and records to show the IRS why the funds are not taxable. You may benefit from speaking to a qualified tax professional if you receive an IRS notice or come under an audit,” said Rigney.
Write checks carefully to avoid the gift tax
Giving money to friends or family does not mean they have to include that amount as income on their tax return. However, if the gift is more than $14,000, the giver could have to pay a gift tax of 40 percent on the excess amount. The $14,000 gift tax exclusion is per taxpayer, so a married couple filing jointly could give $28,000 to an adult son before the gift tax kicks in. They could also give $28,000 to their son’s wife for a total of $56,000 before the gift tax kicks in.
While a $14,000, or $28,000, or $56,000, gift tax exclusion might seem like a high hurdle, gifts include selling something for less than its value or making an interest-free or reduced-interest loan. This could come into play when helping somebody make a down payment on a house or repay their student loans.
For gifts that exceed the annual exclusion limit, a taxpayer can apply a portion of the lifetime unified gift and estate tax exemption to the excess amount. As of 2017, the lifetime gift and estate tax exemption is $5.49 million (potentially $10.98 million for married couples). That means individuals can generally transfer up to $5.49 million of wealth either during life or upon death before the gift or estate tax kicks in.
Alternate, don’t split, a child’s tax benefits
Whether they are divorced parents or an unmarried couple, some taxpayers may want to share their children’s tax benefits.
“Sharing a child’s tax benefits can be complicated. In some cases, IRS law determines which parent can claim the child’s benefits, no matter what the parents want to do. And parents can’t split up tax benefits for the same child in the same year on separate returns, no matter what,” said Rigney.
Instead, they can alternate years. If they have more than one child, they can share the benefits as long as they don’t split the tax benefits for the same child.
There are more tax benefits to having children than just the child tax credit, dependent exemption or dependent care expenses deduction. It could also impact eligibility for the earned income tax credit, which can be worth thousands of dollars, or the head of household filing status, which comes with more favorable tax brackets and rates.
That means the cost of giving up a child’s tax benefits can be greater than a taxpayer might initially think. Rigney advises consulting a tax professional to make sure the family comes out with the greatest overall tax benefit, or at least knows exactly what they are giving up by sharing a child’s benefits.
Actions, even generous ones, have consequences on the tax return. Before making any big gifts – whether they come as a check, a child’s tax benefits or some other form – taxpayers should talk to a qualified tax professional to make sure they don’t cost more than they expect or even cause additional financial burdens for the recipients.