Be generous and smart with any tax-free gifts to family

Do you have someone in your family who could use some financial help? Are you able and willing to provide it? Don’t get out your checkbook without first considering the most tax-advantaged way to help. While estate taxes govern taxation on assets after your death, gift taxes govern what you ca

n give while living. Let’s examine ways you can help your family without hurting your finances.

Within current guidelines, you can still give to your family and friends without facing gift taxes — as long as you watch exclusions and exemptions.

Gift tax annual exclusion: Federal tax law allows you to give up to $13,000 annually (per recipient in 2011) to an unlimited number of individuals, with no tax or reporting obligations.

Gift splitting: Married couples can gift up to $26,000 (per recipient in 2011) each year with their exclusions.

Lifetime exemption: Tax law provides a lifetime gift tax exemption ($5 million in 2011). This allows you to give away as much as $5 million to family and friends over your lifetime without owing any federal gift tax. If you are married, you and your spouse each are entitled to a separate credit. You can use any or all of the credit to offset taxes on gifts, and the amount you have used will not be available to offset any estate taxes.

This means that gifts made under the $13,000 exclusion will not use up any of your lifetime gift tax exemption. However, any gifts you make over the $13,000 limit per individual, per year, will reduce your lifetime exemption.

There are other tax-free ways to help.

Education savings: Another possibility might be to make tax-free contributions to a 529 college savings plan of a beneficiary. In one year, you may invest as much as $65,000 ($130,000 if you split the gift with your spouse) in a 529 plan. However, that $65,000 will be treated as if it were a series of $13,000 gifts made over five years, so you won’t be able to make any other tax-free gifts to that person during that period.

Tuition and medical expenses: There are no limits on the amount of these expenses you can pay, as long as you give the money directly to the medical provider or educational institution where the expenses were incurred.

Loans: You can loan money to family members at a lower interest rate than they would have to pay a bank. To avoid gift taxes, it’s important that you follow the required processes and impose the stated interest rate.

Homes: It’s unclear whether letting someone live rent-free in a home you own is considered a “gift” by the IRS, and therefore subject to gift taxes. You could avoid the issue by making them a part-owner in the home.

A return is generally needed only when you make a gift of more than $13,000 to any person (other than your spouse). Your gifts can be cash, securities or property. As long as the combined value is $13,000 or less per year, per person, no federal gift tax applies and you don’t have to file a gift tax return.

Under current law, you won’t have to pay federal gift tax until all taxable gifts made during your lifetime exceed $5 million. You may want to file a gift tax return for a hard-to-value gift, even when a return is not required. Why? If the transfer is adequately disclosed, the IRS has only three years to challenge the valuation. Without the gift tax return, the IRS could dispute the valuation later when your estate tax return is filed (and justification is much more difficult), potentially forcing your family to pay substantial back taxes.

Making gifts while you’re still alive can help your family when they need it most — and if you plan wisely it can also help you avoid or minimize future estate taxes. Your financial adviser can help you make smart decisions to benefit your family and friends, while also keeping your own financial goals and taxes in mind.

Erin Eddins is a chartered financial consultant, a member of the Financial Planning Association and is a certified financial planner professional. She can be reached at erin.eddins@standard.com or 425-212-5986.