Take Advantage of These Breaks
If you’re planning on leaving a sizable amount to children and/or grandchildren, consider giving money to them as gifts on an annual basis. You can set up trusts for them so that the funds aren’t misused. This way, the money is out of your estate and cannot be subjected to confiscatory estate taxes.
Be careful of triggering “gift taxes,” though. Among the many things the IRS can punish you for is your generosity – specifically, the giving of large gifts. For 2015, you are allowed to give up to $14,000 to any one family member before the gift tax would be triggered. However, you and your spouse jointly can give up to $28,000 per year per person to as many people as you’d like. So, for example, if you have three grandchildren, you and your spouse can give them $84,000 ($28,000 x 3) tax-free.
Before you give cash outright, consider giving assets that have appreciated in value. For example, if you own shares in a company’s stock, and those shares have appreciated by 500% over the past 20 years, you’d have a huge tax liability if you ever sold those shares. But if you give those shares to a child or grandchild who is in a low tax bracket, he or she can sell the shares and take the capital gains liability but pay little or no tax on it. Simply call up your broker and ask to assign ownership of your shares to another person rather than sell them.
To Prevent Your Gifts from Being
Misspent, Set Up a Trust
Transferring money and/or financial assets to minors presents special problems, since they may not be able to hold bank accounts or brokerage accounts in their own name. They can typically open financial accounts with parents as custodians of the account. Still, there is the risk that they (or even their parents) will take the cash that was meant to finance their college educations and do something stupid with it.
To erect a “safe” around the money you give, you can set up an irrevocable trust for the gift recipient and give the actual gift to the trust rather than the individual. You can spell out in the trust agreement exactly how and when the money is to be distributed to the beneficiary. You could, for example, stipulate that no withdrawals can be made until the beneficiary’s 18th birthday. Or you could stipulate that the money is to be used only for college tuition or emergencies until the beneficiary turns 25, at which point he or she would be free to take money out of the trust at his or her pleasure.
The main benefit of the trust is that it gives you (the trustor) the ability to control, to a large extent, how your money will be spent after it leaves your hands. But since the money is no longer in your hands, it’s no longer a tax liability to you or your estate.
The disadvantage of a trust (especially an irrevocable trust, which more or less allows your wishes to be “set in stone”) is that it will require a lot of paperwork and likely the assistance of a lawyer. While a trust can be costly to set up and does require annual tax filings, it can be worth it if both of the following are true: you expect the trust to hold a large amount of assets (tens of thousands of dollars, at least), and you expect the trust
to function for many years.
Hire Children or Grandchildren
and Get a Tax Write-Off
One effective way around the federal gift limitation is to pay wages to children or grandchildren for work they do around the house or in your business. This strategy works best if you own a business, since you’ll have a formal system for paying wages to employees or contractors.
You can deduct any amount you pay in wages as a business expense. As long as the wages are reasonable and actually represent compensation for work performed, it is completely legal to pay family members in this way.
Children who work for their parents are exempt from most child labor laws. A 1982 Tax Court decision held that children as young as 7 years may be employed by their parents. You can have your children clean your office, mail letters, file documents, or do anything else that may be helpful to your business.
If your children are under 18, there is a neat loophole that you (and they) can take advantage of. Wages you pay to your child are exempt from the Social Security tax, provided that your business is not incorporated.
Pay your kids by check to create an audit trail. Have them deposit their checks into their own bank accounts. They can then use the money they’ve earned to buy things for themselves, save for a car, or save for college.
Being able to work and manage their own money at a young age can teach them valuable lessons that most kids don’t learn until later in life.