Tue. Jan 18th, 2022

With tax season soon upon us, we are all reminded of how absurdly complex the tax code is. But even though the tax code as a whole is pretty intimidating, there is the occasional provision that is relatively simple to apply that can be a welcome relief to grandparents or parents eager to lend a helping hand. One of these provisions allows you to pay someone else’s medical or educational expenses without getting caught up in the federal gift tax.

The federal gift tax is one of three major taxes imposed when transferring assets between generations. Incidentally, the federal gift tax is also the only one of the three currently in effect. The federal estate tax and the generation skipping transfer tax have both lapsed and will not be in effect for the remainder of 2010 unless Congress reinstates them. But don’t celebrate yet, they both come back in 2011.

The general rule regarding gifts is that anytime you transfer something of value to another person without receiving something of equal value in return, you have made a gift subject to the federal gift tax. Two important exceptions to this rule allow you to make unlimited payments for medical or educational expenses for someone else. Of course, there are a few rules to follow to ensure your gift meets the regulations, but the exception is broad in some areas, particularly in regard to medical expenses.

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If you want to pay for someone else’s medical expenses, and this may include your adult children, your parents, or a dear friend, the first important rule is to pay the medical provider directly. You may not write a check to your son or your parent that they can then deposit in their account to pay their medical bills. Nor can you reimburse the person for bills they have already paid. These payments would be considered a gift and not qualify for the exception. The payment must be made directly to the medical care provider. Additionally, if medical care expenses are subsequently reimbursed by an insurance company, your gift for that expense does not qualify for the exception to the extent of the reimbursed amount.

What can payments be applied to? According to IRS regulations, the term medical expense includes: expenses incurred for the diagnosis, cure, mitigation, treatment or prevention of disease; expenses for transportation essential to medical care; expenses for prescription drugs; and premiums for medical insurance. Insurance may include regular health insurance and long-term care insurance, with certain spending limitations based on one’s age for the latter.

If you are interested in contributing to someone else’s educational expenses, the same rule requires that payments be made directly to the educational institution, not via the student or anyone else. Unfortunately, the exception for educational expenses is not as broad as that for medical expenses. Qualifying educational expenses are limited to tuition expenses for full-time or part-time students at institutions that maintain a regular faculty and curriculum, and students in attendance. The exclusion does not apply to payments for books, supplies, dormitory and boarding fees, or other similar costs not directly related to tuition.

Before making any substantial gift for medical or education expenses, it is a good idea to discuss the proposed transaction with your CPA or attorney to ensure it qualifies for the exception. Provided that the gift meets the regulations, you can make a world of difference to the person receiving the gift, particularly in these difficult economic times.

By rahul