Many high-earning parents want to provide financial support to their children while minimizing tax liabilities. However, the IRS imposes strict gift tax rules to regulate wealth transfers. In 2024, the annual gift tax exclusion allows parents to give up to $19,000 per recipient without triggering taxes, while the lifetime exemption stands at $13.99 million. Exceeding these limits may require tax filings or impact estate planning.
Fortunately, there are several strategic ways parents can transfer wealth while staying within legal guidelines:
1. Establishing a Trust
A trust allows parents to transfer assets while maintaining control over how and when their children receive them. Parents can set conditions, such as limiting withdrawals or distributing funds at specific ages. While revocable trusts offer flexibility, only irrevocable trusts remove assets from a taxable estate, helping to minimize estate taxes. However, to avoid gift tax implications, the total amount placed in an irrevocable trust must remain within the lifetime exemption limit.
2. Offering a Low-Interest Loan
Instead of gifting money outright, parents can lend money to their children at the IRS-determined applicable federal rate (AFR), which is often lower than market interest rates. This is commonly used for home purchases. The loan must be properly documented with a promissory note, and interest must be charged to avoid IRS scrutiny.
3. Paying for Education or Medical Expenses
Tuition and medical bills paid directly to institutions do not count toward the annual gift tax limit. Contributions to 529 college savings plans also offer tax advantages, as the funds grow tax-free if used for qualified educational expenses.
4. Assisting With Home Purchases
Parents can help their children buy real estate by purchasing a home in cash and then structuring it as a loan repayment or through creative financing like home equity lines of credit (HELOCs). Some parents also co-sign mortgages to help children qualify for better loan terms.
5. Hiring Children
Business owners can employ their children, allowing them to earn income in a tax-efficient way. However, the wages must be reasonable for the work performed, or the IRS may challenge the arrangement.
6. Creating a Family LLC
Parents who own income-generating assets, such as rental properties, can place them in a family limited liability company (LLC) and make their children partners. This allows rental income to be distributed as earnings rather than gifts, helping with long-term wealth transfer.
7. Covering Living Expenses
Some parents provide financial assistance indirectly by covering rent, credit card bills, or other expenses. However, if these contributions exceed the $19,000 annual limit, they should be reported as gifts.
Proceed With Caution
While these strategies are widely used, tax laws change frequently, and improper execution can result in unintended tax consequences. Consulting with a financial planner or tax professional can help ensure compliance while maximizing financial benefits for both parents and children.
