On June 26, 1963, President John F. Kennedy delivered one of the most important speeches of his presidency at the foot of the recently-built Berlin Wall.  During this speech, viewed as a turning point in the Cold War, Kennedy spoke the now famous words, “Ich bin ein Berliner.”  His intent was to express solidarity with the people of Berlin.  Yet these four German words are widely remembered as a gaffe – a most infamous slip of the tongue to be translated, “I am a jelly doughnut.”

The reality is that Kennedy’s words, “Ich bin ein Berliner,” were correctly used that day in Berlin, despite widespread belief to the contrary.  The 120,000 Berliners there to see him speak understood his words without any confusion.  They heard the intended meaning, “I am a citizen of Berlin.”

In the years that followed, folklore took a different direction.  The widespread belief that developed was that Kennedy, by adding the word ‘ein’, had inadvertently labeled himself a jelly doughnut on that day in Berlin.

Some call this misconception or urban legend.  Some call it fake news.  The truth gets distorted, people repeat the inaccuracy, and eventually there is pervasive belief that the faulty thinking is true.

Unfortunately, many such misconceptions exist in personal finance.  It may be that something was true decades ago but has long since changed.  It may be that something gets incorrectly repeated enough and eventually becomes accepted as fact, despite it never being correct. 

While there are plenty such misconceptions that cause people to make uninformed finance decisions, The Astute Angle tackles three widely held and important misconceptions about making and receiving gifts.

1) If I receive a gift from a family member, I will owe taxes.  

This is the easiest misconception to tackle so we’ll start here.  The recipient of a cash gift never owes taxes on the gift.  The recipient of a cash gift has no paperwork filing or tax reporting requirements on the gift.  A gift is not income to the recipient.  The cash gift shows up nowhere on the recipient’s tax return.  To be clear, if you are in the fortunate position of receiving a $20 million cash gift from a relative, you owe zero taxes on the gift and have no reporting requirements. 

Now, we’ve been careful to specify cash gifts because the rules are a little different for gifts of investment assets.  If you are the recipient of a gift of stock or other investment asset from a living person, you still owe no tax on the amount of the gift.  However, you may owe tax when you sell the asset, if the investment has a gain from the time when the initial owner purchased it. 

Consider the case where you receive a $100,000 gift of stock from your living mother that she purchased for $95,000.  As explained before, you owe no tax at the time of the gift.  However, what happens when you sell the stock two years later for $105,000?  At this time, you may owe capital gain tax on the $10,000 of appreciation ($105,000 – $95,000).    

Note that we say “may owe” tax.  There remains a 0% capital gain rate under the new tax law which allows some taxpayers to sell appreciated assets without a capital gain tax.  For those taxpayers where this rate applies in the year of sale, there is no tax on the gift or the gain.   

2) I can only give $15,000 per year to my children, grandchildren, or other family members without owing tax (up from $14,000 between 2013-2017).  

The idea of a $15,000 gift limit is, for most families, an antiquated and irrelevant concept that only gets in the way of rational decision-making about gift size.  While there can be some ramifications for the castle-owning wealthy, this $15,000 figure (technically known as the applicable exclusion amount) really only comes into play for approximately 0.07% of the US population – those families with wealth in excess of $20 million.

Notably, annual gifts from one person to another non-spouse person of more than $15,000 are subject to the gift tax.  Yet there is a very important caveat that usually gets missed – each taxpayer currently has a lifetime exemption of $11,200,000 (technically, the “unified credit” amount) where annual gifts over $15,000 simply reduce this lifetime credit, dollar for dollar. 

Consider the example of a single father who gifts $20,000 to a child this year.  This father would normally be subject to gift tax on $5,000, the amount of the gift over $15,000.  However, the $5,000 merely reduces his lifetime exemption from $11,200,000 to $11,195,000.  In the case of a married couple, both the $15,000 annual limit and the $11,200,000 lifetime exemption are doubled – to $30,000 and $22,400,000.

The result of this large exemption is that most families should be focused on relevant factors – how large a gift they want to make this year or how much of a gift they can afford to make – rather than on an arbitrary and largely irrelevant $15,000 figure.  

3) If I give money to my children to pay off debt, purchase a home, pay for school, pay the bills, etc., I will hinder my grandchildren’s ability to qualify for college financial aid.

We often speak with financially successful parents who are wary of making gifts to a financially challenged child because they’re worried about harming a grandchild’s ability to qualify for financial aid.  In most cases, this is a misconceived reason that only serves to get in the way. 

To keep things simple, we’ll just focus on gifts from grandparents to parents as gifts to grandchildren can become more difficult.  An example should help demonstrate how gifts from grandparents to parents will generally not create any issues with the financial aid application. 

Imagine Grandpa and Grandma make a $50,000 cash gift to their son, Peter.  Remember from before, this gift is not income to Peter.  The gift shows up nowhere on Peter’s tax return.  Peter owes no tax on this gift.  Peter simply has $50,000. 

Now, financial aid eligibility is determined (via the FAFSA) by four items: income of the parents, income of the child, assets of the parents, and assets of the child.  We’ve already concluded that Peter has no additional income. 

For the moment, however, Peter does have $50,000 of additional assets.  This $50,000 would normally impact the financial aid formula except that the FAFSA looks at financial assets at a point in time.  Imagine that between the time he receives the gift and when the FAFSA is completed, Peter uses the $50,000 to pay off his own student loan debts.  What if, instead, he uses the $50,000 as the down-payment on a home or to pay down credit card debt?  Under all of those scenarios, Peter has no additional reportable assets which means that the receipt of this $50,000 gift has zero impact on the financial aid eligibility of his children.

Closing Comments

Many people are not in the position to make large gifts to family members or have no desire to make large gifts to family members.  However, we often encounter financially successful parents and grandparents who have both the ability and the desire to make large gifts but elect not to do so, often because of a misunderstanding of the gifting rules.  Our hope is that any gifting to children, grandchildren, or other family members be based on ability and desire of the donor, not widespread misconceptions.

Have questions, comments, or thoughts?  Please do not hesitate to reach out in the comments section below.

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