Even better than that sweater your Aunt gave you for Christmas

by Mark Scheer - Posted In: Private Wealth Services, Tax

Most people are aware that the federal government imposes a tax on large gifts made by a person.  “Large” for gift tax purposes generally means a gift over the annual exclusion amount.  The annual exclusion amount, currently $13,000, is the amount in cash or property that each of us can give annually to any number of other people before a gift is subject to gift tax.

What many people don’t realize, however, is that other amounts may sometimes be given without triggering the gift tax.

For example, we often advise grandparents that paying a grandchild’s tuition directly to the college or private school, rather than giving the money to their children (i.e., the grandchild’s parent), is excluded from gift tax and does not use any of the annual exclusion amount otherwise available to that child or grandchild.  Likewise, medical expenses paid directly to the medical provider (doctor, hospital, etc.) are also excluded.  A recent Tax Court case, Lang v. Commissioner, TC Memo 2010-286 (December 30, 2010), illustrates the exception and demonstrates some really smart tax planning.

In Lang, the taxpayer, Judith Lang, filed her income tax return and took deductions for medical expenses ($24,559)  and real estate taxes ($5,508). While the medical bills and real estate taxes were Mrs. Lang’s, the bills were actually paid by her mother, Mrs. Field.  The IRS challenged the deductions because Mrs. Lang did not actually pay the bills.  The Tax Court agreed with Mrs. Lang and held against the IRS.  Citing the IRS’s own Treasury Regulations which state that indirect gifts “such as payments made to a third party on behalf of a donee” are to be treated as transfers to the donee, the Tax Court found that the payments were gifts to Mrs. Lang and that Mrs. Lang was to be treated as paying the bills herself.  As a result, Mrs. Lang was entitled to take the deductions for both the medical expenses and the real estate taxes.  The Court further held that it was irrelevant that the payment of medical expenses was not a taxable gift because of the exclusion rule (or that the amount of the real estate taxes were less than Mrs. Field’s annual exclusion amount for gifts to her daughter).

The result was that Mrs. Field paid no gift tax on paying her daughter’s medical bills or real estate taxes and Mrs. Lang saved an additional $3,309 on her income tax bill because she was able to use those payments as deductions.

A copy of the Tax Court’s decision is attached here.

Tags: Mark J. Scheer