How to make unlimited financial gifts tax-free

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(MoneyWatch) A few days ago I wrote about the increased tax-free gifts in 2014 that folks who are planning their estates can make during their lifetime (or through provisions in their wills or trusts). Another form of preferred giving is an annual gift that is excluded from the gift tax, which is limited to $14,000 per person per year.

But if want to reduce your taxes and make even larger gifts, there are two kinds of unlimited giving where amounts are exempt from gift or estate taxes: tuition and medical expenses.

Tuition expenses

The IRS (specifically, section 2503(e) of the Internal Revenue Code) provides gift-tax exclusion for any amount paid on behalf of an individual as tuition to educational organizations for the education or training of the recipient. The exclusion is available regardless of the relationship between the donor (the person making the gift) and donee (the person benefiting from the gift) and is in addition to the annual $14,000 per person per year gift tax exclusion. The exclusion only applies to tuition costs and does not apply to amounts paid for books, supplies, dormitory fees, board or related expenses that do not constitute direct tuition costs.

In order for the exclusion to apply, two requirements must be met. First, the tuition must be paid directly to the qualifying educational institution. And don't make the common mistake of thinking reimbursements made to the student for tuition expenses previously paid qualify -- they don't. Second, if funds are transferred by the donor to a trust providing for distributions to be made by the trustee for tuition expenses incurred by a trust beneficiary, the transfer is not a direct transfer to an educational organization and thus does not qualify for the exclusion. Payments for books, supplies, dormitory fees, board and similar expenses do not qualify for this special exclusion.

The educational organization to which the tuition is paid must meet prescribed criteria. A qualified educational organization is one that maintains a regular faculty and curriculum and that has a regularly enrolled body of students at the place where its educational activities take place.

Medical expenses

The Internal Revenue Code also provides an unlimited gift tax exclusion for amounts paid on behalf of a donee directly to a provider for medical care. The exclusion is available for payments for medical insurance paid by the donor on behalf of the donee, but not for medical expenses previously paid by the donee that are reimbursed by the donor. Also, the exclusion does not apply to medical expenses of the donee that are reimbursed by the donee's insurance.

Accordingly, if a donor pays a medical bill of the donee who is reimbursed by his or her insurance company, the donor's payment is not eligible for the exclusion to the extent of the reimbursement. In such situations, the donor is viewed as having made a gift on the date of the reimbursement.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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