Gifting is an excellent way to show someone you love them. And when it comes to financial gifts, you get the added benefit of helping to contribute to your loved one’s goals.
Especially when the recipient is a child, even a small financial gift today can make a big difference, as it can grow for many years.
But despite the perks of gifting, it’s also important to understand the downsides. For example, there could be tax consequences to your financial gift, even when the recipient is a child.
The good news is that most gifts you make to the children in your life won’t be subject to any taxes, thanks to certain exclusions and creative gifting strategies. But it’s still important to understand how the gift tax works to help you avoid it.
In this guide, you’ll learn how gifts to children are taxed and, even more importantly, how to make tax-free gifts to children.
Is There a Tax on Gifts to Children?
Yes. Gifts to anyone — including children — are subject to gift tax.
The gifter pays the gift tax, not the recipient. Recipients never need to pay tax on gifts they receive unless they receive investments and then sell them (they may then owe capital gains tax).
Taxes on gifts to children may apply for any type of gift. A “gift” is simply anything of value that is transferred to someone else free of charge or sold for a very low price (a $10,000 car for $500, for example).
Gifts can include cash, stocks, investments, physical property, or anything else of value.
Fortunately, there are generous exclusions to the gift tax that make it so most gifts won’t be taxed at all — we cover these in detail in an in-depth section on gift tax exemptions below.
How Does the Gift Tax Work?
Gift tax applies any time something of value is given away. It also applies if an item is sold for far below its actual value (“selling” a $500,000 home to the child in your life for $10,000 would be considered a gift).
Gift tax also applies to gifts to anyone. From a tax perspective, there’s no difference between giving a gift to your daughter and giving a gift to your coworker or friend.
Gift taxes are always paid by the gifter. You don’t need to worry about giving a child a gift and complicating their tax situation — it will be your responsibility to report the transaction and pay gift tax, if necessary.
Gift tax ranges from 18% to 40%. However, most gifts won’t be subject to any taxes.
Gift tax exemptions
There are two main exemptions to the gift tax:
- Annual exemption: $16,000 per year, per person (per year)
- Lifetime exemption: $12,060,000 per person (lifetime)
These exemptions make it relatively easy to avoid gift tax on most gifts.
Any gift of up to $16,000 (for 2022) is covered by the annual exemption. In this case, no gift tax return is required, and no tax is due.
If a gift is made for more than $16,000, then a gift tax return must be filed. The amount in excess of $16,000 would then apply to the gifter’s lifetime exemption ($12.06 million for 2022).
For example, a $100,000 gift would be taxed as such:
- $16,000 would be covered by the annual exemption
- The remaining $84,000 would apply to the gifter’s lifetime exemption
- A gift tax return (IRS Form 709) would need to be filed, but no gift tax would be owed (as long as the gifter hasn’t used up their $12.06 million lifetime exemption)
A smaller gift of $5,000 (whether that’s cash, investments, or a used vehicle) would not be taxed at all. Because it’s under the $16,000 exemption limit, no tax reporting would be required.
It’s important to note that gift tax exclusions are:
- Per recipient
- Per gifter
- Per year (for the annual exclusion)
This means that gifts to different people are treated independently, and each gets their own $16,000 exclusion.
For example, a single father could gift each of his three children $16,000 each without having to file a gift tax return or pay taxes on these gifts. And he could do this each year.
And because gift tax limits are also per gifter, married couples can give twice as much ($32,000).
A married couple could theoretically gift each of their three children — plus everyone else they know — up to $32,000 without paying a dime in gift taxes (and without filing a return).
Gifts to children of over $16,000
Any gift under $16,000 will be covered by the annual exclusion, and nothing will need to be reported on your taxes.
Any gift over $16,000 will need to be reported using IRS form 706.
Form 706 will need to be filed with your standard income tax return. And you may end up owing gift tax — but only if you’ve used up your lifetime exclusion.
For example, if you make a $100,000 gift that’s your first large gift (you haven’t used any of your lifetime exemption), $16,000 would be covered by your annual exemption, and the remaining $84,000 would apply to the lifetime exemption. This would lower your remaining lifetime exemption from $12,060,000 to $11,976,000.
If you continue making large gifts, you could potentially use up your entire lifetime exemption. In this case, you would start owing gift tax on future large gifts exceeding the annual exclusion limit.
Lifetime exemption and estate tax
Estate tax comes into play when an inheritance is given. Keep in mind that the estate tax exemption and the lifetime gift tax exemption are what’s known as a “unified credit.”
This means that any amount that you use of your lifetime gift tax exclusion will lower the amount of inheritance tax your estate can eventually exclude.
In other words, if you use up $2 million of the lifetime exemption during your lifetime, your estate will have $2 million less to exclude from potential estate taxes.
Note: Estate planning is complex. It’s wise to speak to a qualified tax professional before you make any decisions.
Does the Gift Tax Apply to Parents?
Yes. The gift tax applies to all gifts from all gift-givers. It makes no difference whether you’re gifting to your child or to your neighbor.
However, parents need to understand what a “gift” is.
Paying for your child’s regular expenses — food, clothing, etc. — is not considered a gift.
Something like a weekly allowance would technically be considered a gift. However, it’s very unlikely that any tax reporting would be required — unless the amount exceeds $16,000 per year.
Gifts are items of value that are given free of charge. This could include property, vehicles, cash, investments, or artwork.
Gifts can also be items that are “sold” for well below fair market value. If a parent buys a $50,000 car for their child and “sells” it to them for $1,000, the IRS would still consider that a $49,000 gift.
How to Make Tax-Free Gifts to Children
Making tax-free gifts to children is as simple as understanding the gift tax rules.
To recap, here’s what you need to keep in mind:
- Any gift under $16,000 will be tax-free
- This is a yearly limit; you could gift a child $10,000 each year without paying any taxes
- No tax reporting is required
- Any gift over $16,000 will apply to your lifetime gift tax exemption
- The exemption is $12.06 million
- Tax reporting is required (form 706), whether you owe gift taxes or not
Understanding these two exclusions is the primary way you can avoid gift tax on gifts to children. There are other options, however.
Take advantage of doubled limits for married couples
Remember that the annual and lifetime exclusions are per person. If you’re married, all the limits are doubled.
Married couples can give up to $32,000 per recipient, per year, without filing gift tax returns. And they will receive a $24.12 million lifetime gift tax exemption.
Pay for qualifying medical and educational expenses
Any amounts that you pay directly for medical and/or educational expenses are not considered taxable gifts.
For example, you could pay a child’s entire college tuition without filing a gift tax return. Or you could pay for an unlimited amount of medical care with no gift tax requirement. It doesn’t matter if these amounts exceed the $16,000 per year tax-free limit — these expenses are not considered taxable gifts.
To qualify for this exemption, payments must be made directly to the educational institution or medical provider.
You cannot reimburse the child in your life for expenses or send cash to cover them. You must directly pay for these expenses in order to qualify for this exclusion.
Gift investments that will increase in value
Investing for kids is a powerful way to help them build wealth. And it could also potentially help to reduce gift taxes.
This is because investments have time to grow. The best investments for kids are usually stocks, which have higher potential for long-term returns.
For example, investing $16,000 per year for a child from birth to age 18 would result in an ending balance of around $729,000, assuming 10% average stock market returns. (The actual investment performance may vary based on market fluctuations, time horizon, taxes, and fees.)
Keep in mind that the child may have to pay capital gains tax when they eventually sell those investments.
If you instead simply gifted that $729,000 to the child in your life when they turned 18, you might have to pay gift tax on the amount.
Put simply, investing for children is a way to magnify the impact of your generous gift.
How do you go about investing for children? The simplest way is to open an account with EarlyBird.
EarlyBird makes it easy for parents and loved ones to set up custodial investment accounts on behalf of children. The adult serves as the custodian, while the child is the beneficiary. The child will gain access to the account once they become a legal adult.
With EarlyBird, you can automatically invest in a diversified portfolio of stocks, bonds, and ETFs — and you can even buy cryptocurrency. No investing experience is required, and you can get started in just a few minutes.
Plus, EarlyBird makes it easy for loved ones — grandparents, aunts, uncles, close family friends — to collectively invest in the children in their lives.
Once an account is set up, it’s simple for anyone to contribute. Givers can even attach brief video messages to their financial gifts! Once an investment strategy is selected, all money that is contributed can be invested.
Gift taxes, like all other types of taxes, are a fact of life. But that doesn’t mean they aren’t disruptive, especially when you want to make a large gift to a child you love.
The good news is that, unlike some other taxes, it’s actually pretty easy to avoid paying gift taxes. Thanks to annual and lifetime exclusions and some lifetime gifting strategies, you can generally make generous gifts to your loved ones without paying more taxes because of it.
Ready to start gifting to a child in your life? Download EarlyBird today.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.