Helping someone pay off his credit card bills can be a wonderful gesture, particularly if he’s struggling with debt, but it can lead you into risky waters with the Internal Revenue Service if you’re sloppy. In most cases, the tax man treats your generosity as a gift, which may make you liable for taxes associated with the gift in addition to the check you wrote to the credit card company.
Gift Tax Basics
The IRS treats any transfer of money or property to another person where the giver doesn’t receive something of equal value in return as a gift. This covers paying most bills for another person -- paying someone else’s tuition and medical bills generally doesn’t trigger the gift tax if you pay directly to the institution. With limited exceptions, you can give gifts of unlimited value to your spouse without racking up any gift tax obligations, too, so if you’re helping your hubby erase a credit-card debt, don’t sweat any tax implications.
There’s still a chance that you won’t have to treat your act of generosity as a taxable gift, though. The IRS allows you to exclude the first $14,000 in gifts to each individual from taxation as of 2013. If you’re married, you and your husband can pay down up to $28,000 of another person’s debt each year without worrying about paying gift taxes. Even then, you’re only liable for the amount of the gift that exceeds the exemption. For example, if you pay down your niece’s $15,000 credit card bill, you exclude the first 14 grand from gift taxes.
Even if you pay a bill that’s larger than your annual gift tax exemption, you can still wiggle out of owing gift taxes if you choose to use a chunk of your unified credit. The unified credit is an amount of your assets -- $5.25 million as of 2013’s tax laws -- that is exempt from gift and estate taxes. You can choose to use portions of your unified credit during your life, but once you blow through your allowance, it’s gone for good. For example, if you pay off your niece’s staggering credit card bill of $250,000 and don’t want to pay taxes on the amount, you can tap your unified credit. The downside? When you die, instead of excluding $5.25 million of your assets from the estate tax, you’ll only be able to exclude $5 million. If, like most people, you don’t leave behind a multimillion-dollar estate, it’s best to take advantage of the exclusion during your life.
Timing the Gift
Your $14,000 exclusion applies to each person each year, so you can help someone pay down a large credit card debt by paying a portion of their total bill in two different tax years. For example, if your niece owes $18,000 on a credit card, you can pay off $12,000 in 2013, leaving you with $2,000 in value to cover birthday, holiday and other gifts, and pay off the remaining $6,000 in 2014. By splitting the gift across different years, you’ll avoid gift taxes.
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