August 19, 2014 8:30 am

Tax Breaks for Grandparents

The tax law does not contain any tax rules specifically for grandparents. However, there are a number of breaks that grandparents can avail themselves of to reduce their tax bills while helping their families.

Gifts to family members

There are no federal income tax deductions for giving money or property to grandchildren. However, such gifts may be free from federal gift taxes; in any event, gifts reduce the size of your estate, which may minimize or avoid any estate taxes. Here are some ways to make gifts that help grandchildren:

  • Give cash or property up to the annual gift tax exclusion ($14,000 in 2014). Whether the gift is out of the blue or for a specific occasion (e.g., graduation, wedding), it counts toward the exclusion amount.
  • Pay for education or medical expenses. Payments of tuition and medical costs made directly to the provider (e.g., school, hospital or doctor) are tax free in any amount. And they don’t reduce the annual gift tax exclusion for the benefit of the student you are helping.
  • Save in a 529 plan. You can give five times the annual exclusion amount ($70,000 in 2014) without any federal gift tax. And even though you have made a gift (it’s out of your estate), you continue to control investments and beneficiary designations, and even have the option to recoup the contributions and earnings on them. Note: You may be eligible for state income tax breaks for making contributions to 529 plans in your state.
  • Save in a Coverdell Education Savings Account. You can add up to $2,000 annually for a grandchild’s account as long as your income does not exceed set limits. The earnings are tax free to the grandchild as long as funds are withdrawn to pay a wide range of qualified education costs.

Loans

A grandparent may be in a financial position to lend money to a grandchild—to buy a home, start a business, or for any other purpose. Usually, if there is no interest charged, or the interest is below the applicable federal rate for the term of the loan, the lender must report “imputed” interest even though no funds are received. However, there is no imputed income if either of these two conditions exists:

  • The amount of the gift loan does not exceed $10,000.
  • The amount of the gift loan does not exceed $100,000 and the borrower’s investment income does not exceed $1,000.

Important: Be sure to put any loan in writing and include important loan terms (e.g., interest rate if any, repayment schedule, what happens in default). This will allow you to write off the loan if the grandchild fails to repay it. Without a valid promissory note, the IRS may claim you merely made a gift of the money, which is not deductible.

Babysitting

Today, many grandparents are unpaid day care workers, and they love it! If a grandparent is paid for babysitting so the parent can work, the parent can claim a dependent care credit for the wages as long as the grandparent is not the parent’s dependent. The grandparent must report the income.

Conclusion

Being a grandparent is a joy in itself. Tax benefits for you and your family are icing on the cake.