Pay Tuition or Medical Bills to Lower Estate Taxes

Did you know that any money you spend to directly pay for someone's medical bills or school tuition is not subject to federal gift- or estate taxes, no matter what the amount? That's right. This exemption is above and beyond the $13,000 annual gift tax exclusion. It's a fantastic way to give loved ones and friends (the recipient need not be a relative) the help they need while simultaneously reducing the size of your taxable estate.

In order to qualify for this tax exemption, the money must be paid directly to the school or provider of the medical service. If you give the money to the student or person in need of the medical care who then pays the bills, your gift will not be tax-exempt.

For example, you give your nephew $15,000 to pay for unexpected medical bills that his insurance won't cover. You write him a check which he deposits into his account. The same day he writes two checks totaling $15,000 to pay his doctor and the hospital for their services. Because you gave it directly to your nephew, your gift isn't tax-exempt. The $3,000 that exceeds the $12,000 annual gift exclusion is subject to the gift tax.

Likewise, if you give money to a trust for the purpose that it be used to be used to pay for your grandchildren's tuition, your gift is not tax-free. The trust, not the educational institution, is the recipient. Savings accounts and tuition pre-payment plans are treated the same way -- they don't qualify as tax-free gifts. And reimbursing someone who has already paid a tuition- or medical bill is also not allowed as a tax-exempt gift. But if you actually pay their bills (even their health insurance premiums), your payments won't be subject to the gift tax, regardless of the cost.

Medical care spending can include money used to pay for the following services: the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body; any transportation primarily for and essential to medical care; insurance that covers medical care; and lodging while away from home (within certain limits – the lodging can't be extravagant) primarily for and essential to getting the medical care, and the care must be provided by a physician in a hospital or equivalent facility. Additionally, the IRS says that there can be no significant element of personal pleasure or recreation associated with the travel. Cosmetic surgery and similar procedures aren't allowed unless they're medically necessary.

If you pay for someone's medical care and their insurance later reimburses them, your gift no longer qualifies for the exclusion, to the extent of the reimbursement. The IRS will treat your gift as if it were given on the date that the recipient received the reimbursement, even if you didn't know that any expenses would be reimbursed.

Concerning education, only payments for tuition are tax-exempt (other costs, such as room and board, books, or supplies can't be claimed as tax-exempt gifts). Tuition payment applies to any level of schooling – from nursery to graduate. The student may be enrolled full- or part-time. And it's not limited to traditional academic institutions such as colleges and universities. Any educational organization with a regular faculty and curriculum and a student body that meets on a regular basis at a certain place will generally qualify. Just remember, you must pay the school directly in order to take advantage of the tax break.

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