Tax-Free Cash Gifts to Grandchildren

Though you might have nothing but good intentions, giving away your money to your descendants, including grandchildren, can have tax consequences. You might owe the Internal Revenue Service money, or at least have to file a return. In some cases you might owe gift taxes when you gift money to grandchildren. You could also owe generation-skipping transfer taxes, which are triggered when you make a gift to someone two or more generations below you -- like a grandchild. However, there are both annual and lifetime exceptions which will exempt most gifts from taxes.

The IRS sets a maximum amount that you can give a person each year without incurring any gift tax or generation-skipping tax, and without using any of your lifetime exclusion amount. For 2015, you can give up to $14,000 per person, including grandchildren. As long as you stay under the annual exclusion amount, you won't have to file a gift tax return with the IRS. In addition, if you're married, the annual exclusion applies separately to each spouse. For example, as of 2015 a couple can give each grandchild $28,000 without income tax consequences.

The lifetime exclusion is an amount that you can give over your lifetime in excess of your annual exclusions without incurring any gift taxes. As of 2015, the lifetime exclusion for both the gift tax and generation-skipping tax is $5,430,000. This means that you can give a total of $5,430,000 in excess of the annual exclusions gifts to anyone, including your grandchildren. Though this large number means the vast majority of Americans will never owe gift or generation-skipping taxes, you must file a gift tax return for any year that your gifts exceed the annual exclusion even if you won't owe any taxes. For example, if you've never made a gift in excess of the annual exclusion and you give one grandchild $25,000, the first $14,000 is tax-free because of the annual exclusion and the next $11,000 is tax-free because of your lifetime exclusion, but your lifetime exclusion is reduced by $11,000.

If you exceed the annual exclusion, you must file Form 709 to report the gifts to the IRS, even if you won't owe any taxes because your gift is under your lifetime exemption. For example, if you gift $11,000 more than your annual exclusion, you must file Form 709 at the end of the year to report your gift and track how much of your lifetime exemption you have used. You'll need to provide the IRS with the amount of each gift made during the year and the recipient's name and address. Gifts to grandchildren are reported on Schedule A, Part II because they are called a "direct skip" -- a gift from you to someone at least two generations below you.

While you might feel like you're being charitable by giving your hard-earned money to your grandchildren, Uncle Sam doesn't share your sentiments -- at least to the extent of giving you an income tax deduction for gifts you make to other people, including your descendants. The charitable donation deduction specifically excludes gifts made to individuals. For example, if your taxable income is $85,000 and you give a total $10,000 to your grandchildren, you still have to pay taxes on $85,000 because you can't deduct the gifts.