Smart Tips for Parent-Child Family Finances

Family loans and even paying family members for caregiving services may make sense if done properly.

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Figuring out smart ways to convey money and assets to family members does not require a huge estate or sophisticated trusts. Especially during these hard economic times, it can make sense to use some basic tools to help the folks you love, while paying Uncle Sam as few tax dollars as possible.

[See 10 Ways to Boost Your Social Security Checks.]

Gifts. Before exploring more extensive ways to transfer wealth, make sure you've taken full advantage of gift tax rules. You can give up to $13,000 a year to as many individuals as you wish, and what they receive will not be taxed as income. Your spouse can do the same, providing the easiest way to convey family assets to relatives without creating tax liabilities for them. For details, check out IRS Publication 950: Introduction to Estate and Gift Taxes.

Family Loans. It's also possible to structure loans among family members that are very flexible and totally compliant with IRS tax rules. For example, perhaps an older homeowner has a short-term need for some cash. He could take out a home equity loan, but could achieve a better deal with one or more of his children. They can loan him the money, usually at rates lower than those charged by a commercial lender. The IRS maintains current tables of what it calls "applicable federal rates," or AFRs.

Understand that these rates can be a bit tricky. The document that contains each month's current AFRs lacks the explanations that people who aren't tax professionals need to know. For example, there are different rates for short-term, medium-term, and long-term loans, but no explanation of what time periods they cover. An IRS spokesman says short-term is anything less than three years, medium-term is three to nine years, and long-term is any loan outstanding more than nine years. There are other tax-code intricacies in the AFR rules, so working with a tax professional might be required. A key governing principle, from the IRS' perspective, is that the transaction not be viewed as a contrived way to avoid paying taxes.

For explanations of how to report the interest expenses and income on your taxes, there's a section on "below-market loans" in IRS Publication 550: Investment Income and Expenses.

Family Wages. Nearly 45 million older Americans need care, and most of it comes from family members who are unpaid for their efforts. It is perfectly legal to pay relatives for caregiving services, and the IRS treats such payments as wage income to the recipient. Obviously, it might be easier to simply use that $13,000 gift-tax exclusion if you're financially able to help a child or other family caregiver. But there can be many reasons more of an arms-length employer-employee relationship makes sense. For example, wage income helps people build their Social Security earnings record, which can lead to higher payments when they retire. Gifts do not.

[See How to Make Multigenerational Living Work.]

Joseph Matthews, a lawyer and senior editor at Caring.com, says parents can pay children directly for care or, as it sometimes happens, other siblings will pitch in to pay a brother or sister to take care of one or both parents. In both cases, Matthews stresses, there should be a clear description of the care being provided and an explanation of how the relationship is supposed to work. "You don't need to go to a lawyer to do this, but you should put it down on paper," he says. Without clear communication among family members, there can be misunderstanding and friction about why, for example, a parent is sending money to the caregiving child but not to all children.

There also are two situations, he says, in which family members may be paid by third parties for care. Some private long-term care insurance policies may enable family members to be paid for in-home care. Even if care can only be provided by a state-certified caregiver, Matthews says, it may not be that hard for an experienced family caregiver to get certified. Some insurance policies, however, specifically exclude payment to family members, he notes, so it's important to check the terms of the policy before assuming such payments will be permitted.

Lastly, Matthews says, there are pilot programs throughout the country that will permit family members to receive Medicaid funds for caring for disabled parents in their home. Such payments can be much lower than the cost of placing a senior on Medicaid in a nursing home, and there is growing interest in finding better solutions that permit older people to stay in their homes. Fifteen states now participate in what are called Cash and Counseling programs.

Life estate deed. This document permits parents to convey their home to a child with the stipulation that they be allowed to live in it as long as they wish. Hyman Darling, an estate and elder law attorney with Bacon Wilson, P.C. in Springfield, Mass., says he uses this tool frequently with clients. It can be an effective way to transfer wealth, he says, and the home avoids being involved in possibly lengthy probate procedures when the parents die.

[See The Graying of American Housing Continues.]

More importantly, Darling also notes that using such a deed may effectively remove the home from consideration as a personal asset for purposes of Medicaid eligibility. Many people turn to Medicaid to help pay for their long-term care needs, but they can only qualify for the program if they have spent nearly all of their wealth. If they've given away assets within five years of applying for Medicaid, those transfers may need to be repaid and spent down before they're allowed into the program.

However, if a life estate deed is executed before the beginning of this five-year "lookback" period, Darling says, the home can avoid being considered as a disqualifying asset for Medicaid. Meanwhile, the senior can continue living in the home as long as he or she wishes. Darling also notes that a person's lifetime gift tax exclusion was raised to $5 million under the recently enacted estate tax law. For most people, the entire value of their home can be given to family members without triggering taxes. Darling stresses that children need to be responsible and that parents must be able to rely on them not to make poor financial decisions regarding the home.

Twitter: @PhilMoeller