Ask Carrie by Carrie Schwab Pomerantz

Dear Carrie: If my mom gifts her grandchildren $12,000, will they have to pay taxes on it if they are under 18 or full-time students? — A Reader

Dear Reader: I'm glad you asked this question because there's a lot of confusion — and concern about taxes — when it comes to giving money. Although it is always a good idea to consult an expert when it comes to tax issues, the short answer to your question is no. In fact, your mother can gift any amount to her grandchildren, and they will not have to pay income taxes on it because a recipient never has to pay income tax on a gift or inheritance regardless of the amount received.

Because you mentioned age and student status, I think you might be confusing possible taxes on gifts with the so-called Kiddie Tax. This tax applies to unearned income — for instance investment income in a custodial account — for kids under 19 or full-time students under 24. In this case, the first $950 of earnings is exempt, and the second $950 is taxed at the child's rate. After that earnings are taxed at the parents' rate.

When it comes to giving monetary gifts, however, it's not income taxes but gift taxes that have to be considered. There are important limitations that a giver should be aware of to avoid incurring gift taxes, so I'm going to outline some key points here that you may want to share with your mom.

What you can give tax-free

To keep giving simple, you want to be clear on how much you can give and still avoid the gift tax. While these amounts often change year to year, currently:

— An individual can gift up to $13,000 a year (this amount is periodically adjusted for inflation) to anyone and any number of people without incurring gift taxes. A married couple splitting gifts can currently give up to $26,000 a year.

— Direct payments for tuition or medical expenses aren't considered taxable gifts and aren't included in the $13,000 annual limit.

— If someone is in a position to give more, a 529 College Saving Plan allows them to frontload five years' worth of giving ($65,000 for a single giver; $130,000 for a married couple) — also without paying a gift tax, although some tax reporting is required.

This can be a great way for grandparents to make a significant, targeted contribution.

In your mother's case, her grandchildren won't pay income tax on the gift (they don't even have to report it) — and she won't have to pay a gift tax. Just for the record, if you make a gift of more than $13,000 to any one person during the course of the year, you have to file a Gift Tax Return.

Estate tax considerations

For some families, monetary gifting is part of estate planning. Giving the gift reduces the giver's taxable estate, potentially reducing estate taxes. Plus any appreciation on the gift is in the hands of the recipient and out of the estate.

When it comes to estate planning, givers also want to be aware of the $1-million lifetime exemption. This means you can give away $1 million in the course of your lifetime — above and beyond the $13,000 annual limit and excluding any direct payments for tuition or medical expenses — before having to pay a penny in gift taxes.

Giving more than money

No doubt your children are lucky to have such a generous grandmother. In the same vein, I'd encourage her — and you — to help the kids understand what to do with the money they receive. Even young children can learn to save, budget and prioritize. A custodial account can be an excellent way to teach kids about investing.

If the grandchildren are young adults, don't assume that they have the answers. As I mentioned in a recent column, a majority of young people are eagerly seeking guidance on good money management practices. Your mother's gifts could provide an excellent opportunity to discuss both short- and long-term goals and come up with a plan on how to use and invest the money wisely.

In this way, she'll be increasing the value of her gift for her grandchildren — and possibly generations to come.

Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER (tm) is president of the Charles Schwab Foundation and author of "It Pays to Talk." You can e-mail Carrie at askcarrie@schwab.com. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

COPYRIGHT 2009 CHARLES SCHWAB & CO.