With the current gift tax exclusion amount set at a record-setting $5 million, many taxpayers appear to consider the gift tax no longer relevant to their planning. That may be a mistake.
Taxpayers should consider a host of rules that may nevertheless draw them back into liability-prone situations. They should also consider current circumstances as something that they should take advantage of. Based on current law, present rates and exclusions offer only temporary opportunities that will no longer be available after 2012.
A re-unified estate and gift tax, at a 35% rate and a $5 million applicable exclusion amount, was signed into law by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. However, this change sunsets after 2012 and reverts, unless changed by Congress, to a pre-2001 level of a maximum rate of 55% and a $1 million applicable exclusion.
Various proposals have been made, including abolishing the tax, raising the exclusion amount or, as President Barack Obama has recommended, returning to a 2009 regime that calls for a 45% rate, a $1 million lifetime gift tax exclusion and a $3.5 million applicable exclusion.
The amount of a donor's total taxable gifts in any calendar year is reduced by an amount up to the annual exclusion amount for gifts made to each donee. For calendar year 2011, 2010 and 2009, the inflation-adjusted annual exclusion amount for gifts is $13,000. The annual gift tax exclusion is lost, however, if it is not used by the end of the year. Taxpayers with the wherewithal should therefore consider maximizing the annual exclusion for each family member or other donee in 2011 and again in 2012, since a tightened gift tax after 2012 will not come with any "do-overs" for 2011 or 2012.
Also keep in mind that the annual exclusion is not allowed for gifts of future interests in property. Restrictions on gifts can sometimes unknowingly create such a future interest. Although an interest in property may vest immediately in the donee, it is a future interest if the donee cannot immediately use or enjoy the property.
An unlimited gift tax exclusion exists for a donee's medical care and tuition expenses if paid by the donor directly to a provider or institution. Contributions to qualified state tuition programs and education IRAs, however, do not qualify for this unlimited exclusion. The exclusion is not available for advancements or reimbursements that are paid directly to the donee. All this law must be understood in order to properly file Form 709, irrespective of whether the $5 million exclusion effectively zeros out any immediate gift tax liability.
Gift tax returns on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, must be filed by individuals for gifts exceeding the present $13,000 annual exclusion amount and not otherwise exempt. A delinquency penalty under Code Section 6651 is due for failure to file a return on which a tax is due.
Each spouse must file a separate gift tax return for his or her own individual gifts. However, only the donor spouse need file if:
- Only one spouse made gifts of only present interests totaling twice the annual exclusion amount or less to any individual donee; or,
- Only one spouse made gifts of present interests totaling twice the annual exclusion amount or less to any individual donee, and the consenting spouse made only gifts equal to the annual exclusion amount or less to other donees.
The gift tax return is due together with the donor's income tax return for that year, or by the time permitted by extension for the filing of the donor's income tax return for that calendar year. The IRS may postpone the deadlines in certain disaster areas, and postponements are given to certain military personnel.
For 2010 tax year returns only, the 2010 Tax Relief Act extended the deadline for reporting generation-skipping transfers for nine months, until Sept. 19, 2011. Taxpayers under an automatic six-month extension for their 2010 income tax return until Oct. 17, 2011, therefore, can combine their gift and generation-skipping transfer tax reporting on a single Form 709 filed with their income tax return under the extended date. Alternatively, an amended Form 709 gift tax return may be filed. Also since 2010, every person required to make a gift tax return has also been required to furnish an information statement to each person named in the return.
Notably, post-2012 could be the first time the applicable exclusion will go down. This, in turn, would create the problem of a possible clawback. A clawback might occur when a donor's otherwise taxable gifts during 2011 and 2012 use all or part of the $5 million applicable exclusion over an amount to which the applicable exclusion may revert after 2012.
In those circumstances, an issue may arise over whether the excess amount will be drawn into the donor's taxable estate post-2012 at a higher rate and, in addition, unfairly burden the remaining estate. This outcome would be the result of the tax on the gifts under the post-2012 regime exceeding the gift tax that would have been due under the 2011-2012 regime of 35%.
Tax practitioners appear to be split over whether a clawback was intended by Congress and, irrespective of intention, whether further legislation should be forthcoming to put the uncertainty to rest.
In the absence of that re-assurance, donors are advised to keep in mind the possible burdens placed upon the beneficiaries of their eventual estates.
But, that caution should be balanced with consideration of the political probability of an eventual exclusion of at least $5 million coming to pass and, if lower, the probability that appreciation of the gifted assets may well make up for any shortfall caused by the clawback liability.
Gifts to Charities
The Form 709 instructions state that a return need not be made if only gifts to charities are made. But, they also caution that if a return to report non-charitable gifts is required, all gifts to charities then must also be made on the return.
Members of the House Ways & Means Committee recently expressed concern over the Internal Revenue Service's confirmation that it had launched gift tax investigations against taxpayers who donated money to Code Sec. 501(c)(4) organizations to determine if the donations were taxable gifts and if a gift tax return should have been filed. While Form 709 instructions clearly indicate that the gift tax does not apply to transfers to political organizations as defined in Section 527(e)(1), there remains the open issue surrounding whether donations to Section 501(c)(4) organizations that are earmarked for political activities are subject to the same exemption. House Ways & Means Chairman Dave Camp pointed out that the IRS apparently has left the issue unresolved for nearly 30 years. Depending upon the IRS's response to this latest inquiry, a legislative solution may become necessary.
Another twist on the obligation to report gifts to charities is how it may affect the statute of limitations for all gifts reported on a Form 709 for a particular year. The statute of limitations on a gift tax return is generally three years, but is extended to six years if the taxpayer does not report more than 25% of gifts made during the tax year. Gifts to charities that must be reported on Form 709 technically may get figured into that 25% computation.
Gifting Roth Accounts
On the "opportunity" side of the current gift tax regime is the use of the $5 million GST tax exemption in combination with gifting a previously converted Roth IRA or 401(k) account to grandchildren. Due to the young age of the new owner, required minimum distributions over that beneficiary's life expectancy could span many years during which a remaining balance could continuing to grow. The "magic of compounding," combined with the tax-free distribution benefits of a Roth account, therefore, make it worth a second look in determining how best to use up a $5 million exemption.
Gift tax returns have formed a significant part of the financial planning landscape for quite some time. The latest IRS Statistics of Income Bulletin reports that, for 2008, donors filed 235,000 returns on which a total of $40.2 billion was transferred to 928,000 donees, primarily through direct gifts. Gifting techniques ran the gamut, from $14.2 billion in cash, to $7.4 billion in stocks, $6.6 billion in real estate and $1.7 billion in family limited partnership shares.
As long as gifts to each donee amounting to more than the annual exclusion are required to be reported on a gift tax return, similar generosity is likely to be recorded. The amounts likely will ebb and flow as taxpayers weigh the benefits of transferring assets for estate planning purposes now, rather than later. But, instead of making the gift tax irrelevant to many more individuals, the current $5 million exclusion may have just the opposite effect under that analysis.
George G. Jones, JD, LL.M, is managing editor,
and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst,
at CCH Tax and Accounting, a Wolters Kluwer business.