Federal Gift Tax – When This Tax Has to Be Paid
Definition of a Gift
The IRS defines a gift as “giving property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. The gift tax applies whether the donor intends the transfer to be a gift or not.” In other words, if you make a transfer for which you receive nothing or less than the fair market value of the property in return, it is a gift. If you sell your house to a relative for less than the fair market value, the difference is a gift. A promise to make a gift is not enough and a gift must be made of your own free will voluntarily. The gift must be delivered and accepted without the ability to revoke it and be a present interest (you no longer retain control over the property). The gift transaction date is considered to be the date title passes, in the case of cash when the check is cashed. Taxable gifts are reported using IRS Form 709 where a running tally is kept that is used against your unified federal gift and estate tax lifetime exemption (the amounts are cumulative). If a gift is taxable, the donor, not the recipient pays the tax. A ?le of Forms 709 should be maintained through one’s lifetime.
A) The annual gift tax exclusion is $14,000 for 2014. This is the amount an individual may give, free of gift tax and without impacting his/her lifetime exemption, to as many individuals as he/she wishes. A married couple may double the amount. For example, a married couple may gift $28,000 to any one of their children; if a child is married they may gift $28,000 to their child (gift splitting) and their child’s spouse (totaling $56,000 cash or property at fair market value).
B) Tuition, if you pay it directly to the school (no other incidental expenses)
C) Medical expenses you pay directly
D) Gifts to your spouse (if your spouse is a U.S. citizen)
E) Gifts to a political organization for its use
F) Gifts to qualifying charities if not a partial interest (this can be very complex if trusts are involved)
2014 unified estate/gift tax exemption
Gift and estate taxes have a unified federal gift and estate tax lifetime exemption of $5.34 Million per individual for 2014 ($10.68 Million for a married couple); this is the total amount of taxable gifts and taxable estate property and that can be transferred without paying gift or estate taxes. A taxable gift is other than noted above (for example the excess of a gift from one person to another over the $14,000 annual exclusion is a taxable gift). A surviving spouse can add any unused exclusion of the spouse who died most recently to their own, enabling transfers of up to $10.68 million tax-free, if an estate tax return is filing on behalf of the deceased with this election made. Gifts made during your lifetime will reduce the unified tax exemption against your taxable estate at time of death. If you exceed the limit, you will owe tax of up to 40% on the amount in excess. Gift tax applies to lifetime taxable gifts; estate tax applies to property left at death. Gifts are generally valued at cost basis while estate property is valued at fair market value at date of death.
Gifts made during your lifetime will reduce your taxable estate, if you gift property away before the event of death, your estate will not be worth as much. This may especially matter if you are gifting property that will increase in value such as stocks or closely held business interest, art/collectibles etc. At the same time gifts in excess of the $14,000 annual exclusion reduces your estate tax exemption (they are unified as noted above). For example if a married couple gifts $250,000 cash to a single child for ten years, their estate will be worth $2.5 Million less, and their unified exemption will decrease from $10.68 to $8.18 Million.
As an example if stock is given, totaling $250,000 fair market value at time of gifting however originally purchased for $100,000 (cost basis) the value of the gift is the cost basis of $100,000. The stock at the time of the parent’s death may be worth many times more than $250,000, thus if the transfer was not made, it would increase the estate value and possibly the estate tax as estate property gets a ‘step up’ in basis to fair market value at time of death. Thus gifting appreciating assets shelters the gain from estate tax. If the recipient then were to sell the stock in the example they would pay capital gains tax; also the cost basis would include any gift taxes paid on the transfer. Certain valuation discounts may apply to the value of stock/membership interest for closely held businesses such as a FLP due to a lack of liquidity. You need to get a professional appraisal at the time you make the transfer for any asset that is either not cash or publicly traded securities, especially if it is a hard to value asset, like a piece of real estate or a share in the family business.
A family limited partnership (FLP) can be an effective way to manage and control family assets while providing for the tax-effective transfer of wealth to others. The parents gift the majority of the partnership interest to family members in the form of limited partnership interests. Limited partners do not manage the partnership and the operating agreement can specify restriction on sale or borrow against their partnership interests.
Another use of the annual exclusion is to put money in Section 529 College savings plans, setting up a separate account for each family member you want to benefit.
Pay tuition and medical expenses without the payment being treated as a taxable gift to the student or patient, as long as the payment is made directly to the school or provider
Speak with an estate and gift tax attorney regarding various irrevocable trusts that you can gift to on behalf of beneficiaries such as a grantor retained annuity trust (GRAT) a Irrevocable Life Insurance Trust.
Typically the annual exclusion is used to fund a trust such as an Irrevocable Life Insurance Trust. In doing this, beneficiaries receive ‘Crummey powers’ which is the right for 30 or 60 days, to withdraw from the trust the yearly gift attributable to that beneficiary. A Crummey notice must be sent each year to the beneficiaries letting them know about their right to withdraw their portion of the annual gift to the trust. The IRS in an audit can and will ask for them.
State Gift Taxes
Many states have estate or inheritance taxes and they do not all follow the Federal estate tax system. This means the state applies different tax rates or exemption amounts. The exemption amount for your particular state will vary. Consult with a CPA or estate tax Attorney on specific state law and potential options to mitigate state estate or inheritance taxes.
Same Sex Marriages
The IRS states “For federal tax purposes, the terms “spouse,” “husband,” and “wife” includes individuals of the same sex who were lawfully married under the laws of a state whose laws authorize the marriage of two individuals of the same sex and who remain married. Also, the Service will recognize a marriage of individuals of the same sex that was validly created under the laws of the state of celebration even if the married couple resides in a state that does not recognize the validity of same-sex marriages”
Non-US Citizen Spouse
If your spouse is not a U.S. citizen you must file a gift tax return if your gifts to your spouse total more than $145,000 per year. Additional gifts to a non-citizen spouse count against your $5.34 million lifetime exclusion and must be reported on Form 709. Certain large gifts or bequests from certain foreign persons must be reported on Form 3520.
When to file Form 709
If you make gifts in excess of the annual exclusion, you must file Form 709, which is the United States Gift (and Generation-Skipping Transfer) Tax Return. The return is due by April 15 of the year after you make the gift, if you are on extension for form 1040 (form 4868), the extended due date applies to your gift tax return (October 15). To request an automatic six-month extension to file Form 709 without an extension for form 1040, you can file Form 8892. If any gift tax amounts are owed they are due April 15th, if not paid on time, interest and penalties may result. Married couples cannot file a joint gift tax return. Each spouse files their own Form 709 for taxable gifts. Gifts may be “split” with your spouse, doubling the annual exclusion from $14,000 to $28,000 to any one person.
The current federal gift/estate tax rate is 40%.