Issue: Earlier this week, one of my clients emailed me with a question about the current status of the federal gift tax laws, as follows:
I’d like a little advice on a gift tax issue. Until now, I have kept gifts to my various family members under the taxable level (or at least in good faith tried to). One of my sons may be in a situation where neither he nor his wife is employed, at least for a while, and they may need pretty substantial financial help from me. Until now I have never treated any of my gifts as taxable gifts; thus I don’t know how gift taxes are assessed if I give more than the annual exclusion. I have understood that any gift tax is paid by the donor, not the donee. Is that right? What is the tax rate charged on taxable gifts? In other words, once we’re in the taxable-gift territory, how much more does it cost me to give my son (and his wife) a gift of money to use for living expenses?
My response is as follows:
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Tax Act of 2010“), signed by President Obama on December 17, 2010, increased the cumulative fair market value of property (e.g., either real property, or tangible personal property, or intangible personal property) that a person can transfer during his lifetime free of federal gift taxes tax-free from $1 million to $5 million. No gift taxes are due on the first $5 million in property that is given away. After the donor has already transferred property equal to $5 million during his lifetime, any further transfers of property during life are taxed, for gift tax purposes, at 35% of the fair market value of the property that is transferred. Note that these new rules do not affect the annual gift tax exclusion. The annual gift tax exclusion permits a person to give cash or other property valued at up to $13,000 a year to as many people as s/he wishes without those transfers affecting the lifetime gift tax exclusion of $5 million.
Example:
In Year 2011, Andy makes a cash gift of $75,000 to Ben and Ben’s spouse, Cathi. Andy intends for Cathi and Ben to use the cash gift equally (to put a down payment on a new home, to pay or defray household expenses), although this wouldn’t really change the result in this example.
How are Andy’s gifts to Ben and Cathi analyzed for federal gift tax purposes?
Under the gift tax regime I have just described, Andy can make an annual gift tax exclusion gift of $13,000 to Ben and an annual gift tax exclusion gift of $13,000 to Cathi. This removes $26,000 from the total gift of $75,000, thus leaving $49,000 of the gift to be accounted for. This amount, $49,000, is deducted from the $5 million lifetime gift tax exclusion that Andy has been given by the Tax Act of 2010. Assuming Andy has made no other gifts of property that exceed the annual gift tax exclusion to any one done in any one year, Andy’s lifetime gift tax exclusion has been reduced FROM $5 million TO $4.951 million. In other words, the excess amount of the gift over the annual gift tax exclusion ($49,000) must be accounted for when determining the federal gift tax that is due on future gifts during Andy’s lifetime.
How does Andy report the making of the gifts to the IRS?
Whenever a person (the “donor”) transfers property valued at more than the annual gift tax exclusion to any other person (the “donee”) during any one calendar year—even if the value of the property transferred is still less than that person’s remaining lifetime gift tax exclusion—the donor must prepare and file with the IRS a federal gift tax return, known as IRS Form 709, on which the donor provides the following information:
- The fact a gift or gifts of property were made by the donor during the calendar year;
- The value of the property that was gifted (i.e., that was transferred);
- The person or persons to whom the property was transferred;
- A calculation of the affect the transfer of the gift(s) has on the donor’s remaining lifetime gift tax exclusion; and
- If any federal gift tax is due, a calculation of the federal gift tax that has been incurred (which gift tax is paid when the return is filed).
IRS Form 709 is due on April 15th of the year after the year in which the gifts were made and the filing of Form 709 can be delayed until October 15th of that year (i.e., the rules of extending the time to file IRS Form 709 and to pay the gift tax due are the same rules as apply to the filing of Form 1040 and paying of income tax due).
In addition, you should know that there are several kinds of gifts that—if made in a specific manner—will not count either towards the annual gift tax exclusion of $13,000 OR towards the lifetime gift tax exclusion of $5 million, no matter how valuable the gift. Such gifts include payments of medical expenses that are made directly to the medical provider and payments of school tuition (but not “room and board”), provided that the tuition payments are made directly to the educational institution. See Internal Revenue Code Section 2503(e)(2). Thus, if anyone to whom you wish to make a gift has incurred any medical expenses or is attending private school or university, you can pay these expenses directly to the medical provider or educational institution and such payments will not count towards the $13,000 annual gift tax exclusion or the $5 million lifetime gift tax exclusion that you now have under the Tax Act of 2010.
Finally, a gift of cash or other property from the donor to a donee is not subject to income tax. However, any interest, dividend, or other income that is earned by the gift after its receipt by the donee (e.g., bank account interest, dividends paid on stock shares after the shares were gifted, etc.) is subject to income tax. The corpus of the gift itself however, is not subject to income tax.
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Disclaimer: Please note that the information in this blog post does not constitute legal advice, and should not be relied on, since each state has different laws, each situation is fact-specific, and it is impossible to evaluate a legal problem without a comprehensive consultation and review of all the facts and documents at issue. Finally, the information provided to you in this blog post does not create an attorney-client relationship.
Notwithstanding the disclaimer, I hope this information has been helpful. Please leave a comment about this post if you have the time. Thank you. James B. Creighton, Esq., Creighton Law Offices