Gift Tax & Exclusions

TRUIRJCA has modified the lifetime exemption. The 2010 Tax Act reunifies the gift tax exclusion amount with the estate exclusion amount and, as of January 1, 2011, the gift tax exclusion amount is also $5 million (adjusted to inflation). The gift and estate tax exemptions remain unified such that use of the gift tax exemption prior to a decedent’s death reduces the estate tax exemption available at the decedent’s death on a dollar-for-dollar basis. In addition, the gift tax rate is reunified with the estate tax rate of 35% for transfers exceeding the exclusion amount. 

Finally, Section 302 of the Act also repeals Code section 2511(c) which became effective in 2010. This Code provision treats any transfers to a trust as a taxable gift unless the trust is treated as a grantor trust under the provisions of Code sections 671 through 679 with respect to either the transferor or the transferor’s spouse. 

For gifts made after December 31, 2001, pursuant to the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), the Applicable Credit Amount effectively shields the first $1 million dollars of taxable gifts from gifts tax.[5] The maximum tax rate in 2008 is 45%. TRUIRJCA provided that the gift tax exemption is increased to $5 million for gifts made after December 31, 2010. Please note that the increase is repealed in 2013. 

Every individual owns an estate. Of course it can be different in size. Individuals are in control of how much of their assets they want to transfer during their life and where the assets go upon their death. Any transfer of significant or substantial value may be taxed. 

There are several options available to reduce the estate tax liability through lifetime gift transfers and charitable transfers. Before reviewing these options, let’s define what a gift is. 

A “gift” is a completed transfer of property made for less than adequate and full consideration in money or money’s worth. If any consideration is paid, then the gift is the differential between the value of the property transferred and the consideration furnished.[6] Once the gift is made, a tax may be imposed. The gift tax will apply whether the gift is in trust or otherwise, direct or indirect, and whether the transferred property is real, personal, tangible or intangible. Generally, a transferor’s donative intent is not essential to establish whether or not a gift was made; rather the facts and circumstances of a particular transfer determine whether a gift was made. 

Because the gift tax applies only to completed transfers, it is important to determine whether a transfer is complete or incomplete. The transfer is deemed complete when the donor has fully relinquished dominion and control over the property transferred. Examples of uncompleted gifts: (1) the donor retained the power to revoke the gifts; (2) the donor retained the right to change beneficiaries; (3) the donor retained the power to change beneficial interests other than in accordance with a fiduciary power governed by an ascertainable standard. 

A completed gift could be the following situation: The donor transfers property to himself/herself as trustee, receives income from the trust but retains no power over the property except in a fiduciary capacity and retains no power of appointment over the property to direct to whom the property should go at this donor’s death. However, the IRS requests that such complete transfer of property be included in the donor’s estate for estate tax purposes. 

Therefore, taxable gifts consist of the total transfers or aggregate gifts made during the calendar year minus allowable exclusions and deductions. The current year’s tax is then reduced by the donor’s available Applicable Credit Amount to arrive at the tax actually payable. 

The donor is primarily liable for the payment and filing of the gift tax return. However, if the donor does not pay the tax, the donee may become personally liable for the tax due and any interest accrued thereon. A gift tax return is due on April 15 of the year following the calendar year in which the gift is made. The donor’s executor or personal representative is responsible for filing the gift tax return, which is due on the earlier of the due date of the estate tax return, including extensions, or April 15 of the year following the year in which the gift was made. 

Gifts made by either spouse to a third party will be treated as if made one-half by each spouse if the donor elects the gift-splitting. The following rules need to be followed: 

ü Both spouses need to consent to split the gift; 

ü The spouses need to be married to each other at the time of the gifts and do not remarry during the remainder of the calendar year period; 

ü Both spouses were U.S. citizens or residents at the time of the gift. 

The increase in the gift tax exemption from $1 million to $5 million creates a great opportunity for income shifting. A wealthy taxpayer can transfer up to $5 million in assets to family members who are in lower income tax brackets than the donor. 

1.) Transfers Exempted from Estate or Gift Tax 

The IRS accepts that people pay the medical bills and tuition fee for other people without qualifying these payments as gifts. There is no cap on the amount transferred. In order to benefit from this status, the donor has to directly pay the bills or fees to the qualified institution or care provider. 

a.) Tuition Fees 

The exemption is limited to the payment of tuition fees; it does not include books, supplies or dormitory expenses. A qualifying education institution is defined as one that maintains a regular faculty and curriculum and has a regularly enrolled student body at the place where its educational activities are carried out. 

The donor can also enter into a contract with the institution to pay future tuition. The IRS rules that a grandmother would qualify for the exclusion under § 2503(e) for the payment in advance of the tuition of her grandchildren. The IRS required that the payments could not be refunded and were to be forfeited if the grandchildren ceased to attend the school. 

b.) Medical Expenses 

Medical care is defined to include expenses incurred for the diagnosis, cure, mitigation, treatment or prevention of disease, or for transportation for such medical care, and applies only to payments that have not been reimbursed by the donee’s insurance. In addition, the person who pays medical expenses for a third person may report the payment as a deduction on his/her own income tax returns. If the yearly medical expenses exceed 7.5% of the AGI, then this deduction can be reported. This is very important when a family member pays a nursing home. Health care premiums and long-term care insurance are deductible medical expenses. 

The person who pays tuition fees for a spouse or a dependent may also be eligible for an income tax deduction by filing Form 8917 with the federal income tax return. 

c.) Using the Annual Exclusion 

For gifts of present interest only, a donor may exclude the first $10,000 of gifts, adjusted to inflation, made to each donee during any calendar year. Currently the annual exclusion amount is $13,000. As a result the first $13,000 of gifts made to each donee during the year is subtracted from the total gifts made during the calendar year in determining the amount of taxable gifts. If the donor is married, the annual exclusion may be aggregated per couple and increased to $26,000. 

In addition, a donor can contribute a lump sum of $60,000 ($120,000 for married donors) to a 529 College Savings Plan. The IRS accepts that the donor books his/her coming 5 years of annual exclusion for the beneficiary of the 529 College Savings Plan. The beneficiary will be able to take immediate advantage of the potential growth of the 529 Plan investments. If the donor were to die within this 5-year period, a portion of the gift may be includable in the gross estate of the donor. 

d.) Annual Exclusion for Non-Citizen Spouse 

As we will discuss in more detail below, a U.S. citizen spouse has an unlimited transfer deduction. A non-U.S. citizen is not allowed to this deduction. In addition, the presumption that joint property with right of survivorship held between spouses is owned 50% by each, does not apply either. Upon the death of the first spouse, the IRS will presume that the joint property was owned 100% by the decedent. The alien spouse will have to prove his/her ownership interest in the property by tracing the origin of the fund. 

The IRS, under Section 2523(i), allows an annual exclusion of $100,000, adjusted to inflation. The annual exclusion is in the amount of $34,000 for 2010. This is a good estate planning tool when at least one spouse is an alien and the other spouse has a higher income. By making an annual gift, the couple can rebalance their assets. 

e.) Deductions for Transfer to Spouse 

There is an unlimited marital deduction[7] for transfers to a U.S. citizen spouse. This unlimited marital deduction is recognized for transfers of joint property, but where a life estate or a terminable interest in property is created the deduction is generally not allowed. There is an exception to this rule. When the life estate is coupled with a power of appointment in the donee spouse, a marital deduction will be allowed if the following five (5) conditions are met: 

· The donee spouse is entitled for his/her lifetime to all of the income generated by the property; 

· The income is paid to the donee spouse at least annually; 

· The donee spouse has the power to appoint the interest to himself/herself or his/her estate; 

· The donee spouse’s power to appoint rests solely in the donee spouse; and 

· The entire interest is not subject to a power in any other person to appoint any part to any person other than the donee spouse. 

Therefore, a terminable interest in trust will be eligible for a marital deduction if it is a “qualified terminable interest” and satisfies all of the requirements set forth under IRC § 2523(f)(2) for “QTIP” treatment. 

A non-citizen spouse may have the bequest qualifying for the marital deduction if the bequest is held in a Qualified Domestic Transfer Trust (QDT). This trust postpones the payment of the tax due until the first spouse dies, whereas under the unlimited marital deduction the assets are transferred into the surviving spouse estate and the tax is calculated on the surviving spouse estate. Basically, the QDOT needs to have a U.S. trustee and when distributions of principal are made, estate tax needs to be paid. 

f.) Deductions for Transfers to Charity 

A charitable deduction is allowed for all transfers to or for the use of the public or any corporation exclusively established for religious, charitable, scientific, literary or educational purposes. The income tax charitable deduction[8] is parallel to the estate and gift tax charitable deductions.[9] However, the estate and gift tax charitable deductions for property passing outright to charity are unlimited and do not vary with the identity of the charity, so long as the charity is qualified, and are available for foreign charities. 

Some donors are making a charitable gift through a “split interest.” A split interest gift is a gift made in part to a charity and in part to a non-charitable beneficiary. For instance, a property is transferred in trust to pay income to an individual for life with the remainder interest going to charity. No charitable deduction is allowed for a split interest gift unless the charity’s interest is in the form of a: 

ü Charitable remainder annuity trust[10] 

ü Charitable reminder unitrust[11] 

ü Pooled income fund[12] 

ü Charitable lead trust (in the form of either an annuity or unitrust)[13] 

Section 725 of the Act provides tax-free distributions from individual retirement plans for charitable purposes. The termination date of IRC Section 408(d)(8) extended through December 31, 2011, is retroactive to January 1, 2010. For instance, a donor age 70 ½ or over may make charitable donations up to $100,000 directly from IRA accounts to charity. Donations made in January 2011 may be counted as having been made in 2010. 

Gift Tax Returns 

The executor will have to file any gift tax returns, which are required for transfers made by the decedent before his death and not filed by the decedent. The return covering gifts made during the calendar year in which the decedent dies is due no later than the due date, including extensions, of the estate tax return. 

If the decedent died before filing the gift tax returns for gifts made the prior year, the executor will have to file these as well. In such a case, the due date is April 15 following the year of the gift, or the due date for the federal estate tax return (9 months after the death), whichever return is due the earliest. 

If gifts were made to the decedent before his/her death and the donor failed to pay the gift tax, the estate of the decedent (donee) may have to pay the tax. 

If the decedent was married, the executor of the estate can consent to gift splitting for gifts made while both spouses were alive. The consent must be indicated on a timely filed gift tax return, or in the case of late returns, on the first return filed. 

For a gift tax refund, the claim may be made on an amended return or on Form 843, Claim for Refund and Request for Abatement.