Gift Tax and 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  Please note that the increase is repealed in 2013.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 

A 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 accordancgift 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.