Bryant - Course 6. Estate Planning. 3. Gifting Flashcards
Module Introduction
Giving to others is a fundamental value shared by many in society. To support efforts to gift property of value, the government created special tax considerations for gifts.
Gifts given during one’s lifetime may have a favorable impact on income and estate tax liabilities, making it an ideal estate planning technique. Gifting can result in minimizing both income and estate tax, whether done as a purely generous gesture with no thought of estate planning, or as a deliberate strategy to manage one’s estate.
The Gifting module, which should take approximately six and a half hours to complete, will explain gifting and its tax implications.
Upon completion of this module, you should be able to:
* List the requirements of a complete gift from a transfer tax perspective
* Define the purpose of federal gift tax
* Explain the advantages of lifetime gifts
* Understand the definition of a taxable gift
* Describe transfers that are not considered gifts from a transfer tax perspective
* Specify how and when property is valued for gift tax purposes
* List the exclusions and deductions available for gift tax purposes
* Calculate gift tax liability
* Detail the process of reporting taxable gifts
Module Overview
The lifetime gifting of property is one of the most attractive tools available to assist clients in accomplishing their estate planning goals and objectives. Lifetime gifting strategies are employed in addition to many other estate planning tools to assist individuals in implementing their estate plans.
Gifts can be made directly by the donor or through distributions from a trust or other type of intermediary.
When gifting is utilized as an estate planning strategy, assets can be transferred from the donor to recipients who may be younger-generation family members, contemporaries of the donor, unrelated persons, or a charitable organization.
As a general rule, from a transfer tax perspective, $17,000 (2023) of assets gifted by a donor to any number of donees, as long as these gifts satisfy certain rules, will be ignored by the Internal Revenue Service. This amount, known as the annual exclusion, applies on a per donor/per donee basis, and there is no limit to the number of recipients to whom annual exclusion gifts can be made.
In addition to the exclusion from gift tax, gifts covered by the annual exclusion have many other notable advantages for estate planning purposes.
To ensure that you have a thorough understanding of gifting, the following lessons will be covered in this module:
* Gifts
* Federal Gift Tax
* Gratuitous Transfers
* Completed Transfer
* Computing the Tax
Section 1 - Gifts
Taxpayers are always seeking ways to minimize their total tax liabilities: income, estate, and gift.
As long as the donor can afford to give up control over the assets being gifted, a lifetime gifting strategy may accomplish many of the tax reduction objectives outlined below.
-
A gift of income-producing assets shifts the income tax liability from the donor to the donee.
Ideally, the donee in a lower income tax bracket. - Awareness and precise application of the annual and lifetime gift transfer limits allow the donor to leverage asset transfers to the donee(s) without the application of the gift tax.
- The value of assets gifted during a lifetime may not be included in the donor’s gross estate for estate tax purposes. A gift could be made along with an actual sale, exchange, or transfer of property and can be used in various situations to minimize tax and take full advantage of tax deductions.
Lifetime gifting may also lead to the following nontax benefits to the donor:
* Experience, firsthand, the donee enjoying the gifted property.
* Observe the gift(s) being utilized.
* Provide the donor with the joy of giving.
To ensure that you have a thorough understanding of lifetime gifting, from a transfer tax perspective, the following topics will be covered in this lesson:
* Defining Gifts
* Issues in Community Property States
Upon completion of this lesson, you should be able to:
* Define gifting
* Describe the situations in which gifts can be used beneficially
* Explain the tax implications of gifting
* State the effect of gifting in community property states
Define Gifts and Consideration
For gift tax purposes a gift can be broadly defined to include sale, exchange, or other transfer of property for less than full and adequate consideration. Consideration is the sum paid for acquiring an asset, and it may include cash or cash equivalents.
In addition to an outright transfer of assets to an individual, gifts can take other forms. These include:
* The forgiveness of a debt
* Foregone interest on an intra-family interest-free or below-market loan
* The assignment of the benefits of an insurance policy
* The transfer of property to a trust.
With respect to lifetime gifts, there are two definitions we must be familiar with:
* The donor is the person making the gift. The donor is the person who makes the gratuitous transfer of assets to another person or entity.
* The donee is the person or entity that is the recipient of the lifetime gift from the donor.
Describe Ways to Use Gifting
- If the donor owns an asset that has a substantial amount of appreciation potential.
If the asset is properly gifted during the donor’s lifetime, all of the asset appreciation will avoid inclusion in the donor’s gross estate. Therefore, gifting this type of asset allows the donor to control the amount of estate tax liability that may be due upon his or her death. - When a donor would like to see the donee use the gift during the donor’s lifetime.
- When the donor would like to reduce probate costs and estate administration expense.
- When giving away assets (other than closely-held stock, to which all of the following Internal Revenue Code (IRC) Sections apply) will make it easier to qualify for:
An IRC Section 303 redemption of stock,
An IRC Section 6166 installment payout of taxes attributable to a closely held business interest, or
An IRC Section 2032A special use valuation for certain real property used for farming or closely-held business purposes. -
When a married estate owner wishes to equalize the estate of both spouses, enabling each spouse to own sufficient assets with which to fully utilize their respective estate tax exclusion amounts.
Under current federal law, an unlimited amount of assets may be gifted to a U.S. citizen spouse and not be subject to federal gift tax liability. However, it is important to consider any state gift tax liability as well as the federal gift tax liability. - When the donor has the opportunity to reduce his or her income tax liability by gifting an income-producing asset.
For example, a property owner in a high marginal tax bracket (e.g, 37%) may make a gift to a donee in a lower marginal tax bracket (e.g., 12%) to reduce federal income tax.
Describe Net Unearned Income
Unearned income refers to items such as interest, dividends, and capital gains.
The Kiddie Tax applies when all net unearned income of a child is taxed to the child using the parent’s marginal tax brackets.
A child is defined as:
* Age 18 and has not attained age 19 before the close of the tax year.
* A full-time student age 19-23 who does not earn more than half of their own support. Scholarships do not count as support.
When the Kiddie Tax applies, the tax payable for the child is essentially the additional amount of tax the parent would have had to pay if the income of the child were included as the parent’s taxable income. The source of the assets creating the income, the date the income-producing property was transferred, and the identity of the transferor are irrelevant.
If parents have two or more children with unearned income to be taxed at the parent’s marginal tax rate, all of the children’s applicable unearned income will be added together and the tax calculated. The tax is then allocated to each child based on the child’s pro-rata share of unearned income.
When does The Kiddie Tax not apply?
If the Kiddie Tax does not apply, then all unearned income will be taxed to the child at his or her own tax bracket.
The Kiddie Tax will not apply if:
* Both of a child’s parents are dead, since at least one parent must be alive.
* The child is married and files a joint return.
* The child is 18 years old or a student under age 24 earning more than 50% of their own support.
What are the 3 stages that Kiddie Tax is calculated?
Kiddie Tax is calculated in three stages:
* No tax on the first $1,250 of unearned income because of the child’s standard deduction. The standard deduction offsets unearned income first, up to $1,250. Any remaining standard deduction is then available to offset earned income.
* The next $1,250 of unearned income will be taxed to the child at the child’s bracket (10% for CFP Exam purposes).
* Unearned income over the first $2,500 will be taxed to the child at the parent’s marginal tax rate.
Kiddie Tax Calculation Example
A dependent child under age 19 with $2,700 of unearned interest income and no other income is taxed as follows, assuming the parent’s highest marginal tax rate is 32%:
Unearned Income $2,700
Standard Deduction Minus $1,250
Taxed at child’s rate Minus $1,250
* Net Unearned Income $__ ____??____ __
* Taxed at Parents’ Rate Times 32%
* Kiddie Tax $__ ____??____ __
* $1,250 at child’s rate of 10% $__ ____??____ __
* Total Tax $__ ____??____ __
* Therefore, even for children under age 19, some income shifting is still possible.
A dependent child under age 19 with $2,700 of unearned interest income and no other income is taxed as follows, assuming the parent’s highest marginal tax rate is 32%:
Unearned Income $2,700
Standard Deduction Minus $1,250
Taxed at child’s rate Minus $1,250
* Net Unearned Income $200
* Taxed at Parents’ Rate Times 32%
* Kiddie Tax $64
* $1,250 at child’s rate of 10% $125
* Total Tax $189
* Therefore, even for children under age 19, some income shifting is still possible.
What three requirements must be met to be considered a completed gift for gift tax purposes?
To be considered a completed gift for gift tax purposes, three requirements must be met:
* The donor must intend to make the gift.
* The gift must be delivered to the donee.
* The gift must be accepted by the donee.
Gifting Scenario
Caroline is age 55, married, has an account with an FMV of $30,000, generating $1,000 interest income per year. Caroline is presently in a 32% federal income tax bracket. On the advice of her lawyer, in 2023 she gives the $30,000 account to her 15-year-old son James, who is in a 10% federal income tax bracket (splitting the gift with her husband). Caroline successfully transfers the investments to a UTMA on which James is the account holder. James has ownership of the investments and the gift is considered accepted.
Tax Implications of the Gift
* This will have the result of shifting the income tax liability from Caroline, who would have netted only $__ ____??____ __
* James will net $__ ____??____ __.
* Will there be any kiddie tax?
Completed Gift Requirements
Caroline (donor) intended to make the gift.
Caroline delivered the gift to James’s UTMA account.
James accepted and assumed ownership of the assets.
Therefore, this is considered a completed gift.
Tax Implications of the Gift
* This will have the result of shifting the income tax liability from Caroline, who would have netted only $680 = [$1,000 - (32% × $1,000)]
* from the $1,000 interest to James, who will net $1,000.
* There will be no tax because the first $1,250 (2023) of unearned income to James is exempt.
What are issues with gifting in Community Property States?
All community property states have adopted statutes that to some degree, and by different methods, grant equal powers of management and control of community property to each spouse. In many states, one spouse cannot make a gift of community property without the prior written consent of the other spouse.
If one spouse makes a gift of community property to a third person without the consent of the other spouse, the gift is ordinarily voidable rather than void. The gift can be voided only at the request of the non-donor spouse. The amount of the gift that can be declared void and brought back to the community estate is generally dependent upon whether the community circumstance is still in existence.
Similar to the rule in common law states, an unlimited marital gift tax deduction is available on the value of a community interest gifted to a spouse.
In addition, some states like Texas, Louisiana, and Idaho consider the income from assets with a separate property nature to be community property.
Others, like Arizona, California, Nevada, New Mexico, and Washington consider such income to be the separate property of the spouse who actually owns the property.
Thus, in the latter group of states, income that comes from an asset that one spouse had before marriage or which was given to or inherited by the spouse during marriage is the separate property of that spouse.
It is important to maintain in separate accounts the proceeds of the sale of one’s separate property and any separate property income. Commingling these funds can transmute them into community property of both spouses and can result in a gift.
This act may result in state gift tax being imposed even though no gift was intended by using those commingled funds to buy something in co-ownership between the spouses.
Aside from any gift tax aspects, with the increasing frequency of divorce, it may be important for ownership reasons to be able to trace separate and community property.
If the spouses are still married, the entire gift is returned to the community estate. However, if the community has been terminated by divorce or death what percentage of the gift will the spouse have the right to recapture?
* 20%
* 50%
* 80%
* 100%
50%
- The spouse has the right to recapture only 50% of the gift. The other half is allowed to remain with the done. Therefore, it is advisable to obtain both spouses’ consent prior to the lifetime transfer of community assets.
What are the tax implications associated with gifting?
There are several tax implications associated with gifting. These include the removal of future appreciation from the donor’s estate, income tax shifting, and reducing estate tax liability.
The tax implications include:
* Removal of future appreciation in the value of the property from the donor’s gross estate.
* Gift tax may have to be paid if the value of the taxable gift exceeds the lifetime gift tax exclusion amount. A donor should be aware that the lifetime gift tax exemption equivalent is $12,920,000 (2023) equal to a unified tax credit amount of $5,113,800.
* If an individual is married, the maximum gifts that may be made to any donee equal 2 times the annual exclusion ($17,000 x 2 = $34,000), plus two times the lifetime gift tax exclusion amount of $12,920,000.
* Dividends or other income generated by the property given will be taxed to the donee rather than the donor.
* The tax implications also include state gift tax where applicable, which in many instances can be greater than the federal gift tax because of the large credit and exemptions currently available under federal gift tax law.
Section 1 - Gifts Summary
Gifting is an estate planning technique that may be used to reduce tax liabilities. However, lifetime gifts have many nontax benefits to both the donor and the donee. In summary, from a transfer tax perspective, a lifetime gift is the gratuitous transfer of assets for less than full and adequate consideration.
In this lesson, we have covered the following:
* Gifts: For transfer tax purposes are defined as a lifetime sale, exchange, or other transfer of property from the donor to the donee. It must be a gratuitous transfer without adequate and full consideration of money or money’s worth. To qualify as a gift, the property must be accepted by the donee and must divest the donor of control, dominion, and title over the gifted assets. Gifting can provide income and estate tax savings, as well as non-tax benefits. As an estate planning technique, it is best to gift assets that have a substantial amount of appreciation potential. Lifetime gifting may be used to reduce probate and estate administration expenses. It may also be used as a strategy to allow the estate to qualify for IRC Sec. 303, Sec. 6166, and Sec. 2032A benefits. A high-income tax bracket property donor could make a gift to a lower income tax donee to shift the future income from the high bracket to a lower income tax bracket.
- Community property states issues: When one spouse gives his or her community interest in property to the other, a marital deduction is available for the entire amount of the gift. If one spouse makes a gift of community property to a third person without the consent of the other spouse, the gift is ordinarily voidable. If the spouses are still married, the entire gift is returned to the community estate.
A gift for the purpose of the gift tax is a transfer of assets from a donor to a donee, without adequate consideration of money or money’s worth. It can thus include: (Select all that apply)
* Reassign of title of property in a community property state to a beneficiary
* Forgiveness of personal debt
* Forgiveness of interest on an intra family below market loan
* Transfer of benefits of an insurance policy
* Discounts on diamond purchases
Forgiveness of personal debt
Forgiveness of interest on an intra family below market loan
Transfer of benefits of an insurance policy
* In addition to direct transfers, gifts can also take the form of the forgiveness of a debt, foregone interest on an intra-family interest-free or below market loan, the assignment of the benefits of an insurance policy or the transfer of property to a trust. In community property states, one spouse cannot make a gift of the property to the third person, without the consent of the other spouse. Assignment of income or property done only for tax purposes is not considered a gift. Also, discounts and commissions offered as a normal business practice do not fall in the category of gifts.
The reasons for gifting are either to save tax or to see the donee benefit by the gift. Giving away assets more than three years prior to death, other than closely held stock will make it easier to qualify for: (Select all that apply)
* An IRC Section 303 redemption of stock
* An IRC Section 2503(c) uniform gifts to minors
* An IRC Section 6166 installment payout of taxes attributable to a closely held business interest
* An IRC Section 2032A special use valuation for certain real property used for farming or closely held business purposes
An IRC Section 303 redemption of stock
An IRC Section 6166 installment payout of taxes attributable to a closely held business interest
An IRC Section 2032A special use valuation for certain real property used for farming or closely held business purposes
* Giving away assets other than closely held stock will make it easier to qualify for an IRC Section 303 redemption of stock, an IRC Section 6166 installment payout of taxes attributable to a closely held business interest, and an IRC Section 2032A special use valuation for certain real property used for farming or closely held business purposes.
Section 2 - Federal Gift Tax
The federal gift tax is imposed to ensure that the government is compensated for the potential loss of estate and income tax revenues.
The gift tax is an excise tax that is levied on the right of an individual to transfer money or other property to another.
The tax is generally imposed only on transfers by individuals.
The gift tax is based on the fair market value of the property on the date it is transferred.
The law as it relates to the valuation of gifts provides that a gift is the value of the property transferred less the consideration received.
To ensure that you have a thorough understanding of federal gift tax, the following topics will be covered in this lesson:
* Purpose of Gift Tax Law
* Advantages of Lifetime Gifts
* Technical Definition of a Gift
* Types of Gifts
Upon completion of this lesson, you should be able to:
* Describe the purpose, nature, and scope of gift tax law
* Define direct and indirect gifts
* Explain the advantages of lifetime gifts
* State the technical definition of gifts
* Enumerate the elements of a gift
* List and describe the various types of gifts
What is the Purpose of Gift Tax Law?
If an individual could give away his or her entire estate during his or her lifetime without the imposition of any tax, a rational person would arrange affairs so that at death nothing would be subject to the federal estate tax.
Likewise, if a person could, freely and without tax cost, give income-producing securities or other property to members of his or her family, the burden of income taxes could be shifted back and forth at will to lower brackets, and income taxes would be saved.
The federal gift tax was designed to discourage taxpayers from making such inter vivos (lifetime) transfers and, to the extent that this objective was not met, to compensate the government for the loss of estate and income tax revenues.
Describe the Nature of Gift Tax
- The gift tax is an excise tax, a tax levied not directly on the subject of the gift itself or on the right to receive the property, but rather on the right of an individual to transfer money or other property to another.
- The gift tax is based on the value of the property transferred.
- It is computed on a progressive tax rate schedule that ranges from 18% to 40%, and is based on cumulative lifetime taxable gifts made from 1932 to the present.
- All taxable gifts made from 1932 are added to the current year’s taxable gifts, which results in a higher tax rate applied to the gift made in the current year.
- The gift tax is tax-exclusive, paid by the donor from assets other than the gifted property. This means that when a gift tax must be paid, the tax would not reduce the value of the gift made to the donee.
The Gift & Estate Tax Schedule is __ ____??____ __.
I. cumulative
II. progressive
* I only
* II only
* Both I and II
* Neither I nor II
Both I and II
- In general, estate and gift taxes are computed by applying the uniform rate schedule to cumulative transfers and subtracting the gift taxes paid.
- The rates on the schedule get progressively higher with more gifts or larger estates.
- Therefore, the Gift & Estate Tax Schedule is both cumulative and progressive.
The Income Tax Regulations summarize the comprehensive scope of the gift tax law by stating that __ ____??____ __.
Scope
The Income Tax Regulations summarize the comprehensive scope of the gift tax law by stating that
“all gratuitous transfers of property or interests in property from one person to another, regardless of the means or devices employed, constitute gifts subject to gift tax liability.”
Therefore, almost any transfer, or shifting of property or an interest in property, can subject the donor to potential gift tax liability, if the transfer is for less than full and adequate consideration.
Describe Direct and Indirect Gifts
A taxable gift may include direct, as well as indirect gifts, gifts made outright, and gifts in trust (of both real and personal property).
A gift tax is imposed on the shifting of property rights, regardless of whether the property is tangible or intangible.
It can be applied even if the property transferred (such as a municipal bond) is exempt from federal income or other taxes.
Almost any party can be the donee or recipient of a gift subject to tax. The donee can be an individual, partnership, corporation, foundation, trust, or another person.
A transfer of assets to a corporation without a concurrent increase in the value of the corporation is considered a gift to the other shareholders of the corporation.
Similarly, a gift to an irrevocable trust is usually considered to be a gift to the beneficiaries.
In fact, a gift can be subject to the gift tax even if the identity of the donee is not known on the date of the transfer and cannot be ascertained.
Which of the following would be included in a broad definition of a gift?
* Cancellation of a debt.
* Gifts of checks or notes to third parties.
* Exchanges of royalty rights for less than full consideration.
* Transfers of partnership interests.
Cancellation of a debt.
Gifts of checks or notes to third parties.
Exchanges of royalty rights for less than full consideration.
Transfers of partnership interests.
* All of these items are included in the definition of a gift.
What are the Advantages of Lifetime Gifts?
The advantages of gifts are classified as non tax-oriented and tax-oriented.
The non-tax advantages include:
* privacy
* potential reduction of probate and administrative costs
* the financial well-being of the donee.
The tax benefits associated with lifetime gifts include:
* potential federal estate tax savings
* income tax shifting (i.e., gifting income-producing assets from a high income-tax-bracket taxpayer to a low income-tax-bracket taxpayer)
Describe the Unified Estate and Gift Tax Systems
The unification of the estate and gift tax systems imposes the same tax burden on transfers made during the donor’s lifetime, as well as after death.
* Both lifetime gifts and transfers after death are subject to the same tax rate schedule and are taxed cumulatively.
* In other words, the Transfer Tax System is cumulative and progressive; therefore the value of taxable gifts made during the lifetime will increase the estate tax rate imposed on transfers of property made after death.
The highest gift and estate tax rate is currently 40%.
An applicable credit of $5,113,800 (2023) is available to each individual to offset all taxable gifts of up to $12,920,000.
* This amount of $12,920,000 (2023) is known as the exemption equivalent amount.
* Use of the unified credit or the applicable credit as it is often referred to is mandatory.
* Consequently, each time a taxable gift is made the unified credit is reduced.
* The unified credit will be reduced to zero once taxable gifts reach $12,920,000, and the donor will be required to pay a gift tax on any taxable gifts that exceed $12,920,000.
Unlimited marital and charitable deductions are used to offset lifetime gifts and estate taxes, therefore unified credits will not be reduced when gifts and/or bequests are made to spouses and charities.
Describe Gift Tax in Inter Vivos Gifts
Gifts are made while you are alive therefore they are referred to as inter-vivos gifts. In comparison, property transfers made at death are known as bequests.
Many factors need to be considered before making gifts. Taxable gifts that total more than $12,920,000 (2023) are subject to gift tax. Would it make sense to make a gift and pay gift tax in one year if the gift tax rate would be lower for the same gift in a later year? It might if the appreciation potential of the property within that year is great.
Not all gifts are taxable gifts. An individual can give up to $17,000 (2023), known as the annual exclusion amount to an unlimited number of donees in the same calendar year and not pay any gift tax.
* Annual exclusions are available for lifetime gifts but are not available for bequests from a decedent’s estate.
* Gifts that exceed the annual exclusion amount of $17,000 are taxable gifts, but the donor’s unified credit is used to offset the tax on these taxable gifts.
* Each time a taxable gift is made the unified credit is reduced.
* The donor must pay gift taxes on aggregate lifetime gifts that exceed $12,920,000 because the unified credit is reduced to zero at $12,920,000.
This means that a person wishing to make gifts to 8 individuals every year, could make 8 times $17,000 of gifts on an annual basis, or $136,000 of annual exclusion gifts each year, without making any taxable gifts.
Describe Gift Tax in Inter Vivos Gifts in Spouses & Adjusted Taxable Gift
As an individual’s spouse can also give such gifts, a married couple may make totally gift-tax-free gifts up to $34,000 multiplied by an unlimited number of donees. In the example above, the donor and spouse together could give up $34,000 annually on a gift-tax-free basis, for a total transfer of $272,000 that is not subject to gift taxes. In fact, one spouse can make the entire gift if the other spouse consents. The transaction can then be treated as if both spouses made gifts. This is known as gift-splitting.
Gift-tax-free transfers can translate into significant federal estate tax savings because they remove the value of the gift and any potential appreciation from the donor’s gross estate.
* Consider the estate tax savings potential if the amount given to the donees over the donor’s life expectancy is invested in life insurance, annuities, and mutual funds.
Any appreciation accruing between the time of the gift and the date of the donor’s death escapes estate taxation.
* This may result in considerable estate tax savings and probate and inheritance tax savings.
If a father gives his daughter stock worth $100,000, and it grows to $600,000 by the date of the father’s death, only the $100,000 value of the stock at the time of the gift minus the annual exclusion of $17,000 enters into the estate tax computation. This is known as an adjusted taxable gift.
* The $500,000 of appreciation would escape consideration in the calculation of the estate tax liability. This is an excellent example of leveraging a gift.
Practitioner Advice:
Another example of leveraging is making a gift of a life insurance policy, either outright to an individual or into an irrevocable life insurance trust (ILIT). Assuming the life insurance is gifted more than three years prior to the donor’s death, no portion of the death benefit proceeds will be included in the donor’s gross estate.
For example, let’s assume that the donor is the owner and the insured on a life insurance policy with a death benefit value of $4 million.
* If the donor were to die in 2023, the gross estate would include __ ____??____ __ (see IRC 2042 in the Gross Estate section).
* However, if the donor gifted the insurance policy to another person or an irrevocable trust and died more than three years after making the gift, the $4 million death benefit proceeds of the life insurance policy would __ ____??____ __.
* A life insurance policy is often a good item to gift because it has a low gift tax value, and the death benefit may be removed from the insured’s estate.
For example, let’s assume that the donor is the owner and the insured on a life insurance policy with a death benefit value of $4 million.
* If the donor were to die in 2023, the gross estate would include the $4 million death benefit (see IRC 2042 in the Gross Estate section).
* However, if the donor gifted the insurance policy to another person or an irrevocable trust and died more than three years after making the gift, the $4 million death benefit proceeds of the life insurance policy would escape inclusion in the gross estate of the donor.
* A life insurance policy is often a good item to gift because it has a low gift tax value, and the death benefit may be removed from the insured’s estate.
What is the formula to calculate the Valuation of Gifts
In cases where property is transferred for less than adequate and full consideration in money or money’s worth, the regulations dealing with the valuation of gifts provide that:
Value of Property Received – Consideration Received = Gift
This definition focuses on whether the property was transferred for adequate and full consideration in money or the equivalent of money, rather than turning on whether the transferor intended to make a gift.
This is because Congress did not want to force the IRS to have to prove something as intangible and subjective as the state of mind of the transferor. This does not negate the importance of donative intent, but instead of probing the transferor’s actual state of mind, an examination is made of the objective facts of the transfer and the circumstances in which it was made.
What are the factors examined by courts to determine if there was an intent to make a gift?
Intent
Certain factors are examined by courts to determine if there was an intent to make a gift:
* Was the donor legally competent to make a gift?
* Was the donee legally competent to accept the gift?
* Was there a clear and unmistakable intention on the part of the donor to absolutely, irrevocably and currently divest himself or herself of dominion and control over the gift property?
Assuming that these three objective criteria are met, three other elements must be present. There must be:
* An irrevocable transfer of the present legal title to the donee so that the donor no longer had dominion and control over the property in question.
* Delivery to the donee of the subject matter of the gift or the most effective way to command dominion and control of the gift.
* Acceptance of the gift by the donee.
To be exempt from the gift tax, the consideration that the transferor receives has to be equal in value to the transferred property.
* True
* False
Money’s Worth Defined
There are certain factors that can be used to determine the worth of a gift in terms of money.
To be exempt from the gift tax, the consideration that the transferor receives has to be equal in value to the transferred property.
Transfers of property or property interests made under the terms of a written agreement between spouses in settlement of marital or property rights are deemed to be for adequate and full consideration. Such transfers are therefore exempt from the gift tax.
Where a transfer is made pursuant to compromises of bona fide disputes or court orders, these transfers are deemed to be made for full and adequate consideration, and therefore, such transfers are not considered taxable gifts.
Define the Sufficiency of Consideration Test
The measure of a value of a gift is the difference between the value of the property transferred and the consideration received by the transferor.
* Therefore, a $100,000 building that is transferred from a mother to her daughter for $100,000 in cash does not constitute a gift.
However, the mere fact that consideration has been given does not pull a transaction out of the gift tax orbit. To be exempt from the tax, the consideration received by the transferor must be equal in value to the property transferred. This is known as the sufficiency of consideration test.
* If the daughter in the above example had paid $60,000, the excess value of the building, $40,000, would not be removed from the scope of the gift tax.
* To escape the gift tax, there must be adequate and full consideration equal in value to the property transferred.
Describe Non-beneficial Consideration
Consideration is not “in money or money’s worth when the consideration is moral consideration, past consideration or consideration in the form of a detriment to the transferee that does not benefit the transferor.”
The classic example is the case where a man transferred $100,000 to a widow when she promised to marry him.
In this case, if the widow remarried, she would lose $100,000 interest in a trust established for her by her deceased husband.
The $100,000 transferred to her from her fiancé was to compensate her for the loss.
The Supreme Court held that the widow’s promise to marry her fiancé was not sufficient consideration because it was incapable of being valued in money or money’s worth.
Nor was her forfeiture of $100,000 in the trust sufficient consideration, because although the widow did in fact give up something of value, the benefit of that value did not go to the transferor, her fiancé.
What are 2 issues that often arise in connection with the consideration question?
Consideration in Marital Rights
Two issues often arise in connection with the consideration question:
* Does the relinquishment of marital rights constitute consideration in money or money’s worth?
* Does the relinquishment of support rights constitute consideration in money or money’s worth?
The Internal Revenue Code is specific in the case of certain property settlements. It provides that transfers of property or property interests made under the terms of a written agreement between spouses in settlement of marital or property rights are deemed to be for an adequate and full consideration. Such transfers are therefore exempt from the gift tax, whether or not the agreement is supported by a divorce decree, if the spouses enter into a final decree of divorce within 2 years after entering the agreement.
A spouse’s relinquishment of the right to support constitutes consideration that can be measured in money or money’s worth. Likewise, a transfer in satisfaction of the transferor’s minor children’s right to support is made for money’s worth. However, most transfers to or for the benefit of adult children are generally treated as gifts unless, for some reason, state law requires the transferor to support that child.
For example, if a husband agrees to give his wife $10,000 as a lump-sum settlement on divorce in exchange for her release of all marital rights she may have in his estate, the $10,000 transfer is not subject to the gift tax if the stated requirements above are met. But even in a case where the 2-year requirement was not met, a taxpayer has successfully argued that the transfer was not made voluntarily and was therefore not a gift.
Describe Transfers Pursuant to Compromises
Consideration is an important factor where a transfer is made pursuant to compromises of bona fide disputes or court orders. Such transfers are not considered taxable gifts because they are deemed to be made for adequate and full consideration.
Likewise, the gift tax can be applied even in the case of a transfer made pursuant to or approved by a court decree if there is not an adversary proceeding.
For instance, if the property of an incompetent individual were transferred to his or her mother, the transfer would be a gift even though it was approved by court decree, as long as the incompetent individual had no legal duty to care for the parent.
If a mother and a daughter are in litigation and the daughter is claiming a large sum of money, the compromise payment would be considered which of the following?
* A transfer
* A settlement
* Not a gift
* A gift
Not a gift
- A compromise payment by the mother to the daughter is not a gift.
- However, in an interfamily situation in which the court is not convinced that a bona fide arms’ length adversary proceeding was present, the gift tax will be imposed.
What constitutes direct and indirect gifts?
As previously noted, gifts can be classified as direct and indirect.
- Direct gifts include cash or tangible personal property.
- Indirect gifts include the payment of someone else’s expenses, such as when a parent makes payments on an adult son’s car or pays premiums on a life insurance policy his wife owns on his life.
List types of Direct Gifts
Cash or tangible personal property is the most common type of transfer to which the gift tax would apply.
Generally, delivery of the property itself effectuates the gift.
In the case of corporate stock, a gift occurs when endorsed certificates are delivered to the donee or his or her agent or the change in ownership is delivered to the corporation or its transfer agent.
Real property is typically given by the delivery of an executed deed.
If a person purchases a U.S. savings bond, but has the bond registered in someone else’s name, and delivers the bond to that person, a gift has been made.
* If the bonds are titled jointly between the purchaser and another, no gift occurs until the other person has cashed in the bond or has the bond reissued in his or her name only.
Income that will be earned in the future can constitute a gift presently subject to tax.
* For example, an author can give his or her right to future royalties to his or her daughter.
* Such a gift is valued according to its present value. That is, the gift is not considered to be a series of year-by-year gifts valued as the income is paid, but rather a single gift valued on the date the right to future income is assigned.
* Current valuation will be made even if, for some reason, the payments are reduced substantially or even if they cease. No adjustment is required or allowed if the actual income paid to the donee is more or less than the valuation.
List more types of Direct Gifts
Forgiving a debt constitutes a gift in nonbusiness situations.
* For example, if a father lends his son $100,000 and later cancels the note, the forgiveness constitutes a $100,000 gift.
* However, if the father lends the son $100,000 and the initial agreement is that the loan is repayable immediately upon the father’s demand, no gift is made.
Some forgiveness of indebtedness, however, constitutes income to the benefited party.
* If a creditor tore up a debtor’s note in return for services rendered by the debtor, the result would be the same as if the creditor compensated the debtor for the services rendered, and then the debtor used the cash to satisfy the debt. The debtor realizes income and does not receive a gift.
Payments in excess of one’s obligations can be gifts.
* Clearly, a person does not make a gift when he or she pays his or her bills. Therefore, when a husband pays bills or purchases food or clothing for his wife or minor children, he is not making gifts. Courts have allowed considerable latitude in this area.
* But if a father gives his minor daughter a $50,000 ring, the IRS may claim the transfer goes beyond his obligation of support.
* Payments made on behalf of adult children are often considered gifts.
* For example, if a father pays his adult son’s living expenses and mortgage payments, or gives an adult child a monthly allowance, the transfer is a gift subject to tax.
In another situation, the taxpayer, pursuant to an agreement incorporated in a divorce decree, created two trusts for the support of his minor children. He put a substantial amount of money in the trusts, which provided that after the children reached 21 they were to receive the corpus.
* The court measured the economic value of the father’s support obligation and held that the excess of the trust corpus over that value was a taxable gift.
* Only the portion of the transfer required to support the children during their minority was not subject to the gift tax.
List types of Indirect Gifts
Indirect Gifts
Indirect gifts, such as the payment of someone else’s expenses, are also subject to the gift tax.
* For instance, if a person makes payments on an adult son’s car or pays premiums on a life insurance policy his wife owns on his life, such payments are gifts.
The shifting of property rights alone can trigger gift tax consequences.
* In one case an employee gave up his vested rights to employer contributions in a profit-sharing plan. He was deemed to have made a gift to the remaining participants in the plan.
* Similarly, an employee who has a vested right to an annuity is making a gift if he irrevocably chooses to take a lesser annuity coupled with an agreement that payments will be continued to his designated beneficiary. No gift occurs until the time the employee’s selection of the survivor annuity becomes irrevocable.
Third-party transfers may be the medium for a taxable gift.
* For example, if a father gives his son $100,000 in consideration of his son’s promise to provide a lifetime income to the father’s sister, the father has made an indirect gift to his sister.
* Furthermore, if the cost of providing a lifetime annuity for the sister is less than $100,000, the father also has made a gift to his son.
The creation of a family partnership may involve an indirect gift.
* The mere creation or existence of a family partnership that is often useful in shifting and spreading income among family members and in reducing estate taxes does not, per se, mean a gift has been made.
In other cases, where new partners are to contribute valuable services in exchange for their share of the partnership’s earnings and the business does not contain significant capital assets, the formation of a family partnership does not constitute a gift.
List more types of Indirect Gifts
Transfers by and to corporations are often forms of indirect gifts.
* Technically, the gift tax is not imposed upon transfer by corporations.
* But transfers by or to a corporation are often considered to be made by or to corporate stockholders.
* The regulations state that if a corporation makes a transfer to an individual for inadequate consideration, the difference between the value of the money or other property transferred and the consideration paid is a gift to the transferee from the corporation’s stockholders.
Generally, a transfer to a corporation for inadequate consideration is a gift from the transferor to the corporation’s other shareholders.
For example, a transfer of $120,000 by a father to a corporation owned equally by him and his three children is treated as a gift of $30,000 from the father to each of the three children.
* The amount of such a gift is computed after subtracting the percentage of the gift equal to the percentage of the transferor’s ownership.
A double danger lies in corporate gifts. The IRS may argue that:
* In reality, the corporation made a distribution taxable as a dividend to its stockholders, and
* That the shareholders, in turn, made a gift to the recipient of the transfer.
* As any distribution from a corporation to a shareholder generally constitutes a dividend, as long as the corporation is a C corporation, to the extent of corporate earnings and profits, the IRS could claim that a transfer was first a constructive dividend to the shareholders and then a constructive gift by them to the donee.
* For example, if a family-owned corporation sold property with a fair market value of $450,000 for $350,000 to the son of its shareholders, the transaction could be considered a $100,000 constructive dividend to the shareholder-parents, followed by a $100,000 constructive gift by them to their son.
A gratuitous transfer of property by a family-owned corporation to the father of the shareholders of a corporation could be treated as a gift from which of the following choices?
* Father to the corporation
* Father to his children
* Children to their father
* Children to the corporation
Children to their father
- A gratuitous transfer of property by a family-owned corporation to the father of the shareholders of a corporation could be treated as a gift from the children to their father.
What are the 3 situations that Life insurance or life insurance premiums can be the subject of an indirect gift?
Life insurance or life insurance premiums can be the subject of an indirect gift.
This may happen in three types of situations:
* The purchase of a policy for another person’s benefit
* The assignment of an existing policy
* Payment of premiums
If an insured purchases a policy on his or her life, he or she has made a gift measurable by the cost of the policy if he or she:
* Names a beneficiary other than his or her estate
* Does not retain the right to regain the policy or the proceeds or revest the economic benefits of the policy, that is, retains no reversionary interest in self or estate
* Does not retain the power to change the beneficiaries or their proportionate interests, that is, makes the beneficiary designation irrevocable
All three of these requirements must be met, however, before the insured will be deemed to have made a taxable gift.
If an insured makes an absolute assignment of a policy or in some other way relinquishes all his rights and powers in a previously issued policy, a gift is made.
* The gift is measurable by the replacement cost.
* In the case of a whole life policy, the value of the gift is generally equal to the interpolated terminal reserve plus unearned premium at the date of the gift.
* This can lead to an insidious tax trap.
* However, the basis of the trap is the fact that the owner, insured and beneficiary of the policy are all different.
Describe gifting when an insured makes an absolute assignment of a policy or in some other way relinquishes all his rights and powers in a previously issued policy.
Assume a wife owns a policy on the life of her husband. She names her children as revocable beneficiaries.
* At the death of her husband, the IRS could argue that the wife has made a constructive gift to the children.
* The IRS has held that the wife constructively received the death benefit proceeds and made a gift of the proceeds to the kids.
An extension of this reasoning, which was successfully applied by the IRS, is a case where the owner of policies on the life of her husband placed the policies in trust for the benefit of her children.
* As she reserved the right to revoke the trust at any time before her husband died, she had not made a completed gift until his death.
* It was not until his death that she relinquished all her powers over the policy.
* When the husband died, the trust became irrevocable, and therefore the gift became complete.
* The value of the gift was the full value of the death proceeds rather than the replacement value of the policy when it was placed in trust.
Section 2 - Federal Gift Tax Summary
The gift tax is an excise tax because it is not levied directly on the subject of the gift itself or on the right to receive property. Instead, it is a tax on the right of an individual to transfer property to another. Direct and indirect gifts, gifts made outright and gifts in trust of both real and personal property can be the subject of a taxable gift.
In this lesson, we have covered the following:
* Purpose of the gift tax: The gift tax discourages taxpayers from giving away property and income-producing securities of gifts during their lifetime and evading tax. Therefore, the gift tax serves the purpose of compensating the government for the loss of income and estate tax revenues. The gift tax is based on the value of the property transferred and tax rates applied to total lifetime taxable gifts. Almost any transfer or shifting of property or an interest in property can be subject to gift tax if it meets the legal requirements of a gift. It applies even if the property transferred is exempt from federal income or other taxes.
* Advantages of lifetime gifts: There are non-tax and tax advantages to lifetime gifts. One non-tax reason for making a gift is the privacy that gifts offer, which may not be possible to obtain through testamentary transfers. Other non-tax reasons include the potential reduction of probate and administrative costs and protection of the assets from the claims of the donor’s creditors. The motive of the donor may also be to achieve the satisfaction of seeing the donee use and enjoy the gift, and to provide for the financial well-being of the donee. The tax reasons are mainly based on the system of unified estate and gift tax credits. A single unified estate and gift tax rate schedule minimizes the disparity of treatment between lifetime and after-death transfers.
-
The technical definition of a gift: For gift tax purposes, the value of a gift is equal to the value of the property transferred less any consideration received. The three conditions that must be satisfied for a completed gift are:
1. An intention by the donor to make a gift;
2. The donor must make an irrevocable transfer of the present legal title to the donee so that the donor no longer has dominion and control over the property in question; and
3. The donee must accept the gift.
This includes making sure that the donor was competent to make a gift and that the donee was capable of accepting the gift. - Types of gifts: Gifts can be broadly classified as direct and nondirect. Both direct and indirect gifts are subject to gift tax. Some examples of direct gifts are cash and tangible property where the delivery of the property itself effectuates the gift. Direct gifts also include intangible property such as corporate stock gifted by delivering endorsed certificates and real property gifted by delivering the executed deed. Bonds purchased by a person in another’s name and gifted to this person are a direct gift. Even income that will be earned in the future, forgiving debt in nonbusiness situations and payments in excess of one’s obligations can constitute direct gifts.
- Indirect gifts include payment of another person’s expense, third-party transfers and life insurance or life insurance premiums.
The gift tax is tax levied not directly on the subject of the gift itself or on the right to receive the property, but rather on the right of an individual to transfer money or other property to another. In that sense it is:
* An excise tax
* A countervailing duty
* An income tax
* A indirect tax
An excise tax
- The gift tax is an excise tax, a tax levied not directly on the subject of the gift itself or on the right to receive the property, but rather on the right of an individual to transfer money or other property to another.
Assuming that the gift is complete, it can be subject to gift tax, if the donee is: (Select all that apply)
* A trust
* A foundation
* A partnership
* An unknown identity
A trust
A foundation
A partnership
An unknown identity
* Almost any party can be the donee or recipient of a gift subject to tax. The donee can be an individual, partnership, corporation, foundation, trust or other person. In fact, a gift can be subject to the tax, assuming the gift is complete even if the identity of the donee is not known at the date of the transfer and cannot be ascertained.
Assuming that the donor was competent to make a gift, the donee was capable of accepting the gift, and there was a clear intention on the part of the donor to divest himself or herself of dominion and control over the gift property, what are the other requisites in gifting: (Select all that apply)
* A complete delivery to the donee of the gift
* Acceptance of the gift by the donee
* Consideration received by the donor equals the value of the property transferred
* An irrevocable transfer of the present legal title
A complete delivery to the donee of the gift
Acceptance of the gift by the donee
An irrevocable transfer of the present legal title
- Assuming that the donor was competent to make a gift, the donee was capable of accepting the gift, and there was a clear intention on the part of the donor to divest himself or herself of dominion and control over the gift property, three other elements must be present.
1. An irrevocable transfer of the present legal title to the donee must be made so that the donor no longer has dominion and control over the property in question.
2. The donor must make a complete delivery to the donee of the subject matter of the gift or the most effective way to command dominion and control of the gift.
3. Acceptance of the gift by the donee. - The measure of a gift is the difference between the value of the property transferred and the consideration received by the transferor.
- When the consideration received by the donor against a gift is equal to the value of the property transferred, it does not amount to a gift and amounts to the equivalent of a purchase.
Section 3 - Gratuitous Transfers
The regulations of the IRS and past rulings of the court provide sufficient guidelines to help a taxpayer honestly minimize and not evade tax. The IRS does not consider gratuitous services and promises to make a gift subject to gift tax.
Similarly, gifts made with the sole purpose of shifting tax liabilities from a high to a relatively lower income tax bracket are not considered gifts. However, there are certain gifts that are exempt from gift tax, if properly made, such as tuition fees and payment of medical care.
To ensure that you have an understanding of gratuitous transfers, the following topics will be covered in this lesson:
* Gratuitous Services Rendered
* Promise to Make a Gift
* Sham Gifts
* Exempt Gifts
Upon completion of this lesson, you should be able to:
* List the types of transfers not subject to gift tax
* Explain why gratuitous services do not attract gift tax
* Define tax implications of interest-free loans and disclaimers
* Describe the effects of promises to make gifts
* State the types of transfers that constitute sham gifts
* List the transfers exempted from gift tax
What three basic categories is gift tax not imposed since these transfers do not involve gifts in the tax sense?
In a number of property transfer cases, the gift tax is not imposed since these transfers do not involve gifts in the tax sense. These situations fall into three basic categories:
* Where property or an interest in property has not been transferred,
* Certain transfers in the ordinary course of business, and
* Sham gifts.
Are Gratuitous Services Rendered a Gift?
The gift tax is imposed only on the transfer of property or an interest in property. The term property does not include services that are rendered gratuitously. Regardless of how valuable the services one person renders for the benefit of another, those services do not constitute the transfer of property rights and do not, therefore, fall within the scope of the gift tax.
If an executor performs the services required in the course of the administration of a large and complex estate, the services are clearly of economic benefit to the estate’s beneficiaries. Yet, they do not constitute a transfer of property rights. If the executor formally waives the fee within six months of appointment as executor or fails to claim the fees or commissions by the time of filing and indicates through action or inaction that he or she intends to serve without charge, no property has been transferred.
Conversely, once fees are taken or if the fees are deducted on an estate, inheritance, or income tax return, the executor has received taxable income.
* If he or she then chooses not to or neglects to actually receive that money, and it goes to the estate’s beneficiaries, he or she is making an indirect and possibly taxable gift to those individuals.
Does the right to use property such as money at no charge constitute a gift of property?
* Yes
* No
Yes.
* Interest-free and below-market-rate loans are treated as taxable gifts.
* A gift tax is imposed on the value of the right to use the borrowed money based on the rate of interest that the money could be expected to earn in a given situation.
How is a qualified disclaimer (renunciation) treated for gift tax purposes?
Generally, a potential donee is deemed to have accepted a valuable gift unless he or she expressly refuses it.
* If he or she disclaims the right to the gift, that is, refuses to take it, it will usually go to someone else as the result of that renunciation.
As long as the disclaimer rules are satisfied, it will not be treated as if the disclaiming donee is making a transfer of property.
* A disclaimer that meets those rules is called a qualified disclaimer.
* For gift tax purposes, a qualified disclaimer is treated as if the property went directly from the original transferor to the person who ultimately receives the property.
What are the requirements in order to treat a disclaimer as qualified?
- The refusal or rejection of the benefits must be in writing.
- The writing must be received by the transferor, his legal representative, or the holder of the legal title to the property no later than nine months after the later of: the date on which the transfer creating the interest is made, or the date the person disclaiming reaches age 21.
- The person disclaiming must not have accepted the property interest or any benefits of the property.
- Someone other than the disclaimant receives the disclaimed property interest. The person making the disclaimer cannot in any way influence the potential recipient of the property.
Is the promise to make a gift in the future taxable even if the promise is enforceable?
Although income that will be earned in the future can be the subject of a gift, the promise to make a gift in the future is not taxable even if the promise is enforceable. This is because a mere promise to make a transfer in the future is not itself a transfer.
The IRS agrees to this as long as the gift cannot be valued.
But if the promise is enforceable under state law, the IRS will attempt to subject it to the gift tax when it becomes capable of valuation.
Compensation for Personal Services
Situations often arise in business settings that purport to be gifts from corporate employers to individuals. The IRS often claims that such transfers are, in fact, compensation for personal services rather than gifts. The IRS argues that the property transfers constitute income to the transferee rather than a gift by the transferor.
In these cases, the focus changes to the effect on the transferee:
Has the transferee received taxable income or has he or she received a tax-free gift?
Payment may be taken out of the normal gift tax rules and considered taxable income to the recipient since the gift tax rules state that the gift tax is not applicable to ordinary business transactions.
Define an ordinary business transaction.
An ordinary business transaction, defined as:
* a sale,
* exchange, or
* other transfer of property
that is a transaction that is
* bona fide,
* at arm’s length, and
* free from donative intent made in the ordinary course of business.
Transactions meeting the above criteria will be considered as if made for an adequate and full consideration in money or money’s worth, and therefore, not subject to gift tax.
A situation will be considered an ordinary business transaction if it is free from donative intent. Therefore, such a transaction would have income tax ramifications. The taxpayer-recipient, the donee, of course, would like to have the transaction considered an income-tax-free gift. However, the IRS would reap larger revenues if the transfer were considered compensation and treated as taxable income.
