Tax Planning/Tax Opinions Articles – Estate & Gift Taxes2020-04-03T12:29:49-07:00
Tax Planning/Tax Opinions Articles – Estate & Gift Taxes
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Estate & Gift Taxes (4)

When does the Gift Tax Apply?

A gift tax is a tax imposed on the transfer of ownership of property during the giver’s life. The United States Internal Revenue Service says that a gift is “Any transfer to an individual, either directly or indirectly, where full compensation (measured in money or money’s worth) is not received in return.”

Who is liable for the Gift Tax?

When a taxable gift in the form of cash, stocks, real estate, or other tangible or intangible property is made, the tax is usually imposed on the donor (the giver) unless there is a retention of an interest which delays completion of the gift. A transfer is “completely gratuitous” when the donor receives nothing of value in exchange for the given property. A transfer is “gratuitous in part” when the donor receives some value but the value of the property received by the donor is substantially less than the value of the property given by the donor. In this case, the amount of the gift is the difference.

US Gift Tax Law

In the United States, the gift tax is governed by Chapter 12, Subtitle B of the Internal Revenue Code. The tax is imposed by section 2501 of the Code.

For the purposes of whether or not a ‘gift’ is taxable income, courts have defined a “gift” as the proceeds from a “detached and disinterested generosity.” Gifts are often given out of “affection, respect, admiration, charity or like impulses.”

Estate Tax Effect of Gifts

Generally, if an interest in property is transferred during the giver’s lifetime (often called an inter vivos gift), then the gift or transfer would not be subject to the estate tax because it would not be owned by the Donor when they die. In 1976, Congress unified the gift and estate tax regimes, thereby limiting the giver’s ability to circumvent the estate tax by giving during his or her lifetime. Some differences between estate and gift taxes remain, such as the effective tax rate, the amount of the credit available against tax, and the basis of the received property.

There are also types of gifts which will be included in a person’s estate, such as certain gifts made within the three-year window before death and gifts in which the donor retains an interest such as gifts of remainder interests that are not either qualified remainder trusts or charitable remainder trusts. The remainder interest gift tax rules impose the tax on the transfer of the entire value of the trust by assigning a zero value to the interest retained by the donor.

Non-taxable gifts

Generally, the following gifts are not taxable gifts:

  • Gifts that are not more than the annual exclusion for the calendar year (last raised to $15,000 per recipient for any one donor, beginning for 2018)
  • Gifts to a political organization for its use
  • Gifts to charities
  • Gifts to one’s (US Citizen) spouse (non taxable because of something called the gift tax marital deduction)
  • Tuition or medical expenses one pays directly to a medical or educational institution for someone. Donor must pay the expense directly. If donor writes a check to donee and donee then pays the expense, the gift may be subject to tax.

Exemptions

There are two levels of exemption from the gift tax.

          Annual Exclusion

First, gifts of up to the annual exclusion ( $15,000 for 2018 thru 2020) incur no tax or filing requirement.

Gift Splitting by Spouses

By splitting their gifts, married couples can give up to twice this amount tax-free. Each giver and recipient pair has its own annual exclusion; a giver can give to any number of recipients and the exclusion is not affected by other gifts that recipient may have received from other givers.

Lifetime Exemption for taxable gifts and estates

Second, gifts in excess of the annual exclusion may still be tax-free up to the lifetime estate basic exclusion amount ($11.58 million for 2020). For estates over that amount, however, such gifts might result in an increase in estate taxes. Taxpayers that expect to have a taxable estate may sometimes prefer to pay gift taxes as they occur, rather than saving them up as part of the estate because gift taxes reduce the size of the taxable estate if paid more than 3 years prior to death, and also because lifetime gifts can shift future appreciation in value out of the estate for estate tax purposes.

Generation Skipping Transfer Taxes

Beware of the GST when doing gifting. Exemptions to some extent can apply. Careful planning and reporting is crucial.

Non Residents

For gift tax purposes, the test is different in determining who is a non-resident alien, compared to the one for income tax purposes (the inquiry centers around the decedent’s domicile). This is a subjective test that looks primarily at intent. The test considers factors such as the length of stay in the United States; frequency of travel, size, and cost of home in the United States; location of family; participation in community activities; participation in U.S. business and ownership of assets in the United States; and voting. It is possible for a foreign citizen to be considered a U.S. resident for income tax purposes but not for gift tax purposes.

If a person is a non-resident alien for purposes of gift tax, taxation of gifts is determined in a different way. If the property is not located in the U.S., there is no gift tax. If it is intangible property, such as shares in U.S. corporations and interests in partnerships or LLCs, there is no gift tax.

Non-resident alien donors are allowed the same annual gift tax exclusion as other taxpayers . Non-resident alien donors do not have a lifetime unified credit. Non-resident alien donors are subject to the same rate schedule for gift taxes.

U.S. citizens and residents must report gifts from a non-resident alien that are in excess of $100,000 on Form 3520.

Noncitizen spouse

According to 26 USC section 2523(i), gifts to a non-U.S.-citizen spouse are not generally exempt from gift tax. Instead, they are exempt only up to a specified amount foreseen by 26 USC section 2503 (b)

U.S. Federal gift tax contrasted with U.S. Federal income tax treatment of gifts

Pursuant to 26 USC 102(c), the receipt of a gift, bequest, devise, or inheritance is not included in gross income. Thus, a taxpayer does not include the value of the gift when filing an income tax return. Although many items might appear to be gift, courts have held the most critical factor is the transferor’s intent. The transferor must demonstrate a “detached and disinterested generosity” when giving the gift to exclude the value of the gift from the taxpayer’s gross income.The courts have defined “gift” as proceeds from a “detached and disinterested generosity.”

“Gifts” received from employers that benefit employees are not excluded from taxation. 26 U.S.C. § 102(c) clearly states employers cannot exclude as a gift anything transferred to an employee that benefits the employee. Consequently, an employer cannot “gift” an employee’s salary to avoid taxation.

Gifts from certain parties will always be taxed for U.S. Federal income tax purposes. Under Internal Revenue Code section 102(c), gifts transferred by or for an employer to, or for the benefit of, an employee cannot be excluded from the gross income of the employee for Federal income tax purposes. While there are some statutory exemptions under this rule for de minimis fringe amounts, and for achievement awards, the general rule is the employee must report a “gift” from the employer as income for Federal income tax purposes. The foundation for the preceding rule is the presumption that employers do not give employees items of value out of “detached and disinterested generosity” due to the existing employment relationship.

Under Internal Revenue Code section 102(b)(1), income subsequently derived from any property received as a gift is not excludable from the income taxed to the recipient. In addition, under Internal Revenue Code section 102(b)(2), a donor may not circumvent this requirement by giving only the income and not the property itself to the recipient. Thus, a gift of income is always income to the recipient. Permitting such an exclusion would allow the donor and the recipient to avoid paying taxes on the income received, a loophole Congress has chosen to eliminate.

If you or a well-off relative are facing the gift and estate tax, here’s a planning opportunity often overlooked: pay tuition and medical expenses for loved ones.

Such payments, structured correctly, do not represent gifts for gift tax purposes.

The monies spent by you on the qualified medical and tuition payments reduce your net worth and taxable estate, but they do no harm to your income, gift, or estate taxes.

Further, the loved one who benefits from your help does not incur any tax issues.

As unusual as this sounds, with the tuition and medical payments, you operate in a tax-free zone.

Gift and Estate Tax Exclusion

If you die this year, your heirs won’t pay any estate or gift taxes if your estate and taxable gifts total less than the sizeable estate tax exemption.

If you are married and have done some planning, you and your spouse can avoid estate and gift taxes on to twice the exemption amount.

Lawmakers set the current rates with the Tax Cuts and Jobs Act and also set them to drop by 50 percent in 2026. Gifts made now continue as excludable should they exceed the upcoming 50 percent drop.

Avoiding the Gift Tax with Tuition

The tuition exception to the normal gift tax rules involves direct payment of tuition (money for enrollment) made to an educational organization on behalf of another individual.

You may not two-step this. For example, you can’t write a check to grandson Dave for $50,000 that he in turn uses for his tuition. Here, you made a $50,000 gift.

But if you write the $50,000 check directly to the educational organization to pay for Daves’s tuition, you are in the tax-free zone. The $50,000 does not use up any of your annual gift exclusion amount or your gift and estate tax exemptions, because it’s for tuition.

The unlimited benefit here applies only to tuition for full-time and part-time students. You can’t use it for items such as dorm fees and books. You can’t pay the money to a trust and then require the trust to pay a grandchild’s future tuition costs (this fails the test for direct to the institution).

Qualifying Educational Organization

The tax code defines “educational organization” as “an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.”

The regs elaborate by explaining that the term “educational institution” includes primary, secondary, preparatory, or high schools, and colleges and universities.

Example. You have four children, ages 7, 8, 9, and 10, at a private school where the tuition is $17,000 per year per student. Grandma Grace pays directly to the school the tuition for each of the children. Grandma Grace has no gift tax or other tax issues. Her payments are in the tax-free zone.

You can also pay the tuition to a foreign university. That tuition payment is in the tax-free zone just as if you had paid it to the University of California or Harvard.

Irrevocable prepaid tuition meets the rules and offers planning opportunities. Grampa Zeke has four grandchildren all in the first and second grades. He sets up and funds an irrevocable plan with each of the schools to pay the tuition at their respective schools. The plans qualify for tax-free zone treatment.

Planning note. Prepaid tuition can be a great death-bed strategy.

Avoiding the Gift Tax with Medical

The tax-free zone treatment of medical expenses requires that you pay the money directly to the medical care provider or insurance company (when paying for health insurance).

Under this plan, you avoid gift taxes when you pay directly to the provider any medical expense that would qualify as an itemized deduction on your Form 1040. Here are the basics:

• Qualifying medical expenses are limited to those expenses defined in Section 213(d) and include expenses incurred for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body or for transportation primarily for and essential to medical care. (See IRS Pub. 502, Medical and Dental Expenses for an easy-to-understand list of itemized medical deductions—note this link produces a PDF of the publication.)
• In addition, the unlimited exclusion from the gift tax includes amounts paid for medical insurance on behalf of any individual.
• The unlimited exclusion from the gift tax does not apply to amounts paid for medical care that are reimbursed by the donee’s insurance. Thus, if payment for a medical expense is reimbursed by the donee’s insurance company, the donor’s payment for that expense, to the extent of the reimbursed amount, is not eligible for the unlimited exclusion from the gift tax, and the gift is treated as having been made on the date the reimbursement is received by the donee.

Example. Sam, your buddy, takes a big fall while climbing Mount Everest. You pay $67,000 of his medical bills directly to the medical providers. You are in the tax-free zone and face no gift tax.

Say that the insurance company reimburses Sam for $31,000 of the medical bills that you paid, and Sam keeps the money. Now, you have the following tax situation:

• You have $36,000 of medical bills that you paid directly to the provider that are in the tax-free zone and not subject to gift taxes ($67,000 – $31,000).
• You can avoid $15,000 of gift taxes because of the 2020 annual exclusion. Thus, of the $31,000 reimbursed to Sam by the insurance company, you pay gift taxes on $16,000 and avoid taxes on the remaining $15,000 because of the annual exclusion.

Final Thoughts

The primary rule to remember when using the tuition and medical gift tax-free strategy is that you must make the payments directly to the institutions and providers. Commit this rule to memory as rule one for this strategy. Don’t violate it.

If you have a loved one who needs tuition or medical help from you, use the tax-free zone method. For example, you have an estate tax problem, but Uncle Jimmy needs help with his medical bills. Don’t make a monetary gift to Jimmy to help him.

Even if you don’t have a gift tax problem today, use the tax-free method because, who knows, you could win the lottery tomorrow.

And don’t forget this strategy. Sure, you have an $11.58 million estate and gift tax exemption this year (2020). In 2026, that’s scheduled to drop by 50 percent (adjusted for inflation). But the current deficit issues could trigger a drop to, say, the 2008 exemption amount of $2 million, or lower.

The Gift Tax

OVERVIEW

If you give people a lot of money, you might have to pay a federal gift tax. But the IRS also allows you to give up to $15,000 in 2020to any number of people without facing any gift taxes, and without the recipient owing any income tax on the gifts.

Why it pays to understand the federal gift tax law

If you give people a lot of money or property, you might have to pay a federal gift tax. But most gifts are not subject to the gift tax. For instance, you can give up to the annual exclusion amount ($15,000 in 2020) to any number of people every year, without facing any gift taxes. Recipients generally never owe income tax on the gifts.

In addition to the annual gift amount, your can give a total of up to $11.5 million in 2020 in your lifetime before you start owing the gift tax. If you give $17,000 each to ten people in 2019, for example, you’d use up $20,000 of your $11.5 million lifetime tax-free limit—ten times the $2,000 by which your $17,000 gifts exceed the $15,000 per-person annual gift-free amount for 2019.

The general theory behind the gift tax

The federal gift tax exists for one reason: to prevent citizens from avoiding the federal estate tax by giving away their money before they die.

The gift tax is perhaps the most misunderstood of all taxes.

When it comes into play, this tax is owed by the giver of the gift, not the recipient. You probably have never paid it and probably will never have to. The law completely ignores 2020 gifts of up to $15,000 per person, per year, that you give to any number of individuals. (You and your spouse together can can make joint gifts up to $30,000 per person, per year to any number of individuals.)

If you have 1,000 friends on whom you wish to bestow $15,000 each, you can give away $15 million a year without even having to fill out a federal gift-tax form. That $15 million would be out of your estate for good. But if you made the $15 million in bequests via your will, the money would be part of your taxable estate and, depending on when you died, might trigger a large estate tax bill.

The interplay between the gift tax and the estate tax

Your estate is the total value of all of your assets at the time you die. The rules for 2020 tax estates over $11.5 million at rates as high as 40%. That $11.5 million is an exclusion meaning the first $11.5 million of your estate does not get taxed.

So why not give all of your property to your heirs before you die and avoid any estate tax that might apply? The government is ahead of you. As noted above, you can move a lot of money out of your estate using the annual gift tax exclusion. Go beyond that, though, and you begin to eat into the exclusion that offsets the bill on the first $11.5 million of lifetime gifts in 2020. Go beyond the $11.5 million and you’ll have to pay the gift tax—at rates that mirror the individual income tax, up to 40% in 2019.

The tax basis issue

As you consider making gifts, keep in mind that very different rules determine the tax basis of property someone receives by gift versus receives by inheritance. For example, if your son inherits your property, his tax basis would be the fair market value of the property on the date you die. That means all appreciation during your lifetime becomes tax-free.

However, if he receives the property as a gift from you, generally his tax basis is whatever your tax basis was. That means he’ll likely owe tax on appreciation during your life if he sells it, just like you would have if you sold the asset yourself. The rule that “steps up” basis to date of death value for inherited assets can save estate beneficiaries billions of dollars every year.

An income tax basis example

Your father has a house with a tax basis of $600,000 (what they payed for it). The fair market value of the house is now $900,000. If your father gives you the house as a gift, your tax basis would be $600,000. If you inherited the house after your father’s death in 2020, the tax basis would be $900,000, its fair market value on the date of his death. What difference does this make? If you sell the house for $950,000 shortly after you got it:

Your gain on the sale is $350,000 ($950,000 minus $600,000) if you got the house as a gift.
Your gain on the sale is $50,000 ($950,000 minus $900,000) if you got the house as an inheritance.

At a combined federal and state tax rate of 30%, that is a tax savings of $90,000 (350,000 – 50,000 x 30%)

What is a gift?

For tax purposes, a gift is a transfer of property for less than its full value. In other words, if you aren’t paid back, at least not fully, it’s a gift.

In 2020, you can give a lifetime total of $11.5 million in taxable gifts (that exceed the annual tax-free limit) without triggering the gift tax. Beyond the $11.5 million level, you would actually have to pay the gift tax.

Gifts not subject to the gift tax

Here are some gifts that are not considered “taxable gifts” and, therefore, do not count as part of your 2020 $11.5 million lifetime total.

Present-interest gift of $15,000 in 2020 “Present-interest” means that the person receiving the gift has an unrestricted right to use or enjoy the gift immediately. In 2020 you could give amounts up to $15,000 to each person, gifting as many different people as you want, without triggering the gift tax or using any of your lifetime exemption of 11.5 million.

Charitable gifts

Unlimited gifts can be made to a qualifying charity without any gift tax liability and without using any of your lifetime 11.5 million dollar exemption.

Gifts to a spouse who is a U.S. citizen.

No gift tax due to something called the gift tax marital deduction.

However, Gifts to foreign spouses are subject to an annual limits. This amount is indexed for inflation and can change each year.

Gifts for educational expenses.

To qualify for the unlimited exclusion for qualified education expenses, you must make a direct payment to the educational institution for tuition only. Books, supplies and living expenses do not qualify. If you want to pay for books, supplies and living expenses in addition to the unlimited education exclusion, you can make a 2020 gift of $15,000 to the student under the annual gift exclusion.

Example: In 2019, an uncle who wants to help his nephew attend medical school sends the school $17,000 for a year’s tuition. He also sends his nephew $15,000 for books, supplies and other expenses. Neither payment is reportable for gift tax purposes. If the uncle had sent the nephew $30,000 and the nephew had paid the school, the uncle would have made a reportable (but maybe not taxable) gift in the amount of $15,000 ($30,000 less the annual exclusion of $15,000) which would have reduced his $11.4 million lifetime exclusion by $15,000.

The gift tax is only due when the entire $11.5 million lifetime gift tax amount has been surpassed.

Payments to 529 state tuition plans are gifts, so you can exclude up to the annual $15,000 amount n 2019. In fact, you can give up to $75,000 in one year, using up five year’s worth of the exclusion, if you agree not to make another gift to the same person in the following four years.

Example: A grandmother contributes $75,000 to a qualified state tuition program for her grandchild in 2019. She decides to have this donation qualify for the annual gift exclusion for the next five years, and thus avoids using a portion of her $11.4 million gift tax exemption.

Gifts of medical expenses.

  • Medical payments must be paid directly to the person providing the care in order to qualify for the unlimited exclusion. Qualifying medical expenses include:
    • Diagnosis and treatment of disease
    • Procedures affecting a structure or function of the body
    • Transportation primarily for medical care
    • Medical insurance, including long-term care insurance

In addition to these gifts that are not taxable, there are some transactions that are not considered gifts and, therefore, are definitely not taxable gifts.

Adding a joint tenant to a bank or brokerage account or to a U.S. Savings Bond. This is not considered to be a gift until the new joint tenant withdraws funds. On the other hand, if you purchased a security in the names of the joint owners, rather than holding it in street name by the brokerage firm, the transaction would count as a gift.

Making a bona fide business transaction. Even if you later find out that you paid more than the item was worth based on its fair market value, the transaction is not a gift; just a bad business decision.

Gifts subject to the gift tax

The following gifts are considered to be taxable gifts when they exceed the annual gift exclusion amount. Remember, taxable gifts count as part of the $11.4 million in 2019 you are allowed to give away during your lifetime, before you must pay the gift tax.

Checks. The gift of a check is effective on the date the donor gives the check to the recipient. The donor must still be alive when the donor’s bank pays the check. This rule prevents people from making “deathbed gifts” to avoid estate taxes.
Adding a joint tenant to real estate. This transaction becomes a taxable gift if the new joint tenant has the right under state law to sever his interest in the joint tenancy and receive half of the property. Note that the recipient only needs to have the right to do so for the transaction to be considered a gift.
Loaning $10,000 or more at less than the market rate of interest. The value of the gift is based on the difference between the interest rate charged and the applicable federal rate. Applicable federal rates are revised monthly. This rule does not apply to loans of $10,000 or less.
Canceling indebtedness
Making a payment owed by someone else. This is a gift to the debtor.
Making a gift as an individual to a corporation. Such a donation is considered to be a gift to the individual shareholders of the corporation unless there is a valid business reason for the gift. Such a donation is not a present-interest gift, and thus does not qualify for the annual per person per year exclusion.

Example: A son owns a corporation worth $100,000. His father wants to help his son and gives the corporation $1 million in exchange for a 1 percent interest in the company. This is a taxable gift from father to son in the amount of $1 million less the value of one percent of the company.

A gift of foreign real estate from a U.S. citizen. For example, if a U.S. citizen gives 100 acres he owns in Mexico to someone (whether or not the recipient is a U.S. citizen), it is subject to the gift tax rules if the land is worth more than annual gift exclusion amount.
Giving real or tangible property located in the United States. This is subject to the gift tax rules, even if the donor and the recipient are not U.S. citizens or residents. Nonresident aliens who give real or tangible property located in the United States are allowed the 2019 year’s $15,000 annual present-interest gift exclusion and unlimited marital deduction to U.S. citizen spouses, but are not allowed the $11.4 million lifetime gift tax exemption.

How gifts to minors are taxed

If you give an amount up to $15,000 to each child each year, your gifts do not count toward the $11.4 million of gifts you are allowed to give in a lifetime before triggering the gift tax in 2019. But what counts as a gift to a minor?

Gifts made outright to the minor
Gifts made through a custodial account such as that under the Uniform Gifts to Minors Act (UGMA), the Revised Uniform Gifts to Minors Act, or the Uniform Transfers to Minors Act (UTMA)

Note: One disadvantage of using custodial accounts is that the minor must receive the funds at maturity, as defined by state law (generally age 18 or 21), regardless of your wishes.

A parent’s support payments for a minor are not gifts if they are required as part of a legal obligation. They can be considered a gift if the payments are not legally required.

Example: A father pays for the living expenses of his adult daughter who is living in New York City trying to start a new career. These payments are considered a taxable gift if they exceed $15,000 during 2019. However, if his daughter were 17, the support payments would be considered part of his legal obligation to support her and, therefore, would not be considered gifts.
Advantages of making a gift

Giving a gift may earn you more than gratitude:

Reduced estate taxes. Moving money out of your estate via lifetime gifts can pay off even if those gifts trigger the gift tax. How? By removing future appreciation on the asset from your estate. Say, for example, that you give your daughter real estate worth $11,385,000, using up your $15,000 exclusion and your entire $11,400,000 2019 lifetime gift exclusion. If the property were to become worth $20,000,000 when you die, that’s $8,600,000 less to be taxed in your estate.
Reduced income taxes. If you give property that has a low tax basis (such as a rental house that has depreciated way below its fair market value), or property that generates a lot of taxable income, you may reduce income taxes paid within a family by shifting these assets to family members in lower tax brackets.
Teaching your family to manage wealth. Giving family members assets now allows you to monitor their ability to handle their future inheritance.

Disadvantages of making a gift

Reduces your net worth. You need to keep enough assets to care for yourself throughout a long or extended retirement or illness.
The Kiddie Tax. Giving funds to children may subject them to the Kiddie Tax, which applies the parents’ tax rates to investment earnings of their children that exceed a certain amount. For 2019, the Kiddie Tax applies to investment income exceeding $2,200 for a child under age 19 or in certain instances age 19 to under 24 if a full-time student.

How to report and pay the gift tax

If you make a taxable gift, you must file Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return, which is due April 15 of the following year. Even if you do not owe a gift tax because you have not reached the 2019 $11.4 million limit, you are still required to file this form if you made a gift that exceeds the $15,000 annual gift tax exclusion level. The IRS needs to keep a running tab of your lifetime exemption.
Example 1

In 2019, you give your son $16,000 to help him afford the down payment on his first house. This is a gift, not a loan. You must file a gift tax return and report that you used $1,000 ($16,000 minus the $15,000 2019 exclusion) of your $11.4 million lifetime exemption.
Example 2

Same facts as above, except that you give your son $15,000 and your daughter-in-law $1,000 to help with the down payment on a house. Both gifts qualify for the annual exclusion. You do not need to file a gift tax return.
Example 3

Same facts in Example 1, but your spouse agrees to “split” the gift—basically this means he or she agrees to let you use part of his or her exclusion for the year. One spouse, for example, could give $30,000 to his son without triggering the gift tax if the other spouse agrees not to give the son any gift that year. Although no tax is due in this situation, the first spouse would be required to file a gift tax return indicating that the second spouse had agreed to split the gift.
Forms, publications and tax returns

Only individuals file Form 709: U. S. Gift (and Generation-Skipping Transfer) Tax Return—there’s no joint gift tax form. If a both spouses each make a taxable gift, each spouse has to file a Form 709.

On a gift tax return you report the fair market value of the gift on the date of the transfer, your tax basis (as donor) and the identity of the recipient. You should attach supplemental documents that support the valuation of the gift, such as financial statements in the case of a gift of stock in a closely-held corporation or appraisals for real estate.

If you sell property or family heirlooms to your child for full fair market value, you don’t have to file a gift tax return. But you may want to file one anyway to cover yourself in case the IRS later claims that the property was undervalued, and that the transaction was really a partial gift. Filing Form 709 begins the three-year statute of limitations for examination of the return. If you do not file a gift tax return, the IRS could question the valuation of the property at any time in the future.

The Federal Gift Tax

If you make very large gifts during your lifetime, you may owe federal gift tax. But don’t worry too much about gift tax: the vast majority of Americans never need to pay it, because most ordinary gifts aren’t taxed.

How the Federal Gift and Estate Tax Work Together

The federal gift tax is part of what’s called the “unified” federal gift and estate tax. Gift tax applies to lifetime gifts; estate tax applies to assets left at death. The idea is that whether you give assets away while you’re alive, or leave them at your death, they’re taxed the same way, at the same rate. (If there were no gift tax, then anyone could completely avoid the estate tax by giving everything away just before death.)

Under current law (for deaths in 2020), each of us can give away or leave up to $11.58 million without owing federal gift and estate tax. So, for example, if during your life you give your children your house, worth $1 million, plus another $4 million in stocks and bonds, no federal gift tax will be due. If the stocks and bonds were worth $12 million, then your estate would owe gift and estate tax on the amount over $11.58 million. The exemption amount is indexed for inflation and goes up each year.

In addition to the $11.58 million exemption, many other gifts are not subject to the gift tax—for example, gifts to a spouse. So if you give your $1 million house and $10 million of other property to your children, and another $7 million to your spouse, you still won’t owe any gift tax because the taxable gifts to your children did not exceed $11.58 million.

Gift Tax Basics

If a gift is taxable, the person who makes the gift—not the recipient—must file a gift tax return and pay any tax owed. However, very few people end up paying gift tax during life because gift tax is not owed until your cumulative taxable gifts exceed the $11.58 million exemption. Very few people give away that much money during their lives.

At someone’s death, federal estate tax is calculated. In addition to the property left behind (the estate), the amount of taxable lifetime gifts is included in the total that may be subject to estate tax. Again, no tax is due unless the taxable estate exceeds the exempt amount.

What’s a gift?

A gift is any transfer for which you receive nothing, or less than “fair market value,” in return. For example, if you hand someone a check for $1,000, that’s a gift. And if your house would fetch $100,000 on the open market but you sell it to your son for $10,000, you’ve made a $90,000 gift to him.

What’s “fair market value?” The fair market value is the price at which an asset would sell when there’s a willing and knowledgeable buyer and seller.

What’s a taxable gift?

Lots of ordinary gifts are NOT taxable, including:

  • Gifts that are not more than the annual exclusion amount, $15,000 in 2020 (you can give this amount to any number of different recipients; you and your spouse can give $30,000 per year per recipient)
  • Tuition, if you pay it directly to the school (other expenses related to education, such as books, supplies and living expenses, do not qualify for this exemption)
  • Medical expenses you pay directly
  • Gifts to your spouse (if your spouse is a U.S. citizen)
  • Gifts to a political organization for its use
  • Gifts to certain charities

What’s the gift tax rate?

The current federal gift/estate tax rate is 40%.

Filing a Federal Gift Tax Return

If you make a taxable gift—for example, you give your son $25,000 to help him buy a house—then you’ll need to file a gift tax return (IRS Form 709). This isn’t a do-it-yourself project; hire an experienced attorney, enrolled agent (EA), or certified public accountant (CPA). (Or better yet, structure the gift so it isn’t taxable. See “Reduce Estate Tax by Making Gifts.”)

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