Gifting Strategies for Tax Pros in Our Complicated 2020 Environment
Many tax practitioners are wrestling with the income and transfer tax considerations in making gifts in our highly unusual coronavirus environment.
Our discussion in this article will focus on full, rather than partial gifts. We will also discuss certain gift/estate tax considerations and income tax aspects of gifts, but generation-skipping and state tax issues are beyond our current scope.
In mid-2020, there is some emphasis on valuation decline given the COVID-19 economic impact. There may also be more issues or contingencies as to future needs of the current owner. There may also be more need – and low income tax rates - with possible recipients, such as young adults who were laid off from that first job after college.
Many are anticipating a reduced effective income tax rate due to having less income. The lesser rate may also apply to long-term capital gain income. While projections often assume a 20-percent capital gains tax, the capital gains rate may be zero depending on the individual’s circumstances.
The Prospect of Legislative Change
We write in late July 2020, the familiar general rule for appreciated property is step-up in basis at death. Reports are that this could at least to some extent be repealed under Mr. Biden’s proposals.
The latter’s proposals also include a tax of 39.6 percent on long-term capital gains and qualified dividends on income over $1 million (Details and Analysis of Former Vice President Biden’s Tax Proposals, The Tax Foundation, April 29, 2020, taxfoundation.org).
There are significant unknowns here but the prospects of legislative change suggest not throwing away those old cost records. The inability to establish basis can translate into disallowed loss deductions.
A recent example is Duffy v. Commissioner, T. C. Memo 2020-108 (July 13, 2020). The importance of basis from an income tax standpoint is not limited to sale situations. The prospects of significant legislative change as to transfer taxes are much discussed but very unclear at this time.
Transfer Taxes – Just the Basics
The estate and gift tax systems are unified, such that a gift over the annual exclusion would reduce the exemption amount (unified credit) available for estate tax purposes. Current gifts may well be at reduced valuations compared to the recent past. Lifetime gifts may use less of the donor’s lifetime exemption, or incur less gift tax in those situations where tax is incurred.
Gift tax per se is a reporting concern but rarely a tax-paying matter. As the law exists as of this writing, there is higher level of transfer tax exemption available through 2025.
“Individuals taking advantage of the increased gift tax exclusion amount in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels.” (Frequently Asked Questions on Estate Taxes, irs.gov; see also Estate and Gift Tax FAQs, irs.gov). The 2017 Tax Cuts and Jobs Act temporarily increased the transfer tax exemptions for years after 2017 and before 2026 (Conference Rep. to Accompany H.R. 1, 115th Cong., 1st Sess., House Report 115-466, December 15, 2017, p. 307-316).
The per-person transfer tax exemption level for 2020 is $11,580,000 and twice this amount for a married couple. The 2020 annual gift tax exemption per done is the same $15,000 as in 2019.
Overview of the Income Tax Basics
Gifts received are not subject to income tax, albeit later income from the gifted property is taxable to the new owner. “Gross income does not include the value of property acquired by gift, bequest, device, or inheritance.”(IRC Section 102). The general rule is that the donor’s tax basis carries over to the donee. Following is a basic write-up from the IRS.
So, what if a client sells property that has been given to them? The general rule is that your basis in the property is the same as the basis of the donor. For example, if you were given stock that the donor had purchased for $10 per share (and that was his/her basis) and you later sold it for $100 per share, you would pay income tax on a gain of $90 per share (Note: The rules are different for property acquired from an estate (Frequently Asked Questions on Gift Taxes, IRS.gov, https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes). There is an exception to step-up in the case of income in respect of a decedent (Section 1014(c)).
There is an exception to step-up when the decedent passes within a year of receiving the gift, and the decedent passes the property back to the donor or the donor’s spouse (Section 1014(e)). One generally wouldn’t want to give declined-value property to the kids, other than, say, personal assets where any loss is personal and nondeductible.
Another possible consideration is that an asset’s classification may eventually change with the transferee. For example, the parent’s old house would typically be an investment asset to the child who doesn’t live there.
The long-term and short-term aspects of gifted property generally carry over to the donee. The child receiving short-term securities by a lifetime gift usually looks to the parent’s time of acquisition, whereas property inherited at death is long-term without looking back at the parent’s date of acquisition.
If the plan is to hold property until death for purposes of step-up, the like-kind exchange rules may play a role in avoiding lifetime gain. Beginning Jan. 1, 2018, like-kind exchange treatment is limited to real property.
Looking at current, relatively low valuations may also invite gift transfers just to attain known, relatively low valuations for purposes of transfer tax. If the decision is made to transfer more assets by lifetime gift, this may shift low-basis assets within the family.
Consider here, if possible, the recipient’s income tax bracket, federal and state. Consider spreading gifts so that it isn’t just one family member making the large sale. Spreading the gain among family members will likely reduce the tax, but the generality may not be true in a particular case.
Charitable dispositions by the donor and/or done should also be considered in planning. There is still the income tax incentive of holding appreciated assets until death to attain step-up, or at least hoped-for step up.
In community property states, the death of the predeceasing spouse normally steps up both halves (Section 1014). This is still a very compelling consideration in many cases.
As is so often true in tax planning, it is generally important to “do the math” with as many facts as can be garnered for all the affected family members.
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Mike Pusey, CPA is National Tax Director at Rojas & Associates. He has a BBA and Master of Science in Accounting from Texas Tech where he graduated with honors. He planned to be an accounting professor and worked a year on the Ph. D. at the University of Arizona before beginning his career at KPMG Peat Marwick, where he worked in audit and...