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What Tax Pros Should Know About Gift Tax Exclusion

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The general political context is one of extraordinary government expenditures in the wake of COVID-19, which suggests higher taxes, particularly upon the wealthy. In 2021, taxpayers generally need to be more concerned with transfer tax issues.

Mar 9th 2021
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President Biden spoke of reducing the gift tax exemption levels to $3.5 million, perhaps even $1 million for lifetime transfers, plus an increase in the top tax rate to 45 percent. Even under current law, the post-2025 gift tax exemption is scheduled to drop to $5 million as adjusted for inflation. 

Our context not only suggests clients take advantage of the higher exemption levels available under current law, but a “back to basics” remembrance of taking full advantage of the annual gift tax exclusion.

Under the gift tax rules, a gift can arise when the transferor receives nothing, or less than full value, in return. Each donor files his or her own gift tax return.  here is no such thing as a joint gift tax return.  

“Only individuals are required to file gift tax returns. If a trust, estate, partnership, or corporation makes a gift, the individual beneficiaries, partners, or stockholders are considered donors and may be liable for the gift and GST taxes.” (Instructions to Form 709 (2020).

As adjusted for inflation, the annual exclusion is $15,000 per donee in 2021, unchanged from 2020. Split-gifting with a spouse makes gifts of $30,000 possible without any use of one’s transfer tax exemptions

The annual exclusion is limited to gifts of a “present interest.”  The term includes vested or contingent interests available for the donee’s immediate use, possession or enjoyment (Regs. 25.2503-3(b)).  

A trust may contain restrictions that preclude the exclusion, but it is also possible the rights of the beneficiary to assets or income of the trust will be such that the transfer qualifies for the annual exclusion. Interests in trusts are often designed with Crummey powers that allow a person to receive a gift that is not eligible for a gift-tax exclusion, and then effectively transform the status of that gift into one is eligible for a gift-tax exclusion. The donor’s expectation is that such powers will not be exercised.

The IRS may at times be receptive to retroactive corrections of the trust to accommodate such exclusions (PLR 201845029, 11/9/2018). Gifts to minors can qualify for the $15,000 exclusion if they meet certain requirements (Sec. 2503(c) Regs. Sec. 25.2503-4). 

Gifts usually arise directly and are known as such, but gifts can also arise when sales are at less than fair market value. The general measure of a gift is FMV. Partial payment of the asset’s value effectively reduces the measure of the gift but it does not eliminate the element of gift.   

The income tax rule generally allows the entire basis to be subtracted from sales proceeds even if the proceeds are less than full fair market value (Compare the special income tax basis rule that can apply in the context of sales to a charity at less than FMV. Sec. 1011(e)).

The annual gift tax exclusion is available to nonresident aliens and gifts in excess of the annual exclusion are reported on Form 709. The valuation for gift tax purposes is fair market value at the time of the gift. This is true even if there is relatively low tax basis that carries over to the donee for income tax purposes. It can sometimes be helpful for the tax practitioner to obtain a history of prior gifts by the donor (See generally “Frequently Asked Questions on Gift Taxes, “How do I secure a gift tax return account transcript,” IRS.gov.).

There are other major gift tax benefits which are unlimited. Gifts to a spouse are exempt from gift tax, as are gifts to charity, and transfers to medical and educational organizations even if they benefit specific individuals. Important in this general context is that gifts received are not subject to income tax, and gifts given are generally not deductible for income tax purposes; e.g., they’re not business expenses or investment expenses (Sec. 102).

Conclusion 

The savings from taking advantage of the annual exclusion can be significant even in circumstances that are not unusual. The potential savings depend on the circumstances, including future circumstances, but let’s assume no change in the annual exclusion and gifts to two kids and five grandkids, which eventually reduces the estate. 

We’ll assume the gifts would be taxed at the current estate tax maximum of 40 percent and the gift program removed assets over just a five-year period. We have seven annual exclusions over 5 years or 35 exclusions at $15,000 or $525,000. The savings at the 40 percent current maximum rate would be $210,000 – just from the simplest gift program over a moderate term.  

Under President Biden’s proposal of a 45 percent maximum rate, the savings could be as high as $236,250. As indicated, our calculations can’t factor in future increases in the annual exclusion.

Keep in mind the basics, particularly in the current environment, including taking advantage of the annual gift tax exclusion. Also, consider any gift tax issues in your state and how they may vary from the federal rules. The state tax rules may well be more stringent than the federal rules.

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