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STRATEGIC GIFTINGANDTHE GIFT TAX RETURNClackamas ChapterOREGON ASSOCIATION OF TAX CONSULTANTSOctober 17, 2016ByJudi KrussowPO Box 424Corbett, OR 97019503-313-9722JUDI KRUSSOWJudi is a Licensed Tax Consultant and Enrolled Agent. She is a member of the Oregon Association of Tax Consultants, the National Association of Tax Consultants, the Oregon Society of Tax Consultants, and the National Association of Enrolled Agent. Currently, Judi is operating a small tax business out of her home.She has over 50 years’ experience in the tax field preparing not only personal income tax returns, but has specialized in the preparation of estate and trust returns. She has taught personal income tax classes and fiduciary classes for several professional organizations in Oregon and Washington. Ms. Krussow is a 2002 recipient of PESI’s Excellence in Education Award.TABLE OF CONTENTSPageGeneral Comments 1What is a Gift 1Indirect Gifts, Interest-Free & Family Loans 2Debt forgiveness of $14,000/year 3Transfers not considered gifts 4Transfers with a Retained Life Estate 5Creation of Joint Interests 6Family Limited Partnerships 7Charitable Remainder Trusts 8FILING REQUIREMENTS & EXCLUSIONSWho must file, due dates of returns 11Extensions, Where to file 12Annual Exclusion 12Gift Splitting 13Adequate Disclosure 13Form 709GIFT TAXGeneral CommentsThe federal gift tax was first enacted in 1924, approximately eight years after the adoption of the estate tax. As originally enacted, the tax was largely ineffective because it was computed on an annual basis without regard to gifts made in prior years.The tax was repealed in 1926, revived in 1932, and has remained in effect since that date. Unlike its predecessor, the 1932 tax was computed on a cumulative basis—that is, the tax rates applicable to a gift were determined by reference to the total amount of taxable gifts made by the donor during his life, rather than by reference only to taxable gifts made in a given year.The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value in return. The transfer may be direct or indirect (e.g. in trust) and is measured by the value of the property passing from the donor.The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.Surprise!! – Mom & Dad give you a nice check! Maybe it’s enough for dinner, or maybe it’s more of an “early inheritance”. Either way, do you need to worry about paying tax on your gift?First, a gift must be quite substantial before the IRS takes notice. A gift of $14,000 or less in a calendar year (2015) doesn’t even count. If a couple makes a gift from joint property, the IRS considers the gift to be given half from each. Mom & Dad can give $28,000 with no worries.A couple can also give an additional gift of up to $14,000 to each son-in-law or daughter-in-law. The effective annual limit from one couple to another couple, therefore, is $56,000 ($14,000 X 4 = $56,000).What is a Gift?When a beneficial interest in property is transferred for less than full and adequate consideration in money or money’s worth, a gift subject to gift tax occurs. Code Section 2511(a) provides that the gift tax is to apply “whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.”Reg. 25.2511-1(c)(1) states that “any transaction in which an interest in property is gratuitously passed or conferred upon another, regardless of the means or device employed, constitutes a gift subject to tax.”Thus, a taxable gift tax can occur by creating a trust, forgiving a debt, making interest-free or below-market interest rate loans, assigning a judgment, or by assigning the benefits of a life insurance policy, as well as by direct transfer of cash or other property.Gift tax is not an issue for most peopleThe person who makes the gift (donor) files the gift tax return, if necessary, and pays any tax. If someone gives you more than the annual gift tax exclusion amount ($14,000 in 2015), the donor must file a gift tax return. That still doesn’t necessarily mean they owe gift tax. For example, if someone gives you $20,000 in one year, and you and the donor are both single, the donor must file a gift Tax return, showing an excess gift of $6,000 ($20,000 - $14,000 exclusion = $6,000). Again, while there is not a gift tax, the gift tax return still must be filed.Each year, the amount a person gives other people over the annual exclusion accumulates until it reaches the Lifetime Gift tax exclusion. Currently, a taxpayer does not pay a gift tax until they have given away over $5,430,000 (2015) in their lifetime.Small Gifts are GiftsMost taxpayers know that direct transfers of cash or property are subject to the gift tax. However, many may not recognize that birthday and holiday gifts must be considered when determining the amount of total gifts for the year. NOTE: Practitioners should develop procedures for identifying all the gifts made by their clients during the year to ensure they do not inadvertently exceed their annual exclusion ($14,000 for 2015).Indirect GiftsIndirect gifts can occur when an economic benefit is transferred, even though the transfer is not characterized as a gift. For example, a surviving spouse, the income beneficiary of a QTIP trust created by her husband’s estate, permitted her children, who were the trustees, to take excessive trustee fees. The IRS ruled that the surviving spouse had made gifts to the children by consenting to the excessive fees because she was allowing the children to take funds that should have been distributed to her (TAM 200014004).The same result can occur when a mandatory income beneficiary fails to take distributions from a trust and allows those funds to go to other beneficiaries. If wealth is transferred from one family member to another, the IRS will attempt to classify all or part of the transfer as a gift regardless of how the transfer is labeled.Interest-Free, Family, and Low-Interest Loans An indirect gift may occur if a creditor forgives a debtor’s obligation to pay accrued interest on a loan, or if the creditor makes a low-interest (or interest-free) loan to the debtor. In general, below-market interest rate loans are re-characterized to impute the payment of interest by the borrower at the applicable federal rate (AFR), compounded semiannually. The lender is treated as providing the funds to the borrower for payment of the imputed interest, thereby creating a gift from the lender to the borrower.A below-market interest rate loan between family members will generally be treated as a gift loan. If the gift loan is a below-market term loan, the lender makes a gift on the date the loan is made in an amount equal to the excess of the amount loaned over the present value of all required payments under the terms of the loan. The present value is determined on the date of the loan by using a discount rate equal to the AFR [IRC Sec. 7872(f)(1)]In the case of a demand loan (a loan which carries no fixed repayment date), the amount of the gift is determined by subtracting any interest payments due under the loan from the amount of the interest that would have accrued under the AFR (i.e., the foregone interest) [Prop Reg. 1.7872-6(c)].Example: Interest-free loan to a sonOn January 2, Don loaned his son, Michael, $300,000, payable on demand. Don did not charge interest on the loan. On December 31, the entire loan remained outstanding.Assuming the Applicable AFR is 5%, Don is deemed to have made a gift to his son on December 31 in the amount of $15,188 ($300,000 x 5%, compounded semiannually). Don must report the gift on Schedule A of Form 709. For each year or part of the year in which the outstanding loan balance exceeds $10,000, Don must file a gift tax return for the amount of foregone interest.The IRS allows an exception for below-market rate de minimis loans of $10,000 or less. For any days on which the aggregate outstanding amount of the loan does not exceed $10,000, there is no imputed interest and no gift (IRS Sec 7872(c)(2)(A)]."Transactions within a family group are subject to special scrutiny, and the presumption is that a transfer between family members is a gift". Harwood v. Commissioner [Dec. 40,985],That presumption may be rebutted by an affirmative showing that at the time of the transfer the transferor had a real expectation of repayment and an intention to enforce the debt. Estate of Van Anda v. Commissioner, supra at 1162.Forgiving Debt of $14,000 per Year However, some donors may want to gift larger amounts rather than just the annual exclusion ($14,000 for 2015). A common technique has been for a donor to gift the amount allowed by the annual gift tax exclusion and take a note for any excess. Then, instead of the borrower making payments on the note, the donor simply forgives a portion of the principal (and interest) each year equal to the annual gift tax exclusion. However, a Tax Court decision (affirmed by the 9th Circuit) highlights the potential pitfalls of using this approach with clearly establishing a bona fide debtor-creditor relationship (Elizabeth B Miller v Commissioner).Whether a transfer is a gift or a loan depends on all of the facts and circumstances, such as whether:a promissory note or other evidence of indebtedness existed,interest was charged on the notes,there was any security or collateral for the notes,the notes have a fixed maturity date,a demand for repayment was madeany payment were actually made on the notesthe recipients have the ability to repay their notes, andthe records of the transferor and/or transferee reflect the transfers as loans.Example: Loan to children treated as giftsLaura Morgan loaned her two adult sons (Ben & Bill) $100,000 each. Each son signed non-interest bearing notes for $100,000 that were payable on demand or, if no demand, at the end of three years. Within the three-year period, Laura forgave a portion of each loan. Ben also made a $15,000 payment on his loan. However, when the notes matured at the end of the three year, both still had a balance due on them. Laura never made a demand for repayment nor took any steps to enforce collection or to renew the notes. Instead, over the next several years, she forgave the remaining principal due on the loans.Although there is no one deciding factor on whether these transfers are loans or gifts, the Tax Court was troubled by evidence showing that when the loans were made, there was no apparent intention of demanding repayment. Thus, the Tax Court found that a bona fide creditor-debtor relationship was lacking and that the transfers to each son were in fact gifts rather than loans (Elizabeth B Miller v Commissioner).Transfers Not Considered a GiftSome transfers of money are never considered to be gifts, no matter the amount.For purposes of the gift tax, it’s not a gift if: It’s given to a husband or wife who is a US Citizen. Special rules apply to spouses who are not US Citizens.It’s paid directly toan educational institution for tuition expenses [IRC Sec. 2503(e)],a medical facility for someone’s medical or dental expenses [IRC Sec. 2503(e)],gifts to a political organizationgifts to a qualified charity.You do not have to file a gift tax return to report gifts to your spouse regardless of the amount of these gifts and regardless of whether the gifts are present or future interests.Medical and Educational Expenses:For the medical or educational exception, it doesn’t have to be a child, or even a relative, for this exception to apply. These gifts do not count towards any of the limits.For Educational Expenses, the exclusion applies to tuition for full or part-time students paid directly to the educational institution. Amounts paid for books, room, board, other supplies, or entertainment are not eligible for the exclusion (Reg. 25.2503-6).The amounts paid for Medical Expenses must meet the requirements for deductibility under IRC Sec. 213(d) and generally include expenses paid for diagnosis, cure, mitigation, treatment, or prevention of disease. Amounts paid for medical insurance are also pleted Gift RequirementA gift is complete if the donor has parted with all dominion and control over the transferred property, leaving the donor with no power to change its disposition, whether for the benefit of the donor, or for the benefit of others.If the donor reserves any power over the disposition of the property, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon the facts of the case [Reg. 25.2511-2(b)]. An incomplete gift will be included in the donor’s gross estate upon his death.The distinction between complete and incomplete transfers determines whether property will be included in an estate at death. The value of property that was incompletely transferred during life will be included in the gross estate at death (Code Sections 2035-2038). Therefore, any appreciation in the value of incompletely transferred property will be included and taxed in the estate, whereas none of the value of completely transferred property will be included in the estate.Gift Paid by CheckMany individuals make gifts at year end to take advantage of the annual exclusion. The IRS ruled that a gift will be considered complete for transfer tax purposes on the date the donee deposits the check, cashes it against his available funds, or presents the check for payment if (Rev. Rul. 96-56): The check was paid by the drawee bank when first presented to the drawee bank for payment.The donor was alive when the check was paid by the drawee bank.The donor intended to make a gift.Delivery of the check by the donor was unconditional.The check was deposited, cashed, or presented in the calendar year for which completed gift tax treatment is sought and within a reasonable time of issuance.Example:On December 15th of the current year, Donna gave her daughter a check for $14,000 dated December 13th as part of an annual giving program Her daughter deposited the check in her account on December 30, and the check cleared Donna’s account on January 3rd of the next year.Since the gift meets all the requirements of Rev. Rul. 96-56, it is considered complete in the year the check was deposited. Thus, Donna is entitled to use her current year annual exclusion to offset the gift.NOTE: If the donor dies before the check clears the bank, a non-charitable gift will not be complete and will be included in the donor’s estate (Newman). Transfers with Retained Life Estate Transfers with a retained life estate are covered in Code Sec. 2036. Life estates are most commonly used with real estate and are created by the owner of the real estate by signing and delivering a deed to the property to the person(s) that the owner wants to give it to, but that contains a clause “Reserving unto the Grantor a Life Estate in the Property conveyed hereby”.An interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express, or implied, that the interest or right would later be conferred [20.2036-1(a)(1)].The transfer/gift of the property to the persons who are deeded the property is a completed gift. Detailed regulations exist that specify the value of the asset transferred (known as the remainder interest) and the value of the retained life estate (Reg. 1.170A-12) (Reg. 20.2031-7). A gift tax return must be filed with respect to the transfer made of the remainder interest.Example:If a person who is 70 years old deeds away their property that is worth $100,000 and retains a life estate, they are deemed to have given away a remainder interest worth $39,478 (39.48%) and to have retained a life estate worth $60,522 (60.52%). The value of the life estate is important if there is a sale of the property prior to the death of the person holding the life estate.Creation of Joint InterestsThe creation of a joint tenancy with right of survivorship may create a taxable gift, depending on the type of asset involved, the rights of the various joint tenants, and their relative contributions toward the acquisition of the property.When one joint tenant contributes a disproportionate amount toward the acquisition of property held in joint tenancy, a taxable gift usually results. For example, when one joint tenant purchases property with their own funds and has the title conveyed to themselves and another person as joint tenants with right of survivorship, the purchaser is deemed to have made a gift of half of the property’s value to the noncontributing joint tenant [Reg. 25.2511-1(h)(5)]Example:Bill purchased a personal residence with his own funds for $1 million and had the property titled in the name of Bill and his son, Jim, as joint tenants with right of survivorship. Under state law, either joint tenant has the legal right to sever his interest.Upon creation of the joint tenancy, Bill is deemed to have made a taxable gift of $500,000 to Jim. This transfer also qualifies for the annual gift tax exclusion.In the case of a transfer to a joint brokerage account where the securities are held in “street name” (e.g., held in the name of the broker), rather than in the name of the joint tenants, no taxable gift occurs until the noncontributing joint owner draws upon the account for their own benefit (Rev. Rul. 69-148).In addition, no gift results at the creation of joint bank accounts, when the contributing joint tenant can revoke the gift without the consent of the noncontributing joint tenant simply by withdrawing the balance of the account [Reg. 25.2511-1(h)(4)].Example:Emma transferred $50,000 of her funds to First National Bank to open a savings account for herself and her grandson, Mike, as joint tenants with rights of survivorship.Emma’s transfer of funds to a joint account for herself and her grandson is not a taxable gift at the time the account is established. Instead, Emma will be treated as having made a gift to Mike when Mike withdraws funds from the account.Family Limited PartnershipsThe Family Limited Partnership (FLP) is a limited partnership created to transfer ownership of assets to family members with a minimum of tax consequences. The FLP is designed to lower the value of your investments and assets (for estate tax purposes) while still allowing you to maintain full control of your estate inside the limited partnership. It works well to transfer a family business, real estate or an investment portfolio to the next generation.The partnership is comprised of both general and limited partners. The general partners manage and control the partnership. The limited partners have equity interest in the partnership, but have no decision making authority over the partnership or the assets therein.The senior family members can transfer the value of the assets to their children, removing it from their estates for federal estate tax purposes. The transfer of limited partnership interests are also eligible for the annual gift tax exclusion. The value of limited partnership shares can be discounted when transferred to family members.It is important that a FLP be formed for valid business purposes and not merely to reduce estate and gift taxation. The IRS views FLP’s as artificial tax avoidance devices. Factors that tends to protect FLP’s against IRS attack:The FLP is not created shortly before the death of the decedentThere is a business purpose for creation of the FLPThe assets transferred to the FLP are operating assets requiring management, rather than passive investments, such as marketable securitiesThe decedent retains inadequate assets to support himself without receiving income from the FLPThere is not a pattern of distributions from the FLP to the decedent for his supportAll the formalities of partnership existence and operation are carefully observed.Charitable Remainder Trusts A Charitable Remainder Trust (CRT) provides an annual income stream to one or more non-charitable beneficiaries for a term of years or for the beneficiary’s life. At the expiration of the income interest, the remainder interest in the trust passes to charity. However, since the gift qualifies for the charitable deduction under IRC Sec. 2522, no gift tax is due as long as the grantor or grantor’s spouse retains the income interest.Key Characteristics: ?Potential immediate (partial) tax deduction based on the value of the eventual gift to charity?May eliminate capital gains tax for gifts of long-term appreciated securities and/or property?Accepts many types of assets?Income may be for life or for a fixed term of no more than 20 years?Requires setup and ongoing maintenance costs (Filing of tax return, Form 5227)One of the major benefits of the CRT is an immediate potential income and gift tax deduction for a charitable contribution for the present value of the ending balance of the trust’s assets designated for the charity.A CRT is an irrevocable trust typically funded with highly appreciated property. The CRT is structured so that there is a current beneficiary who is either the donor or a named individual and a remainder beneficiary, which is a qualified charity. A CRT is exempt from tax on its investment income. Thus, a trustee of the CRT can sell the appreciated asset and reinvest the full proceeds. There is no tax on the capital gains at the entity level. The donor is able to diversify from a concentrated position in a tax-efficient manner. When distributions are made to the donor or beneficiary pursuant to the terms of the trust, the donor or beneficiary must report a portion of the income and gains in respect to the property distributed.The CRT can provide that the named beneficiary receive either a fixed amount each year or a percentage of the value of the trust each year, for a period of years that can be for the individual’s life or for a period not to exceed 20 years.However, as the tax burden is spread out over time, more money is available for reinvestment within the CRT, benefiting both the lifetime beneficiary and charitable remainder beneficiary.] 0000FILING REQUIREMENTS & EXCLUSIONS Who Must File In general. If you are a citizen or resident of the United States, you must file a gift tax return (whether or not any tax is ultimately due) in the following situations:If you gave gifts to someone in 2014 that total more than $14,000 (other than to your spouse), you will need to file Form 709. Certain gifts, called future interests, are not subject to the $14,000 annual exclusionSpouses may not file a joint gift tax return. Each individual is responsible for his or her own Form 709.You must file a gift tax return to split gifts with your spouse (regardless of their amount) If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $100,000 of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return.Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.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.The donor is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.If a donor dies before filing a return, the donor's executor must file the return Due Dates of Returns Form 709 should be filed on or before April 15 of the year following the close of the calendar year in which the gifts were made [IRC Sec. 6075(b)].If the donor died during the year of the gift, the return is due on or before the earlier of: The due date (including extensions) for filing the donor’s estate tax return (i.e., Form 706, orApril 15 of the year following the year in which the gift was made.If no estate tax return is required to be filed, the gift tax return will be due on or before April 15 of the year following the year of death. The donor’s executor is responsible for filing the return.Filing of ExtensionsTwo methods exist for extending the time for filing the Form 709. By extending the donor’s individual income tax return using Form 4868 or Form 2350 orBy extending the gift tax return using Form 8892.Form 4868: Extending a donor’s individual income tax return with Form 4868 automatically extends the time for filing the donor’s gift tax return for that calendar year until the due date for the income tax return [IRC Sec. 6075(b)(2)]. If gift or GST tax is due, and the donor files Form 4868 to extend his individual income tax return, Form 4868 is used to extend the gift tax return but the donor must also use Form 8892-V as a payment voucher for paying gift or GST tax.Form 2350: Taxpayers whose home is in a foreign country and who expect to qualify for the foreign earned income exclusion (and/or the foreign housing exclusion or deduction) may request an extension of time to file Form 1040 by completing Form 2350. This filing will also extend the time to file Form 709. As with Form 4868, if there is a balance due for the Form 709, the taxpayer must use Form 8892-V as a payment voucher for the gift tax due.Form 8892: A donor must use a Form 8892 to extend the Form 709 when the donor does not extend the time to file the individual income tax return. If there is a balance due for the Form 709, the taxpayer must use Form 8892-V as a payment voucher for the gift tax due.Forms 4868 and 8892 may be filed at different IRS centers. Forms 8892 and 8892-V are filed with the Department of the Treasury, IRS, Cincinnati, OH 45999, while form 4868 is filed based on the individual’s state of residency.Unlike the Form 4868, the Forms 8892 and 8892-V cannot be used for joint filings; thus, if married couples are extending only their gift tax return, each individual must complete a Form 8892. Likewise, Form 8892-V cannot be used for payments of gift and generation-skipping taxes for more than one person. The forms should be mailed in separate envelopes.Where to File: For returns filed during 2014, Form 709 should be filed with the Department of the Treasury, IRS, Cincinnati, OH 45999.Annual Exclusion Generally, the total amount of gifts for the year is reduced by an annual exclusion of $14,000 (for 2013, 2014, & 2015) per donee, provided the gifts are present (and not future) interest in property [IRC Sec. 2503(b)]. For a gift in trust, each beneficiary of the trust is treated as a separate donee for purposes of the annual exclusion.A gift is considered a present interest if the donee has all immediate rights to the use, possession and enjoyment of the property or income from the property.In regard to transfers of assets to a family limited partnership (FLP), the donor needs to be mindful of the structure of the partnership agreement. If the agreement is structured so that the limited partners have no right of withdrawal, the gifts would probably be treated as future interest gifts, as in Ltr. Rul. 9751003.A gift is considered a future interest [IRC Sec. 2503(b)] if the donee’s rights to the use, possession, and enjoyment of the property of the income from the property will not begin until some future date. Future interests include reversions, remainders, and other similar interest.NOTE: For gifts made to spouses who are not US Citizens, the annual exclusion has been increased to $145,000, provided the additional (above the $14,000 annual exclusion) $131,000 gift would otherwise qualify for the gift tax marital deduction.Gift-Splitting A married couple does not file a joint gift tax return. Spouses may elect to treat a gift made by one spouse to a third person as if the gift had been made half by each [IRC Sec. 2513. The gift splitting is available regardless of who actually made the gift. However, if the election to split gifts is made, all gifts made by the spouses during the calendar year must be split.If the election is made, each spouse files their own Form 709, but they should file both gift tax returns together (i.e., in the same envelope) to avoid correspondence from the IRS.To be eligible to split the gift;Spouses must be legally married at the time of the giftIf divorced or widowed after the gift, you did no remarry during the rest of the calendar yearBoth spouses must be us citizens or residents on the date of the giftOne spouse may not create a general power of appointment in the other spouse over the property transferred.Adequate Disclosure To meet the “adequately disclosed” requirement, regulations require taxpayers to furnish extensive information with the gift tax return to cause the statute of limitations to begin [Regs. 20.2001-1; 25.2504-2; and 301.6501(c)-1(e), and (f). To start the statute of limitations, the gift tax return (or a statement attached) must include [Reg. 301.6501(c)-1(f)(2)]: a complete and accurate description of the transferred property (for real estate, include the legal description of the property and a copy of the deed);any consideration received by the transferor;the identity of the transferor and each transferee;the relationship between the transferor and the transferee;if the transfer is in trust, the trust’s EIN and a description of the trust terms (or a copy of the trust instrument);a detailed description of the method used to determine the FMV of the transferred property, including any financial data used to determine the FMV and a description of any discounts;any restrictions on the transferred property that were considered in determining its valuation;a statement of any position contrary to proposed, temporary, or final Treasury regulations or any revenue rulings published at the time the transfer occurred. ................
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