LIFETIME TRANSFERS -GIFTS AND THE GIFT TAX

 

 

 

 

 

INTRODUCTION

 

Lifetime gifts can be effective estate planning tools.  Lifetime gifts can result in substantial tax savings and provide a source of personal satisfaction to the donor.  Tax considerations are but one factor to consider in estate planning.  No one should ever give away property that may be needed some day for support and maintenance. 

 

As an estate planner one must be familiar with the gift tax laws because gifts over a certain amount are taxable.  Gifts are a tool by which a property owner may direct the disposition of property during lifetime.  Also the property owner would have the immediate satisfaction of seeing the recipient enjoy the property, and also realizing that the given property will be avoiding Probate and its related high fees. 

 

Another advantage would be that the transfer would avoid long delays or would not be subject to attack by estate creditors or disgruntled heirs.  Also, the original owner is relieved of any property management by transferring the property during life.  This can be very important to elderly clients.  Since Wills become a matter of public record after death, lifetime gifts provide an alternative means of property disposition in which privacy is important to the individual. 

 

There are many advantages of gifting in an Estate Plan.

 

There are two other major considerations that should be examined when making gifts.

 

One major consideration involves the removal of highly appreciating assets from estates.  The key is picking assets which will actually appreciate in value.  However, if a highly appreciative asset is given to your spouse, and you die first, the asset with all its appreciation will not be subject to estate tax on your death;  the asset and its appreciated value will be subject to estate tax on your spouse’s death.  If you give highly appreciating property to someone other than your spouse, you will remove both the assets and all its future appreciation from your estate, and your spouse's estate.

 

If one gives highly appreciating property to someone other than the spouse, they may pay federal gift tax on its value, as of the date of the gift, but neither husband or wife nor their respective estates will ever pay federal estate tax on the appreciation of the property.

 

Another consideration in making lifetime gifts involves reducing federal income tax.  If one owns property, which generates taxable income, they may wish to give the property to one or more family members who are, or will be, in lower federal income tax brackets.

 

 

GIFT GIVING BASICS

 

A gift is defined as any transfer of property for which the giver receives less than the full value in return.  To the extent the transfer is for less than full value, a gift has been made.  Intent or desire to make a gift is generally irrelevant for federal gift tax purposes.  The mere act of delivering the property to its recipient is enough to create a gift subject to federal gift tax laws.  A person who makes a gift is called a "Donor,” and the person who receives the gift is "Donee.”  Three criteria must be met for a transfer to qualify as a gift.

 

1.     There must be a transfer for less-than-adequate consideration.

 

2.     Donor must deliver the subject matter of the gift.

 

3.     Donee must accept the gift.

 

The valuation of a gift is the equal value of property transferred minus consideration received when property is transferred for less than “adequate and full consideration in money and money's worth.”  The definition of “adequate and full consideration" in money or money's worth is that the consideration given must equal the value of the property transferred.

 

 

Consideration must also be evaluated.  If consideration is not "in money or money's worth" or if the consideration is a moral consideration;  a past consideration or a consideration that does not benefit the transferor, we have a gift.

 

 

CONSIDERATION IN MARITAL/SUPPORT RIGHTS

 

1. If in a written agreement, one spouse relinquishes certain marital rights to the other spouse in exchange for a property settlement, the transfer is not a gift.

 

1. If one spouse gives up the right to support by the other spouse in exchange for a property settlement, full and adequate consideration has been received and there is no gift.  These transfers are exempt from the gift tax if the divorce occurs within a three-year period beginning one year before entering into the agreement.

 

 

 

POTENTIAL PROBLEMS WITH COMPLETED TRANSFERS

 

Incomplete delivery occurs when technical details are left out or when a stage in the transfer process is not completed.  With incomplete delivery requirements there are usually four situations that may occur to create a incomplete delivery:

 

1.     A gift made by a dying person who later recovers is an incomplete transfer;  the gift is not complete until the donor's death.

 

2.     A Gift of money made by check is not complete until the check is cashed.

 

3.     When one party transfers money to a joint bank account with another individual, the gift is not complete until the other joint tenant withdraws the funds.

 

4.     Transfer of U.S. Government Bonds is governed by Federal rather than State Law.  Therefore no completed gift has been made until the registration is changed in accordance with Federal Regulations.

 

 

Another potential problem with a completed transfer would be the cancellation of notes.  A donor transfers property, then takes back notes from the donee.  If the donee pays off the notes, the transaction is a sale.  However, if the donor forgives (cancels) the notes, the transaction is a gift.

 

 

The third problem area for completed transfer would be incomplete gifts in trust.  Property transferred to a revocable trust (that is -the donor retains the right to revoke the transfer) is not a completed gift.  Only when the trust becomes a irrevocable (donor gives up all retained control) is the gift completed.  For example, a Totten Trust (Bank savings account where donor makes deposit for donee and keeps the savings book) is revocable.  Two examples can best illustrate this point:

 

Bertha establishes an irrevocable trust for her son, Ernie, and her daughter Erin.  Bertha placed   $50,000 of common stock into the trust.

 

1.     If Bertha retains the federal gift taxes to alter the amount of income and principal for each of her children, the gift is incomplete.

 

2.     If Bertha relinquishes the right to allocate income to her beneficiaries at some future time, the stock may substantially increase in value, which would increase the gift tax Bunny must pay.

 

 

TYPES OF GIFTS

 

There are two types of gifts, direct and indirect gifts.

 

DIRECT GIFTS

 

Direct gifts come in four basic forms:

 

1.     When cash/tangible personal property is transferred from one individual to another.

 

2.     An author gives a right to future royalties to another (this type of transfer is taxed as a single gift, valued on the date the right to future income is given).

 

3.     Forgiving a debt in non-business situations.

 

 

4.     Payments in excess of support obligations.

 

INDIRECT GIFTS

 

While there are many situations, six of the more popular indirect gifts are illustrated.

 

1.     Paying someone else's expenses such as making car payments for an adult child; life insurance premiums etc.

 

2.     Shifting property rights

 

3.     Third-party transfers.

 

 

4.     Creating a family partnership in which some family-member partners provide no services/assets.

 

 

5.     Transfers by/to corporation (e.g., a transfer to a corporation for inadequate consideration is deemed a gift by the transferor to the other corporate shareholder).

 

 

6.   Life insurance is an indirect gift if the insured buys a policy on his/her own life and:

 

1. Retains no reversionary interest.
2. Makes the beneficiary designation irrevocable
3. Names a beneficiary other than own estate.

 

7.     If an insured makes an absolute assignment of a policy or in some way relinquishes all rights and powers in a previous policy, a gift is made which is   measurable by the policy's replacement cost.  This can lead to a tax trap.

 

 

 

GRATUITOUS TRANSFERS

 

There are three categories of gratuitous transfers that are not considered gifts:

 

1.  Property/Interest in property that has not been transferred.

 

2.  Transfers in the ordinary course of business.

 

3.  Sham gifts.

SERVICES NOT CONSIDERED AS A GIFT 

 

SERVICES RENDERED GRATUITOUSLY

 

Property does not include services rendered gratuitously.  Even though services are of economic benefit, no gift tax will occur.

 

 

 

DISCLAIMERS

 

An intended donee refuses to take the gift.  A qualified disclaimer is not subject to a gift tax.  There are four requirements for a qualified disclaimer:

 

1. Intended donee must refuse in writing.
2. Written refusal must be received by transferor/representative within nine months after date of transfer or date the disclaiming donee is age 21, whichever is later.
3. Disclaiming donee must not have accepted any benefits of the gift (including interest).
4. Because of the refusal, someone else must receive the property interest.

 

PROMISE TO MAKE A GIFT

 

A promise of a future gift is not taxable.  (Only when the promise is enforcable does the promise become capable of valuation and subject to gift tax).

TRANSFERS IN THE ORDINARY COURSE OF BUSINESS

 

An ordinary business transaction is a bona fide transfer of property, made at arm's length and free from donating intent.

 

1.  COMPENSATION FOR PERSONAL SERVICES

 

There is a gift tax on transfers from corporate employers to individuals as compensation for personal service if payment is made as a legal/moral duty or in anticipation of an economic benefit.  Donating intent on payments to employees is determined by:

1.     Length and value of employee's services.

2.     How the employer determined the value of the payment.

3.     Whether the payment was deducted as a business expense.

 

2.  BAD BARGAINS

 

A transfer for less than adequate consideration made in the ordinary course of business is not taxable as a gift (for example, the selling of stock to key employees at less than fair value as an impetus to heightened performance is not a gift).

 

3.  SHAM GIFTS

 

Refers to a transfer whose only purpose is to shift the income tax burden from a high bracket tax payer to a lower bracket family member is not considered a gift by the I.R.S./Courts and will not shift the incidence of taxation.

 

4.  EXEMPT GIFTS

 

Gratuitous transfers of property exempted by law from the gift tax.  There are five main types of exempt gifts:

 

1. Qualified disclaimer

 

1. Certain property transfers between spouses upon divorce and a choice of settlement options and beneficiary designations for receipt of qualified plan death benefits.

 

1. Tuition paid to an educational institution.

 

1. Payment for medical care.

 

1. Transfer of money/property to a political organization if the transfer is for use of the organization, not an individual.

 

 

 

VALUATION OF PROPERTY FOR GIFT TAX PURPOSES

 

The basic premise of gift tax valuation is that property and property interest transferred during lifetime is valued on the date the gift is made (fair market value is used).

If donee must pay tax on property, gift value is reduced by the tax imposed.

 

INDEBTEDNESS AND TRANSFERRED PROPERTY

 

A.    If the donor is personally liable for indebtedness secured by a mortgage on the gifted property, the amount of the gift is the entire value of the property, unreduced by the debt.

 

B.    If the donee has no right to recover the debt from the donor, the amount of the gift is merely the amount of the donor's equity in the property.

 

RESTRICTIONS ON USE

 

Restrictions limiting the donee's use/disposition of the property do not fix the value of the property, but may have a persuasive effect on price.

 

Mutual fund shares gifts are valued at the shares' net asset value (bid price).

 

 

LIFE INSURANCE/ANNUITY CONTRACTS

 

• If the policy is transferred within the first year of purchase, the gift is valued at the gross premium paid to the insurer.

 

• A single premium or paid-up policy is valued at the replacement value (premium amount the insurer would change for the same type of policy of equal face amount on the insured's life), based on the insured's age at time of transfer.

 

• A policy in the premium-paying stage is valued at the sum of the interpolated terminal reserve (roughly equal to the policy's cash value) and the unearned premiums on the date of transfer.

 

Once it is established that (1) a gift has been made (2) its value is known and (3) it did not fit one of the exempt categories, it is now possible to determine if a gift tax will be assessed.

 

 

FEDERAL GIFT TAXATION

 

Gift taxes were instituted to discourage persons from transferring property during lifetime to avoid estate tax.  Reduction to the federal gift tax are allowed, including gift splitting, the annual exclusion, the marital deduction and the charitable deductions.  Three gifts to minors which qualify for the annual exclusion are the 2503 (B) trust, the 2503 (C) trust and the uniform gifts to minor act (UGMA) arrangement.  ^(Supp.)

 

CONCEPTS TO REMEMBER

 

1.     The purpose of the federal gift tax was to discourage gifts that would avoid estate and income taxes.  For federal gift tax, gifts are all transfers of property/capital for less than adequate consideration.

 

2.     The federal gift tax is an excise tax levied on the right to transfer property to another person.  The federal gift tax is imposed regardless of property's exemption from any income tax.

 

3.     A good rule of thumb: If a transfer during life shifts either the income or estate tax liability from one person to another, there will be a gift tax consequence.

 

4.     The donor is primarily liable for the federal gift tax.  If donor fails to pay the tax then the donee becomes liable to the extent of the value of the gift.

 

• Federal gift tax must be paid when federal gift tax return is filed.

 

• Extension of time for payment can be granted by the I.R.S..  The true test for an extension would be undue hardship.

 

• Federal gift tax return is filed annually.  Under Economic Recovery Tax Act the due date for filing a gift tax return is April 15.  If a gift is made in the year the donor of the gift died, the gift tax return must be filed no later than the date for filing the state tax return.

 

5.     The federal gift tax is imposed only on the transfer of property and is not imposed on services that are rendered gratuitously.

 

6.     The relationship of the federal gift tax to the Federal estate tax involving the following three concepts:

 

• Identical tax rates are used for both Testamentary transfers and gifts made during life.

 

• The unified credit (discussed later) can be applied to both lifetime gifts and transfers made at death.  Any remaining credit is available for use against estate tax payable at death.

 

• The federal estate tax is computed by adding lifetime gifts to the taxable estate.

 

FILING A GIFT TAX RETURN

Just like Income Taxes, Taxable gifts are reported annually and must be filed in most cases, if the donor makes a gift of more than $10,000 (present interest) to any one donee during the year, or makes a future-interest gift of any amount.

• A gift to a spouse that qualified for the gift tax marital deduction does not require a gift tax return to be filed.
• The gift tax return (Form 709) must be filed and any gift tax due paid by April 15^th for gift made in the previous calendar year (just like your income tax).  If the due date for the donor’s income tax return has been extended, this would also apply to the Form 709.
• If the donor dies, the gift tax return is due on the same date as the donor’s federal estate tax return, including extensions if any. 
• A gift tax return must be filed in order to elect gift-splitting or to claim the unified credit.  Therefore, even if no gift tax is due because the credit offsets the tax, the return must still be filed.
• If a life insurance policy has been assigned by gift, then the form 712 will be provided by the insurance company, and must be filed.
• The gift tax liability is the responsibility of the donor in most circumstances.  The payment of taxes due is due at the same time as the return.  It appears that the philosophy of gift giving is that if one can afford to make a gift, that person must also then pay the taxes.  If the donor does not or cannot pay the tax, then the burden falls on the donee.

 

TAX  ADVANTAGES OF  LIFETIME GIFTS

 

There are three major reasons why clients should consider making lifetime gifts for tax advantages:

 

1.     Annual Exclusion allows an individual to give up to $10,000 in gifts to each of an unlimited number of donees.

 

 

2.     Gifts made within three years of death:

 

• ERTA rules state that gifts made within 3 years of death will not be included in the gross estate.

 

• One must look at this rule carefully!  Any gift tax paid on a gift made within three years of death will be included in the gross estate.

 

 

C.       Remember that any gift of a life insurance policy made within three years of death will be included in the gross estate at the face value of the proceeds.  Life insurance is a future interest if transferred to a trust.

 

D.       Gifts made within three years of death will not be included in the gross estate but the value of any taxable gifts will be brought back as adjusted taxable gifts.

 

3.     When a gift is made during the donor's lifetime, any appreciation on the property between the time of the gift and the time of the donor's death is not taxed.

 

 

GIFT TAX COMPUTATION

 

There are five additional considerations prior to computing the Gift Tax.:

 

1.     Gift splitting.

 

2.     Annual exclusion.

 

3.     Gifts to minors.

 

4.     Gift tax marital deduction.

 

5.     Charitable deductions.

 

GIFT SPLITTING

 

When elected on the federal gift tax return, a married donor, with written consent of the non donor spouse, can elect to treat a gift to a third person as though each spouse had made half the gift.  Splitting lowers total tax!

 

A.    A married couple can give away $ 20,000 per donee, each year - no gift tax!  If the spouses elect to split gifts to third parties, all gifts during the reporting period (annually) must be split.

 

B.    The couple must be married in order to split gifts.  If legally divorced or if one spouse dies, no gifts are split.  A gift tax return is required for any split gift even if the annual exclusion of $ 20,000 per donee is not exceeded.

 

B.    Gift splitting, in community property states applies only to separate property (non community property).

 

ANNUAL EXCLUSION

 

Up to $ 10,000 of gifts to any number of persons each year can be made free of gift tax.  The purpose is to avoid administrative problems of keeping track of numerous small gifts.

 

A.    Applies only to present-interest gifts  (possession and enjoyment begin immediately upon receipt of the gift). Present-interest gifts of $ 10,000 or less do not require a gift tax return and would not be included in the decedent's gross estate.

 

 

B.    Education expenses (direct tuition costs, not room, board, books) and payments for direct medical care are allowed in an unlimited amount in addition to the $ 10,000 exclusion.

 

C.    If there is a gift (transfer) within three years of death "with respect to a policy" (meaning life insurance), the full amount of the proceeds will be includible.  (Theory being this is the fair market value at date of death.)

 

D.    The contribution to a spouse's IRA is considered a gift of a present interest.  This contribution will qualify for the $10,000 annual gift tax exclusion!

 

E.    Non-dividend-paying stock may not qualify for gift tax exclusion for two reasons:

 

        1.        Right to income is a future interest.

 

        2.        Value of income interest in property that is not income-producing at the time of the gift cannot be determined.

 

F.    Consumer Application Examples of present interest and future-interest gifts:

 

 

 

 

•  

      GIFTS TO MINORS

 

An unqualified and unrestricted gift to a minor, with or without the appointment of a guardian, is a gift of present interest.  This means that the gift does qualify for the $ 10,000 annual exclusion.

 

• If the gift is made to a trust (to provide management and control), does the transfer still qualify as a present-interest gift?

 

Section 2503 of the Internal Revenue Code provides three ways of qualifying gifts to minors for the exclusion:  Section 2503(B) Trust; Section 2503(C) Trusts;  Uniform Gift to Minors Act Arrangement.

 

B.  Section 2503(B) Trust:  Gifts are made to a trust;  the trust is required to distribute income annually to or for the use of the minor beneficiary.

 

1.         Distribution of the trust assets (corpus) does not have to be made at age 21.  The corpus may be held in trust for as long as the beneficiary lives of the corpus may pass the beneficiary and go to someone else.  The trust agreement controls corpus disposition should a minor die before receiving the trust assets.

 

2.         The gift placed in trust is divided into two parts for federal gift tax purposes:

 

A.  Principal: Does not qualify for the  $10,000 annual exclusion;  this is not a present interest.

 

B.  Income:  The present value of the income to be paid will qualify for the annual exclusion.

 

3.     Key points about a 2503(B) Trust:

 

A.     Advantage:  Distribution of principal is not required when the minor reaches age 21.

 

B.     Disadvantage:  Annual distribution of income is required.

 

C.     Section 2503 - C Trust:  Income and principal must be distributed when the minor reaches age 21.  Income does not have to be distributed annually.

 

1.  Three requirements for a "C Trust.”

 

a.  The income and principal may be expended by or on behalf of the beneficiary (the child).

 

b.  Income and principal must pass to the beneficiary at age 21.

 

c. If the beneficiary dies before age 21 (or legal age of majority)  

     income and principal will go to beneficiary’s estate or appointees      under general powers of appointment.

 

2.   The tax court has stipulated that the following six items are essential

•                   elements of a bona fide gift:

 

• A donor is competent to make a gift.
• A donee capable of taking the gift.
• An actual irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the donee, so that the donor can exercise no further active dominion or control over gift.
• A clear and unmistakable intention on the part of the donor to absolutely and irrevocable divest self of the title, dominion and control of the subject matter of the present-interest gift.
• A delivery of the donee of the subject of the gift or of the most effective means of commanding the control of the gift  (e.g., a gift of a car may be evidenced by delivery of the car keys).
• Acceptance (exercise of the control over the gift) of the gift by the donee.

 

D.  Uniform Gifts to Minor Act (UGMA) During life an adult can make a gift of stock, a life insurance policy, endowment policy or an annuity contract, cash or other property to a minor.  The adult becomes the custodian for the minor's property;  smaller gifts are normally involved.  The custodian has limited powers as defined by state statute.  Custodial assets must be paid to the beneficiary upon reaching majority.

 

1.  If a donee is not age 21 on the date of the transfer, no part of the gift is a gift of future interest where all three of these conditions are met.

 

A. Both the income and the property may be spent by the donee-or for the benefit of the donee before donee attains age 21.

 

B. When the donee reaches age 21 any part of the property and property's income which has not been spent by/for the use of the donee will pass to the donee at that time.

 

C. If the donee dies before age 21, any part of the property and income not spent by or for the use of the donee will be payable to the estate of the donee or as the donee appoints under a general power of appointment.

 

2.  Typically, the donor irrevocably transfers annuities, cash, securities or life insurance to a minor by registering the property in the name of a custodian designated by the donor.

 

                        A.  The donor would not be the custodian!

 

Please refer to chart to see a comparison between trust and Uniform Gifts to Minor Act lifetime transfer by gift.

 

GIFT TAX MARITAL DEDUCTION ^(Supp.)

Spouses who transfer property to each other are allowed an unlimited deduction on such transfer.  The purpose of this gift tax marital deduction was to finally treat spouses as one economic unit.  There are two requirements for the gift tax marital deduction:

 

1.     Donor must be a United States resident or a citizen at the time of gift.

 

2.     Recipient must be the donor's spouse at the time of gift.

 

This 100 percent unlimited marital deduction provision also applies to married taxpayers in community - property states.

 

 

 

CHARITABLE DEDUCTIONS

 

There is no limit on the amount of tax-free gifts made to a qualified charity (certain religious, scientific or charitable organizations).

 

The charitable deduction is equal to the value of the gift to the extent that value is not already excluded by the annual exclusion.  Also, where a charitable remainder is transferred to a qualified charity, a current income tax deduction is permitted for the present value of the remainder interest only if one of the following conditions is met:

 

1.  Personal residence or farm was transferred.

 

2. Transfer was made to a charitable remainder annuity trust.

 

Charitable gifting falls into a few general categories.  These categories include outright gifts, gifts of a part of or an interest in property, and gifts in trust.  All these methods can be used during one's lifetime or at death but remember each one has separate Federal income tax and Estate tax implication.

 

 

 

 

OUTRIGHT GIFTS

 

Outright gifts of property are probably the most commonly used form of giving.  People making an outright gift can make their gifts in money, personal property, or real property.

 

To receive all the tax benefits that can result from a charitable gift, the gift must be made to an Internal Revenue Code qualified charity.  To qualify, the charity must be public, semipublic, or a private foundation which has received special approval from the I.R.S..  I.R.S. approval is generally given if the charity is a governmental agency;  a religious, charitable, scientific, literary, or educational organization; or a war veterans or domestic fraternal organization.

 

A lifetime charitable gift has two distinct tax advantages.  The first is that an income tax deduction is generated.  The second is that assets, along with their future appreciation are removed from the value of an estate.

 

Normally, the income tax deduction that can be taken by the giver is limited to 50% of adjusted gross income.  Adjusted gross income is not taxable income;  it is all income less certain deductions.  The income tax deduction is limited, however, to 30% of the adjusted gross income when the gift is made to semipublic or private charities.  If one wishes to use the 50% limitation, then the total amount of the deduction is not allowed.  The deduction is limited to the basis or cost of the property.  This amount is then subject to the 50% limitation.  Any excess cannot be carried forward.

 

 

Keep in mind that while charitable gifting almost always has income tax ramifications, direct charitable gifting, providing it follows the rules, never results in gift taxes.  A charitable gift made within three years of death generally cannot be brought back into an estate for federal estate tax purposes.

 

 

GIFT SELECTION FACTORS

 

Four factors to consider in determining what property to give:

 

1.  COST BASIS OF THE GIFT PROPERTY:

 

A.        If cost basis is above the fair market value, no capital loss can be recognized.

 

B.        If cost basis is lower than the fair market value, property should be retained to take advantage, at death, of the stepped-up basis.

 

C.        If the donor is seriously ill or elderly, gift of cash or property valued at close to the original cost should be made, as opposed to making gifts of greatly appreciated property.

 

2.  INCOME TAX BRACKET OF DONEE: 

 

If lower than the donor's income tax bracket, high income producing property is desired.  If the donee's bracket is higher (e.g., retired father, successful son),  the father would be best advised to make a gift of growth-type stock with a current low yield!

 

3.  APPRECIATION: 

 

If property is likely to appreciate in value, there can be little doubt that this property should be used!

 

4.  INDEBTEDNESS OF GIFT PROPERTY:

 

Are there any debts on the potential gift property?  I so, it would be best to eliminate such debts before gifting such property.

 

 

FINAL CALCULATION OF FEDERAL GIFT TAX  ^(Supp.)

 

Before starting to tabulate the various gifts and calculate the tentative gift tax due, the following four factors must be considered:

 

1.      UNIFIED GIFT TAX CREDIT

 

Publication 950, Introduction to Estate and Gift Taxes, Unified Credit,  An Internal Revenue Publication, describes the Unified Tax Credit as follows:

 

“A credit is an amount that eliminates or reduces tax.  A unified credit applies to both the gift tax and the estate tax.  You must subtract the unified credit from any gift tax that you owe.  Any unified credit you use against your gift tax in one year reduces the amount of credit that you can use against your gift tax in a later year.  The total amount used against your gift tax reduces the credit available to use against your estate tax.”

 

The Unified Credit will be discussed at length in a later chapter.

 

2.      PROGRESSIVE TAX

 

Computation of the gift tax is a progressive tax, which is also cumulative.  This means, the tax is determined not by each year's total taxable gifts alone, but by the total of all taxable gifts made in prior and current periods. 

 

In essence the greater the number of gifts, the higher the effective tax rate will be each time a new taxable gift is made.

 

3.      TENTATIVE GIFT TAX MATHEMATICS

A.    Aggregate of all prior and present taxable gifts.

B.    Tentative tax on "A" (from current tax table).

C.    Aggregate of all prior taxable gifts.

D.    Tentative gift tax "C" (from current tax table).

E.    Tentative gift tax on present gift ("B" less "D").

F     Gift tax credit.

G.    Aggregate gift tax taken for prior post 1976 gifts (but not more than "C").

H.    Gift tax credit available for current gift ("F" less "G" but no more than "E").

I.     Gift tax payable for current gift ("E" less "H").

 

 

CONSUMER APPLICATION

James is married to Sue, and they have one son, Bill, a daughter Jan, and a Granddaughter Jean (Jan’s daughter).  James and Sue have always helped their children financially and at the present time, are planning on giving Bill $45,000 so that he can make a down payment on a house.  Their history of giving money to their family is as follows, in respect to James:

 

1. In 1980, Bill was given $10,000 from Bill and Sue.  Prior to 1982, the Marital Exclusions was $3,000.  Therefore, the taxable gift amount was $2,000.
2. In 1981, James gave $30,000 as a wedding present to his wife, Sue.  Prior to 1982, the marital deduction was 50% of the amount (not 100%).  With the marital exclusion of $3,000, the taxable deduction was $15,000.  The taxable gift amount was $12,000.
3. In 1982, Jan was given $25,000 by Bill and Sue.  The gift amount was $5,000.  Since each can give up to $10,000, the taxable gift amount for James was $5,000. ($25,000 minus $20,000 [$10,00 from each, Bill and Sue].
4. In 1984, Bill was given $25,000 by James only.  Bill had to make a financial settlement with a previous fiancée, and Sue disagreed with the decision to give this money to Bill.  Therefore, Bill can only give $10,000 to Bill, so $15,000 would be shown as a gift amount.
5. In 1990, Jean was given $10,000 by Bill.  Since this would be within the exclusion amount, there be no gift amount.
6. In 1992, Bill gave Sue $45,000 as a 45^th birthday gift.  The total amount passes 100% to Sue, no gift amount for tax purposes for Bill.
7. In 1994, Jan was given $40,000 jointly by Bill and Sue.  $20,00 would be passed under the gift tax exclusion.  50% of the remainder would be gift taxable to Bill ($10,000).

 

Before calculating the tax on the new gift, the taxes on the gifts to date should be calculated, as follows:

1. $2,000 x 18% = $360
2. $12,000 x ($1,800 + 20% of $2,000) = $2,200
3. $5,000 x 18% = $900
4. $15,000 x ($1,800 + 20% of $5,000) = $2,800
5. There is no gift tax.
6. There is no gift tax.
7. $10,000 x 18% = $1,800

The total gift tax on previous gifts total $8,060.

 

The present gift of $45,000 to Bill by James and Sue would allow $20,000 to be passed gift tax-free.  Bill would show 50% of the remainder, $12,500, as a taxable gift amount.  The gift tax on $12,500 is [$1,800 + 20% of $2,500] would be $2,300.

 

The combined amount of gift tax would be $10,360 by adding the previous gift tax and adding the gift tax on the new gift.

 

However, the first step to determine the tax on the new gift is by adding the total amount of taxable gifts combining the past and the present gifts of $56,500 ($44,000 previous gifts, plus $12,500 new gift), the gift tax would be:  $8,200 + (24% of $16,500 = $3960) for total of $12,160. 

 

From this amount, the tax on the previous gifts is subtracted from the total, to determine the gift tax on the new gift.  ( tax on old gifts of $44,000 is $9,160; then $12,160 - $9,160 = $3,000. 

 

Note the difference in the gift tax in the new gift by adding it with the old gifts, and then subtracting out the tax by the amount of gift tax on the new tax; and simply calculating the new gift tax alone.  However, James will draw upon his unified gift tax credit to avoid paying the $3,000 due.  While he has used part of his credit previously, he still has a lot of gifts left before he starts to pay as he will use his total unified tax credit only when total gift amounts exceed $650,000 (in 1999). 

 

CHAPTER 4 - STUDY QUESTIONS

 

1. With lifetime gifts

A. the gift is complete when the donor offers the property to the donee.

B. taxes can be evaded.

C. privacy is protected.

 

2. A gift

A. of money is complete when the donor signs the check.

B. is any transfer of property for which the donor received less than full value in returned.

C. cannot be made if highly appreciating assets.

 

3. Which of the following would be a complete gift.

A. Property is transferred to an irrevocable trust.

B. Property is transferred to a revocable trust.

C. A donor transfers, then takes back a note from the donee, and the donee pays off the note.

4. A direct gift would be

A. paying another’s expenses.

B. the donor promises to transfer property to the donee in the future.

C. when a donor gives the donee cash.

 

5. The Federal Gift Tax

A. is imposed on the transfer of property and services.

B. is to discourage gifts that would avoid estate taxes.

C. rates are the same as the IRS income tax rates.

6. A gift tax return

A. must be filed by the donee within one year of receiving the gift.

B. must be filed if the donor makes a gift with a value under $10,000.00 to any one donee.

C. is filed annually.

7. The annual exclusion applies to gifts

A. up to $10,000.00 to any number of persons each year.

B. between spouses.

C. to relatives only.

 

8. Bob and his wife, who is a homemaker, want to give their son $20,000.00 and pay no gift tax.

A. Bob’s wife cannot be a donor because she does not have an income.

B. A married couple can give away $20,000.00 per donee (gift splitting).

C. Because Bob is the only breadwinner the gift is limited to the $10,000.00 annual exclusion and a gift tax must be paid on the balance of the gift.

 

9. Any gift to a minor

A. qualifies for the $10,000.00 exclusion.

B. can only be made if a trust is established.

C. if used for educational expenses in non-taxable up to $10,000.00.

 

10. The Unlimited Marital Deduction

A. applies to all married couples.

B. does not apply to real estate.

C. allows married couples, when the donor is a U.S. resident or citizen an unlimited deduction on property transfers between each other.

 

 

 

Answers to Chapter 4 quiz: 1C, 2B, 3A, 4C, 5B, 6C, 7A, 8B, 9A, 10C