According to the Internal Revenue Service (IRS) Statistics of Income program, in a typical year, taxpayers file over two hundred thousand Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return, and pay hundreds of millions of dollars in gift taxes. Each calendar year, taxpayers gift billions of dollars to friends, family, charities, and trusts. Taxpayers file gift tax returns not only to report lifetime gifts to the IRS but also to allocate their generation-skipping transfer tax exemption to some or all of those transfers. In turn, the IRS uses the gift tax returns to impose gift and generation-skipping transfer taxes on taxpayers who have exhausted their lifetime exemptions and to keep track of a taxpayer’s remaining exemptions for taxpayers who may owe estate tax at the time of their death.
While lifetime gifting remains an integral part of estate planning and asset protection, taxpayers often make gifts for other reasons: for example, parents might buy their child a car as a college graduation present or a widow might take her lifelong friend on a cruise around the world. Gifting occurs more often than the numbers indicate because many gifts go unreported. The average taxpayer likely has never heard of Form 709 and does not know of the gift reporting obligations. Taxpayers—to protect themselves from failure-to-pay and failure-to-file penalties—and attorneys—to provide adequate guidance to their clients—must remain cognizant of the reporting requirements associated with gifting. With tax season in full swing, here is a quick refresher on the topic of gift reporting.
1. Differentiating between Reportable and Nonreportable Gifts
The Internal Revenue Code (I.R.C.) assumes that all gifts are taxable gifts unless the gifts fall into one or more exceptions or exclusions. See I.R.C. § 2503(a). I.R.C. § 6019 provides a list of nontaxable gifts that a taxpayer does not need to report on a Form 709, including the following:
- a present interest gift no greater than the annual exclusion amount (I.R.C. § 2503(b))
- qualified transfers made directly to educational and medical institutions on behalf of another individual (I.R.C. § 2503(e))
- gifts to a US-citizen spouse pursuant to I.R.C. § 2523, either outright or in further trust if the trust meets the requirements of I.R.C. § 2523(e)
- gifts to a noncitizen spouse that do not exceed the increased annual exclusion amount of I.R.C. § 2523(i)
- certain charitable gifts that qualify for a deduction under I.R.C. § 2522
If all the gifts made by a taxpayer during the year fall under one or more of these categories, the taxpayer does not need to file a Form 709.
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2. Benefits of Submitting a Voluntary Form 709
A taxpayer may wish to file a voluntary Form 709 even if the taxpayer only made nonreportable gifts. Under I.R.C. § 6501(a), the IRS must assess gift tax within three years after a taxpayer files a Form 709. The three-year statute of limitations begins to run when the taxpayer files the gift tax return and also adequately discloses the gift on the gift tax return. I.R.C. § 6501(d). Pursuant to 26 C.F.R. § 301.6501(c)-1(f)(2), adequate disclosure requires (among other things)
- a description of the transferred property and any consideration received by the transferor;
- the identify of, and relationship between, the transferor and each transferee;
- a detailed description of the method used to value the gift;
- if the transferee is a trust, information regarding the trust instrument; and
- a statement describing any position taken that is contrary to any proposed, temporary, or final Treasury regulations or revenue rulings published at the time of the transfer.
For taxpayers who take advantage of valuation discounts or gift difficult-to-value assets such as an interest in a closely held family business, it may be in their best interest for the statute of limitations to begin running immediately upon the filing of Form 709. For example, assume a taxpayer takes advantage of the annual exclusion amount and valuation discounts to transfer business interests valued at $25 million to the taxpayer’s children, grandchildren, and great-grandchildren. Over the thirty years that it took the taxpayer to complete the gifts, the taxpayer did not file gift tax returns because filing was not required under I.R.C. § 6019. Since no gift tax returns were filed, the statute of limitations never began to run. Now, the IRS has the ability to assess gift tax on every one of the gifts made by the taxpayer over the thirty-year period. Not only can the IRS require the taxpayer to pay any unpaid gift taxes, but it can also require the payment of interest and penalties. If the taxpayer in this scenario had filed voluntary gift tax returns, the taxpayer would be much better off because the IRS could only look back to the past three years of returns.
3. Gifting Considerations for Married Individuals
For gift tax purposes, each spouse is generally considered to own one-half of community property. For example, if married US residents make an outright gift of community property valued at $30,000, each taxpayer’s filing requirement is based on one-half of the gift. In this example, each taxpayer has made a gift of $15,000. Since the $15,000 gift is not greater than the annual exclusion amount, the taxpayers do not need to file a Form 709.
On the other hand, when one spouse gifts separate property, the gift is made by only that spouse. In such cases, the spouses should consider electing gift splitting, which deems each spouse to have made one-half of the gift of separate property. To elect gift splitting, each spouse must be a citizen or resident of the United States at the time of the gift as required by I.R.C. § 2513, they must both consent, and they must file a Form 709 in accordance with 26 C.F.R. § 25.2513-1. Once gift splitting is elected, the spouses must split all gifts made to third parties during the calendar year. I.R.C. § 2513(a)(2).
In order to avoid unnecessary gift tax return filings, taxpayers should consider the ownership of the property. For a married couple, gifting from a separate bank account as opposed to a joint bank account could cause the taxpayers to file an avoidable Form 709.
Keeping these three considerations in mind as you advise your clients can potentially lead to substantial gift tax savings.