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George F. Bearup, J.D. Senior Legal Trust Advisor

11-Jul-18

Gift Tax Returns: Did You Know That…?

Take-Away: While a federal gift tax return appears fairly simple in form to complete, the rules that must be followed to complete that Form 709 are far from simple. A complex rules follow which indicate the complexity associated with completing the ‘simple’ federal gift tax Form 709.

Split-gifts:  Married taxpayers who are U.S. citizens or residents can elect to split their gifts, where one spouse owns the transferred asset, but the other spouse elects to have the gift as made one-half by each spouse. [IRC 2513(b).]This is a convenient rule that avoids the need for an additional step of one spouse formally gifting half an asset to the other spouse, and then both spouses gift their 50% interest in the same asset to the donee.

  • But gift-splitting is only permitted when both spouses are US citizens.
  • The spouses must obviously be married when the split-gift is made, and  if a divorce later occurs in the year of the gift, they cannot be remarried to another person at the end of the calendar year in which the split-gift was made;  in short, the donors cannot remarry in the same year as the split-gift.
  • Both spouses must signify their consent to the election to treat the gift as split by signing the gift tax returns.
  • The split-gift is of any amount, even if the total value of the gift was below the one spouse donor’s annual exclusion gift amount; regardless of the amount of the gift, if the gift is to be split by the spouses, it must be reported on a Form 709.
  • The election of the spouses to make a split-gift is irrevocable; the consent of the spouses cannot be revoked after the April 15 deadline for filing the gift tax return.
  • All gifts reported on the Form 709 will be treated as split-gifts by the spouses; all, or none, will be treated as split by the spouses, i.e. no ‘cherry-picking’ some gifts to be treated as split and others not.
  • If a gift tax, or a GST tax, is later assessed after the split-gift, the spouses will be jointly and severally liable for the additional tax that is owed, so there is some financial risk to the consenting spouse. [IRC 2513(d); Treas. Reg. 25.2513-4.]

529 Contributions: The contribution to an IRC 529 account qualifies for the federal gift tax annual exclusion.

  • As an additional incentive to transfer cash to a 529 account is the fact that a donor can contribute up to 5 years’ worth of annual exclusions to a 529 account, e.g. $15,000 X 5 years = $75,000.] [IRC 529)(c)(2)(B).] This amount can be doubled if there is gift-splitting, i.e. $150,000 transferred to a 529 account at one time for a single donee. [Grandparents with 5 grandchildren can move $750,000 from their taxable estates with this gifting opportunity.]
  • The Form 709 requires that a box must be checked to note the donor’s election to ‘front-end-load’ the gift to a 529 account. Failure to check the box on Form 709 will result in a taxable gift of the 4 extra years of front-end-loaded funding the 529 account.
  • Yet another trap is that this front-end-loading of the 529 account with annual exclusion gifts for 5 years means that any other gifts made to or on behalf of the donee in the 4 following years will be taxable, which includes birthday and Christmas gifts to the same donee. Thus, usually a donor to a 529 account will not max out their annual exclusion gifts to children or grandchildren, to enable them to continue to annually make birthday and Christmas gifts to the same donee.

Gifts of Entity Units: Often an interest in a limited liability company or a family limited partnership will be gifted to children or trusts established for the children.

  • Yet another box must be checked  when completing the Form 709, this one to claim a valuation discount for the reported gift of the entity interest.
  • In addition to checking a disclosure box that a valuation discount was claimed for any of the gifts reported on the Form 709, the donor must also attach an explanation of the valuation discount and how it was derived. Failing to check the box will      invite more IRS scrutiny of the gift tax return.
  • Moreover, some gifts of entity units or interests will not even qualify for the federal gift tax annual exclusion. In order to qualify for the federal gift tax annual exclusion ($15,000 a year per donee), the interest that is the subject of the gift must be a present interest. A present interest is formally described as ‘an unrestricted right to the immediate use, possession, or enjoyment of property or the income from the property.’ [Treas. Reg. 25. 2503-3(b).] Consider the restrictions that are often included in an LLC operating agreement or a family limited partnership agreement, which exist either to justify a valuation discount of the interest that is the subject of the gift, or simply to keep the gifted interest within the family. This was the case in Hackl, 118 Tax Court 279 (2002), aff’d 335 F.3d 664 (7rd Cir 2003) where the family LLC held only non-income producing farm land, subject to restrictions that prevented the transfer of the LLC units outside the family, where the gift of the LLC units were denied present interest treatment.
  • If the subject of a gift is a closely held interest like an LLC or family limited partnership interest, one way to assure present interest treatment of the gift is to give to the donee at the same time as the gift a put right to the donor, which enables the donee to sell the gifted interest back to the donor in exchange for cash, e.g. a right to compel the donor to redeem/repurchase the gifted interest for 60 days after the transfer, much like the limited  30 day window period associated with a crummey withdrawal right which is intended to deliberately cause the transferred interest to be treated as a present interest.

Adequate Disclosure of Gifts: If a gift is adequately disclosed on a Form 709 federal gift tax return, the IRS will generally have 3 years in which to audit the gift tax return. [IRC 6501(a).]

  • But if the gift is not adequately disclosed on the Form 709 return, the statute of limitations never runs, and the value of the gift can be challenged by the IRS at any time. [IRC 6501(c).] If the adequate disclosure rule is satisfied, then the gift may not be revalued by the IRS for federal estate tax purposes, once the statute of limitations has run. [IRC 6501(c)(9); Treas. Reg. 301.6501(c)-1(f)(8).]
  • The adequate disclosure rules are extremely comprehensive, including what must be included in a qualified appraisal prepared by a qualified appraiser.
  • Suffice it to say that the ‘what the IRS doesn’t know won’t hurt the IRS’ is not a good practice to follow, especially if a hard-to-value asset is the subject of the gift.
  • This adequate disclosure obligation extends to sales where the price paid by the purchaser (donee) might be subject to debate, with some risk that a disguised gift is part of the sales transaction. Thus, if a sales transaction is reported on Form 709 as a gift with $0.00 value, that will allow the 3 year statute of limitations to begin to run since the potential gift was formally disclosed to the IRS.
  • If  a $0.00 gift is reported on the Form 709 return, it is wise to also provide an explanation why the donor believes the transfer is not actually a gift. [Treas. Reg. 301.6501(c)-1(3) and (f).]

Charitable Gifts: As a generalization, charitable and marital gifts that meet some requirements will not have to be reported on a gift tax return.

  • The transfer of an entire interest (not a partial interest) to a charitable organization will qualify as a charitable gift that does not require a federal gift tax return to be filed. [IRC 2522; IRC 6019(3).]
  • But if a donor has to otherwise file a gift tax return, the donor must report all charitable gifts on the Form 709 to comply with the Form 709 Instructions.
  • If a later-discovered taxable gift was revealed, causing the donor to have to file a Form 709 gift tax return with regard to the newly revealed gift, that gift tax return will then have to report the earlier charitable gifts, even when standing alone the charitable gift did not require a gift tax return to be filed.

These are just some of the surprises that donor’s encounter when filing a federal Form 709 gift tax return. If there is one big ‘take-away’ on this topic, it is always, always, read the Instructions to Form 709 first before filing that tax return.