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Understanding Gift Tax: Rates, Exclusions, and Strategies

Discover the reasons behind gift taxation, tax rates on gifts, exemptions, donor-donee dynamics, types of gifts, and more. Learn who pays gift tax, its impact on social welfare, and effective gifting strategies.

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Understanding Gift Tax: Rates, Exclusions, and Strategies

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  1. Finance 553 Gift Tax

  2. Gift Tax • Why are gifts taxed? • Gifts were made to avoid estate taxes • Gifts were made to avoid income taxes • Taxes in general are for social welfare • Avoiding taxes through gifting reduced the general welfare of the state (country) • Who pays the gift tax? • Usually it is the donor • Can have arrangement where donee pays

  3. Gift Tax • Tax Rates on Gifts • Exhibit 5.1 (page 135) • Lowest rate 18% from $0 to $10,000 gift • Marginal rate increases to 40% over $1,000,000 • Tax exclusions • Annual exclusion now $14,000 per year per individual • Lifetime exclusion currently $5,430,000 (federal) • Tax credit is $2,117,800 • $345,800 for first $1,000,000 and 40% x $4,430,000 • No gift tax on charity gifts or to spouse (U.S. citizen) • Rates now the same for estate, gift, and generation skipping taxes but…Congress can always change rates…

  4. Gift Tax • Characteristics of a Gift • Two parties involved, donor (giver) and donee (recipient) • Voluntary transfer • Less than full consideration • Donor sells donee $1,000,000 worth of land to donee for $100,000 • Gift is the difference in FMV and consideration paid, $900,000 • Donor must be competent to make gift • Donor must part with property (surrender all rights to property or income from property) • Donee must be capable of taking gift • Donee must take delivery • Donative intent present, donee must have conscious desire to make the gift

  5. Gift Tax • Characteristics of a Gift (continued) • Consideration • Value transferred to Donor from Donor for the “gift” • Consideration must be less than value of gift, otherwise just a sale • Types of Gifts • Direct gifts (direct payment of cash or property to donee) • Indirect gift (payment of donee’s debt by donor, pay to third party) • Indirect gift (property titled in donee’s name but purchased by donor) • Complete or Incomplete Transfers • Complete when donor releases all control • Incomplete when donor has future recourse • Gift to revocable trust • Gift to revocable beneficiary

  6. Gift Tax • Interest Free Loan or Reduced Interest Loan • Less than $10,000 – no gift tax • Between $10,000 and $100,000 – no gift tax if “interest” would be less than $1,000 per month • Over $100,000 – gift is annual interest at difference between Annual Federal Rate (AFR) and loan rate • Calculate the annual gift for the following loan: • $250,000 principal • AFR is currently 6% • Loan rate is 2% • Calculate annual payments under both, find annual interest, take the difference and see if the loan is a partial gift…

  7. Gift Tax • Characteristics of a Gift (continued) • Example of incomplete gift • Donor sets up joint banking account • Deposits funds in account • Authorizes donee to make withdrawals • Retains the rights to make withdrawals • Gift becomes complete when donee withdraws funds • Gift is complete because donee has taken delivery • Amount of gift is the amount withdrawn • Revisionary Interests • Gift originally transferred to donee but reverts to donor in future • Value of gift is present value of right to use property • Revision interests determined by Treasury regulations

  8. Gift Tax • Characteristics of a Gift (continued) • Net Gifts • Normally the donor pays the gift tax but here the donee agrees to pay the gift tax • Donor must report taxable income for the gift tax that exceeds the adjusted basis in the gift • Example 5.11 page 141 • Brianna gifts property worth $250,000 to Kenny • Kenny pays gift tax on receipt • Value of gift to Kenny is $250,000 – gift tax • Net Gift = $250,000 / (1 + 0.40) = $178,571 • Assumes tax rate of 40% • Tax paid by donee is $250,000 - $178,517 = $71,429 • Issues for Financial Planner?

  9. Gift Tax • Exclusions and Exemptions • Annual Exemption -- $14,000 from one individual to another • Lifetime Exemption -- $5,430,000 Federal Exemption in 2015 • Non Citizen Spouses -- $145,000 • Split Gift (with spouse) -- $28,000 annual exemption • Donor uses their $14,000 annual gift exemption and • Spouse consents to use their annual gift exemption for same donee • Form 709 is required of all split gifts and both spouses must sign • For gifts from “community property” both spouses are deemed to have donated the gift as they are 50/50 owners of the property • Deceased Spouse Unused Exemption Amount (DSUEA) • A spouse can use the deceased’s exemption if transferred at death

  10. Gift Tax • Gifts of Present and Future Interests • Present Gifts are ones that transfer immediately and qualify at that time for annual exclusion • Future Gifts need a future event to take place before property transfers • Usually gifts into revocable trusts are future gifts • But if trust has mandatory income interests then… • Crummey Provision – explicit right of trust beneficiary to immediate withdrawal from trusts for up to 30 days following contribution • Qualifies gift as present interest • Creates general power of appointment for estate tax purposes • Typically only the annual exemption amount can be withdrawn from trust • Five and Five Lapse Rule (can withdraw the maximum of five thousand dollars or five percent of trust assets ) within 30 days • Example 5.29, pages 154 -155 • Failure to withdraw by one of the three individuals distributes funds to all beneficiaries (assumes other beneficiaries withdrew maximum amount of available funds at contribution)

  11. Gift Tax • Transfers with No Gift Tax • To Political Organizations • Party Committee, Association, Fund, etc. for exempt purpose • Exempt purpose to select, nominate, elect, or appoint individual to federal state or local public office or in political organization • Qualified Transfers • Payments directly to educational institutions for tuition • Payments directly to medical care provider • Not part of annual exclusion or lifetime exclusion • Payments for Support (i.e. child support, graduate school or professional education, divorce payments) • Business Settings • Spouse (U.S. Citizen) unlimited, Non citizen spouse only $145,000 • Charities – Federal, State or Local and 501(c)(3) and 501(c)

  12. Gift Tax • Gift Tax Calculations – Over the years • Lifetime exclusion now $5,430,000 (Federal Tax Only) • Annual tax exclusion at $14,000 per individual donee • Example 5.33 – Pages 160 – 162 • Gift of $611,000 in 2005 (annual exclusion for 2006, $11,000) • Gift of $712,000 in 2006 (annual exclusion for 2007, $12,000) • Gift of $4,054,000 in 2014 (annual exclusion for 2014, $14,000) • Tax calculation for 2005 yields no gift tax • Tax calculation for 2006 yields gift tax of $124,000 • Tax calculation for 2014 yield gift tax credit of $124,000 • Overall gift tax for 2005 to 2014, $0

  13. Gift Tax • Income Tax Issues Related to Gifts – File Form 709 (page 163) • Filed Annually if over annual exemption or lifetime exemption • If donor cannot pay taxes, IRS may seek taxes from donee • Adjusted Basis • Donee’s basis is the donor’s basis and includes the donor’s holding period • Gift just continues the asset from it’s original acquisition by the donor to the donee • Example of Adjusted Basis • Donor gifts property purchased on in 1995 at $400,000 to child • Current fair market value is $690,000 • Donee has basis of $400,000 but current holding period of 20 years • Double Basis for Holding Period • When FMV below adjusted donor’s basis use date of transfer if loss occurs • If eventual gain on sale use the donor’s acquisition date for holding period

  14. Gift Tax • Gift Strategies (Client Goals) • Gifts to Spouse – no taxed but • Can provide additional tax breaks when spouse gifts the assets • A-B By Pass Trust… • Appreciated Gifts • To Charities so that tax is avoided on the appreciated asset • Charities do not pay taxes so it increases total cash flow • Gifts to Minors • Through a trust to minimize “bad” spending • But administrator of trust can spend “badly” so appointment of administrator also important • Example 5.41 on Page 172 - 173

  15. Gift Tax • What are the implications for Financial Planning? • Timing of gift? During life or as bequest? • What property best for gifting? • Tax law changes and planning for future gifting? • Future gifting (to trusts) • Changing beneficiaries of gifts over time • Changing amount of gifts over time • Other issues?

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