© 2007 ME™ (Your Money Education Resource™) Estate Planning for Financial Planners Chapter 5: Gift Tax

2 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Historical Background  The gift tax is an excise tax on the right to transfer assets to another person during life.  Developed in 1932 (after the estate tax – 1915). Gift rates were lower.  In 1976, Congress unified the rates.  In 2003, the systems were again split.

3 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 EGTRRA 2001  Tax Rate Schedules – Exhibit 5.1, page 116. In 2014, 40%  Exemption Amounts – Exhibit 5.2, page 117. In 2014, $5,340,000, large increase from previous exemption of $1 million.

4 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Parties to a Gift  Donor (person who makes a gift) Must be competent to make the gift. Must have intent to make a voluntary transfer.  Donee (person who receives a gift) Must be competent to receive the gift. Must take delivery. Must accept the property.

5 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Definition of Gifts  Voluntary  Transfer of Property  Without full consideration

6 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Consideration  Transfer of property or payment in return for property.  If there was fair consideration, then it is not a gift. Bad deal: buying Tribune Company?

7 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Direct Gifts  A direct payment of cash or transfer of property from one person to another.

8 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Indirect Gifts  Indirect transfer on behalf of a donor for the benefit of a donee. Makes a payment for someone else. Titles property jointly. Below-market loans. The amount the lender imputes is a gift.

9 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Below-Market Loan Loan AmountImputed Interest $0  $10,000 $0 $10,001  $100,000 The lesser of: Net investment income, or Interest calculated using AFR less interest calculated using stated rate If borrower’s unearned income < $1,000 then $0 imputed interest > $100,000 Interest calculated using AFR less interest calculated using stated rate.

10 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Below-Market Loan Example Loan AmountNet Investment Income Lender Imputes $10,000N/A$0 $100,000$500$0 $100,000$1,500 $100,000$9,000$5,000 $100,001N/A$5,000 AFR = 5%

11 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Complete vs. Incomplete Gifts  Incomplete are gifts that have not come to fruition. They are not taxable gifts for gift tax purposes. Joint bank accounts?  Completed gifts are gifts that have come to fruition. The donor has released all control over the asset and the donee can be identified.

12 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Reversionary Interests  Interests that have been transferred by a transferor and subsequently revert back to the transferor.

13 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Net Gifts  Normally the donor is responsible for all gift tax.  A net gift is a gift made on the condition that the donee pay any gift tax due.  The donor will have taxable income to the extent that any gift tax paid by the donee exceeds the the donor’s adjusted basis in the property.

14 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Valuation of a Gift  FMV at the date of the gift. Real estate – need appraisal. Publicly traded securities are valued at the high and low trading price for the day. Bonds – PV of the expected future payments. Discounts may be allowed for lack of marketability, lack of liquidity, or lack of control.

15 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Annual Exclusion  All individuals may gift up to $14,000 (for 2014) tax free per donee each year (adjusted for inflation).  Gift must be a present interest.  Use it or lose it!  Non-U.S. citizen spouses “Super Annual Exclusion” = $145,000 in 2014

16 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Split Gifts  Married spouses can elect to split gifts effectively doubling the annual exclusion to $28,000 (for 2014).  Requires gift tax return (Form 709).  Must be elected for all gifts for that year.  Only counts for the time they were married.  No gift-splitting for community property (no returns needed).

17 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Applicable Exclusion Amount  Each person also has one lifetime credit equivalency amount up to $5,340,000 of cumulative taxable transfers.  See Gift and Estate Tax Credit chart in text for past credit amounts. Exhibit 5.4, page 129.

18 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Gifts of a Present Interest  Unrestricted right to the immediate use of the property.

19 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Future Interest Gift  Interest that is limited in some way to a future date or time.  Donee’s right to the property is contingent upon some future date or time.  Example Remainder beneficiary of a trust

20 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Crummey Provision (1 of 3)  Allows the trust beneficiary to withdraw some or all of any contribution to a trust for a limited period to create a present interest.  5/5 Lapse Rule Taxable gift occurs when the power to withdraw in excess of $5,000 or 5% of the trust assets is lapsed by the powerholder. Only comes into play when >1 beneficiary

21 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Qualified Transfers  A qualified transfer is a payment for someone else paid directly to a: Qualified educational institution for tuition. Medical care provider for qualifying medical expenses.  Key here is that it must be paid directly to the institution.  Does not count against the annual exclusion or applicable exclusion amounts.

22 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Payments for Support  Payments for legal support are not gifts.  Legal support does not necessarily stop at age 18.

23 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Payments to Divorcing Spouses  Payments pursuant to divorce decree are nontaxable property settlements and not gifts.

24 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Transfers in a Business Setting  Transfers in a business setting are presumed to be compensation, not a gift.  De minimis gifts are exceptions.

25 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Gifts to Spouses  Unlimited marital deduction allows for unlimited transfers between married people without gift tax.  Spouse must be a U.S. citizen.  Different rules for non-U.S. citizens – will be discussed later.

26 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Charitable Gifts  Unlimited gift tax deduction for gifts to qualified charities.  Will be covered later in Chapter 9.

27 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Form 709  Must be filed – April 15 of the following year.  Can be extended by extending income tax return.  The donor is primarily liable for gift tax but the donee can become responsible if the donor does not pay.

28 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Who Must File  Everyone who gifts unless gifts are: Under the annual exclusion. Qualified transfers. Transfers to spouses (generally). Transfers to charities.  Remember – if split gifts there must be a tax return even if less than annual exclusion (does not apply to community property).

29 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Income Tax Issues Related to Gifts (1 of 2)  In general the donee will take the adjusted basis and holding period of the donor.  Exception – Asset is in a loss position Dual basis and holding period AB for gains – carry over holding period FMV for losses – holding period starts at date of gift

30 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Income Tax Issues Related to Gifts (2 of 2)  Exception – Gift tax paid on appreciated property If gift tax is paid, then the basis will increase by the gift tax paid attributable to the appreciation.  Cost: $100,000  FMV: $300,000  Gift Tax: $90,000  Basis: $160,000

31 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Gifting Strategies (1 of 4)  Achieving client goals with direct gifts Effective and efficient  Gifts of appreciating property Reduces future gross estate  Gifts to spouses Often used to equalize the estates  Gifts to minors May need trusts or custodial accounts

32 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Gifting Strategies (2 of 4)  Single party strategies Rarely wise to gift cash. The donor should prepare a current balance sheet with a forecast of what is likely to appreciate the most. Transfer the asset likely to appreciate the most. This will remove highly appreciating assets from the donor’s gross estate and the appreciation will occur in the hands of the donee. Unless the donor is very close to death, such a strategy should generally be superior to receiving a step up in basis for transfers at death. See Example 5.37, page 149.

33 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Gifting Strategies (3 of 4)  Multi-party strategies Never gift property in a loss position…sell it instead. Gift property with the greatest appreciation potential to the youngest donee. Gift appreciated property to charities to avoid the capital gain taxes. Gift income-producing property to the donee in the lowest marginal income tax bracket so that the income is subject to the lowest possible income tax. See Example 5.38, page 150.

34 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Gifting Strategies (4 of 4) Optimize qualified educational transfers. Optimize annual gift exclusion. Utilize the marital deduction to equalize estates. Utilize the lifetime applicable gift tax credit equivalency amount ($5,340,000 in 2014). Any gift tax paid on gifts prior to three years of death will also reduce the estate of the transferor.