Federal Gift Tax – Overview
The federal government has several taxes on gratuitous transfers – meaning transfers where no consideration was given – and includes inter vivos gifts and transfers of property from the decedent's estate.
The relationship between the federal gift tax and estate tax has changed over the years. Before 1976, gift taxes were lower than the estate tax. However, the Tax Reform Act of 1976 equalized their rates and established the new unified transfer credit that could be applied to offset the liability of either gift or estate taxes. Gift and estate taxes were unified because the wealthy often gave gifts to reduce the value of their estate. Hence, it made sense to treat them the same. The Tax Relief Reconciliation Act of 2001 retains the gift tax, but lowers its rates so that the highest rate is equal to the highest marginal rate on income taxes, which, in 2010, was 35%.
In December, 2010, the tax law was amended so that the exemption for gift, estate, and generation-skipping transfer (GST) taxes is increased to $5 million for tax years 2011 to 2012, and the top rate for all gratuitous transfer taxes is 35%.
The exemption amount is in the form of a lifetime unified tax credit that can be used to offset the tax on any gratuitous transfer. Reducing the gift tax with the unified credit reduces the amount of credit remaining for additional gifts, or for the estate and GST taxes. In 2012, the unified credit equaled $1,772,800, which is the tax on $5,120,000 of gratuitous transfers.
States do not tax gifts, except Connecticut and Tennessee.
What is a Gift?
Although the federal government taxes gifts, it doesn't define exactly what a gift is. However, the law has settled on the definition of a gift as a transference of property without adequate consideration for the donor. According to state law, which federal law uses to determine if the transference is a gift or not, a gift has the following 5 elements:
- the donor must be competent;
- the donor must have the intention of making a gift;
- the donee must be capable of receiving and possessing the property;
- there must be actual or constructive delivery of the property to the donee or the donee's representative;
- the donee must accept the gift.
A gift does not include the performance of services nor the lending of property for a finite period of time.
Another defining attribute of the gift is that the donor must have given up sufficient control over the gift – the donor cannot later revoke, benefit, or change the owner of the gift or otherwise reverse the transference of the gift. If the donor dies without relinquishing control of the property, then it becomes part of his estate. Hence, it will be subject to estate tax but not gift tax.
Example: If Bill creates a revocable trust that pays its income to Mary with the remainder going to Christine, then there is no gift since Bill retains the right to revoke the trust. Bill also retains liability for the income tax generated by the income of the trust. However, if the trust was irrevocable, then Bill incurs a federal gift tax liability for both the gift to Mary and to Christine.
If the power to revoke or change the owner of the gift is held by a third-party, then whether it is a gift or not depends on whether the third party is an adverse party — a beneficiary who would be adversely affected by the gift or who is not related or subservient to the grantor. If control is retained by an adverse third-party, then it is not considered to be a gift.
However, a donation may be considered to be a gift, even if the donor retains power over the gift or benefits from it, if the power is limited by an ascertainable standard, such as using income from the gift only for a donor's health, education, support, or maintenance.
Generally, the IRS includes any transference of property between family members as a gift, unless the donor can prove that it was a bona fide arms-length transaction. Was the transaction conducted as if it were done with a stranger and was the consideration for the property adequate. For instance, when the IRS looks at a loan to a family member, it considers the following as indicating a bona fide transaction:
- the borrower signed a promissory note;
- a market interest was charged on the loan;
- the loan had a fixed term;
- the borrower was able to repay the loan;
- the borrower has made every payment during the term of the loan.
A disclaimer is an irrevocable and unconditional refusal by the gift recipient to accept the gift, thereby causing the gift to go to the alternate beneficiary specified by the donor of the gift. Even though a disclaimer transfers the property interest, it is not considered to be a gift by the disclaimant, as long as it complies with IRC §2518:
- the disclaimer is in writing;
- the disclaimer is executed within 9 months of the party receiving the property interest or 9 months of the disclaimant reaching age 21;
- the disclaimant never accepted any benefit in the disclaimed property;
- and the disclaimant does not determine to whom the disclaimed property is to go but simply passes to the alternate beneficiary specified by the donor of the gift.
A gift tax will only be incurred if the transference satisfies the legal requirements for a gift and the value of the gift is determined when all of the legal requirements for the gift have been satisfied.
Gift tax applies to all gifts made by United States residents and on all property located in the United States or property received by a resident from a foreigner.
The donor of the gift is generally liable for the gift tax, but if he is unable to pay, then the donee must pay it — aka the doctrine of transferee liability, §6324(b).
The gift tax is assessed on the fair market value of the gift at the time the gift was made, but the donee receives the donor's tax basis basis in the property, which is referred to as the carryover basis.
Gift Tax Annual Exclusion
There is also a gift tax annual exclusion, wherein no tax liability is incurred on the gift if its value is less than the exclusion amount. In 1997, Congress set the size at $10,000, to be increased in $1000 increments according to inflation, but rounded down to the nearest thousand. In 2013, the amount is increased to $14,000 from $13,000 that applied to 2009 - 2012.
|2009 - 2012||$13,000|
|2006 - 2008||$12,000|
|2002 - 2005||$11,000|
|1998 - 2001||$10,000|
The purpose of the annual exclusion is to eliminate the need to report or pay tax on numerous gifts such as those given at weddings or during Christmas. Any gift that qualifies for the exclusion does not reduce the lifetime limit on gifts or bequests that can be transferred tax-free (IRC §2503).
Property can also be transferred tax-free to multiple heirs, even if the property is more than the annual exclusion, by providing for joint ownership of a property that is not easily divisible, such that the value of each ownership interest is less than the annual exclusion.
In addition, a gift of 5 times the annual exclusion can be given to a donee through a 529 educational plan as long as the donor does not give any more gifts to the donee within 5 years and the donor lives at least that long.
Example — Fair Market Value, Carryover Basis, and Gift Tax Annual Exclusion
Carl buys 10,000 shares of XYZ stock for $10 per share. Carl gives Amanda the stock in 2009 when the stock was $20 per share and the annual gift exclusion was $13,000. Amanda subsequently sells the stock for $30 per share.
- Gift tax is assessed on $100,000 - $13,000 = $87,000.
- Amanda pays capital gains tax on $300,000 - $100,000 = $200,000.
A married couple can give twice the annual exclusion tax-free by splitting the gift, even if only 1 spouse is giving the gift. The spouse must agree to split the gift, and Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return must be filed with the IRS, even if no tax is due. Of course, if both spouses are giving the gift, then gift-splitting is not necessary, since each spouse has the same annual exclusion for each donee.
Gift Splitting Example
Bill and his wife, Susan, decide to split their 2009 gifts, with Bill giving his nephew, Carl, $22,000, and Susan giving her niece, Tina, $18,000. Although each gift is more than the $13,000 annual exclusion, gift splitting eliminates gift tax liability, since Bill's gift to Carl is treated as ½ ($11,000) from Bill and ½ ($11,000) from Susan, and Susan's gift to Tina is treated as ½ ($9,000) from Susan and ½ ($9,000) from Bill. Thus, each apportioned gift is less than the annual exclusion; therefore there is no gift tax liability. Nonetheless, a gift tax return must be filed to notify the IRS of the gift splitting.
Note that if Bill had actually given Carl $11,000 and Tina $9000 and Susan had actually given Carl $11,000 and Tina $9000, then no gift splitting would have been required, since all 4 gifts would be within the $13,000 annual exclusion limit for each donor-donee gift, and no gift tax return would have to be filed.
Example: With Gift Splitting, Large Amounts of Wealth Can Be Transferred Tax-Free
In 2010, Mitt Romney, a 2012 presidential candidate, had 5 sons and 18 grandchildren. Since he and his wife were in their early 60s, and could easily live another 30 years, how much wealth could they transfer tax free, using only gift splitting and the annual gift exclusion?
|Gift-Splitting Annual Exclusion||$26,000|
|Number of Heirs||23|
|Amount that can be transferred tax-free annually||$598,000|
|Total Amount that can be transferred over 30 years||$17,940,000|
As can be seen in the above table, they can transfer quite a bit of wealth every single year and almost $18 million of net present value, since the annual exclusion is adjusted for inflation, over the next 30 years. Actually, this is a conservative calculation. There are various means of actually giving much more and still remain within the annual exclusion, by, for instance, giving property, or shares of property, that is conservatively valued. By using the gift annual exclusion, none of their unified credit is used up, so, if they wanted to, they could give $10,240,000 tax-free to their descendents in 2012, then continue giving the annual exclusion.
Lifetime Gift Exclusion
A tax liability is incurred for any gift with a value greater than the annual exclusion, but the law gives each donor a lifetime unified tax credit that allows at least $5 million worth of property to be given as a gift that is above the annual exclusion. However, the lifetime gift exemption is a unified credit that also applies to gifts from the donor's estate, and can also be used to offset the generation-skipping transfer tax. Any use of the unified credit to reduce any transfer taxes reduces the remaining lifetime credit available to offset the other transfer taxes. So that the IRS can keep track of the amount of gifts given that are above the annual exclusion amount, the donor of the gift must file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, even though no gift tax needs to be paid if the lifetime exclusion has not been exceeded.
For many years, the lifetime gift exclusion was $1,000,000 for the value of gifts above the annual exclusion amount over the lifetime of the donor. However, in 2010, the lifetime gift exclusion had been increased considerable and is now adjusted for inflation:
Example — Lifetime Gift Exclusion
In 2011, you give your daughter $5,013,000. You incur a tax liability for the $5,000,000 that is more than the annual exclusion, but you can use your unified tax credit to offset your liability, assuming that you have not used any of your credit previously. You must also file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return with your 2011 tax return. When you die, your entire estate will be subject to the estate tax since you used up all of your unified credit for the gift to your daughter.
Gifts Within 3 Years of Death Rule
Gifts made within 3 years of the decedent's death plus any gift taxes paid on these gifts are added to the estate.IRC §2035 This prevents tax avoidance strategies, such as giving a life insurance policy to beneficiaries when the death of the insured seems imminent; otherwise, the federal government would collect much less transference taxes because the value of a life insurance policy while the insured is still alive is always considerably less than the actual payout, which the beneficiaries, as the new owners of the policy, would receive tax-free.
Because both the gift and paid gift tax reduces the estate of the donor, the IRS includes any gift and the associated taxes paid within 3 years of the decedent's death as being part of the estate. However, credit is given for any gift taxes that were paid but added to the estate.
Gifts to Spouses
There is no gift tax on gifts to spouses who are United States citizens, but if the spouse is not a citizen, then there is an annual limitation, which is adjusted annually for inflation, on the amount that could be given tax-free:
When a United States citizen receives a gift from a foreigner, then the citizen must report the gift and pay the tax, if the total value of all gifts received from foreigners within one year is more than $13,258, which is adjusted annually for inflation. However, foreign gifts of payments made directly to a school for tuition or to a medical facility for the benefit of a United States citizen is exempted.
Gifts of Future Interests
A gift of a future interest in property is considered to be a gift, although for tax purposes, its value will be less since it only becomes possessory in the future. The gift tax is assessed on the present value of the future interest. Likewise, contingent future interests, or future interests subject to divestment, are still considered be property interests that can be transferred as a gift. However, the uncertainty of possession reduces its value below that of an unqualified future interest. Generally, the value of conditional future interests are equal to the present value of the interest multiplied by the probability that the event will happen, when it is ascertainable.
Value of Conditional Future Interest = Present Value of Interest × Probability of Contingent Event
However, unlike other gifts, most gifts of future interests in property do not qualify for the annual gift exclusion. If a minor receives a future interest in property then it may be considered to be a gift of a present interest and qualify for the annual gift exclusion if the following is true:
- the property and interest are given to the minor before the age of 21 for his benefit;
- the property and all income is given to the minor when the minor reaches 21;
- if the minor dies before then, all of the property is added to his estate. IRC 2503 (c).
Marital Property Settlements
Because the settlement of marital property rights during divorce is generally not for consideration, such transfers could be subject to federal gift tax. However, if the transfers of property interests are made pursuant to the terms of a written agreement between the spouses to settle their marital property rights or to provide support for children, then §2516 deems the transfers to be for adequate consideration if the divorce occurs within 2 years of the written agreement, even if the written agreement is not part of the divorce decree.
If the donor retains an interest in property held by a trust and the interest is mandatory, then there is no gift. If the interest is discretionary, then whether it is actually a gift or not depends on whether the discretion is governed by an ascertainable standard. If the trustee's discretion is governed by an express ascertainable standard, then no gift is made for gift tax purposes, since a gift must be gratuitous. However, in most jurisdictions, even if the trustee has absolute discretion it is still not considered to be a gift if creditors of the settlor can force the trustee to exercise his discretion in favor of the creditors, although in a few jurisdictions, discretion that has no express standard would be considered to be a gift for gift tax purposes.
A special type of trust, called a Crummey trust, allows a wealthy grantor to transfer the proceeds of a life insurance policy to an irrevocable life insurance trust so that it is not included in the grantor's estate, where it would be subject to estate tax. The premiums of the life insurance policy are paid by the trust with money received from the grantor, which are considered to be gifts to each of the beneficiaries by allowing them to withdraw the gift within a short time of its deposit in the trust — which is called a Crummey withdrawal right. The Crummey withdrawal right allows a gift to be considered to be one of present interest and therefore eligible for the annual gift exclusion for each beneficiary. The beneficiaries are expected not to withdraw the money so that it could be used to pay the premiums on the life insurance policy, the proceeds of which will be paid to them when the grantor dies, free of estate taxes.
Transferences That Are Not Subject to Gift Tax
Because the gift tax and estate tax apply to different property, to avoid double taxation, any property subject to the gift tax is not subject to the estate tax, and vice versa.
Gifts are any property given by the donor during his lifetime, where the donor has not received adequate consideration for the gift. Hence, business transactions between unrelated parties are not generally considered to be gifts, but transactions between related parties may be suspect.
Also excluded are payments for the education or medical expenses for another if they are paid directly to the provider of the services and not to the donee. IRC §2503(e)
There is also a marital deduction which allows a spouse to give an unlimited number of gifts with unlimited value to the other spouse – whether inter vivos or testamentary – incurring neither the gift nor estate tax. The marital deduction is allowed since the U.S. government expects that the value of the property will be included in the spouse's estate when she dies, which is why if the spouse is not a U.S. citizen, then only $60,000 of property qualifies for the marital deduction.
Also excluded from the gift tax are the following:
- gifts to charities;
- payments satisfying an obligation of support, which is determined by state law;
- transfers to political organizations.
Filing Form 709, United States Gift Tax Return
For any gift for which there is a gift tax liability or for any split gift, the donor must file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return with his tax return, even if no gift tax is due.
Additional documents that must be attached include:
- copies of appraisals of the gift property,
- copies of relevant documents regarding the transfer,
- documentation of any unusual items shown on the return, including partially-gifted assets, or other items relevant to the transfer that may affect tax liability.
The IRS usually audits gifts when it audits estate tax returns. If it disallows any gifts, then it will assess gift taxes, interest, and penalties.
Gift Taxes of Other Countries
Although most other countries tax gifts, the law concerning gifts varies widely. Below are a few examples:
- Australia, Canada, and New Zealand do not have gift taxes.
- Most countries tax the donor of gifts, but in India, the recipient is taxed.
- Germany taxes gifts between spouses.
- Norway, Portugal, Spain, and Switzerland do not apply the gift tax to gifts to spouses and children.
- England subjects gifts to an inheritance tax if the donor dies within 7 years of giving the gift at a tax rate that is inversely proportional to the length of time that the donor survives after giving the gift; otherwise no gift tax is due. A donor can also give a gift of any amount to anyone free of tax if the gift comes from earned income that is over the amount necessary to pay basic living expenses. For instance, if someone earns £30,000 pounds annually but requires only £10,000 to live, then the worker can give £20,000 annually to anyone. Parents of the bride or groom can give £5000 to their child as a wedding gift; grandparents can give £2500 and anyone else can give £1000.
- If the gift is property that can appreciate, then either the donor or the recipient may be liable for capital gains tax when the property is sold.
- Many countries also tax conditional gifts, which are gifts that are completed only if specific conditions are satisfied. Conditional gifts are often considered to be the property of the donor, since the donor has not relinquished complete control of the gift.
Gift-tax Saving Tips
- If property has already appreciated significantly, then it is better to leave it as part of the estate, since it will receive a stepped-up basis.
- Give rapidly appreciating property to beneficiaries at the beginning of the year so that the appreciation is not included in the value of the gift.
- For charities, give at the end of the year so that you can enjoy the income from the property until the very last moment.
- The federal gift tax is governed by Title 26, Subtitle B, Chapter 12 of the Internal Revenue Code: §§2501 – 2524.
- History, Present Law, And Analysis Of The Federal Wealth Transfer Tax System - Scheduled for a Public Hearing Before the SENATE COMMITTEE ON FINANCE on November 14, 2007 — Prepared by the Staff of the JOINT COMMITTEE ON TAXATION
Gift Tax Statistics
- SOI Tax Stats - Total Gifts of Donor, Total Gifts, Deductions, Credits, and Net Gift Tax
- 2007 Gifts - This article describes gifts made during calendar year 2007. There were a total of 257,485 gift tax returns filed in 2008. 247,932 returns, or 96.3 percent, were nontaxable. The remaining 9,553 (3.7 percent) were taxable.
- Wealth Transfers, 2005 Gifts - This article describes gifts made during calendar year 2005. A total of $38.5 billion in assets was transferred from donors to donees, or gift recipients. Only 2.9 percent of returns were taxable, with $1.7 billion in gift tax liability reported.
- Inter Vivos Wealth Transfers, 1997 Gifts - This article describes gifts made during calendar year 1997. Like transfers of wealth at death, wealth transfers during life—called inter vivos wealth transfers—are subject to Federal taxation. Only individual gifts in excess of $10,000 were potentially taxable for Gift Year 1997.