You Can Look that Gift Horse in the Mouth, and Also Owe the Tax Man

By Frank S. Macgill, published on March 5, 2005, in Savannah Morning News.

Most of us think we know a gift when we see it. It comes colorfully wrapped and tied up with a bow. However when it comes to gifts for federal gift tax purposes, sometimes a gift can mean more (or less) than we would expect.

For tax purposes, a gift is a transfer of money or property without consideration or compensation in return. Gifts are subject to federal gift taxes at marginal rates of up to 47 percent, with important exceptions:

First, annual gifts of $11,000 or less per recipient are not subject to federal gift taxes. These are referred to as “annual exclusion gifts.”

A donor may make annual exclusion gifts to an unlimited number of recipients in any year provided that the total of gifts to any single recipient does not exceed $11,000 per year.

Second, gifts between spouses are not subject to federal gift taxes.

Finally, gifts that exceed or otherwise do not qualify for the annual exclusion will be covered by an individual’s lifetime gift tax exemption amount, which is presently capped at $1 million.

Thus, gifts that qualify for the annual exclusion and gifts to a spouse are completely excluded from federal gift taxes.
Other gifts up to $1 million may be covered by the lifetime gift tax exemption (with the result that no gift tax will be due). However, to the extent the gift tax exemption is used to cover lifetime gifts it reduces dollar for dollar the donor’s estate tax exclusion available at death.

Certain provisions of the tax law also provide that gifts in the form of a direct payment of tuition and fees to qualifying educational institutions are fully excluded from federal gift taxes regardless of the amount.

Thus, a parent may pay tuition directly to a child’s or grandchild’s college without running afoul of the $11,000 per year annual exclusion limitation. A similar rule applies to direct payments of certain medical expenses.

Although these payments are technically a gift for the benefit of the recipient, if the check is made directly to the school or medical facility it is not a taxable gift.

While gifts of cash or property directly to an individual are easy to identify, sometimes a potentially taxable gift lurks hidden in a seemingly benign transaction.

For example, a mother creating a trust for the benefit of her daughter may transfer property to a trustee under a written trust agreement. The trustee is charged with administering the property for the benefit of the daughter.

Is there a gift, and if so, to whom?

For federal gift tax purposes, the contribution of property to the trustee may be considered a potentially taxable gift for the benefit of the daughter.

Gifts in trust present a unique problem in that not all gifts in trust qualify for the $11,000 annual exclusion. Thus, a gift of any size in trust may consume all or part of a donor’s lifetime gift exemption and/or result in tax.

To avoid this adverse result, donors frequently employ a technique that allows a trust beneficiary a limited right to withdraw the gift from the trust in a manner which qualifies the gift for the donor’s $11,000 annual exclusion.

These creative withdrawal rights are often referred to as “Crummey powers” based on the name of the taxpayer whose tax court case legitimized their use. The tax law also provides other types of trusts for “annual exclusion” gifting, but only if the trust meets specified requirements.

Another hidden gift can occur when real property is titled in the name of more than one owner.

For example, if a father buys a vacation cabin and, at closing, takes title in his name and his son’s name as joint owners, he has made a gift of one-half of the property to his son.

Depending on the circumstances, the gift may qualify for the annual exclusion. Any excess will be applied against the father’s lifetime gift tax exemption and/or may even result in tax if the value of the interest exceeds the $1.0 million lifetime cap.

A married donor may make an annual exclusion gift of $22,000 (double the regular $11,000 amount) if his or her spouse elects to treat the gift as being made to the donor and by the donor’s spouse. This election is made by filing a federal gift tax return electing to “split the gift” to his or her spouse.

However, a spouse electing to split a gift may be precluded from making his or her own annual exclusion gift to the same recipient.

With the exception of gifts between spouses and annual exclusion gifts, donors are required to file federal gift tax returns to report the value of taxable gifts made during the year.

If the gift is less than the donor’s available lifetime gift exemption, no taxes will be due. If the gift exceeds the available gift exemption, then gift taxes will be due.

Under current law, the federal gift tax rate is scheduled to decline to 35 percent in 2010, although the lifetime gift exemption amount will remain fixed at $1 million.

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Frank S. Macgill is the managing partner at HunterMaclean in Savannah. His practice focuses on trusts and estates, taxation, tax-exempt organizations and corporate law. He can be reached at 912-236-0261 or fmacgill@huntermaclean.com.