Thursday, April 20, 2017

Overview of Gifting Rules and Strategies


Even though the federal estate and gift tax exclusion is high enough to discourage many people from gifting solely for tax purposes, I still receive numerous gift tax questions.  So, gifting is not usually utilized as a strategy for minimizing potential estate tax at death.  However, many people accumulate significant amounts of property, both tangible and intangible, as well as cash during life.  Among the common estate planning goals of many clients is a desire to preserve that accumulated wealth during life, as well as transfer ownership interests in family businesses to other family members before death as a supplement to property transfers occurring at death. 

Today’s post examines the basic rules surrounding the gifting of property during life and some common gift planning strategies.

Present Interest Annual Exclusion

The present interest annual exclusion is a key component of the federal gift tax.  For gifts made in 2017, the exclusion is $14,000 per donee. That means that a donor can make cumulative gifts of up to $14,000 (in cash or an equivalent amount of property) to as many donees as desired without triggering any gift tax, and without any need to file Form 709 – the federal gift tax return.  Because the exclusion “renews” each year and is not limited by the number of potential donees, but only the amount of the donor’s funds and interest in making gifts, the exclusion can be a key estate planning tool.  Used wisely, the exclusion can facilitate the passage of significant value to others (typically family members) pre-death to aid in the succession of a family business or a reduction in the potential size of the donor’s taxable estate, or both.

But, to qualify for the exclusion, the gift must be a gift of a present interest – the exclusion does not apply to future interests.  A present interest is an “unrestricted right to immediate use, possession, or enjoyment or property or the income from the property.  Treas. Reg. §25.2502-3(b). A remainder interest, for example, would be a future interest. 

There’s a special rule that comes into play for gifts made by spouses.  They can elect “split gift” treatment regardless of which spouse actually owns the gifted property, if certain conditions are satisfied and the spouses consent to gift splitting treatment.  They are simply treated as owning the property equally.  This allows gifts of up to $28,000 per donee annually.  So, as an example, let’s say that Mom and Dad have 4 children and 5 (unmarried) grandchildren.  Also assume that each child has a spouse.  That makes 13 persons that Mom and Dad could make annual exclusion gifts to without triggering the need to file a federal gift tax return.  That would be 13 present interest annual exclusion gifts of $14,000 each for Mom and Dad - $182,000 each, annually.  In addition, if those gifts are of interests in a closely held business, discounting those interests for lack of marketability and minority interest could leverage those present interest gifts and increase the total amount that can be given gift-tax free by another 30 percent or so.

There is also a special rule that allows for the direct payment of certain educational and medical expenses.  Under the rule, these transfers are not even deemed to be gifts.  Thus, the limitation of the present interest annual exclusion does not apply to those gifts. 

“Coupled Estate and Gift Tax Systems”

The estate and gift tax systems are “unified.”  The unified credit $2,141,800 (for 2017) offsets lifetime taxable gifts of $5.49 million or a taxable estate of $5.49 million.    The unification or “coupling” of the estate and gift tax systems create tremendous opportunities for higher net worth individuals and families to leverage the $5.49 million exemption equivalent of the unified credit through lifetime gifting.  Present interest annual exclusion gifts do not count against the lifetime $5.49 million limitation.

Valuation of Gifts

It’s also necessary to know the value of the property at the time of the gift. The donor needs this information to determine whether the gift exceeds the $14,000 annual exclusion amount and, if so, the amount to report on Form 709 that will be required to be filed.  The recipient of the gift may also need this information to determine whether a deduction is available if the property is later sold at a loss. Gifts are valued for gift tax purposes at their fair market value as of the time of the gift.  I.R.C. §2512.  Fair market value is defined as “the price at which the property would change hands between a [hypothetical] willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”  Treas. Reg. 20.2031-1(b).  As noted above, discounts from fair market value can be recognized for interests in closely-held entities that are minority interests and/or lack marketability, as well as fractional interests in real estate.

Generation-Skipping Transfer Tax (GSTT) Implications.

The GSTT is imposed on both outright gifts and transfers in trust to or for the benefit of related persons that are more than a generation younger than the donor, or unrelated persons who are more than 37.5 years younger than the donor. The GSTT is imposed only if the transfer avoids incurring a gift or estate tax at each generation level. For 2017, each individual has a $5.49 million exemption from the GSTT.  With respect to split gifts made during a calendar year, each spouse is treated as the transferor for GSTT purposes of one-half of all gifts eligible for gift-splitting.  Thus, each spouse can allocate their GSTT exemption to one-half of each gift that is split.

True” Gifts

A gift of income-producing property does not trigger income in the hands of the donee to the extent the gifts are true gifts.  But, income tax cannot be avoided, for example, on money or other property received in exchange for services. 

Income-Producing Property

The recipient of a gift of income-producing property must report any income that the property produces after the gifted property is received.  For example, a gift of stock would require the recipient of the stock to report any dividends paid on the stock after the gift.  Gifts of income-producing property can also be used to shift the income from the property to other family members that are in a lower tax bracket. 

Sometimes a gift of income producing property is made in the form of interests in a business entity as part of an overall family estate and succession plan.  If the entity owns only non-income producing property (such as vacant real estate) another potential problem arises in that the gifted property may not qualify for the present interest annual exclusion if it is determined to not be a gift of a present interest.

Income Tax Basis and Holding Period

Now, there’s a potentially major drawback to gifting.  If the gift consists of property other than cash, the basis and holding period of the property in the hands of the donee is the same as it was in the hands of the donor.  I.R.C. §1015.   It’s important for the recipient to know when the donor acquired the property, the cost of the property, and any other information that would affect the property’s basis. Ideally, the recipient of the gift should also receive records that will provide adequate proof of these facts.  So, while gifts of property during the donor’s lifetime will remove the gifted property from the donor’s estate computation, the gift also removes the ability to obtain a stepped-up basis on that property.  Measuring estate tax savings against the tax implications of reduced basis step-up is an important part of the overall planning process.  With the coupled estate and gift tax exclusion at $5.49 million for 2017, the basic plan for many people would be to hold the property until death to achieve a basis step-up.  The tax savings for the heirs that might later sell the property will often outweigh that estate tax cost of having the property included in the estate.


The change in the rules governing the transfer tax system a few years ago has significantly changed gifting strategies.  While there still remain significant income tax incentives to gifting, the transfer tax system rules indicate to many people that it may be better to not gift property and thereby cause it to be included in the estate at death where the exclusion will prevent it from being subject to federal estate tax.  By causing the property to be include in the estate will result in a basis step-up equal to the fair market value of the property as of the date of death.

When considering gifting assets or doing significant estate planning, make sure to consult professionals for assistance.

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