Sunday, December 20, 2020
Federal estate and gift tax planning changed significantly starting in 2013 due to changes in the law. Since then, gifting has become less important for many because of the significant increase in the federal estate and gift tax unified credit. The exemption equivalent of that credit offsets $11.58 million in federal estate tax for death and gifts made in 2020. With the “stepped-up” basis rule of I.R.C. §1014, most people find it advantageous to not make gifts of property during life and hold the property until death where it will be taxed in the estate but covered by the exclusion and receive a date-of-death fair market value basis in the hands of the heir(s). There is also the option to make annual cumulative gifts of up to $15,000 (for 2020 and 2021) in cash or property value to a donee.
But what constitutes a gift? The answer to that question may not be as simple as it might seem.
When is a transfer of property a completed gift for federal gift tax purposes? It’s the topic of today’s post.
Dominion or Control
Generally, the ownership or possession of property is not necessary to make a gift. The measuring stick for the imposition of federal gift tax is not a change in ownership. Rather, it is the relinquishment of dominion and control. Treas. Reg. §25.2511-2(b). This rule applies to outright transfers as well as to transfers in trust. Any resulting gift tax is the primary and personal liability of the donor in the amount of the value of the property that passes from the donor to the done, regardless of whether the donee is known and ascertainable at the time of the transfer. Treas. Reg. §25. 2511-2(a).
The notion that a change in ownership is not necessary to trigger gift tax is, perhaps, best illustrated with a transfer in trust. With respect to a trust, a trustee (rather than a beneficiary) owns assets, but a beneficiary can be the one that makes a gift. Examples of this include the beneficiary releasing a lifetime general power of appointment (such as a Crummey right. See Crummey et al. v. Comr., 392 F.2d 87 (9th Cir 1968)), or allowing the power to lapse. A gift may also result from the beneficiary making a transfer a beneficial interest in trust (e.g., signing a non-judicial settlement agreement that modifies a trust). A gift can also result where a beneficiary has the right to receive all of the income of a trust coupled with a lifetime special power of appointment and exercises that power of appointment. The exercise of the power constitutes a gift of the income interest. This is another illustration of how a taxable gift can be made of an asset that the donor does not own, at least on paper. The point is that when the overall property rights give a taxpayer dominion and control over those property rights, a transfer of those rights will be a taxable transfer for gift tax purposes.
The main power that allows a person to avoid the types of gifts mentioned above is known as a disclaimer. A disclaimer is simply the right of the holder of the power to say “no” to the receipt of a beneficial interest or a power of appointment so long as certain requirements are satisfied. I.R.C. §2518. If the requirements are met, the disclaimer is known as a “qualified disclaimer” and the act of disclaiming would not be a gift for gift tax purposes. I.R.C. §2518(a)-(b). A qualified disclaimer is defined as an irrevocable and unqualified refusal by a person to accept an interest in property but only if the refusal is in writing and the writing is received by the transferor of the interest not later than the date that is nine months after the later of the date of the transfer or the day on which the person attains age 21. Also, the disclaimant must not have accepted any of the benefits of the property and, as a result of the refusal, the interest must pass without any direction on the disclaimant’s part. I.R.C. §2518(b).
Thus, if a beneficiary of property does not accept the benefits or dominion or control of the property and, as a result, the property passes without the beneficiary’s direction, a qualified disclaimer has been made. In that instance, the beneficiary is treated as being deceased before the initial transfer so that the beneficiary can never have dominion or control or the ability to direct how the property is to pass. But remember, there is a time limit governing a qualified disclaimer. Nine or fewer months must have passed since the initial transfer or, if later, since the beneficiary attained the age of 21.
Recent IRS Memo
Recently, the Chief Counsel Office of the IRS issued a Memorandum illustrates these principles in the context of a Foundation. In CCA 202045011 (Jun. 10, 2020), the taxpayer was a U.S. resident and was the primary beneficiary of a foreign Foundation. The Board of the Foundation resolved to transfer the remaining Foundation assets to the taxpayer. U.S. citizens and residents are subject to U.S. federal gift tax on worldwide assets – including accounts that might be of a foreign foundation in another country but, nonetheless, might be subject to U.S. gift tax.
The taxpayer, after receiving notice from the Board, gave written instructions to the Board to send the funds the Foundation’s account denoted as “Bank 1 Account” to “Bank 2 Account.” The taxpayer did not own “Ban 2 Account” and couldn’t withdraw the funds once there were in the account. Instead, the funds contained in “Bank 2 Account” belonged to other beneficiaries. The IRS concluded that, as a result of the Board’s resolution, the minute that resolution hit, the taxpayer had dominion and control over the Foundation’s account – Bank 1 Account. Thus, as a result, once the taxpayer directed the Board to send those assets to Bank 2 Account, the direction amounted to a release of dominion and control by the taxpayer over the Bank 1 Account constituting a taxable gift. In addition, since the transfer was at the direction of the taxpayer, it wasn’t a qualified disclaimer. As noted above, a qualified disclaimer requires the disclaimed property to transfer without the disclaimant’s direction. Also, even though it was a foreign account, the U.S. resident had U.S. gift tax on that foreign account.
But the point remains – federal gift tax is not necessarily driven by a change of ownership, instead it is driven by the relinquishment of dominion and control.
Federal gift tax is triggered on the release of dominion and control over property. That can be a distinct concept from that of a change of ownership. It’s a sometimes subtle difference, but a difference with a distinction. While the tax consequence of gifting isn’t that big of a tax issue for very many given the current exemption level, that could change if the political winds change in the future and the applicable exemption for the coupled federal estate and gift tax systems decreases. It could also become a bigger issue if the stepped-up basis rule is eliminated and/or estate and gift tax rates change.