By: David F. Bacon
It is always best to start the discussion of any topic by first defining the terms to be discussed.
What is a gift?
A gift is the transfer of any asset from one person to another for less than adequate compensation.
A gift contemplates the surrender of the original owner’s control of the asset to another person or entity.
Are taxes generated by the making a gift?
It is best to start with the initial rule that all gifts are taxable.
Who pays the tax caused by a gift?
The person making the gift is referred to as the Donor of the gift. The person receiving the gift is referred to as the Donee of the gift. Gifts are never taxed as income to the Donee. If there is a gift tax generated by the making of a gift, it is paid by the person making the gift, the Donor.
Is the gift tax a federal tax or a state tax?
The gift tax is a federal tax and is governed by federal tax law.
Are there any exceptions to the rule that all gifts are taxable?
The answer is yes. There are several exceptions.
ANNUAL GIFT EXCLUSION
The first exception is often referred to as the annual gift exclusion amount. The federal gift tax rules currently provide that any person may give an amount not exceeding $14,000 (and as annually and federally adjusted) to any other person once each year. Gifts of this amount or less are excluded from the payment of any federal gift tax. There is no limit as to the number of persons to whom annual exclusion gifts may be made in any one year.
If a donor is married, he or she may give twice the annual exclusion amount ($28,000) to a donee using his own and the spouse’s annual gift exclusion amount and all the assets comprising the gift may be made from one spouse. However, in no event can a married couple give an amount in excess of $28,000 to any one individual in any one year and use their annual gift exclusion amount as an exception to shield the gift from gift tax.
Is this $14,000 amount comprising the annual gift exclusion subject to change?
The answer is yes. From time to time the annual gift exclusion amount is recalculated by the taxing authorities and has historically been adjusted slightly upward. The amount of the exclusion does not change until this adjusted figure has climbed by at least one thousand dollars. Accordingly, when the annual exclusion amount has reached $15,000 the annual gift exclusion should adjust accordingly.
Are there any rules to which a gift utilizing the annual gift exclusion must comply before the Donor is eligible to use this exception?
The answer is yes. In order to qualify for this gift tax exception the gift in question must have been made absolutely which means subject to no restrictions whatsoever. If there is a restriction made on the gift, such as, “Here is $14,000, son. You can do whatever you want with the money, but you can’t buy a car with it,” then in that event the gift would not qualify for the annual gift tax exclusion exception rule. The gift would still have been made, but the gift unless otherwise covered by another exception to the gift tax would be taxable to the Donor.
Are there any exceptions to the requirement that gifts be absolute in order to qualify for the annual gift tax exclusion?
The answer is yes. Gifts may be made to minors (those persons under legal age or the age as set by State statute for this particular exception) under the Uniform Gift to Minors Act. This federal legislation allows Donors to place restrictions on gifts to minors and still qualify for the annual gift exclusion exception. When the minor reaches the age of majority these restrictions are removed and the Donee of the gift is thereafter free to do whatever it is that he or she desires with the gift.
If a gift is made of $14,000 or less to any one person is the Donor required to file a gift tax return?
The answer is no. There is no requirement that a gift tax return be filed by the Donor for gifts of $14,000 or less to any one person.
LIFETIME GIFT EXCLUSION
Are there other exceptions to the gift tax in addition to the annual exclusion amount just discussed?
The answer is yes. In addition to each person’s ability to make any number of annual gift exclusion amount gifts to Donees each year every under current federal gift tax laws a Donor may over the course of his or her lifetime make gifts in an aggregated amount which amount [currently] shall not exceed five million dollars.
Gifts utilizing the Donor’s million dollar lifetime credit must be reported in a federal gift tax filing (Federal Gift tax form 709) on or before April 15th of the year succeeding the year in which the gift was made.
ESTATE TAX INCLUSION
I understand that I may currently die leaving an estate of not more than five million dollars before I am required to pay federal estate tax upon my death. Is this lifetime gift tax credit in addition to my five million dollar federal estate tax credit, or a part of it?
The gift tax credit during lifetime is currently part of and tied to the estate tax exclusion amount available at death. Accordingly if you have used your lifetime credit against the gift tax to make gifts during your lifetime and not pay gift tax, your remaining estate tax credit amount at your death will be reduced accordingly.
Are these gift and estate tax credit figures subject to change?
The answer is yes. The federal government is constantly changing the rules regarding gift and estate tax credits and exclusion amounts. Prior to any estate or gift tax planning strategies are undertaken a qualified estate and gift tax professional should be engaged to review the current rules and regulations and the probable tax effects of gifting.
INCOME TAX CONSEQUENCES
Are there tax consequences in gifting in addition to potential gift tax consequences?
The answer is yes. There is an additional potential income tax consequence which arises upon the sale of an asset which was received as a gift by the Seller.
It is important to understand that both the gift tax and the estate tax are essentially taxes on the appreciated value of an asset which taxes are calculated and assessed upon the transfer of the asset.
The goal of both the gift and the estate tax is to calculate the appreciation of an asset and tax this appreciation upon transfer once in every generation. For purposes of determining what defines a generation, husbands and wives for the purposes of these taxes are always considered to be the same generation. Accordingly gift and estate taxes are never assessed on assets transferred between spouses who are both United States citizens either during their lifetime or upon their death.
In a compensated transfer of an asset (sale) a commercially reasonable sale price determines the value of the asset. The Seller is required in his income tax accounting for the year of the sale to determine his basis in the sold asset (usually this figure is the seller’s acquisition price). This basis figure is subtracted from the sale price and the taxable gain from the sale is calculated. The gain is ordinary income unless the Seller is able to apply the capital gains income tax rate upon the realized profit in which case the tax is reduced accordingly. The purchaser of the asset has his purchase price of the asset which will determine his basis should he ever sell the asset.
A gift of an asset to any person other than a spouse results in a transfer of an appreciated asset to a person in another generation. As previously stated, gifts are never income to the donee. Accordingly no transfer tax is assessed upon the making of a gift. However a transfer of an appreciated asset to someone in another generation has occurred and the taxing authorities have been unable to collect their tax on the appreciation upon this transfer. Accordingly this situation is addressed by requiring the Donee of the gifted asset to use the basis in the asset of the Donor who gave the gift to him upon the Donee’s subsequent sale of the gifted asset.
By way of example; a father has ten acres of land he purchased for a thousand dollars an acre. Each of these acres is now worth $14,000. The father now wishes to use his annual exclusion credit (currently $14,000) to give some of this acreage to his son. The father’s gift tax consequences are determined by the current value of the asset upon the date of the gift. Accordingly the father can give the son one acre and use his annual exclusion credit to shelter the gift from the payment of any gift tax.
The receipt of the acre as a gift is not income taxable to the son as gifts are never income taxed to the Donees.
However, if the son thereafter elects to sell this acre for $15,000, he will not use the value of the asset on the day he received it ($14,000) as his basis in calculating his taxable gain realized by the sale. As the son received the acre as a gift he will instead be required to use his father’s basis in the property as his basis for purposes of calculating his taxable gain on the sale. In this example the sale price would be $15,000. The basis of the son in the acre is the father’s basis of $1,000 and the taxable gain would be $14,000.
For this reason when a gift of an appreciated asset is made to a Donee, the Donor and the Donee should pay close attention to the Donor’s basis in the gifted asset and contemplate in advance the income tax consequences of the Donee of the asset upon a subsequent sale.
Assets passing by reason of death under current estate tax laws are stepped up to market value prior to being exposed to any applicable estate tax laws. Accordingly beneficiaries of assets from a decedent’s estate have their basis in the asset established by the decedent’s date of death value in the asset. This is referred to as a step up in basis.
This article was written by David F. Bacon, Attorney licensed in Ohio and Florida. David Bacon, Jeffrey Roth, and Jessica Moon are members in the law firm of Roth and Bacon Attorneys, LLC. Their Offices are located in Upper Sandusky, Marion, and Port Clinton, Ohio, and Fort Myers, Florida. They have focused their practice to provide estate and business planning concepts to their clients. Nothing in this article is intended for, nor should be relied upon as individual legal advice. The purpose of this article is to help educate the public on concepts of law as they pertain to estate and business planning.
Copyright @ David F. Bacon 2012.