Introduction
The federal gift tax (Form 706)
is one of the most misunderstood sections of the tax code for nonlawyers. While
many are aware of the annual
exclusion ($16,000 for 2022), they often mistakenly believe that any amount
gifted exceeding the annual exclusion will result in a gift tax being due. However,
taxable gifts are first deducted from the taxpayer’s lifetime
estate and gift tax exemption (12.06 million for 2022), and only once an
individual has exhausted their lifetime exemption will they have to pay a gift
tax. Therefore, while there is a filing requirement for any calendar year in
which a taxpayer gifts to another individual in excess of the annual exclusion,
a gift tax will only be payable if the taxpayer has exhausted the entirety of
their lifetime exemption.
Many readers may have already
dismissed the gift tax as inapplicable to them because of the large lifetime
exemption. However, there are many reasons why taxpayers whose net worth is
well below the lifetime exemption may need to file a gift tax return.
Why do People File Gift Tax Returns?
First, filing a gift tax return is
required in order for any gift to be deemed “completed”
for tax purposes. A gift would need to be completed in order for the amount to
be deductible from the taxpayer’s estate size for estate tax purposes. Thus,
gift tax filings are common in the Massachusetts estate planning field because
the state estate tax
exemption is set at only one million dollars and many taxpayers utilize
gifting in order to reduce their estate size.
Second, the lifetime exemption is
liable to change before a taxpayer’s eventually death. Therefore, while it is
true that the exemption is 12.06 million in 2022 currently
set to sunset to 5 million adjusted for inflation in 2026; Congress has the
power to change the exemption to a lower amount at any time. Indeed, bills have
recently been introduced to Congress which purpose to lower the lifetime
exemption to as little as one million dollars. Thus, taxpayers with a net worth
in excess of one million dollars need to be cognizant of the correlation
between gift, estate, and capital gains taxes when executing their retirement
and estate planning.
Finally, filing a gift tax return
starts the toll on the three-year
statutory period during which the IRS may contest the validity of the gift.
After the statutory period has expired, the IRS can no longer challenge the
validity of the gift, unless the IRS shows that there was some form of material
misrepresentation on the tax return. In certain circumstances it can be
extremely important for a taxpayer to file the gift tax return in the taxable
year that the gift occurred so that the IRS does not attempt to contest the
transaction at the time of estate tax filing, at which time it will be too late
to try to make adjustments to the gift so that the IRS will deem it valid.
Does Intent Matter?
Many
clients will think that donative intent is required in order for a transaction
to be a gift for tax purposes. However, while it is true that donative intent
is a required element at common law; intent is not required when it comes to
the tax code. Indeed, the code clearly
states that donative intent is not a prerequisite for a transfer to be
considered a gift. Furthermore, the US Supreme Court ruled in Dickman v.
Commissioner, 465 U.S. 330 (1984) that interest free loans of less than $10,000
constituted a taxable gift. Finally, even indirect transfers of wealth can be
considered a gift, such
as forgiveness of a debt or the assignment of benefits of an insurance policy.
Conclusion
While there
are few taxpayers who need to pay a gift tax; there are many who will need to file
a Form 709 as a part of their estate plan.
The Form 709 is essential for irrevocable
trusts designed to minimize estate tax exposure in Massachusetts.
Furthermore, the 709 may be necessary for larger estates wishing to plan for an
eventual minimization of the lifetime exemption, or families wishing to gift closely
held business interests to the next generation at a discounted rate. Regardless,
you should consult your accountant, financial advisor and estate planning
attorney before making any taxable gift over the annual exclusion in a calendar
year.
