Timothy J. Erasmi, Esq. – Virtual Estate Attorney

When do you Pay a Gift Tax?

gift tax

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.

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