When Making Those Gifts It’s Very Important To Properly Report Them

By: Randall A. Denha, Esq.

It’s usually this time of year that I receive requests from clients for the gifting of assets to various family members or trusts for their benefit. Oftentimes, the client understands that once the gift is made that there is additional work left to do.  From updating corporate records to providing appropriate notices to tax filings, there is work left to be done.  However, not all clients want to provide the requisite follow-up and would prefer to bend the rules, especially in the area of adequate gift tax reporting. Failure to follow the rules for reporting gifts could result in the IRS imposing gift taxes years later.

Currently, the annual gift tax exclusion amount is $15,000 per person per year (and doubled if married.) This represents the maximum amount that can be given on an annual basis without diminishing the lifetime exclusion amount, which currently is $11,180,000 for 2018. It also represents the maximum amount that can be given without triggering the need to file a gift tax return. To illustrate how it works, suppose you have three adult children and seven grandchildren. In 2018, you could give each family member $15,000 — for a grand total of $150,000 — without owing any gift tax. The annual gift exclusion is available to each taxpayer. If you’re married and your spouse consents to a joint gift — also called a “split gift” — the annual exclusion amount is effectively doubled to $30,000 per recipient for 2018. So, in the previous example, a married couple with ten family members could gift up to $300,000 in 2018 completely exempt from gift tax.

More specifically, if the combined fair market value of all gifts in a year to any one person is $15,000 or less, most gifts need not be reported on a federal gift tax return. To qualify, such unreportable gifts must have a “present interest,” generally meaning that the donee must have the unrestricted right to the immediate use, possession, or enjoyment of the gifted property. Gifts in trust often run afoul of the present interest requirement, mandating special reporting rules. Gifts in trust can include transfers to insurance trusts (ILITs), spousal lifetime access trusts (SLATs), grantor retained annuity trusts (GRATs) or an irrevocable gift trust for children or grandchildren, to name a few.

In addition, if you gift an amount that’s above the annual gift tax exclusion, you can also tap into the lifetime estate and gift tax exemption. The lifetime exclusion amount effectively shelters from tax $11.18 million, indexed for inflation. However, if you tap into the lifetime exclusion amount, it erodes the estate tax exemption amount that would be available when you die.

For instance, suppose an unmarried individual gives gifts to family members valued at $1,150,000 in 2018. After the annual gift tax exclusion is applied to $150,000 of gifts, the lifetime exemption can shelter the remaining $1 million from gift tax. That leaves an available estate tax exemption of $10.18 million if the individual dies in 2018 (assuming the decedent hadn’t ever tapped into his or her lifetime exemption in a previous year).

Gift Tax Return Required

A gift tax return is required if you individually exceed the annual gift tax exclusion amount or a joint gift with your spouse collectively exceeds the amount. For the latter, each spouse must file an individual gift tax return for the year in which they both make gifts.

The deadline for gift tax returns is April 15 of the year following the year of the gift, the same as the due date for personal income tax returns. (The deadline is moved to the next business day if it falls on a weekend or holiday.) So, for gifts made in 2018, you must file a gift tax return by April 17, 2019. However, if you extend your federal income tax filing to October 15, 2019, the extension also applies to your gift tax return.

If it is a gift of cash or publicly traded securities, the donors should simply keep in their records documentation of the donee, date of gift, and the value. A copy of a cancelled check, bank statement, or investment statement will suffice.

If the gift consists of real estate, a closely held business interest, or tangible personal property, additional documentation is strongly recommended because those assets generally do not have a readily accessible market value, and the IRS could challenge at any time the taxpayer’s opinion of value. In such instances, the taxpayer’s best defense is a strong offense. Such a strategy would entail filing a gift tax return with appropriate documentation supporting the value of the gift. By filing the return with adequate disclosure, the statute of limitations period begins to run, thereby limiting the time during which the IRS can question values. If the taxpayer chooses not to file a return for such gifts, the taxpayer should retain thorough documentation of the gift and its value indefinitely. Such documentation may include appraisals, business valuations and/or financial statements for business interests.

Many clients file no gift tax returns if they believe they owe no gift tax. This is either the result of bad advice, the feeling that no gift tax is owed because of an artificially low value based on a tax payer estimate or one arrived at by a non-qualified appraiser or a feeling that the IRS will not discover it.

Valuation

For a gift of cash, the value of the gift is obvious. If the gift is marketable securities, the fair market value (FMV) per share or bond is the mean between the highest and lowest quoted selling prices on the date of the gift. 

If the gift is an asset for which there is no ready market, its FMV is the amount that a willing purchaser would pay to a willing seller for the asset, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.  When at all possible, the donor should determine the value of these gifts through a qualified appraisal issued by a qualified appraiser.  Many taxpayers fall short in this area and it may prove problematic at a later time.

It is very important for the donor to adequately disclose each gift on Form 709 because the three-year limitation on the period of assessment does not begin to run unless and until the gift is adequately disclosed on a gift tax return. Adequate disclosure generally prevents revaluation of gifts for both gift and estate tax purposes after the three years have elapsed (regardless of whether gift tax was paid or the transfer was reported as a non-gift).  In general, adequate disclosure requires:

• Description of transferred property and any consideration received;
• Identity of and relationship between the parties;
• If applicable, the trust’s taxpayer identification number and description of its terms or a copy of the trust agreement;
• Description of the method used to determine the property’s FMV, including any discounts taken, or an appraisal; and
• If applicable, an explanation as to why the transfer is not a gift. 

If any valuation discount (i.e. for lack of control or lack of marketability) is claimed in valuing any gift, a certain box needs to be checked on the tax return.

Without adequate disclosure, the IRS can rear their ugly head many years later as they did in the Estate of Redstone. The Redstone case underscores why taxpayers must file returns even when they believe they owe no gift taxes. In the Redstone cases, the IRS argued that two brothers made gifts in 1972 when they transferred shares to their children pursuant to a reorganization. Because they filed no gift tax returns, the statute of limitations never started. That failure forced the brothers to argue that the transfer occurred in the ordinary course of business. The court found in favor of one brother, but determined that the other brother’s transfer resulted in $737,625 of gift taxes. Through the end of 2015, interest would have increased the amount due to over $16 million. By failing to file a gift tax return, both brothers left the door open for the IRS to assert gift taxes decades later.

Adequately disclosing the non-taxable gifts according to the guidelines set forth by the IRS (Treas. Regs. Sections 6501(c)(9) and 301.6501(c)-1(f)) remains the best way to stop a latent IRS audit from starting. As has been said, adequate disclosure remains the best way to protect the future against the past.