Gifting: A Property Transfer Tool of Estate Planning
by Marsha A. Goetting, Ph.D., CFP®, CFCS, Professor and Extension Family Economics Specialist; Joel Schumacher, Extension Economics Associate Specialist, Department of Agricultural Economics & Economics.
This guide explains how to use laws that allow gifts of real and personal property to reduce income taxes and eventual estate taxes. Includes changes resulting from the Economic Growth and Tax Relief Reconciliation Act of 2001.
MT199105 HR Revised 1/09
ONE GOAL OF ESTATE PLANNING IS TO ENSURE
maximum enjoyment of the property while the owners are alive and then at death, transfer it according to their wishes. However, some people believe that they receive the greatest benefits from estate planning when they transfer property before their death, while they can still guide and affect the outcome. This can be accomplished through an estate planning tool called gifting. In addition to expressing love and affection, gifts serve other purposes. They can give children an opportunity to participate in the management of a family business, help finance a college education, or pay medical costs. Gifts reduce the size of the estate that must pass through court administration, thereby cutting probate costs and, to some extent, federal estate taxes. Gifts are an important estate planning tool for those with taxable estates. Gifts can also accomplish income tax savings. Through gifts of income-producing property, income can be shifted from one family member to another who is in a lower tax bracket. Lifetime gifts, however, whether to a spouse, children or others, should be examined very carefully. Those making the gifts should be sure they are not depleting assets to the point they don't have enough for their own support.
lifetime without adequate and full consideration. In other words, any transfer of value is subject to federal gift taxation if the person making the gift does not receive something of similar value in exchange. The monetary value of the gift is the fair market value of the property on the date the gift was made, less the fair market value of any property received in return. The IRS definition of fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under compulsion to buy or to sell, and both having reasonable knowledge of all relevant facts. Example A: If a father gives his child land worth $50,000, the father has made a $50,000 gift. If the father sells the same land to his child for $1,000, he has made a gift of $49,000 the difference between the fair market value ($50,000) and the value received ($1,000). There is no gift until the transfer is complete. The person making the gift must part with the property and control over it (or part of it) before it is considered a gift. This can be accomplished by title transfer. Example B: A father purchases a section of farmland with his personal funds. He places the title in his name and his son's name as joint tenants with right of survivorship. Although the son did not contribute towards the purchase price of the farmland, he has a legal and/or tax interest in the property. For this reason, the one-half interest in the farmland would be considered a gift from father to son. If the owner maintains any right to the property, such as the ability to receive income or receive a remainder interest if the donee should die before the donor, then the gift transfer is not complete.
Federal gift tax law Giving away property may sound simple at first, but one must consider the federal gift tax law and changes resulting from the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001. Highlights of the law are summarized throughout this MontGuide. The federal government levies a gift tax upon transfers of real and/or personal property made during the transferor's
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Example C: A father creates a revocable trust under the terms of which he receives income for life for himself with the principal to his daughter upon his passing. Because the father has reserved income for himself it is not a completed gift.
lower than the annual exclusion ($13,000). The annual exclusion is not cumulative. It cannot be carried over from one year to the next. Example F: A mother gifted her daughter $5,000 in 2009. The annual exclusion is $13,000. She cannot carry over the remaining $8,000 in 2010 and have $21,000 as an annual exclusion. In 2010, only the $13,000 gift would fall under the annual exclusion.
Who pays the federal gift tax? The person liable for the payment of the gift tax is the individual making the gift (donor). If the donor does not pay the gift tax, the receiver (donee) of any gift becomes personally liable for the tax that is due. The donee is not required to declare the gift amount as income. The donee, however, must pay state and federal income tax on any income produced by the property after the date of the gift.
Example D: A mother gave her adult daughter $10,000 in cash. The gift is not considered as income to the daughter. The daughter placed the money in a certificate of deposit that earned $500 during the year. The interest earned on the CD is added to the daughter's annual income of $26,000. The daughter is responsible for state and federal income taxes on her total income of $26,500 ($26,000 + $500 = $26,500).
Gifts by married couples Each spouse can give up to $13,000 per person per year, for a total of $26,000 by a married couple. Gifts made by a married couple from jointly held assets, such as jointly owned real estate, a joint bank account, or a joint investment account, are treated as being made equally by each spouse. Sometimes, an asset is title solely in the name of one spouse. In that event, if the spouse who doesn't own an interest in the asset elects to split the gift by making an election on a properly filed gift tax return, the gift is treated as being made equally by both spouses.
Example G: A father and mother can give each of their three children up to $26,000 annually. The parents can continue gifting for as many years as they wish and reduce their taxable estate by $78,000 each year. The children will not have to pay gift taxes on the $26,000 each received, but they will have to pay state and federal income taxes on any income earned on the property following the date of the gift. Example H: A husband owns land worth $26,000. The husband desires to give the land to his son, but it exceeds the $13,000 annual exclusion. The wife may consent to split the gift with her husband on a properly filed gift tax return. In that event, the husband and wife will each be treated as having made one-half of the gifts of land to the son, or $13,000 each, and both gifts will fall within the annual gift tax exclusion. If only one spouse is making a gift that exceeds the annual exclusion the other spouse should sign on the 709 gift tax return as well as file his or her own return reporting one-half of the gift. This will ensure that the federal gift tax on the $26,000 gift is eliminated because both the husband and wife have taken advantage of their annual exclusion of $13,000 each. Alternatively, each parent could write a check for $13,000 and avoid having to file a federal gift tax return.
Annual exclusion Types of property that can be transferred as a gift include: real estate, stocks, bonds, certificates of deposit, or cash. Federal law permits an annual exclusion of up to $13,000 on transfers to family members or other persons without payment of the federal gift tax. Thus, a person may give up to $13,000 per donee a year to as many people as he or she desires. Prior to 2002, the amount of the annual exclusion was $10,000; from 2002-2005, $11,000 from 20062008, $12,000. The annual exclusion has been indexed for inflation since 1998 but by regulation could not be increased until the increment reached $1,000.
Example E: A father could give each of his four children up to $13,000 in assets annually. No federal gift tax return would be required. The father could continue gifting for as many years as he desired and reduce his taxable estate by $52,000 each year. His children would not have to pay income taxes on the amounts they received. Each child is only responsible for taxes on any income earned on the gift property following the date of the gift. The 709 Federal Gift Tax return does not need to be filed with the Internal Revenue Service for gift amounts
Deductions and exemptions The federal gift tax law contains several provisions for deductions and exemptions, including the gift tax marital deduction, the education and medical services exemption, and the charitable deduction.
Gift Tax Marital Deduction Married people can make gifts of any amount to one another by taking advantage of the unlimited marital deduction provision in the federal gift tax law. No gift tax is due, and no gift tax return is required to be filed for gifts between spouses. The marital deduction is only unlimited, however, if the spouse is a U.S. citizen.
Example J: Jennifer could place her husband's name as a joint tenant on a $100,000 home that she inherited from her mother and no federal gift tax form would be required.
tax charitable deduction, it should be made to the church rather than to the minister. If there is any doubt whether an organization is a qualifying charitable organization under [501(c)(3)], ask the organization to provide a copy of the IRS determination letter granting exempt status or obtain their [501(c)(3)] tax identification number.
Transferring life insurance The transfer of ownership of a life insurance policy without retaining incidents of ownership constitutes a gift for federal gift tax purposes. Incidents of ownership include the right to borrow against, cash in, or change beneficiaries. The value of a gift of life insurance that is paid up at the time of the gift is equal to the cost of replacing the policy. If the policy is not paid up, the amount is approximately equivalent to the cash value. These values may be obtained from the insurance company.
Example N: A father transfers ownership of a paid up life insurance policy to his son. The son becomes the new owner and is designated as the beneficiary of the life insurance proceeds. The father remains as the insured. The replacement value of the policy was $31,000. An annual exclusion of $13,000 was allowed. The remaining $18,000 was subject to federal gift taxation. The transfer of a life insurance policy may also have federal estate tax consequences. Example O: If a father lives three or more years after a life insurance policy transfer, the $300,000 death benefit will not be included in his gross estate upon his death. However, if the father dies within three years of the transfer, the $300,000 would be included in his gross estate. Payment of a life insurance premium on a policy owned by another is considered a gift of the premium amount. The amount is subject to the annual exclusion.
Education and Medical Services Exemption Any amounts paid by a donor directly to a qualified educational organization for tuition or to a health care provider for medical services are excluded from federal gift taxation.
Example K: Merle's granddaughter is attending an Ivy League school with an anticipated cost of $50,000 annually. Merle can write a check directly to the university for tuition and fees. The amount is not subject to federal gift taxation because the expenses fall under the education exemption. Merle could also gift $13,000 directly to his granddaughter under the annual exclusion provision. Example L: Joe's grandson had a medical condition that was not covered by his parents' medical insurance. Joe can write a check directly to the hospital for $30,000 and not have to file a federal gift tax return because the expenses fall under the medical services exemption.
Charitable Deductions Gifts made to qualified charitable, religious, educational, government agency and numerous IRS qualifying organizations with a tax-exempt status [501(c)(3)] are completely gift tax free.
Example M: A 4-H leader plans to gift land valued at $250,000 to the Montana 4-H Foundation for a youth camp. The amount would qualify as a charitable deduction because the Montana 4-H Foundation is a qualifying organization with a tax exempt status. The gift should be made directly to the organization specified. For example, if a gift is to qualify for the gift
Applicable credit and exclusion Federal law allows for the deduction of an applicable credit from the tentative gift tax. The federal gift tax applicable credit is $345,800. The applicable credit is used to offset gift taxes on transfers made during life. However, when the applicable credit is used during life on gifts, the amount of credit available to offset the federal estate tax is reduced. The applicable credit translates into an applicable exclusion of $1 million. This means a person can transfer during life, in addition to the annual exclusion of $13,000, up to a total of $1 million in assets and no federal gift tax is due (Table 1, p. 4).
Under prior law, the applicable exclusion was tied to the federal estate tax exclusion that increased each year. The new law has capped the federal gift exclusion at $1 million while allowing the federal estate tax exclusion to increase to $3.5 million by 2009 (Table 1, p. 4). Example P: A rancher has $4.5 million estate in 2006. If he transfers land valued at $1 million to his daughter, he has used up his gift tax credit of $345,800. If he dies in 2009, his federal estate tax applicable credit is $1,110,000 ($1,455,800 - $345,800 = $1,110,000).
to reduce the gift tax payable. When the taxes payable are larger than the unused applicable credit amount, the excess must be paid as a gift tax. Example S: A father makes a gift of $12,000 to each of his eight children and their spouses in the years 2007 and 2008. In 2009, he gives each child and spouse $13,000. He is allowed an annual exclusion of $12,000 for each gift in 2007 and 2008. His annual exclusion increases to $13,000 per gift in 2009. The amount subject to tax each year is zero. The father has reduced his estate value by $192,000 in 2007 and 2008 and $208,000 in 2009. Gifting allowed the estate value to be reduced y $592,000 over three years. Example T: In 2009, a father makes a $30,000 gift to each of his eight children and their spouses for a total of $480,000. He is allowed an annual exclusion of $13,000 for each gift for a total of $208,000. The remaining $272,000 of the total gift will reduce his gift applicable exclusion and credit. The federal gift tax on $272,000 in 2009 is $78,280. The gift tax ($78,280) is subtracted from the available applicable credit ($345,800). The remaining amount of the father's applicable credit is $267,520 ($345,800-$78,280 = $267,520).
Federal gift tax rates The tax rates for gifts during years 2006-2011 are provided in Table 2, p. 7. The accumulated lifetime taxable gifts over the $1 million applicable exclusion amount will create a gift tax liability, while the same amount transferred at death may be passed tax-free because the amount may fall under the estate tax applicable exclusion.
Example Q: Bill has a business that is valued at $2.5 million. If he gifts the business to his son in 2009, there is a gift tax exclusion of $1 million plus an annual exclusion of $13,000. The remaining $1,487,000 would result in a federal gift tax of $550,210. Example R: If Bill died in 2009 and willed a business to his son, there would be no federal estate tax because the federal estate tax exclusion is $3.5 million. Whether Bill decides to gift the business while alive and pay a federal gift tax or bequeath the business after his death and avoid the tax depends on his financial objectives.
Accumulation of gifts Federal gift tax law requires the value of all taxable property given each year to be accumulated into one total before computing each year's gift tax. The accumulation of lifetime gifts results in higher rates of taxation on later gifts. The applicable credit amount of $345,800 is used
Gifts within three years of death Generally, the value of gifts (other than gifts of life insurance) made by a decedent (the person who dies) within three years of death is not included in the gross estate. However, interests in property otherwise included in the gross estate under the so-called "strings attached" provisions or which would have been included had the interest been retained by the decedent) are included in the gross estate if transferred within three years of death. In addition, any gift tax paid by the decedent or his or her spouse within three years of death will be included in the gross estate for federal estate tax computation purposes.
TABLE 1: Federal Estate and Federal Gift Tax applicable credits and applicable exclusions 2009 - 2011 Federal Estate Tax* Year of Death 2009 2010 2011 Applicable Credit 1,455,800 Repealed 345,800 Applicable Exclusion 3,500,000 Repealed 1,000,000 Applicable Credit 345,800 345,800 345,800 Federal Gift Tax Applicable Exclusion 1,000,000 1,000,000 1,000,000
*For further information about the federal estate tax, see MSU Extension MontGuide MT199104HR, Federal Estate Tax.
Example U: When a father learned he had cancer, he gifted his $1.6 million ranch to his son. He filed a gift tax return, used up his applicable credit and paid the required gift tax. By the time the father died four years later, the ranch was worth $1.9 million. Under current law, neither amount is included in the father's gross estate. A gift of a life insurance policy made by a decedent within three years of death is included in the decedent's gross estate. Example V: Assume that a father owns a term life insurance policy with proceeds of $500,000 payable at his death and that they policy has no current gift tax value. In 2007, he transfers ownership to his daughter, who is the beneficiary. No other taxable gifts were made. In the year 2009, the father dies owning ranch land and securities valued at $3.3 million. While the life insurance proceeds ($500,000) pass directly to his daughter, the value is included in the father's gross estate for estate tax computation purposes because he did not live three years after transferring the policy to his daughter. The father's gross estate includes the life insurance policy proceeds ($500,000) and the other property ($3.3 million) for a total value of $3.8 million. The federal estate tax would be $135,000 ($1,590,800 tentative tax - $1,455,800 applicable credit = $135,000). Example W: If the father had lived three years (dies in 2011) after transferring ownership of the policy to his daughter, the $500,000 would not have been included in his estate. The estate tax would have been computed on $3.3 million instead of $3.8 million. The father's ownership of the term life insurance policy within three years of his death cost his estate an additional $135,000 in federal estate taxes.
Example X: In 2009, a father gifts land to his daughter that is currently worth $1 million. The father paid $100,000 for the land. The daughter assumes her father's $100,000 basis in the property. If she sells the property, she is responsible for capital gains tax on the difference ($900,000) between the basis ($100,000) and the fair market value ($1 million). Thus, the daughter would owe federal capital gains taxes of $135,000 on the $900,000 profit (Assuming a rate of 15%). Example Y: If the father had died and willed the land to his daughter, she would have received a stepped-up basis in the property. This means the value in the land will be stepped-up from $100,000 to $1 million. If she sold the property for $1 million after her father's death, there would be no capital gains tax because she sold it at the stepped-up basis value. There was no federal estate tax on the property because of the applicable exclusion of $3.5 million in 2009.
Basis of property All property (real estate, stocks, and bonds) that a person owns has a basis for tax purposes. For example, land purchased in 1977 for $47,000 has a basis of $47,000 even though its current market value is $900,000. Property received by a donee as a gift from a donor has a carryover basis. This means that the basis in the hands of the donee is the same as it was in the hands of the donor. Property that is received from a person who died (decedent) has a stepped-up basis. This means the value is stepped-up to the fair market value at date of the decedent's death or stepped-down if the property is worth less than the decedent paid for it.
Federal gift tax return A donor is required to file a gift tax return (IRS form 709) to report gifts amounting to more than $13,000 (adjusted annually by the consumer price index after 1998) to any one donee (other than a spouse) in any one year. Gifts of future interests (certain gifts in trust) of any amount are required to be listed on a gift tax return. Future interest is a complex legal term that includes reversions, remainders, and other interest or estates that the donee can "enjoy" at some future date. A remainder interest in a trust is an example of a gift of future interest. Future interest gifts do not qualify for the annual gift exclusion. In other words, a gift of the future remainder interest in an irrevocable trust to grandchildren is fully taxable. The amount is not reduced by $13,000 for each grandchild. The annual exclusion per donee applies only to gifts of a present interest. If a gift tax return (Form 709) is required, it must be filed by April 15 following the close of the calendar year in which the gift was made. For example, if a mother makes a taxable gift to her daughter in November 2009, she must file a gift tax return by April 15, 2010. Gifts for my situation? Gifting is usually combined with other estate planning tools as individuals and families develop and implement their estate plans. Farm and ranch families with family farm partnerships and corporations often make annual gifts of stock or partnership shares to their descendants. This can be a very effective means of making incremental shifts in ownership and control. However, if the number
of intended heirs is large, gifts of stock also can result in the corporation having many owners, with each having a small ownership interest. Cash gifts to intended heirs can be used to pay the premiums of life insurance on the donor. The policy may be owned by the gift recipient. Upon the death of the donor, the life insurance proceeds can be used to pay estate taxes, to implement a buy-sell agreement, to pay the remaining balance of a sales contract for land purchased from the donor, or for other similar uses. Life insurance policies owned by beneficiaries are not included in the donor's estate unless the policy was gifted within three years of the donor's death. Changes are continual in federal gift and estate tax laws. Contact an attorney and/or a certified public accountant to learn what effect these changes may have on your present or future estate planning objective of gift giving particularly in light of the Economic Growth and Tax Relief Reconciliation Act of 2001.
Acknowledgments Representatives from the following reviewed this MontGuide and recommend its reading by all Montanans. · Business, Estates, Trusts, Tax and Real Property Section State Bar of Montana
· Montana Society of Certified Public Accountants · Montana Association of Insurance and Financial Advisors
Disclaimer This publication is not a substitute for legal advice; rather it is designed to help persons become better informed of the basic provisions of the Federal gift tax law. There are numerous exceptions and conditions to some of the concepts discussed. Future changes in laws cannot be predicted and statements in the MontGuide are based solely on the laws in force on the date of publication.
TABLE 2: Federal Estate and Gift Tax Rate Schedule, 2009-2011 TAxABLE ESTATE BRACkETS COLuMn 1 FROM 0 10,000 20,000 40,000 60,000 80,000 100,000 150,000 250,000 500,000 750,000 1,000,000 1,250,000 1,500,000 2,000,000 2,500,000 3,000,000 COLuMn 2 TO 9,999 19,999 39,999 59,999 79,999 99,999 149,999 249,999 499,999 749,999 999,999 1,249,999 1,499,999 1,999,999 2,499,999 2,999,999 UnliMiTED 2009* 0 1,800 3,800 8,200 13,000 18,200 23,800 38,800 70,800 155,800 248,300 345,800 448,300 555,800 780,800 780,800 780,800 TAx On COLuMn 1 2010 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2011 0 1,800 3,800 8,200 13,000 18,200 23,800 38,800 70,800 155,800 248,300 345,800 448,300 555,800 780,800 1,025,800 1,290,800 FEDERAL ESTATE AnD GIFT TAx RATES On AMOunTS OVER COLuMn 1 2009 18% 20% 22% 24% 26% 28% 30% 32% 34% 37% 39% 41% 43% 45% 45% 45% 45% 2010 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 2011 18% 20% 22% 24% 26% 28% 30% 32% 34% 37% 39% 41% 43% 45% 49% 53% 55%
Estate Tax Computation Example: Jack is considering gifting land to his daughter valued at $1.1 million in 2009. The tax on the first million is $345,800. The remaining $100,000 is taxed at a rate of 41% resulting in additional taxes of $41,000. The tentative gift tax of $386,800 ($345,800 + $41,000) is then reduced by the applicable credit of $345,800. The federal gift tax that is due is $41,000.
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File under: Family Financial Management (Retirement Savings and Investing) Revised January 2009 1000-109SA