This time of year, many people are focused on gathering their income information and filing their annual income tax returns. But people often overlook the need to file gift tax returns, which share the same due date. With high federal exemption amounts and the ability to transfer up to $15,000 ($30,000 for married couples) each year to any number of individuals tax free, it’s unusual for even very wealthy clients to have to pay a gift tax. So why does the IRS require you to report taxable gifts on an annual gift tax return (Form 709) even if no tax will be due? And what constitutes a taxable gift?
A taxable gift is the transfer of anything of value from one person to another without “consideration” (i.e., without receiving something of equal value in return). Believe it or not, birthday and holiday presents are considered taxable gifts. So are funds provided to your child for the purchase of a car or the payment of rent on their college apartment.1 Loaning money to someone is not a gift, because of the borrower’s promise to repay you. But if you decide to let the borrower off the hook and forgive the debt, the forgiveness is treated as a gift to the borrower.
Most people make many taxable gifts a year, but not all taxable gifts have to be reported. The annual exclusion, which is currently $15,000 per donee per year, is meant to exempt “routine” gifts like birthday and holiday presents from the annual gift reporting requirement. However, if you make gifts in excess of the annual exclusion amount, you must report them to the IRS on a gift tax return.
Filing a gift tax return gives you an opportunity to make important elections with regard to the gifts you report:
- Currently the gift and estate tax exemptions are “unified,” so the exemption amount ($11,700,000 in 2021) is the same whether wealth is transferred by gift during your lifetime, or as a result of your death. However, your lifetime gifts reduce, dollar for dollar, the amount of exemption available at the time of your death. Filing a gift tax return alerts the IRS to the fact that you have used some of your lifetime exemption to make a gift, and the IRS tracks how much of your exemption remains to be applied to your estate on your death.
- In addition to the gift and estate tax exemption, you also have (in 2021) an $11,700,000 generation-skipping transfer tax exemption (GST exemption) that can be applied to gifts to grandchildren or other beneficiaries who are two or more generations below you. In the case of gifts to grandchildren in trust, the GST exemption may need to be affirmatively allocated on a timely filed gift tax return in order to ensure that future distributions from the trust will not be subject to the GST tax, which, at current rates, would reduce the distribution by 40%.
- The marital deduction allows you to make unlimited gifts to your spouse free from gift tax. But in the case of certain gifts to a spouse in trust you may need to make an election (called a QTIP election) on a gift tax return in order for the gift to qualify for the marital deduction.
- If you are married, you and your spouse can make an election on your gift tax returns to “split” your gifts, so that you can take advantage of your spouse’s annual exclusion and lifetime exemption amounts to ensure no gift tax will be incurred on your gifts - even if all of the gifts come from you individually.
Finally, filing a gift tax return will start the statute of limitations running on the IRS’s ability to question the value assigned to the gift of any hard to value asset, like artwork or closely held stock. As long as you adequately disclose to the IRS the nature of the gift and the method used to determine its value, once three years have passed from the date the gift tax return is filed the IRS cannot audit the return and change the value of the gift. The so-called adequate disclosure rules are beyond the scope of this article, so if you make a gift of anything other than cash or marketable securities, it is a good idea to consult with a tax professional regarding what information about the gift must be disclosed to the IRS to start the statute of limitations running.
Under current law, most taxpayers will never have to pay a gift tax. However, failing to file a gift tax return can have long reaching negative tax consequences for you or the recipients of your gifts. If you have questions about whether you have made a gift or whether gifts you have made must be reported to the IRS on a gift tax return, please contact any attorney in our Estate Planning Department who will be happy to advise you.
1. Note that payment of tuition (but not room and board) directly to an educational institution, or payment of medical expenses directly to a medical provider, are not treated as gifts. However, if, instead of paying tuition or medical expenses directly, you instead reimburse the student or patient for expenses they have paid themselves, those reimbursements are taxable gifts and will need to be reported on a gift tax return if they exceed the annual exclusion amount.
Karen L. McKenna is a Partner in the Estate Planning & Administration practice group at Tarlow Breed Hart & Rodgers, P.C. in Boston, Mass. Attorney McKenna can be contacted at (617) 218-2053, or via email at firstname.lastname@example.org