Ch.10
Gift Tax Paid:
•"A" has a basis in stock: $25,000 - At time of gift to "B" FMV = 65,000 - Suppose "A" has already used up her unified credit of $4,577,800 because she made previous gifts totaling over $11,580,000. - "A" can use an annual exclusion of $15,000 to reduce the gift if she has made no other gifts to "B" this year. - $65,000-$15,000 = $50,000 (taxable gift) -->(calculated to be $20,000 in gift tax) - Exclusive tax because it will be paid from a source other than the gift.
Gift tax
•A donor can make $15,000 in tax free gifts to unlimited persons each year; •Since the money used to pay the tax is not itself subject to taxation = tax exclusive (the amount of the gift that doneereceives is not reduced) •Estate taxes are tax inclusive = estate tax liability is paid with money included in the decedent's gross estate, and it is taxed.
If FMV of a gift is less than donor's adj. basis:
•If FMV is less than donor's basis, the doneesnew basis will be the FMV of the gift at date of transfer. •Dad's basis in stock $12,000 - Gifted to son FMV = 10,000 - Son sells stock later for 8,000 - Short term capital loss = 2,000
FMV of a Gift Exceeds the Donor's Adjusted Basis:
•The Fair Market Value(FMV) of a Gift Exceeds the Donor's Adjusted Basis: •$12,000 = adjusted basis value of stock •$15,000 = value of stock when mother gifts stock to daughter $ 3,000 = capital gains realized by daughter - If the FMV if an asset on the date a gift is made is greater than donor's basis, then doneewill take over donor's basis and donor's holding period.
Other advantages of gifting:
•To reduce a person's estate tax liability; •A donor can give up to $15,000 gift tax free to an unlimited number of doneesin 2020. •Married couples can "gift-split" so that $30,000 can be given tax free to unlimited numbers of persons; •Any gift taxes paid more than 3 years before donors death remove that money from the donor's gross estate.
Determining the Basis of Gifted Property
- Amount realized - Adjusted basis = Gain - The higher the basis, the lower the reportable gain on the sale of the asset; - For an asset acquired by purchase, basis is usually the cost of the property; - If Donor gifts to Donee, and Donee later sells property - gain depends on donee's basis. - To calculate the tax on gifted property that is sold, the donee must first determine his carry-over basis.
Elements of a gift:
Before a gift is subject to federal gift tax, these requirements must be met: •Donor is competentto make a gift; •Doneeis capableof receiving a gift; •There must be an "intention" by donor to make a gift. •Donor must deliverthe gift to done; •Doneemust take possession of the property.
Client situation: Reduction of a gift 2019
Review slide 35
Reverse Gift:
•A donor with low basis property can gift property to a doneewho is seriously ill in order to receive the property back with a full step-up basis at donee'sdeath: •Example: Jerry gifted stock worth $80,000 which has a basis of $20,000, to his dying wife Connie. If Connie dies more than 1 year after receiving the gift, Jerry will receive it back with a full step up basis of $80,000. (avoids capital gains if he sells at $80,000) •If Connie dies 11 months later, the stock will not receive a step-up in basis to FMV unless she bequeaths it to someone other than Jerry.
Gift subject to mortgage:
•A gift of property with a mortgage that is greater than it's cost to donor may result in capital gain: •Example: Vince purchased a building in 1980 for $100,000. Vince gifts the building to his wife in 2019; •The building has appreciated in value by (2019) to $1,000,000. •The mortgage on the building at time of the gift = $700,000. •This results in an income tax gain to Vince in amount of $600,000. •$700,000 (outstanding debt at time of transfer to wife) - 100,000 (Vince's original basis in building) = $600,000 (taxable gain to Vince after the gift to wife)
Gift and Estate Tax differences:
•A unique aspect of gift tax that does not pertain to estate tax = •Gifts can be reduced by the annual exclusion of $15,000 per person per year; •In other words, a donor can make tax-free gifts of $15,000 to unlimited number of doneesin 2019 without reducing their unified credit. •Gift splitting is available to married couples and reduced the value of a gift by one-half for each spouse; A couple can then gift $30,000 gift tax free to unlimited doneesin 2019.
Completed gifts in trust: Irrevocable trusts and no control
•Alan transferred $100,000 of stock into an irrevocable trust for his two children and 3 grandchildren. The income is payable to his children for as long as they live, remainder to grandchildren; •If Alan retains control over the trust (to vary amount of income payable or reach the corpus to enhance security = incomplete gift; •If Alan relinquishes control = completed gift. •If the stock had increased substantially in value by the time Alan relinquishes control, the taxable gift -- and possibly the gift tax payable by Alan - may also increase substantially!
Completed Gifts:
•Any property transferred into an irrevocable trust = completed gift. •However, these may constitute incomplete gifts and are not taxed if: - The power to alter the interest of the beneficiaries is retained; - The power to name new beneficiaries of the trust is retained; - A testamentary general power of appointment over the remainder of the trust, to dispose of the trust assets at death is given;
How does depreciating rental property help?
•As a landlord, there are tax benefits of depreciating your rental property. •Your annual net income is reduced by amounts deducted for depreciation, reducing the amount of taxes you owe. •Example: Commercial rental property costing $2 million, you would receive an annual deduction of $51,282 ($2m / 39yrs. = $51,282) •Your annual net income is reduced by that amount for tax purposes each year until it fully depreciates. •You would not want to gift away property that you can depreciate for obvious reasons.
Bargain sale to Family Member = Donee'snew basis
•Bargain sale = part sale & part gift •Lucy sold her vacation home worth $600,000 to her son Billy for $400,000. •Lucy's original basis (1995): $100,000 •Fair Market Value (2015): $600,000 •Sales price to Billy (2015): $400,000 •Lucy's taxable gain (2015): $300,000 (sales price - original basis) •DoneeBilly's basis (2015): $400,000 (the sales price) •Donor Lucy's taxable gift to Billy: $200,000 (FMV - sales price)
Relationship of Gift Tax & Estate Tax systems:
•Beth has reduced the value of her estate by making taxable gifts totaling $10,000,000. If she makes another gift of $1.4 million, she has used all of her unified credit. •Any gifts made after she has used all of her unified credit ($11,580,000) will be taxed at the rate of 40%. For example, if she makes a gift to her sister of $100,000, she will pay $40,000 ingift tax when she files her gift tax return.
Taxable gifts:
•Can be both: •Direct-made outright to others •Indirect- (irrevocable trust, someone's expenses, forgiving debt)
Cumulative & Progressive:
•Client situation: •Gary and Renee made their first gift to their daughter Kenna last year. The taxable gift for each spouse was $15,000 and tax on the gift was $2800. This year they made another taxable gift of $15,000 to their daughter Rory. The tax on this year's gift is $3200, not $2800. Even though they made the same amount of taxable gift each year, the gift tax is higher this year because the gift tax is cumulative and progressive. •2014: Gift to Kenna = $15,000 tax = $2800 •2015: Gift to Rory = $15,000 tax = $3200 (higher because they were bumped into a higher rate bracket because gifts are cumulative)
Other Gifting Issues:
•Completed transfer - necessary before gift tax can be applied. This means donor has irrevocably parted with dominion and control over the gift. The property is valued for gift tax on the date the completed gift is made. (sometimes difficult to say exactly when). Property transferred into a revocable trust is not a completed gift. •Personal checks or notes: Not a gift until the check is cashed. •Gifts Causa Mortis: A gift made on one's death bed. This gift is not complete until the donor actually dies. •Stock- gift on the date stock is transferred or date endorsed certificates are delivered; •Totten Trust - Donor makes a deposit for the doneeand retains possession = revocable transfer. No gift until doneemakes a withdrawal.
Best property to keep cont'd:
•Depreciating income property: offsets owners income tax liability •Any property you own, and each year your accountant depreciates it in order to offset income tax liability. This property should be kept until it is fully depreciated. (39 yrs. for commercial property, 27.5 years for residential property) •An Example of Rental Property Depreciation •Purchase price - land value = building value. •Building value divided by 27.5 equals your annual allowable depreciation deduction. •Example: If the cost of rental property is $110,000, 90% of the cost is attributable to the building ($99,000), and 10% ($11,000) is the value of the land. ($99,000 / 27.5 = $3,600 allowable depreciation yr.)
Direct vs. Indirect Gifts: Present vs. Future gifts:
•Direct gifts= made outright to others, of real or personal property. Gifts subject to gift tax can also include transfers of cash, life insurance policies, stocks, bonds, partnership interests and royalty rights. •Indirect gifts = money or property placed in an irrevocable trust; the payment of someone's expenses; the forgiveness of debt; 0% interest on an intra-family loan; the assignment of benefits in an insurance policy. •Present gift =doneehas unrestricted rights to immediate use/possession or enjoyment of the property. •Future-interest gift =doneemust waitto have use and enjoyment of property; Example: income producing property transferred into a trust, but the income must accumulate for a time before any income is distributed to the beneficiaries = future interest in the trust property.
If donor gifts property with FMV less than his adjusted basis, and doneesells for a gain:
•Donee'sbasis is the donor's adjusted basis, and doneeassumes the donor's full holding period: •Uncle purchases volatile stock: $50,000 - Gifts to Ted when FMV = $30,000 - Ted sells stock 6 mo. later for : $60,000 - Ted's carry-over basis is uncles adjusted basis = $50,000 - Ted's long term capital gain: $10,000
Gift and Estate Tax Differences:
•Each person can make taxable gifts up to $11,580,000 through lifetime inter-vivosgifts, or $11,580,000 through bequests at death, and avoid taxation = exemption equivalent escaping taxation. •Each taxpayer has a unified credit, also called an applicable credit, which offsets the tax on a dollar-for-dollar basis. Based on the current years unified gift and estate tax table, the tax on $11,580,000 = $4,577,800, but the unified credit (of $4,577,800) will offset the entire gift or estate tax liability; (up $72,000 from 2019) •Once the unified credit is used to offset tax each time a gift is made, and the unified credit is fully depleted, gifts or estates exceeding $11,580,000 (in 2020) pay tax at the rate of 40%.
Incomplete gifts in a trust: Revocable trusts
•Emily creates a revocable trust for the benefit of her disabled brother, Peter. She transfers $90,000 into the trust and gave the trustee discretion to make disbursements for her brother's health, education and maintenance. •In 2020 the trust distributed $16,000 to Peter; •Only $16,000is a completed giftsubject to gift tax - not $90,000 initially transferred into trust; •Compare: - If Emily makes the trust irrevocable this year = completed gift will occur and the trust corpus will be subject to gift tax.
Tax loss harvesting: reduces capital gains tax
•Example: Suppose terminally husband had purchased stock at $100 share and it depreciated to $50 when he gifts it to his wife. •The wife sells the stock at $25 a share and realizes a loss of $75 share. •The wife can use that loss to offset gains in her taxable portfolio. •However, if husband had bequeathed it to her, she would have received a step-down basis of $50 share and only realized a loss of $25 share when sold. If the husband had gifted to stock to his son when it was worth $50 share and he sold it at $25, the son would have a loss of only $25 per share.
What is a Gift?
•Gift:a voluntary transfer without adequate consideration. To escape gift tax, there must be adequate and full consideration equal in value to the property transferred. •Reasons / advantages of gifting: •Vicarious enjoyment; provide for education and support; •Provide an opportunity for the donee(see how well or poorly they manage); •To maintain privacy (not possible through probate); •Reduce probate and adm.costs and delays; •To protect donor from creditor claims;
Best property to keep: (let'eminherit it after death to get stepped up basis)
•Highly appreciated property likely to be sold after owner's death: •Example: Harriet purchased a 5 carat diamond ring in 1945 for $500; at her death in 2019, the ring will receive a stepped up basis to the fair market value (FMV) of $350,000. If the ring is expected to be sold after Harriet's death, the person who inherits the ring will not have to pay a capital gains tax on the subsequent sale. •Property that, if sold, would result in a loss: •Example: James Gandolfini'sItalian villa, he purchased it in 2003 for $6,000,000; At his death, it is valued at $10,000,000. Because his estate lacks enough liquid assets to pay estate taxes, the villa must be sold quickly. This most likely will result in a loss. If he gifts the property to his children, they can take the lesser of the donor's basis ($6 million) or the FMV as of the date of transfer ($10 million). They will not be able to use this ($4 million) loss to reduce his estate tax problem if they already own it at his death.
Unified Credit: enables you to give away $$
•In 2019 each person can make taxable gift up to $11,400,000 through lifetime inter-vivosgifts or transfer this amount by bequests at death and avoid taxation. (doubled from 2017 ($5,490,000) •This amount escapes taxation; •Each taxpayer has a unified credit, also called an applicable credit, which offsets the tax on a dollar-for-dollar basis. •The tax on $11,400,000 is $4,505,800, but the unified credit (of $4,505,800) will offset the entire gift or estate tax liability. •The tax on $11,580,000 is $4,577,800, but the unified credit of ($4,577,800 ) will offset the tax dollar for dollar. •(see page 551 Appendix B, Exemptions and Rates)
Purpose of Gift Tax Law:
•Introduced in 1932, prevents taxpayers from transferring their entire estates to others during lifetime without paying a transfer tax. •Gift tax = Excise tax - this is the right of an individual to transfer money or other property to another. •Elements of a gift (before it's subject to federal gift tax: - Donor must be competent to make a gift; - Donee is capable of receiving a gift; - There must be an "intention" by donor to make a gift. - Donor must deliver the gift to done; - Donee must take possession of the property.
Other Gifting issues:
•Joint Bank Accounts - Because a person making a deposit can withdraw all or part of the funds, the donor has retained a power to revoke = incomplete gift. (similar to Totten Trust) •Joint Brokerage Accounts- Not a gift until the joint owner makes a withdrawal for his personal benefit. •Real Estate - requires execution of a deed in favor of done; if donor retains the deed, does not record it, makes no attempt to inform doneeof the transfer, no transfer occurs. •Forgiveness of a note: a gift occurs when the donor makes the note "cancelled by gift". •Split-interest gifts: Owner of property keeps a lifetime interest and gifts remainder interest away = gift of the present value of the remainder interest. Doneemust wait to own property outright, but a gift is made when donor transfers the property interest into a trust or changes title on the deed.
If gift is sold at price greater than FMV at time of gift, but less than donor's basis:
•No gain or loss is recognized on the sale: •Mom's basis in stock = $20,000 - Value at time of gift = 16,000 - Son sells stock for $ 18,000 - Carry over basis = $ 16,000 = no capital gain or loss on sale
Gift Tax Relationship to Income Taxes:
•One purpose of gift tax law was to discourage taxpayers from making gifts to family members in lower tax brackets to reduce their taxable incomes. •It is important for financial planners to understand the relationship and impact of income taxes on property transfers to individuals and trusts, and the basis rules for gifted property.
The best property to gift:
•Property likely to appreciate in value, i.e. stocks, antiques and art, and real estate; •Property that has a low gift tax value and high estate tax value. i.e. life insurance (low present value) but high appreciation potential. (Tip: transfer life insurance policies to individuals or trusts to keep the death benefit out of the owner-insured's estate.) •Income-producing property if the doneeis in a lower income tax bracket than donor; Kiddie tax rules apply to anyone younger than 19, or age 19-23 in college; •Property that has already appreciated in value (if a sale is contemplated) and doneeis in a lower income tax bracket. •Appreciated property as a gift to charity,(avoids capital gains tax, receive tax deduction to charity) •Property located in another state than owner's state of domicile,(avoids ancillary probate).
Marital and Charitable Deductions:
•Property transferred to your spouse permits deduction in gift and estate taxes; •The marital deduction can be claimed on the donor spouse's gift tax returns or on decedent spouse's estate tax return. A gift made to a qualified charity during life can result in both income tax and gift tax charitable deduction; •If a bequest is made to a charity, only an estate tax charitable deduction will result;
Pros and Cons of Gifting:
•Pros: The value of the property is removed from your gross estate; •The property will receive a stepped-up basisto FMV if held until death; •Heirs will receive the property at the step-up basis (FMV) and if they intend to sell the property, this is an advantage; •Cons:You lose control over the property; •You diminish your wealth; •If gifted during donor's lifetime, the doneetakes the donor's adjusted basis in the property (often less than the FMV of the gift);
Holding Period at Death
•Regardless of the actual holding period, inherited property that is subsequently sold is long-term capital gain. •$100,000 = amount of stock inherited by son from dad with stepped up basis; •$120,000= amount stock is sold for 5 months later $ 20,000 = long-term capital gain
Transfers that do not create a gift tax:
•Services rendered for benefit of another •Compensation for professional services •A Disclaimer (written refusal to accept a gift) •A promise to make a gift in the future •Bad bargains (sales for less than adequate money) •Sham gifts (which shift income tax burden to one in lower tax bracket) •Assignment of income to another person •Payments made pursuant to a legal decree or court order •Contributions to political parties
Relationship of Gift Tax toEstate Tax System
•These are both "transfer taxes" unified under federal transfer tax system; •Lifetime gifts and testamentary transfers are again subject to the same unified gift and estate tax rate schedule; •Thus, the same tax burden on transfers made during life as at death; •Cumulative and Progressive: •Gift and estate tax rates range from 18% to 40%; •Unified Credit: Each person can make up to $11,580,000through lifetime inter-vivosgifts, or transfer this amount through bequests at death and avoid taxes. Each time you make a taxable gift, your unified credit decreases. Once you gift away your unified credit, tax must be paid. The excess amount is 40%.
Taxable estate example (2017):
•What that means is that a taxable estate of $1.1 million would have owed a tentative tax of $345,800 plus 40% of $100,000, or $385,800. However, the tentative tax doesn't take into account the unified credit against the estate tax, which is incorporated into what's known as the lifetime exclusion amount. •$1,000,000 = estate tax payable: $345,800 • 100,000 = estate tax payable @ 40% = $40,000 •Total estate tax due = $385,800