January 11, 2011

Gift Tax Law

In a previous post, I discussed the Estate Tax and the nuances behind it. Another one of the transfer taxes is Gift Tax. Here are some questions commonly posed in regards to Gift Tax. 

1. What is Gift Tax 

The Gift Tax is a transfer tax imposed by law where a person, the donor, gives the recipient, the donee, an item of property free of consideration. In IRS speak, Gift Tax is imposed on lifetime transfers of property for less than adequate and full consideration in money or money's worth. IRC §§2501(a), 2512(b). For example, if I gave my 325i BMW to my cousin Bob for free, this would constitute a gift and Gift Tax would follow. 

2. What gifts are always excluded from Gift Tax? 

Contributions made for the following items, regardless of the contribution amount, are exempt from Gift Tax: medical expenses, educational expenses, charitable donations and gifts between spouses who are U.S. citizens. IRC §§2503(e); 2522(a); 2523(a). 

3. Who pays Gift Tax? 

Surprisingly the donor pays Gift Tax rather than the donee. IRC §2502(c); Treas Reg §25.2511-2(a). For instance, if Donald gave Hugo a $20,000 Rolex watch as a gift, then Donald would be liable for paying Gift Tax. 

4. What is the annual exclusion amount? 

The annual exclusion amount represents the figure at which a donor may avoid Gift Tax liability if they gift property for less than or equal to the annual exclusion amount.

In case you are wondering, the annual exclusion amount for 2011 is $13,000. IRC §2503(b). Spouses can gift up to $26,000 to one individual because California is a community property state.

The annual exclusion amount is also not cumulative. Thus, if a donor uses less than their annual exclusion amount for one year, they cannot transfer the surplus to the next.  For example, if Donald gave Hugo $10,000 in 2011, he could not give Hugo $16,000 (assuming the annual exclusion amount stays the same) in 2012. 

5. How does Gift Tax harmonize with estate planning? 

In light of the annual exclusion amount, some clients utilize Crummey Trusts for their children while other clients create irrevocable life insurance trusts (“ILITs”). 

6. What prompted Gift Tax? 

The Gift Tax was enacted by the federal government to prevent a person from giving away all of their property to avoid the Estate Tax. Since the Estate Tax is imposed only at death, a person could presumably drain their estate through gifting over time to prevent its application. Not surprisingly, the federal government closed this loophole in 1932 when it instituted Gift Tax. 

7. What is the Gift Tax rate? 

The Gift Tax rate starts at 18% and caps out at 35%. IRC §2502(a)(2). 

8. What is the legal definition of a gift? 

The following link explains this well. 

9. Is there a federal Gift Tax? 

Yes, there is a federal Gift Tax. All that is mentioned in this post relates to the federal Gift Tax. 

10. Is there a California Gift Tax? 

No, the State of California does not impose Gift Tax. The California Gift Tax was repealed by the California electorate via ballot proposition on June 8, 1982. Rev & T C §§13301-14302. 

11. Is inheritance considered a gift? 

Inheritance is not considered a gift in the strict legal sense. While in substance inheritance is very much like a gift in that you did nothing to earn the property, inheritance is subject to the Estate Tax not the Gift Tax. 

12. Who can I give gifts to? 

Anybody is eligible to receive a gift on your behalf. Furthermore, there is no limit on the number of donees that a donor may benefit. For example, if a donor had $130,000, he or she could gift $13,000 to ten different individuals absent Gift Tax liability. 

13. Is extending a loan to a relative a gift? 

Yes, provided you extend to the borrower-relative a below market interest rate. Federal law stipulates the minimum interest rates that must be used between a lender (you) and a borrower (relative) and lays out the income and Gift Tax consequences if the loan incorporates an interest rate below the required minimum rate of interest. IRC §7872. 

14. Can I gift services? 

No, Gift Tax applies to the transfer of property, not to services. 

15. How do you value gifts? 

A gift is valued at its “fair market value” as of the date of the gift. IRC §2512(a). Fair market value is defined as "the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts." Treas Reg §25.2512-1.