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Chapter 12:The Gift Tax

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THE GIFT TAXTHE GIFT TAX

Unified transfer tax systemGift tax formulaTransfers subject to gift taxAnnual exclusionGift tax deductionsGift-splittingTax computation

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Unified Transfer Tax Unified Transfer Tax SystemSystem

Excise tax on wealth transfer when adequate consideration not received

Components of transfer tax systemPurpose of transfer taxesTax on wealth transfersCumulative and progressive taxUnified rate schedule

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Components of Transfer Tax System

Gift tax: Inter vivos transfers– Transfers while alive

Estate tax: Testamentary transfers– Property ownership transfers at death

Generation-skipping transfer tax– Property transferred to a second or younger

generation

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Purpose of Transfer Taxes

Raise revenue for federal governmentPrevent evasion of estate taxRecover revenues lost by shifting

assets to taxpayer in lower income tax bracket

Redistributing wealth

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Tax on Wealth Transfers

Gifts & inheritances NOT incomePerson making gift has PRIMARY

obligation to pay any tax dueTax applies to act of transferring

propertyTax applied against FMV of gift

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Cumulative & Progressive Tax

All taxable gifts made after 1976 accumulated for each donor

Cumulative total determines tax rate applied to current gift

Prior gift taxes paid and/or unified credit may negate or reduce amount of current tax due

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Unified Rate Schedule

Top marginal rate in 2003– 49% on amounts exceeding $2M

Top marginal rate decreases between 2002 & 2010 to 35% on amounts exceeding $500K

Unified credit reduces tax $ for $ See inside back cover for unified transfer tax

rates

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Gift Tax FormulaGift Tax Formula(1 of 2)(1 of 2)

All individual’s gifts for current period

- ½ of 3rd party gifts w/gift-split election

+ ½ of spouse’s gifts w/gift-split election

- Annual exclusion ($11K per donee)

- Marital deduction (unlimited)

- Charitable contrib deduction (unlimited)

= Taxable gifts for current period

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Gift Tax FormulaGift Tax Formula(2 of 2)(2 of 2)

Taxable gifts for current period+ All prior taxable gifts= Cumulative taxable gifts (CTG) Compute tax on CTG w/current rates- Tax on prior gifts w/current rates= Tax on current gifts- Net Unified credit= Tax payable for current period

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Transfers Subject toTransfers Subject toGift TaxGift Tax

Transfers for inadequate considerationTransfers NOT subject to gift taxCompleted transfersGift tax consequences of certain

transfers

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Transfers for Inadequate Consideration

Transfer of cash, stock, securities or real estate

Forgiveness of debtAssignment of a life insurance policyTransfer of federal, state, or municipal

bondsTransfer of other assets

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Transfers NOT Subject toGift Tax

Transfers in normal course of businessQualified transfers for direct payment of

educational tuition or medical careTransfers to political organizationsProperty settlements in divorceTransfers disclaimed by recipient Incomplete transfers

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Completed Transfers

Gift does not occur until transfer is completeTransfer complete when donor has given up

“dominion & control”– Leaves donor no power to change gift’s

disposition, whether for own benefit or for benefit of another

Gift valued at FMV upon transfer

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Gift Tax Consequences ofCertain Transfers (1 of 2)

Creation of joint bank accounts– Incomplete transfer until “donee”

withdraws funds

Creation of other joint tenancies– All joint tenants own an equal share– Donee’s ownership portion is a completed

gift

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Gift Tax Consequences ofCertain Transfers (2 of 2)

Transfer of life insurance policies– Changing beneficiary an incomplete gift

– Irrevocable transfer of policy ownership rights is a completed gift

– Premiums payments are a completed gift if policy owned by another

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Annual ExclusionAnnual ExclusionAll gifts valued at FMVExclude transfers up to $11,000 (in 2003) per

person per donee each year– Indexed for inflation after 1998

Husband and wife may each give $11,000 per child w/o tax consequence

Gift must constitute present interest

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Gift Tax DeductionsGift Tax Deductions(1 of 5)(1 of 5)

Martial deduction – Unlimited tax-free transfers between

husband and wife– Some terminal interests ineligible for

martial deduction»Terminal interest is an interest that ends or is

terminated when some event occurs (or fails to occur) or a specified time passes

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Gift Tax DeductionsGift Tax Deductions(2 of 5)(2 of 5)

Marital deduction (continued)– Transfers of qualified terminal interest property

(QTIP) eligible for marital deduction– QTIP is property

»Property transferred by donor-spouse in which donee has qualifying income interest for life AND

»A special election has been made

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Gift Tax DeductionsGift Tax Deductions(3 of 5)(3 of 5)

Marital deduction (continued)– Qualifying income interest for life

»Spouse entitled to ALL income from property annually or more often AND

»No person has power to appoint any part of property to any person other than donee-spouse unless power cannot be exercised while spouse is alive

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Gift Tax DeductionsGift Tax Deductions(4 of 5)(4 of 5)

Charitable contributions – Contributions in excess of $11,000

NOT reported on gift tax return if income tax deduction available and entire interest is gifted

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Gift Tax DeductionsGift Tax Deductions(5 of 5)(5 of 5)

Charitable contributions (continued) – If charity is a qualified organization,

amount of gift above $11,000 allowed as a deduction

– No gift tax due since taxable amount zero

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Gift-SplittingGift-Splitting

Spouses may elect to treat gifts to third parties as coming ½ from each spouse regardless of who actually made the gift

Allows the couple to give up to $22,000 per donee per year w/o gift tax consequences

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Tax ComputationTax Computation(1 of 2)(1 of 2)

Large gifts– Tax rates progressive, from 18% to

49% (tax base over $2M) in 2003

– 5% phase-out of lower rates repealed for tax years ending after 2001

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Tax ComputationTax Computation(2 of 2)(2 of 2)

Unified credit– $345,800 against gift tax

»Shelters $1M of taxable gifts from taxation

»The unified credit for estate tax purposes increases above $345,800 in between 2002 and 2009

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Kenneth W. Monfort College of Businessrichard.newmark@PhDuh.com