Chapter 12: The Gift Tax Chapter 12: The Gift Tax

THE GIFT TAX Unified transfer tax system Gift tax formula Transfers subject to gift tax Annual exclusion Gift tax deductions Gift-splitting Tax computation

Unified Transfer Tax System Excise tax on wealth transfer when adequate consideration not received Components of transfer tax system Purpose of transfer taxes Tax on wealth transfers Cumulative and progressive tax Unified rate schedule

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

Purpose of Transfer Taxes Raise revenue for federal government Prevent evasion of estate tax Recover revenues lost by shifting assets to taxpayer in lower income tax bracket Redistributing wealth

Tax on Wealth Transfers Gifts & inheritances NOT income Person making gift has PRIMARY obligation to pay any tax due Tax applies to act of transferring property Tax applied against FMV of gift

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

Unified Rate Schedule Top marginal rate in 2002 50% on amounts exceeding $2.5M Top marginal rate decreases between 2002 & 2010 to 35% on amounts exceeding $1.5M Unified credit reduces tax $ for $ See inside back cover for unified transfer tax rates

Gift Tax Formula (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

Gift Tax Formula (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

Transfers Subject to Gift Tax Transfers for inadequate consideration Transfers NOT subject to gift tax Completed transfers Gift tax consequences of certain transfers

Transfers for Inadequate Consideration Transfer of cash, stock, securities or real estate Forgiveness of debt Assignment of a life insurance policy Transfer of federal, state, or municipal bonds Transfer of other assets

Transfers NOT Subject to Gift Tax Transfers in normal course of business Qualified transfers for direct payment of educational tuition or medical care Transfers to political organizations Property settlements in divorce Transfers disclaimed by recipient Incomplete transfers

Completed Transfers Gift does not occur until transfer is complete Transfer 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

Gift Tax Consequences of Certain 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

Gift Tax Consequences of Certain 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 pmts are a completed gift if policy owned by another

Annual Exclusion All gifts valued at FMV Exclude transfers up to $11,000 (in 2002) 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

Gift Tax Deductions (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

Gift Tax Deductions (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

Gift Tax Deductions (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

Gift Tax Deductions (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

Gift Tax Deductions (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

Gift-Splitting Election to treat each spouse as giving 1/2 of each gift given Allows one spouse to give up to $22,000 per donee per year w/o tax consequences

Tax Computation (1 of 2) Large gifts Tax rates progressive, from 18% to 50% (tax base over $2.5M) in 2002 5% phase-out of lower rates repealed for tax years ending after 2001

Tax Computation (2 of 2) Unified credit $345,800 in 2002 for gift tax Completely eliminates tax liability on $1M of taxable gifts Credit against estate tax increases between 2002 and 2009

End of Chapter 12 Comments or questions about PowerPoint Slides? Email Richard Newmark at richard.newmark@PhDuh.com