Consider This: Gifts and Gift Taxes

By Jimmy R. Hammond

Recently heard that John Travolta gave Oprah Winfrey a Rolls Royce valued at $700,000 for her birthday. My CPA brain immediately began to contemplate the gift tax ramifications of such a spectacular present. That gift also prompted me to look back at a television series called The Millionaire which was popular from 1955-1960. The premise of the show was that an anonymous donor would give one million dollars tax-free to a randomly selected stranger. The two conditions of the gift, explained to the donee by the donor’s servant, were that the recipient could not reveal how much he received nor how he received it. I can still remember my surprised reaction to the tax-free reference and the personal speculation of what a gift like that would mean to me and my family. That was at a time when millionaires were a minority and a million dollars was a truly a small fortune. As recently reported by High Beam Research at www.FindArticles.com, “According to Cap Gemini Ernst and Young (with assistance from Merrill Lynch), 2.22 million people in North America have more than $1 million in investable assets—a decline of 40,000 from last year. And the rich got poorer.” I assume we have reached a plateau if, in fact, millionaires are now in a decline.

I was probably in college before I understood why gifts of this nature were almost always tax-free to the recipient. According to the IRS web site, “The donor is generally responsible for paying the gift tax. However, under special arrangements the donee may agree to pay the tax instead. The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax generally applies whether the donor intends the transfer to be a gift or not. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.”

Gifts of a million dollars from a stranger might be uncommon, but it is not uncommon for individuals—normally families—to give gifts at or below the Federal annual exclusion limit of $11,000. If you are married, both you and your spouse can separately give up to $11,000 to the same person in 2002, 2003, 2004 or 2005 without being taxed and gifts to spouses are normally not taxable. The individual Federal annual exclusion amount was created to allow assets to be transferred to any individual annually, free of tax and reporting. For tax years beginning in 2003, recipients of gifts from certain foreign persons may have to report gifts under Sec. 6039F if the total value received in a taxable year exceeds $11,827. Annually gifting at below the annual exclusion limit remains a common estate tax planning technique used to reduce the total potential estate assets of an individual even though individuals may be entitled to give as much as a million dollars tax-free during a lifetime. The million-dollar lifetime exclusion is scheduled to remain at that level through 2009. Refer to IRS Publication 950, Introduction to Estate and Gift Taxes, for more instructions for the IRS form 709, the annual reporting form. Gifts to individuals are not deductible on the donor’s income tax returns.

The gifting scenario to reduce estate assets has been less effective as a tool with the nontaxable limits rising on estates through 2009. The nontaxable estate is currently at one million five hundred thousand dollars and rising incrementally over the next four years to three million five hundred thousand. Unfortunately, the limit reached in 2009 is not permanent and is scheduled to revert to one million dollars in 2010. Congress and the President are continuing to struggle over the sunset provision of federal estate tax and the limits. The arguments are that the estate tax punishes your lifetime achievement and is essentially a double tax, although only 2% of estates now pay any taxes. Stay tuned for more on this battle and any changes that result. Today, however, there is a web site at www.banksite.com/calc/estate which provides you with an online tool to assess your taxable estate and, correspondingly, the effect gifts might make in your particular situation based on the current tax law.

There is an issue related to the computation of the tax that might not be apparent and should not be overlooked. The calculations of gift and estate taxes are made using a graduated scale ranging from 18% to 45% based on current law. You can see these rates fully described on a number of web sites, or check them out at www.smbiz.com/sbrl017.html. You can see from the rate schedules that you are essentially given a tax credit up to $345,800 for gifts up to one million dollars. That means any gift above a million dollars will be assessed a tax at 41%. That calculation means that a non-exempt gift of $10,000 could cost $4,100 or more in taxes. Watch out!

While there may be a statistical decline in personal wealth at higher levels, gift and estate planning opportunities abound for many Americans. It has never been more important to seek professional accounting and legal help to create gift and estate planning scenarios that work for you now and beyond 2009. If you don’t take the initiative yourself, your family could be left without your guidance and then there is the government. I am sure neither group would properly represent you or take into account your wishes.

Make your first New Year resolution now to be more informed about your gifting and estate planning options and to get your plan in place on January 1, 2006.