Back to the basics: common gift tax return mistakes.

• Author: Ransome, Justin P.

This article addresses various issues that may arise in the preparation of federal gift tax returns. It discusses the basic rules for whether a gift tax return needs to be filed and some general rules that can be used to properly prepare the return. While the issues discussed in this article were identified during the preparation of gift tax returns for prior years, the focus is on gift tax returns that will be filed to report gifts made during 2009 or 2010. Unless otherwise indicated, most of the information provided here is further explained in the instructions for the gift tax return.

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Who Must File?

In General

If a donor makes gifts of present interests in property and the total value of those gifts to any donee exceeds the annual exclusion amount, the donor must generally file a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. The annual exclusion amount is $13,000 for 2009 and 2010. The annual exclusion is available only for gifts of present interests in property. (1) An outright gift to an individual of property such as cash, marketable securities, real estate, and tangible personal property qualifies as a gift of a present interest. In some situations, transfers of interests in unmarketable assets--such as stock in closely held corporations, interests in limited partnerships, or interests in limited liability companies--may not qualify as gifts of present interests. (2)

In general, transfers to a trust are considered gifts of a future interest and do not qualify for the annual exclusion. However, a donor may structure such transfers to qualify for the annual exclusion. The most common way to meet the present interest requirement is by the use of a Crummey withdrawal right. (3) In general, a Crummey withdrawal power refers to the right granted in the trust agreement to named beneficiaries or members of a class that allows those individuals to withdraw from the trust any contribution (or a portion thereof) made to the trust for a limited period of time after the contribution. If properly drafted and implemented through notification to the donee of the withdrawal right, the property subject to the Crummey power is a gift of a present interest and qualifies for the annual exclusion.

If a gift does not qualify as a present interest in property, the donor must file a gift tax return regardless of the amount of the gift. There are, however, special filing requirements for transfers for certain medical and educational expenses and for transfers to the donor's spouse and to charity.

Medical and Educational Expenses

Transfers made on behalf of an individual directly to a qualifying educational organization as tuition for the education or training of the individual are not treated as a transfer of property by gift for gift tax purposes, and the donor does not report them on Form 709. Similarly, transfers made on behalf of an individual directly to a person or institution that provided medical care for the individual are not treated as a transfer of property by gift for gift tax purposes and are not reported on Form 709. (4)

Gifts to 529 plans: Gifts to 529 plans for qualified higher education expenses do not qualify as payments of qualified educational expenses under Sec. 2503(e). However, they do qualify for the annual exclusion (as well as nontaxable gifts for generation-skipping transfer (GST) tax purposes) regardless of the fact that gifts to these plans are transfers of a future interest. (5) Thus, a transfer of the annual exclusion amount to a 529 plan would not otherwise require a donor to file a Form 709.

The donor may want to take advantage of the ability to spread the gift over five years so that one-fifth of the gift is treated as made in the year of the contribution to the plan and one-fifth is treated as if made in each of the following four years. The election, however, is only applicable with respect to contributions not in excess of five times the annual exclusion amount for the year of the contribution. (6) If such an election is made, the donor is required to file a Form 709 for the year of the gift and to check line B of Schedule A, Computation of Taxable Gifts. In addition, the donor must attach an explanation to Form 709 containing:

* The total amount contributed per individual beneficiary;

* The amount for which the election is made; and

* The name of the individual for whom the contribution was made.

For each of the five years, the donor must report one-fifth of the amount for which the election is made. However, during this five-year period, if the donor does not make any other gifts that would otherwise require him or her to file a Form 709, the donor is not required to file a Form 709 in the four years subsequent to making the election simply to report the amount of the gift to which the election applies. The same rule applies if the donor and his or her spouse choose to split gifts in the year the contribution is made.

Gifts to the Donor's Spouse

The donor is not required to report on a Form 709 any outright gift to the donor's spouse who is a U.S. citizen. (7) Similarly, gifts to certain types of trusts for the benefit of the donor's spouse are not required to be reported on a Form 709. Such trusts must provide that the spouse is entitled to all the income from the trust for life (payable at least annually), the spouse has a general power to appoint the assets in the trust, and no part of the trust may be subject to another person's power of appointment. (8)

If the transfer is to a qualified terminable interest property (QTIP) trust, the donor must report the transfer on Form 709. The QTIP election can be made only on a timely filed Form 709. (9) Note that...