Chapter 7.3 The Federal Gift Tax

• Jurisdiction: Washington

§7.3 THE FEDERAL GIFT TAX

The federal gift tax applies to "taxable gifts." A donor may give up to $15,000 (in 2019) in present interests in property to an individual without creating a taxable gift. Gifts in excess of this $15,000 "annual exclusion" to any one individual (or any gifts of future interests in property, regardless of the amount) are taxable gifts. The annual exclusion is adjusted for inflation and should therefore rise (in $1,000

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increments) over time. The maximum annual exclusion for gifts to spouses who are not U.S. citizens is $155,000 in 2019.

(1) Gift transfers

First, there must be a determination that the donor has made a transfer of property by gift. If so, the focus then shifts to whether the transfer is shielded from taxation by virtue of some applicable exclusion or the marital deduction.

(a) Transfers in general, I.R.C. §2511

For transfer tax purposes, any completed transfer of property for less than full consideration is a gift. Unlike the federal income tax, we do not care whether the transferor acts out of "detached and disinterested generosity." See Treas. Reg. § 25.2511-1(g)(1). We care only whether the transferor receives adequate consideration on the transfer. Furthermore, the consideration paid to the donor must be "in money or money's worth." I.R.C. §2512(b). Consideration in other forms does not count. Thus, when a donor transferred property to a recipient in exchange for the recipient's promise of marriage, the transfer constituted a gift. Comm'r v. Wemyss, 324 U.S. 303, 65 S.Ct. 652, 89 L. Ed. 958 (1945); see also Treas. Reg. § 25.2512-8. Transfers in satisfaction of a parent's obligation to provide support for a child, however, are not considered gifts subject to the tax. Rev. Rul. 68-379, 1968-2 C.B. 414. Likewise, bad business deals, like purchasing property from a dealer at a price far in excess of fair market value, are not treated as gifts as long as there was negotiation of a bona fide transaction at arm's length and the absence of any donative intent by the parties. Treas. Reg. § 25.2512-8.

Gratuitously provided services are not subject to the federal gift tax. Thus, if a lawyer prepares a will for a neighbor and charges no fee, the lawyer does not make a gift subject to taxation.

The federal gift tax only applies to gift transfers that are "complete." For a transfer to be complete, the transferor must give up dominion and control over the property. Thus, if an individual "gives" property to a child but continues to exercise exclusive dominion over the property, the gift is not complete and thus not yet taxable. Burnet v. Guggenheim, 288 U.S. 280, 53 S.Ct. 369, 77 L. Ed. 748 (1933).

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Example: Mother opens a joint bank account for herself and Daughter by depositing $10,000 into the account. The terms of the account allow either party to withdraw funds. There is no completed gift at the time of the deposit because Mother can still withdraw the entire balance on demand. But when Daughter withdraws funds from the account without a duty to account to Mother, Mother makes a completed gift to Daughter of the amount withdrawn. Treas. Reg. § 25.2511-1(h)(4); Treas. Reg § 25.2511-2(c).

(b) Valuation of gift transfers, I.R.C. §§2512, 2701, 2702

Generally, gifts are valued based on the fair market value of the transferred property at the time of the gift. I.R.C. §2512(a). If gifted property is encumbered or otherwise charged with a debt, the amount of the gift is the transferor's equity in the property (i.e., the excess of the value of the property over the principal amount of the encumbrance).

Additional valuation rules applicable to gift transfers are located in I.R.C. §§2701-2704. These rules were added in 1990 primarily in response to certain estate planning techniques that leveraged the valuation rules in place prior to the adoption of I.R.C. §§2701-2704. The rules target certain intrafamily transfers in which the transferor (or another family member) retains certain interests in the gifted property (which the statute calls an "applicable retained interest").

I.R.C. §2701 requires use of the "subtraction method" for valuing gifts of interests in corporations and partnerships. In doing so, it commands that certain discretionary rights retained by the transferor be ignored for the purpose of calculating the interest. Thus, when a parent transfers stock in a closely held corporation to a child but retains a call right over the gifted property, the parent's call right is valued at zero, meaning the parent is deemed to make a transfer of the stock at full fair market value.

I.R.C. §2702 applies a similar zero-value rule in the context of gifts to trusts for the benefit of a transferor's family member(s). All but certain limited retained rights over trust property are to be valued at zero, thus increasing the value of the gift to the beneficiaries.

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Example: D transfers $100,000 to an irrevocable trust, the terms of which require payment of income annually to D for D's life followed by a distribution of the remainder to D's child, C, or C's estate. Under I.R.C. §2702, the completed gift of the remainder interest to C is valued at $100,000 because D's income interest must be valued at zero.

I.R.C. §2702 does not apply, however, if the transferor retains a qualified interest: a right to receive a fixed amount payable at least annually (an annuity interest), an amount payable at least annually equal to a fixed percentage of the fair market value of the trust property determined annually (a unitrust interest), or a noncontingent remainder following one of the above. Note that the right to receive the income from property is not a qualified interest and will be disregarded for gift tax purposes.

Example: D transfers $100,000 to an irrevocable trust, the terms of which require payment of $5,000 annually to D for D's life followed by a distribution of the remainder to D's child, C, or C's estate. Here, D's retained annuity interest is a "qualified interest," so the completed gift of the remainder interest to C is valued at $100,000 minus the value of D's annuity interest. In other words, D's qualified interest is not ignored in computing the value of the gift.

Comment: A number of techniques in contemporary estate planning involve the application of qualified interests to avoid the zero-value rule of I.R.C. §2702. These include so-called "grantor-retained annuity trusts" (GRATs) and "qualified personal residence trusts" (QPRTs), the details of which are beyond the scope of this introductory chapter.

(c) Split gifts, I.R.C. §2513

Under I.R.C. §2513, married couples are entitled to "split gifts" if both spouses are U.S. citizens or residents and consent to split gifts on a federal gift tax return. If a couple so consents, all gifts during a calendar year are deemed to be made one-half by the husband and one-half by the wife. It is not possible to split less than all gifts made during a calendar year. The consent to split gifts may be revoked only if the couple files an amended gift tax return prior to the April 15 deadline for that year's federal gift tax returns. Revocations after that date are not valid.

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The split-gift provision was intended to bring separate property states in line with community property states. In Washington, any gift of community property is, as a matter of state law, a gift from both spouses. Thus, spouses in Washington do not need to file a federal gift tax return to split gifts of community property. In other words, if a Washington couple only makes annual exclusion gifts of community property (i.e., a total of $30,000 to each donee), there is no need for either spouse to file a federal gift tax return. If spouses in Washington wish to split gifts of one spouse's separate property...