U S Taxation – Gift Tax – Interesting facts to know
Happy Sankranti/Pongal and new year 2017 Greetings to all readers.
As a CPA, I am often requested by my clients whether they can gift anything to their dear ones. The laws governing gift in India and USA differ basically.
We shall only deal with gifts made by a US citizen or a Green card holder.
Let us analyze what is considered as a gift? Whether contributing cash, a property or giving a donation to a charity has any relevance? Alternately, some may even give a hospital some money towards the medical expenses of his friend or towards the educational needs of his friend’s son, directly to the educational institution.
Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return is considered as a gift.
For the next question as to what can be excluded from gifts, the general rule is that any gift is taxable gift. However, there are exceptions to this rule. Generally, the following gifts are not taxable gifts:
- Gifts that are not more than the annual exclusion for the calendar The annual exclusion for 2014, 2015, 2016 and 2017 is $14,000.
- Tuition or medical expenses one pays for someone directly to the educational institutions or hospitals.
- Gifts to one’s
- Gifts to a political organization for its use.
- In addition to above, gifts to qualifying charities are deductible from the value of the gift(s) made.
During life, a taxpayer who undertakes “ Taxable gifts” in the calendar year is expected to file Form 709, United States Gift (and Generation Skipping Transfer) Tax Return. Taxable gifts are generally amounts over the annual exclusion ($14000 in 2017) to anyone than a spouse or a charity. The running total of taxable gifts made during the donor’s lifetime is used to calculate Gift Tax.
The current year tax is the difference between gift tax on all gifts from the current and prior years and gift tax calculated on gifts from prior years. Until the donor makes cumulative taxable gifts of more than the gift tax exclusion (5,490,000 in 2017), no tax is therefore
levied.
Gift is not subject to tax until the gift is complete which happens when the donor has parted with the dominion and control so that he or she has no power or capacity to change its disposition. State Law plays a major role in determining whether the donor has parted with dominion and control. Gifts are valued on the date completed.
Information on Gift Tax
A taxpayer entitled to an annuity for his/her life alone makes a gift by irrevocably electing to take a smaller annuity that includes a survivorship annuity.
Gifts of municipal bonds are subject to gift tax even though the income is exempt from income tax.
Until the checks donated are paid by donor’s bank, the gifts are not complete.
In case of a stock, the moment the donor delivers an endorsed certificate to a donee, the gift is complete.
A transfer to an irrevocable trust is complete when the donor does not retain any right
or power over the property.
A transfer to an irrevocable trust is a completed gift if the donor retains no power over the property. A transfer to a fully revocable trust does not qualify as a gift.
Loans
If an individual makes a loan and as a part of a prearranged plan intends to forgive the debt, the debt may be considered as a gift at the time the loan is given. If there is no prearranged plan, the lender may claim to have given the gift when the loan is being given. Interestingly, cancellation of a debt intended as a gift is not a taxable income to the borrower.
In case of below market loans, if the interest on a loan is less than the applicable federal rate (AFR), the interest foregone is a gift from the lender and considered taxable income to the
lender. Husband and wife are treated as one individual.
In case of term loans (where the period of the loans is known, say, 36 months), the lender is said to have made the gift on the date of the loan of the amount loaned and the present value of all payments due under the loan.
For a demand loan, the lender makes the gift each year for the difference between the
interest charged and the applicable federal rate (FDR). One can find the federal rates at:
Apps.irs.gov/app/picklist/list/federalRates.html Joint Tenancies
The creation of a joint tenancy is a completed gift for some assets. For other types of assets,
the gift is not considered as completed until the assets are withdrawn by the donee without obligation to account for the proceeds to the donor. Obviously, the State Law decides
whether any gift is complete or not. The provisions of the State Law may be referred by professionals for interpretation.
Let us consider an example of a joint tenancy of a house. In 2015, Sachdev in Lawrence,
Kansas changed his house and bank accounts with U.S.Bank, to a joint tenancy with his daughter, Laxmi. Since Laxmi is entitled under the State Law to half the proceeds in case the house is sold, Sachdev has made a completed gift of half of his house. The transfer of the bank accounts is not a completed gift in case Laxmi made no withdrawals from the bank account in 2015. This type of gifts are normal in U.S.A. in case of old parents and daughter who take care of her parents. Expectedly, the parents and the daughter live at places nearer to each other.
For an interesting question as what would happen in case of joint tenancies at death, if the original owner is still a joint tenant at death, the entire property is considered to be acquired from a decedent. Its full value is included in the gross estate for estate tax. If the gift was reported on Form 709 popularly known as Gift Tax Return, when the joint tenancy was created, the gift is excluded from adjusted taxable gifts reported on line 4, form 706, and any gift tax paid is credited to the estate.
In case of life estates and remainders, the same rules are applied when an owner reserves a life estate and transfers the remainder interest. The transfer may be considered as a gift. If the original owner is still a life tenant at death, the value of the entire property is included on Form 706.The taxable gift reported on form 709 is not included on form 706.
No, these are not Gifts
The following are specifically excluded from gift tax. Yes, you are right to say that they won’t be reported in Form 709.
Qualified transfers for tuition or medical expenses. The donor directly makes the payments to the school or care provider. But payments made to the beneficiary do not qualify even if the payments just benefit the beneficiary for having made the payments towards those expenses.
Interestingly, the donor and the donee need not be related and also no limit has been fixed for those type of transfers. The writer presumes that this tax benefit to the society helped U.S.A. to develop the habit of giving. Whenever, I used to profusely thank any one for the help received, I used to be told to “Pass it on”, meaning to continue the habit and spread around the people. We may also learn from this information since many professionals like CAs consider it as secret even to give their business cards during the conferences.
Medical expenses include any unreimbursed medical expenses that would be medical expenses eligible for deduction on form 1040.
Tuition qualifies if paid to an institution either domestic or foreign educational institution maintaining regular faculty, curriculum and an enrolled body of students in attendance in a place where it carries on its educational activities. One can easily recollect a large number of bogus universities which have cheated students, particularly from India and other developing countries but functioning in California.
Discussion on Form 709 – Gift Tax Return – continued
Form 709 is popularly known as United States Gift (and Generation-Skipping Transfer) Tax Return. Information about form 709 and its separate instructions is at www.irs.gov/form709
Form 709 consists of 5 pages and is normally prepared for submission whenever a gift of more than $14000 is made during the tax year. Its filing requirements are given below:
One has to file Form 709 if a gift is given for more than $14000 to anyone other than a spouse or charity and a future interest of any value. Obviously, gifts less than 14000 are not reported.
To report gifts to charity if a return is required-a partial interest in property (i.e. a trust remainder interest)
Discussion on Form 709 – United States Gift (and Generation-Skipping Transfer) Tax Return itself
Let us analyze the above form in detail. It consists of 5 pages with the following details:
Page 1 consists of 20 columns which contain details of gift by husband or wife to third parties under Serial Number 12 and the consenting spouse signature under S Number
- Part 1 contains the general information while Part 2 contains the Tax Computation. The first page ends with the signature of the donor.
Page 2 called Computation of Taxable Gifts starts with Schedule A with the following parts:
- Part 1- Gifts subject only to Gift Tax
- Part 2- Direct Skips
- Part 3- Indirect Skips
- Part 4- Taxable gift reconciliation (cont. on 3)
Schedule B on page 3 contains the Gifts from Prior Periods. Page 4 contains Schedule C
with the title of Deceased Spousal Unused Exclusion (DSUE) Amount, and Schedule D with the details of Computation of Generation-Skipping Transfer Tax. Detailed discussion on Generation-Skipping Transfer Tax which is an interesting concept with peculiar facts are given in the following paras.
Page 5 concludes with the calculation of Total generation-skipping transfer tax.
Let us understand” What is generation-skipping transfer tax”?
The story goes back to 1997 when I was handling the audit department of a leading nationalized bank with nearly 100 audit reports of various types of branches. In those days, the big bosses decided the fate of many successful branch managers who in spite of virtual socialization of banks and total unwillingness of a large number of branch managers to avoid lending, had to be part of banking by lending, recovery of lending, deposit mobilization, employee management etc.
My big boss, in those days, at the rank of a Deputy General Manager, asked me in writing to allow my Ex- Executive Director to open a Fixed Deposit Account with his grandson. I was certain that it was against the bank rules since his grandson, a minor was only allowed to open bank accounts with either of the parents as guardian. But, in those days, very few executives would have objected to the views of the big bosses. I persisted with my views in writing which were ultimately referred to our Law Division which upheld my views. But the
intelligence of my Ex Executive Director could be inferred from the following information on U.S.A.
But, what would have happened in U.S.A. if a similar situation had arisen?
American grandparents, like my Ex Executive Director, always wanted to bypass their sons/daughters and pass on the benefits to their grand kids by the way of gifts. To avoid a similar situation, federal estate and gift tax has been designed to tax property as it passes
from each generation to the next. The GST tax is an additional tax that applies to transfers during life and at death that skip a generation.
Transfers not in trust that qualify for the annual exclusion are excluded from GST tax. Obvious exclusions to above tax from our earlier discussions include direct qualified transfers for tuition and medical care.
Each taxpayer has a GST exemption equal to the estate tax exclusion ( $5.49 Million). GST tax is set at a flat rate equal to the highest estate tax rate (40%).
GST tax is imposed on any of the following transfers:
Direct skip. A transfer subject to gift or estate tax made to a skip person
Taxable termination. A termination of a trust interest that passes property or property interest to a skip person.
Skip persons are grandchildren and other relatives two or more generations below the donor. Obviously, spouses, former spouses, tax-exempt organizations and charitable trusts are non- skip persons.
Conclusion
The purpose of this article is obviously to lead the readers to the present position regarding gift tax as applicable to a US Citizen. It is reported that nearly 5,00,000 Indians living in India are US Citizens. With the ageing population and rising prosperity, it is not unexpected that grandparents would love to gift to their sons, daughters, grand kids or contribute directly to the educational institutions which are engaged for the education of their grand kids, relatives or their kids or in unfortunate cases for the medical expenses of their relatives directly to the hospitals. Applicability of gift tax has been a nagging problem for most of these persons. This article tries to explain some of the basic concepts of gift tax by referring to various provisions of Internal Revenue Service regulations.
As usual, if you would ask me whether this type of knowledge would be suffice to prepare the final gift tax return for the tax payer during his life time or after his demise, the simple answer is to use the services of a good Certified Public Accountant (CPA) since the preparation of estate tax and gift tax are very confusing and complicated and invariably invite the attention of IRS which keeps a close watch since returns of diseased persons for estate tax or gift tax have been grey areas for avoidance of federal/state tax.
References
- https://www.irs.gov/pub/irs-pdf/f709.pdf- United States Gift (and Generation- Skipping Transfer) Tax
- Form 709- instructions – https://www.irs.gov/pub/irs-pdf/i709.pdf
- Charitable contributions- Form 1040- https://www.irs.gov/pub/irs-pdf/i1040gi.pdf
About the Author
Subramanian Natarajan C.P.A. (USA), M.Sc., C.A.I.I.B., took voluntary retirement from
Punjab National Bank after handling various facets of banking such as deposit mobilization, marketing, auditing, human resources and management of borrower accounts. After living in USA for 12 years during which period he worked in various international audit firms specializing in international taxation, auditing, IFRS and IFRS Training, he continues his practice now in New Delhi, India. He can be reached at [email protected] or telephone 9015613229, 8802735392. His name appears as tax consultant in the web site of American embassy New Delhi. He thanks the readers who give encouragement and a large number of suggestions for improvement. The enthusiasm of young and brilliant professionals encourages him to write more.
