The other April 15 deadline: Gift-tax returns
Tax pros estimate twice as many Americans will need to file gift-tax returns this year, after rushing to give away assets during the 'fiscal cliff' frenzy.
This post is by Deborah L. Jacobs of Forbes.com.
In the countdown to April 15, many people rushing to prepare their individual income tax returns will overlook another key tax document that’s due the same day: Form 709, covering taxable (or potentially taxable) gifts made during the previous year. Tax pros estimate there are more than twice as many people in this category for the current filing season (covering 2012) than for the previous one.
This is one more thing to blame on the year-end fiscal cliff frenzy. Unless you were living under a rock or have already mentally repressed the details, you probably recall that the $5.12 million per-person exclusion from the federal estate and gift tax had been scheduled to dip automatically to $1 million on Jan. 1, with the tax on transfers above that amount rising from 35% to as much as 55%.
At the urging of their financial advisers, some wealthy people rushed to make lifetime gifts that would pare down their estates, ruining the holiday season for their lawyers and tax advisers.
As their clients jetted off to ski chalets and beachfront properties, lawyers left to do the paperwork felt like Cinderella. Their chores mostly involved setting up trusts and funding them with the full $5.12 million per-person ($10.24 million for married couples) exemption.
The story had a happy ending at the dawn of 2013, when Congress made permanent the system that was in effect before anyone heard of the fiscal cliff, raising the top tax rate to 40%. To cap it off, the IRS announced on Jan. 11 that, with an inflation adjustment, the estate-tax exclusion amount for deaths in 2013 would be $5.25 million.
But now the lawyers have one more reason to be busy: You must report 2012 gifts on Form 709 even if you don’t owe tax. Among other things, that’s so the IRS will know how much of the $5.12 million ($5.25 million for 2013) tax-free amount you have used so far.
Do-it-yourself types can download the form -- along with the instructions that go with it -- as a fillable PDF from the IRS web site. But if you made the kind of gifts that were getting all the attention late last year, you will probably delegate this job to your tax adviser. Based on the volume of work late last year, lawyers meeting in January in Orlando, Fla., at the Heckerling Institute on Estate Planning, the annual Super Bowl of the subject, were predicting that there would be twice as many gift-tax returns filed for the 2012 tax year as for the previous one.
It will be interesting to see whether statistics bear out their forecasts. For the 2011 tax year, there were 219,544 gift-tax returns filed, according to IRS statistics. However, very few of them, about 3,000, involved gifts of $1 million or more. Most related to using what’s called the annual exclusion. This is the amount that you are allowed to give, in cash, property or gifts, to as many people as you want each year without dipping into your lifetime exemption amount. Last year, the annual exclusion was $13,000. The annual exclusion for 2013 is $14,000.
There are various reasons why you might need to report these relatively small (in the scheme of things) gifts. To come within the annual exclusion, a gift must be a present interest, meaning the recipient can use the gift immediately. That’s certainly true with cash, but can be a different story with gifts to trusts, in which beneficiaries don’t have any rights until later. Any time you make a gift that isn’t a present interest, it must be reported, no matter how small the amount.
A popular use of the annual exclusion is to put money in Section 529 college savings plans, setting up a separate account for each family member you want to benefit.
The law also permits lump-sum deposits of as much as five times the annual exclusion, which this year would be $70,000 for individuals or $140,000 for married couples, per person at once. However, in that case you must file a gift-tax return electing to treat the gift as if it had been spread over five years. During this five-year period, you cannot make additional annual exclusion gifts to the beneficiary of the 529 plan. If you die before the five-year period is up, part of the gift, reflecting the number of years still to go on your five-year gift, will be included as part of your estate.
Special rules also apply when spouses combine their gifts. It’s called gift splitting. By using the annual exclusion this way they can jointly give away up to $28,000 this year to as many people as they want without dipping into the $5.25 million lifetime allotment. Ordinarily couples must then file a gift-tax return and consent, on each other's returns, to gift split.
It’s also possible for spouses to share their $5.25 million lifetime exclusion amount. (Here, too, they must file a gift-tax return and consent to gift split.) But keep in mind this reduces the amount available to each of them to make tax-free transfers at death to someone other than each other, for example, to children. And when the first spouse dies, there will be less unused exclusion left for the survivor to carry over through portability.
Timing is everything
So let’s say you need to file a gift-tax return for 2012 -- either for one of these run-of-the-mill reasons, or because you used all or part of your life time exclusion amount. Should you get an extension to file Form 709?
Getting one is easy enough. To request an automatic six-month extension, you can file Form 8892. If you are applying for an extension for your personal income taxes, filing the necessary paperwork for that (Form 4868) automatically extends your time to file Form 709, so you don’t need to request the extension separately. Either way, though, if you owe taxes, you must pay it by April 15 (use the voucher on the Form 8892 for this), or you will owe interest and perhaps penalties.
But there’s a strategic reason for filing on time, especially this year. If the lawyers are right that there’s a deluge of gift tax returns coming, the 350 or so tax examiners typically assigned to this task will have that much less time to scrutinize your return. If there’s any room for quibbling about the value you’ve attached to your gift, that could be a good thing.
As usual, the sooner you file, the sooner you start the statute of limitations running on your gift tax return. Under the tax law and Internal Revenue Service regulations, to start the statute of limitations running on your gift-tax return, you must make “adequate disclosure” of the gift. The only way to do that is to file a gift-tax return reporting the gift. So even if you’re not required to file a return, you might want to do it anyway if there’s room for debate about what your gift is worth.
Odds of an audit
As with other tax returns, gift tax returns get audited, and filing one (even just to start the statute of limitations running) means you might get audited. However, when you make a transfer that’s clearly a taxable gift, the law requires you to report it. Plus, after you die, during an estate-tax audit, the IRS can question -- and tax -- gifts you made many years earlier if you didn’t file a return reporting them.
If you didn’t file gift-tax returns for past tax years, it’s not too late to correct the situation. Generally speaking, you have until the IRS catches the problem. When you’re not liable for gift tax, there’s no penalty for late filing.
Since the $5.25 million lifetime exclusion from gift tax and any gift tax you pay are cumulative, you must keep the returns indefinitely. Your heirs need them to calculate the tax, if any, on your estate. And the most likely time for the IRS to flag unreported gifts or to question the value of the gifts you made is after you die. You do everyone a favor by leaving all the documentation behind.
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