For 2022, the lifetime gift and estate tax exemption has reached a whopping $12.06 million ($24.12 million for married couples). As a result, few people will be subject to federal gift taxes. If your wealth is well within the exemption amount, does that mean there is no need to file gift tax returns? Not necessarily. There are many situations in which it is necessary (or desirable) to file Form 709, “United States Gift (and Generation-Skipping Transfer) Tax Return” – even if you are not liable for any gift taxes.
All Gifts are Taxable, Except…
The federal gift tax regime begins with the assumption that all transfers of property by gift (including below-market sales or loans) are taxable, and then sets forth several exceptions. Nontaxable transfers for gift tax purposes include:
- Gifts of present interests (as opposed to future interests; see “Traps to Avoid”) within the gift tax annual exclusion amount ($16,000 per recipient in 2022),
- Direct payments of qualifying medical or tuition expenses on behalf of an individual (see “Medical and Tuition Expenses”),
- Gifts to political organizations and certain tax-exempt organizations,
- Deductible charitable gifts, and
- Gifts to a U.S. citizen spouse, either outright or to a trust that meets certain requirements, or gifts to a non-citizen spouse within a special annual exclusion amount ($164,000 for 2022).
If all your gifts for the year fall into these categories, no gift tax return is required. But gifts that do not meet these requirements are generally considered taxable – and must be reported on Form 709 – even if they are shielded from tax by the lifetime exemption.
Traps to Avoid
If you make gifts during the year, consider whether you are required to file Form 709. And watch out for these common traps:
- Future interests. Gifts of future interests, including most transfers in trust, are not covered by the gift tax annual exclusion, so you are required to report them on Form 709 even if the amount per recipient is less than $16,000. Be aware, however, that it is possible to have gifts in trust meet the present interest requirement by giving beneficiaries Crummey withdrawal powers (the right to withdraw a contribution for a limited time after it is made).
- Spousal gifts. If you make a gift to a trust for your spouse’s benefit and want the gift to qualify as a nontaxable transfer, the trust must 1) provide that your spouse is entitled to all the trust’s income for life, payable at least annually, 2) give your spouse a general power of appointment over its assets and 3) not be subject to any other person’s power of appointment. Otherwise, the gift must be reported. And be careful with gifts to a non-citizen spouse: If they exceed the $164,000 annual exclusion, they must be reported regardless of whether they are outright gifts or gifts in trust.
- Gift splitting. Spouses may elect to split a gift to a child or other donee, so that each spouse is deemed to have made one-half of the gift, even if one spouse wrote the check. This allows married couples to combine their annual exclusions and give up to $32,000 to each recipient in 2022. To make the election, the donor spouse must file Form 709, and the other spouse must sign a consent or, in some cases, file a separate gift tax return. Keep in mind that, once you make this election, you and your spouse must split all gifts to third parties during the year.
- 529 plans. If you make gifts to a 529 college savings plan, you have the option of making a lump sum gift of up to five times the gift tax annual exclusion per recipient and spreading the gift over five years. So, for example, you can contribute $80,000 to a beneficiary’s 529 plan ($160,000 if you and your spouse split the gift) and treat the gift as being made ratably over five years. Since the amount each year does not exceed the annual exclusion amount, the entire transfer will be nontaxable for gift tax purposes. To take advantage of this benefit, you must file an election on Form 709.
Consider Filing Voluntarily
It may be advisable to file a gift tax return even if you are not required to do so. For example, if you make annual exclusion gifts of difficult-to-value assets, such as interests in a closely held business, a gift tax return that meets “adequate disclosure” requirements will trigger the three-year limitations period for audits.
Suppose you transfer business interests valued at $10 million over a period of years, through a combination of tax-free gifts to your spouse and annual exclusion gifts to your children. If the gifts are adequately disclosed each year on Form 709, the IRS can only challenge the valuations for up to three years after the relevant gift tax returns are filed. However, if gift tax returns are not filed, the IRS has unlimited time to potentially adjust the values of your gifts. For example, the IRS could later find that the interests were worth $15 million, which exceeds the lifetime exemption amount, and could assess gift taxes plus penalties and interest.
Medical and Tuition Expenses
Paying tuition or unreimbursed medical expenses on behalf of a child or other loved one is an effective strategy for making unlimited tax-free gifts without using up any of the $16,000 annual exclusion for the intended recipient or your $12.06 million lifetime exemption. But it works only if you make the payments directly to a qualifying educational institution or medical provider.
A common mistake is for a parent or grandparent to advance the child the funds he or she needs to pay the expenses or to reimburse him or her for expenses that have already been paid. These payments are treated as gifts to the child, which must be reported on Form 709 if they exceed the annual exclusion amount.
A smart gifting strategy continues to offer significant benefits for you and your loved ones. However, to keep from running afoul of the IRS, it is critical to know when you need to file a gift tax return. If you have questions on gift tax filing requirements and how they might apply to your situation, please contact your Bennett Thrasher tax advisor by emailing firstname.lastname@example.org.