Now that fewer people are subject to federal gift taxes, because of a generous $11.58 million lifetime gift tax exemption for 2020, a question many are asking is: “Do I need to file a gift tax return?” The short answer is “no” if your wealth is well within the exemption amount. However, there are scenarios where it’s necessary (and possibly advantageous) to file Form 709 — “United States Gift (and Generation-Skipping Transfer) Tax Return.”
The federal gift tax regime begins with the assumption that all transfers of property by gift (including below-market sales or loans) are taxable, but there are exceptions. Nontaxable transfers that need not be reported on Form 709 include:
- Gifts of present interests (see below) within the annual exclusion amount (currently, $15,000 per donee),
- Direct payments of qualifying medical or educational expenses on behalf of an individual,
- Deductible charitable gifts,
- Gifts to one’s U.S.-citizen spouse, either outright or to a trust that meets certain requirements, and
- Gifts to one’s noncitizen spouse within a special annual exclusion amount (currently, $157,000).
If all your gifts for the year fall into these categories, no gift tax return is required. But gifts that don’t meet these requirements are generally considered taxable — and must be reported on Form 709 — even if they’re shielded from tax by the lifetime exemption.
Beware of pitfalls
If you make gifts during the year, consider whether you’re required to file Form 709. And watch out for these common pitfalls:
Future interests. The $15,000 annual exclusion applies only to present interests, such as outright gifts. Gifts of future interests, such as transfers to a trust for a donee’s benefit, aren’t covered, so you’re required to report them on Form 709 even if they’re less than $15,000. Be aware, however, that it’s possible for gifts in trust to meet the present interest requirement by giving beneficiaries Crummey withdrawal powers (the right to withdraw a contribution for a limited time after it’s made).
Spousal gifts. As previously noted, gifts to a U.S.-citizen spouse need not be reported on Form 709. However, if you make a gift to a trust for your spouse’s benefit, 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 watch out for gifts to a noncitizen spouse: If they exceed the $157,000 annual exclusion, they must be reported whether they’re 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 $30,000 to each donee. 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 bunching five years’ worth of annual exclusions into the first year. So, for example, you can contribute $75,000 to the plan ($150,000 for married couples) and treat the gift as if it were made over the next five years for annual exclusion purposes. To take advantage of this benefit, you must file an election on Form 709.
When to file voluntarily
It may be a good idea to file a gift tax return, even if it’s not required. 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 IRS finds that the interests were worth $15 million, which exceeds the lifetime exemption amount, it can assess gift taxes plus penalties and interest. If you don’t file regular gift tax returns, the IRS has unlimited time to challenge the values of your gifts.
Proceed with caution
Making gifts remains an excellent way to reduce the size of your estate and benefit your loved ones. If you’ve made gifts, contact your estate planning advisor to help determine if you need to file a gift tax return with the IRS.