Gifts, Taxes, and IRS Form 709

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Gifts, Taxes, and IRS Form 709

Most people are unaware that giving a gift can be a taxable event because they themselves have not yet experienced the tax. However, some very generous people do face this unusual tax.

The reason we have a gift tax is because we have an estate tax. If there was no gift tax, then when someone with a large estate knew they were dying, they could give nearly all their money away, reducing their estate to a non-taxable level and dodge the estate tax. The government does not like this scenario, so they created a gift tax to stop it.

The good news is that it only taxes gifts after a certain threshold. One individual can give $14,000 to another individual without it being a taxable event or requiring any reporting. If you do give over the limit to one person in one year, only the amount you went over is taxable.

For married couples, each spouse can give up to the $14,000-per-recipient limit tax-free, so as a couple, you can give $28,000 to one person without running into gift tax problems.

Because gift taxes exist as a pre-death estate tax, their rate is the same as the estate tax, which is currently 40%.

If you give over the $14,000-per-recipient limit, you can avoid paying the gift taxes now by reducing the amount of credit you can apply against your estate taxes ($5.45 million per person in 2016). Most people will choose to do this because it saves money while they are alive and only costs more when they are dead.

With such a high tax rate, you normally want to avoid both paying gift taxes and avoid reducing your credit. However, there are some scenarios when using the credit could be the right decision.

Imagine that you have $6 million of invested assets now, will live another 20 years, and have one heir. Let’s assume an annual return of 3% over inflation.

If you do nothing, by the time you have to pay estate tax, your portfolio will have grown to over $10.5 million. About $5 million of that will be taxed at 40%, leaving your heir with $8.5 million.

If you give away the gift limit every year to your heir, you would give him $14,000 for each of those 20 years. Meanwhile, the remainder of your assets would grow to just over $10 million. About $4.6 million of that will be taxed at 40%, leaving your heir with close to $8.3 million. The $280,000 you gave across those 20 years could have grown to over $380,000 for a total inheritance of $8.7 million. This is $200,000 more than what they would have received without proactive giving.

Alternatively, giving away $2 million now ensures that this portion of your portfolio’s growth will be estate-tax-free. You don’t even have to pay tax on it now because you can offset the tax due by using up some of your estate exemption.

In this scenario, you would give $2 million to your heir now and have $4 million growing at 3% per year for 20 years. Your portfolio could become a little over $7 million.

Since you used up $2 million worth of credit when you made the gift (minus the tax-free $14,000), only $3.5 million of your portfolio is exempt from estate tax. The remaining $3.5 million is taxed at 40%, leaving your heirs with $5.6 million from your estate along with the $2 million you gave them as a gift which has now grown to $3.5 million for a total inheritance of $9.1 million.

In this manner, by giving earlier to your heirs, they could receive $600,000 more than if you had left the money to grow and be taxed later. (This is the same logic that makes Roth conversions a good idea.)

When you do want to make a gift, you should keep good records about the transaction for the IRS.

Although gifts equal to or under the $14,000-per-recipient limit do not need to be filed with the IRS, gifts of higher amounts do. Even if you are using your estate credit to make the gift non-taxable, you will still need to file a gift tax return to keep record of the fact that your estate credit should be reduced in the future. This return is called Form 709.

For any kind of gift, you should keep documents proving that the transfer took place. The type of gift you make determines what other information you will need to provide.

Form 709 asks you to describe the property given in column B.

For bonds, this means the number of bonds given, the principal amounts of each bond, the obligor’s name, dates of maturity, interest rates, dates when interest is payable, the exchanges where they are listed or the business office of the corporation if they are unlisted, and CUSIP numbers.

For stocks, you should include in column B the number of shares given, whether you gave common or preferred stock, the exchanges were they are listed or the business office of the corporation, state of incorporation, and date of incorporation if they are unlisted, CUSIP numbers, and for preferred stock, the issue, par value, quotation at which returned, and the name of the corporation.

For any gift, you should keep record of the cost basis. This goes in Form 709’s column D.

And lastly, column F asks for the gift’s fair market value. For valuable items or real estate, you should keep a copy of appraisals of the items’ values. For stocks and bonds, fair market value should be calculated by taking the mean of the high and low prices on the date of valuation of the gift.

Note that this high-low-average valuation is not what your broker uses on confirmations they send to you. It must be calculated separately after the fact. You can do so by using a reputable security price website, such as Yahoo Finance.

You put the amount of credit you want to apply against the gift tax that would otherwise be due on line 7 of the form. The following lines track how much you have used so far in preceding years and make sure you aren’t claiming more credit in your lifetime than you should.

This may sound like a lot, but a good CPA should be able to help you through the filing process.

Photo used here under Flickr Creative Commons.

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Matheson Russell is the Financial Analyst for Marotta Wealth Management. He specializes in tax laws, forms, policy, and planning. He loves complex rules systems, animals, and Koine Greek. His favorite stories are The Jungle Books.

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