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Do I Need to Worry About Gift Taxes?

Date Published Feb 2009 San Francisco Business Times

In the countdown to April 15, many people rushing to prepare their individual income tax returns will overlook another important tax return that is due the same day. They will overlook the filing of a Form 709 which must be filed with the IRS reporting taxable gifts made during the prior year. Filing to file a gift tax return can result in an expensive oversight.

For example, suppose a generous woman decides to make considerable gifts to her children and grandchildren during her lifetime. However, she fails to file gift tax returns with the IRS reporting the gifts made to children and grandchildren. Now, suppose she dies with an estate worth approximately $5 million. If the IRS were to audit her estate and discovers that the generous women failed to file gift tax returns during her lifetime, the IRS may assess significant back taxes, penalties, and interest against the estate of the generous women. The back taxes, penalties, and interest may eat up most of her family’s inheritance. To avoid a similar nightmare, we hope this article will provide our readers with a basic understanding of gift taxes.

Contrary to common misconceptions, the donor of a gift is responsible for paying any gift tax due on the transfer, not the recipient of the gift. Gift taxes are cumulative and based on how much you give away during your lifetime. The top rate for gift tax is approximately 35 percent. You can give up to $13,000 worth of gifts every year to as many people as you like, gift-tax free and without reporting the gift. Anything above this “annual exclusion” must be reported. Whether you will owe a gift tax depends on whether you have used up your lifetime gift exemption. Currently, taxpayers are allowed to gift $1 million during their lifetime. The IRS requires taxpayers to file gift tax returns to determine how much of the exemption has been used up. Spouses can pool their annual exclusions for a gift up to $26,000. This practice is known as “gift splitting.” However, each spouse is still required to file a gift tax return. In order to avoid the filing requirement, each spouse can make out a separate check for $13,000, rather than writing one check for the entire $26,000 amount. However, payments to service providers such as a doctor, school, and insurance companies are exempt from the above mentioned rules.

Filing gift tax returns is the only way to start the clock ticking on the three year statute of limitations on audits for gift taxes with the IRS. (The statute of limitations is six years if the gift’s value is understated by twenty-five percent of more). However, you should keep the gift tax returns indefinitely for your own protection. Because the gift tax rules are complex and intertwined with the estate tax rules careful consideration must be given to a wide variety of factors, as well as, personal preferences in making good decisions.

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