Gifting – Rules Now and Maybe in the Future

• August 18, 2021
• Paul Neiffer

Before we get into today’s post, we wanted to review how this post gets to you via email.  When we post something on let’s say a Monday (anytime before Midnight), the email of the post will automatically be generated and sent to you sometime around 2-3 am Pacific Time.  Any of the out of office notifications then will come to my Inbox.  Sometimes I wake up to over 300 emails in my Inbox and almost all of them are these types of emails.

However, we seem to have had some issues with our email provider and they have been going out a few days late.  For example, the last post before this one was done last Tuesday and you likely received it Monday morning.  We are hoping this issue has been resolved.  Now for the post.

Senator Grassley indicated today that the transfer tax appears dead on arrival, however, other major changes may be coming in the gift tax area.  This post will outline the current rules and then go over some “expected” changes and how they may impact your succession plans

First, any asset transferred from you to another person (or in trust for a person) is considered a “taxable” gift unless there is a specific exemption as follows:

• Outright gifts to your spouse (assuming s(he) is an American Citizen),
• Direct payments to an Educational Institution (can’t give it to the person first),
• Direct payments for medical costs (again can’t give it to the person first),
• Total transfers less than $15,000 per donee-per year (indexed to inflation), and 
• Political or Charitable gifts.

Let’s key in on the annual exclusion.  During your lifetime (including at death), you can currently give away $11.7 million.  Next year, it will likely rise to at least $12.4 million (unless Congress changes it to be discussed later in this post).  Each person can give to as many persons they want up to $15,000.  This is an exempted amount which means you do not need to file a gift tax return (Form 709).  If you go over this amount for any person, your are required to file a gift tax return, but will owe no tax until you give away taxable gifts at least equal to the lifetime exemption amount ($11.7 million in 2021). 

If you give let’s say $115,000 to one person, you will be required to file a Form 709 but not owe any gift tax.  Rather, $15,000 is exempted, the remaining $100,000 simply reduces your lifetime exemption from $11.7 million to $11.6 million.

This allows farm couples with large amounts of farm assets (especially land) to gift a fair amount each year to keep their taxable estate low.  Let’s look at an example.

Jim and Jennifer Farmer have a taxable estate of $25 million.  They have 4 married children and 12 grandchildren.  Each year, they gift LLC units that hold their farmland to the children, their spouses and grandchildren (either outright or in trust).  Jim can gift $300,000 and Jennifer can gift the same amount.  This reduces their estate from $25 million to $24.4 million and the following year it will drop to $23.8 million and so on.  This may be a case where they will file a Form 709 to lock in the three-year statute of limitations even though it will not eat into their lifetime exemption amount.

This is the current law.  Now let’s look at some of the changes that may occur by the end of the year.

First, there is a lot of chatter about decoupling the lifetime estate and gift exemption.  Under current rules, any gifts made during lifetime simply reduces the amount available at death.  Decoupling these exemptions may create more tax during lifetime or reduce the benefit at death if not done correctly.  It appears that many want the gift exemption to be $1 million and the estate exemption to be $3.5 million.  Let’s look at an example to see how this may affect Jim and Jennifer.

Jim continues to take advantage of the annual gift exemption but does not make any “taxable gifts during his lifetime.  At his death, his estate is worth $10 million.  The estate exemption reduces the taxable estate to $6.5 million which will be subject to tax.  If he had made $1 million of taxable gifts during his lifetime, the estate tax would only be owed on $5.5 million, thus costing the family at least $400-450,000 in additional estate tax (and we are ignoring any increase in values).

Second, many want to place a limit on the amount of annual gifts that will be exempted.  It appears that cash or outright gifts of stocks, bonds, personal property, etc. may still qualify for the $15,000 per donee exemption, however, gifts made to a trust or gifts of pass-through entities will be limited to $30,000 per donor not donee (indexed to inflation).  This wills severely curtail the ability to make annual gifts for many farm couples.  Let’s see how this may affect Jim and Jennifer.

Jennifer continues to gift $300,000 per year.  Only $30,000 of this gift is now exempt, thus $270,000 becomes a taxable gift.  In year four (assuming no inflation), she will now owe gift tax on $80,000 of gifts (4 years times $270,000 is $1,080,000 minus the $1 million lifetime gift exemption).  If she continues to make these gifts she will owe gift tax on $270,000 each year.

Now many will ask why does Jennifer continue to pay gift tax.  The payment of gift tax is not considered a gift and reduces her estate.  By paying the gift tax during her lifetime, her estate will go down by the amount of the tax paid, thus increasing the net after-tax estate to her heirs by the gift and estate tax rate (expected to be at least 45%).

Finally, many want to curtail the use of discounts between related parties, especially the minority discount.  It appears that the discount for lack of marketability may remain, but the minority discount will be eliminated for related party transfers.  This will result in additional “value” being report on Form 709 or 706 (estate tax return).  Let’s see how this may affect Jim and Jennifer.

Jim and Jennifer each transfer Farmland LLC units to their kids and grandkids.  Under current valuation rules, the allowed discount is about 35%.  This allows them to transfer about $450,000 of gross land value for their $300,000 gift.  The new rule would drop this to about $375,000 of land value (a 20% lack of marketability discount only allowed).

Even though the transfer tax may not happen, it is highly likely that major changes will be made to gift taxes.  It is important to understand how the current rules work and how they may change.  We will keep you posted.

 

, COVID-19 regulatory and tax updates, Farm Taxes, Legacy Planning | 1 Comment »