Filing a gift tax return can work in your favor.
If you make annual gifts to reduce your taxable estate, you may not be required to file a gift tax return. But in some cases you should do it anyway. Filing a return may save your family a great deal of bother — and money — in the future. This is especially true in the case of illiquid, hard-to-value assets, such as stock in a privately held business.
You are allowed to give up to $14,000 worth of gifts tax-free to as many recipients as you want each year. And if you stay within that limit, no gift tax return is required.
Married couples can give up to $26,000 to each recipient. Even if one spouse provides most of the gift, the other spouse may join in the gift and “split” it by filing a gift tax return.
When you hand out cash or shares of publicly traded companies, there’s no valuation problem. Just be sure to keep records of the transaction in a safe place. But consider what can happen if you give an interest in your family business or an interest in real property. Those are hard-to-value assets.
If for example, you give your son $20,000 worth of stock in your company, valuing it at less than $14,000, no gift tax return is necessary. But what happens if, after your death many years later, your estate tax return is audited and the IRS questions the value of that transfer?
Unless your executor can justify the valuation, which can be difficult to do a decade later, your estate may face an enormous bill for back taxes, interest and penalties. Fortunately, there’s a “safe harbor” you can use for protection. File a gift tax return and attach an explanation justifying your valuation. The clock starts running once you file the gift tax return, and assuming all valuations are adequately disclosed, the IRS has three years to question the valuation in that return.
You’re home free once three years pass. The IRS can’t look back at your gift tax return 25 years from now and demand more information from your executor. A similar situation arises when you make gifts to grandchildren or to a trust that names your grandchildren as beneficiaries. There’s a painful generation skipping tax on these transfers when they exceed the lifetime exemption. The exemption was recently raised to $5,000,000.
By filing a gift tax return, you can allocate a portion of your lifetime exemption from the generation skipping tax to the reported gift.
That doesn’t cost anything and it may help your family avoid the dreaded tax, currently 35 percent of the “skip” amount.
Please consult with our office if you have any questions about these matters.