Gift and Estate Tax Planning Considerations

By Sarah Lovinger, CPA, Irvine, Calif.

Editor: Mark G. Cook, CPA, MBA

Estates, Trusts & Gifts

The federal tax system looks to collect revenues from transactions through which value is transferred between parties, whether as income or as a gift. While corporate and individual income taxes constitute the lion’s share of total tax revenues, according to IRS statistics, estate and gift taxes contributed approximately $27 billion to the gross revenues collected in 2007, the most recent year available. However, with thoughtful planning, taxpayers can minimize gift and estate taxes while retaining some control of transferred assets by establishing trusts or limited partnerships and using the annual gift tax exclusion.

Gift and estate taxes, which follow one after the other in the Code, are interrelated in concept and calculation. The estate tax, as described in Regs. Sec. 20.0-2, is “neither a property tax nor an inheritance tax” but rather “a tax imposed upon the transfer of the entire taxable estate and not upon any particular legacy, devise, or distributive share.”

In general, an individual’s taxable estate is determined as the value of the net assets owned by the individual at the time of death reduced by specified exemptions and deductions. To this is added the taxable gifts made during the decedent’s life (other than those that are included in the decedent’s gross estate). This total is then subject to a graduated tax rate, which currently ranges from 18% to 35%. (The top rate is scheduled to increase to 55% on Jan. 1, 2013.)

The gross amount of tax is reduced by gift taxes previously paid or payable, certain credits for foreign death taxes paid, a credit for tax on prior transfers, and the unified credit against estate tax. Estate tax is a liability of the estate, and it is the responsibility of the executor or administrator of the estate to satisfy this liability out of the estate’s assets (Regs. Sec. 20.2002-1). Estate tax therefore can significantly reduce the total value passing from the decedent to the heirs.

For most taxpayers, the unified credit offsets all estate tax liability. Under Sec. 2010, the unified credit is described as the amount of estate tax that would be due if the graduated rates identified above were applied to a value equaling the applicable exclusion amount. For individuals who died in 2011, the exclusion amount was $5 million, which equates to a unified credit of $1,730,800. The exclusion amount is adjusted for inflation and increased to $5.12 million for 2012, which equates to a unified credit of $1,772,800 (Rev. Proc. 2011-52). Also, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312, modified Sec. 2010 to create a portability election that allows a surviving spouse to increase his or her unified credit by an amount equal to the unused portion of the first-to-die spouse’s unified credit amount. This is referred to as the deceased spousal unused exclusion (DSUE) amount. The DSUE provision is effective beginning in 2011 as an election to be made on the estate tax return of the first-to-die spouse. To minimize estate tax liability, taxpayers may consider taking steps to reduce their estates so they do not exceed the unified credit.

Gift Tax Strategies

A possible planning strategy for managing the value of a taxpayer’s estate is to gift assets over the taxpayer’s lifetime to remove those assets from the taxpayer’s future estate. However, a gifting strategy should be carefully planned to avoid possible gift tax liability because, functionally, the gift tax is a prepayment toward future estate tax liability.

Gift tax is imposed under Sec. 2501 on the transfer of property by individuals as gifts on a calendar-year basis. A gift is the direct or indirect transfer of real, personal, tangible, or intangible property made with no consideration or with consideration of less than fair value received in exchange (Secs. 2511 and 2512). The formula for calculating gift tax is set forth in Sec. 2502(a), which states that for each calendar year, the amount of gift tax due

shall be an amount equal to the excess of a tentative tax . . . on the aggregate sum of the taxable gifts for such calendar year and for each of the preceding calendar periods, over a tentative tax . . . on the aggregate sum of the taxable gifts for each of the preceding calendar periods.

This means that gift tax is calculated annually on a taxpayer’s cumulative lifetime of taxable gifts using the same graduated rates as the estate tax and is offset by the same unified credit plus, if applicable, DSUE amount.

In crafting a gifting plan, taxpayers should recognize that not all gifts are taxable. Transfers that are not considered taxable gifts for the purposes of gift tax include:

  • Tuition at an educational institution when paid directly to the institution (Sec. 2503(e)(2)(A) and Regs. Sec. 25.2503-6(b)(2));
  • Payments for medical care, including payments for medical insurance (Sec. 2503(e)(2)(B) and Regs. Sec. 25.2503-6(b)(3));
  • The waiver of a survivor benefit from a pension plan under Sec. 401(a)(11) or Sec. 417 before the death of the participant (Sec. 2503(f));
  • Loans of qualified artworks to a Sec. 501(c)(3) tax-exempt organization (other than a private foundation) to be used by the organization toward its tax-exempt purpose (Sec. 2503(g));
  • Gifts of intangible property made by certain nonresident aliens (Sec. 2501(a)(2));
  • Gifts to political organizations (Sec. 2501(a)(4));
  • Gifts to U.S. federal or state governments or subdivisions thereof for exclusively public purposes (Sec. 2522(a)(1));
  • Gifts to charitable organizations that are deductible on Form 1040, Schedule A, Itemized Deductions (Secs. 2522(a)(2) through (4)); and
  • Gifts between spouses (Sec. 2523).

Second, a gifting plan should be scheduled to take full advantage of the annual exclusion from gift tax. As provided in Sec. 2503(b), the first $10,000 of gifts (other than gifts of future interests in property) made to any person by the taxpayer during the calendar year are excluded from the calculation of taxable gifts for that year. This annual exclusion amount is adjusted for inflation and increased to $13,000 for the 2012 calendar year (Rev. Proc. 2011-52). Any gifts that do not exceed the annual per-person exclusion limit are not included in the taxpayer’s cumulative lifetime gift total and thus do not absorb any of the unified credit.

A perk for married taxpayers is the ability to double the annual exclusion limit by taking advantage of gift splitting. Under Sec. 2513(a), gift splitting occurs when “[a] gift made by one spouse to any person other than his spouse . . . [is] considered as made one-half by him and one-half by his spouse, but only if at the time of the gift each spouse is a citizen or resident of the United States.” Thus, if one spouse gives a gift of $26,000 during the 2012 calendar year to one recipient, the gift may be treated as having been given by both spouses so that it does not exceed the annual exclusion limit for either spouse. Both spouses must consent to the arrangement. Per Regs. Sec. 25.2513-2, consent is expressed by filing a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return , signed by both spouses and marking the box to indicate consent.

Present-Interest Gifts

The annual exclusion is available to offset only gifts of a present interest. If a taxpayer gives a gift of a future interest, that taxpayer must file a Form 709 and use the unified credit. A future interest includes “reversions, remainders, and other interests or estates . . . which are limited to commence in use, possession, or enjoyment at some future date or time” (Regs. Sec. 25.2503-3)(a)). In contrast, a present interest is “[a]n unrestricted right to the immediate use, possession, or enjoyment of property or the income from property” (Regs. Sec. 25.2503-3(b)). Examples of gifts of a future interest include those that are payable on the occurrence of a future event, such as the payout of a life insurance trust upon the death of the grantor, or gifts made as contributions to a trust where the trustee has discretion over payments to the beneficiary, resulting in uncertainty at the date of the gift with regard to what the beneficiary will ultimately receive.

To clarify how the present-interest rule applies to minors, whose legal capacity to take possession of a gift may be limited, Sec. 2503(c) states that

[n]o part of a gift to an individual who has not attained the age of 21 years on the date of such transfer shall be considered a gift of a future interest in property for purposes of [the annual exclusion] if the property and the income therefrom may be expended by, or for the benefit of, the donee before his attaining the age of 21 years, and will to the extent not so expended pass to the donee on his attaining the age of 21 years, and in the event the donee dies before attaining the age of 21 years, be payable to the estate of the donee or as he may appoint under a general power of appointment . . .

Even though an individual’s minority is disregarded by the Code for the purposes of gift tax, taxpayers may be reluctant to relinquish control of assets to an individual below the age of 21 out of concern that the recipient will mismanage the assets. However, if the taxpayer gives a gift but stipulates that the recipient must reach a certain age or satisfy some other requirement before having full access to the gifted asset, then the taxpayer has given a gift of a future interest and may not offset the gift with the annual exclusion. Out of this disconcerting situation, a convention has developed whereby the taxpayer creates a trust for the benefit of the minor and gifts assets to the trust. Through the trust agreement, the taxpayer may stipulate conditions that place controls over the trust’s property. This is known as a Crummey trust after the case in which the Ninth Circuit upheld its validity as a gift of a present interest.

In Crummey, 397 F.2d 82 (9th Cir. 1968), the taxpayers created trusts for the benefit of their four children, contributed assets to the trusts, and claimed the annual exclusion on their gift tax returns. The property in the trusts was tightly controlled by the trust agreement, which provided that any income produced by the trust’s assets was to be accumulated and added to the trust corpus until the beneficiaries reached age 21. During this time, distributions were permissible at the trustee’s discretion. From age 21 through 35, income was to be distributed to each beneficiary. After age 35, distributions of income and corpus reverted back to the discretion of the trustee.

Along with these restrictions, the trust agreement also contained a demand provision that allowed each beneficiary the option to demand a distribution of the current year’s contribution to the trust, as long as the demand was in writing and submitted no later than Dec. 31 of the year in which the gift was given to the trust. Further, the trust agreement provided that if a beneficiary failed in legal capacity due to minority or otherwise, the beneficiary’s guardian could demand the distribution on the beneficiary’s behalf. On account of the restrictions contained in the trust agreement, the IRS sought to treat the contributions to these trusts as future interests and deny the annual exclusion.

In deciding the case, the Ninth Circuit noted that, under previous case law, for a gift to be of a present interest, its recipient must have a present “right to enjoy” the property. The beneficiaries of these trusts did have a present ability to enjoy the property contributed to the trusts because of the permissive demand provision, regardless of whether a demand was ever tendered. Also, the lack of an appointed guardian to make a demand on behalf of the minor beneficiaries was disregarded because it was legally feasible to appoint such a guardian or for the parent to act as the child’s natural guardian. Having determined that the gifts to the trusts were indeed present interests, the court allowed the taxpayers to apply the annual exclusion to the gifts.

Gifts of Limited Partnership Interests

Recently, the Tax Court ruled on another situation where the IRS disputed the present-interest nature of a gift in Estate of Wimmer, T.C. Memo. 2012-157. George Wimmer and his wife established a limited partnership whose purpose, the court said, was to “increase family wealth, control the division of family assets, restrict nonfamily rights to acquire such family assets and, by using the annual gift tax exclusion, transfer property to younger generations without fractionalizing family assets.” This was accomplished by structuring the partnership agreement to generally restrict the transfer of partnership interests, with the exception of transfers to related parties (defined as descendants or ancestors) and by investing the partnership’s assets. The Wimmers then gifted limited partnership interests to various family members and claimed the annual exclusion for these gifts.

In determining whether the gifts qualified as present interests, the court noted that, due to the partnership agreement’s restrictions on transfers of partnership interests, the donees “did not receive unrestricted and noncontingent rights to immediate use, possession, or enjoyment of the limited partnership interests themselves.” Therefore, the court alternatively considered whether the donees received these rights with regard to the income produced by the partnership. For the gifts to be considered of a present interest, the court said, it must have been expected at the time of the gift that (1) the partnership would generate income; (2) some portion of that income would flow steadily to the donees; and (3) that portion of income could be readily ascertained.

The facts presented showed that before any gifts of a partnership interest had been made, the limited partnership invested in publicly traded, dividend-paying stocks as its only asset. This substantiated that the partnership was expected to generate income. Second, per the partnership agreement, the net income and distributions were allocated pro rata based on ownership percentages. Third, the partnership agreement and state law imposed fiduciary duties on the general partners.

As some of the limited partners were trusts whose only assets were the partnership interests, the general partners were obligated by their fiduciary duty to distribute partnership income so that the trusts would have cash available to satisfy their income tax liability arising from the partnership’s passthrough income. This ensured that the limited partners could reasonably expect to receive a steady flow of income, and the records showed that distributions had indeed regularly occurred. With respect to the third test, because the partnership had invested in publicly traded stocks, limited partners could reasonably estimate their allocations of dividend income based on the stocks’ dividend payment histories. Having satisfied these three tests, the court determined that, even though the partnership agreement imposed limitations, the limited partners “received a substantial present economic benefit sufficient to render the gifts of limited partnership interests present interest gifts on the date of each gift” and permitted the taxpayers to apply the annual exclusion.

As the year end approaches, taxpayers should consider their options for managing the value of their estates by creating a gifting plan, whether through trusts, partnerships, or other means, and taking advantage of the 2012 annual exclusion for gift tax.


Mark Cook is a partner at SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600, ext. 2143, or

Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.

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