Charitable & Estate Gift Tax Planning

Reciprocal Gifts Between Relatives

Making gifts to relatives can be a smart way to reduce your estate.  You can make up to $14,000 ($28,000 if your spouse joins in) in gifts to any person annually without gift tax consequences.  Thus, even if you’re single, you could give $14,000 to each of your four children, reducing your estate by $56,000.  However, some individuals have tried to stretch the limit by making gifts not only to their children, but relative’s children in return for an agreement that the relative would do likewise.  For example, you not only give $56,000 to your children; you give $14,000 to each of your sister’s 3 children.  She, in turn, makes gifts of $14,000 to 3 of your children.  In effect, you’ve increased your gifts to your children by $42,000.  The IRS will challenge this technique of “reciprocal gifting”. In one recent court case the Court agreed with the IRS.  The judgment doesn’t preclude you from giving property to your sister’s children, but you must be careful if she gives you or your children gifts in return.

Family Loan

If you’re loaning money to a child or other relative for a home purchase, be sure to establish a formal mortgage or gift-loan and record the document with the county clerk. This affords protection for the both of you.  You protect yourself should the loan go into default by way of a “bad debt” tax deduction.  The borrower ensures interest paid will be deductible but only if the loan is secured by the residence.

Income From Property Given to a Child

Property you give as a parent to your child under the Model Gifts of Securities to Minors Act, the Uniform Gifts to Minors Act, or any similar law, is a true gift for federal gift tax purposes.  Income from property transferred under these laws is taxable to the child unless it is used in any way to satisfy a legal obligation of support of that child.  The income is taxable to the person having the legal obligation to support the child (the parent or guardian) to the extent that it is used for the child’s support.

Savings Account with Parent as Trustee

Interest income from a savings account opened for a minor-child, but placed in the name and subject to the order of the parents as trustees, is taxable to the child if, under the law of the state in which the child resides, the account legally belongs to the child and the parents are not legally permitted to use any of the funds to support the child.

Is an Inheritance Taxable?

In most cases, an inheritance is not taxable to you. But there are exceptions…

  • At some point in your life you may inherit money or property which, in most cases, is not taxable to you.  Life insurance proceeds are included in the deceased person’s estate, and not taxable to the beneficiaries.  Bank accounts and other income-producing assets such as stocks are not taxable to you when received, but the income these assets generate is taxable to you.
  • If you are not sure if something was included in the decedent’s taxable income, check with the administrator, tax accountant, or attorney handling the estate.  You may get a K-1 form for items that are allocated to you from the estate.  If you inherit a pension or IRA, you must pay tax on the amounts received in the same way that the deceased would have paid tax.  Only the spouse of the decedent can roll over funds tax free to a plan in his/her own name.  There are special withdrawal options for recipients of inherited IRAs.  Consult your tax advisor for additional details on distribution options associated with an inherited IRA.
  • Have you heard of the term “stepped-up basis”?  This means that your investment in inherited property is considered to be the value as of the date of death.  When you sell property that you inherited, you only pay tax on the difference between the amount you sold it for and the value of the property as of the date of death (or six months thereafter, as determined by the estate administrator).  There can also be a loss if you sell the property for less than this date of death value.

IRS Clarifies When a Gift is Complete

Jim decides to make a cash gift to his son Junior in December.  He writes the check and gives it to Junior and Junior brings it to his bank on December 30; however, the check doesn’t clear Jim’s bank until early January. When is the gift considered complete for gift tax purposes?  The IRS addressed this question in a Revenue Ruling.

The IRS says the gift will be considered complete in December.  Applying a decision by the Fourth Circuit Court of Appeals (Metzger v. Commissioner 1994), the IRS agrees that the gift “relates back” to the date on which the check was presented for payment, even if is not paid until the following year.  However, according to the Service, this rule applies only if certain conditions are met:

  1. The check is paid by the drawee bank (Jim’s bank, in our example) when first presented for payment;
  2. The donor is alive when the bank pays the check;
  3. The donor intended to make a gift;
  4. The delivery of the check was unconditional; and
  5. The check was deposited, cashed or presented within a reasonable time of issuance, and within the same calendar year.

This ruling does not address the situation in which a check is not deposited in the bank until after the first of the year. The IRS maintains that such a gift is not complete until January, because the donor could stop payment.

Consider using certified or cashier’s checks for year-end gifts. The IRS agrees that a gift is considered complete if the gift-giver has “parted with dominion and control,” and has no power to change or revoke the transfer.

A different rule applies to charitable donations, which are considered complete when the check is written and placed in the mail.

Gift of Future Interests

For example, you deed your vacation home to your two children, but with the understanding that you are the only one who is allowed complete access, you pay the real estate taxes, upkeep, etc.  Under the law, your gross estate includes the value of property transferred by you if you reserve or retain for your life (or for a period which does not end before your death) the use, possession, right to the income, or other enjoyment of the transferred property.  The same rule holds if you have the right to designate the person or persons who will possess or enjoy the transferred property.  What if you retain less than the full rights to the property?  For example, you share title to your child’s residence, but you provide all of the down payment. Your estate retains the property’s equity to the extent of your equity interest – irrespective of joint ownership.