Unfortunately, the Internal Revenue Service has specific rules about making gifts to anyone, regardless of relationship and the most important rule is the dollar limitation annually. For 2003, the dollar value limitation, based on current market value, is an aggregate of $11,000 per donee (the person who receives your gift) for the calendar year. Therefore, if you've recently written your grandson a check for $10,000 as a gift for graduating from college, the value of his birthday and holiday gifts to be made before years' end cannot exceed $1,000 or you'll be required to file a gift tax return. Filing a gift tax return doesn't necessarily mean you'll owe gift tax, but more about that later. Let's look at some more examples of how gift valuation works.
Obviously, if you write a check or give a gift card or cash or purchase an item specifically as a gift, you know the current fair market value of the item. But what if you decide to make a gift of stock that you bought 10 years ago? The value for gift purposes is the fair market value on the date of the gift - which is further defined by whether or not you handed over a certificate to him, with the reverse side completed with the transfer information, had the shares transferred into a broker account for him or simply wrote a letter to the transfer agent requesting the transfer be made. Whatever that date happens to be, the valuation is then made by averaging the high and low of the listed security on the date of transfer.
For instance: 300 shares General Electric transferred on 5/15/03:
$28.93 - High
$28.35 - Low
$28.64 - Average
$8,592 - Extended value for 300 shares
If the transfer of the stock is the first gift made in 2003, the remaining value of gifts that can be made without needing to file a gift tax return is $2,408. But, what if you transfer 400 shares of stock on May 15? Then the extended value for the shares is $11,456 and you'll be required to file a gift tax return by 4/15/04 (without extension) for the 2003 gift of stock shown above along with any other gifts to your grandson in 2003.
In addition to the fair market value of the stock on the date of the transfer, you need to tell the donee the basis in your hands at the time of the gift so your grandson can determine profit or loss when he sells all or part of the stock. Let's pretend that you bought 200 shares of General Electric in 1993 for a total cost of $12,300, including commission. Since you purchased the stock, there have been a number of splits, but no prior gifts or sales. As a result, on 5/14/03, you held 1,200 shares of General Electric with a total cost of $12,300 or $10.25/share. Your gift of 400 shares to your grandson on 5/15/03 carries a basis of $4,100 to him. And your remaining 800 shares have a basis of $8,200.
To follow this gift a bit further, if on 5/23/03 your grandson sold 200 shares from his gift and realized $5,825 after commission, he would report the sale of those 200 shares as follows:
$5,825 - 200 shares sold
$2,050 - 200 shares basis
$3,775 - Taxable gain to grandson for shares acquired by gift
Your grandson gets your holding period, so these shares would qualify for long-term capital gain treatment since the combined holding period by you and your grandson is more than 12 months. He would have 200 shares remaining in his portfolio with a basis of $2,050. If he has no knowledge of the basis, it's assumed to be zero and his capital gain on the 200 shares sold would be $5,825!
Assets with a basis, i.e., stock, bonds, mutual funds, real estate, artwork, and antiques will always have a transfer of the original basis to the donee; otherwise, the IRS would never get its tax from the appreciation that has occurred from the original purchase date. On the other hand, gifting assets with a large appreciation can be a smart move if the donee is in a lower tax bracket than you are. And given the new capital gains rates that were signed into law this year, your grandson may pay less in taxes than you would have on the stock transactions shown above, which is perfectly legal.
What if you decide to deed your house to your daughter for $1 and go live in a retirement community? First, you'll need to see your attorney regarding state rules on these kinds of transfers. And then, you need to think about the need to file a gift tax return. For IRS purposes, the value of your house is the fair market value on the date of the transfer, as determined by an independent appraiser. Your basis in the property then becomes her basis, which she will use to determine profit if and when she sells the house later.
When your gifts for the year aggregate more than the $11,000 per donee amount, you must file a gift tax return, Form 709. This return is filed as an individual, even if you are married. There are special rules (the IRS always has rules) for splitting gifts with your spouse. The return is due by 4/15/04 for 2003 gifts, although you can extend the time for filing the return just as you do for an individual income tax return. Any amount over the $11,000 per donee limitation results in a taxable gift. If this is the first year you have a taxable gift, chances are you won't pay any gift tax, since any gift tax calculated on the return is offset first by a unified credit available on the first $1,000,000 of taxable gifts. However, taxable gifts are cumulative. In subsequent tax years, taxable gifts from the preceding years will be taken into account when calculating the gift tax. It's not as complicated as it sounds; however, good recordkeeping is essential when reporting gifts.
First, you need to keep a record of the value of gifts made to relatives and friends on an annual basis. Include the date, nature of the gift, and fair market value of the property gifted. Next, when it's tax time, be sure to let your tax professional know that you have potential gifts and want him/her to review the ledger you've kept to see if a gift tax return is required. And finally, if you do need to file a gift tax return, your attorney needs to have a copy so that your estate plan is up-to-date for the lifetime gifting. Why? The unified credit for gifts is tied into the unified credit for estate tax purposes. Presently, gifts have a lifetime limitation of $1,000,000 before there is a tax. On death, the lifetime gifts and assets at death combine for a limitation of $1,000,000 for 2003 periodic increases to $3,500,000 by 2009. These are the Federal rules. States vary as to what they require annually and what is taxed at death.
NOT part of the annual limitation are the following:
1. Gifts to your spouse
2. Payments directly to an education institution for tuition (books and fees are not eligible for this exclusion) for someone who is not your dependent
3. Payments directly for medical care, including medical insurance, for someone who is not your dependent
Suppose you wrote the following checks in 2003:
$9,500 = 1/3 = City College for grandson
$10,000 = 1/6 = My grandson $10,000
$2,850 = 6/15 = R. Smiley, DMD for grandson
$22,350 = Total
You would not have to file a gift tax return as the check to your grandson is the only reportable gift for 2003, and that check is below the $11,000 threshold.
Rules about gift taxes fill volumes of text. What is important to remember from this short essay is this:
1. Keep good records as to whom, what, and when you make gifts during the tax year.
2. Keep good records on historical cost for all assets that have a basis and share that information with the donee.
3. Inform your tax professional and estate-planning attorney when you make gifts so the proper tax forms can be filed and your estate documents are kept in good order.
4. Remember that the fair market value of the item is the trigger for meeting the annual limitation per donee (person receiving the gift).
5. With proper planning, gifts of appreciable assets can save income tax and estate tax.
More questions? Call your tax professional at Tax Matters and we will be glad to help you . . .