Because in recent weeks I’ve seen so many erroneous gift tax returns, today’s column is devoted to what clients need to know before having their CPA or attorney file one. Estate, gift, and generation skipping taxes are transfer taxes, governed by an entirely different subtitle of our federal tax code (US Code Title 26 Subtitle B – Chapters 11-15) than are income taxes (US Code Title 26 Subtitle A Chapters 1-6).
Just because your CPA is adept at personal, corporate and partnership income taxes does not equate to a working understanding of transfer tax law, which is vitally necessary to file a Federal Gift Tax Return Form 709. News flash − many accounting programs don’t require transfer tax courses in order to graduate. Take it from me, I’m a CPA and a board certified wills, trusts and estates attorney. All of my transfer tax courses were taken in law school, not in my undergraduate or masters level accounting studies.
And many lawyers who practice estate planning never took tax law courses. My gift and estate tax course in law school had only eight students out of my graduating class of 190. The income taxation of estate and trust course only six. Students don’t like these courses because they’re difficult, and quite frankly, boring. Yet many practice in the field since it’s more fun and rewarding than the academic minefield one must navigate to properly learn it. Never mind the task of keeping up with endless IRS rulings, pronouncements, regulations, federal legislation, and court rulings through continuing education during one’s career.
Unlike income tax returns, which are, absent carryforwards, independent of one another from year to year, every gift tax return affects the next, and ultimately is filed as an attachment to your Federal Estate Tax Return Form 706. An error on any one gift tax return cascades to every future transfer tax filing, resulting in headaches for you and your loved ones.
A professional who doesn’t possess a detailed and thorough understanding of our transfer tax laws can’t possibly expect to file a correct gift tax return. To understand why I’m devoting an entire column to this issue, allow me to illustrate recent problem filings I’ve encountered:
- Unlike income tax returns that allow married couples to file jointly, gift tax returns must be filed separately for a husband and wife. I saw a recent return where the filer “split the gift” between husband and wife yet failed to file wife’s return, attributing all of the gift to husband’s return.
- Filers frequently miss the generation skipping transfer (GST) tax issues. Transfers to irrevocable trusts that may one day distribute to a second generation should be listed under that section of the return. There, the taxpayer may opt-out of automatic allocation of this valuable exemption, or else the exemption is deemed consumed. For large estates, you don’t want to waste this exemption. Careful thought should be made to its consumption.
- Determining when an irrevocable trust belongs to the GST portion of the return requires understanding whether a trust is an indirect skip, a taxable distribution, or a taxable termination. Each has different consequences.
- Speaking of GST issues, there’s a little-known rule that disallows the allocation of GST exemption until the gift cannot be included in the transferor’s estate for estate tax purposes. Qualified Personal Residence Trusts (QPRTs) and Grantor Retained Annuity Trusts (GRATs) are examples subject to this rule. Because those trusts might be included in the transferor’s estate if she doesn’t survive the term, the ETIP (estate tax inclusion period) rules apply, and GST exemption can’t be allocated until the trusts expire. At that time, if allocated, the GST exemption will consume the fair market value of the assets, rather than the discounted value reported for gift tax purposes. I’ve seen this botched many times.
- Normally, annual exclusion gifts (those gifts that don’t exceed the $15,000 current limit) need not be reported. When reporting taxable transfers, however, the annual exclusion gifts should also be reported. Those gifts don’t generate tax and don’t consume exemption even when reported. Many times I’ve reviewed gift tax returns that don’t report any annual exclusion gifts.
- I’ve seen errors associated with lack of proper documentation. Discounts associated with transfers of closely held business interests and family partnerships require documented verification. Moreover, real estate agents’ estimations of fair market value are insufficient proof. If a return lacks the sufficient support, the three-year statute of limitations on IRS challenges never tolls.
I could go on. At risk of appearing self-righteous, I’ve seen too much to not warn consumers. More professionals should decline this work based on inadequate knowledge of the area. This same lack of knowledge affects drafters of estate plans, but that’s a subject for another column.
If your 709 is on extension, ask some hard questions before it’s filed.
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