Estate and gift tax rates have never been lower. Presidential hopeful Hillary Clinton would like to change that, making this an especially important time to engage in lifetime gift planning. As if that isn’t enough to encourage gifts, proposed Treasury Regulations would all but eliminate family business valuation discounts for lack of marketability.
However, paying gift taxes is hard to swallow. For some, the solution is not to pay gift taxes. Instead, have the donee pay gift taxes.
Generally, when a taxable gift is made, the donor must pay gift taxes, once the gift exceeds the annual exclusion amount and all lifetime gifts exceed the applicable exclusion amount (currently, $5,450,000). For example a $10 million gift, all of which is taxed at 40 percent, would mean paying $4 million of gift taxes.
But, what if the donee pays the gift taxes as a condition of receiving the gift? By assuming responsibility for paying the gift taxes, the value of the gift is reduced. In the end, the donee is enriched only by the amount of the gift in excess of the gift tax that must be paid.
From the donor’s perspective, the amount of the gift tax receivable from the donee constitutes receipt of consideration for the property transferred to the donee, and so reduces the value of the gift.
Such a gift is known as a “net gift”.
The IRS recognized net gifts in Rev. Rul. 75-72. Computation of the taxable gift is accomplished under a formula, which is simple only when the 40 percent gift tax rate applies to the entire gift.
In the example, above, the amount of the net gift (“G”) is $10 million, minus 40 percent of the net gift. The tax, (“T”) is 0.4G. The formula that gives us the amount of the tax is (0.4/1.4) times $10 million, or $285,714.29.
There’s no real tax advantage to making a net gift
If the donor dies within three years of making the gift, then the gift tax is includible in the donor’s estate. Generally, that tax is payable by the decedent’s estate, which could work an inequity on heirs other than the donee of the gift. To remedy that inequity, the donee could agree to provide the funds to pay the estate tax on the gift tax. If the donee does agree to do so, then that, too, reduces the value of the gift.
The value of the gift, then, is equal to the value of the property that the donor gives to the donee, reduced by the gift tax and the possible additional estate tax payable if the donor dies within three years of making the gift.
Seemingly, an algebraic formula and algebraic manipulations should produce the needed adjustment to the amount of the taxable gift. But, that wouldn’t take into account that the donor might or might not die in three years. Actuarial computations must therefore be introduced to arrive at the correct result.
The IRS didn’t easily accept any of this. It was forced to do so by the courts, and the taxpayers won. But, computations alone didn’t justify the net, net gift result. The taxpayer in each case had to show that the donees were actually obligated, and that the obligation wasn’t merely a duplication of estate tax apportionment statutes under applicable state law.
Many estate planning professionals don’t know what a net, net gift is and this strategy can be a complex one to work through. That’s why you should join us and nationally renowned CPA, Mike Jones, on Thursday, September 22, 2016 at 9am Pacific Time (12pm Eastern Time) for an 60-minute presentation on this complex strategy entitled, “Everything You Need to Know About Net, Net Gifts”.
For more information and to register, click here.
ABOUT THE AUTHOR
Michael J. Jones, CPA is a partner in Thompson Jones LLP, Monterey, California. His tax consulting practice focuses on estate planning and administration of retirement benefits, sophisticated wealth transfer strategy, trust and probate matters (both administration and controversy resolution), and family business transitions.
Mike is the author of Inheriting an IRA and Final Regulations Governing Required Minimum Distributions, a special supplement to The Pension Answer Book. He has written over 100 published articles. Mike serves as Chair of Trusts and Estates magazine’s Retirement Benefits Committee. He has been quoted in New York Times, Forbes Magazine, The Wall Street Journal, Ed Slott’s IRA Newsletter, Bloomberg Financial Report and others.
Mike has served as adjunct faculty at Santa Clara Law School, and has spoken extensively for the Jerry A. Kasner Symposium, Southern California Tax & Estate Planning Forum, Hawaii Tax Institute, American Institute of CPAs, New York University’s Tax Institute, California CPA Education Foundation, and others.
OTHER ARTICLES IN THIS ISSUE
- PRACTICE-BUILDING: Pardon My Bloopers! by Philip J. Kavesh, J.D., LL.M. (Taxation), CFP®, ChFC, California State Bar Certified Specialist in Estate Planning, Trust & Probate Law
- ESTATE PLANNING: You, Inc.: Branding Yourself in a Competitive Estate Planning Industry by Steven J. Oshins Esq., AEP (Distinguished)
- TAX PLANNING: Planning for 2704 Proposed Regs: Be Wary of the Step Transaction Doctrine by Martin M. Shenkman, CPA, MBA, PFS, AEP, JD
- SUPPORT & ADMINISTRATIVE STAFF: How to Write a Proper Business Letter by Kristina Schneider, Executive Assistant