Don’t Forget about Annual Exclusion Gifting

As published yesterday in LISI Estate Planning Newsletter #2056 (January 30, 2013).*

With all eyes focused on a potential “fiscal cliff” in the last quarter of 2012, some might have missed the IRS’ October 18, 2012 announcement of an increase in the gift amount allowable under the annual exclusion.  See Rev. Proc. 2012-41. In 2013 a person will be able to give $14,000 to each donee, free of gift tax.

While as of late planners have largely been concerned with helping clients make larger gifts under the unified credit, this announcement reminds us of our old friend—the annual exclusion.

This article will offer brief reminders and a few planning points related to making gifts under the annual exclusion.

The Internal Revenue Code excludes from the computation of “taxable gifts” the first $10,000 (adjusted for inflation and rounded to the nearest $1,000) gifted to any person by a donor during the calendar year.

IRC Section 2503(b).   Since 1998 the inflation-adjusted annual exclusion amounts have been as follows:

Following are a few brief reminders and planning points related to the annual exclusion:

1) Gift splitting.  When exclusions are combined through gift splitting, spouses may together transfer double the annual exclusion amount.  See IRC Section 2513.  Currently, that would allow gifts by married couples of up to $28,000 per donee.   To take advantage of gift splitting, the donor spouses must each properly file a Form 709 gift tax return.

2) Present interest requirement.  The annual donee exclusion is available only when the gift constitutes a present interest in property commencing in possession or enjoyment immediately.  Id.  Transfers to certain irrevocable trusts can qualify, assuming certain conditions are met.  Some of those conditions are as follows:

a. Exception where the beneficiary is a minor child.  The annual donee exclusion is available when making a gift to a trust where the transferred property (1) may be expended by, or for the benefit of, the minor child as a beneficiary before his or her attaining the age of 21 years; and (2) will, to the extent not so expended—pass to the beneficiary at the time he or she reaches age 21, and be payable to the beneficiary’s estate or as he or she may appoint under a general power of appointment in the event the donee dies before reaching age 21. IRC Section 2503(c).

b. Temporary right of withdrawal.  In the famous Ninth Circuit Crummey case, notice to a beneficiary of his temporary right of withdrawal in the principal of an irrevocable trust established a present interest in property for purposes of excluding a transfer to said trust as a gift under the annual exclusion.  Crummey vs. Commissioner, 397 F.2d 82 (9th Cir. 1968).   Many practitioners increase the number of annual donee exclusions by naming additional beneficiaries in a Trust who would be entitled to discretionary distributions of trust income and/or principal. See Cristofani vs. Commissioner, 97 TC 74 (1991).

c. Mixed inclusion ratio for Generation-Skipping Transfer (GST) trusts.  Individuals who have used their entire GST exemption cannot make transfers to trusts under the annual exclusion without bringing about the added complexity of a mixed GST tax inclusion ratio in the trust.  With that said, additional GST exemption may be made available over the years through inflation adjustments.  In 2013 such inflation adjustment will provide each taxpayer with an additional $130,000 GST exemption ($5.25 million total) over and above that which was available in 2012. See Rev. Proc. 2013-15.

3) Reciprocal gifts.  The annual exclusion cannot be used to make reciprocal gifts.  A reciprocal gift takes place where two donors agree that each of them will make reciprocal transfers to the other’s loved ones. See Furst v. Commissioner (TC Memo 1962-221); United States vs. Estate of Grace, 395 U.S. 316 (1969); and Sather vs. Commissioner, 251 F.3d 1168 (8th Cir. 2001).

4) Not cumulative.  Use it or lose it!  The failure of a donor to use the annual exclusion one year does not enable a greater exclusion amount in subsequent years.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

David Grant

Mark Dodds

*  The full version of the above posting was originally written by the authors, David Grant and Mark Dodds, and published as LISI Estate Planning Newsletter #2056 (January 30, 2013) at http://www.leimbergservices.com.

It is reproduced courtesy of Leimberg Information Services, Inc. (LISI) and the authors.  Other reproduction in any form or forwarding to any person is prohibited without express permission.