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August 2009
Spreading Your Wealth?
By John Blair

     Some will argue that wealth is simply a state of mind. Unfortunately, the Internal Revenue Code and the tax statutes of many states consider wealth to be more than merely a perception. Under their provisions, wealth is considered readily quantifiable and subject to taxation under certain conditions.

     In particular, the Internal Revenue Code includes provisions related to estate, generation-skipping and gift taxes that, in essence, extract a toll on gratuitous transfers of wealth. The scope of this article, however, will be exclusively focused on federal gift taxes.

     Because a limited number of individuals are inclined to give away substantial amounts of wealth during their lifetime, few are subject to gift tax. Nevertheless, individuals who intend to make gifts of substantial amounts of their wealth should be familiar with (i) when gift taxes are assessed, (ii) how they are determined, (iii) who is responsible for paying them, and (iv) what can be done to avoid them.

     As a point of clarification, a tax on gifts is separate and distinct from a tax which is based upon earnings and income. Income taxes require consideration of equal value to be voluntarily exchanged between the parties of a taxable transaction. On the other hand, gift taxes may apply if property is conveyed by a donor, to a donee, for no value or for value which is less than the value of the property conveyed. In essence the transfer must be wholly or in part gratuitous or free to the recipient.

     Consequently, if your affluent uncle spontaneously gives you $100,000 as an expression of his affection the day your first child is born or you graduate from college, the gift will usually be subject to gift tax. It would not, however, be considered taxable income to you.

     Federal gift taxes are determined using rules that permit a portion of the gift that would otherwise be taxable to be excluded from taxation. One of the permitted exclusions is for annual gifts individuals make that do not currently exceed $13,000 per recipient. (This amount is periodically increased in increments of $1,000 based upon inflation.) This annual exclusion is allowed only when a gift of a “present interest” is made. Consequently, many times a gift made to a trust may not qualify for the annual exclusion unless certain requirements are met.

     A significant exclusion is provided for gifts made between spouses. It is known as the marital deduction and its provisions permit a spouse to make a gift to his or her spouse and to have the entire value of the gift excluded from gift tax almost without limitation. These rules apply, however, only if both spouses are citizens of the United States. Otherwise, limitations are imposed on the amount of wealth that can be transferred between spouses.

     Gifts paid directly for medical or education expenses are also excluded from taxation.

     The gift tax provisions of the Internal Revenue Code also include a credit that all individuals can use to offset federal taxes they may owe on gifts made during their lifetime. This credit in many instances is expressed in terms of the value it would exclude from taxation.

     Currently, the gift tax exclusion is $1,000,000 (and is not indexed for inflation). Generally this means anyone can make lifetime gifts totaling this amount of value—after reduction for the annual gift tax exclusion—and pay no federal tax on the gifts.

Gift taxes are primarily the responsibility of the donor; however, in the event the donor fails to pay any gift tax liability when due, the donee becomes personally liable for the gift tax.

      Calculating the tax applicable to gifts made during a year is based, in part, on a whether a donor has made any gifts in prior years that were not covered by a provision that excludes it from taxation. As a donor’s aggregate lifetime taxable gifts increase, the rate used to calculate the gift tax increase from 18 percent to 45 percent. For current year gifts the rate starts where the progressive rate schedule stopped for gifts made in prior periods, if any.

     More specifically, the gift tax payable for current year gifts is the excess of the gift tax payable on the total of all taxable gifts made by the donor during the current year plus all taxable gifts made by the donor in prior periods, over the gift tax payable on taxable gifts in all previous periods.

     So, the more you give, the more gift tax you owe, which is probably not the perception of spreading your wealth!

     Co-written by John D. Blair Sr., a managing partner, and Roberta S. Cianfrone, tax manager at Blair, Bohlé & Whitsitt, PLLC., a CPA firm that provides accounting, assurance, tax compliance and planning services in addition strategic planning and tax minimization strategies to privately held businesses. Contact them at 704-941-9800 or visit www.bbwpllc.com.

John D. Blair Sr. is a managing partner at Blair, Bohle & Whitsitt, PLLC.
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