Christopher Stoneman Estate Planning Articles

XII - Federal Transfer Taxes - Part II

In the immediately preceding article, we noted several basic features of the gift, estate and generation-skipping transfer (GSTT) taxes which warranted further attention - realizing, of course, as we now examine these, that treatises have been written - and will no doubt continue to be so - on each of these three taxes.  Let us take each of them in turn, beginning with the gift tax.

A.  The gift tax;
     1.  Exclusions from gifts;
     2. Gift-splitting by spouses;
     3. Certain gifts which are subject to the GSTT;
     4. Certain property settlements accompanying a divorce; and
     5. Gift-tax marital and charitable deductions        

1.  Exclusions from gifts. 

(a) The annual exclusion.  Were it not for the annual per-donee gift-tax exclusion (Section 2503(b)), the material joys of Christmas, birthdays and assorted other gift-giving occasions would at least technically be marred by the donor’s obligation to file a gift-tax return on Form 709 for even the most paltry donation. Originally set at $10,000, the exclusion amount, after adjustment for inflation, has now risen to $12,000 and will presumably continue to grow.  All gifts during the calendar year to a particular donee which amount in the aggregate to $12,000 or less qualify for the exclusion, provided that they either satisfy the statutory “present interest” requirement (Section 2503(b)(1))  or meet the terms of Section 2503(e) (Certain Transfers for Educational or Medical Expenses).

"Present interest”- general rule.  As noted, a gift to an individual must constitute a present interest if it is to be eligible for the annual exclusion.  The gift-tax regulations describe a present interest as

[a]n unrestricted right to the immediate use, possession or enjoyment of property or the income from property (such as a life estate or term certain)….

Most, but by no means all, trust interests* fail to meet this definition since they constitute future interests.

To take a simple example, G makes a Christmas gift to each of his five adult grandchildren of shares of stock having a value of $8,000.  Earlier in the year he had given his favorite grandchild, G-2, a birthday gift of $5,000.  A gift-tax return is required for G’s gifts to G-2 but not for his gifts to the other four grandchildren.

“Present interest” -  gifts to minors.  Unless it fits within the exceptions discussed below, a gift to a minor is a future interest and therefore may not be excluded in the determination of taxable gifts. For gift-tax purposes a person remains a minor until she reaches the age of 21.** 

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*   Basically, the key question is whether the trustee of the trust has discretion to pay or not pay income or principal to the trust beneficiary. If a beneficiary has the unrestricted right to currently receive all of the trust income but only so much, if any, of the principal as the trustee decides to give him, the beneficiary has been given both a present interest (the right to income) and a future interest (the possibility of receiving principal).
**   But where, as in Vermont and many other states, the age of majority is 18, the IRS has ruled that if the other requirements of Section 2503(c)(3) are satisfied, the adulthood-at-18 provision of state law will not vitiate application of Section 2503(c)(3). 

For the avoidance of future-interest status, the gift itself and any income which it generates may be expended by or for the benefit of the donee before he reaches the age of 21 and, to the extent not so expended, will pass to him when he turns 21 or, if he dies before then, will be payable to his estate or be subject to his general power of appointment.*  A trust which meets these requirements is often referred to as a 2503(c)(3) trust, Section 2503(c)(3) being the Code provision which spells out the requirement.

If a trust is used, it may contain a provision allowing the donee to extend the term of the trust upon reaching the age of majority and may also provide that the trust will automatically continue until a later date unless the donee exercises the right to withdraw the trust property within a specified “window” immediately following the majority date. The use of a trust may be avoided by making the transfer to a custodian under a state Uniform Gifts to Minors Act** or  Uniform Transfers to Minors Act, under both of which the donor will be entitled to his exclusion.

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*  Even though the donee dies, say, at the age of five, blissfully unaware of the existence of the power (which may be a testamentary power - i.e., exercisable only by will), and the terms of the gift provide that if he does not exercise it, the property and its undistributed income will be payable, say, to his parents. It is gratifying to note, however, that the IRS has seen fit to rule that there can be no 2503(c)(3) exclusion with respect to an unborn child - a child, as the common law has it, en ventre sa mere.
**  In Vermont, 14 V.S.A. Sec. 3201 et seq.

Finally, under this head, we should note something known as the “Crummey” trust device, so named after the 1968 victory of a taxpayer of that name. There, the eponymous taxpayer authorized the minor beneficiary of the trust to demand a part of the trust principal donated during the year in question equal to the donor’s annual exclusion amount.  This the Ninth Circuit held, was sufficient to entitle the donor to a present-interest exclusion for the gift year even though applicable state law might require the appointment of a guardian of the beneficiary to make such a demand - and regardless of whether such an appointment was in fact made.  Later cases, notably the Tax Court’s 1991 Cristofani decision, extended this result to minor contingent remainder beneficiaries - grandchildren of the donor.*

In short, for the well-advised donor the annual gift-tax exclusion remains well within his reach without his running much of a risk that the minor will “take the money and run” at a tender age.

(b)  Section 2503(e) - exclusion for certain educational and medical expenses.  Section 2503(e) provides that certain “qualified transfers” are excluded from the application of the gift tax. Regardless of the age of the individual for whose benefit the donation is made or the amount of the transfer, a qualified transfer is defined as

a payment to a Section 170(b)(1)(A)(ii) educational organization**  for such individual’s education or training
                      or
a transfer to any person who provides medical care*** with respect to such individual as payment for such medical care.

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*     Not surprisingly, the name of Mr. Walt  Disney’s famous rodent creation has often been invoked in description of this result.
**   One “which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the  place where its educational activities are regularly carried on.”  This would necessarily rule out correspondence or internet schools which have no campuses.  And since Section 170 (of which the definition is a part) requires that a donee Section 170 organization be a “domestic” organization and that no part of its net earnings “inure to the benefit of any private shareholder or individual,” for-profit (i.e., proprietary) institutions as well as organizations which are incorporated abroad, would appear to be outside the scope of Section 2503(e). 
***  “Medical care” is defined at great length by Section 213(d) and includes costs of health insurance and certain amounts for lodging away from home (“not lavish or extravagant under the circumstances”), provided that it does not cost more than $50 per night and there is “no significant element of personal pleasure, recreation or vacation in the travel”!

 2.  Gift-splitting by spouses. Section 2513 authorizes a married couple*, both of whom are citizens or residents of  the United States at the time of the gift and neither of whom remarries before the end of the year, to  elect to have a gift made by either of them to a third party be considered as having been made one half by each of them.  This requires the consent of the non-donor spouse.  The mechanics of such consent depend upon the specifics of the donor spouse’s gift.  In some cases, it may be given upon the donor’s gift-tax return; in others, a separate gift-tax return must be filed by the non-donor spouse.

As an example, H and W have five children whom they wish to benefit.  W decides to make a gift to all of them but for obvious reasons would prefer not to use any part of her unified credit.  She goes ahead and gives each child $24,000 in 2007, followed by similar gifts in 2008.  If H agrees to the splitting of the gifts, W will have reduced her gross estate by $240,000 without the payment of any tax or the use of any of her credit.** Nor will the exercise have cost H or his estate anything.
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*   Whether a couple are married to one another is determined by their marital status at the end of the calendar year in which the gift is made.  They must also have been married to one another at the date of the gift.
**   The result will be the same if the children are the children of W by a prior marriage, regardless of whether H has become their co-parent by adoption.  The donees’ relationship to the actual donor is immaterial.

3.  Certain gifts which are subject to the GSTT.  Section 2515 provides that any taxable gift which is a “direct skip”* within the meaning of Section 2612(c) must be increased by the amount of any GSTT imposed on the donor.

4.  Certain property settlements accompanying a divorce.  Section 2516  deals with the situation where a husband and wife enter into a written agreement relating to their marital and property rights. If their divorce occurs within the three-year period beginning one year before they enter into that agreement (whether or not the agreement is approved by the divorce decree), any settlement of the marital or property rights of either or to provide a “reasonable allowance for the support of issue of the marriage during minority,” is deemed to have been made for a full and adequate consideration in money or money’s worth. Accordingly, it is exempt from gift tax.

5.  Gift-tax marital and charitable deductions.  Because of the close similarity of the gift-tax marital and charitable deductions to the corresponding estate-tax marital and charitable deduction provisions, discussion of the gift-tax marital deduction (Section 2523) and charitable deduction (Section 2522) will be subsumed in the estate-tax discussion.  

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*  See later GSTT  article

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