Gift Tax Return Requirement for 2012 Transactions

During 2012, uncertainty about future estate and gift tax exemptions and rates led many of our clients to make substantial gifts during 2012 to their descendants or to trusts for descendants. These clients are now required to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, on or before April 15, 2013 to report gifts, unless (i) the client extends his or her individual income tax return by filing Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return (which automatically extends the gift tax return due date to October 15, 2013), or (ii) the client files a Form 8892, Application for Automatic Extension of Time to File Form 709 and/or Payment of Gift/Generation-Skipping Transfer Tax, that extends the gift tax return due date to October 15, 2013. If 2012 gifts exceeded the client’s gift tax exemption amount ($5,120,000), gift tax on the excess amount must be paid on or before April 15, 2013, whether or not the filing date for the Form 709 is extended.

A Form 709 must be filed if a client made a gift in 2012 regardless of whether any gift taxes are payable. In addition, many clients choose to file the Form 709 to report sales of interests or property at fair market value where there was no intent to make a gift. Filing the Form 709 disclosing the sale with a gift tax value of zero starts the three-year statute of limitations on the IRS for reviewing the return.

In January of this year, Congress made the $5,000,000 federal gift and estate tax exemption permanent, and included an annual inflation adjustment, so that the adjusted exemption in 2013 is $5,250,000 ($10,500,000 for a married couple). Thus, clients who elected to make smaller gifts or take a “wait and see” approach in 2011 and 2012 may now be considering substantial gifts (or additional gifts) to use up some or all of this substantial exemption amount.

Use of “Defined Value” Gifts and Sales

Clients who wish to give or sell ownership interests in their closely held business entities to descendants or trusts for descendants are often concerned about the valuation risk associated with these types of transfers. Even with an appraisal from a well-qualified appraisal firm, the IRS may assert on audit that the transferred interest was undervalued, which could result in assessment of additional gift tax liability.

To reduce the valuation risk, we often use “defined value” transfers, in which the client agrees to transfer (by gift, sale or a combination of both) all or a portion of a specified ownership interest (such as a 10% limited partnership interest) and directs that, if the value of the interest reported on the gift tax return is increased on audit, the excess portion of the interest will pass to another trust or to charity so that the excess portion results in a very small taxable gift, if any. As a result, if a higher value is agreed upon in audit, the donor is not responsible for additional taxes. A number of recent court cases have approved this technique and ruled in favor of the taxpayer.