GIFT TAX FORMULA

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GIFT TAX FORMULA

• Total gifts, less the annual exemption of 11,000
  (adjusted for inflation) less gifts to spouses,
  less charitable gifts taxable gifts. Multiply
  that by the tax rate to produce the tax, and
  reduce the tax by the applicable credit (the
  exemption, sort of, which is 2 million in 2006,
  or a credit of 780,800 for the estate tax, but
  only 1,000,000, or a credit of 345,800 for the
  gift tax) to obtain the amount of any liability.

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DOUBLE TAXATION, NON-RESIDENT ALIENS AND
EXPATRIATION, pp. 40,41

• The United States taxes the property of its
  residents and citizens no matter where located.
  A credit for taxes paid to a foreign country is
  available which we will study later. For
  example, a US citizen-decedent owns land in
  England
• Non-resident aliens can be subject to the US tax
  if they own certain types of property located in
  the United States. Treaties with other nations
  must be consulted.
• If you renounce your citizenship within ten years
  of your death the decedent is still taxable in
  the US, but probably not as a practical matter..

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BASIS ADJUSTMENT AT DEATH

• A donee of a gift usually takes the income tax
  basis of the donor.
• An heirs basis in inherited property is the
  fair market value of the property at the date of
  death.
• The new law (in 2010) provides for a carry-over
  basis from the decedent to the heir except for a
  1,300,000 floor and 3 million of assets left to
  a surviving spouse, for an overall ceiling of
  4.3 million. Another 1.3 million step up is
  available for the second spouse to die. This
  rule is contingent on the repeal of the estate
  tax or whatever happens this year 2006 in
  Congress.

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COMMISSIONER V BOSCHS ESTATE

• In calculating the gift and estate tax the
  definition of property, and property
  rights, is a matter of state law. If, under
  state law, a decedent has an interest in property
  its value will be included in his gross estate.
• Most sizable estates are involved in probate,
  which is a court proceeding probate judges
  commonly decide these state law questions.
• A probate judge is likely to side with a family
  against the government in a tax dispute, and a
  charade is easy to arrange.

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CIR V BOSCHS ESTATE

• Here, the husband gave his wife a power of
  appointment over property in trust that would
  qualify the value of the trust for the marital
  deduction. If this is confusing, dont worry, we
  will cover the specifics later. The wife
  converted the power to one which would not
  qualify for the marital deduction, but after her
  death the probate judge said her action was a
  nullity, salvaging the marital deduction and
  saving a large amount of tax.
• IRS would have had no standing in the probate
  court to challenge the estate, nor would the
  judge likely sympathize with the IRS position if
  it did appear.

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BOSCHS ESTATE CONTINUED

• The issue here is when will a federal court
  accept, as binding, a state court decision on
  matters affecting federal taxes?
• IRS wanted the test to be whether the proceeding
  was adversary. Other courts had adopted other
  tests, e.g, was the issue fairly presented.
• The Supreme Court instead held that the federal
  courts are only bound to follow the decisions of
  a states highest court when any federal tax
  issue income, excise and other taxes are
  included in this principal is involved. This is
  the Erie v. Tompkins diversity rule.

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ESTATE OF BUSHEE, 303 N.W.2d. 320 (ND 1981)

• The first clause of decedents will said to pay
  his debts and taxes and then split the estate 1/3
  to his wife and 2/3 to his sons by a previous
  marriage. The probate Grand forks County court
  said that the wife took her share before the
  estate tax was paid IRS claimed the taxes were
  to be paid first so that the wifes share bore a
  part of the estate tax. Remember, property
  passing to a spouse is normally free of gift and
  estate tax. IRS then reduced the marital
  deduction by the amount of tax borne by the wife
  and increased the amount of the tax. If this is
  confusing, forget the facts.
• The sons had to appeal the probate court
  decision to the North Dakota Supreme Court so as
  to take advantage of the Estate of Bosch
  decision.

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BUSHEE, CONCLUDED

• If the sons won in the Supreme Court, their
  stepmother would have to pay part of the tax and
  that would increase their inheritance.
• If the sons lost in the Supreme Court, IRS would
  have to allow an increase in the marital
  deduction and the tax would be reduced. Whether
  the sons won or lost, the tax savings for the
  sons was about the same. Had they not appealed,
  they would have lost both ways. What if this had
  been a Minnesota estate?

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DICKMAN V C.I.R.

• Dad and Mom loaned money to their son, on a note
  calling for no interest, payable on demand. IRS
  contended that the use of the money was a taxable
  gift.
• The Supreme Court agreed, despite the obvious
  problem of valuing the gift, and the fact that
  the IRS had not taken this position for decades.

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DICKMAN SUMMARIZED

• You may find the arguments for and against the
  result in this case interesting, but the only
  nugget of value for you to learn is the result
  and the statutory aftermath.
• Remember, interest free loans are not the only
  transactions affected by 7872, IRC. For
  example, a sale of land by a mother to her son,
  on the installment basis, with interest, must use
  the federal interest rates or higher or be
  subject to the statutory rules.

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THE TAX EFFECT OF AN INTEREST FREE LOAN

• A Gift tax is imposed, yearly, upon the donor
• The donor has interest income each year.
• The donee has an itemized interest deduction each
  year with severe limits on the deductibility of
  the interest so as to make it almost worthless.
• The federal interest rate, published by the IRS
  monthly, is used.
• Example Assume an interest free loan of
  17,000,000. These were the facts in the Crown
  case P. 46
• The statute is 7872, IRC.

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AFTERMATH OF DICKMAN

• Congress stepped in at once to legislate the
  details of below market interest. In Crown,
  (the 17 million loan case) assuming a federal
  interest rate of 10, the tax result would be as
  follows
• Dad and mom are treated as making a gift of
  1,700,000 each year the gift tax is, say,
  650,000.
• Dad and mom have yearly interest income of
  1,700,000 from an imaginary interest payment
  made by the son and the son deducts that amount
  as an itemized deduction subject to some serious
  limits on the deductibility of itemized
  interest. The parents income tax is about
  700,000 the sons deduction is not much.

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INTEREST FREE LOANS CONCLUDED

• Hence, the total tax imposed on the parents is a
  gift tax of 6500,000 plus an income tax of
  700,000, EACH YEAR!
• Obviously, this strategy is no longer used.
• The rules of 7872 apply to any below market
  loans you will consult the tables published by
  the IRS monthly to learn the applicable interest
  rates, and will do so for true sales as well as
  gifts.
• There are no cases where the IRS has attempted to
  tax the free use of property other than cash.

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BRADFORD V. CIR

• The husband owed 305,000 to a bank and the debt
  was troublesome to his employer, so he persuaded
  the bank to place 205,000 of the loan in his
  wifes name. Her total net worth was only about
  15,000. She never made a payment to the bank.
• IRS claimed that the wife made a gift to the
  husband of 205,000, but the court held to the
  contrary.

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BRADFORD V CIR

• Can the assumption of a debt be a gift? Certainly
  if the one assuming the debt intends to pay the
  loan.
• Is this a fact question or one of law? The real
  issue is whether the wife really assumed her
  husbands debt.
• What if the wife had made a payment to the bank?
  Would that be a gift? Yes, at that time, but not
  today.
• There was a prior case between these parties
  IRS claimed Mrs. Bradford had income from debt
  discharge when the bank wrote off a portion of
  her loan, but IRS lost that case as bad
  sports, IRS brought this gift tax case The
  prior case is reported at 233 F2d 935
• Dont be confused today no transfers between
  spouses are taxable gifts, but they were in 1938.

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When is a gift taxable?

• Dad sells the farm to son for 110,000, payable
  (with adequate interest ) over 10 years at
  11,000 principle per year.
• Situation 1 Dad always intended to forgive
  each years payment in that situation there is
  a gift of 110,000 when the contract is signed.
  Dad will use up this years annual exemption of
  11,000 and 99,000 of his lifetime
  exemption-applicable credit.
• Situation 2 Dad might forgive a payment or all
  of them. There is no gift until a forgiveness
  occurs and in this example the amount of the gift
  would be reduced, each year, to zero by the
  yearly exemption.

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LOAN GUARANTEES AND OPTIONS

• Say dad guarantees a childs loan at the bank
  without the guarantee the bank would not have
  made the loan. This is not a gift, probably
  because it would be impossible to value. The son
  is expected to pay off the loan.
• Mom gives a child an option to buy the farm for
  200,000 the farm is actually worth 200,001.
  She made a gift of 1 if the option period is
  lengthy, is is theoretically possible the amount
  of the gift is larger, but there has not been a
  case applying that principle.

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DIMARCOS ESTATE

• Dimarco joins IBM at age 24, in 1950, when he was
  single, and is automatically covered by IBMs
  survivors income benefit plan.
• DiMarco dies in 1979, and his wife gets three
  years salary from IBM under the plan. Dimarco
  could not name the beneficiary of the program.
• Did Demarco make a gift in 1950? If so, how
  much? How about 1979? Did Dimarco ever
  transfer anything?
• Note that this payment is income taxed.

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LESSONS FROM DEMARCO

• A gift occurs when the donor parts with
  possession of the property.
• The gift must be valued when it is made. If
  valuation is impossible, there still has been a
  gift, but probably of zero value.
• Another lesson. DiMarco never transferred
  anything. A transfer is necessary to trigger
  both the gift and estate tax.
• This loophole allows large amounts to escape
  both the gift and the estate tax. See the Rev.
  Rule 92-68, footnote, p. 66. Today, widows of
  CEOs often are paid millions in such death
  benefits, none of which will be estate taxed but
  all of which will be income taxed. The payments
  are deductible by the employer in computing its
  income tax.