Apparently, the IRS has significantly increased the number of audits it performs for intrafamily transfers of property, where there is no gift tax return filed by the person making the transfer. The extent of the effort is detailed in an article in today’s Forbes.com: The New Gift Tax Audits: IRS Identifies Non-Filers Using State Property Records.
The Internal Revenue Code (IRC) requires that anyone who transfers an asset, valued more than $13,000, to another person without consideration, must file a federal gift tax return. The Form 709 is used for this purpose. The IRC requires the filing of the return even if there is no gift tax liability arising from the gift. The gift tax return must be filed for gifts to charity as well. There is no requirement for filing a gift tax return if total gifts during a calendar year to any individual are less than the annual exclusion amount – currently $13,000. The tax code allows an individual to make gifts up to $13,000 each to as many people as you want, without the need for filing a gift tax return.
For the vast majority of people, there will be no gift tax liabiility because of the lifetime exemption from gift tax that each person has available. Currently the lifetime exemption is $5,000,000. (Absent Congressional action before 2013, the lifetime exemption will return to $1,000,000 on January 1, 2013.) That means that each individual has the ability to transfer $5,000,000 worth of assets to other people during our lifetime without incurring any gift tax liability. For someone whose lifetime gifting exceeds $5,000,000 the gift tax is calculated at 35% (currently, rising to 45% on January 1, 2013) of the value that exceeds the lifetime exemption and the $13,000 annual exclusion the IRC allows for gifts made to the same person in the same calendar year.
The IRC requires filing the gift tax return, even though there is no tax liability, in large part because the failure to file the gift tax return means the IRS has no record of the lifetime transfers made by the individual. At death, the exclusion from estate tax is reduced by the amount of the lifetime exemption that was used. For instance if you make $1,000,000 of gifts during your lifetime, your $5,000,000 exemption from estate taxes is reduced to $4,000,000. Failing to file the gift tax return, even when no gift tax liability is present, means your estate tax may be higher at death, and without the gift tax returns on file the IRS would not be aware of that fact.
The Forbes article describes how the IRS is examining property transfer records maintained by the various states to identify intra-family transfers of real property. When such a transfer is identified, and no gfit tax return has been filed, the penalties are significant. Those penalties, which include failure to file and failure to pay (where there is a tax liability), can be as much as 25% of the tax liability for each penalty. Ouch!
One positive aspect of filing the gift tax return is that the filing of the return starts the statute of limitations for the IRS to challenge the value of the property being gifted. The IRS has 3 years from the date of filing the return within which to challenge the value of the gift as reported. If the asset gifted is a hard to value asset, such as the stock of a closely held corporation, raw land, or in today’s environment just about any parcel of real property, the IRS must challenge the value reported on the return within three years of the filing of the return. For gift tax returns where there is no liability for gift tax reported, there is a high probability the IRS will not challenge the value prior to the expiration of the limitation period.
Based on the information provided by the Forbes article, it’s a good idea to file a gift tax return anytime you’ve made a gift greater in value than the $13,000 annual exclusion. Your CPA or estate planning attorney can assist you in determining whether you are required to file the Form 709. Based on the level of audits described in the Forbes article, it’s a good idea to file those returns timely.
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