The Tax Cuts and Jobs Act (“TCJA”) temporarily increased the federal estate, gift and generation-skipping transfer (“GST”) tax exemptions from $5,000,000 to $10,000,000 (the federal estate and gift tax exemption is referred to as the “Basic Exclusion Amount” or “BEA”), adjusted annually for inflation. On January 1, 2026, under the TCJA, the BEA (and GST exemption) reverts to $5,000,000, adjusted for inflation.
After the 2020 election, certain tax proposals provided for a reduced BEA (from $11,700,000 in 2021) to take effect as soon as January 1, 2022, four years earlier than the TCJA sunset. As such, many wealthy families completed gifting plans in 2021 to use the increased BEA, and will need to report taxable gifts on a Federal Gift Tax Return – Form 709. Form 709 is due on April 15, 2022, unless the donor (i) files an extension of time to file the donor’s federal income tax return, or (ii) files Form 8892 to extend the time to file Form 709. Note that as of the date of this article, no change to the BEA was made, and the 2022 BEA is $12,060,000.
Typically, gifts in excess of the annual exclusion amount ($15,000 in 2021, $16,000 in 2022), as well as gifts of future interests that do not qualify for the annual exclusion, are subject to federal gift tax reporting requirements. Gifts made for qualifying educational or medical expenses are excluded from gift tax and are not required to be reported on Form 709.
Taxpayers may elect to split gifts with their spouse, such that all gifts reported on Form 709 are treated as being made one-half by each spouse, thereby utilizing a portion of both spouses’ BEAs. However, not all married couples should make the gift-splitting election. For married couples who gifted $11,700,000 in 2021, the donor spouse may choose to use their full BEA, rather than splitting gifts and having each spouse use $5,850,000 of BEA. If gift-splitting is elected, each spouse would have little remaining BEA after the sunset in 2026, whereas if gifts are not split, the donor spouse will have utilized the full $11,700,000 BEA under the TCJA, and the other spouse will continue to have their then remaining BEA. The Internal Revenue Service has issued final regulations stating that gifts utilizing the increased BEA under the TCJA will not result in an estate tax if the donor dies after 2025.
Gifts are disclosed on Form 709, Schedule A, which is divided into three Parts. Gifts which are only subject to gift tax, such as outright gifts to the donor’s children, are disclosed on Part 1.
Gifts which are subject to gift tax and GST tax, such as gifts made to “skip persons”, are disclosed on Part 2. “Skip persons” are persons (i) related to the donor who are two or more generations below the donor’s generation, such as grandchildren, or (ii) unrelated persons who are more than 37.5 years younger than the donor.
Gifts which are subject to gift tax at the time of the gift, but may be subject to GST tax later, are disclosed on Part 3. One common estate planning technique is gifting assets to a GST trust for the donor’s child for life, and upon the child’s death, the trust assets are distributed to the child’s children – the donor’s grandchildren. The transfer may be subject to GST tax later because the initial lifetime beneficiary is the donor’s child, who is not a skip person.
Each donor has a lifetime GST exemption. In 2021, the GST exemption was equal to the BEA of $11,700,000. The donor’s BEA and the donor’s GST exemption may diverge; for example, outright gifts to a donor’s children will reduce the donor’s BEA, but will not utilize GST exemption. It is important to track the use of the donor’s GST exemption on Form 709, and to correctly allocate the donor’s remaining GST exemption.
There are complex rules and elections regarding allocation of GST exemption. Section 2632(c) of the Internal Revenue Code (“Code”) provides a set of automatic allocation rules. GST exemption is automatically allocated to “GST Trusts”. “GST Trusts” are specifically defined in the Code, and the definition has many nuances that may cause unintended consequences. It is possible to opt out of the automatic allocation rules by checking Box C on Part 2 and/or Part 3 of Schedule A. To avoid any ambiguity, Schedule D of Form 709 must be completed to properly allocate GST exemption to taxable gifts, and practitioners may wish to include a notice of allocation.
Taxable gifts made in prior years are reported on Schedule B. It is important to accurately report prior taxable gifts. Failure to accurately track the use of BEA may result in unexpected gift tax liability.
On Schedule C, if the donor survived their spouse, the donor may be able to utilize the predeceased spouse’s unused BEA, referred to as the “Deceased Spousal Unused Exemption” or “DSUE”. To use the DSUE, the executor of the deceased spouse’s estate must timely file a federal estate tax return (Form 706) to elect “portability”.
All taxable gifts should be adequately disclosed, including all information required by Form 709 and its instructions, such as information pertaining to the donee (the gift recipient) and the gift. In 2021, many donors utilized “defined value clauses” to protect against unintended gift tax liability. Common defined value clauses describe the gift in terms of a specific dollar amount of the gifted item based upon the fair market value of the property as finally determined for tax purposes, rather than a specific portion of the property. The description of the gift on Form 709 should be consistent with the donor’s intent, as stated on the gift document.
The donor must provide sufficient information to report the fair market value as of the date of the gift, which may include a qualified appraisal and/or description of valuation methodology. If available, appropriate discounts, including lack of control and lack of marketability, should be reviewed. If any discounts are applied, the box on Schedule A, Line A of Form 709 must be checked and the discounts must be explained. It is also important to ascertain and disclose the donor’s adjusted basis in the gift.
The donor should include other relevant information and append supplemental documents as exhibits to support the values stated on Form 709. For example, certain estate planning techniques, such as gifts to grantor-retained annuity trusts, use complex calculations to determine the amount of the taxable gift, based upon federal interest rates, annual annuity calculations, and other factors. Such calculations should be included with Form 709.
Practitioners should also consider whether a protective qualified terminable interest property (“QTIP”) election should be made to minimize gift tax risk. For example, many spousal lifetime access trusts (“SLATs”) were recently funded. SLATs utilize the donor’s BEA while providing benefits for the donor’s spouse for life, and are not included in either spouse’s estate. If the value of assets transferred to the SLAT is determined to exceed the donor’s remaining BEA, a gift tax will be due. If the SLAT terms meet the requirements to qualify for a QTIP election, a protective QTIP election can help to avoid an unexpected gift tax.
Another important election is the qualified tuition program election on Schedule A, line B, regarding gifts to 529 plans. A donor can front load a 529 plan in one year by contributing up to five times the annual exclusion, and elect to treat the contribution as being made ratably over 5 years.
Note that New York does not impose a gift tax and does not require reporting of taxable gifts. However, New York state law requires certain taxable gifts made within three years of death (which are not already included in the decedent’s federal gross estate) to be included in the New York taxable estate (the 2022 New York state estate tax exemption is $6,110,000). As such, a New York resident may gift up to $12,060,000 in 2022 without federal or New York gift taxation, and if such individual lives more than three years after the date of the gift, the gift is not included in their New York taxable estate.
Fearing potential law changes, many taxpayers made gifts outright and in trust in 2021. To properly report taxable gifts, it is important to understand the type of gift that was made, the identity of the donee, the provisions of any donee trust, and the applicable reporting requirements. Beginning on the date Form 709 is filed, the Internal Revenue Service typically has three years to assess gift tax liability. However, if gifts are not adequately disclosed on Form 709, the statute of limitations may remain open. Donors should consult with their attorney and/or tax advisor for assistance to timely file Form 709, and to adequately disclose all gifts and consider elections and allocations.
ABOUT THE AUTHORS:
Gregory L. Matalon is a Partner at Capell Barnett Matalon & Schoenfeld in New York. His practice focuses on estate planning and administration, eldercare law and religious and charitable organizations.
Erik M. Olson is an Associate in the New York offices of Capell Barnett Matalon & Schoenfeld. His practice includes estate planning and estate administration.