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Charities and advisers tell donors about the income tax reporting to substantiate charitable gifts — for example, the “$250-and-over” receipt rules, rules for cash gifts under $250, rules for gifts of used clothing, household items and vehicles and qualified appraisal requirements.
Sometimes, however, there’s not even a peep about the gift tax implications or the gift tax reporting rules for charitable gifts.
Last month and this month. Last month, I detailed the gift tax reporting rules for outright gifts, charitable remainder trusts (CRTs) and pooled income fund gifts. In this issue, I tell you the rest of the story — the rules for gift annuities, charitable remainder interests in personal residences and farms and charitable lead trusts. I conclude with filing deadlines, extensions of time to file and adequate disclosure. Oh yes, don’t overlook that business about penalties.
Charitable Gift Annuities
●One-life annuity for donor. The value of the charitable gift element of a gift annuity is deemed a present interest. The donor must, nevertheless, report the gift if it exceeds the $13,000 annual exclusion. The donor then takes an offsetting gift tax charitable deduction.
●One-life gift annuity for annuitant other than donor. A donor who creates a gift annuity with payments to another (for example, a spouse or child) makes two gifts: one to the annuitant (the actuarial value of the annuity) and one to the charity (the gift element). The charity's gift is a present interest gift and is reportable if it exceeds the $13,000 annual exclusion. It’s then deductible resulting in a wash.
Annuitant’s interest when annuitant isn’t the donor's citizen-spouse. The gift to the annuitant may qualify for the $13,000 annual exclusion. If it exceeds $13,000 and the gift isn’t offset by the $5.12 million gift tax exemption (for 2012), gift tax will be due. It may qualify for the $139,000 in 2012 annual exclusion for a non-citizen spouse. I use the “may” because there isn’t “authority” on this point.
Annuitant’s interest when annuitant is the donor’s spouse.One-life gift annuities when a citizen spouse is the annuitant automatically qualify for the unlimited gift tax qualified terminable interest property (QTIP) marital deduction. You have to “elect out” if you don’t want it. The gift tax marital deduction isn’t available for non-citizen spouses. But the $139,000 in 2012 gift tax annual exclusion, as stated above, may be available.
●Two-life gift annuity funded with donor’s separate property when the donor is the first annuitant. A donor who uses his own property to create a gift annuity that pays an annuity to the donor for life and then to a survivor annuitant makes two gifts: one to the charity (which is reportable if it exceeds the $13,000 annual exclusion, and then deductible resulting in a wash), and one to the survivor annuitant (the right to receive annuity payments if he survives the donor). The gift to the survivor annuitant is a future interest and, thus, doesn't qualify for the $13,000 annual exclusion. For the same reason, it doesn't qualify for a gift tax marital deduction.
Pointer:The donor can avoid making a gift to the survivor annuitant by retaining the right to revoke the survivor’s life interest. Should the donor exercise that right, the payments will terminate, not on the death of the survivor of the donor and the second beneficiary, but on the donor’s death. The donor needn’t actually exercise the right, but retaining the right avoids making a completed taxable gift to the survivor annuitant. Unlike donors to CRTs, a gift annuity donor can retain the right to revoke during life, by will, or both, without disqualifying the gift annuity. I believe that it’s best, however, to keep the right to revoke by will to avoid possible income tax issues.
●Two-life gift annuity funded with joint, tenancy in common or community property when donors are spouses and are the annuitants and payments are made to them jointly and then to the survivor. Citizen-spouses’ interests qualify for QTIP marital deductions. Alternatively, each spouse can reserve the power to revoke the survivor’s interest in the payments from his half share of the joint, tenancy in common or community property. Joint and survivor annuities automatically qualify for the unlimited gift tax QTIP marital deduction. You have to “elect out” if you don’t want it. The gift tax marital deduction isn’t available for non-citizen spouses.
Caution:It's not clear that the QTIP marital deduction is available for gift annuities that make consecutive payments—first to one spouse and then to the survivor for life—as opposed to paying the spouses jointly for life and then the survivor for life. Presumably, it can qualify. But to be safe, donors should reserve the right to terminate the surviving spouse’s annuity. Unlike charitable remainder unitrusts (CRUTs), annuity trusts and pooled income fund gifts, in which the right to revoke can only be by will, a charitable gift annuity donor can keep the right to revoke during life, by will or both without disqualifying the gift annuity. I believe that it’s best, however, to keep the right to revoke by will to avoid possible income tax issues.
Deferred Payment Gift Annuities
●One-life deferred payment gift annuity for donor. The value of the charitable gift element of a deferred payment gift annuity is deemed a present interest. However, the donor must report the gift if it exceeds the $13,000 annual exclusion. The donor then takes an offsetting gift tax charitable deduction.
●One-life deferred payment gift annuity for annuitant other than donor. A donor who creates a deferred payment gift annuity with payments to another (for example, a spouse or child) makes two gifts: one to the annuitant (the actuarial value of the annuity) and one to the charity (the gift element). The charity’s gift is a present interest gift and is reportable if it exceeds the $13,000 annual exclusion. It’s then deductible resulting in a wash.
Annuitant’s interest when annuitant isn’t the spouse.It’s not clear whether the gift to the annuitant qualifies for the $13,000 annual exclusion.
Annuitant’s interest when annuitant is the spouse.The gift tax marital deduction isn’t available for one-life deferred payment gift annuities created for a spouse because the spouse has no immediate right to income. If a donor during his life wishes to provide a one-life deferred payment gift annuity for the donor’s spouse, he should consider making an outright gift to the citizen spouse. That gift qualifies for the unlimited gift tax marital deduction. The spouse may then use the gift to establish a one-life deferred payment gift annuity for himself. The spouses than take the income tax charitable deduction on their joint income tax return. This end run gives them income tax benefits and wipes out gift tax concerns. For deferred annuities for non-citizen spouses, consider a gift of up to $139,000 (the 2012 annual exclusion for a non-citizen spouse) to the non-citizen spouse. Then the non-citizen spouse creates his own deferred payment gift annuity.
●Two-life deferred payment gift annuity funded with donor’s separate property when the donor is the first annuitant.A donor who uses his own property to create a deferred payment gift annuity that pays an annuity to the donor for life and then to a survivor annuitant makes two reportable gifts: one to the charity (which is reportable if it exceeds the $13,000 annual exclusion, and then deductible resulting in a wash) and one to the survivor annuitant (the right to receive annuity payments if he survives the donor). The gift to the survivor annuitant is a future interest and, thus, doesn’t qualify for the $13,000 annual exclusion. For the same reason, it doesn't qualify for a gift tax marital deduction.
Pointer:The donor can avoid making a gift to the survivor annuitant by retaining the right to revoke the survivor’s life interest. Should the donor exercise that right, the payments won’t terminate on the death of the survivor of the donor and the second beneficiary, but on the donor’s death. The donor needn’t actually exercise the right; merely retaining the right avoids making a completed taxable gift to the survivor annuitant. Unlike CRTs, a deferred payment gift annuity donor can retain the right to revoke during life, by will or both without disqualifying the annuity. I believe that it’sbest, however, to keep the right by will to avoid possible income tax issues.
●Two-life deferred payment gift annuity funded with joint, tenancy in common or community property when donors are spouses and are the annuitants and payments are made to them jointly and then to the survivor. The gift tax marital deduction isn’t available for joint and survivor deferred payment gift annuities created for a spouse because the spouse has no immediate right to income. To avoid adverse gift tax implications, each annuitant should reserve the right to revoke the other annuitant’s interest. If that right were exercised, the charity would only have to pay half of the payments to the survivor annuitant for his life. The gift to the charity—the gift element—is a present interest gift and is reportable if it exceeds the $13,000 annual exclusion. It’s then deductible resulting in a wash.
Charitable Remainder Interest in Personal Residence or Farm
●Gift of a charitable remainder interest with life estate reserved for donor’ life. The value of the charitable remainder interest in a personal residence or farm isn’t subject to federal gift tax. However, the donor must report the remainder gift, regardless of size, because it’s a future interest. The donor then takes an offsetting gift tax charitable deduction.
●Gift of charitable remainder interest with life estate reserved for beneficiary other than the donor. A donor who gives a charitable remainder interest in a personal residence or farm creating a life estate in another who’s not a spouse (for example, a child) makes two reportable gifts: one to the life beneficiary (the value of his life interest) and one to the charity (the value of its remainder interest). The charitable remainder interest is reportable regardless of size, because it’s a future interest. It’s then deductible as a charitable contribution, resulting in a wash. The donor makes a gift to the life tenant of the value of his life interest. The life interest is a present interest and qualifies for the $13,000 exclusion. If the value of the interest exceeds the $13,000 annual exclusion, and the gift isn’t offset by the $5.12 million gift tax exemption (for 2012), gift tax will be due.
●Gift of charitable remainder interest with life estate reserved for spouse. If the donor’s spouse is a citizen, the entire value of the property (not just the spouse’s life interest) is eligible for the unlimited gift tax marital deduction if the donor elects to have the transfer treated as a gift of a QTIP. If the donor elects to treat a life interest in a personal residence or farm as a qualified terminable interest, the property will be includible in the spouse’s estate on his subsequent death. Property included in the spouse’s estate will be treated as passing from the spouse to the charity. Thus, the surviving spouse’s estate will be entitled to a charitable deduction for the property passing to charity, resulting in a wash. A gift of a life estate to a non-citizen spouse should qualify for the special $139,000 (in 2012) annual gift tax exclusion.
●Gift of charitable remainder interest with life estate retained for two lives. A donor who makes a gift of a remainder interest using his own property — reserving a life estate for the donor’s life and then for the life of another — makes two reportable gifts: one to the charity (the remainder interest) and one to the successor beneficiary (his life interest if he survives the donor). The charitable remainder interest is reportable regardless of size because it’s a future interest. Then, it’s deductible as a charitable contribution resulting in a wash.
Second life tenant’s interest when the tenant isn’t the donor’s spouse.The donor makes a gift to the second life tenant of the value of his survivorship life interest. Because the gift is of a future interest, it doesn't qualify for the $13,000 annual exclusion. Pointer: The donor can avoid making a completed gift to the survivor by providing in the deed of transfer that he reserves the right to revoke the survivor’s life interest. Unlike CRUTs and annuity trusts, the right to revoke a survivor’s life interest in a personal residence or farm needn’t be exercisable only by will. The donor needn’t actually exercise the right to revoke, but retaining the right avoids the donor’s making a completed gift for gift tax purposes to the survivor beneficiary.
Second life tenant’s interest when the tenant is the donor’s spouse.A citizen-spouse’s future life estate doesn’t qualify for the gift tax marital deduction as a QTIP because the spouse’s life interest starts in the future. Gift tax concerns can be avoided by having the donor reserve the right in the deed to revoke the surviving spouse’s interest. Also, reserve that right when the spouse is a non-citizen.
●Gift of charitable remainder interest in joint, tenancy in common or community property when donors are spouses. The charitable remainder interest is reportable regardless of size because it’s a future interest. It’s then deductible as a charitable contribution, resulting in a wash. The actuarially older spouse makes a gift to the actuarially younger spouse of the difference in value of their survivorship interests. But a citizen-spouse’s survivorship interest doesn’t qualify for the QTIP marital deduction. To avoid gift tax, each spouse can reserve the right to revoke the other’s survivorship interest. It can be a testamentary right or a lifetime right. Also, reserve that right when a spouse is a non-citizen.
●Charitable lead trusts. Gift tax reporting is required for both grantor and non-grantor trusts.
●When to file. Form 709 is an annual return. Generally, you must file the 2012 Form 709 on or after Jan. 1, but not later than April 15, 2013.
●Extension of time to file. There are two methods of extending time to file the gift tax return. Neither method extends the time to pay the gift or generation-skipping transfer (GST) taxes. If you want an extension of time to pay the gift or GST taxes, you must request that separately. (See Treasury Regulations Section25.6161-1.)
Method 1: Extension to file your income tax return.Any extension of time granted for filing your calendar year 2012 federal income tax return will also extend the time to file your 2012 gift tax return. Make requests for income tax extensions by using Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, or Form 2350, Application for Extension of Time To File U.S. Income Tax Return. See Form 4868 to get an automatic 6-month extension (four months if “out of the country”) and for instructions for using the Internal Revenue Service’s electronic filing program or a credit card to pay part or all of the federal income tax (but not gift or GST taxes) you expect to owe for 2012. Use these forms only to extend the time for filing your gift tax return if you’re also requesting an extension of time to file your income tax return.
Method 2: Extension for gift tax return only.If you don’t request an extension for your income tax return, use Form 8892, Application for Automatic Extension of Time To File Form 709 and/or Payment of Gift/Generation-Skipping Transfer Tax, to request an automatic 6-month extension of time to file your federal gift tax return. In addition to containing an extension request, Form 8892 also serves as a payment voucher (Form 8892-V) for a balance due on federal gift taxes for which you are extending the time to file.
●Adequate disclosure. To begin the running of the statute of limitations regarding a gift, the gift must be adequately disclosed on Form 709 (or an attached statement) filed for the year of the gift. In general, a gift will be considered adequately disclosed if the return or statement provides:
• A description of the transferred property and any consideration received by the donor,
• The identity of, and relationship between, the donor and each donee,
• If the property is transferred in trust, the trust’s employer ID number and a brief description of the terms of the trust (or a copy of the trust instrument in lieu of the description), and
• Either a qualified appraisal or a detailed description of the method used to determine the fair market value of the gift.
See Treas. Regs. Section 301.6501(c)-1(e) and (f) for details, including what constitutes a qualified appraisal, the information required if no appraisal is provided and the information required for transfers under Internal Revenue Code Sections 2701 and 2702.
●Penalties.The law provides for penalties for both late filing of returns and late payment of tax, unless you have reasonable cause. There are also penalties for valuation understatements that cause an underpayment of the tax, willful failure to file a return on time and willful attempt to evade or defeat payment of tax.
The late filing penalty won’t be imposed if the taxpayer can show that the failure to file a timely return is due to reasonable cause. If the IRS sends a notice about penalties after the Form 709 is filed, the taxpayer should send an explanation and the IRS will determine if the reasonable cause criteria has been met. An explanation shouldn’t be attached to the Form 709 when it’s filed.
A substantial valuation understatement occurs when the reported value of property entered on Form 709 is 65 percent or less of the actual value of the property. A gross valuation understatement occurs when the reported value listed on the Form 709 is 40 percent or less of the actual value of the property.
And that’s the news from Lake Taxbegone.
© Conrad Teitell 2012. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.