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Ordinarily, gift tax liability on a
taxable gift falls on the donor under the gift tax rules. However, there
is nothing to prevent the donor from making the gift conditional on the
donee paying the gift tax.
This type of gift is a called a
"net" gift. The gift tax liability is based on the value of the
taxable portion of the gift, just as with any gift. However, the gift is
deemed to be smaller, i.e. reduced by the tax bill to the donee, which in
turn lowers the tax liability.
The following is an illustration of how
net gifts work. (Remember that the gift tax annual exclusion makes a
certain amount given to each donee each year nontaxable. The amount of
the exclusion in 2005 is $11,000. In addition, the amount covered by the
gift tax credit for gift tax purposes is $1 million in 2005.)
Assume that a donor made $1 million in
lifetime taxable gifts in early 2005 so any additional 2005 taxable gifts
(i.e. gifts above the $11,000 annual exclusion) result in a gift tax
liability. Donor wishes to gift $61,000 to a relative (which would be a
$50,000 taxable gift), but wants the relative to pay the gift tax. Under
the current gift tax rates, the gift falls in the 41% tax bracket--the
gift tax would be $20,500. However, if the donee must pay the tax, then
the gift is not $50,000, but is only $29,500 ($50,000 less $20,500).
Thus, the gift tax would be only 41% of $29,500 ($12,095) and not
$20,500. But if the gift tax is only $12,095, then the gift is higher
than $29,500, which would mean the gift tax liability is higher, the gift
lower, and so on and so on and so on. To escape this circular
calculation, the IRS permits the following formula to be used to arrive
at the correct gift tax: tentative tax/ (1 + tax rate). As a
result, since the tentative tax is $20,500, the tax would be $20,500/1.41
= $14,539. This makes the gift $35,461 ($50,000-$14,539).
Although the net gift technique allows
for a reduction of gift tax liability, it only applies in a situation in
which the donee is obligated to pay the gift tax under the terms
of the gift. If the donee voluntarily pays the tax, the net gift rules do
not apply. It is necessary that the donee's obligation to pay the gift
tax be memorialized as a condition of the gift in a written memorandum of
gift.
Please remember that under 2001 federal
tax legislation, the estate tax was reduced and then repealed, effective
2010 (and resurrected in 2011). However, the gift tax was not repealed
and continues as a powerful consideration in the structuring of lifetime
dispositions and in estate planning.
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Quick Links...
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Dear Reader,
As we
head into the dog days of summer, we have taken this opportunity to
update you with some new tax developments in this month's issue. Further,
an interesting planning strategy, "net" gifting, is our
featured article.
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· Recent NYS Tax Law Changes
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In
connection with the recent passage of New York's budget, a variety of tax
law changes occurred that will affect corporate and individual taxpayers.
First,
the new law amends the formula corporations must use to allocate business
income between New York and other states (for those doing business in
other states) in calculating corporate tax. The law provides for an
allocation of entire net income based solely on the percentage of the
taxpayer's New York sales (or receipts) to its total sales/receipts.
Under current law (for years beginning before 2006), New York, as most
other states, uses a three-factor formula (property, payroll and a double-weighted
sales/receipts) to allocate business income within and without New York.
The new law's change to a single sales/receipts factor is phased in over
a three-year period. The sales/receipts factor will constitute 60% of the
business allocation percentage of taxable years beginning on or after
1/1/06; 80% for taxable years beginning on or after 1/1/07; and 100% for
taxable years beginning on or after 1/1/08.
The
impetus for this significant change was the Legislature's intent to
encourage businesses to relocate to or stay in New York. Under the new
formula, having additional property and equipment and/or additional
employees in New York will no longer cause a greater portion of the
corporation's multistate income to be taxed in New York.
Second,
effective for taxable years beginning on or after 1/1/05, the Legislature
increases the maximum amount of entire net income from $290,000 to
$390,000 for purposes of qualifying as a small business taxpayer. Such
corporate taxpayers are eligible for a lower corporate franchise tax
rate.
Third,
the NY Assembly had sought to extend a temporary personal income tax rate
increase that had been enacted in 2003. Under this budget package, the
temporary individual income tax rate increase is allowed to expire as
originally scheduled. This will benefit individual taxpayers with annual
income over $500,000.
Lastly,
applicable to taxable years beginning in 2005 and 2006, the filing fees
for LLCs and LLPs has been increased from $50 to $100 per member, with a
minimum fee of $500 (previously $325)
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· Revised Application for Extension of Time to File
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The Internal Revenue Service has
recently released a draft of the revised Form 4868, Application for
Extension of Time to File US Individual Income Tax Return. If approved,
it will give individual taxpayers a six-month extension of time to file
(until October 15th) without the need to file an intervening extension
request by August 15th. This change will become effective for the 2005
tax year; for the current year, a taxpayer filing Form 4868 has until
August 15, 2005 to file his/her return and would need to file Form 2688
to obtain an additional extension of two months until October 15th.
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· Tax Treatment of Scholarships
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Scholarships and fellowships are
generally tax-free, whether for elementary or high-school students, for
college or graduate students, or for students at accredited vocational
schools. It makes no difference whether the scholarship takes the form of
a direct payment to the individual or a tuition reduction.
However, for the scholarship to
be tax-free, certain conditions must be met. The most important are that
the award must be used for tuition and related expenses (and not for room
and board) and that it must not be compensation for services rendered.
Tuition and related expenses. A scholarship is tax-free only to the
extent that it is used to pay for tuition and fees required to attend the
school or fees, books, supplies and equipment required of all students in
a particular course. Expenses that don't qualify include the cost of room
and board, travel, research and clerical help.
To the extent a scholarship award
is used for nonqualifying items, it is taxable. The recipient is
responsible for determining how much of the award was used for qualifying
items and must maintain records to substantiate the use of the
scholarship money.
Scholarship awards can't be for
payment of services. A scholarship
is not tax-free if the payments are linked to services that your child
performs as a condition for receiving the award, even if those services
are required of all degree candidates. Thus, a stipend your child
receives for required teaching, research or other services is taxable,
even if the child uses the money for tuition or related expenses.
Please note that the scholarship
should not impact the parent's ability to obtain a dependency exemption
on their tax return. Although a requirement of the exemption is that a
parent must provide more than 50% of the dependent's support, a special
rule provides that educational costs covered by a scholarship for a
dependent who is a child of the taxpayer (but not for other dependents)
aren't included in the calculation for total support. Thus, the exemption
will not be threatened by the receipt of scholarship money.
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· Tax Deadlines
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As noted in one of the above
articles, 2004 individual income tax returns on extension from April 15th
are due by August 15th. However, an additional extension of time to file
to October 15th is available. IRS 2688 must be filed by August 15th-an
explanation as to why additional time to file is needed is required on
this form.
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