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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 tax.
This type of gift is 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 gift tax liability.
The following is an illustration of how
this works. (Remember that the gift tax annual exclusion makes a certain
amount given to each donee each year nontaxable. The amount of the
exclusion in 2006 is $12,000. In addition, the amount covered by the gift
tax credit for gift tax purposes is $1 million in 2006.)
Assume that a donor made $1 million in
lifetime gifts in early 2006 so any additional 2006 taxable gifts (i.e.
gifts above the $12,000 annual exclusion) result in a gift tax liability.
Donor wishes to gift $62,000 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% gift tax bracket, so
the gift tax bill 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-
$20,500). So the gift tax is 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 merely volunteers to pay the tax, the net gift
tax 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tax legislation, the estate tax was reduced and then repealed, effective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 However, the gift tax was not repealed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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Dear Richard,
In last
month's issue of our tax newsletter, we discussed the highlights of the
recently enacted Pension Protection Act of 2006. This month, we will
concentrate on a few of the provisions that may provide some interesting
planning opportunities.
We also
have a "repeat performance" of an article first appearing in
one of our 2005 newsletters that garnered much feedback--a discussion of
net gifts.
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· Tax-Free IRA Distributions for
Charitable Purposes
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For
distributions in tax years beginning in 2006 and 2007, the new Act
provides an exclusion from gross income, not to exceed $100,000, for
otherwise taxable IRA distributions from a traditional or Roth IRA that
are qualified charitable distributions. To constitute a qualified
charitable distribution, the distribution must be made: (1) directly by
the IRA trustee and (2) on or after the date the IRA owner attains age 70
1/2.
To
illustrate, a 71 year-old taxpayer has a traditional IRA with a balance
of $100,000 consisting solely of deductible IRA contributions and
earnings. He makes a qualified charitable distribution of the entire
$100,000. Under the Act, no amount is included in the taxpayer's income
as a result of the distribution and the distribution is not taken into
account in determining his charitable deduction for the year. Under
pre-Act law, the taxpayer would have been taxed on the $100,000 of IRA
distribution income and, if he itemized, would have been allowed a
charitable deduction, subject to applicable limitations.
Note
that there is no carryover provision. Thus, if he aggregate amount of a
taxpayer's qualified charitable distributions exceed $100,000 in a tax
year, the excess amount cannot be carried over to the following year and
must be included in the taxpayer's gross income for the tax year in which
the excess distribution was made. Further, the exclusion does not apply to
distributions made from simplified employee pensions (SEPs) or SIMPLE
IRAs.
The new
provision clearly saves taxes for nonitemizers who take advantage of it
and can save taxes for itemizers to the extent charitable limitations
would have reduced the amount currently deductible for the contribution
of the IRA proceeds in the absence of the provision. Even if the
limitations would not cause a reduction in the amount of the charitable
deduction for itemizers, the new provision can still save taxes by lowering
adjusted gross income and thereby making it less likely to lose certain
tax breaks pegged to AGI, such as medical expense deductions. Using IRA
distributions, rather than other funds, to make charitable contributions
can also help reduce the amount of social security benefits included in
gross income.
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· Donations of Clothing and Household
Items
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For contributions made after
August 17, 2006, no deduction is allowed for contributions of clothing
and household items that are not in "good" used condition or
better. Household items include furniture, furnishings, electronics,
appliances, linens, and other similar items, but don't include food,
paintings, antiques, and other objects of art, jewelry, gems, or collections.
In addition, the IRS may deny a deduction for any contribution of
clothing or a household item with minimal monetary value, such as used
socks and undergarments. A deduction may be allowed for a contribution of
an item of clothing or a household item not in good used condition or
better if the amount claimed for the item is more than $500 and the
taxpayer includes with his return a qualified appraisal with respect to
that property.
According to the Joint Committee
on Taxation (JCT), the IRS statistics for the amount claimed as
deductions for clothing and household items in 2003 exceeded $9 billion.
The JCT expects the IRS, consistent with the goals of improving tax
administration, to exercise its authority to disallow a deduction for
some items of low value and ensure that donated clothing and household
items are of meaningful use to the donee charitable organizations.
Apparently, our legislators have finally come to the conclusion that
there have been simply too many abuses as it pertains to the donation of
used clothing and household goods and have given the IRS authority to
rectify these abuses.
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