Q:

Subject: S Corp Gifting 

I stumbled into your web site back in 2007 when I was thinking of changing from a C Corp to an S Corp.
Very helpful information written for the non-accounting business owner.

My company (S Corp) has had a banner year and I am now facing a HUGH tax check payable to Uncle Sam.

Here is my question: Obliviously trying to lower my bottom line as much as I can before years end, can I
gift 2 of my best employees $100K each. Our company would pay the taxes for them but then they would
gift back to me $50K each making all of us happy and lowering my bottom line?

I love these guys and they have been employed here for over 35 years each. I have already given them
a bonus of $20K to employee #1 and $13K to employee #2 this Thanksgiving. They are both happy to
receive and willing to file form 709 on their taxes for a cut of the $100K. Can I do this?

Thank you for any help –

A:

I don’t want to seem harsh, but I’m getting the impression that you have been trying to navigate the tax waters on your own, without the assistance of professional tax advisors. Any tax pro would have been able to explain how misguided your proposed gifting plan is.

Your ideas regarding the use of gifting as a tax savings strategy are dangerously off-course. Here are just a few of the reasons why this idea is completely wrong for achieving your goal of reducing your 2016 taxable income.

Gifting is a strategy for reducing future Estate (aka Inheritance) taxes and does not produce any kind of current income tax deduction. You could give away everything you have and it would have zero effect on your current year income taxes.

Gifting can only be done by individuals, because only humans are subject to the Estate Tax. Corporations have potentially infinite lives, so they are not ever subject to the Estate Tax.

Gifts have to be no strings attached. Having the recipients gift you back half of the gift clouds what the transaction really is.

True gifts are tax free to the recipients and not deductible by the giver, unlike wages and bonuses, which are reported on W-2s and fully deductible by your business. If you were to gift any person more than $14,000 during a calendar year, you as the giver would need to file a Form 709 Gift Tax return and either pay Gift taxes or utilize part of your lifetime exclusion. The gift recipients do not file 709s. Only the givers do.

There are a number of simple ways that you can still actually reduce your 2016 taxable income. Since most of them will need to be done by 12/31/2016, you need to start working with a professional tax advisor ASAP.

Good luck.

Kerry

From a Reader:

Subject: 709 form question

Hi, If my husband and I want to both gift the max ($14000) to our child and we both write separate checks, do either of us need to file a 709 ? Thank You

My Reply:

As long as either of your total gifts to your child for the year, not counting the exempt types (medical & education), don’t exceed $14,000 for the calendar year, neither of you will need to file a 709.

This is important to be aware of because if you each give him/her $14,000 this early in the year, additional gifts later in the year could push the total for 2016 over the $14,000 threshold and 709s may end up being necessary.

I have attached a short flyer that explains the gifting rules in a little more detail.

Good luck.  I hope this helps.

Kerry

Follow-Up Q:

Hi Kerry,

   One last follow-up … Do the checks need to be written out of separate accounts that belong solely to myself and my husband ? Meaning, not joint accounts.

thanks

Follow-Up A:

It really doesn’t matter which accounts the money comes from.

It can all come out of a joint account and you can claim that half of the gift is made by each of you.

Likewise, all of the money can come out of a separately owned account and using the IRS approved concept of Gift Splitting, the gift can be attributed to both spouses.

I have attached more info on this from one of my main tax reference services, TheTaxBook.

I hope this into is useful.

Kerry

Final Q:

Thank you!  But as long as both checks are under 14k , we do not need to file the 709, is that correct?

Final Reply:

You may have missed my point from the previous email about joint gifts.

The gifts don’t have to be in separate checks or from separate accounts. 

They can be in one or a dozen checks.  All you need to worry about is that the total given to your child during the year is less than $28,000.

I hope this info helps.

Kerry

Final Comment:

Ok, thanks again !  appreciate the return !!

A very common technique for gifting large amounts of money to kids or other persons without needing to file Gift Tax returns is to loan the money to the kids and then forgive the debt in annual installments that are equivalent to the exclusion amounts.  A client was a little confused as to how this works.

From Client:

Subject: Annual Payback Note and Mortgage (Our Children)

Hi Kerry:

We loaned our kids and recorded a Real Property $140,000. Mortgage @ 2% Interest for 10 Years.  Minimum annual payment $14,000. (Equal One Gift of $14,000. to our daughter or her husband)

QUESTION:  If we gift $14,000 X 2 = $28,000. for 2015, do they in turn write back a $28,000 check plus 2% interest in 2015?  Or does time need to pass for a repayment amount? 

How will the IRS view this?  Or how do we comply with IRS laws and regulations?  You have convinced me that that IRS Clerk sitting behind that desk may be unable to get a family loan and for sure not receive a dollar gift each year. She may have grounded her experiences in a chick flick void of real life stuff. Plus she may have a Bill Clinton definition of "is". Yes Sherry, it’s a woman! (haha) Men are nice:).

The $140 K mortgage is established in our Quick Books.  I will need to calculate the exact amount of daily interest at the time the kids pay.

Appearing simple is why there is fear and trepidation.  Plus, I’ve learned it’s the little things that will get you.

Being Very Cautious

My Reply:

While using actual money back and forth is possible and would give a good audit trail, that is not how this is normally handled.

While not the only way to handle this, normally the donors (you and your wife) give the recipients (your daughter  & her husband) a Gift Letter that announces that you have forgiven a certain amount of the principal of the loan, and then show what the new balance of the loan is.

This can be posted into QB just like a monetary transaction.  In your QB, you would use the General Journal to debit the Gift expense account and credit the Loan Receivable account.
 
In the QB for the kids, they would make a similar entry; a credit to the Gift Income account and a debit to the loan’s liability account.

For the interest you are charging, that would be cleaner all around if it were handled with a check from the kids to you and your wife.  They can deduct it as home mortgage interest on their Schedule A and you would report it as interest income on your Schedule B.

The annual tax return free gift exclusion for 2015 and 2016 is $14,000 per donor per donee and is calculated on a calendar year basis (Jan 1 to Dec 31).  Depending how much you want to gift, you and your wife are allowed to each gift up to $14,000 to each other person without needing to file any Gift Tax returns.  That actually works out to as much as $56,000 per year for you two to gift to your daughter and her husband.  You don’t have to gift that much, but it’s more than the $28,000 figure you were using in your question.

There is no time delay required for the first Gift Letter.  If you haven’t already used up your $14,000 allowance for 2015, you can make that gift any time before the end of the day on December 31, 2015.  You can then make the second Gift Letter as of January 1, 2016 because that would be in a new calendar year.  Obviously, the earlier you make the gift, the less interest you will be charging them.

In another year or two, the annual exclusion will be bumped up to $15,000.  It only goes up in $1,000 increments when the cumulative inflation factor is high enough. You will then be able to gift up to $60,000 per year to them.

I hope I haven’t made this too confusing for you.  Let me know if you want to discuss any aspect of this on the phone.

Kerry

From a Client:

Subject:  Accounting for Girls’ Inheritance "Forward"

Kerry:

Our plan is to loan our daughter and her husband $140,000. Annual payments will be their annual "gifts".  Their loan will be secured by a mortgage on their land and secured by a note @ zero interest. Their closing is soon.

Problem? Or problems?

My Reply:

You are on the right track here.  I’m assuming you are trying to work with the annual tax free gifting exclusion, which is currently $14,000 per donor (giver) per donee (recipient).

You just need to be sure to call the $140,000 a loan in your books and on your kids’.

Each calendar year, you can forgive $56,000 of principal as gifts from you and your wife to your daughter and to her husband.  A letter explaining this each year would be perfect documentation, as would recording it as such in your personal books.  This assumes there haven’t already been other large gifts that would count towards the $14,000 annual limit.  If so, you can just reduce the debt forgiveness by enough to keep the year’s total at no more than $14,000.

Some other relevant trivia:
The gifting limits are done on a calendar year basis.

You don’t need to wait a full year from the date of the loan to make the first debt forgiveness gift. It just needs to be before midnight on December 31, 2015.  Technically, you can give the second one on January 1, 2016.  However, if you do that, you won’t be able to give any more large gifts for the rest of 2016 and stay under the annual limit.

Every few years, the annual limit is bumped up by $1,000 when the cost of living warrants it.  It was last raised to $14,000 as of 2013.  When it is increased to $15,000 in the next year or two, you can increase your annual gifts accordingly.

I hope this info isn’t too confusing and is useful for your gifting plans.  Let me know if you have any questions.

Kerry

Follow-Up:

Thanks. Perfect advice.

From a CPA:

Subject: Gift tax

Hi Kerry,

I have a question for you. I will be the first to admit that I am not well versed on estate and gift taxes. A new client of mine is thinking of giving his current residence to his father (probably a bad idea). Based on what I have read, my client would have to pay a gift tax on the transfer equal to the fair market value of the house multiplied by the tax rate in effect at the time of transfer. Is that correct?

Further, am I understanding correctly that the father’s basis would be the son’s adjusted basis? This hardly seems fair in that since a gift tax has been paid on fair market value at the time of transfer, why wouldn’t the father’s basis for a future sale be the value of the house at the time of the gift. Perhaps I’m reading the regs incorrectly. Please enlighten me.

Thank you,

A:

There are a lot of issues to be reviewed here.

First is whether a gift worth more than the $13,000 annual exclusion will even require the payment of an actual gift tax.  There is still a lifetime exclusion of one million dollars per person; so that is generally needs to be used up before any gift tax is required to be paid.  You didn’t specify the value of the home or any prior use of the lifetime exclusion; so I don’t know if the gifted home will trigger an actual tax obligation.

Next is the calculation of the gift tax.  It is not a flat rate as you seem to believe it to be.  It is a “progressive” graduated tax rate schedule, much like the one used for income taxes.  In fact, it is the same rate schedule for Estate taxes on Form 706.  As you can see, the rates range from 18% up to 45% for 2009.  For 2010, the maximum rate is 35%.

Attached are two versions of the gift tax rate schedule; one from the official 2009 IRS instructions for Form 709 and one from Page 21-1 of the 2009 Small Business Edition of TheTaxBook.

Next is the issue of the cost basis for the gift recipient (aka Donee).  It has always been an unfair double standard that the gift tax is based on the current fair market value, while the basis for the recipient is the same as it was for the previous owner (donor).  This creates some critical tax planning issues when dealing with gifts of highly appreciated assets.  The donee is literally accepting personal responsibility for the previously accrued capital gains taxes on any future sale.

In this particular situation, there may be an opportunity to minimize overall taxes.  If the current home owner qualifies for the Primary Residence Section 121 tax free exclusion of $250,000 of gain per person, he may want to sell the home to his father at the current market value.  This will establish the current market value as the cost basis for the father.

If the home had been used for rental or other business purposes and has a lot of accumulated deprecation that would need to be recaptured under a sale, that might not be a wise move tax-wise.  You would need to crunch the numbers to see the trade-off.  A gift of depreciated rental property would transfer the future capital gain to the father, but if he lives in the home long enough, he may be able to use the Section 121 exclusion to shield all or part of the gain from actual taxation.

One other misconception that I noticed in your email.  If there is gift tax required to be paid, that amount can be added to the cost basis of the home for the father.  It’s obviously not as good as using the full market value; but it is a small help in reducing his future profit.

I hope this helps you see that there are a lot of issues to be considered when discussing gifting plans with your clients.

Kerry Kerstetter

Follow-Up:

Thx Kerry. Forgot about the lifetime exclusion.

Q:

Subject:  Question about gifting

My dad passed away this year and my mom is now interested in gifting to have some money in my name only. The non taxable amount this year I know is $13,000. Does the 2009 contribution need to be written out (dated before dec 31st) or do we have until April and the end of the tax season to have the gift given? I know after Jan 1st she can gift again for 2010. I believe this is how it works according to an accountant friend of mine. Do you know if these gifts are excluded from the 5 year look back rule which applies to turning over ownership of a house?

Thanks

A:

For Gift Tax purposes, gifts are totaled up on a strict calendar year basis from January 1 through December 31.  The Gift Tax return (709), if applicable, is due on the same schedule as 1040s are, April 15 plus extensions.

So, to be a valid 2009 gift, you do have to receive the actual money before midnight New Year’s Eve.

The look-back rules in regard to impoverishment planning for elderly Medicaid eligibility are state specific; so you all need to be working with an elderly law specialist in your area.

Good luck.  I hope this helps.

Kerry Kerstetter

Q:

Hello Kerry,

I was wondering if you could help me out with a few questions. I have been doing quite a bit of extensive searching for the maximum gift exclusions for years 1994, 1995, and 1996 and haven’t been able to get anywhere. Was wondering if maybe you might know what these numbers would be? I found your website during the many searches I’ve done.

Thanks so much for your help in advance.

A:

It was $10,000 for each of those years, as you can see in the attached chart, which was part of the more extensive history of the gift tax that you can download from here.

Good luck. I hope this helps.

Kerry Kerstetter