The US gift tax is a tax imposed on the transfer of property by way of gift. The giver of the gift (the donor) is the party who must pay the tax. Generally, any transfer to an individual without receiving something of equal value in return (measured in money or money’s worth) is treated as a gift. The general rule is that any gift is a taxable gift, but there are many exceptions to this rule. For example, gifts that do not exceed the permissible annual exclusion for the calendar year, are not taxable gifts.
The annual exclusion applies to gifts made to each individual recipient. The current annual exclusion is $15,000 per recipient, per year. So if you gift each of your four children $15,000 this year, the annual exclusion applies to each gift and you need not file any gift tax return or pay any tax. (The annual exclusion amount for 2014, 2015, 2016 and 2017 was $14,000. For 2018, 2019, and 2020, the annual exclusion is $15,000).
The Internal Revenue Service (IRS) has prepared a series of FAQs covering the more common questions and answers about gift tax issues. You may also find additional information in the IRS Publication 559.
Lifetime Exemption
Once a gift exceeds the annual exclusion amount, the gift is treated as a “taxable” gift. The donor need not pay gift tax to the IRS if he can draw down on the so called “lifetime exemption” amount available to US citizens and foreign nationals who are treated as “domiciled” in the United States. Full details on the US gift tax issues for foreign individuals and the concept of “domicile” are available at my earlier blog post. The lifetime exemption amount is first used to offset gift tax owed on taxable gifts made during one’s lifetime. To the extent it is not used during one’s life, it is used at death to offset any estate tax.
Thanks to the Tax Cuts and Jobs Act (TCJA), the United States federal estate and gift tax lifetime exemption amounts increased dramatically in 2018. As of January 1, 2020, these exemption amounts are US$11,580,000 for individuals (US$23,160,000 for married couples). The exemption amounts increase with inflation each year through 2025.
Use It Before You Lose It!
On January 1, 2026 a sunset provision will cause the exemption amounts to revert back to the 2017 levels. Assuming no further legislative action is taken, the exemption amounts will revert to the 2017 level of US$5 million, as adjusted for inflation. Given the devastating economic effects of COVID-19, I believe it is inevitable that the lifetime exemption amount will revert back. The US Treasury will be in dire need of funds. In fact, even though the increased exclusion amounts are not set to expire until January 1, 2026, depending on the results of the November 2020 elections, it is possible we can see an earlier lowering of the exclusion amount.
The sunset provision created a question as to whether gifts greater than the inflation-adjusted $5,000,000 exclusion would be subject to gift and estate tax after 2025. The IRS clarified the situation in final Treasury Regulations confirming there would be no “clawback” for gifts made under the increased exemption amounts put into place by TCJA. Thus, individuals who take advantage of these increased estate and gift tax exclusions in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop. This presents a unique opportunity for strategic gift planning.
The highest marginal federal estate and gift tax rates are currently 40%, and so, the increased lifetime exemption amounts are quite valuable to US citizens and to foreign nationals who are “domiciled” in the United States for purposes of the US gift and estate tax rules. (Foreign nationals who are not “domiciled” in the United States do not receive the benefit of these large lifetime exemption amounts. Instead an exemption from estate tax is permitted for the equivalent in value of US$60,000 of US-situs assets).
The Pandemic – If You Have to Find a Silver Lining….
The COVID-19 crisis is sweeping the world and has caused untold human suffering leaving astounding numbers of individuals who have been infected or died. It has also had a seismic impact on the world economy and there are strong fears that the world economy may be driven into recession. While COVID-19 has wreaked pandemonium throughout the globe, the abrupt downturn in the financial markets coupled with extremely low interest rates provide a unique opportunity to leverage the significant (and in my view, most likely temporary), increase in the exemption amounts. Now is the time to take advantage of utilizing the gift tax exemption amount by making gifts of assets at depressed values to children, grandchildren or other loved ones. The gifts can be made outright to the individual recipient, or to a new or an existing trust.
If a taxpayer gifts an asset to a family member at a depressed value, when the market turns around again (as it inevitably will), the appreciation in value will be out of the taxpayer’s estate for estate tax purposes. In other words, assume a gift transfer is made today of an asset having a value of $1 million. The donor of the gift will use $1 million of his lifetime exemption amount upon making that gift (he will still have over $10.5 million left to use at a later time, pending the sunset provision). If at the time of death, and after economic conditions have improved, the asset is valued at $2.5 million, the taxpayer will have effectively removed $1.5 million of appreciation from his taxable estate.
Making Gifts in Trust – Foreign Assets and Foreign Trusts
Many times, the donor does not wish to give gifts outright since the recipient(s) may be too young or otherwise unprepared to manage the assets in question. In such cases, use of a trust vehicle can be very helpful. Care must be taken when creating a trust. If the trust is a foreign trust and US persons are in any way involved, professional guidance is a must. The use of foreign trusts can result in very harsh tax consequences, or, with many instances and proper structuring, in very beneficial tax results. It all depends on the particular facts of the case. Specialist advice is necessary to navigate the US tax maze.
Matters become especially tricky when it comes to trust structures and foreign assets. For example, it may not be so easy to transfer real properties located overseas into a trust structure. Furthermore, many foreign jurisdictions simply do not recognize trusts. The same jurisdiction may, however, recognize a “foundation” which is a legal entity created under the country’s specific laws and shares characteristics with both a corporation and a trust. A foundation can be used in manners similar to a trust, for example, to benefit one’s family. If properly structured it may be possible to have the foundation treated as a foreign “trust” for US tax purposes. This opens up all sorts of planning opportunities.
Over the past few years, the United Arab Emirates (UAE) has enacted three foundations law regimes, and is coming to the fore as a high quality location for wealth and succession planning, asset protection and planning for the future. A foundation established in the UAE may be the ideal solution for succession planning especially when it comes to UAE real properties. One of the more pronounced benefits with use of a foundation is the founder’s ability to maintain significant control over the assets through the foundation’s council and guardian. With guidance from a Sharia scholar, Muslims following Sharia mandates can look to the use a UAE foundation.
I will be writing more blog posts on the use of such foundations – watch this space!
Posted May 14, 2020
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