Rule Change Creates New Gift Reporting Strategies

Proper documentation of gifts can lead to simplification and savings down the road.

New rules limit the ability of the IRS to revalue prior gifts once the statute of limitations has expired. To insure this protection, however, taxpayers must comply with “adequate disclosure” requirements, which may call for a new approach to gift tax reporting.

Background

A program of lifetime giving is an important component of a sound estate plan. By making the most of the annual gift tax exclusion (currently $11,000 per recipient; $22,000 for gifts “split” by a married couple), one can transfer a significant amount of wealth tax-free.

And any future appreciation in the value of the transferred property is removed from the donor’s estate. To protect these tax benefits, it’s important to substantiate the value of gifts with a contemporaneous appraisal, particularly for gifts of interests in a closely held business.

The statute of limitations for an IRS challenge to a gift tax valuation is generally three years. Under prior law, however, the IRS was able to do an end run around the limitations period.

Here’s how: Estate tax liability is determined by computing the tax on the sum of the taxable estate and all prior taxable gifts, and then subtracting any gift tax paid previously. Gift tax is computed in much the same way: The tax is applied to all gifts made in the current year and prior years, and this figure s reduced by previous gift tax payments.

Under this system, even if the IRS was barred by the statute of limitations from challenging a prior gift tax valuation, it could still revalue the gift in determining gift or estate tax in a later year.

New Law

Effective for gifts made after August 5, 1997, the Taxpayer Relief Act of 1997 prohibits the IRS from revaluing a gift after the limitations period has expired, provided the gift was adequately disclosed on a gift tax return. Recently proposed regulations outline the requirements for adequate disclosure. In general, the gift tax return must contain details on the:

New Strategies

To protect gift tax valuations from an IRS challenge after the statute of limitations expires, it’s important to take measures to ensure that the gift is adequately disclosed. Gift tax returns should be prepared carefully to comply with the regulations and, if appropriate, should be accompanied by a fully documented, professional appraisal.

In some cases, it may make sense to report a gift even when a gift tax return isn’t required. For example, a gift tax return isn’t ordinarily required for a gift valued at less than the annual exclusion amount. But if the gift isn’t adequately disclosed, there’s nothing to prevent the IRS from revaluing it at a higher amount years later.

Taxpayers might also consider reporting certain transactions that they don’t even consider to be gifts. That way, if the IRS claims, more than three years later, that the transfer was a taxable gift after all, the original valuation can be preserved.