October 15, 2013, is the final deadline for filing the 2012 IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. Given the massive volume of gifts made at the end of 2012, many 2012 gifts may have open items, such as appraisals of the gifts made, that pushed filing out to the final 2013 deadline. As a result, many practitioners still face the challenges of completing these returns.
2012 was an unusual year, not only for the volume of gifts consummated, but also because of the nature of those gifts. Yet, perhaps the most significant characteristic of 2012 gifts was size. At the end of 2012, there was fear that the gift tax exemption might be reduced to $1 million in 2013 from $5.12 million and concern that restrictions on generation-skipping transfer (GST) tax and other planning may have stifled later planning. As such, many clients completed large gifts. The size of those gifts, as well as securing GST benefits, resulted in more of those gifts being made to complex trusts than ever before. The complexities of these trusts affect the proper reporting on the gift tax returns, as well as ancillary reporting.
The following discussion highlights some of the many nuances CPA financial planners and practitioners need to consider.
Who Is the Trustee?
When a trust is listed as the donee on a Form 709, who should be listed as the trustee?
Historically, most trusts either named a single trustee or co-trustees to manage the trust. Modern trust drafting has parsed this simple concept of a trustee into a multitude of fiduciary positions. For example, it is common to have a general or administrative trustee. In addition, a trust may name a separate distributions trustee to make distribution decisions and perhaps an investment trustee or adviser to make investment decisions. In addition, many trusts now use trust protectors to address certain limited decisions concerning the management of the trust.
Be certain the person listed in the gift tax return and ancillary filings is the correct person because there potentially are significant planning implications. Many clients established trusts in trust-friendly jurisdictions that have laws far more favorable—the most common include Alaska, Delaware, Nevada, and South Dakota. Listing the signer incorrectly as trustee in the client’s home state could be more than a mere clerical error; it might undermine the validity of the trust. Some of these trusts are required to be administered in the state in which they were formed in order to avail themselves of the laws of that state.
Hiring the tax preparer and filing the return may, in some instances, be viewed as an important, even integral, part of that administration. This will affect not only who is listed as trustee on Form 709, but who should be listed as the signing fiduciary on Forms 1041 and even on K-1s of entity interests that were gifted or sold to the trust. If you are uncertain about which of the many possible fiduciaries should be listed in which capacities, you should consult with the attorney who drafted the trust.
Reporting Relinquishment of Interests in Joint Property
In most years, gifts are made by one spouse or the other, and gift splitting may or may not be elected. 2012 again raises some unusually annoying issues concerning the source of gifts.
A common type of trust used in 2012 planning was an inter-vivos spousal lifetime access trust (SLAT). Although this is quite similar in many respects to a bypass trust that forms the foundation of many estate plans, a SLAT is only completed during the client’s lifetime and often with more sophisticated provisions. Given the haste with which many 2012 gifts were completed, the husband may have established a SLAT for the wife (or vice versa) by using a check from a joint checking account or by transferring securities from a joint brokerage account to fund that trust.
That is problematic for a number of reasons. First, who is the transferor of those assets to the trust? In this scenario, if the wife is deemed to be a co-transferor (co-grantor) and she is also a co-trustee and beneficiary, the trust will be characterized as a self-settled trust. Self-settled trusts, also known as domestic asset protection trusts, are only permissible in 14 states (as of this writing), with the 4 trust-friendly states noted previously being the most common. If the clients reside in another state, gifts to the trust emanating from the wife, the beneficiary, or both would characterize the trust as a self-settled trust that would be reachable by creditors in most states. Therefore, it would be included in the wife’s estate, and the plan could be defeated.
It might be feasible to have the wife execute a gift letter giving any interests she may have had in the joint account to the husband prior to the gift the husband made to the SLAT to benefit the wife. It is not clear that this will address the risks, but it may be the only option still available. Practitioners might also consider reporting that transfer on a gift tax return for the husband, or even the wife, to deflect a future challenge by the IRS.
The Form 709 instructions clearly provide that no return is required on gifts to a spouse, in general. The instructions provide that a return is required on a spousal gift to make a qualified terminable interest property election or if the spouse is not a U.S. citizen. The instructions do not state that a return cannot be filed; they merely state that the taxpayer does not have to file. Conceptually, this may not be any different than filing a gift tax return to report a non-gift transaction, such as a note sale. Obviously, one of the risks the relinquishment of rights by the wife in the joint accounts raises is the IRS asserting the step transaction doctrine or that the relinquishing spouse should be treated as a co-grantor to the trust. The gift letter and filing of the gift tax return seem to be the only steps to address what otherwise would be a fait accompli or presumably irreversible deed or fact.
In almost every year, it was common to include annual demand or Crummey powers in irrevocable gift trusts. Many of the trusts completed in 2012 intentionally omitted these powers because the focus was on a single large gift to use the exemption many feared would disappear in 2013. Also, some attorneys opted not to include Crummey powers to minimize issues concerning who might appropriately be characterized as the grantor for income tax purposes of the trust.
In contrast, another common trust technique, the beneficiary defective irrevocable trust (BDIT), is based on the existence of a Crummey power to create grantor trust status for income tax purposes to the beneficiary, not the trust’s settlor. Don’t make assumptions about the existence of a Crummey power either being in or not being in a trust, if that trust was not reviewed. Reporting a portion of the gifts as annual gifts for a typical gift trust would be an error. Missing reporting the annual gifts in a BDIT goes to the heart of the trust plan. If the trust, in fact, included an annual demand or Crummey power, get copies of the signed notices for your client’s permanent file and consider attaching them as exhibits to Form 709.
Every practitioner is well aware that discounts (lack of marketability, for example) are on the IRS hot list. On Form 709, Page 2, Schedule A, Item A requires that a box be checked indicating whether discounts were claimed and that a statement be attached. Be certain that the box is checked if discounts exist. This may not be ascertainable until the final appraisal reports are obtained. In addition, the attached statement must be adequate to explain what the basis was for the discounts claimed. Practitioners should confirm that the appraisal determining the discount meets the requirements of a qualified appraisal. Consider referencing the specific pages of the appraisal report that provide the supporting analysis for the discounts claimed.
Form 709, Page 2, Schedule A, Part 1 requires reporting all charitable gifts, a reporting requirement that is less likely to be complied with and more likely to be overlooked. Be certain to report all charitable gifts to ensure the return is complete and accurate. This could be especially problematic in some instances. For example, if the client established a BDIT for a child and made a $5,000 gift to fund that trust, failing to report charitable gifts might be interpreted as such a significant underreporting on the return that the statute of limitations might be extended.
Allocate GST When Appropriate
Many, but far from all, 2012 gift trusts were structured as GST exempt trusts. As noted previously, this was done to capture GST benefits before several proposed changes in their rules. In addition, the exemption might have been changed. Compared to planning in many prior years—and given the high level of the exemption amount—many taxpayers who may have preserved valuable GST exemption for gifts targeted specifically for skip-persons may benefit in 2012 for allocating GST exemption to gifts made to trusts. This is characterized as a GST trust, and as defined in the GST automatic allocation rules, GST exemption will be automatically allocated. However, to avoid an issue about whether the automatic allocation rules apply, or to ensure that all transfers are protected, consider attaching a statement affirmatively allocating sufficient GST exemption to assure that the trust has a zero inclusion ratio.
To help ensure that the gift is adequately disclosed to meet the statute of limitations, consider creating an exhibit list and attaching all relevant documents that might be necessary to report the transfers. Although an appraisal report that meets the requirements of a qualified appraisal may be at the heart of the disclosures, practitioners might consider adding a host of other documents, including the following, to the exhibits to assure adequate disclosure:
- Exhibit 1: Complete executed copy of the trust, if the trust is a donee of the gifts.
- Exhibit 2: Declaration of gift. Some advisers have clients sign statements confirming that an intended transfer is a gift. If any have been prepared, be alert for multiple gift letters; this same comment applies to any other transfer documents in this list. Why? In 2012, many clients made initial gifts to trusts, given the time pressures and uncertainty in the law. As the 2012 year wound down, many of these clients completed additional transfers. Be sure to disclose all relevant documents for each transfer.
- Exhibit 3: Check or other initial gift. For many 2012 gift plans, clients may have opened trusts with an initial check or wire transfer and later transferred interests in a family entity or business or real estate to the trust.
- Exhibit 4: Membership interest assignment, stock power, or similar document effecting the actual gift or sale transfer of entity interests to the trust.
- Exhibit 5: Appraisal report. This should be attached in full, including all schedules and other relevant items. You should also confirm that this meets the requirements of a qualified appraisal and reference this in Exhibit 1. You should also confirm the correct calculation appears in the appraisal. You want to be certain that any last minute changes in the nature or amount of the gift were properly reflected in the appraisal report.
- Exhibit 6: Notice of allocation of GST tax exemption. Consider attaching that an affirmative statement regarding GST allocation was made and that the taxpayer intends that the GST automatic allocation rules apply to allocate exemption. The entire value of all gifts and other transfers made to this trust shall be protected by an allocation of GST exemption. The taxpayer affirmatively allocates to these transfers the above amount, or the smallest amount of the taxpayer’s GST exemption necessary to produce an inclusion ratio of zero for the trust. This is a formula allocation that will change if the values are changed on audit or otherwise. Some statements that are used do not have broad enough language to cover an intended sale that in part is recharacterized by the IRS as a gift, a sale, or both. Some practitioners choose to affirmatively elect out of the automatic allocation rules to avoid any ambiguity as to their application, then affirmatively elect to allocate the amount of GST exemption they wish. Also, be alert on 2012 gifts that exceeded the exemption amount as to which donee trusts should receive an allocation of exemption.
On the surface, gift tax returns appear to be simple short returns, but don’t be misled. Incredibly complex planning decisions affect almost every Form 709. As practitioners near the 2012 filing deadline and plan to address the 2013 gift tax filing season in 2014, they should be alert for new developments, ensuring the complexities are properly addressed.
About the Author
Martin M. Shenkman, CPA/PFS, MBA, AEP, JD, is an attorney in private practice in Paramus, New Jersey, and in New York City. His practice concentrates on estate and tax planning and estate administration. He is active in many charitable causes and founded RV4TheCause, which educates professional advisers on planning for clients with chronic illness. Shenkman has written 42 books and more than 800 articles and is a regular source for The Wall Street Journal, Fortune, Money, and The New York Times. He has appeared on The Today Show, CNN, NBC Evening News, CNBC, MSNBC, and CNN-FN. Contact him at email@example.com.
Additional Planning Resources
This article is a follow up to “The CPA’s Role in Estate Planning After the American Taxpayer Relief Act,” by Martin Shenkman that ran in the May/June 2013 Planner.
A webcast, “Advanced Gift Tax Return Preparation Issues” was held in February 2013 to help CPAs identify and deal with the many complex issues regarding 2012 Form 709 gift tax return filings. Presenters included Craig Janes, CPA; Robert S. Keebler, CPA, MST, AEP; and Laura Peebles, CPA/PFS. PFP section members, inclusive of PFS credential holders, can access the webcast recording and presentation materials.
The CPA’s Guide to Financial and Estate Planning is a comprehensive 1,000-page, 4-volume, downloadable publication that provides guidance to CPAs advising clients in estate, tax, retirement, investment, and risk management matters. It also reflects the new law and planning implications of the American Taxpayer Relief Act of 2012 and the net investment income tax. Volume 1 of the guide includes chapters on charitable giving and the use of trusts.