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________________________________________________ Gifts Although many transfers obviously qualify as taxable gifts for federal tax purposes, not all taxable gifts consist of a direct transfer from the donor to the donee. Indirect gifts occur in a multitude of settings, and being aware of the various types of indirect transfers can avoid unintended results. Two types of transactions involving indirect taxable gifts are of special concern: loans and powers of appointment. Look
at Low-Interest-Rate And Interest-Free Loans Certain interest-free and below-market-interest-rate loans result
in a taxable gift from the lender to the borrower. The lender is
treated as making a gift of the amount necessary to pay the market
rate of interest on the loan in excess of the actual interest rate
of the loan. For demand loans (loans due and payable at any time at the demand
of the lender), the gift amount equals the amount of the foregone
interest calculated by using the Applicable Federal Rate (AFR),
published monthly by the Internal Revenue Service (IRS). For term
loans, the gift amount equals the excess of the amount loaned over
the present value of all payments due under the loan, determined
as of the day the loan was made, using a discount rate equal to
the AFR. There is an exception for certain small loans: Generally, a taxable gift of the foregone interest is ignored for gift loans directly between individuals when the aggregate outstanding loans between them does not exceed $10,000. Consider
Powers of Appointment A general power of appointment usually exists under a trust arrangement.
It is a right or power to direct the trustee to distribute assets
in favor of the power holder, his or her estate, or his or her creditors.
Such a power is unrestricted, and distributions are not limited
by an ascertainable standard (such as only for his or her reasonable
support, maintenance, education and health). The exercise of a general
power of appointment, as well as the release of a general power
of appointment, is a gift by the holder of the power to the recipients
of the assets over which the power could have been exercised. Similarly, the failure to exercise a general power of appointment
before the power lapses is a taxable gift by the holder of the power.
Unlike the release, the value of the gift is the amount by which
the lapse exceeds the greater of $5,000 or 5% of the value of the
trust assets over which the power could have been exercised (the
5-and-5 rule). Lapses of powers of appointment often are associated with irrevocable
trusts where the cash or other contributions to the trust are subject
to limited withdrawal rights granted to the beneficiaries (Crummey
rights). The Crummey withdrawal rights are powers given to the beneficiaries
to withdraw all or a part of the gifted funds for a limited period
of time and therefore are general powers of appointment. Granting Crummey rights allows the gifted funds to qualify for the $10,000 gift tax annual exclusion. Assuming the withdrawal rights are not exercised, the funds are then available to pay premiums. Therefore, it is not desirable for the right of withdrawal to remain, and the Crummey rights generally are structured to lapse each year within the 5-and-5 rule discussed above, resulting in a gift with no federal gift tax consequences. Other
Ways You May Make a Gift Without Knowing It Loans and powers of appointment are not the only areas where an
unintended gift can occur. Here are some common situations where
unintentional gifts may be made: Third Party Transfers. You transfer assets to a third person
with the understanding that he or she will transfer the property
to someone else. The assets are a taxable gift from you to the ultimate
recipient of the property. Forgiveness of Loans. You make a loan to a child or other
relative with the intent of forgiving part of the debt each year
in an amount equal to the gift tax annual exclusion. The whole loan
amount is a taxable gift in the year the loan is made because you
have no intent to collect on the loan. Joint Bank Accounts. You establish a bank account or a brokerage
account (where the investments are held in nominee or street name)
as a joint account. The noncontributing joint owner makes a withdrawal
from the account for his or her own benefit. This withdrawal is
a taxable gift from you. (No taxable gift is made at the time the
account is established.) Life Insurance Premiums. You pay premiums on an insurance
policy on your life that is owned by an irrevocable life insurance
trust. The payments are taxable gifts to the trust beneficiaries.
Similarly, premium payments you make on an insurance policy on your
life owned by any third party are a gift to that third party. Life Insurance Proceeds. You own an insurance policy on
your life. Your spouse is named as beneficiary. You make a gift
of the policy to your children to get the policy out of your estate.
If you die without your children having changed the beneficiary
designation to themselves, your children will have made a gift of
the insurance proceeds to your spouse. Payment of Outstanding Mortgage. You pay the outstanding
balance of a mortgage on a principal residence held in a Qualified
Personal Residence Trust (QPRT) after it is established and before
the end of the trust term. This payment is a taxable gift to the
remaindermen beneficiaries. Also, under a QPRT, any improvement
or remodeling of the residence paid for by the grantor of the trust
is a gift. Relinquishing Pension Plan Rights. You relinquish your vested
rights in your employer's contributions under a nonqualified pension
or profit-sharing plan and trust. You have made a taxable gift to
the other plan participants. Gift of Stock From Child to Grandchild. You transfer common
stock in a family-owned corporation from you to your child. Under
the new estate freeze rules, this transfer may be a taxable gift
by your parents to your child if your parents own preferred stock
in the family-owned corporation. Lapse of Voting or Liquidation Rights. You lapse your voting
or liquidation right in a corporation or partnership. This lapse
is treated as a taxable gift by you if you and members of your family
hold, both before and after the lapse, control of the entity and
if the lapse occurs during your lifetime. Disclaimers of Property. You make a disclaimer of property either later than nine months after the property interest is created or that causes the disclaimer not to be a qualified disclaimer. For federal gift tax purposes, you have made a taxable gift to those who receive the property. Awareness
Is the Key Lifetime gifts play a major role in many estate plans. Significant
tax savings can be achieved that would not be available if the transfers
were delayed until death. However, a gifting program should occur
by intent and not by default. The federal gift tax laws contain many different provisions that
can cause unintended gifts by an estate owner. All intrafamily transactions
involving corporations, limited liability companies, partnerships,
trusts and buy-sell agreements can give rise to gift tax consequences
and should be carefully planned. Awareness of the situations that give rise to indirect gifts is
essential, both to take advantage of the tax saving potential available
through lifetime gifts and to prevent taxable gifts from occurring
through innocent transactions.
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Copyright 2001 Fahlman & Olson. All rights reserved.
LEGAL NOTICE
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