As you are preparing your annual income tax return, you should also consider whether you need to file a federal gift tax return. The gift tax return (Form 709) is a calendar-year return normally due on April 15th. Generally, you must file this return:
1. If you gave gifts to any particular recipient (or to a trust for the benefit of a particular individual) in 2006 that totaled more than $12,000. Bear in mind that gifts to a trust – even a trust that contains “Crummey” notification letter provisions – should be evaluated carefully to determine if a gift tax return is required to be filed.
2. If you are married and you “split gifts” with your spouse. Splitting gifts allows you and your spouse to treat all gifts made by either of you to third parties during the calendar year as being made one-half by each of you. For example, if one of you gave a $24,000 gift in 2006 to a particular person, you and your spouse may each file a gift tax return so that one-half of that gift can be attributed to each of you (so that each of your $12,000 annual exclusion amounts can apply to the gift).
3. To apply your generation-skipping transfer (“GST”) tax exemption to trusts that are designed to take advantage of available GST exemptions. It is important to remember that it may be necessary to file a gift tax return to allocate GST exemption even where the annual gifts are less than $12,000 per donee. In 2006, the GST exemption was $2 million.
4. To prevent your GST exemption from being applied to trusts that are not designed to take advantage of that exemption. Under tax laws enacted in 2001, transfers to trusts having certain beneficiary and distribution characteristics will receive automatic allocation of GST exemption unless the transferor elects out of the automatic allocation. Taxpayers may (i) annually opt out of the automatic allocation rules for contributions to particular trusts or (ii) elect to have all contributions – present and future – to particular trusts not receive automatic allocations. In either case, the election would be made on a timely filed gift tax return. Bear in mind that there is a common situation that falls within the automatic allocation rules: making a contribution to a trust that: (i) holds insurance on the life of one spouse; (ii) provides a trust for the benefit of the surviving spouse after the death of the insured; and (iii) following the death of that surviving spouse, provides a further trust for children until complete distribution to them at a specified age. A trust with those provisions would receive automatic (and unintended) GST exemption allocation (i.e., because the required distribution to the children could waste GST exemption allocated to that trust). If you have created such a trust and have not yet opted out of automatic allocation, you should consider filing a gift tax return for 2006 to do so.
Even if you are not required to file a gift tax return for 2006, you should consider filing one:
1. To keep a record of any automatic allocation of your GST exemption. As noted above, the GST exemption is automatically allocated to certain transfers. Even if you want the exemption to be allocated (i.e., you do not need to opt out as described above), you may still want to file a gift tax return that shows the amount of the GST exemption allocated. Otherwise, it may be practically impossible for you (or the executor of your estate) to have an accurate record of the aggregate GST exemption you consumed over your lifetime.
2. To disclose certain other problematic gifts. For example, if there is a possibility that the IRS may challenge a gift as undervalued, you might want to disclose that gift on a filed gift tax return. Adequate disclosure would prevent the IRS from revaluing the gift — even for estate tax purposes — once the gift tax statute of limitations (generally, three years after the return was filed) has expired. Or you might consider reporting gifts made to irrevocable insurance trusts to minimize challenges many years later that “Crummey” notification letters were not properly circulated, which could call into question the validity of the annual gift tax exclusions for those gifts.
