In recent years, lifetime gifting has exploded in conjunction with the steadily rising Internal Revenue Code (IRC) §2010 lifetime estate and gift exemption. In 2023, each individual taxpayer has up to $12.92 million of available lifetime estate and gift tax exemption. This amount offers spouses $25.86 million of portable, federal estate and gift tax exemption. Further, each taxpayer has a nonportable lifetime generation-skipping transfer (GST) tax exemption of $12.92 million in 2023 applicable for generation-skipping gifts. However, the Tax Cuts and Jobs Act of 2017 did not authorize a permanent increase in these exemptions. The act halves these exemption amounts for 2026 (leaving an exemption of $5 million as adjusted for inflation). Taxpayers will not be taxed or penalized for their prior used exemption over the new amount once the exemption drops. As such, taxpayers hoping to maximize the use of their exemptions (and minimize their estate and gift tax liability) have a considerable incentive to use these high exemption amounts while they can. Given the substantial amount of available exemption, lifetime gifts have become an essential tool as taxpayers plan and provide for their loved ones, in the present and the future.
Form 709 filing
The contemplation of gifting begins and ends with the Federal Form 709: Gift Tax Return. As a threshold matter, taxpayers must determine whether their gifts in a particular year will necessitate a gift tax return. For instance, IRC §2503(e) specifically excludes “qualified transfers” made directly to (i) political organizations; (ii) “qualifying domestic or foreign educational organizations as tuition”; and (iii) medical care providers for the benefit of the donee from the gift tax filing requirement. This article will examine the gifting situations that require filing a Form 709.
Gift and GST Annual Exclusions
The IRC §2503(b) gift tax annual exclusion plays a significant role in these determinations. Each taxpayer has a per-donee annual exclusion available for present-interest gifts. For 2023, this amount equals $17,000 per donee. Gifts of the annual exclusion or less will not reduce a taxpayer’s available lifetime gift tax exemption. Moreover, if a taxpayer gives the annual exclusion or less directly to a skip-generation donee (i.e., a grandchild), this gift will also qualify for the annual GST tax exclusion under IRC §§2642(c)(1) and 2642(c)(3)(A). However, for certain gifts to trusts, a gift may qualify for the gift tax annual exclusion while not qualifying for the GST tax exclusion (see
Withdrawal Notices below). Gifting directly to donees in the amount of the annual exclusion or less will not itself trigger a Form 709 filing requirement.
Gifts to Spouse
Typically, a Form 709 will not need to be filed to record gifts to a spouse. Gifts to a spouse are not subject to federal gift tax provided that the spouse is a U.S. citizen. Between U.S. citizen spouses, gifts of both present and future interests qualify for the unlimited marital deduction. Gifts of terminal interests may be exceptions to this general maxim. Even when gifted to a citizen spouse, gifts of terminal interests must be included on a Form 709 unless the terminable interest in question is a life estate with a power of appointment under Code of Federal Regulations (CFR) §25.2523(e)-1. Spousal gifting is further limited if the receiving spouse is not a U.S. citizen. In 2023, taxpayers have up to $175,000 in annual gift tax exclusion available for gifts to a non-U.S.-citizen spouse. Gifts exceeding this amount in a calendar year will require a taxpayer to file a Form 709.
Gifts to Trusts
Often, donors will make gifts to trusts rather than directly to the individuals, which requires different gift tax reporting depending on the trust beneficiaries. Gifts to trusts often have GST tax implications, because the beneficiaries will often include one or more skip-persons. IRC §2613(a) defines a “skip-person” as a person who is two or more generations younger (for unrelated donees, 37.5 years younger) than the transferor
or a trust with only skip-person beneficiaries.
A trust may have a mixture of skip- and non-skip-person beneficiaries. Gifts to such trusts are referred to as “indirect skips” because the transfer to the trust may at some point vest in a skip-person as defined in IRC §2632(c)(3)(A). Therefore, if a trust has the potential to distribute to a skip-person, this eventuality will likely qualify the trust as a “GST trust” under IRC §2632(c)(3)(B).
Withdrawal Notices
Certain trusts grant a power of withdrawal to the beneficiaries, allowing a beneficiary to withdraw all or a portion of the contribution within a certain time following the contribution to the trust. If present, this power of withdrawal can qualify gifts to an irrevocable trust as present-interest gifts for gift tax purposes provided that the beneficiaries are notified of their right to withdraw through the issuance of a withdrawal notice from the trustee. A withdrawal notice operates to alert a beneficiary of his or her right to withdraw a particular amount, solidifying a beneficiary’s present interest in that amount. As a result, these withdrawal notices make the gifted amount eligible for the gift tax annual exclusion to the extent authorized by the trust document.
Even if withdrawal notices qualify gifts for the annual gift tax exclusion, gifts to trusts with skip-person beneficiaries will not qualify for the annual GST tax exclusion, unless a skip-person is the only beneficiary of the trust, and the trust either terminates before the death of the beneficiary or is includible in the beneficiary’s estate (see
Minor’s Trust below). Unless that exception applies, a donor should file a Form 709 for gifts to skip-person trusts to either record or opt out of the use of the GST tax exemption for the transfer. Per CRF §26.2632-1(2), automatic allocation of the GST tax exemption will apply to gifts to indirect skips, even if a Form 709 is not filed to report the transfer. Therefore, a donor may wish to file a Form 709 to maintain an official record of the GST tax exemption used for the donor’s lifetime gifting, even where withdrawal notices exclude the gifts from using lifetime gift tax exemption. A donor must file a Form 709 to
opt out of automatic allocation to such a transfer (see
GST Allocation Elections below).
Minor's Trust
The “minor’s trust” provides another way for a trust to qualify for the annual exclusions. A minor’s trust under IRC §2503(c) is an irrevocable trust that gives a single minor beneficiary the right to withdraw the gifted amounts upon attaining age 21. A valid minor’s trust has a single beneficiary, generates income and principal for the benefit of the beneficiary during the trust term, and is included in the estate of the beneficiary if the beneficiary dies prior to age 21. A §2503(c) minor’s trust qualifies for the gift tax annual exclusion. A minor’s trust will also qualify for the GST tax annual exclusion if established for a skip-person.
Grantor-Retained Annuity Trusts (GRATs)
Grantor-retained annuity trusts (GRATs) are a gifting strategy that often begets a Form 709 filing. A GRAT is an irrevocable trust, which lowers the value of the taxable gift to the beneficiaries. The donor retains an interest in the gift by receiving annuity payments for the specified period. As a gifting strategy, GRATs allow taxpayers to functionally freeze their interest in the growth of a gifted asset, giving the excess growth (over the standard IRC §7520 interest rate) to the beneficiaries of the GRAT without using additional exemption on the growth. In certain cases, GRATs may have GST tax implications depending on what happens at the end of the estate tax inclusion period (ETIP), the period after a transfer where the transferred property remains includible in the estate of the transferor (see
GST Allocation Elections below). Given the potential savings from GRATs, a taxpayer should always report a GRAT on a timely filed Form 709 to ensure that the IRC §6501(a) three-year statute of limitations runs on the gift to the GRAT to protect the reported valuation of the gifted assets.
Elections requiring Form 709
Certain gifts necessitate a Form 709 to make a specific gift tax election, regardless of the amount gifted or the amount of exemption used. In some cases, the IRS requires a timely filed Form 709 as the only proper method for a taxpayer to make such elections.
Gift-Splitting
Married persons have the option to elect to gift-split in a particular gifting year. A gift-splitting election allows gifts made by an individual taxpayer to be split with the taxpayer’s spouse. Per IRC §2513(a)(1), the gift may be considered as made half by the taxpayer and half by the spouse. Such a split may maximize the use of the annual exclusion, by applying the available annual exclusions of both the taxpayer and the spouse to a gift. Typically, the gift-splitting election requires both the taxpayer and spouse to file their own gift tax return. Each spouse signs the other’s gift tax return to indicate gift-splitting consent. However, an important caveat remains that the gift-splitting election will apply to all gifts made in the calendar year (IRC § 2513(a)(2)).
Per the Form 709 instructions, a gift tax return filed only by the donor fulfills the Form 709 filing requirement for gift-splitting in two situations. First, the IRS does not require a separate consenting spouse return to gift-split present-interest gifts made by only one spouse, for which the total value given to each donee does not exceed $34,000 in 2023. The other exception allows a taxpayer to forego a consenting spouse return where the donor spouse made present-interest gifts of more than $17,000 but not more than $34,000 to any third-party donee and the consenting spouse only made present-interest gifts under $17,000 to other donees. In these cases, the donor must file a Form 709 signed by the consenting spouse.
Ratable 529 Funding
Under IRC §529(c)(2)(B), a taxpayer may elect to treat a contribution to a 529 plan as a five-year ratable contribution beginning in the year of the gift. This practice is called superfunding. In these cases, the ratable 529 election may be desirable since such gifts qualify for the annual exclusion and the GST tax annual exclusion (as applicable). For example, a taxpayer could superfund a 529 for his or her grandchild in 2023 with $85,000. Treating this transfer as made ratably over five years makes the annual gift $17,000 starting in 2023. The taxpayer’s estate is reduced by $85,000 (assuming the donor survives the five years), but the gift stays under the annual exclusions, never using lifetime gift tax or the GST tax exemption. Married couples could superfund a 529 from a joint account or combine this election with a gift-splitting election to fund a 529 plan with $170,000 in 2023 without using any lifetime gift or GST tax exemption.
The election to treat the superfunding of a 529 plan as ratable must be made on a Form 709 filed for the year of the contribution. However, the ratable 529 election does not trigger a gift tax return filing requirement for every year of the election. After the year of the election, a donor does not have to file a gift tax return reflecting that year’s portion of the gift, unless other gifting in a subsequent year requires the donor to file a Form 709.
GST Allocation Elections
Gifts to indirect skips are subject to automatic allocation of the GST exemption (CFR §26.2632-1(2)). For such trusts, the GST exemption will be automatically allocated to these transfers even where a Form 709 is not filed. Automatic allocation may result in a wasted GST tax exemption for indirect skips with only a remote possibility of a skip-person receiving a distribution. To prevent this outcome, a taxpayer can affirmatively elect on the Form 709 to opt out of automatic allocation for such transfers (either in the current year alone or also in all future years until the election is terminated). Alternatively, taxpayers wanting to make sure to maximize the use of their GST tax exemption may file a Form 709 to elect that a trust be treated as a GST trust even if the trust does not meet the statutory requirements (CFR § 26.2632-1(3)). As discussed, such treatment will trigger the automatic allocation of the GST tax exemption for the transfer, shielding the skip-person beneficiary from a 40% GST tax on received distributions from the transfer.
With respect to GRATs, GST tax implications may arise at the close of the ETIP if the GRAT spills over into lifetime trusts that qualify as GST trusts. Unless a taxpayer desires to use the GST exemption for this purpose, a timely gift tax return must be filed to opt out of automatic allocation of the GST tax exemption for the assets in the GRAT at the close of the ETIP. This election to opt out of the automatic allocation provisions may be done either on the initial Form 709 reporting the gift to the GRAT or on a Form 709 filed at the close of the ETIP. Consideration of GST allocation consequences at the close of the ETIP is invaluably important to avoid unintended GST tax consequences ranging from imposition of GST tax on a nonexempted remainder trust to the inadvertent waste of the donor’s GST tax exemption due to a failure to opt out of automatic allocation.
Conclusion
Given that the lifetime gift tax and GST tax exemptions sit at $12.92 million for individuals in 2023, most taxpayers will not even come close to owing gift tax. Yet, no tax due does not equate to the return being ancillary or unimportant. Gifting strategies are often more complicated than they appear at first glance with long-term implications. As discussed above, many of the elections that maximize the benefits of lifetime gifting must be made on a timely filed Form 709. Armed with the knowledge of which gifting situations require gift tax returns, the next installment of this gift tax series will detail the minimum requirements and standards for adequate disclosure on the Form 709 as necessary to shield donors from potentially unlimited statutes of limitations. As I like to say, happy gifting and happy filing!
Morgan Torbert currently works as a senior associate at Mazars USA primarily responsible for estate tax returns, gift tax returns and trust reviews. She has a passion for the foundational creativity and ingenuity endemic in gifting and estate planning. Prior to her work at Mazars USA, she received her Juris Doctorate from Boston College Law School and her undergraduate degrees in philosophy and policy studies from Rice University. In her spare time, Torbert enjoys getting coffee, traveling, and spending quality time with her friends and family.