Unreported Gifts to Family Members: A Trap for the Unwary

Dear Clients, Colleagues, and Friends,

As we have noted in our previous Client Alerts, the current law provides unprecedented gift tax planning opportunities. Until the end of this year, the gift tax exclusion (which is cumulative over one’s lifetime) is $5,120,0000. In addition, the law allows each person to make annual gifts of up to $13,000 to any donee without reporting the gift to the IRS. To this end, during our planning meetings to review the gift tax planning opportunities before the end of this year, we have necessarily inquired about prior gifts. Surprisingly, many people have told us that they have engaged in transfers (gifts) to their kids, parents, and other related donees in excess of the $13,000 gift exclusion but did not file a gift tax return with the IRS. Some of these gifts involved the transfer of real property to a parent, child, or grandchild.

In 2011, the U.S. District Court for the Eastern District of California denied the IRS’ ex parte petition for leave to serve a “John Doe” summons on the California State Board of Equalization in an effort to get information about its citizens of real property transfers from parents to children or from grandparents to grandchildren that were made for less than fair and adequate consideration, i.e., a gift, from January 2005 to December 2010. This data is compiled from the real property tax exemption forms filed with each county assessor’s office. I expect most of the other states have a similar exemption reporting system for exempting reassessments for real property tax purposes. The IRS claimed that an estimated 50 to 90 percent of the individuals in this class didn’t file Form 709 to report taxable gifts (exceeding $13,000 per person/per year).

At first, the Court denied the IRS’ request for information it was seeking expressing “serious concerns” about the “John Doe” summons on a state for a myriad of reasons. Nevertheless, the Government was able to convince the Court of the validity of their request for information, and the Court has granted relief pursuant to a revised summons (In re Tax Liabilities of John Does 2012-1 USTC 50, 104, 108 AFTR 2nd 7499) which allows the IRS to access this information from the State.

Taxpayers who failed to report taxable gifts should reconsider their decision. There is no penalty for late filing if no tax is owed on the gift. The filing of the return will also start the clock running under the 3-year statute of limitations for revaluing the gift.

Gifts of Entities: Making a gift of entities (such as corporations, LLCs and LPs) which hold real estate without filing the required gift tax return could also become problematic. California’s Board of Equalization is in the process of amending its statutes to require legal entities holding real estate to file a change of ownership statement within 90 days of the date of a change in ownership or change in control of the entity.

If the foregoing situation applies to you, a visit to your tax advisor is critical. If you are going to take advantage of the current but temporary $5,120,000 gift exclusion, you will want to make sure you have captured your prior unreported gifts since the gift exclusion is cumulative. You will likely not owe any penalties but it is imperative you accurately report the gift as it appears that the IRS will now be working with the states to find those taxpayers who have not been in compliance.

We hope this information is helpful to you.

Jeffrey M. Verdon, Esq.

Jeffrey M. Verdon Law Group, LLP