Tax Tip of the Week: You Take a Friend on Your Yacht. Is It a Taxable Gift?

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Interesting article on taxable gifts.

 -Belinda Stickle

You Take a Friend on Your Yacht. Is It a Taxable Gift?
 
Billionaire Harlan Crow took Clarence Thomas on lavish trips and more, and that’s shining a spotlight on U.S. gift taxes for everyone. ‘It’s not a gift, it’s a party,’ one tax pro says.
 
By Laura Saunders  May 19, 2023
 
Taxes touch every aspect of Americans’ lives. Consider the controversy over benefits received by Supreme Court Justice Clarence Thomas from his longtime friend, Dallas billionaire and political donor Harlan Crow.

Crow provided Thomas with luxury travel on private planes and his yacht, paid private-school tuition for his grandnephew, and bought and improved his mother’s house while allowing her to live in it for the rest of her life, ProPublica has reported.
      
The benefits are raising important questions about judicial ethics and disclosures. They’re also highlighting an area that receives little focus: U.S. gift taxes. These are levies sometimes owed by givers (like Crow) who transfer cash, assets or value to recipients (like Thomas).

On April 24 and May 17, Senate Finance Committee Chairman Ron Wyden (D., Ore) sent letters to Crow asking for granular details of the benefits to gauge his compliance with gift-tax laws. (One letter acknowledged that there’s an exemption for tuition.) On May 8, Crow’s lawyer responded with a letter asserting the gift tax doesn’t apply in cases of personal hospitality and that the home purchase wasn’t a gift.

What gift taxes, if any, are due? That’s for Crow, his lawyers and perhaps the Internal Revenue Service to sort out. Andrew Katzenstein, an attorney with Proskauer Rose who advises high-net worth individuals, says, “The tax laws have many specific rules allowing people to provide value to others free of gift tax.”

The controversy may be prompting questions about taxes on your own generosity. Here’s more to know.  

What is the gift tax?

The U.S. gift tax was enacted in 1924 as a backstop to the estate tax, to prevent wealthy Americans from shrinking taxable estates by transferring assets to others before death. The tax kicks in above a lifetime exemption that applies both to an individual’s total taxable gifts made during life and assets left at death. Currently the top rate is 40%, and the giver, not the recipient, owes the tax—a fact many people don’t understand.  

For 2023, the combined gift- and estate-tax exemption is $12.92 million per individual, or $25.84 million per married couple. The lifetime exemption is indexed for inflation, so it wipes out federal gift and estate taxes for all but the wealthiest.  

What counts as a gift?

It’s typically the transfer of cash, assets or value “for less than adequate and full consideration,” according to the law. “Consideration” often means money, but it could be other assets. 

So if you write a check for $10,000 to your grandchild, that’s a gift. And if you sell your child your business for less than it’s worth, the difference could be a gift. However, the rules allow for ordinary business discounts, as when a merchant offers an item for sale.

Isn’t there another gift-tax exemption in addition to the lifetime exemption?

Yes, and it’s highly useful. Each person can make tax-free gifts annually to other individuals, whether they’re related or not. For 2023, the limit is $17,000 per giver, per recipient. So one couple with two married children and three grandchildren could make total tax-free gifts of $238,000 this year to those seven relatives, plus $34,000 to as many other individuals as they want. No gift-tax return needs to be filed for annual gifts below the $17,000 threshold.

If one spouse has most of the couple’s assets, then that spouse could give the combined exemption of $34,000. This is called “gift splitting,” and a Form 709 gift-tax return should be filed although there’s no tax. 

In addition, taxpayers can bunch up to five years of annual gifts and contribute them to a 529 education-savings plan for the benefit of someone, such as a child. Using this provision, the Obamas contributed a total of $240,000 to 529 plans for their two daughters for 2008. This also needs to be reported to the IRS, although there’s no tax. 

What if I give my daughter $25,000 to help her buy a home this year?

If you give it in a lump sum, then in many cases you would need to file a Form 709 gift-tax return with the IRS. While $17,000 could count as a tax-free annual gift, the other $8,000 would be deducted from your $12.92 million lifetime exemption. 

But you could avoid the need to file if you give up to $17,000 this year and the rest early next year. Or if the child is married, you could split the gift between the child and spouse to stay under the limit.

I enjoy taking friends and family on cruises on my boat, and the value is more than $17,000 per person. Is there a gift tax on my hospitality?

Probably not, according to two noted tax scholars, emeritus Prof. Michael Graetz of Columbia University and Prof. James Repetti of Boston College. However, there appears to be little case law directly on this issue. 

Both professors also agree that a key difference between hospitality and a taxable gift is likely the presence of the giver. So, if you’re on board for the entire cruise, says Graetz, “It’s not a gift, it’s a party.”

But if you provide a cruise to someone and don’t go along, says Repetti, that could be a taxable gift.

What if I give my wife expensive jewelry or buy a car for my son?

Transfers between spouses are typically tax-free if both are U.S. citizens. 

The tax treatment of the car depends on the circumstances. If you are legally obligated to support your child, the car could be part of the support and therefore free of gift tax. 

If the son is a self-supporting adult, then the first $17,000 of the price would likely qualify as an annual gift and the rest would count against your lifetime exemption—unless you structure the gift to avoid it. Many taxpayers likely ignore these rules.

While the IRS isn’t known for auditing these issues, it sometimes does. In an audit of one of attorney Katzenstein’s wealthy clients, an agent asked to see any checks to family members of more than $5,000 over 20 years. 

Are there other gift-tax exemptions?

Yes. Payments of someone’s tuition or many medical bills aren’t subject to gift tax. But to qualify, these payments must be made directly to the school or care provider. 

Credit goes to Laura Saunders. Published May 19, 2023 in the Wall Street Journal.
Copyright ©2023 Dow Jones & Company, Inc. All Rights Reserved.  
Appeared in the May 20, 2023, print edition as 'What Counts as a Taxable Gift?'.
 
Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.
 
This Week’s Author, Belinda Stickle

-until next week