Martin M. Shenkman, CPA, JD, MBA, PFS, AEP (distinguished), estate- and tax-planning attorney based in New York City. He is coauthor of Powers of Attorney: The Essential Guide to Protecting Your Family’s Wealth. ShenkmanLaw.com
If you give someone a big gift, the IRS will have a gift for you, too—a tax form that’s a lot trickier than it appears.
IRS gift-tax–filing requirements seem simple enough at first glance—give any recipient other than a spouse a gift in excess of the annual gift-tax exclusion ($16,000 in 2022, $17,000 in 2023), and you should file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. The portion of your gift that exceeds the annual gift-tax exclusion will be deducted from your lifetime gift-tax exemption, which was $12.06 million in 2022 and is $12.92 million in 2023. That lifetime gift-tax exemption is due to be cut in half in 2026—so big gifts have become particularly common in recent years, as well-off people try to remove assets from their taxable estates. While these numbers are huge, there are lots of more common lower-value items that you might want to report.
Problem: Mistakes are very common with Form 709. Even professional tax preparers sometimes go wrong. Given the IRS’s recent hiring spree and mandate to focus its audit attention on high-bracket taxpayers, it is possible that the agency will start to pay very close attention to Form 709 in the coming years.
So Bottom Line Personal asked tax expert Martin M. Shenkman, CPA, to explain the seven most common errors on Form 709 you should avoid…
Mistake #1: Not knowing when to report “non-gifts.” There are lots of non-gifts you might benefit from reporting. If you sell assets to a trust or make a “regular” trust exempt from the generation-skipping transfer (GST) tax so it can avoid estate and GST tax in succeeding generations, you may need to file a return. If you “decant” an irrevocable trust—that is, shift its assets into a new irrevocable trust—that likely is not a gift, but it could be considered one under some very specific circumstances. These transactions sometimes attract IRS attention, so consider reporting them as “non-gift transactions” on Form 709 even though this isn’t required. This starts the three-year clock on the audit statute of limitations, at least ensuring that you and your heirs don’t have this audit risk hanging over you long into the future.
Mistake #2: Failing to report gifts to charities. Many charitable gifts are not subject to gift taxes, but, counterintuitively, they all should be reported on Form 709 under certain circumstances.
If your charitable gifts are your only gifts that exceed the annual gift-tax exclusion, you don’t need to file Form 709. But if you are required to file this form because of noncharitable gifts, your charitable gifts must be listed as well. This detail often is overlooked. No taxes are due on charitable gifts, so it might seem that there’s no penalty for neglecting to list them. But there is a hidden downside: If you underreport your gifts by 25% or more on Form 709, the statute of limitations for audits increases from three years to six…and unmentioned charitable gifts count toward that 25% threshold. Result: If you’re not careful, your generous gift to a charity could double the time that the IRS has to audit you.
Mistake #3: Assuming that you don’t need to report gifts between spouses. Spouses generally can transfer assets between themselves with no gift- or estate-tax consequences, and there’s no requirement to report spousal gifts on Form 709—but sometimes it makes sense to do so anyway.
Reporting spousal transfers on Form 709 helps prove that the transactions truly occurred, which in turn helps ensure that the transfers provide the tax results the married couple had in mind. Example: A surgeon transferred money to her husband to protect those assets from the threat of medical malpractice lawsuits. If she is later sued, the existence of a tax form showing the transaction will help her prove in court that the money truly was transferred.
Mistake #4: Reporting gifts on the wrong section of Form 709. Gifts can be reported in three different places on Form 709—Part 1 of Schedule A is for gifts subject only to gift tax, such as gifts to the taxpayer’s children…Part 2 is for gifts subject to gift and GST tax, such as gifts to grandkids, great-grandkids or unrelated persons more than 37.5 years younger than the donor…Part 3 is for gifts that currently are subject to only the gift tax but that might also be subject to the GST tax later, such as gifts made to common trusts.
If that sounds complicated, it is, particularly when trusts are involved. Even tax pros sometimes report gifts in the wrong section. Be sure your tax preparer has experience with gift-tax returns even if that means going to a specialist for this task.
Mistake #5: Overlooking gifts because you didn’t realize the IRS considers them gifts. If you sell something to one of your heirs for less than it’s worth, the excess value is considered a gift. If you forgive a loan, the amount forgiven is a gift. If you give an adult child your old car when you buy a new one, the value of that old car is a gift. If you make an interest-free loan to a family member or friend, the interest that would have been due had the loan had an interest rate of at least the “applicable federal rate” may be a gift. If you pay your adult child’s rent while he/she is between jobs, those rent payments are gifts.
And—if the total value of these and other gifts given to any recipient is more than $17,000 in 2023, Form 709 likely should be filed.
Mistake #6: Applying a questionable valuation to a gift. If a gift is cash or shares in a publicly traded company, the value is clear. But valuations can be less certain when a gift is real estate, a share in a family business, art, antiques or collectibles.
Don’t take chances with these valuations—the IRS often challenges those that are not well-supported. Obtain an appraisal from a professional appraiser who has strong credentials in the relevant field. Example: Someone holding an “MAI membership designation” from the Appraisal Institute typically is a good choice for a real estate appraisal.
One way to further reduce the odds of problems stemming from disputed valuations: Use a “Wandry clause.” These clauses are especially common when the gift is an interest in a family business. It works like this: Rather than give a percentage share in the business, the gift officially is a specific dollar value of that business. An explanation is included noting that this dollar amount is believed to equal a certain percentage share. Example: If an appraiser puts a value of $12 million on a 40% interest in a family business, the business owner could specify that he is giving his daughter a gift of a $12 million interest in the business, which he believes to be 40% of the business. If the IRS later argues in Tax Court that a 40% interest in the business actually was worth $20 million, the family could respond, “Okay, then the gift was less than 40% of the business—but it’s still worth only $12 million. That’s less than the 2023 estate-tax exemption of $12.92 million, so no estate taxes are due either way.” Even though the IRS does not agree with this reasoning, it has held up in Tax Court.
Mistake #7: Paying insufficient attention to Form 709’s “valuation discount” question. At the top of Schedule A on Form 709 is the question, “Does the value of any item listed on Schedule A reflect any valuation discount?” Valuation discounts might apply if, for example, the gift is something difficult to liquidate and/or a minority interest in a family business or property. Checking “yes” here greatly increases the odds that the return will be audited, so if “yes” is checked on yours, ask your tax preparer to confirm that the statement attached to the return explaining this discount is sufficiently detailed to satisfy the IRS and/or ask your financial advisers if they have a tax pro on staff who can review this.