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Taxing issues: ‘Possible’ clawback of the gift tax

For the 2011 and 2012 tax years the lifetime gift tax exclusion and the estate tax exemption were increased from $1 million to $5 million by The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ($5.12 for 2012 after the inflation adjustment). This allows individuals who had already reached the maximum tax-free gifting of $1 million to make additional tax free gifts in 2011 and 2012 of $4 million. Sounds great, right? But what happens in 2013?

The way the tax laws read right now, in 2013 the provisions of the 2010 Tax Relief Act will sunset. This will throw the lifetime gift tax exclusion and the estate tax exemption back to the 2002 rate of $1 million. This may result in what is being referred to as a clawback of gifts made over $1 million, or in other terms, the extra $4 million of tax free gifts, will be taxable.

Let’s take a look at some examples:



Example A: Joe has not made any prior gifts in his life. He makes a gift of $5 million in 2011 and then an additional gift of $1.4 million in 2013, when the exclusion has sunset to $1 million at a tax rate of 50 percent. His tax in 2013 would be $700,000 (50 percent of $1.4 million).

There is no additional tax on the gifts over $1 million made in 2011 because the gift tax is calculated as: the tentative tax on current and prior year gifts ($6.4 million X 50 percent tax rate = $3.2 million), reduced by the tentative tax on only the prior year gifts ($5 million X 50 percent = $2.5 million; $3.2 million – $2.5 million = $700,000).



Example B: Bob gifts $1 million in 2002 and an additional $4 million in 2011. He then dies in 2013 with an estate valued at $6 million. His tax in 2013 would be $5.5 million (55 percent of $6 million + $4 million – $0).

This is where we see the clawback of the prior gifts, due to the fact that the estate tax is calculated differently than the gift tax. Specifically, the estate tax is reduced by the tax paid, or payable on the prior gifts rather than the tentative tax on the prior gifts. There was no tax paid, or payable on the prior gifts and so the estate tax is reduced by $0. If no gift had been made in 2011 and Bob had died in 2013 with a $10 million estate his tax would have been the same $5.5 million.

Will Congress let this happen? It’s hard to say. One would hope they would act before the sunset happens, but let’s prepare for the worst and hope for the best. Worst case – you end up back in the same place had you not given the gift.

If you are considering gifting please contact your local GHG representative for further advice.

dana fisher is a cpa with galusha, higgins & galusha (ghg) based in havre, mt. the office specializes in farm and ranch tax planning and preparation. contact fisher at po box 1530 havre, mt 59501; call 406-265-3201; or e-mail danar@ghg-cpa.com.


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