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Indecent Disclosure: Should You Sing Like a Canary?

Do you wake up in cold sweats wondering when the IRS will challenge the value of that gift you made a few years ago? You know the one I mean. . . that heavily discounted family business stock you gave to the kids. Or, can you ever breathe easier about that big family limited partnership valuation discount you took last year?

Decency demands a time limit for the IRS to challenge a gift tax return. After all, memories fade, records get lost, etc. So, Congress enacted the statute of limitations to limit the time for an IRS challenge. We affectionately call it the statute. If the statute runs, the IRS is out of luck and can't collect any taxes for that year.

Ask most people and they'll tell you that the statute runs three years after filing the gift tax return. But that's not really true. Although the donor is primarily liable for the tax for three years, the IRS can go after the donee for four years.

Runaway Statute Any way, the statute never starts running unless you file a gift tax return and adequately disclose the gift. This rule applies even if no gift tax return is required (e.g., because you think the gift is worth less than the $11,000 annual exclusion or the kids bought property from you for its appraised value). Disclosure requirements include:

 

  • A description of the transferred property and any consideration received by the transferor;
  • The identity and relationship of the transferee;
  • If the property is transferred in trust, the trust's tax identification number and either a brief description of the trust terms or a copy of the trust instrument;
  • An appraisal or a detailed description of the method used to determine the fair market value of property, including financial data and a description of any discounts;
  • If you do not report the transaction as a gift, an explanation of why (e.g., the kids or the trust bought the property for fair market value); and
  • Congress is a little schizophrenic about certain freeze transactions it authorized in 1990. So, it gives the IRS an unlimited time to challenge grantor retained annuity trusts (GRATs), qualified personal residence trusts, and corporate and partnership freezes unless you make some very specific and detailed additional disclosures.

Transfers to members of the family that are in the ordinary course of business (e.g., compensation or rent paid to family members that might be excessive) are exempt from these disclosure requirements if they are properly reported by the parties on their income tax returns.

But, do you really want to sing like a canary in your gift tax return? Won't all that disclosure rub the IRS nose in your arguably dirty laundry, bringing down its full wrath? Wouldn't it be better to let sleeping dogs lie? I can think of some better expressions, but this is a family newsletter.

Why Disclose?

Disclosure advocates argue:

 

  • The IRS is so short-staffed that they rarely look at gift tax returns until the donor dies. Hopefully, the statute will run before that happens.
  • Bring em on! I'd rather defend against the feds while I'm alive and memories are fresh than leave an open issue for my widow and kids to grapple with when I'm gone.
  • If I'm successfully challenged, I'll have to pay interest on any gift tax that is assessed. If the statute does not run, they might challenge me 20 years from now and the interest would be ruinous! Plus, the interest is not deductible on my income tax return.
  • Maybe I can hide the disclosure by a) designing the transaction as a small gift (reported on the face of the return) and a large non-gift transaction (like a sale that is disclosed in attachments) so that a lazy IRS examiner might miss it entirely or b) use really small type face and a streaky printer that will make the agent give up in frustration even if he spots it.

Why Not Disclose?

Some folks believe that discretion is the better part of valor. Arguments against disclosure include:

 

  • Why in the world would I want to invite the IRS into my life by disclosing something that I am not required to disclose?
  • How in the world could an IRS agent even become aware of the transaction absent disclosure?
  • The IRS is so short-staffed that they rarely look at any gift issues until the donor dies. By that time, the transaction will have faded into history and the IRS won't discover that it occurred. Even if they do, it will be difficult for them to generate the factual information to mount a meaningful challenge.

There isn't a right or wrong here, except with hindsight. Talk with your advisors and I suspect that the best answer for you will come clear. Either way, sweet dreams!

 

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