Date Tue, 19 Oct 2004 100227 -0600

Subject IRS Email Tax Law Assistance

To: David

NOTE Thank you for your inquiry. Our response to your tax law question appears below. I hope this information has been helpful. If you have a follow-up question or another general tax law question, please return to our web site at (http//www.irs.gov) to submit it. Please do not use your "reply" button to respond to this message. More helpful information is provided at the end of this message.

Your Question Was

It is my understanding that I can give a gift of up to $12,000 a year that is tax exempt to the receiver. The question is about who what the receiver is. Can I give a gift to a corporation ? Can I give a gift to a Trust which has a beneficiary? I m not totally clear as to who can receive a gift. Example if I have a family member who wants to start a business can I just give his business $1000, as a gift, where by he does not have to pay tax on the funds being given? If I give such a gift - do I report it, or does the person/entity have a special form to report the gift to separate out a gift from a taxable event. I thank you in advance for your help and answers. - David Nelson

The Answer To Your Question Is

Dear Mr. Nelson

Thank you for your question.  There are several concepts that you must understand before I simply set out the answers to your question. The foundation must be set.

1. First is the concept that when a person gives a gift (is a donor), it is the donor that is subject to gift tax; the recipient of the gift (donee) *generally* gets the gift income tax free. <><>
2. Second is the concept of the annual exclusion. The annual exclusion, currently at $11,000 for the 2004 year (not $12,000), is that amount that can be gifted by a donor to a donee without having to report the making of a gift (which would be reported on a Form 709). That is, if a donor makes a present interest gift to a single donee of $20,000 in a calendar year, the donor must file a Form 709 to report the gift. On the Form he subtracts his annual exclusion amount for that gift to that donee, and then reports a taxable gift of $9,000. (Only a present interest gift, as opposed to a future interest gift, is subject to the annual exclusion. For more on this concept, read the Instructions for Form 709, available at www.irs.gov.)
3. Third in this series of concepts is the following As of year 2004, each person can gift up to $1,000,000 in taxable gifts without actually paying gift tax. That is, such a donor would file gift tax returns showing gifts made, but no gift tax would be due until the donor used up his lifetime exclusion for gifts of $1,000,000.

So, to extend my previous example of a $20,000 gift to a single donee If this is the first gift by the donor, and it's a present interest gift, then the donor would file his Form 709 showing the gift of $20,000, netting a taxable gift (after the annual exclusion) of $9,000. However, because the donor has not used up his lifetime exclusion, although there is a taxable gift of $9,000, he will pay no gift tax--he will simply use up a part of his unified credit (also called the applicable credit amount) to "cover" the tax on that gift.

You can read more about these concepts in Publication 950, Introduction to Estate and Gift Taxes. <><> So, now we can get to your actual questions and comments. One, remember from above that the donor can gift $11,000 in 2004 (the amount for 2005 is not published yet) without having to file a gift tax return (Form 709).

If the donor gifts more than that to any single donee, in cash or other property, then he has to file a gift tax return to report the taxable gift. Regardless of how much the donor gifts to the donee, the gift is generally income tax free to the donee. To clarify, if a donee receives a cash gift, he does not include it in his taxable income. It is not included on his Form 1040. If a donee is given stock, the donee takes the donor's basis in that property (typically the donor's cost for the property) as his own; hence would use the donor's transferred basis to determine his gain for income tax purposes on later sale of that gifted stock. <

Getting to your "gift to a corporation" question Gifts can only be given to natural persons. That is, a gift to a corporation (or other similar entity) is treated as a pro rata gift to the owners of the corporation.

To begin a new example If A and B own XYZ Corporation and C makes a cash gift of $100,000 to the corporation, the gift *must* be shown as a $50,000 gift to each A and B. The gift is not shown as being given to XYZ Corporation. Further, if A and B then use that money in the corporation, or leave it in the corporation, they are recorded in the corporate books to have each made a $50,000 contribution to the corporation, increasing their investment in the corporation. <><> Thus, the same result occurs if the donor simply gifts $50,000 to each A and B and they contribute it to their corporation. In this scenario, the donor would file a Form 709 showing his two $50,000 cash gifts. He would take two annual exclusions (one for each present interest gift to each donee), showing taxable gifts of $39,000 to each, for total taxable gifts of $78,000 in that year (presuming no other gifts were made).

If the donor has not exceeded his lifetime exclusion for gifts, then although he files a gift tax return, there is no gift tax to be paid. He will be deemed to have used part of his unified credit to "cover" the gift tax. Finally, the $50,000 gift to each A and B is not income taxable to them on receipt of the gift. Not until they use it as they would use their own funds and produce taxable income (say interest, income, gain, dividends, etc.) would they report the taxable transactions from the receipt of that gift. That is, once a donee receives a gift and it is his property, he reports future taxable transactions with respect to that gift, as he would his normal property (bank account interest, stock gain or loss, etc.). <><> Again, you can read more about these basic concepts in Publication 950, Form 709 and Instructions for Form 709, all available at www.irs.gov.

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