The Ultimate Guide to Form 709: An Intro
The Ultimate Guide to Form 709: An Intro
Key terms and items to note for completing gift tax returns
Series Index
Table of Contents (click here to skip to intro)
Intro
One of my principal purposes for starting a paid newsletter was to create a guide to completing Form 709 for professionals, without creating a universally-accessible consumer how-to guide. Disclaimer: I bring that up to say that if you are a do-it-yourselfer seeking guidance, I unfortunately cannot assist and I strongly discourage you from signing up for this newsletter in order to learn tips and tricks for your own tax filing. This article is provided for educational purposes only and is not intended to substitute for legal or tax advice. If you are an individual seeking assistance or a second opinion for yourself, I cannot and will not assist nor respond to e-mails from you.
Now that the legal disclaimer is out of the way, I want to introduce you to the ultimate force multiplier for wealth transfer techniques – the United States Gift and Generation-Skipping Transfer Tax Return, or Form 709. While this form is not always required, we will explore how preparing and filing this form is a good idea to leverage the benefits of any lifetime transfer of wealth including, but not limited to, the 3-year statute of limitations for the IRS to challenge values reported on Form 709.
Ultimately, what I plan to do is create articles on specific gifting strategies while noting where and how they should be reported for purposes of Schedules A and D of Form 709 (which, as I will explain below, are where most of the action takes place). This introductory article will remain free, but most others will be behind the wall for paid subscribers. I will start out with 529 accounts and Crummey withdrawal rights in subsequent articles, and then move on from there.
To start, it is helpful to explore some principles about gift tax that any practitioner in this area should know. This is not a complete primer on gift tax, but instead is designed to highlight some key fundamentals. The rest of this article is fairly dense, but many of the points that could get lost in the density will be repeated in later articles (especially as relates to GST exemption and related elections).
Gift Tax Principles to Know
Donor and Donee are the parties to a gift. A donor may incur gift tax on a gift of cash or property to a donee, whether directly or indirectly, in trust or otherwise. The gift tax can still apply even if the donee doesn’t become the direct owner of property gifted by the donor. Donees will usually be individuals, but gifts in trust can be reportable gifts, and this situation may require the disclosure of individual donees who are trust beneficiaries.
Value: The value of any non-cash gift will be the fair market value of the gifted property as of the date the gift is complete. Fair market value (FMV) is generally the value at which property would change hands between a willing buyer and willing seller, neither being under any compulsion to complete the transaction. Even in a sale or exchange, the value of a gift can be the positive difference (the bargain) between the FMV of what the donor gave away and the FMV of what the donor received as consideration.
3-Year Statute of Limitations: This is often a key reason for filing Form 709. For gifts that are adequately disclosed and are not subject to certain understatements of value (usually later determined on audit), the IRS has 3 years to challenge the gift tax return. Most returns will not generate gift tax liability, so the 3-year rule is usually deployed to lock in the gift tax value of transferred property - even for sales or exchanges. This increases certainty when estimating liability for estate taxes.
Completed gift: A gift is completed when the donor cannot do anything to take back the gift or revoke a transfer. Incomplete gifts often include a transfer to a revocable trust, a transfer to a joint cash or investment account, or a transfer to an irrevocable trust but subject to a lifetime or testamentary power of appointment. Incomplete gifts can later become complete, based on the FMV of the gifted property at the time the gift becomes complete. But, if what a donor thought was an incomplete gift is later revealed to have been complete, the FMV of gifted property can be locked in through a 709 filing.
Annual exclusion: An exclusion of $18,000 per donee is available for gifts of present interests by a donor during a calendar year (indexed for inflation in multiples of $1,000). Since this is per donee, per year, this creates massive leverage for a donor. For example, a donor with 20 children and grandchildren could gift each of them $18,000 in present interests per year, or $360,000, without incurring gift tax or using applicable credit – and as we will see this can be doubled for a donor who is married. Because this exclusion is applied per donee, the annual exclusion is limited to the lesser of $18,000 or the total present interest gifts to a donee during a calendar year.
Applicable credit: A gift tax credit against the tentative tax on cumulative lifetime taxable gifts. The credit applies after applying annual exclusions and deductions. The credit is the gift tax that would be owed on a gift of applicable exclusion amount.
Applicable exclusion: A sum of the basic exclusion amount, currently $13,610,000 for 2024 (adjusted for inflation) for each U.S. citizen or resident, and any deceased spousal unused exclusion amount left to a donor from a predeceased spouse (not adjusted for inflation, but applied first to lifetime gifts before using basic exclusion).
GST exemption. This is an individual’s exemption from federal generation-skipping transfer (GST) tax, which can be allocated to transfers that benefit living or unborn skip persons. For more information about GST tax and skip persons, click here. The GST exemption mirrors the basic exclusion amount of $13,610,000, but unlike the basic exclusion amount it cannot be left to a surviving spouse if unused.
Present interest: A gift to a donee for which the donee has, or is deemed to have (under the Internal Revenue Code), an immediate right to possess, use, or enjoy gifted property once the gift is complete. Usually includes direct transfers, but can also include trust transfers subject to a donee’s Crummey withdrawal right, transfers to a 529 or custodial account, and transfers to a 2503(c) minor’s trust or a 2503(b) mandatory income distribution trust (to the extent of a donee’s share of that trust). A gift to any donee in excess of the annual exclusion invokes the need to file Form 709.
Future interest: A gift to a donee which is not a present interest and which does not qualify for the annual exclusion. Future interests include transfers to a nonqualifying trust not subject to a Crummey withdrawal right, remainder interests, and certain interests in entities under which a donee cannot receive distributions of income or a return of capital. Any gift of a future interest invokes the need to file Form 709.
Medical exclusion: A donor’s direct payment of medical expenses of any amount on behalf of a donee is not subject to gift or GST tax, so long as the payment is directly to the provider of medical services and so long as it is not reimbursed by medical insurance. These payments do not have to be reported on Form 709.
Educational exclusion: A donor’s direct payment of qualified tuition of any amount on behalf of a donee is not subject to gift or GST tax, so long as the payment is directly to the educational institution. These payments do not have to be reported on Form 709, but 529 plans are not included in this and still require use of annual exclusion and possibly applicable credit (but subject to a special 5-year superfunding rule to later be discussed).
Marital deduction: A deduction, after taking into account the annual exclusion, for a qualifying transfer to a donee spouse who is a U.S. citizen at the time the gift is completed. For a donee spouse who is a U.S. resident or nonresident, no marital deduction is available, but $185,000 (in 2024) of gifts are excluded from gift tax so long as the portion exceeding the annual exclusion would otherwise qualify for the marital deduction if the donee spouse was a U.S. citizen. Many transfers in trusts or transfers of term or life interests are treated as terminable interests not qualifying for the marital deduction, unless the trust or life interest is structured a certain way and (sometimes) certain elections are made on Form 709.
Charitable deduction: A deduction for qualifying transfers to a qualified charitable organization, including certain charitable trusts, pooled income funds, and donor advised funds. Note, however, that gifts to organizations described in 501(c)(4), 501(c)(5), and 501(c)(4) are excluded from gift tax and thus do not have to be reported on Form 709.
Reportable gift: A gift that must be included on a gift tax return, even if eligible for an annual exclusion or a deduction.
Taxable gift: The net amount of a gift to a donee after subtracting any annual exclusion and deduction. The presence of any taxable gift for the year invokes a requirement to file Form 709. Only taxable gifts generate gift tax, and only taxable gifts use applicable credit. Most gifts of future interests will be taxable gifts on a dollar-for-dollar basis, but subject to possible retained interest discounts and the QTIP election.
Optional gifts: This is not a technical term, but I use it to include transactions such as qualified disclaimers, certain releases, elections such as the 2702 election, election out of the automatic allocation rules, GST trust elections, or sales or exchanges that could be treated as gifts if the donor gives up more than is received in return or if there is a technical defect.
Form 709 - Overview
For purposes of this series, we can classify any 709 filing as either:
· A required return; or
· An elective return.
For a required return, all reportable gifts for the calendar year should be included. For an elective return, it is a good idea to include all reportable gifts for the calendar year, but some practitioners vary on their perspectives. In either case, optional gifts (i.e., sales or swaps) may be included on either type of return.
The following graphic illustrates when a required return must be filed, versus an elective return.
Generally, if there is any taxable gift or gift of a future interest, this will lead to a required return. In addition, spousal elections such as the gift splitting election and the QTIP election lead to a required return. But, elective returns often pop up when there is a desire to elect out of automatic allocation of GST tax exemption, or where there is an optional gift. For optional gifts, the utility of filing Form 709 is the running of the 3-year limitations period. The 3-year limitations period limits the amount of time the IRS has to challenge the value of transferred assets for gift tax purposes, so long as there is substantial disclosure of each gift.
In this video, I discuss a bit more about when a 709 should be filed:
Schedule A
Schedule A is where most of the “action” on Form 709 happens. Schedule A can be tricky, because it involves a balance between accurate numbers and accurate words. But, there is often more leeway on the words than on the numbers. Perfect can be the enemy of good when drafting gift descriptions and disclosures, but there are certain items (under adequate disclosure regulations and other principles) that must be included. Certain choices on Schedule A, such as the application of a valuation discount or election out of automatic allocation of GST exemption, may also generate the need for a separate statement on the 709 or as an attachment.
Gifts of any amount and any description, other than for a close of an ETIP (a subject for another article), get reported on Schedule A. This Schedule forms the backbone for all other parts of the 709, and is usually the place to start (other than Part 1 of the 709 containing basic information about the donor and other elections we will later discuss).
Schedule A is broken down into four parts as illustrated below. These parts are not separated by the type of property transferred, but instead are usually based on the GST tax effects of the transfer.
Schedule A, Part 1 – Gifts Subject Only to Gift Tax
This schedule includes those gifts for which no GST tax exemption can be automatically allocated, or gifts to trusts that are not GST trusts and for which there will be no election to treat them as GST trusts. This usually includes gifts that only benefit non-skip persons, and charities (including gifts to charitable remainder trusts and pooled income funds, even if the remainder beneficiaries are skip persons). Per the 709 instructions, any gift that is subject to an estate tax inclusion period (ETIP) is usually reported here - creating a challenge we will later discuss on electing out of automatic allocation of GST exemption at the close of an ETIP. Also, Crummey rights for non-skip persons usually won’t be reported here unless the Crummey rights lapse into a trust qualifying under Treas. Reg. 26.2642-1(c)(3).
Schedule A, Part 2 – Direct Skips
This schedule only includes gifts to, or for the exclusive benefit of, donees who are skip persons. This could include a direct gift, a skip person’s Crummey withdrawal right meeting the requirements of IRC Section 2642(c)(2), or a transfer to a trust under which the current beneficiaries of income or principal (but not remainder beneficiaries) are all skip persons. This could also include a one-time gift to a 529 plan for a skip person which is not subject to the 5-year rule (to later be discussed). But, ironically, the instructions for Form 709 direct that 5-year elections for 529 plans should be included on Schedule A, Part 1, even if for skip persons.
In addition to the annual exclusion, direct skips are assigned an “annual exclusion” for GST tax purposes of up to $18,000 per skip person. These are tracked on Schedule D, Part 1, as a “nontaxable” part of the transfer (to be later discussed), not necessarily as an exclusion but instead as a portion of a transfer that is assigned an inclusion ratio of zero for GST tax purposes.
One unique feature, as you will see above, is the ability to elect out of automatic allocation of GST exemption. This is elected by checking the box in Column C, marked “2632(b) election out.” Unlike the gift tax, which forces you to use all applicable credit before paying gift tax, the election out for direct skips allows you to elect to pay GST tax. This may be more advantageous than payment of estate tax for estates that have a projected estate tax liability. Note, however, that GST tax cannot be paid on indirect skips because GST tax liability is not determined until a skip person later benefits through a taxable termination or taxable distribution.
Schedule A, Part 3 – Indirect Skips and Other Transfers in Trust
All other gifts get reported on this schedule, other than direct gifts (all direct gifts should be on Schedule A-1 if to a non-skip person or Schedule A-2 if to a skip person). Most transfers to trust, whether a gift, sale, or swap, will be reported on this Schedule. Also, Crummey withdrawal rights structured as hanging powers or otherwise not qualifying under IRC Section 2642(c) will be reported on this Schedule as well.
Similar to Schedule A-2, this Schedule grants the ability to elect out of automatic allocation of GST exemption. See Column C, allowing a “2632(c) election.”
The scope of gifts reported on each part of Schedule A may be affected by the gift-splitting election.
Schedule A, Part 4 – Taxable Gift Reconciliation
This is where we go from total gifts to taxable gifts – taxable gifts being the number that carries over to Part 2 of the 709 for tax computation and application of applicable credit. This is also where you must affirmatively make a QTIP election for deductible terminable interests eligible for the marital deduction, or elect out of QTIP treatment for annuities.
Gift-Splitting Election
While we will later discuss the gift-splitting election in a separate article, the gift-splitting election can affect what gets reported on Schedule A. If both spouses are required to file gift tax returns (by virtue of both making taxable gifts after application of the gift-splitting rules), then Schedule A must be supplemented to divide each gift in half under Columns G and H and to include the donor’s deemed one-half share of spousal gifts as new items under Schedules A and D.
The gift-splitting election, authorized by IRC Section 2513, allows a non-donor spouse to elect to have any of the donor spouse’s calendar-year gifts (other than gifts to the non-donor spouse) to be treated as being made one-half by each spouse. This election typically applies where a donor spouse is the sole owner or deemed owner of transferred property. But, if spouses transfer interests in community property, or property held as joint tenants with right of survivorship or tenants by the entirety, the gift will automatically be treated as being made one-half by each spouse without the need for a gift-splitting election.
Schedule D
Schedule D of Form 709 is where GST exemption gets allocated, and perhaps is the second-most active Schedule of Form 709. There will be several articles in this series about allocation, or non-allocation, of GST exemption.
Schedule D is broken down into three parts, as follows:
Schedule D, Part 1 – Generation-Skipping Transfers
This Part is where direct skips (both by the donor, and split with the donor’s spouse) usually have exclusions applied, in order to determine the net transfer to which GST exemption may be applied. Like the applicable credit, the GST exemption only gets applied once a GST tax “annual exclusion” is applied. But, this annual exclusion may only be used for direct skips or for certain Crummey rights.
As we will later discuss, if the close of an ETIP occurs in the calendar year for which a 709 is filed (whether or not the purpose of filing is the close of the ETIP), it is also reported on this Part subject to the ability to elect out of automatic allocation on the 709 filed at the time of the transfer (usually in a prior year) that initially created the ETIP.
Schedule D, Part 2 – GST Exemption Reconciliation
GST exemption is allocated both to the net amount of direct skips, and to the net amount of indirect skips, on this Part. But, if there is an election out of automatic allocation, this Part also instructs you to attach an Election Out statement – this statement will usually refer back to Schedule D and not Schedule A. A later article will contain sample Elections Out and Notices of Allocation.
Schedule D, Part 3 – Tax Computation
This Part is usually only used when there are direct skips (including split direct skips). This Part takes the net amount of direct skips from Schedule D, Part 3 and allocates GST exemption. This is important, because in any calendar year GST exemption is allocated first to direct skips before allocation to indirect skips. But, if there is an election out of automatic allocation to direct skips (such that GST tax is generated), this is where the GST tax is computed. This relates back to Part 2 of the actual 709, as under IRC 2515 taxable gifts are increased by the amount of any GST taxes actually paid.
The exemption allocated here will carry over to Schedule D, Part 2.
Interestingly, this Part does not involve indirect skips. This is because indirect skips never generate GST tax liability at the time of completion of the gift. Instead, indirect skips later require a taxable distribution or taxable termination which are reported on IRS Forms 706GS(D) and 706GS(T), respectively.
On that note, this Part allows you to lock in an inclusion ratio of greater than zero for a direct skip. But, reporting the inclusion ratio for an indirect skip usually requires a separate statement or attachment for the 709 reporting the completed gift that is treated as an indirect skip.
Schedule B
This part applies if gift tax returns have ever been filed. This is important for reconciling how much applicable exclusion amount remains, and how must GST exemption remains.
Later, we will discuss how to get copies or a transcript of one or more prior 709s.
Schedule C
This Schedule only applies if the donor is a widow (whether single or remarried) who has deceased spousal unused exclusion amount from a prior portability election which may be applied, or has been applied, to taxable gifts.
Conclusion
While this article is dense, please bookmark it as a quick reference tool. We will later discuss the non-Schedule parts of Form 709.
Next up, we will examine 709 reporting for gifts to 529 accounts and creation of Crummey withdrawal rights. If you would like to access subsequent articles in this series, please consider becoming a paid subscriber.