Gift Tax

Annual Exclusion Amount for Each Recipient
A key concept in the federal income tax law is and it is defined broadly to include “all income from whatever source derived,” Internal Revenue Code Section 61(a). Even so, there is an exception: if a donor makes a gift of $12,000 or less to a unique recipient then, by the authority of IRC Section 2503(b), the transfer–and the transfer must be that of a present interest in the property–is tax free: the recipient isn’t required to include the value of such gift in her gross income and the donor doesn’t have to pay federal , reduce his $1 million exclusion for lifetime gifts, or file a gift tax return. In other words, because the annual is not an aggregation but rather a limit that starts anew with each recipient, there is no limit on the number of recipients who are eligible for a donor’s annual exclusion.

A common form of gift is a transfer of money or property; however, this type of gift does not exhaust the category: in the gift tax law, the category of gift also includes, but is not limited to, a payment made to a third-party on behalf of another, an assignment of a judgment, an interest-free loan or, in the case of a loan with an interest rate lower than market or a sale of a property at less than fair market value, the below-market portion of such loan or sale.

The character of a transaction is determined by objective facts not subjective motives; donative intent is not an essential element in determining whether a transfer is a taxable gift. In short, if the substance of a transaction is a gratuitous transfer of property or a transfer without adequate consideration, then it will be classified by the Internal Revenue Service as a gift that could be subject to tax.

A gift is valued on the day it is completed and taxed in the same calendar year. If a donor’s gift is made by check, it is complete on the day the check is cashed or deposited (assuming, of course, the deposit or presentation of the check is timely, the donor is alive at such time, and the check isn’t rejected).

A Present Interest in the Gifted Property Required for Exclusion
A recipient with a present interest in a gifted property has, at the moment of gift, full possession of, and an unrestricted and irrevocable right to, the property or its income. With a present interest, these rights are immediate and not deferred to a future date. If, on the other hand, recipient’s rights were deferred, then she would have a nonexcludable future interest in the property and the donor would be required to file a (pdf file) and possibly pay .

A Gift in Excess of the Annual Exclusion Amount
If a donor’s gift to a recipient is greater than the $12,000 annual exclusion, then the recipient must include any amount in excess of the exclusion in her gross income. At the same time, the donor must file a gift tax return and pay on, and reduce his $1 million exclusion for lifetime gifts by, the excess amount.

Increasing the Annual Exclusion by Gift Splitting
Gift splitting is a device a married donor can use to increase her annual exclusion amount from $12,000 to $24,000 for a gift she makes separately; there is, however, a flip side: a gift-splitting election applies to all gifts made in a calendar year, both spouses must consent, each spouse must file a gift tax return (there is no joint gift tax return), and one-half of the value of a spouse’s gift is allocated to, and considered to be made by, the other spouse. A gift-splitting election is not required for a gift of property a married couple holds in joint tenancy or as community property; such gift is automatically split evenly between the spouses.

Additional relevant articles on the topic of gift tax are listed below:

Many happy returns, Roger

Mortgage Forgiveness

Normally, the amount of a taxpayer’s debt that is canceled or forgiven must be included in her gross income. However, as a result of the passage of a by Congress, the Internal Revenue Code allows an income exclusion of up to $2 million ($1 million if a taxpayer is married and filing separately or filing as a single taxpayer) for cancellation or forgiveness of either a taxpayer’s qualified principal residence indebtedness (more concisely, qualified mortgage debt) or refinancing of such indebtedness during the period 2007-2012. The price of this income exclusion for is a reduction in the basis of taxpayer’s principal residence. And while this tradeoff could have the effect of deferring rather than permanently forgiving cancellation of mortgage debt income (hereafter abbreviated as COMD income for ease of exposition), the large gain exclusion on the sale of a principal residence–$500,000 for those filing a joint return and $250,000 if a taxpayer is married and filing separately or filing singly–should compensate for the reduction in the property’s basis, effectively making the temporary exclusion for COMD income a permanent exclusion. (Remember the equation for calculating gain or loss on the sale of a property: Gain [loss] = amount realized - adjusted basis; put differently, the smaller the basis, the higher the odds a taxpayer will recognize a gain on the sale of her principal residence.)

Qualified principal residence indebtedness, that is to say, qualified mortgage debt, is debt secured by taxpayer’s principal residence and incurred for the acquisition, construction, or substantial improvement of such residence. The category of qualified mortgage debt does not include a home equity loan or a second mortgage unless the loan is used to construct, acquire, or improve a principal residence. Furthermore, a vacation home or a second home is not considered a principal residence, which fact makes any related debt ineligible for the COMD income exclusion.

Although the provision for the exclusion of a taxpayer’s COMD income was written primarily for outside of foreclosure, it may also apply in the event of foreclosure, but only to the extent the canceled or forgiven mortgage indebtedness exceeds the property’s fair market value (FMV) at the time of foreclosure.

Example: In April 2005, Kathleen Novak, a single taxpayer, purchased a principal residence for $450,000, making a down payment of $50,000 and assuming a recourse mortgage for the balance ($400,000). (Note: A borrower with a recourse mortgage is personally liable for any deficiency remaining after foreclosure.) On October 31, 2008, Novak’s lender forecloses on her home. According to her lender’s amortization schedule she owes, at the time of foreclosure, $397,000 on the mortgage. If the property is sold on November 3, 2008 for $300,000 in complete satisfaction of the debt, then Novak’s COMD income is $97,000, the amount by which the balance on her mortgage ($397,000) exceeds the property’s FMV ($300,000). Novak will not recognize COMD income, however, as the amount of her canceled debt is less than the applicable $1 million exclusion for COMD income. She also realizes a nondeductible personal loss on the transaction, because her basis in the property is greater than its FMV.

The reader should be aware that the exclusion for COMD income also provides relief to taxpayers who are not insolvent; click on for full information.

Additional relevant articles on the income exclusion for mortgage debt forgiveness are listed below:

Many happy returns, Roger

Student Loan Forgiveness

As a rule, the amount of debt that is canceled or forgiven must be included in taxpayer’s gross income. A previous article, , outlines several exceptions to this rule. The focus of this article is on the exception the Internal Revenue Code grants for .

In a nutshell, if a taxpayer attends a qualified educational institution–an institution providing a suitable curriculum, employing a competent faculty, and regularly enrolling a body of students in a set location–and enters into a student loan agreement that makes provision for the discharge of debt in exchange for work, then the amount of debt forgiven is excluded from taxpayer’s gross income.

To qualify for an income exclusion, a student loan agreement must specify the terms of , in particular, the amount of time a taxpayer must work in an occupation or area with unmet needs. Perhaps your physician or dentist worked on an Indian Reservation for a set period of time in order to pay off her student loans. Or perhaps your favorite high school teacher taught at a low-income school to pay his student loans in full; if you’re a student teacher, click on for full information. However, this income exclusion for student loan forgiveness is available only if the loan is made by one of the qualified lenders listed below:

  1. A federal, state, or local government or its instrumentality, agency, or subdivision.
  2. A state, county, or municipal public hospital that is controlled by a tax-exempt public benefit organization. Employees of the hospital must be classified as public employees under state law.
  3. An educational institution but only if it receives funds from a governmental unit or a tax-exempt organization described in (1) or (2) above.
  4. An exclusion is also available if the educational institution has a program wherein a student loan is forgiven in return for a student’s work in an area or profession with unmet needs and the program is supervised by a governmental unit or a tax-exempt section 501(c)(3) organization. The income exclusion rules for canceled or forgiven student debt also apply to a loan that is refinanced through such a program. (Note: Section 501(c)(3) organizations operate for charitable, religious, educational, literary, or scientific purposes; also in this class are organizations that test for public safety needs, promote national or international amateur sports competition, or help prevent cruelty to children or animals.)

Additional relevant articles on student loan forgiveness follow below:

Many happy returns, Roger

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