Filing a Gift Tax Return Regardless of Whether it’s Required May be a Plus

Did you know that it may be advantageous to file a gift tax return when transferring property to a family member, even when one isn’t required? If the return meets the IRS’s “adequate disclosure” requirements, the three-year statute of limitations clock starts.

Avoiding future tax surprises

Generally, the IRS has three years to challenge the value of a transaction for gift tax purposes or to assert that a nongift was, in fact, a partial gift. But unless the transaction was adequately disclosed, there’s no time limit for reviewing it and assessing additional gift tax. That means the IRS can collect unpaid gift taxes — plus penalties and interest — years or even decades later.

There’s a reluctance to file gift tax returns disclosing nongift transactions for fear of drawing the IRS’s attention. However, a carefully prepared gift tax return can be the best insurance against unpleasant tax surprises down the road.

Define adequate disclosure

If you file a timely gift tax return that meets the adequate disclosure requirements, the IRS has only three years in which to challenge the valuation. To fulfill these requirements a return must include:

  • A description of the transferred property and any consideration received,
  • The identity of, and relationship between, the transferor and each transferee,
  • The trust’s tax identification number and a brief description of its terms (or a copy of the trust instrument) if property is transferred to a trust,
  • Either a detailed description of the method used to value the transferred property or a qualified appraisal (see “Benefits of an independent appraisal” below),
  • A statement describing any position taken that’s contrary to any proposed, temporary or final tax regulations or revenue rulings published at the time of the transfer, and
  • An explanation as to why transfers reported as nongifts aren’t gifts.

Additional requirements apply to transfers of interests in a corporation, partnership (including a limited liability company) or trust to a member of the transferor’s family.

Other requirements

Adequate disclosure also requires a description of the transactions. This includes:

  • A description of the transferred and retained interests and the methods used to value each,
  • The identity of, and relationship between, the transferor, transferee, all other persons participating in the transactions, and all parties related to the transferor holding an equity interest in any entity involved in the transaction, and
  • A detailed description (including all actuarial factors and discount rates used) of the method used to determine the amount of the gift (if any), including, for equity interests that aren’t actively traded, the financial and other data used to determine value.

Financial data generally includes balance sheets and statements of net earnings, operating results, and dividends paid for each of the preceding five years.

Benefits of an independent appraisal

Obtaining an independent appraisal offers significant benefits, particularly for difficult-to-value property, such as interests in closely held businesses. An appraisal by a qualified appraiser helps ensure that the gift tax return contains all valuation information necessary to satisfy the adequate disclosure rules. Plus, if the appraisal is conducted at or near the time of the transfer, it will go a long way toward persuading the IRS that the original valuation of the property was accurate.

Speak to your advisor

In some cases, it’s advisable to file a timely gift tax return that satisfies the adequate disclosure requirements. Contact us for more information.

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