How do Gift Taxes and Annual Exclusion Gifts Work?

How do Gift Taxes and Annual Exclusion Gifts Work?

Many people are aware that gift taxation rules exist, but do not understand the actual process for determining when reporting or payment is required. Fortunately, the types of gifts most people make each year fall under broad exclusions to the gift tax rules such as charitable giving, interspousal gifts, or annual exclusion amount gifting. This article focuses on annual exclusion amount gifting. Most individuals in the United States regularly rely on annual exclusion amounts to avoid filing burdens, for things like buying Christmas presents or treating someone to lunch, without ever realizing the exception is operating. However, relying on the annual exclusion amount without understanding it can lead to negative tax ramifications.

Before discussing the exception, we need to begin with the general rule. Internal Revenue Code Section 2503(a) provides that “taxable gifts” means the total amount of gifts made during the calendar year. A “gift” is a transfer of any type of property from one person to another for no or less than full fair market value. For example, if a person sells property with a fair market value of $100,000 to another for $100,000, no gift has occurred because the property was transferred for full value. If the property is instead given away for no payment, a gift of $100,000 has occurred. You may also be making a gift by allowing use of property without fair payment, even if the property itself is not outright transferred or is set to return to you. An example could be, residing in a property without rent or making an interest free loan. Determining “fair market value” can sometimes be difficult, but generally is the price which the property would trade hands for between unrelated individuals, both of which are fully informed about the characteristics of the property and under no compulsion to buy or sell it. Between unrelated parties, the presumption is that the transfer price is the fair market value. Between related parties, higher scrutiny is applied as it is more likely the transfer price was determined not by market value, but instead by charitable motivations.

IRC Section 2503(b) provides the annual exclusion rule. This rule exempts from “taxable gifts” an inflation adjusted at $10,000 (adjusted to $16,000 in 2022) annually made by any person to any other person. This annual amount prevents routine transfers like Christmas presents, birthday cards and paying for meals from requiring any special tax filings. Using up to the maximum amount each year for cash or security transfers is a common tool used by wealthy estate planning clients seeking to shift money out of their estates whose value may otherwise incur estate taxes at death. While $16,000 may not seem like much in the context of multi-million dollar estates, the multiplying force of “per donor” and “per recipient” can allow significant annual transfers. Consider a wealthy married couple with three children, each of whom are married with two children of their own. By using annual exclusion limits, each spouse can give to each child $16,000. They can give $16,000 to the spouse of their child plus additional $16,000 gifts from each grandparent to each grandchild. In this example, $384,000 a year could be transferred gift and estate tax free. The “annual” nature of the exclusion is measured by the calendar year, so it is common for transfers that may otherwise not qualify for the exemption to be split into separate smaller gifts on a December-of-one-year then January-of-the-next schedule.

Making annual exclusion gifts needs to be weighed against other options for the assets. Highly appreciated assets in estates without estate tax exposure would typically be better off being held until death to benefit from tax basis adjustment rules. Gifted assets generally have a “carryover” tax basis from the donor. Conversely, newly acquired stock expected to rise in value makes for a powerful transfer option, as the growth in value will occur under the new owner and has been removed from the donor’s estate at a relative discount compared to its anticipated future value.

To count as a gift completed in any given year, the gift must be of a “present interest” and “complete”. These requirements can become quite complex in certain types of advanced planning – such as Crummey withdrawal notices for gifts made with the intention to fund trusts or the ownership interests in highly restricted Family Investment LLCs. Generally, the requirements mean that the value and use of the property needs to have changed hands in an irrevocable manner and without contingencies. For example, telling a child in college “If you get all A’s this semester, I will give you $1,000” does not constitute a gift, but once the funds have changed hands, the gift would be complete. The same would apply to naming someone a beneficiary on a bank account as the designation is both revocable and payment is contingent on the grantor’s death. This differs from naming someone as a joint owner on an account, as that conveys an ownership interest at the time it is made. Failing to satisfy this requirement can create problems if large gifts are made in consecutive years. For example, if in 2022 a father gifts to their son a car worth $15,000 and then in 2023 gifts $15,000 worth of stock in their family business, then the gifts each year were under the annual exclusion limits. Conversely, if in 2022 the father tells his son, “Consider the car yours, I will get the title transferred soon”, then in 2023 the car is actually transferred and the gift of stock is made, then, because the gift of the car was not complete in 2022, both gifts took place in 2023 and the exemption is not large enough for both 2023 asset transfers.

If gifts are made in excess of the annual exclusion limit and no other exemption applies, then under the general rule of IRC Section 2503(a), the gift is a “taxable gift” and needs to be reported on IRS Form 709 – the gift tax return. However, this does not necessarily mean that any tax is owed – in fact it rarely does. Taxable gifts made during life reduce the amount of exemption available for the donor to use to protect assets from the estate tax at their death. To summarize, estate taxes operate by valuing the assets a person owned at their death, then applying a heavy tax on the value of assets over their exemption amount ($12,060,000 per person in 2022 – a historically high figure). So taxable gifts made during life reduce that exemption amount at death. If a person dies without owing estate taxes under the reduced amount, then no tax is collected at any point for the gifts made during their life. If the exemption is entirely used up, either during life or at death, then a tax is owed.

This combined system of gift and estate taxation makes sense when the legislative objectives are understood. Gifts and inheritances share the common trait of passing assets without compensation, usually to younger family members. Without the unified credit, large near-death or deathbed gifts could be used to avoid estate taxes, which are important for both revenue generation and curbing wealth inequality. However, without the annual exclusion exemption, the general rule of taxability would mean that every small routine gift would be a reportable gift. This would create a paperwork nightmare, both for average citizens whose tax filing burdens would substantially increase and for the IRS who would need to review and process these submissions. Further, because no tax is owed as long as there is available exemption, this massive paperwork burden would generate very little tax revenue as the vast majority of people do not have estates large enough to trigger the estate tax (at least under current exemption limits).

As a final note, it is important to understand that the annual exclusion gift exemption only applies for purposes of calculating taxable gifts – the exclusion does not apply for determining Medicaid eligibility and reportable transfers during the look back period, which are governed by entirely separate and far stricter rules. This article is meant to provide a basic overview of the gift tax system and annual exclusion gifting. As always, professional advice from an attorney or accountant should be sought when determining the effects of any specific course of action.

Post Pandemic Public Benefits, Who Will Lose Eligibility?

Post Pandemic Public Benefits, Who Will Lose Eligibility?

During the Public Health Emergency (PHE), the State of Wisconsin was required to keep people enrolled in Medicaid as a condition of receiving a temporary increase in the federal share of Medicaid costs.  When the PHE ends (recently extended to January of 2022) so will the increased funding, and the state will need to look at whether currently eligible individuals will be renewed for benefits. 

Those individuals who could keep benefits during the PHE were:

  • Individuals who did not pay their patient liability or monthly cost share;
  • Individuals who did not report changes in assets, income, work status or household composition;
  • Individuals who received maximum FoodShare benefits during the pandemic regardless of qualification; and
  • Individuals over age 65 who received prescription drug benefits but did not do their annual renewals or pay the annual fee.

When the enhanced federal funding ends, states will need to resume processing renewals for eligibility, many of which have been pending for almost 18 months.  Current federal guidance provides that states will have up to 12 months to discontinue benefits that were extended under the PHE.  Further, an individual must be provided with at least 60 days advanced notice before losing benefits.

For individuals who properly reported the receipt of excess assets and income during the PHE and continued to receive benefits, an overpayment occurred that has not yet impacted benefits.  For those who did not properly report changes in resources, a discontinuance of benefits may be looming.  The fate of those who properly reported changes remains to be seen in terms of how the penalty for overpayment will be treated.  Generally, only those overpayments that are due to a consumer’s failure to report or provide updated information are recoverable.  Consult with your attorney to ensure that you are provided with the requisite time frame to provide necessary eligibility verification and proper notice of any adverse action regarding benefits.

 

Can I Disclaim an Interest in an Estate?

Can I Disclaim an Interest in an Estate?

When someone dies and leaves you property in their will, by beneficiary designation, or through the intestate beneficiary laws of their state, it is possible, and sometimes wise, to reject the would-be inheritance by “disclaiming” your legal interest to it. However, there are certain procedural rules and mechanics necessary to effectively complete the disclaimer.

Someone may choose to disclaim their interest in an inheritance for a variety of reasons. They may simply not need it or would prefer another person to receive it. Disclaiming in these circumstances may be preferable to accepting the asset, then gifting it to the recipient. Disclaiming may also be warranted if receipt of the asset could lead to it being seized by creditors, impacting the person’s tax planning, or affecting their eligibility for certain government programs. For very wealthy individuals, receipt of additional assets through inheritance may prove problematic for purpose of the estate tax and later cause taxation at the recipient’s death that could have been avoided by a timely disclaimer. In fact, some types of trusts, commonly known as Disclaimer Trusts, anticipate the disclaimer process being utilized for estate tax purposes and create mechanisms to take advantage of the disclaimer process to minimize the repeated taxation of assets as they move through a family tree.

Wisconsin Statute § 854.13 governs the rules for disclaiming assets in Wisconsin. To be a valid disclaimer under the statute, the disclaimer must meet certain technical requirements. It must contain a description of the asset to be disclaimed, declare the intent to disclaim, the extent to which the disclaimer applies, and must be signed by the disclaimant. The disclaimer must be delivered within nine months after the effective date of the transfer, although extensions are sometimes possible “for cause” with court permission. The disclaimer must be delivered to the party identified under WI. Statute §854.13(5), which is typically the personal representative of an estate or the trustee of a trust holding the relevant asset. The delivered disclaimer must then be filed with the probate court with jurisdiction over the estate and, for real estate, recorded with the Register of Deeds of the county the real estate is located in. When the individual disclaiming the interest is a minor or incapacitated, the statute includes special rules which apply to ensure their guardian or agent acting under power of attorney is acting in the best interest of the disclaimant.

Importantly, the disclaimer must also be made before the individual accepts the asset or any benefit from the disclaimed asset. For example, if the contents of an investment account are liquidated and transferred to the beneficiary’s account, those funds have been accepted and the person can no longer disclaim them. Similarly, if someone is to inherit a vehicle and drives in it, they have accepted the benefit of the asset and can no longer disclaim it. Accidental acceptance of an asset can sometimes be disastrous, so if you are considering disclaiming your interest, make sure to be mindful of the management and use of the asset so you do not accidentally bar yourself from disclaiming it by accepting the asset or its benefit. The possibility of accidental acceptance is also a limitation of the Disclaimer Trust described previously, and some estate planning attorneys choose to avoid it in favor of other methods – like formula funded trusts – to avoid this risk.

To be valid for federal tax purposes, the IRS also imposes requirements for a “Qualified Disclaimer” in Section 2518 of the Internal Revenue Code, which are similar, but distinct from the Wisconsin rules.

A properly executed disclaimer is irrevocable and causes the asset to be treated as if it never vested in or transferred to the disclaimant. Assuming a divestment is effectively made, the asset passes under the rules set forth in WI. Statute §854.13(7) through (10). The general effect of the disclaimer is that the asset would pass as if the disclaimant has died before the decedent. For example, if a person dies without a will and the laws of intestacy direct that the asset would pass to the decedent’s surviving parent, who then disclaims, the asset passes as if the parent has predeceased and it passes to any living siblings of the decedent. As another example, if an individual dies with a will providing all assets would pass to their surviving spouse, and to their children if the spouse predeceases them, a disclaimer by the surviving spouse would cause the assets to pass to the children.

Despite the “general rule” outlined above, the statutes contain many exceptions and special rules for certain scenarios. Because a disclaimer is irrevocable once made, it is important to fully understand where the asset will pass before completing the disclaimer. If you have any questions about disclaiming assets from an estate, please do not hesitate to reach out to one of our attorneys.

 

Go Buy An Umbrella

Go Buy An Umbrella

The above title is not encouraging you to buy something to protect you from the rain! It refers to purchasing an umbrella insurance policy to protect you and your family from liability claims, and to provide you with ample coverage for your losses due to injuries sustained in an auto accident. The typical cost for a $1,000,000 umbrella policy can be as little as $200 or $300 per year. This is a bargain for an additional $1,000,000 in protection.

As attorneys, not only do we represent clients, we also counsel them. One of my favorite topics to discuss with clients is having adequate insurance, including the purchase of “umbrella” coverage. This coverage refers to an extra layer of protection on top of your existing insurance coverage, of at least $1,000,000 or more, to protect you in case you have personal liability in an auto accident or under your homeowner’s policy. The umbrella policy you purchase should also include an endorsement to apply to your underinsured and uninsured motorist coverage on your automobile insurance policy. Some insurance companies may offer an umbrella policy you can purchase, and some may not. Some insurance companies may sell you an umbrella policy that applies to liability coverage only, for example, if you are at fault under your homeowner or auto policy. However, you need to consider being insured by a company that offers an umbrella policy that covers liability and has an endorsement to cover underinsured and uninsured motorist coverage in case you sustain serious injuries in an auto accident. You need to specifically ask for all three of these protections to have the best protection possible.

The reason for having an umbrella policy is to simply provide a significant increase in insurance coverage for a very low cost. In our practice, we see all types of auto accidents, and homeowner’s liability issues, and the first thing we ask our clients when they come to us is what type of insurance is available from the other party, and from our client. All too often we must tell our clients that the person who ran into them with their vehicle either had no insurance, or minimum insurance limits. We then look to our client’s insurance policy for potential additional coverage, and if they have low underinsured or low uninsured coverage there may be very little we can do to obtain compensation for our clients for their significant losses. Given the high cost of medical care, injured parties can easily sustain tens of thousands or hundreds of thousands of dollars in medical bills, in addition to significant wage loss and potential permanent disability preventing future earnings. If you have an umbrella policy of at least $1,000,000 that applies to liability and uninsured motorist coverage and underinsured motorist coverage, you will have a better chance of protecting yourself and obtaining full compensation for your injuries.

In summary, go buy an umbrella policy to protect yourself and your family. In order to give yourself full protection, you need to tell your insurance agent that you need the umbrella policy to cover (1) liability for home and auto, and (2) an endorsement so that the umbrella applies to your underinsured and uninsured automobile coverage. If you have any questions about an umbrella policy, please feel free to contact me and I will be happy to discuss it further with you.

 

The Book of Surprises

The Book of Surprises

There is an elephantine book with 995 chapters that most Wisconsinites know exists, but no one has ever read cover-to-cover. The topics in this book are eclectic and cover a staggering range of subjects from “wild animals and plants” to “communicable diseases” to “prison labor” to “gambling.” It is not the Bible and it is not a thesaurus, nonetheless it is the authority on all aspects of our daily lives.

Open the book to a random chapter and behold the magnitude of its content. For example, Chapter 882 tells us that “An adult may be adopted by any other adult, who is a resident of this state.” Considering opening a bawdyhouse? Think again! Chapter 823 calls such establishments a nuisance and allows for taking of “furniture” and “musical instruments” used in such a business. Looking for some entertainment on October 10th, Chapter 995 informs us that “appropriate exercises and celebrations may be held” in honor of William D. Hoard’s birthday. For those not in the know, William Hoard was the 16th Governor of Wisconsin and is the namesake of Hoard’s Dairyman, a magazine.

Curiosities abound in this book. It blesses marriages between first cousins “where the female has attained the age of 55 years or where either party, at the time of application for a marriage license, submits an affidavit signed by a physician stating that either party is permanently sterile.”

Want to know the difference between a “pet bird” and a “wild bird?” It is in the book. Chapter 169 defines a “pet bird” to mean a “bird that is either a psittacine or a soft bill and that is not native” as opposed to a “wild bird” which is “a wild animal that is a bird.” There is also practical guidance such as in Chapter 29, the prohibition against capturing or killing “any wild animal with the aid of any explosive or poison gas.”

The book is also practical where it gives guidance to employers including that an “employer shall, at the time of hiring, notify each employee about any hairstyle, facial hair or clothing requirement.” To this point, it even threatens a fine of not less than $10 nor more than $30 to an employer “in any manufacturing, mechanical or mercantile establishment” who fails to “provide suitable seats for its employees.”  And, if there were any doubt about where a municipal judge should hold court, it is removed by Chapter 755, which states: “No judge may keep his or her office or hold court in any tavern, or in any room in which intoxicating liquors are sold, or in any room connecting with a tavern or room in which intoxicating liquors are sold.”

These archaic rules laid down in this massive tome may come as surprise. However, this book is free, routinely updated and available for study. Every citizen of Wisconsin has imputed knowledge of all 995 chapters of this book. Ignorance of the rules of the book won’t save a person that runs afoul of any command of the book. Ignorantia juris non excusat—ignorance of the law does not excuse. This book, of course, is our beloved Wisconsin Statutes. https://docs.legis.wisconsin.gov/statutes/statutes.

 

What is Mediation and How Does it Work?

What is Mediation and How Does it Work?

Mediation is a private process for resolving disputes by which an independent mediator assists the parties in reaching a mutually satisfactory settlement. While the courts can require that some cases go to mediation, the process remains voluntary in that the parties are not required to come to an agreement.

Issues That are Typically Mediated

When a lawsuit is filed, it is common for courts to require the parties to engage in some form of informal dispute resolution to attempt to settle their case. The types of cases that are typically mediated include disputes involving personal injuries, business transactions, real estate, insurance, construction, breach of contract, as well as family law and custody disputes, to name a few. It should be noted that a case does not have to be in the court system or in litigation for mediation to be utilized or to be effective. Informal disputes between businesses, neighbors, or among people within a workplace could also benefit from voluntary mediation even without being in a lawsuit.

The Role of the Mediator

Mediators are typically attorneys and retired judges. The mediator will not decide the outcome of the case. The mediator is neutral, impartial and does not choose one side’s position over the other. The mediator’s job is to help the parties resolve their issues through a process that encourages each side to air their dispute, identify their strengths and weaknesses, and to address potential solutions to the problem that will be satisfactory to all sides. The primary goal of a mediation is for all parties to work out a solution they can live with. Nothing will be decided unless both parties agree to it. The mediator will assess the case, highlight the strengths and challenges of each side, point out the risk and expense associated with continuing with the dispute and having a trial, and the uncertainty of leaving it in the hands of a judge or a jury to decide the parties’ fate.

Typical Mediation Procedure

There are different methods for how mediations are conducted. Mediations often take place at a mediator’s office or at the office of one of the attorneys involved in the dispute. Many mediations that take place in the context of a lawsuit are conducted with the parties in separate rooms for the entire mediation. Each side presents a statement to the mediator about the dispute and how they would like it resolved. It is typical for the parties and their attorney to file written submissions to the mediator at least a week in advance of the mediation so that the mediator will be familiar with the issues involved in the dispute. The mediator will then go from one room to the other to discuss potential avenues for resolution with each party with the goal of reaching an agreement. The discussions the mediator has with each side in separate rooms are completely confidential and are not disclosed to the other side. If an agreement is reached, it will then be reduced to a written document that can be enforced in court. Mediations can last a few hours to a full day, or even longer, depending on the complexity of the issues and the number of parties involved.

Other styles of mediation involve the parties having a joint session where they are all in the same room for the entire mediation and the parties discuss potential ways to settle their issues with the mediator facilitating that discussion.

The Benefits of Mediation

Mediation has many benefits when compared to a dispute that works its way through the court system and all the way through a trial. These benefits include the following: (1) Everything said by the parties at mediation is confidential and is not admissible in court; (2) The parties can resolve their dispute privately without having to testify in open court; (3) The parties can avoid the costs of ongoing litigation expense and trial; (4) The parties have total control over the outcome of their own dispute, without having to take the risk of presenting their issues to a judge or jury who will ultimately decide the parties’ fate; and (5) Mediation can be conducted even before a lawsuit is filed, which can significantly shorten the timeframe in which the parties can resolve their dispute.

Attorney Richard H. Fuller at Anderson O’Brien not only represents parties at mediations, but he also conducts mediations as part of his civil litigation practice. If you have any questions about mediations, please do not hesitate to contact him.

 

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