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No, You Shouldn't Ignore Gift Tax, but There Are Legal Ways to Get Around It

August 09, 1998|LIZ PULLIAM

Q: I'm curious about how the government enforces gift tax rules. I've often heard that you have to file a gift tax return with the IRS if you give more than $10,000 to any one person in a given year. But how would the IRS know about your gift if you chose not to file?

A: For most readers, this is a theoretical concern--few people have to pay these taxes. And when they do, they are usually dead anyway. But to answer your question: Your chances of getting caught are pretty slim if you're Joe Generous slipping cash to your son on his wedding day.

If you're Mary Multimillionaire trying to move big chunks of money out of your estate, however, you'd better think twice.

Technically, every dollar you give away over the $10,000-per-person limit is counted against your lifetime estate tax exemption. And whether or not you reach the limit, the IRS wants you to file a form each year so it can keep track. Even then, you don't have to send money unless you go over your lifetime exemption.

The exemption this year is $625,000. It is set to increase each year until it reaches $1 million in 2006. So if you died tomorrow with $600,000 worth of property and you gave away $100,000 over the gift-tax limits during your lifetime, estate taxes will be levied on $75,000.

For the vast majority of people, estate taxes aren't an issue. The IRS says less than 1.5% of all the adults who die leave taxable estates.

Those estates get pretty close scrutiny, however. The IRS goes where the money is, after all, and tax professionals will tell you that estate returns get audited far more often than individual returns. So if you leave behind a Bel-Air manse and $2.95 in your checking account, the IRS will start nosing around to find out who got your money and how. Bank records, brokerage accounts, mortgage applications, vehicle registrations--for you and for your heirs--are just some of the places agents will look to find the dough.

The recipient of your gift could also give you away. Say you bestow $100,000 on your daughter, who launches a successful restaurant. Since self-employed people, successful people and cash-based businesses are all audit magnets, no one is too surprised when the IRS comes calling.

The IRS spots the $100,000 infusion and demands to know where it came from. Eager to please (and avoid heavy penalties for undeclared income), your daughter gives you up.

That money is deducted from your lifetime exemption and you face penalties for failing to file Form 709. If you die and your estate is settled before the IRS catches on, your daughter could be on the hook for the taxes and penalties. You may think that's a just reward for her betrayal, but c'mon--she's still your daughter. And if your goal was to avoid taxes for you and your family, you're certainly not ahead.

All that said, there are several legal ways to get around the $10,000 limit:

* You can combine your giving with a spouse and jointly bestow $20,000 a year on as many people as you want. That means you could give $80,000 to a family of four.

* You can let someone use your property, such as a car, for free, as long as you remain the legal owner. Or you can offer your services, from baby-sitting to orthodontia, without declaring a gift.

* You can pay someone's medical or tuition bills without regard to the limit.

* You can also make tax-free loans or set up certain kinds of trusts. It's probably worth consulting a good estate-planning attorney. After all, if you've got enough money to worry about estate taxes, you've got enough money to pay for help to make sure you do it right.

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Q: I hear a lot of ads on the radio touting the benefits of setting up a Nevada corporation to reduce your taxes and protect your assets. I was so intrigued by one of the ads that I sent for more information. This seems like a plausible way to save money. What's the catch?

A: The two things tax officials hate the most are failure to file tax returns and failure to declare income. Nevada corporation schemes typically encourage you to do both. The state Franchise Tax Board has agents that are expert in pulling apart these set-ups. They will be more than happy to educate you about the importance of paying California income tax on California income, and they will tack on some attention-getting penalties and interest to make sure you don't forget.

If you have any doubt, take your Nevada scheme to any reputable certified public accountant. Once the CPA stops laughing, you can talk about legitimate ways to reduce your taxes.

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Liz Pulliam is a personal finance writer for The Times and a graduate of the certified financial planner training program at the University of California, Irvine. She will answer questions submitted--or inspired--by readers on a variety of financial issues in this column. She regrets that she cannot respond personally to queries. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.

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