For Me? You Shouldn't Have! - Legal Considerations for Gifting
While usually synonymous with one's birthday or the holidays, lifetime gifts can also serve an important role in one's estate planning. In its simplest form, gifting provides for a transfer of wealth and assets from one individual to another. In this regard, a gifting strategy may be used to complement broader wealth transfers through traditional wills and trusts. However, like any effective estate plan, it is important to understand the legal landscape of gifting, including the many legal issues and considerations impacting what constitutes a gift, the tax implications of gifting, and how gifting fits within an estate plan.
Given the complex nature of estate and tax planning, volumes have been written comprehensively covering all relevant aspects of legal gifting. In the interest of brevity, this article will highlight a few of the more critical considerations.
What Constitutes a "Gift?"
Aside from the ubiquitous ill-fitting sweater given at the holidays, legal "gifting" may include cash, tangible property (e.g. personal property, real estate, motor vehicles, stock or bond certificates) and/or intangible property (e.g. business interests). In Michigan, three elements are necessary to constitute a valid gift: (1) the donor (i.e. the person making the gift) must intend to gratuitously pass title/ownership of the property to the donee (i.e. the recipient of the gift); (2) actual or constructive delivery of the property must be made; and (3) the donee must accept the gift.1 With respect to the transfer/delivery of the gift, it is critical that title to the gift pass to the donee and that the delivery of the gift be unconditional; this means that a gift must be fully consummated during the lifetime of a donor2 and must invest ownership in the donee beyond the power of recall.3 Delivery may, however, be made either actually (i.e. delivery to the donee) or constructively (i.e. delivery to someone designated by the donee to receive the property on behalf of the donee).4 As to acceptance, the donee is presumed to have accepted the gift where the receipt of the gift would be otherwise beneficial to the donee.5
For a demonstration of these elements at work, consider the following examples:
- A relative sends you a personal check made payable to you for $1,000 on your birthday. The gift is complete upon your receipt of the check.
- A relative sends you a card on your birthday notifying you that he has opened a joint checking account in your and his name and that you may withdraw $1,000 from the account. The gift is not completed until you withdraw the funds from the account; until that time, the relative can regain the funds by unilaterally withdrawing all the funds.
In the hypotheticals above, the donative intent of the donor (the relative) was clear: he was providing a gift for you on your birthday; the occurrence and timing of the delivery were at issue. As described in more detail below, the intent of a donor, including whether a gift was actually contemplated, may not always be clear. Revisiting the joint checking account example above, if your name was added to the account only to enable you to assist the relative with check writing and other banking tasks, a gift would not occur even if you were to withdraw monies. Similarly, if your ability to negotiate (cash) the $1,000 check was expressly conditioned upon the occurrence of a future event (e.g. a note written on the check's "memo" line which states "for your graduation from a four year, accredited college") the requisite donative intent to make a $1,000 gift at the time when the check was initially delivered to the donee would not exist.
Tax Implications of Giving/Receiving a Gift
As a general matter, gifting implicates several types of tax regulations including income taxes, gift taxes, and estate taxes. For the donor, a well-planned gifting strategy can assist in the transfer of the donor's assets and wealth to reduce estate tax exposure. Generally, the donor is liable for gift taxes arising out of the transfer of the gifted property. However, federal law, particularly the estate and gift tax applicable exclusion amount, provides each individual with a basic exemption amount adjusted for inflation. In 2017, this exclusion amount is $5,490,000 ($10,980,000 per married couple). This exclusion is available to offset taxable gifts made during the donor's lifetime, and the balance of the applicable exclusion amount, if any, is available at death. In addition, the Internal Revenue Code also provides for "an annual gift tax exclusion," permitting each donor to exclude up to $14,0006 of gifts per donee per the calendar year tax-free. Married couples can "split" gifts and make tax free gifts of up to $28,000 per year, per donee. In order to qualify, the gift/transfer must be of a present interest - meaning the donee has all immediate rights to the use, possession, and enjoyment of the property as well as the income from the property.
As a matter of illustration of the tax exclusions described above, consider the following: A wealthy widow has nearly $7 million in assets and four children. The widow gives each of her four children $20,000 a year for 10 consecutive years leading up to her death. Following her death, the balance of her assets - $6 million - are split evenly among her four children ($1.5 million per child) through her will. By operation of the annual gift tax exclusion, $14,000 of the annual $20,000 yearly gift per child is tax exempt. The remaining $6,000 of the yearly gift given to each child would be offset by the estate and gift tax exemption ($5,490,000). In the current example, $240,000 ($6,000 x 4 children x 10 years) of the yearly gifts would be applied against/reduce the $5,490,000 exemption, leaving a remaining available exemption balance of $5,250,000 to be used at the time of the donor's death. With respect to the $6 million left to her children following her death, only $750,000 would be subject to estate tax (i.e. the amount which exceeds the $5.25 million exemption balance). Had the gifting strategy not been made, the taxable balance of the widow's assets would have exceeded $1.31 million, reducing the net amount received by the four children.
From the donee's perspective, the receipt of a gift generally does not constitute income for federal tax purposes (I.R.C. 102). However, where the property gifted generates income (e.g. a gift of real estate which is subject to a lease agreement with a third-party), the income received by the donee (e.g. the monthly lease payments from the third party) is treated as taxable-income. (I.R.C. 102). Additionally, if the donee subsequently sells the property gifted to him/her, both income tax and/or capital gains tax may be triggered. In this regard, at the time the donee sells the previously gifted property, the "basis" (i.e. cost) of the property for tax purposes is the same basis as the donor had in the property at the time of the gift (called a "carryover basis"). For example, if a donee sells a stock previously gifted to him for more than the donor paid to acquire the stock (the carryover basis), a capital gain occurs, triggering the capital gains tax. An exception to the basis-determination above occurs where the fair market value of the property at the time a gift is made is actually less than the donor's initial cost to acquire the property. In such instances, the carryover basis which the donee would look to at the time he/she sells the property gifted would be the fair market value of the property at the time the gift was made. (I.R.C. 1015). It is important to note that these principles apply generally to gifted property. The sale of property by a decedent's estate involves a different tax analysis altogether.
Legal Challenges to Gifts
In the context of estate planning, gifting is no more or less immune to legal challenges than other estate planning tools. In this regard, legal challenges to a donor's capacity to make a gift, or for the potential of undue influence exerted on the donor by the donee, are similar in concept and application to the same such challenges to a will or a trust. A donor, like a settlor of a trust or grantor of a will, must have sufficient legal capacity (must be of a legal age of majority - 18 years old in Michigan) and mental capacity to make a gift. Michigan law does not expressly define mental capacity for gifting; the standard applied by courts, rather, is similar to the standard for capacity to make a will (MCL §700.2501).7 Adapted in the gifting setting, mental capacity is understood as the (a) ability to understand that the donor is providing for the disposition of his/her property, (b) the ability to understand the nature and extent of his/her property, (c) the ability to understand the nature and extent of the donor's natural objects of his/her bounty (i.e. the donor's closest relatives, such as children, spouse, siblings, and relatives), and (d) the ability to understand in a reasonable manner the general nature and effect of the gift to be made. Legal challenges may arise where concerns surround a donor's ability to meet the aforementioned standard, such as when a gift is made during a marked illness of an elderly donor. Conversely, in situations where the mental and legal capacity of the donor is not in dispute, challenges to gifts may nonetheless arise where undue influence8 may have been exerted upon the donor by third parties. Most commonly, claims to challenge a gift or to enforce a gift's terms will be brought in the appropriate probate court; however, the probate court's jurisdiction to hear such claims is not exclusive. Depending on the nature of the claim asserted (e.g. a claim for declaratory judgment), a circuit court may also be an appropriate forum for the litigation of such disputes.
Depending on the circumstances, challenging or enforcing a gift arrangement can be a complex and difficult process and, in such situations, the assistance of an experienced attorney is essential in order to provide you with the needed guidance, advice, and expertise. For a consultation with a Clark Hill attorney regarding gifting, please contact Thomas E.F. Fabbri, Mallory A. Kallabat, Jonathan M. Martone, Nicholas E. Papasifakis, or another member of Clark Hill's Estate Planning & Probate Litigation practice group.
1 Osius v Dingell, 375 Mich 605, 611 (1965)(citing Buell v Orion State Bank, 327 Mich 43, 41 (1950)).
2 With respect to inter vivos or "living gifts": specific bequests or "legacies" of property or money in a will, which are also often considered "gifts" involve transfers of property after the donor's death.
3 Osius v Dingell, supra at 611 (citing Lumberg v Commonwealth Bank, 295 Mich 566 (1940)).
4 Id. at 611 (citing In re Herbert's Estate, 311 Mich 608 (1945)).
5 Id. at 611 (citing Buell, supra).
6 Under current 2017 amounts - the total annual gift tax exclusion adjusts each calendar year.
7 See generally Grand Rapids Trust Co v Bellows, et al, 224 Mich 504 (1923).
8 What constitutes undue influence is a vast and complex area of the law, outside of the scope of this article. However, as a means of general understanding, undue influence occurs where the free will of the donor is subverted by the actions of another, either through threats, coercion, isolation, or a similar abusive-patterned course of conduct.