Take Advantage of New Gift Tax Statute of Limitations

Until recently, an anomaly in the Internal Revenue Code statute of limitation for gifts allowed the Internal Revenue Service (IRS) to attack the value of a gift in determining the amount of the estate tax. Now, under the the Taxpayer Relief Act of 1997, once the gift tax statute of limitations has run out, gifts that are adequately reported on a gift tax return may not be revalued by the IRS for the purpose of computing the estate tax.

Before the Act

For estate tax purposes lifetime gifts are added back to determine the taxable estate, and credit is then given for any gift tax paid. Before the act, the value of a gift was the amount reported when the gift tax was assessed or paid and the statute of limitations (generally three years) had run out. The statute of limitations prevented an IRS attack on the value of gifts reported on gift tax returns for gift tax purposes. But, because it didn’t prevent an attack on the value of the gift by the IRS for estate tax purposes, the IRS could redetermine the value of a prior gift, increasing the estate tax. The effect was slightly offset by the estate receiving a credit for the gift tax that would have been paid if the higher value had been reported on the gift tax return.

Advantages Under the Act

Legislation in 1998 has clarified that the finally determined value of the gift (i.e., the value when the statute of limitations lapses) controls the value used in determining the amount of a taxable gift even if no gift tax was paid or assessed on the gift. So, if the IRS does not issue a final notice of redetermination of value within the applicable statute of limitations, then it may not revalue a gift that has been adequately disclosed on a gift tax return. It is a good idea to make gift disclosures in enough detail so they won’t be attacked by the IRS as inadequate. Even after the changes made by the Act, the statute of limitations will not run on a gift that is not adequately disclosed.

Another benefit under the new law is that you may request a hearing before the U.S. Tax Court on the valuation of gifts, and the court can issue a declaratory judgment to determine the value of gifts. The court may make such judgments even where the gift is sheltered from tax by the applicable exclusion amount.

Caution Areas

Not all of the changes under the act relating to the valuation of gifts are favorable. The six-year statute of limitations that applied to substantial omissions regarding the reporting of gifts (the omission of over 25% of the total amount of gifts reported on the return) applies only if the gifts were adequately disclosed. Otherwise, an unlimited statute of limitations now applies. And if no return is filed, there continues to be no applicable statute of limitations for gift tax purposes.

Also, the relief only applies to gifts made after August 5, 1997, so those made earlier remain subject to attack for estate tax purposes even after the gift tax statute of limitations has run.

Although the generation-skipping transfer (GST) tax statute of limitations may not run until much later, by allocating the GST exemption on a timely filed gift tax return, the value of the property will be determined on the running of the gift tax statute of limitations for the purpose of determining the GST exclusion ratio.

The fact that the IRS can no longer revalue gifts for either gift or estate tax where no gift tax is owed or assessed and where the statute of limitations has run provides welcome relief from the uncertainty that previously existed. But continue to properly and adequately report gifts when made, because other changes in the law expand the statute of limitations in some situations to six years and an unlimited time in others.