Pennsylvania and Ohio residents who have recently gifted real estate to family members without filing gift tax returns may soon receive audit notices from the Internal Revenue Service (“IRS”). According to IRS examination teams, an estimated 60% to 90% of taxpayers who gift real estate to family members fail to file required gift tax returns. This pattern of noncompliance has incentivized the IRS to launch an initiative whereby land transfer records filed in state and county offices are reviewed to identify individuals who may be liable for gift taxes.
As a general rule, the transfer of property from one person to a non-spouse for less than full fair market value constitutes a taxable gift. Under the current framework, an individual may transfer the annual exclusion amount ($13,000 in 2012) to any number of donees each calendar year without triggering a filing requirement. Taxpayers also have a lifetime exclusion that shields gifts in excess of the annual exclusion up to a cumulative lifetime threshold. The lifetime exclusion has been increased to $5.12 million for 2012, but stood at $1 million for most of the last decade. Gifts in excess of the lifetime exclusion are taxable, and a gift to a single donee that exceeds the annual exclusion must be reported even if no taxes are payable.
Property transfer records in state and county offices are available for public inspection. However, extensive manpower would be required to visit each individual county and to mine through vast archives of documents in order to identify the comparatively small percentage of transactions that the IRS seeks to investigate. Since some states maintain databases that can be easily screened to identify intrafamily transfers, the IRS has called upon state agencies that maintain these records to furnish the requested information.
Pennsylvania and Ohio are among 15 states that have voluntarily supplied the IRS with intrafamily transfer records for years 2005 through 2010. The remaining states include Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Tennessee, Texas, Virginia, Washington and Wisconsin. Although California initially declined to release its databases, the IRS filed a court petition, and on December 15, 2011, a Federal District Court Judge issued an Order forcing California to produce the requested information. It is believed that the IRS compliance initiative will expand to other states in the near future.
Transfers to a single donee in excess of the annual exclusion in a given year will be subtracted dollar-for-dollar from the taxpayer’s remaining lifetime exclusion. Gift tax will be imposed on any portion of the gift that exceeds the taxpayer’s available lifetime exclusion. Once the lifetime exclusion has been reached, future gifts above the annual exclusion for the remainder of the taxpayer’s lifetime will be fully taxable. Also, if the unreported transaction generated gift tax, penalties can be imposed for late filing and late payment unless it can be established that there was reasonable cause for the noncompliance.
Documents filed in the California case have revealed that, as of October 2011, the IRS has investigated 658 taxpayers who gifted real property to relatives. Of those, the IRS determined that 238 taxpayers did not file required gift tax returns. So far, gift taxes have been assessed in 20 cases. In light of the magnitude of the IRS investigation, practitioners are advised to notify clients to file missing gift tax returns without delay.
Michael W. Darpino, LL.M., JD, MBA also contributed to this Insight.
In Re Does, (DC CA 12/15/2011)
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