Gift to noncitizen spouses and preparing the gift tax returnMay 26, 2015 - Phil HodgenExpatriation
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- May 29, 2015, 8:30 am — NYS Society of CPAs, 14 Wall Street, 19th Floor, New York, NY 10005
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One of the easiest ways to bring your net worth down below $2,000,000 — and be a noncovered expatriate — is to give stuff away. U.S. citizens married to noncitizens are especially good candidates for this strategy.
This week’s episode is a very hands-on application of this idea. A step-by-step “how to” — answering the key question on a gift tax return to report such a gift.
This Week’s Question
The situation is simple: a U.S. citizen gives $300,000 cash to a non-citizen spouse. In order to make this a winning strategy for exit tax purposes, a gift tax return will be necessary. There is a puzzling piece of the job.
Here is the question from reader F:
We have a gift tax related question and really getting to the nitty-grittys. In 2014, I (US citizen) gifted cash of $300,000 to my nonresident alien spouse. Where on Form 709, Part 4, Page 3, do I claim my marital deduction? I realize that my annual exclusion is $145,000 with $14,000 going to Line 2. But the remaining $131,000? I wanted to put something on Line 4, Part 4, but the instructions caution not to put anything there for gifts to noncitizen spouses. Does the $131,000 go to Line 5? Or does the exclusions mean something else? On Line 6? On line 5 and 6?
Any light you can shed would be so awesome!
The short answer
Here’s how to do it, F:
- $300,000 goes on Schedule A, Part 4, Line 2.
- $145,000 on Schedule A, Part 4, Line 2.
- For your own sanity, attach a statement to Form 709 that tells the IRS the amount on Schedule A, Part 4, Line 2 is because this is a gift to a noncitizen spouse and you are claiming the applicable exclusion amount for 2014 under Internal Revenue Code Section 2523(i)(2).
- Do the rest of the gift tax return according to instructions.
Your suspicions are correct. Do not put anything on Schedule A, Part 4, Line 4.
Gifts from U.S. citizen spouses to U.S. citizen spouses
When a U.S. citizen is married to another U.S. citizen, all transfers of property between them will be tax-free.
- There is no capital gain tax — it is impossible to have a taxable “sale” by one spouse to another. IRC §1041.
- There is no gift tax — because of the “marital deduction”. IRC §2523(a).
The idea behind the marital deduction is simple. The gift to a spouse is theoretically fully taxable. But in computing the taxable amount of the gift to a citizen spouse, you reduce its value dollar for dollar.
A quick example will show how it works.
A U.S. citizen husband gives $1,000,000 to his U.S. citizen wife. He has made a taxable gift of $1,000,000, but IRC §2523(a) gives him a gift tax deduction of $1,000,000. This means the taxable value of the cash gift to his wife is zero. Shazam, zero gift tax.
Gifts to non-U.S. citizen spouses
Gifts from U.S. citizen to non-citizen spouses will not get the marital deduction. It is much harder to move assets tax-free to a non-citizen spouse.
No marital deduction
When a U.S. citizen makes a gift to a non-U.S. citizen spouse, the marital deduction will not be allowed:
If the spouse of the donor is not a citizen of the United States—
(1) no deduction shall be allowed under this section[.]
Again, a quick example will demonstrate how this works.
A U.S. citizen husband gives $1,000,000 to his non-U.S. citizen wife. He has made a taxable gift of $1,000,000, and IRC §2523(i)(1) denies him the marital deduction. This means the taxable value of the cash gift to his wife is $1,000,000. Shazam, the gift is fully taxable.
A big annual exclusion helps
Recall that a gift to a non-citizen spouse does not enjoy the marital deduction. IRC §2523(i)(1).
Instead, a gift to a non-citizen spouse gets a very large annual exclusion. We are now moving from the marital deduction to a gift tax exclusion. IRC §2523(i)(2) says:
If the spouse of the donor is not a citizen of the United States—
(2) section 2503(b) shall be applied with respect to gifts which are made by the donor to such spouse and with respect to which a deduction would be allowable under this section but for paragraph (1) by substituting “$100,000” for “$10,000”[.]
The Lord giveth, and the Lord taketh away. Take away a deduction (IRC §2523(a)) and give a much larger exclusion (IRC §2503(b)).
The $100,000 exclusion granted by IRC §2503(b) means that the first $100,000 of gifts to a noncitizen spouse are simply not counted as gifts.
The $100,000 amount is increased annually for inflation. IRC §2503(b)(2). The indexed value for 2014 was $145,000. You can find the correct amount in the Instructions to Form 709. (That’s the gift tax return).
For more fun reading, here are the relevant Regulations: Regs. §§25.2503-2(f), 25.2523(i)-1(c).
And so does the unified credit
For all annual gifts above the annual exclusion amount ($145,000 for gifts in 2014 to a noncitizen spouse), the U.S. citizen making the gift will either use up some of his/her “unified credit” or will pay actual cash money as a gift tax.
The “unified credit” is an amount that a U.S. citizen can give (or pass at death) without incurring gift or estate tax. The “unified” adjective refers to the fact that it applies equally to gift tax (transfers during life) or estate tax (transfers upon death).
This amount is indexed for inflation every year, too. For 2015, you can give away $5.43 million (or die and leave that much to someone) (or a combination of the two) without any tax.
The expatriation strategy, for someone who wants to reduce net worth below $2,000,000, is to give away stuff without paying tax. Use the annual exclusion amount and use the unified credit as much as possible.
I suspect that is what is happening with F. By giving away $300,000, F’s personal net worth at the time of expatriation will be less than $2,000,000. No covered expatriate status. No tax pain.
Let’s do a tax return
OK. Enough meta. Let’s do the tax return.
Let’s make some assumptions:
- F has never made a taxable gift before.
- This is a $300,000 cash gift to F’s noncitizen spouse.
I am going to highlight the parts of the gift tax return that directly answer F’s question. The rest of it is just noise. Important noise, to be sure: the IRS will get grumpy if you do not fill it in, or do it wrong. But it does not affect the dollar cost of making the gift.
Schedule A, Part 1
F’s question is centered right on this question of the annual exclusion. Here is how we answer F’s question.
Here is where the gift is listed. Key point: in column H the amount of the gift will be $300,000. The gift to F’s noncitizen spouse goes on the first line of Part 1.
Schedule A, Part 4, Line 2
This is where the taxable amount of the gift is computed. The gift amount is $300,000, but the taxable amount is less than that.
- Line 1 – Bring the $300,000 value over from Schedule A, Part 1, Column H.
- Line 2 – Insert the annual exclusion amount for gifts to noncitizen spouses, which is $145,000 in 2014.
- Line 3 – Simple subtraction. Result? $155,000.
- Line 11 – After a bunch of zero or N/A answers for Lines 4 through 10, the end result is $155,000.
We have just answered F’s question. F rightly understood that the normal annual exclusion is $14,000 for gifts in 2014, and $145,000 for gifts to noncitizen spouses. However, the Instructions to Form 709 are not very clear.
But we know this is true, because the $14,000 exclusion (for gifts to people who are not a spouses) and the $145,000 exclusion (for gifts to people who are noncitizen spouses) are both authorized at the same place: IRC §2053(b).
Why Not Schedule A, Part 4, Lines 4 – 8?
The only other place that F could possibly put the correct reporting information would be in Lines 4 – 8. But this will not work. Remember that we are talking about “exclusions” and not “deductions”. Since F’s gift cannot qualify for the marital deduction, it is not correct to put it here.
The Instructions tell us flat out what goes here on Line 4:
Enter all of the gifts to your spouse that you listed on Schedule A and for which you are claiming a marital deduction. Do not enter any gift that you did not include on Schedule A. On the dotted line on line 4, indicate which numbered items from Schedule A are gifts to your spouse for which you are claiming the marital deduction.
It is impossible to claim a marital deduction for a gift to a noncitizen spouse. Therefore, F cannot use Line 4 to reduce the gross amount of the gift ($300,000) to its taxable amount ($155,000).
Transport $155,000 to page 1
From now on, it is easy. Take the number from Schedule A, Part 4, Line 11 to page 1, Part 2, line 1, then follow the lines down to use up your unified credit or pay a gift tax.
Recommended: Add A Statement
The IRS does not expect to see $145,000 on Schedule A, Part 4, Line 2. It expects to see multiples of $14,000.
You will do yourself a favor if you attach a statement to your Form 709 giving enough information for an IRS person to look at the return and say “These are not the droids we are looking for” or something like that.
A statement looks like this:
- In the top left corner, write your name
- Underneath that, write 2014 Form 709
- Underneath that, write your Social Security Number
All of that is intended to make sure that if the page gets separated from the gift tax return itself, someone at the IRS will be able to reassemble it.
- Skip a few lines then write “Attachment to 2014 Form 709” as a centered heading
- Leave some white space and then write a simple explanation.
The explanation probably sounds something like this:
The cash gift identified on Schedule A, Part 1, Item 1 was a gift to the spouse of the donor. The donee is a noncitizen of the United States.
The donor has claimed the annual exclusion for gifts to noncitizen spouses on Schedule A, Part 4, Line 2 in the amount of $145,000, as authorized by Internal Revenue Code Section 2523(i)(2).
OK, F. This is merely an illustration and not actual tax or legal advice to you. Read the form instructions carefully and make your own decisions. Maybe you want to pay someone a small amount of money to get help, if you are a bit unsure on how to do this. I don’t know all of the facts about your situation and what I told you might be wildly wrong.
See you in New York
Ping me if you want to meet up while I’m in New York. Otherwise, see you next week on the internets.