This is the sixth article of a series dealing with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). For the first five articles, see:
Part 1 – Charitable IRA Rollovers
Part 2 – Estate Tax/Carryover Basis Election for 2010 Decedents
Part 3 – Temporary $5 Million Estate Tax Exemption
Part 4 – Temporary $5 Million Gift Tax Exemption: Use it or Lose It
Part 5 – Gifting Without Making Yourself a Pauper
Part 5 discussed methods for making gifts that do not decrease your cash flow. One significant blow to your cash flow could be Tennessee gift taxes. Tennessee does not have an exemption from taxable gifts. If you make a $5 million taxable gift, you will owe $463,400 of Tennessee gift taxes. A lot of our clients would be willing to make a significant taxable gift if they did not have to pay Tennessee gift taxes. This article will explain methods for avoiding or reducing Tennessee gift taxes.
Tennessee is one of only two states that impose gift taxes. Therefore, if you can arrange for the gift to be made by someone who is not a Tennessee resident, you can avoid paying Tennessee gift taxes. Several of our clients have either changed their residence to another state or are considering making this change.
Sometimes, one spouse has become a resident of another state, while the other spouse has remained a Tennessee resident. If the gift is made by the spouse who is not a Tennessee resident, no Tennessee gift taxes will be required. The gift by the non-Tennessee spouse can be split for federal gift tax purposes (this would allow a total gift of up to $10 million). Splitting the gift for federal gift tax purposes would not require the Tennessee non-donor spouse to file a Tennessee gift tax return.
Someone who is planning to move to Tennessee should make the gift prior to moving here.
The Tennessee gift tax does not apply to gifts from QTIP Trusts that were established by someone who was not a resident of Tennessee. This may be useful for someone who moved to Tennessee after a QTIP was established when they lived in another state. The beneficiary of the QTIP trust might be able to convey their interest in the trust to the remainder beneficiaries, thereby accelerating the vesting of the trust in the remainder beneficiaries. If the QTIP Trust has a spendthrift clause, you will first have to modify the trust to eliminate this clause.
Tennessee gift taxes do not apply to gifts of real estate or tangible personal property that is physically located in another state. Our clients frequently take advantage of this exception by establishing Qualified Personal Residence Trusts for vacation homes located in other states.
It is much less common to deliver possession of tangible personal property while outside of the state. Assume that you want to give a valuable painting or piece of jewelry to a child. You and your child could drive to Bowling Green, Kentucky, and exchange the property while present in Kentucky. I recommend that you take a picture and perhaps prepare a contemporaneous memorandum that is witnessed by someone who is not a party to the gift transaction.
Tennessee gift taxes do not apply to gifts to 529 accounts. 529 accounts work best when the funds in the account will be used for college education expenses of the beneficiary. However, it is possible for the beneficiary to withdraw the portion of the account that is not needed for these expenses. When withdrawals are not made for qualified education purposes, federal income taxes and a penalty will be assessed on the income earned by the account.
If you plan to make a gift that requires you to pay Tennessee gift tax, you should consider splitting the gift between 2011 and 2012. If you split the gift between two years, this will reduce the overall taxes by $11,600. For example, if you make a gift of $440,000 in 2011 and a gift of $4,560,000 on January 1, 2012, your total taxes will be $451,800 rather than $463,400. Furthermore, the time for paying most of the tax will be postponed until April 15, 2013. Unlike income taxes, you are not required to make estimated payments throughout the year.
Alternatively, you could reduce the gift on January 1, 2012 to $4,120,000. If the $5 million gift tax exemption is extended to 2013, you could make the final gift of $440,000 on January 1, 2013. If the exemption is not extended, you would make the final $440,000 gift later in 2012. Waiting gives you the opportunity to reduce taxes by another $11,600 if the higher gift tax exemption is extended.
When deciding whether to delay making a portion of your gift in order to reduce Tennessee gift taxes, keep in mind that the sooner you make the gift, the sooner you can get income and appreciation out of your estate.
Tennessee gift taxes are a serious concern for clients who want to take advantage of the 2 year opportunity to make large taxable gifts without paying federal gift taxes. There are various types of gifts that can be made without incurring Tennessee gift taxes. If you must pay the taxes, splitting your gift between multiple years can soften the blow.