Failure to Disclose Foreign Holdings | Tax Expert Blog (2024)

What happens when a taxpayer fails to file the required gift tax return? How severe are the penalties for failure to file?

Cautionary Note

While we address certain aspects of the requirements to file a gift tax return in this post, our focus in this post is to address the penalty provisions for failure by an individual taxpayer to file a gift tax return.

Some General Gift Tax Return Filing Requirements

Taxpayers use IRS Form 709 to report gifts they make. Per the IRS Form 709 instructions, if you are a citizen or resident of the United States, you generally must file a gift tax return (whether or not any tax is ultimately due). Some general gift tax rules are listed below.

You gave present interests gifts to someone in 2021 totaling more than $15,000 (other than to your spouse). Certain gifts, called future interests, are not subject to the $15,000 annual
exclusion and you must file Form 709 even if the gift was under $15,000.

Spouses may not file a joint gift tax return. Each individual is responsible for his or her own Form 709. You must file a gift tax return to split gifts with your spouse (regardless of their
amount). If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $100,000 of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return. Likewise, each spouse must file a gift
tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.
Gifts to charities are generally not considered taxable gifts. There are exceptions, such as when a partial interest is transferred to a charity. IRS Publication 526 is a valuable resource to identify a qualified charity.

Who Is Responsible for Paying the Gift Tax?

This question often arises when the donee (recipient) receives a gift from another individual (the donor). While appreciative of the gift, donees often are aware that a gift tax may be due, and wishing to be in compliance, ask how much in gift tax they must pay. They are pleased to learn that it is the donor who is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.

How the Gift Tax Is Computed

The gift tax rates can be found in the IRS Instructions for Form 709 and are not addressed for purposes of this post regarding the penalty provisions.

How are the Penalties for Failure to File a Gift Tax Return and Failure to Pay the Gift Tax Due Computed?

Similar to the computation for failure to file (FTF) an income tax return or failure to pay (FTP) the income tax due, the penalty for FTF a gift tax return and the penalty for FTP the gift tax is based on the amount of tax due.

With respect to an income tax return, the taxpayer generally has a tax liability that is due and the penalty for FTF an income tax return or/and the penalty for FTP the income tax due is based on the unpaid income tax liability.

If those situations where no income tax is due (such as when sufficient income tax withholdings or estimated income tax payments were made), there are no FTF or FTP penalties assessed.

The Gift Tax Exclusions

We briefly mentioned the 2021 annual gift tax exclusion of $15,000. Gifts that don’t exceed $15,000 are not subject to a gift tax. (There is a special exclusion from the gift tax for Sec. 529 college savings plan gifts where the donor is allowed to make 5 years of contributions in one year). In addition to the annual gift tax exclusion, there is also a lifetime exclusion, currently set at $11.7 million (which could be greater if the portability rules come into play for a deceased spouse).

What is the Penalty Enigma?

Since the penalty is based on the amount of gift tax due, there is no gift tax due unless the fair market value of the gift exceeds the annual and lifetime gift tax exclusions. Thus, in most cases where a gift tax return was due and not filed, there is no FTF or FTP penalty because those penalties are based on the amount of the tax due. No tax due – no penalty.

Hypothetical Example Illustrates Non-compliance Dilemma

Bob makes a gift today with a value of $11 million to his only child and files the required Form 709, Gift Tax Return. There is no gift tax due with the filing of his return. For illustration purposes, let’s assume that after claiming the annual and lifetime exclusions, the remainder of this life estate exclusion is an even $700,000. Bob passes away a few years later and leaves $12.7 million to his surviving son. He now has $700,000 of his lifetime exemption remaining, which means that there is a federal estate tax due on the $12 million his son inherits.

Tom, Bob’s brother, has also been financially successful and he too gifted $11 million to his only child. Unlike Bob, Tom did not file a gift tax return. When Tom passes away, he too leaves $12.7 million to his only child. Since no gift tax return had been filed by Tom, the IRS has no record that a prior gift was made and that the lifetime exemption was almost completely used. Will the executor of his estate, which could be his only child, remember that Bob gifted $11 million and only has $700,000 remaining of his lifetime exemption? Is the executor ignorant of the prior gift? Will the executor have selective amnesia?

The problem with how the penalty is computed and the IRS’s apparent inability to track all prior gifts, is that the penalty is hollow as it has no teeth in it to deter a situation like that found with Tom. One could argue that the manner in which the penalty is computed rewards non-compliant taxpayers.

Tax Tip #1

We advise all taxpayers with a sizable estate to consult with an experienced estate tax attorney and their tax professional to plan how to minimize their taxes, whether they be income, gift, or estate taxes.

Tax Tip #2

File all required tax returns, including gift tax returns. While Tom’s not filing the required gift tax return may at first glance appear alluring, it can cause many sleepless nights and could eventually create significant penalties for any taxpayer taking this route. By filing a gift tax return when due, the 3-year statute of limitations begins to run and the taxpayer has closure with respect to the gift transaction. This means that the IRS has 3 years from the date the return was filed to audit it and question the valuation of the gifts made. If it is determined that the fair market value of the gifts was substantially understated (as is sometimes the case when closely held stock is gifted or valuation discounts are used), in addition to FTF and FTP penalties, the IRS could assess a 20% penalty on the understated value for “substantial valuation understatement” or a 40% penalty on the understated value for “gross valuation understatement”.

Two other possible reasons to file a gift tax return on time is that failure to do so, (1) you lose the ability to allocate the general skipping transfer (GST) exemption based on the value of the property on the date of the gift; and (2) you have reflected the date of the gift which is important if a beneficiary of the estate contests who inherits the property of the deceased.

Tax Tip #3

While Congress has historically increased the annual gift tax exemption, the lifetime exemption amount is at the whim of Congress and could possibly be decreased or eliminated. This is why as the tax law changes, it is a good time to meet again with your estate planning attorney and tax professional to update wills, trusts, etc.

If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.

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BE SURE TO READ THE DISCLAIMER PAGE: Tax laws, IRS rules and regulations change frequently. Although we hope you’ll find this information helpful, this blog is for educational purposes only and should not be considered as the rendering of tax, legal or investment advice. The publisher shall not assume liability for any losses, injuries, or damages from the display or use of this information.

About F. Bryan Haarlander, EA, CTRS:

BryanHaarlander is an IRS licensed Enrolled Agent and who owns and operates aspecialized tax services firm serving clients in the western suburbs ofPhiladelphia, PA, which includes the cities of Chester Springs, Coatesville,Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia,Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks,Chester, Delaware, Montgomery andPhiladelphia Counties, as well as clients in Delaware, New Jersey, New York andthroughout the continental USA.

A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.