Three French Hens, Two Turtle Doves, and Money for My Tax Lien

by Greenberg Glusker Fields Claman & Machtinger LLP
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With the holiday season upon us, we all have so much to be thankful for: our health, happiness, Amazon Prime shipping, and — if you’re Lindsay Lohan — an extra $100k from your Uncle Charlie* (Sheen) to help you out of your tax troubles with your Uncle Sam.

That’s right: ‘tis a season of giving and, like any holiday season, it will be filled with scrooges. The odd thing is that the scrooge Bah-Humbugging a gift is usually the giver, not the receiver. Maybe Lindsay is just not into the holiday spirit, but multiple reports have surfaced this week that Lindsay has yet to say, or even text, thank you to Charlie for his generous gift of $100,000 (maybe Charlie should have helped with her phone bill first). [Update: Lindsay finally thanked/apologized to Charlie, citing a “broken phone” and “lost contacts” for the delay — the modern social equivalent of “the dog ate my homework.”] Lindsay reportedly owes more than $200,000 in back income taxes, interest and penalties to the IRS, and Sheen had reportedly gifted Lindsay the money to help her pay off her IRS tax lien.

Generosity Is Taxing

You’re probably familiar with the concept that gifts of money or other property are subject to gift tax (if given during your lifetime) or estate tax (if given at your death), and that there is a certain amount you can give away without paying gift or estate tax (the credit against gift and estate tax). You might also know that there is an amount of money ($13,000 in 2012 but rising to $14,000 in 2013) that you can give each year to each of an unlimited number of individuals without using any part of your credit. What you might not know is that this applies to gifts of any kind and to any donor, not just to family members passing large amounts of money to each other for estate planning purposes.

That’s right — the $20 Starbucks gift card you gave your co-worker for the office’s gift exchange? Now you only have $12,980 left to give that person this year. The $10 check that grandma gave you for your birthday and that ugly sweater that your best friend bought you (on sale, of course) just because she was thinking about you? Gifts! Even those hand-me-downs that you gave your friend after you lost (or put on) that weight is considered by the IRS to be a “gift.” Generally, the IRS just doesn’t care until you hit $13,000 to the same person in one year. If the total value of all gifts you make to any one person exceeds $13,000 in one year, you are required to file a gift tax return reporting those gifts to the IRS.

Santa is very careful about keeping costs down by keeping his gifts small (and by hiring non-unionized Elves following the North Pole’s passage of a “Right to Work” bill). On the other hand, when you’re handing out $100k stocking stuffers, that’s a bit of a different story.

‘Tis Really the Season

If there has been any recent year in which to feel generous, 2012 has been that year.

Thanks to the some down-to-the-wire, eleventh-hour negotiations to avoid the fiscal cliff of December 2010 — yes, 2010 (déjà vu anyone?) — Congress gifted America the “2010 Tax Act,” bestowing upon us the well-known (and soon to expire) extensions of the 2001 Bush tax cuts. As part of the 2010 tax deal, the estate and gift tax credit was increased to $5 million for 2011 and $5.12 million for 2012. The 2010 Tax Act also unified the amount that could cumulatively be given away during lifetime (the gift tax credit) with the amount that could be passed at death (the estate tax credit), so that the wealthy-and-generous could take full advantage of the entire amount during their lifetimes. Prior to the 2010 Tax Act, only up to $1 million of credit could be used during lifetime.

But, as we prepare — again — to dive off the fiscal cliff, absent Congressional action, the estate and gift tax credit will go back to $1 million (pre-Bush era amounts) and the tax rate will increase to 55% (from its historically low rate of 35%). So, in the “use it or lose it spirit,” the proverbial 1%ers have jumped on the 2012 giving bandwagon and are racing to transfer assets to their kids before the rates change on January 1.

Say Thank You, Lindsay!

Charlie Sheen seems to follow the “use it or lose it” mentality in many areas of his life, including his giving. The good news for Charlie is that his gift of $100,000 to LiLo likely won’t cost him any gift tax — the first $13,000 will be sheltered by the annual exclusion from gift tax and the other $87,000 will probably fall within Charlie’s $5.12 million gift tax credit. This, of course, assumes that Charlie hasn’t jumped on the same bandwagon as the rest of the 1% and already given away $5.12 million over his lifetime through responsible planning under the advice of good tax advisors (stop laughing…it could happen).

But let’s just say Charlie is getting good tax planning advice and has made his $5.12 million of lifetime gifts already — the $100,000 gift to LiLo is going to cost Charlie about another $30,000 in gift tax. That’s a tax Charlie is going to owe the IRS, not Lindsay. So, really, Lindsay, you should thank Charlie twice. You just got an extra $100k from Considerate Charlie….and he is footing the tax bill, if any!

It Was a Gift, Right?

According to recent reports, it seems that maybe Charlie felt Lindsay was owed this money for work relating to Scary Movie 5, in which she appeared with Charlie, that was never paid to her. Careful, Charlie: sounds like you’re saying this is income that Lindsay earned, which would mean she has to pay income tax on it! Lucky for Lindsay, unless the IRS can demonstrate that Lindsay was employed by Charlie, this probably won’t constitute taxable earned income to Lindsay and really is just a nice gift.

Maybe this wasn’t really a gift and Charlie just loaned Lindsay the money? Well, that’s double the benefit for the IRS. Either Lindsay has to pay interest to Charlie, which is taxable interest income for him (but no gift), or Charlie will be treated as if he received the interest income and then gifted it back to Lindsay! In other words, option A is that Charlie pays income tax on the interest he receives, and Option B is that Charlie pays income tax and gift tax on the interest he foregoes (double whammy!), but every option is money in the bank — for the IRS. And if it is a loan, Lindsay better add that $100k principal debt to her liability sheet — and Charlie will take backseat to the IRS in being repaid.

Rejoice

So, if you are lucky enough to be like Lindsay and receive a large gift from someone who cares, thank that someone not only once, but 1.35 times, because that gift may be costing more than just the price of the gift itself — that someone may be paying the gift tax on the gift as well. On the other hand, if you, like most people, are stuck in the $10 check or ugly sweater category, you can simply thank them once (or not at all, depending on how ugly the sweater really is).

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*We should note that Charlie Sheen is not actually Lindsay’s uncle. The fact that they are not related makes a difference. In addition to gift tax, the IRS imposes a “generation-skipping transfer tax” (an additional 35% tax) on any gifts made to someone who is two generations or more below you (such as in the case of grandma’s check). In the case of a non-relative, that means someone more than 37.5 years younger than the donor. Lindsay is only 21 years younger than Charlie, so Charlie is safe. Playboy mogul Hugh Hefner isn’t as lucky…the ginormous engagement ring he gave fiancé Crystal Harris (who, at only 26, is 60 years his junior) is technically a gift (subject to 35% gift tax rate) to someone two generations below (resulting in an additional 35% tax). The only way to fix this is to actually marry her, because spouses are exempt from this gift tax and generation-skipping transfer tax. Is that one of the ways Crystal convinced Heff to say “I do?” Crafty woman!

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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