Friday, June 3, 2011

Gift from Mom Does Not Defeat Deduction

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Most estate planners have advised their clients on how to provide for impecunious children. With high unemployment rates for young people and the advent of "boomerang" children, parents are increasingly called upon to cover their children's living expenses, usually on an out-of-pocket basis.

Although most of us are familiar with the gift tax implications of these arrangements, few have given thought to the income tax consequences. If a parent pays a child's deductible expense, who gets the deduction? Is the payment considered that of the parent, or of the child?

The Tax Court recently concluded in Lang v. Comr., T.C. Memo 2010-286 (12/30/10), that the expense and the deduction belong to the child. In Lang, the taxpayer's mother, Frances, paid $24,559 for the taxpayer's medical expenses and $5,508 to cover her real estate taxes. Both payments were made directly to the provider. The child, Judith, deducted both amounts on her 2006 income tax return, taking the position that these were gifts to her that were then used to pay her obligations. The IRS took a form-over-substance approach, arguing that the person who makes the payment is the only one entitled to the deduction.

The Tax Court sided with Judith, finding that Frances had made the payments with donative intent. As such, the court decided, the payments should be treated as gifts to Judith that were then used to satify her obligations. The court noted that, per Regs. §25.2511-1(a), payments to a third party may be treated as an indirect gift.

Harold W. Pskowski, Managing Editor for Estates, Gifts and Trusts

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