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Chapter 12. Gift Tax


... taxable gifts of prior periods were undervalued as long as a gift tax ... gifts after August 5, 1997, this rule applies even if the donor paid no gift tax ... – PowerPoint PPT presentation

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Title: Chapter 12. Gift Tax

Chapter 12.Gift Tax
  • Howard Godfrey, Ph.D., CPA
  • Professor of Accounting

  • The student should be able to
  • 1. Understand the concept of the unified transfer
    tax system. (Pg. 2)
  • 2. Describe the gift tax formula. (Pg. 4)
  • 3. Identify a number of transactions subject to
    the gift tax. (Pg. 7)
  • 4. Determine whether an annual gift tax exclusion
    is available. (Pg. 16)
  • 5. Identify deductions available for gift tax
    purposes. (Pg. 18)
  • 6. Apply the gift-splitting rules. (Pg. 22)
  • 7. Calculate the gift tax liability. (Pg. 23)
  • 8. Understand how basis affects the overall tax
    consequences. (Pg. 26)
  • 9. Recognize the filing requirements for gift tax
    returns. (Pg. 30

  • Highlights of Recent Tax Law Changes
  • The 2001 Act reduced the unified transfer tax
    rates in 2002 by replacing the former top two
    brackets on amounts exceeding 2.5 million with a
    50 maximum tax rate. In later years, for both
    estate gift tax purposes the maximum tax rate
    is reduced in 1 increments until in 2007 the top
    rate is 45 on amounts over 1.5 million. In
    2005 the max tax rate is 47. The 2001 Act
    repeals the estate generation skipping taxes
    effective January 1, 2010. At that date, the max
    gift tax rate will decline to 35. The 35 rate
    will apply to tax bases exceeding 500,000.
    Congress retained the gift tax to make up for the
    loss in income tax revenue that could occur
    should wealthy individuals shift assets free of
    gift tax to donees in lower income tax brackets

  • Highlights of Recent Tax Law Changes
  • Once the statute of limitations has expired, the
    IRS cannot argue that taxable gifts of prior
    periods were undervalued as long as a gift tax
    was paid. For gifts after August 5, 1997, this
    rule applies even if the donor paid no gift tax
    as long as the method for valuing the gift is
    properly disclosed.
  • The amount of the annual gift tax exclusion is
    11,000 in 2004 and 12,000 in 2005.

  • Lecture Outline
  • I. Concept of Transfer Taxes.
  • Gifts and inheritances are specifically excluded
    from the income of a recipient. The donor must
    pay a gift tax on the value of property
    transferred by gift. The estate pays an estate
    tax on the value of property in the taxable
  • A. The US has had an estate tax since 1916 and a
    gift tax since 1932. The structure of these
    taxes has remained fairly constant. One purpose
    of a tax is to raise revenue. Because of the
    generous exclusion, the gift tax raises little
    revenue. The gift tax also provides a backstop
    for the estate tax. The gift tax prevents
    wealthy donors from transferring large portions
    of their assets during life to escape the estate

  • II. The Unified Transfer Tax System.
  • A. Unified Rate Schedule. Before the 1976 Act,
    there was a separate rate schedule for gift tax
    purposes that was only 75 of the estate tax
    rates. Since that time there has been a unified
    rate schedule with graduated rates, currently up
    to a maximum of 47. The 2001 Act reduced the
    unified transfer tax rates beginning in 2002 by
    replacing the former top two brackets on amounts
    over 2.5 million with a 50 maximum tax rate.
    In 2002, amounts exceeding 2.5 million will be
    taxed at a 50 max rate. In 2003, the top rate
    declines to 49 and applies to tax base above 2
    million. In later years the rate will be reduced
    until in 2007 the max rate is 45 on amounts over
    1.5 million. In 2005, the max rate is 47 on a
    base of 2 million.

  • II. The Unified Transfer Tax System.
  • B. Since 1977, taxable gifts are added into the
    estate tax base. They are valued at their FMV on
    the date of gift. The addition of post-1976
    adjusted taxable gifts to the estate tax base
    results in higher marginal rates being applied to
    transfers made at death. Gift taxes paid on
    these gifts are subtracted from the estate tax
  • C. The unified credit reduces dollar-for-dollar a
    certain amount of the tax computed on the taxable
    gifts or the taxable estate. The amount of the
    credit varies depending on the year of transfer.
    For years 2002 through 2009, the amount of the
    credit is 345,800. This number is to remain
    constant while the credit for estate tax purposes

  • III. Gift Tax Formula
  • A. Determination of Gifts. A determination must
    first be made as to whether any transfers made by
    a taxpayer constitute a gift. The transfer is
    valued at the FMV of the prop on the date of the
    gift. The aggregate amount of gifts for the
    period is then determined. Aggregate gifts are
    reduced by any exclusions or deductions to
    determine taxable gifts.
  • B. Exclusions and Deductions. For 2004, the
    amount of the annual exclusion is 11,000 per
    donee per year. If the amount of a gift to a
    person does not equal 11,000, the exclusion is
    limited to the FMV of the gift. Exclusions may
    be claimed for an unlimited number of donees.
    Unlimited deductions are allowed for marital
    transfers and gifts to charities. The annual
    exclusion is indexed for inflation using
    multiples of 1,000. It is 12,000 for 2006.

  • III. Gift Tax Formula
  • C. Gift-Splitting Election. Congress authorized
    gift-splitting to provide for comparable tax
    results for residents of community property
    common law states. Under this provision, gifts
    made to third parties by one spouse will be
    treated as made one-half by each for purposes of
    the annual exclusion and unified credit.
  • D. Cumulative Nature of Gift Tax. Computation of
    gift tax is cumulative in nature. The marginal
    tax rate depends on both the taxable gifts of the
    current and prior periods.

  • III. Gift Tax Formula
  • E. Unified Credit. Prior to 1977, the Code
    allowed a 30,000 specific exemption. The
    exemption was repealed and replaced by the
    unified credit. The unified credit amount has
    changed over the years. A table showing the
    amount of the unified credit and credit
    equivalent is provided on the inside back cover.
    In 2004, the credit amount is 345,800 and
    remains at this level through 2009. In 2010, the
    credit will be 330,800, the tax on 1 million at
    a top rate of 35. There is no credit allowed for
    taxable gifts made prior to 1977.

  • IV. Transfers Subject to the Gift Tax.
  • A. Transfers for Inadequate Consideration.
    Property transferred for less than adequate
    consideration in money or money's worth is deemed
    a gift. A transfer is subject to the gift tax
    even though not entirely gratuitous if the value
    of the property transferred exceeds the value of
    money or other consideration given.
  • 1. Bargain Sales. Family members may wish to
    transfer property at less than adequate and full
    consideration. A part-sale, part-gift will then
    occur. The amount of the gift is the difference
    between the sales price and the property's FMV on
    the date of the transfer.
  • 2. Transfers in Normal Course of Business. A
    transfer arising in the ordinary course of
    business, which is bona fide, arm's length, and
    free from any donative intent is considered made
    for adequate consideration.

  • B. Statutory Exemptions from the Gift Tax.
  • 1. Payment of Medical and Tuition Expenses. A
    qualified transfer is not treated as a gift. A
    qualified transfer is defined as an amount paid
    on behalf of an individual to an educational
    organization for tuition or to any person who
    provides medical care as payment for such medical
    care. The payment must be made directly to the
    educational institution or the person or entity
    providing the medical care. It includes tuition,
    but not room, board and books. The identity of
    the person benefiting is not important and does
    not need to be a relative. If payments made are
    for the support of an individual under state law,
    the payments do not constitute a gift. State law
    determines the definition of support.
  • 2. Transfers to a political organization are not
    considered gifts.

  • B. Statutory Exemptions from the Gift Tax.
  • 3. Under Section 2516 property settlements in
    connection with a divorce are exempted from being
    treated as a gift. To come under these
    provisions, the spouses must adopt a written
    agreement concerning their marital property
    rights and the divorce must occur during a
    three-year period beginning one year before the
    agreement is made.
  • 4. People may disclaim a gift if they are old,
    ill or very wealthy. States provide disclaimer
    statutes, which allow an individual to disclaim a
    gift. People making a qualified disclaimer will
    be treated as though they never received the
    property. State law and/or another provision in
    the will address how to determine who will
    receive the property after the original
    beneficiary declines to accept it. A qualified
    disclaimer must meet the four tests listed on p.
    C12-10. (Contrast with earning income and saying
    give it to my relative.) Assignment of income

  • C. A gift does not occur until a transfer becomes
    complete. A gift is complete and thus is deemed
    made and valued when the donor has parted with
    dominion and control so as to leave him without
    power to change its disposition, whether for his
    own benefit or the benefit of another.
  • 1. A transferor who conveys property to a
    revocable trust has not made a completed
    transfer. If the trustee makes a distribution
    from a revocable trust to a beneficiary, a
    completed gift is made.
  • 2. Transfers to an irrevocable trust may not be
    deemed complete with respect to the portion of
    the trust that the creator keeps control over.
    If a donor reserves any power over the property's
    disposition, the gift may be wholly or partially
    incomplete depending upon the facts in the case.
    A gift is incomplete to the extent the donor can
    name new beneficiaries or change the interests of

  • D. Valuation of Gifts.
  • 1. General Rules. All gifts are valued at FMV on
    the date of the gift. FMV is the price at which
    such property would change hands between a
    willing buyer and a willing seller, neither being
    under any compulsion to buy or sell, and both
    having reasonable knowledge of relevant facts.
  • 2. Life Estates and Remainder Interests. The
    value of a transfer of a life estate or a
    remainder interest is determined based upon
    actuarial tables found in Appendix H. Table S is
    used for valuing life estates and remainders and
    Table B for term certain interests. The interest
    rate is to be revised every month to the rate
    that is 120 of the Federal midterm rate
    applicable for the month of the transfer. (See
    Examples C12-19 through C12-22.) You may at this
    point wish to use the Stop and Think example,
    which illustrates the effect the age of the
    income beneficiary has on the value of the
    remainder interest.

  • D. Valuation of Gifts.
  • 3. Special Valuation Rules Estate Freezes.
    Congress became concerned that individuals were
    able to shift wealth to other individuals,
    usually in a younger generation, without paying
    their fair share of the transfer taxes. An
    approach commonly used was the estate freeze,
    where a corp was recapitalized. In 1990 Congress
    addressed this problem by enacting new Chapter 14
    (Secs. 2701 through 2704). These rules are too
    complex for discussion here. Several examples
    are provided in the text on p. C12-13.

  • E. Gift Tax Consequences of Certain Transfers.
  • 1. Funding a joint bank account is an incomplete
    transfer. A gift occurs when one party withdraws
    an amount in excess of the amount they deposited.
  • 2. A completed gift occurs when a transferor
    titles real estate or other properties in the
    names of him and another as joint tenants. Each
    joint tenant is deemed to have an equal interest
    in the property. The person furnishing
    consideration for the property is deemed to have
    made a gift to the other joint tenant in an
    amount equal to the value of the donee's pro rata
    interest in the property.
  • 3. Naming of another as beneficiary on a life
    insurance policy is an incomplete transfer. If
    the owner of a policy irrevocably assigns all
    rights in the policy to another, a completed gift
    has been made. Ownership rights include the
    ability to change the beneficiary, borrow against
    the policy, and cash the policy in for its cash
    surrender value. The payment of premiums on a
    policy is considered a gift to the policy's owner
    in the amount of the premium paid.

  • E. Gift Tax Consequences of Certain Transfers.
  • 4. A power of appointment exists when a person
    transfers property and grants someone else the
    power to specify who will eventually receive the
    property. Powers can be general or special. A
    person possesses a general power of appointment
    if he has the power to appoint the property to
    himself, his creditors, his estate, or the
    creditors of his estate. A gift occurs when a
    person exercises a general power of appointment
    and names some other person to receive the
    property. The gift is made to the person
    receiving the property. The exercise of a power
    of appointment in favor of the holder of the
    power is not a gift.
  • 5. A net gift occurs when an individual makes a
    gift to a donee who agrees to pay the gift tax as
    a condition to receiving the gift. The amt of
    the gift is the excess of the value of the
    transferred property over the amount of the gift
    tax paid by the donee.

  • V. Exclusions
  • A. The amount of the gift tax exclusion is
    11,000 for 2005. It is available annually for
    an unlimited number of donees. The exclusion is
    indexed for inflation with adjustments rounded to
    the next lowest multiple of 1,000.
  • B. Present Interest Requirement. A donor
    receives an exclusion for a gift only if it is a
    gift of a present interest.
  • 1. A present interest is an unrestricted right to
    the immediate use, possession, or enjoyment of
    property or the income from property.
  • 2. A future interest is the opposite of a present
    interest. Gifts of a future interest are not
    eligible for the annual exclusion. A future
    interest is a legal term and includes reversions,
    remainders, and other interests..., which are
    limited to commence in use, possession, or
    enjoyment at some future date or time.

  • V. Exclusions
  • 3. Parents creating trusts for children under the
    age of 21 can provide that income be accumulated
    in the trust and the trust will qualify for the
    annual exclusion provided the trust meets the two
    Sec. 2503 trust requirements on p. C12-17.
  • 4. A Crummey trust is a technique that allows a
    donor to set up a trust and obtain an annual
    exclusion. The trust can terminate at whatever
    age the donor specifies and can be created for an
    individual of any age. A "Crummey power"
    entitles each beneficiary to demand a
    distribution of the lesser of a specific amount
    or the amount transferred to the trust that year.
    If the power is not exercised by a certain date,
    it expires. The demand power is held to be a
    present interest.

  • VI. Gift Tax Deductions
  • A. Marital Deduction. The marital deduction
    results in tax-free interspousal transfers.
    There is an exception for terminable interests.
  • 1. The marital deduction is unlimited. Transfers
    of community property are eligible for the
  • 2. Gifts of Terminable Interests - A terminable
    interest ends or is terminated when some event
    occurs (or fails to occur) or a specified time
    passes. A marital ded is denied only when the
    transfer is a nondeductible terminable interest.
  • 3. Under QTIP provisions, transfers of qualified
    terminable interest property are eligible for the
    marital deduction. Donors can take the marital
    deduction without having to grant their spouse
    full control over the property. The deduction is
    elective. If the donor claims the marital ded,
    the donee-spouse must include the QTIP property
    in their estate.

  • B. Charitable Contribution Deduction. Gifts to
    charitable organizations do not have to be
    reported on a gift tax return provided a
    charitable contribution deduction is available
    and the charitable organization receives the
    donor's entire interest in the property. There
    is no percentage limitation for a charitable
    contribution for gift tax purposes. An income
    tax deduction can also be claimed subject to the
    percentage of AGI limitations. (See Example
  • 1. A gift tax deduction is allowed for a gift to
    a charitable organization. A deduction is
    available for gifts to the categories of
    organizations on p. C12-21.
  • 2. Split-Interest Transfers. Special rules apply
    when a transfer is made for both private and
    public purposes. An example would be a gift of a
    residence made to a sister for life, and with the
    remainder to a college or university.

  • VII. The Gift-Splitting Election
  • The gift-splitting provisions allow spouses to
    treat a gift that is made to a third party as if
    each spouse had actually made one-half of the
    gift. Each year's election stands alone and is
    not binding on future years. Upon the death of
    the actual donor or the spouse who consented to
    gift splitting, the amount of such decedent's
    adjusted taxable gifts must be included in the
    estate tax base. Adjusted taxable gifts include
    only the portion of the gift that is taxable on
    the gift tax returns filed by the donor-decedent.
    The Stop and Think example at this point
    illustrates a situation where gift splitting may
    not be desirable.

  • VIII. Computation of the Gift Tax Liability
  • The gift tax computation is a cumulative process.
    All previous gifts made in 1932 or later years
    plus the taxable gifts for the current year
    affect the marginal tax rate at which the current
    gifts will be taxed.
  • Congress enacted a unified credit for transfers
    made in 1977 and later years. The amount of the
    credit has been increased over the years. In
    2004 the credit is 345,800 and will remain this
    amount through 2009. Any credit used in
    post-1976 gift transfers reduces the amount of
    the credit currently available.

  • X. Basis Considerations for a Lifetime Giving
  • Prospective donors should consider lifetime
    gifts. There are estate tax savings, and income
    tax savings through the removal of income to a
    return with lower marginal tax rates. There are
    disadvantages as well.
  • A. Carryover basis rules apply to property
    received by gift. All of the gift taxes paid are
    added to the donor's basis for pre-1977 gifts.
    For post-1976 gifts, only the gift tax on
    appreciation in the property's value is added to
    the donor's basis. In no event can this
    adjustment plus the donor's basis exceed the FMV
    of the property on the date of the gift. If the
    FMV is less than the donor's basis on the date of
    the gift, the FMV is the donee's basis for
    purposes of determining loss. No gain or loss is
    recognized if the donee sells the property for an
    amount between the FMV and the adjusted basis.
    Prospective donors should sell property that has
    declined in value instead of gifting it.
  • B. Property received from a decedent has a basis
    equal to its FMV on the date of death or
    alternate valuation date.

  • XI. Below Market Loans Gift Income Tax
  • One of the most interesting issues in recent
    years has been whether interest-free loans
    constitute a gift. Historically the government
    has held that a gift of the foregone interest
    occurs in each period the loan is outstanding.
    The lower courts had held that interest-free
    demand loans did not constitute a gift. The
    Supreme Court held in the Dickman case (1984)
    that the gratuitous transfer of the right to use
    money is a transfer of property for purposes of
    determining whether a gift is made. The Court
    did not address how to value the gift.

  • XI. Below Market Loans Gift Income Tax
  • A. General Rules. Section 7872 provides
    definitive rules concerning both the income and
    gift tax consequences of below-market loans. The
    lender is treated as making a gift to the
    borrower and receiving interest income. The
    borrower is treated as paying interest expense.
    In the case of a demand loan, the lender is
    treated as making a gift in each year the loan is
    outstanding. The foregone interest is treated as
    being retransferred from the borrower to the
    lender on the last day of each calendar year the
    loan is outstanding. The lender reports the
    foregone interest as income for the year. The
    borrower gets an interest expense deduction
    unless one of the rules limiting the interest
    deduction applies.

  • B. De Minimis Rules. Neither the income nor the
    gift tax rules apply to any gift loan made
    directly between individuals for any day on which
    the aggregate loans outstanding between the
    borrower and the lender are 10,000 or less. All
    loans are counted irrespective of their interest
    rate. For loans of 100,000 or less, the amount
    of interest income and expense that is imputed
    for income tax purposes is limited to the amount
    of net investment income of the borrower. If the
    borrower's net investment income for the year is
    1,000 or less, the amount of net investment
    income is treated as zero.

  • XII. Tax Planning Considerations.
  • A. Tax-Saving Features of Inter Vivos Gifts.
  • 1. If gifts are made to several individuals early
    in a person's lifetime, substantial amounts of
    property can be transferred free of tax- Annual
  • 2. Post-gift appreciation is removed from an
    estate through gifting property.
  • 3. With one exception, gift taxes paid by the
    donor are removed from the transfer tax base.
    Gift taxes paid on gifts made within three years
    of death are included in the tax base for estate
    tax purposes.

  • XII. Tax Planning Considerations.
  • 4. The compression of income tax rates beginning
    in 1987 has lessened the benefits of income
    shifting. Income tax benefits that do accrue
    will do so over a period of years and may become
    quite sizable.
  • 5. Gift in Contemplation of Donee-Spouse's Death.
    A terminally ill spouse may have few assets. If
    they die, their unified credit may be wasted. If
    the healthier spouse is wealthy, gifts can be
    made to the terminally ill spouse to take
    advantage of that spouse's unified credit. (That
    spouse will leave the assets to kids.)
  • 6. All states except Nevada levy a death tax. In
    most states with a gift tax, the state tax cost
    of lifetime transfers is lower than for transfers
    at death.
  • 7. When charitable transfers are considered, the
    income tax implications should be considered as
    well. Transfers during one's lifetime are
    eligible for both the gift tax charitable
    contribution deduction and the income tax
    charitable contribution deduction.

  • B. Negative Aspects of Gifts.
  • 1. The donee receives no step-up in basis for
    property acquired by gift. Also, keep in mind
    that any gain on the sale of gifted property is
    likely to be taxed at a 15 rate and property
    remaining in the estate may be taxed at a rate as
    high as 48.
  • 2. Prepayment of Estate Tax. A donor making
    gifts in excess of the exemption equivalent must
    pay a gift tax. The tax paid during the donor's
    lifetime reduces the amount of estate taxes to be
    paid. The payment of gift taxes results in the
    prepayment of estate taxes. Time value of money.

  • XIII. Compliance and Procedural Considerations.
  • A. Donor files Form 709 (United States Gift Tax
    Return) or a simpler Form 709A when annual gifts
    to an individual exceed 11,000. A return is not
    filed for gifts to charitable organizations if
    the gift is deductible and the organization
    receives the donor's entire interest in the
    property. A return is not filed for gifts to a
    spouse, unless the gift to the spouse is a
    qualified terminable interest.
  • U.S. persons who receive aggregate foreign gifts
    or bequests in excess of 11,000 a year that they
    treat as gifts or bequests must report such
    amounts as prescribed by the Regulations. The
    11,000 is to be indexed for inflation.
  • B. Gift tax returns must be filed on a calendar
    year basis, by April 15 after the gift year. An
    extension for the filing of the income tax return
    is deemed an automatic extension for the filing
    of the gift tax return. Estimated payments are
    not required for gift taxes.

  • XIII. Compliance and Procedural Considerations.
  • C. In order for gifts to be computed under the
    gift-splitting provisions, both spouses must
    consent to gift splitting by one of the ways
    listed on p. C12-31.
  • D. A gift tax return is necessary for gift
    splitting even if no gift tax return is due.
    Form 709A can be filed.
  • E. The gift tax is paid by the donor and, if the
    spouses consent to gift splitting, the entire
    gift tax is a joint and several liability of the
  • F. The determination of value for a gift is one
    of the most difficult problems. This is
    especially true for stock in a closely held
    business, an oil and gas property, or land in an
    area where few sales occur. If property is
    difficult to value, it should be appraised before
    filing the gift tax return.
  • 1. Section 6662 imposes a penalty at varying
    rates on underpayments of gift and estate taxes
    resulting from a valuation understatement.

  • XIII. Compliance Procedural Considerations.
  • G. Statute of Limitations. The statute of
    limitations is three years for gift tax purposes.
    This is extended from three to six years if the
    donor omits from the gift tax return gifts whose
    value in total is more than 25 of the gifts
    reported on the return. If no return is filed,
    the tax may be assessed at any time. Once the
    statute of limitations has expired, the IRS
    cannot argue that taxable gifts of prior periods
    were undervalued (and thus that the current
    period's gifts should be taxed at a higher rate
    than that used by the donor) as long as a gift
    tax was paid on the earlier gifts. For gifts
    after August 5, 1997, this rule applies even if
    the donor paid no gift tax.

  • Court Case Briefs
  • Arthur W. Clark,, 65 T.C. 126 (1975).
  • Arthur Clark made gifts of interests in Central
    Wisconsin Motor Transport Co. stock, which was
    the principal of two Clifford trusts that had
    been set up for the benefit of Clark's two sons.
    In the years of these gifts, Clark claimed the
    then-applicable annual gift tax exclusion of
    3,000 per donee in his annual gift tax returns.
    The IRS contended that the stock represented
    future interests and the gift tax exclusion was
    not allowable. The court upheld the common law
    doctrine of merger under Wisconsin law, which
    meant that the income beneficiaries had all the
    rights and full possession of the stock upon
    execution of the principal interests in the
    stock. The gift tax exclusion was therefore

  • U.S. v. Ray Dodge, 443 F. Supp. 535 (DC OR,
  • Ezra Bonnie Royce were brothers who engaged in
    several very successful joint businesses. Bonnie
    had no children and made an oral agreement with
    Ezra in 1938 that one-half of Bonnie's estate
    would go to Ezra's only child, Eunice, if Ezra
    took care of Bonnie's business and served as
    executor for Bonnie's estate with no pay. Ezra
    fulfilled these obligations. The brothers were
    later estranged and Bonnie prepared new will
    which did not include Eunice. Upon Bonnie's
    death Eunice sued to have the 1938 agreement
    recognized and to collect one-half of Bonnie's
    estate. Such recovery was granted, two years
    after Ezra's death. The IRS tried to include the
    right to this property in Ezra's estate as a
    taxable gift by Ezra to Eunice because Eunice was
    only entitled to the property because Eunice
    fulfilled his obligation to Bonnie. The court
    held that the right to this property was
    uncertain enough at the time of Ezra's death that
    Ezra could not have passed this right on to
    Eunice. Ezra's estate was not liable for tax
    thereon or to include the "gift" in the estate.
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