Generally speaking, hasn’t the income that’s being gifted already been subject to tax? If I made $100,000 last year, declared it on my returns, and paid taxes, why does the Fed need to know where I give it away?
The reason is that the Feds apply the amount given to the recipient’s modified AGI; they use the MAGI to compute the extra premium amounts you owe for Medicare Part D, etc. Therefore, all that federally-exempt income that your investments earn is indeed taxed and deducted from your federal benefit.