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George F. Bearup, J.D. Senior Legal Trust Advisor

4-Jan-22

Splitting Gifts- Deceptively Simple

Take-Away: The ability of spouses to split their gifts is a great opportunity to avoid paying gift taxes. However, there are several ‘traps’ to avoid when spouses split gifts. Perhaps the biggest ‘trap’ is ignoring the scheduled decrease in the spouses’ applicable exemption amount in 2026.

Background: The donor’s spouse, for gift tax purposes, may elect to be treated as the donor of one-half the value of the gifts the donor makes from his or her estate. [IRC 2513.] Accordingly, the gift tax liability can be split between two spouses, even though only one spouse possesses the wealth or the asset that is the subject of the gift. As a result of gift-splitting, a married couple can join in giving any number of individuals up to $30,000 per year in annual exclusion gifts without incurring gift tax liability, regardless of the fact that the funds that were actually the subject of the gift were the property of only one spouse. [Note: The federal gift tax annual exclusion amount increases to $16,000 per individual in 2022, so spouses with gift-splitting can transfer up to $32,000 per donee per year.]

  • Example 1: Ted wants to make a $20,000 gift to his daughter Chelsea in 2021. If Ted makes the gift by himself and his wife, Alice, does not consent to gift-splitting, Ted’s gift would exceed his annual exclusion, and either Ted would have to use a portion of his unified credit or, if that had been exhausted previously by Ted with gifts, Ted would be subject to a gift tax on $5,000. On the other hand, if Alice consents to treat half of Ted’s gift as having been made by her, then even though the gift was made from Ted’s funds, each spouse is deemed to have made a $10,000 gift to Chelsea for gift tax purposes. In this gift-splitting scenario, both gifts are absorbed completely by Ted and Alice’s annual exclusions.
  • Example 2: Ted and Alice, with two married children, have four grandchildren. Most all of their assets are in Ted’s name alone, which he inherited years ago. Ted wants to gift some of his inherited assets before the end of 2021. Ted and Alice elect to split gifts. Ted can give each of these six blood relatives up to $30,000 per year without incurring any transfer tax. If Ted decides to include the spouses of their children in this gift program, Ted increases the group of donees to 8 and can give each of these 8 donees up to $30,000 a year. Thus, with Alice consenting to make these gifts with Ted, together they can make gifts up to $240,000 per year, each and every year, without incurring any transfer tax liability and without using any of their unified credit.

While gift-splitting is an excellent way to avoid paying gift taxes, or consuming some of the donor’s available unified credit, there plenty of traps that need to be avoided in order to exploit the split gift opportunity.

Pitfalls to Avoid: There are plenty of technical rules and ‘hoops to jump through’ in making the decision to split gifts by spouses.

Election: To elect to split gifts, the donor must file a Form 709 Federal Gift Tax Return and the donor’s spouse must consent by checking a box on that return and sign it. If the gift exceeds $30,000 the spouse must file his/her own federal gift tax return. If two Form 709’s need to be filed, they should be mailed in the same envelop to help the IRS process the returns and avoid future correspondence from the IRS. [Form 709 Instructions, page 5.] The consent to split gifts cannot be made after the later of (i) April 15th of the year following when the gifts were made; or (ii) when the donor-spouse files the gift tax return. This means that the married couple is not able to file a gift tax return, reporting all of the gifts as having been made by one spouse, and then wait and see if the filed return is audited before electing gift-splitting. However, while a ‘late’ filed gift enables gift-splitting, a ‘late’ gift tax return cannot be filed if a Notice of Deficiency has already been sent by the IRS to the donor-spouse.

All Gifts: Once the election is made to split gifts, the spouses must split all gifts made to third parties for the calendar year. In short, there can be no ‘cherry-picking’ which gifts are split, and which gifts are not split between spouses. [Regulation 25.2513-1(b).]

No Split Gifts With a Noncitizen: To be eligible for gift-splitting, the donor’s spouse must be a S. citizen.

Divorce and Remarriage: To split gifts, the donor must be married at the time of the gift that is split. The donor is ineligible for gift-splitting if he/she divorces and either spouse remarries during the calendar year in which the gift was made. [IRC 2513(a).] Consequently, if spouses split gifts and then divorce in the same year, they should not remarry in the same year as the gift and their divorce. If there is a divorce after gifts have been split earlier in the calendar year, it might be wise to include a provision in the divorce settlement agreement to address the additional gift tax costs to the donor if the consenting spouse remarries in the same year as the gift.

Gifts of Future Interests: Gift-splitting can be used only for present interests. Consequently, a gift in trust qualifies for gift-splitting only if the beneficiary receives a present interest. This can be achieved only if the beneficiary possesses a Crummey withdrawal right over the transferred property to the trust.

Three-Year Rule: If the donor dies within three years of splitting a gift, some of the tax benefits may be lost. [IRC 2035.]

Benefitting Spouse: Gift-splitting is ineffective if the donor makes the gift to the spouse, rather than to a third party. No gift-splitting is possible if the donor’s spouse is given a general power of appointment over the transferred property, or if the spouse is a potential beneficiary of the gift. Accordingly, if the donor makes a gift to a trust of which the donor’s spouse is a beneficiary, gift-splitting is prohibited unless the chances of the spouse benefiting from the trust are extremely remote. If the spouse’s interest in the trust is ascertainable, i.e. severable, some of the gift to the trust can be split by the spouses. [Private Letter Ruling 200345038.]

  • Example 3: Ted makes a gift to a trust for the benefit of his wife Alice and their descendants. The trustee may distribute trust property for any of the beneficiaries’ health, support and maintenance. Because Alice could potentially receive a distribution from the trust of all trust property, the election to split gifts will not be effective as to Ted’s gift to the trust.
  • Example 4: Ted makes a gift to a trust for the benefit of his descendants. Alice, his wife, is given a withdrawal power over $5,000 of Ted’s gift to the trust, but she has no other beneficial interest in the trust. Because Alice’s interest in the trust is ascertainable and it can be severed from the balance of Ted’s transfer to the trust, Ted and Alice may not split $5,000 of Ted’s transfer to the trust, but they may split the balance of Ted’s gift.

No Valuation Discounts: Even though a spouse’s consent to gift-splitting causes a gift by the donor-spouse to be treated as made one-half by the consenting spouse, no fractionalization or other valuation discounts will apply merely because of that 50/50 attribution of one-half the gift to the consenting spouse. The gift is valued first by the donor spouse on Form 709, and only then it is split for gifts, and reported as a ‘net gift.’ As such, no valuation discount arises from spouses agreeing to split a gift by one spouse.

‘Sunset’ of the Applicable Exemption Amount: The currently large applicable exemption amount is set to sunset after December 31, 2025. Electing to split a substantial lifetime gift followed by the reduction in the lifetime applicable exemption amount could put a married couple’s estate at a disadvantage from an estate and gift tax perspective. An example explains this risk:

  • Example 5. Assume that Ted makes a $!0,030,000 gift in 2021 to his daughter Chelsea. Ted timely filed a Form 709 federal gift tax return, which Alice signs, consenting to split the $10,30,000 gift in 2021. Ted and Alice would each need to file a federal gift tax return, disclosing their respective lifetime gifts of $5,000,000 in 2021 ($5,015,000 gift per spouse, less each spouse’s $15,000 annual exclusion gift.) If Ted and Alice do not elect to gift split, only Ted’s annual exclusion gift of $15,000 could be applied to the $10,030,000 gift. Ted would need to timely file a federal gift tax return disclosing a $10,015,000 gift, against which Ted’s applicable exclusion amount would be applied, but not gift tax paid. Electing to split the $10,30,000 gift with Alice provides a slight advantage in preserving an additional $15,000 in combined lifetime exemption between Ted and Alice. The problem, however, arises when the applicable exclusion amount is drops in 2026 for both Ted and Alice.

    Assume that the applicable exemption amount drops to $6,700,000 in 2026 and Ted and Alice elected to split the $10,030,000 gift to their daughter Chelsea in 2021. Ted and Alice would have only $3,400,00 in combined lifetime exemption remaining to them starting in 2026. If Ted and Alice had not elected to gift split in 2021, and they chose to apply only Ted’s lifetime exemption to the $10,030,000 gift, Ted would have no remaining exemption in 2026, but Alice would have her full $6,700,000 federal estate and gift tax exemption available (dropping automatically from $11,700,000 starting in 2026 with the sunset.) If Ted and Alice both died in 2026, when the lower exemption amount is available, they would pass a total of $16,700,000 to their daughter Chelsea (in excess of annual exclusion gifts) free of federal estate tax. That amount  is $3,400,000 more than their estates would have been able to pass estate tax-free to Chelsea if Ted and Alice had elected to split their $10,030,000 gift in 2021. Thus, the decision to split large gifts between now and 2026 could actually cost more in federal estate taxes than if no gift-splitting occurred in 2021. That is a big risk to assume.

Opportunities: There are a couple of situations that are sometimes overlooked when a spouse makes a gift and gift-splitting might still be available:

Death of Spouse: The Personal Representative for a deceased spouse, or the guardian of a legally incompetent spouse, may sign the consent to split a gift made prior to the death of the deceased spouse. [Regulation 25.2513-2(c).] However, there can be no gift-splitting by the donor after their spouse’s death. [Revenue Ruling 55-506.]

Irrevocable- One Exception: While the election for gift-splitting is usually irrevocable, there is one exception to this general rule. Either spouse may rescind the election to split gifts if: (i) the consent was originally made on a return filed prior to April 15th  of the year after the gifts were made, and (ii) the consent is rescinded before April 15th of the year after the gifts were made. To rescind the election, either spouse may file in duplicate a signed statement of revocation with the IRS. [Regulation 25.2513-3(a)(1).]

Community Property: If community property is used to fund a gift, each spouse will automatically be deemed a one-half donor of the gift. However, if a married couple resides in a community property state and one of the spouses would like to split a gift made from their separate property, the couple can utilize gift splitting to characterize the separate property gift as being made one-half by each spouse.

Conclusion: Gift splitting by a married couple is not a difficult concept for them to understand. However, following the technical rules to gain the benefits of gift-splitting can prove to be a bit challenging to navigate. The even bigger challenge is to assess the risk of the spouses splitting a gift now when they consider the impact of the scheduled sunset in the donor(s)’ applicable exemption amount starting in 2026.