Take-Away: Spouses who decide to make large gifts at this time in order to use their large transfer tax exemptions need to think twice about electing gift-splitting. In addition, they need to be careful not to trigger the IRS’ step-transaction doctrine.

Background: When filing a gift tax return [Form 709] that reports a completed gift, either to individuals or to a trust, a married donor is faced with the decision whether to make an election to split gifts with his or her spouse. If the election is made to split the gift, all taxable gifts in the year elected are deemed to have been made one-half (50%) by each spouse, regardless of which spouse transferred the property. [IRC 2513; IRC 2652(a)(2).] By splitting the gift, both spouses can use their annual exclusion gifting opportunity [IRC 2503(b)] and their gift and generation skipping transfer tax exemptions without first equalizing their estates.

Consenting Spouse Not a Settlor: The consenting spouse can also benefit from a split-gift.  Although the amount of the gift that is split to a trust in which the consenting spouse is a beneficiary is limited to the ascertainable portion of the transfer that is attributable to the non-spousal interest, splitting gifts also enables the consenting spouse to remain a discretionary beneficiary of a trust sheltered with his or her own transfer tax exemption without requiring him or her to be the settlor of the trust that receives the gift. Therefore, the trust neither be treated as, nor qualify as a self-settled trust by the consenting spouse. If the consenting spouse is a beneficiary of the trust, the donor spouse may only elect to split gifts if the consenting spouse’s interest in the trust is ascertainable, severable and de minimis. [Revenue Ruling 56-439.] Even though the non-spousal interest may be split for gift tax purposes, a full one-half [50%] of the transferred amount or property will be treated as having been transferred by the consenting spouse for GST tax purposes. [[Treasury Regulation 26.2652-1(a)(4).]

A Wasted Exemption: There has been considerable activity in recent months with lifetime gifts in the belief that an individual’s lifetime transfer tax exemption will be dramatically reduced in the near future with a change in Administration and the need to generate revenues to deal with the pandemic relief programs. The question is whether gift splitting, or even equalizing spousal estates, risks unnecessarily the waste of one or both spouse’s lifetime exemption amount. The donor’s decision goes back to the way the 2017 Tax Act increased an individual’s transfer tax exemption, and how it is applied.

Bonus Exemption: A donor must first make taxable gifts that exhaust his or her original exemption that existed in 2017 before he or she will be able to achieve any benefit of the additional transfer tax exemption that the 2107 Tax Act created. That additional exemption, either called the temporary or bonus exemption, can only be used after the donor’s original exemption is used. [Proposed Regulation 106706-18.] Consequently, for a donor who decides to make a large gift now that are within the limits of his or her original exemption (prior to the scheduled sunset of the bonus exemption increase on January 1, 2026) they will have their remaining original exemption available to them. The donor will not be treated as having made taxable gifts with their bonus exemption that was made available to them at the time of the increase in their transfer tax exemptions when the 2017 Tax Act was enacted. Restated, a donor will not have taken advantage of his or her bonus exemption unless he or she first gifts an amount above his or her original exemption amount; the donor’s bonus exemption is set to disappear in 2026 (if not sooner if Congress decides to change the transfer tax laws.)

  • Gift-Splitting Is Tax Inefficient: For a married couple who intend to make gifts that exhaust no more than a single spouse’s current $11.58 million exemption, gift-splitting results in an inefficient use of the transfer tax exemption because, as a marital unit, neither spouse will fully maximize his or her increased exemption available before the transfer tax exemption level falls back to its 2017 level, i.e. the original exemption amount.
  • Example: Jack and Jill intend to make a large gift prior to the end of 2020. The asset is in Jack’s name alone. Jack, as the donor, makes a $11.58 million gift before the end of 2020. Jack and Jill do not split Jack’s gift. Jack will have used both his original exemption and his bonus exemption to shelter his $11.58 million gift from gift taxes. Although Jill will not make gifts large enough to have used any of her bonus exemption, her original exemption will still be available to her to be used in later years, e.g. after 2025. If Jack and Jill had split the $11.58 million gift in 2020, both Jack and Jill, as the consenting spouse, would have only used their original transfer tax exemptions. In later years, assuming the sunset has occurred, neither Jack nor Jill will have any of their original exemptions remaining, either to shelter later gifts from taxation, or to shelter the survivor’s estate from federal estate taxation. Consequently, splitting the 2020 gift of $11.58 million could cost Jack and Jill millions in future gift or estate taxes.
  • Use One Spouse’s Bonus Exemption First: Accordingly, married individuals who intend to make large gifts in excess of a single spouse’s current $11.58 million transfer tax exemption should prepare to fully utilize one spouse’s bonus exemption before the other spouse begins to make gifts or consents to split future gifts.

Intra-Spousal Gifts: For married couples who can afford to make large enough gifts, splitting such gifts in excess of the bonus exemption will also result in an inefficient use of their exemptions. The failure of the donor to split such large gifts with their spouse will result in the payment of a gift tax.

Step-Transaction Concerns: Married couples should consider each making separate gifts, using their own transfer tax exemptions. If the less wealthy spouse does not have enough assets necessary to make the gifts, the wealthier spouse can make an equalizing gift to the less wealthy spouse to use to make his or her gifts. However,  there is the concern that the IRS will claim that the less wealthy spouse’s gift was actually a gift by the wealthier spouse, which will result in the imposition of a gift tax. The policy behind the IRS’ step-transaction doctrine is to negate unnecessary intermediate steps in a transaction that were taken in order to bypass undesirable tax consequences that would result if the steps had been skipped. In such a situation, the IRS can disregard the intermediate steps. If the step-transaction doctrine is applied to the intra-spousal gift, the court will either ignore one or more of the various steps in the structure of the transaction, or collapse all the steps into a single transaction. In order to avoid the imposition of the step-transaction doctrine, the intra-spousal gift should be made at a time different from the donor-spouse’s gift (either before or after the donor’s gift, but with plenty of time between the intra-spousal gift and the later gift by the less wealthy spouse), and the asset transferred to the less wealthy spouse should not be similar, or the same, as what the donor spouse gave, and preferably, the donee of the gift will be different than the donee of the wealthier spouse.

Conclusion: With the renewed interest in lifetime gifts, married individuals will have to consider the benefits, and the risks, associated with reporting the taxable gift as a split-gift. A $5.79 million bonus exemption should not be squandered, nor should the consenting spouse waste their original exemption amount when the donor spouse’s own bonus exemption could have been used to shelter the same transfer from gift taxation.