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We are all aware of gift-splitting, and most of us have probably recommended that our clients double their annual gift tax exclusion amount by gift-splitting with their spouse. The rule is simple enough—a married couple can split a gift by one of the spouses so that each spouse is deemed to have gifted half—but there are intricacies to the rule that every advisor needs to be aware of.
Most gifts are subject to the gift tax, but a majority of people never pay gift tax, due to the $13,000 annual exclusion and $5 million lifetime exemption ($5,120,000 for 2012). Gift-splitting allows a married couple to double their exclusions by making joint gifts to third parties for gift tax purposes. So, for example, if Father makes a lump sum $25,000 gift to son, the couple can elect to split the gift, and the entire gift will be free of gift tax under the $13,000 annual exclusion which is doubled to $26,000 for the couple.
There are a few basic rules associated with gift-splitting:
- The gift must be made to a third party—i.e. the gift cannot be made to either of the spouses.
- At the time of the gift both spouses must be U.S. citizens or residents.
- The spouses must be married at the time of the gift.
- If the spouses divorce before the end of the year that they made the gift, neither can remarry before the end of the year.
- Both spouses must consent to gift-splitting.
- The spouse making the gift cannot give the consenting spouse a power of appointment over the gifted property.
Gifts Made Jointly to a Third Party and the Spouse
Under the first requirement, a gift that is made both to a third party and the spouse cannot be split unless the third party’s interest is ascertainable. In other words, the value of the gift being made to the third party must be determinable so that it can be separated from the gift to the spouse.
Once Elected, All Gifts During the Year Must Be Split
Once gift-splitting is elected, all eligible gifts must be split for that year; but that requirement is avoidable in some cases. As discussed in the previous paragraph, if a gift is made both to the spouse and a third party, the gift cannot be split unless the value of the third party’s interest is ascertainable when the gift is made. As a result, if gift-splitting is elected for a particular year, but the couple does not want to split another gift made that year, gift-splitting can be avoided for a gift by giving an unascertainable portion of the gift to the spouse—for instance, by granting the spouse an interest in the trust, distributions from which are entirely left to the discretion of the trustee.
Both Spouses Must Consent
Do not make the mistake of assuming a spouse will consent to gift-splitting. If the spouse refuses—for instance because the couple divorces later that year—it may be too late to revoke the gift.
Gift-Splitting and the Generation-Skipping Transfer Tax
If gift-splitting is elected for a particular year, each spouse will be treated as having made one-half of all the couple’s eligible gifts for generation-skipping transfer (GST) tax purposes. It is important to note that the deemed allocation rules relating to the GST exemption will be applied to both spouses’ portions of the gifts, so if some other allocation is desired, both spouses will need to file gift tax return to make the desired allocations.
Gift-Splitting Within Three Years of the Consenting Spouse’s Death
A gift made within three years of death will be pulled back into the grantor’s estate for estate tax purposes. Does that mean that a gift will be included in a consenting spouse’s estate if the consenting spouse dies within three years of the gift?
No. The consenting spouse is deemed to have made half the gift for gift and GST tax purposes only; a gift is not deemed split for estate tax purposes.
Yes, gift-splitting can go wrong for advisors who do not understand its intricacies. First, it is essential that a spouse’s consent is not assumed. If the couple divorces, or a spouse otherwise refuses to consent to the split, a plan could be thrown in disarray.
The second key is that a gift is not eligible for gift-splitting if the consenting spouse is given an interest in the gift. If a gift is made to a trust that has the consenting spouse and children as beneficiaries and distributions of principal and income from the trust are fully discretionary, the gift will not be eligible for gift-splitting since the value of the children's interests cannot be ascertained. If, without the gift split, the gift is sizeable enough to eat up the annual exclusion and the grantor spouse's exemption amount, the remaining gift will be subject to gift tax.
Finally, if gift-splitting is elected for one particular gift, all eligible gifts in that year must be split. It is still possible to do an end run around that rule by granting the consenting spouse an interest in the gift that has an unascertainable value.
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See also The Law Professor's blog at AdvisorFYI.