- Gift splitting allows a married couple to combine their individual gift tax exemptions to help enhance the benefits of tax-free gifting.
- This process is not automatic and the ability to split gifts requires that certain prerequisites are met, including the consent of both spouses on a filed federal gift tax return.
- In some situations, splitting gifts could create unfavorable tax consequences—couples should consider obtaining the advice of a tax advisor prior to making a gift splitting election.
Just as married couples can jointly file their income tax return, federal tax law allows couples to share their gift tax exemptions—allowing gifts made by one spouse to be considered made one-half by each spouse.1
This concept is known as "gift splitting" and it allows the spouse who desires to make a tax-free gift (the "donor" spouse) to utilize the non-donor spouse's annual gift exclusion or lifetime unified gift and estate tax exemption (lifetime exemption). While this may appear relatively straightforward, it is critical that both spouses understand the rules related to gift splitting to protect against unintended consequences that could be costly in the long run.
Gift and estate tax basics
Before diving into the particulars surrounding gift splitting, it is important to review and fully understand foundational concepts related to federal gift and estate taxes; specifically, the annual gift exclusion, lifetime exemption, and the generation-skipping transfer tax (GSTT) exemption.
- The annual gift exclusion amount is set at $15,000 per person in 2021. This means that an individual can gift up to $15,000 per recipient without reducing their lifetime exemption, being required to report the gift to the IRS, or pay federal gift tax.
- The lifetime exemption represents the amount that an individual may gift during their lifetime (in excess of annual gift exclusions) or pass to beneficiaries at death, free of federal gift or estate tax. The lifetime exemption is currently set at $11,700,000 per person in 2021.
- The GSTT exemption allows the earmarking of certain gifts that skip a generation (or are transferred to anyone more than 37.5 years younger than the donor), or are made in trust for the benefit of multiple generations
Further, a GSTT exemption is separate from the gift and estate tax exemption and can be applied to gifts made either during life or at death.
The distinction is whether the donor allocated their GSTT exemption to the assets being transferred (up to $11,700,000), making these assets exempt from gift and estate tax and GSTT. A common example is a gift from a grandparent (1st generation) to a grandchild (3rd generation), which skips a child (2nd generation). The gifted amount will not be included in the child's estate and will not be subject to federal estate tax when the child dies, therefore "skipping" a generation of taxation.
With these points in mind, let's look at a simple example of gift splitting:
Jack and Sarah are married, both US citizens, and live in Massachusetts. Jack decides that he wants to gift $30,000 to their daughter, Ashley. If Sarah consents to split this gift with Jack, the gift is recognized as $15,000 being transferred individually from each spouse to Ashley. By splitting this gift, Jack and Sarah are individually maximizing the use of their $15,000 annual gift exclusions.
How gift splitting works
There are several prerequisites which need to be met for a gift to be split between spouses:
- The couple must be legally married under state law.
- Each spouse must be a US citizen or resident during the year in which the gift is made.
- Both spouses must provide their consent to the IRS to split gifts.
- The spouse making the gift cannot provide the non-donor spouse a general power of appointment over the assets that are gifted.
To consent to split gifts, the donor must complete and file a federal gift tax return (Form 709), which the non-donor spouse must also sign, providing their consent to split gifts for the calendar year applicable to the gift tax return. A married couple typically has up until the tax filing deadline for the prior year to elect to split gifts made in the prior year.2 If the couple already filed a federal gift tax return consenting to split gifts and wish to revoke their consent, they must do so before the tax filing deadline; otherwise, the consent to split gifts that was previously provided becomes irrevocable.3
It is important to note that if consent to split gifts is provided by the non-donor spouse, all gifts must be split in the year in which consent is provided. A married couple cannot choose which gifts will be split and which will not be split within the same year. If this poses an issue for a married couple's gifting plans, the couple might consider making gifts over 2 or more years, where in one year the couple makes the gift splitting election and in other years they do not.
Furthermore, post-death consent may be provided by the deceased spouse's executor/representative to split gifts if all gift splitting prerequisites have been met.4 The gift(s) attempting to be split must have been made prior to the deceased spouse's death. If the surviving spouse makes gifts after the deceased spouse's death, these gifts may not be split.5
Finally, if either spouse makes a gift that exceeds the couple's combined annual gift tax exclusion ($30,000 in 2021), or if each spouse make gifts that exceed that spouse's individual annual gift tax exclusion ($15,000 in 2021), both spouses will need to file their own federal gift tax return and each spouse will need to provide their consent to split gifts on the other spouse's return.6 Each gift tax return should also disclose one-half of the amount over the combined annual exclusion as a lifetime gift. If gifting to a grandchild, or someone who receives a gift, who is more than 37.5 years younger than the donor, each spouse's available GSTT exemption is automatically allocated to the gift unless they voluntarily opt out of applying GSTT exemption on their gift tax return.
Hypothetical example: Giving more than the annual gift exclusion amount
Jack decides to gift $50,000 to daughter Ashley in 2021 and wife Sarah elects to split this gift with Jack. The couple meets all required gift splitting prerequisites. Jack completes a federal gift tax return, which Sarah signs, consenting to gift splitting in 2021. Accordingly, each spouse is deemed to have made a $25,000 gift to Ashley. Since this amount is $10,000 more than the annual gift exclusion of $15,000 per person, Sarah will also need to file a gift tax return and Jack will need to provide his consent on Sarah's return to split gifts. Both Jack and Sarah will need to disclose on their respective gift tax return that they are making a $10,000 lifetime gift (in excess of annual gift tax exclusions).
Each spouse's respective $10,000 lifetime gift will reduce each of Jack and Sarah's current $11,700,000 lifetime exemptions by $10,000. Assuming Jack and Sarah have not used any of their lifetime exemption up to this point, they would each have $11,690,000 in remaining exemption based upon the 2021 lifetime exemption amount. If Jack and/or Sarah had already used their full $11,700,000 lifetime exemptions by making prior lifetime gifts, this $10,000 lifetime gift would be assessed a gift tax at the current rate of 40%, or $4,000 ($8,000 total), which Jack and/or Sarah would be responsible for paying.
5 common pitfalls to avoid when splitting gifts
While the prerequisites for spouses to gift split appear to be relatively straightforward, be mindful that failing to complete or qualify under any one prerequisite will result in gift splitting being disallowed. Below are 5 common pitfalls to avoid when attempting to split gifts.
- Failing to make the gift splitting election. The donor spouse must file a federal gift tax return and the non-donor spouse must provide their consent to split gifts (and file their own gift tax return if the total gift exceeds $30,000 or if they made another gift that exceeds $15,000). This is the only available method to elect to split gifts.
- Spouse benefitting from the gift. Gift splitting is generally not allowed if the non-donor spouse receives or benefits from the gift, or if the non-donor spouse is given a general power of appointment over the gifted assets. As an example, if the donor spouse makes a gift to a trust in which the non-donor spouse is a beneficiary and/or has a general power of appointment, this gift would generally not be eligible to be split between spouses.
- Making a future interest gift. Only "present interest" gifts can qualify for the $30,000 annual gift exclusion. This applies mainly in the context of a gift to a trust, where the beneficiary has no current right to receive or withdraw the trust property. This would be considered a "future interest" and would count against the donor's lifetime exemption. To address this, beneficiaries of an irrevocable life insurance trust (ILIT) are often given a short window of time after a gift is made—30 days is common—during which they may withdraw their share of the gift, up to the annual exclusion amount of $15,000 in 2021 per grantor (donor), per beneficiary (or $30,000 in 2021 in the case of a married grantor expected to split gifts).
- Attempting to split gifts with a non-US citizen or non-US resident. Both spouses must be US citizens or residents to split gifts.
- Overlooking the value in meeting with a tax advisor prior to making an annual or lifetime gift. Everyone's tax situation is different. Analyzing the rules and risks ahead of making an annual or lifetime gift with a qualified tax professional will help to reduce the chance of unintended consequences.
Gift splitting in community property states
If you live in a community property state which assesses a state estate tax, it is important to have properly drafted documents that are flexible enough to take advantage of both federal and your state's exemption amounts. The rules vary greatly among these states but, generally speaking, assets in community property states are characterized as either "community property" or "separate property."
- Community property includes all assets acquired during the marriage, except those assets received by gift or inheritance. Common examples include salary or wages. It is not dependent upon where the couple lives at the time of the gift.
- Separate property is classified as all assets belonging to either spouse that were acquired prior to the marriage and assets acquired during the marriage by gift or inheritance.
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 separate property, the couple can utilize gift splitting to characterize the separate property gift as being made one-half by each spouse.
Community property state example
John and Rebecca reside in Arizona, a community property state, and John would like to gift $80,000 to their son, Matthew, from an inheritance that John received from his parents (i.e., separate property). John and Rebecca can split this gift so it is considered to be made one-half by each spouse, or $40,000 each. John would need to timely file a federal gift tax return with Rebecca's consent to gift splitting and disclose a $25,000 lifetime gift ($40,000 less John's annual gift exclusion of $15,000). Rebecca would need to timely file a gift tax return providing John's consent to gift splitting and disclosing a $25,000 lifetime gift as well.
Instead of making the gift from John's separate property, if John and Rebecca were to make an $80,000 gift to Matthew from their community assets, this gift would automatically be considered to have been made one-half by each spouse. Rebecca would be considered a donor of one-half of the gift, so she would not need to provide her consent to gift split, but she would still need to file a gift tax return disclosing the $25,000 lifetime gift (as would John).
For more detail, read: Don't take the "state" out of estate planning
Weighing the options and assessing risks of gift splitting
In certain circumstances, it could benefit a married couple to decide not to gift split. Let's examine 2 risks involved with gift splitting and a few hypothetical examples to help illustrate potential changes in the lifetime exemption.
Key risk #1: Reduction in the lifetime exemption
The current $11,700,000 lifetime exemption has risen substantially over time. The lifetime exemption was set at $5,490,000 per person in 2017, then jumped up to an $11,180,000 per person exemption in 2018. This substantial increase was due to the passage of the Tax Cuts and Jobs Act of 2017 (TCJA). The TCJA is due to expire at the end of 2025.
It is also important to note that in the past, going back to 2012, there has been a question as to whether the IRS would "claw back" lifetime gifts that were made in a year when the lifetime exemption was higher than the year in which the donor of the gift passes away.
The Treasury Department and the IRS issued final regulations in 2019 stating that the IRS will not seek to claw back gifts made while the TCJA's larger exclusion amount was in effect, even if the donor passes away after the lifetime exemption amount has decreased.7 This anti-clawback regulation could be changed by future tax legislation, but any changes would be unlikely (although possible) to apply retroactively.
In addition, with discussions about tax reform currently in full swing, there is some possibility that we could see the lifetime exemption reduced sooner than the expiration of the TCJA and to perhaps an even lower lifetime exemption amount. One current proposal suggests a reduction in the lifetime exemption to $3,500,000 per person, with a graduated estate tax rate starting at 45%.
With these considerations in mind, the following 3 hypothetical scenarios illustrate how gift splitting could impact a married couple's lifetime exemption. As you review these scenarios, pay attention to the following key points:
- Electing to split a substantial lifetime gift followed by a reduction in the lifetime exemption could put a couple's estate at a significant disadvantage from a gift and estate tax perspective.
- Utilizing the vast majority, or all, of one spouse's lifetime exemption could prove to be a more productive option, but this depends upon the figures and circumstances involved. When considering whether to split gifts, seek the advice of a tax advisor to help examine the pros and cons in your specific situation.
Hypothetical #1: $11,700,000 lifetime exemption in 2021
Let's assume that Jack makes a $10,030,000 gift in 2021 and he timely files a federal gift tax return, which Sarah signs, consenting to gift splitting in 2021. Jack and Sarah would each need to file a federal gift tax return, disclosing respective lifetime gifts of $5,000,000 in 2021 ($5,015,000 gift per spouse, less each spouse's $15,000 annual gift exclusion).
If Jack and Sarah do not elect to gift split, only Jack's annual gift exclusion of $15,000 could be applied to the $10,030,000 gift. Jack would need to timely file a federal gift tax return disclosing a $10,015,000 gift.
As shown here, electing to split the $10,030,000 gift shows a slight advantage in preserving an additional $15,000 in combined lifetime exemption between Jack and Sarah. If Jack and Sarah both died in 2021 (the year in which the gift was made), there would be no difference in the amount that could be passed estate tax-free to their beneficiaries. Despite the gift splitting election showing a favorable outcome when reviewing 2021 in isolation, if the lifetime exemption is decreased in the future, as shown in the hypothetical examples to follow, the decision whether to split (or not split) the $10,030,000 gift in 2021 could have a significant impact, especially given any potential changes to estate law in the coming years.
Hypothetical #2: Reduction of lifetime exemption to $6,700,000 in 2026
Looking beyond 2021, if we see the lifetime exemption decrease to $6,700,000 in 2026 and Jack and Sarah elected to split their $10,030,000 gift in 2021, they would have only $3,400,000 in combined lifetime exemption remaining in 2026.
Conversely, if Jack and Sarah did not elect to gift split in 2021 and chose to apply only Jack's lifetime exemption to the $10,030,000 gift, Jack would have no remaining exemption in 2026, but Sarah would have her full $6,700,000 federal estate tax exemption available. Based on these facts, if Jack and Sarah both died in 2026, they would pass a total of $16,700,000 (in excess of annual exclusion gifts) to their beneficiaries free of estate tax, which is $3,400,000 more than would have been able to pass estate tax-free if they elected to split their $10,030,000 gift in 2021.
Hypothetical #3: Potential reduction of lifetime exemption to $3,500,000
Similar to the reduction in the lifetime exemption to $6,700,000 as illustrated above, a further reduction in the lifetime exemption to $3,500,000 per person could leave Jack and Sarah without any available lifetime exemption if they elected to split the $10,030,000 gift in 2021.
In addition, if Jack and Sarah both died in a year when the lifetime exemption was $3,500,000, (having not split the 2021 gift), they would pass a total of $13,515,000 free of estate tax, which is $3,515,000 more than would have been able to pass estate tax-free if they elected to split their $10,030,000 gift in 2021.
Key risk #2: Divorce
Under the hypotheticals highlighted in this article, it could be more efficient for a married couple to use only one of the spouses' lifetime exemption for gifting and to preserve the non-donor spouse's exemption. But what if the couple proceeds with this gifting plan and then later divorces? One spouse would have their lifetime exemption substantially or fully available, while the other spouse may have used all (or a significant majority of) their exemption.
Once a donor spouse's lifetime exemption has been used, it cannot be recovered or split retroactively between both spouses. Also, if a couple were to divorce and one or both spouses remarry in the same calendar year, any gifts which took place that year prior to the divorce could not be split. While gift splitting could be less efficient in certain circumstances, it does level the playing field in applying both spouses' lifetime exemptions. The risk of divorce could be a factor to consider when structuring a gifting plan with a tax advisor.
Gift splitting is not a difficult concept to understand but applying the procedural rules and analyzing the current and future risks of splitting a gift can be far from simple. These complexities are then further exacerbated by potential changes in tax laws. Consider working with your Fidelity planning team to discuss how gifting impacts your overall financial plan. Your tax advisor can help identify any state and local tax implications of gifting as well as help examine the various ways that gifts can be made, including gifts into a trust. Remember to keep an eye on long-range strategies to help reduce the risk of collateral consequences and enhance the efficient use of available tax exemptions.