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Monday, November 22, 2021

Of Spousal Gifts and the Substance Over Form Doctrine

U.S. spouses each have a unified credit that allows for substantial gifting to third parties without requiring the payment of gift tax. What happens if one spouse has assets to be gifted away, but that spouse does not have sufficient remaining unified credit exemption to cover the gift and wants to use the exemption of the other spouse?


At times, the spouses can agree to split the gift for gift tax purposes, which treats 1/2 the gift as coming from each spouse. This allows the unified credit of the spouse not making the gift to be used to avoid gift tax on the 1/2 that such spouse is treated as making. However, it can be an imperfect solution if the spouse with the assets does not have enough unified credit to offset his or her 1/2 of the gift.


Oftentimes, the parties may contemplate having the party with the assets transfer them by gift to the other spouse (a tax-free gift under the gift tax marital deduction), and then the receiving spouse makes a gift to the third party applying his or her own unified credit. The question in these circumstances is whether the IRS will respect the transaction and allow the receiving spouse's unified credit to be applied to the gift to the third party, or whether it would seek to apply the "substance over form" doctrine to treat the gift as coming from the spouse who transferred the assets to the other spouse and does not have enough unified credit to fully cover the gift.


This is not a black and white issue. On one end of the spectrum, ideally, you have a transfer between the spouses occurring many months or years before the subsequent gift to the third party, with no intent to make a gift to a third party before the transfer between spouses, and the receiving spouse has no restrictions on the use of the received property and takes full and complete ownership over it. It is safe to say that the IRS would have an extremely difficult time imposing the substance over form transaction in this circumstance.


On the other end of the spectrum, there is an almost simultaneous transfer from one spouse to the other and then the gift to the third party, the recipient spouse is not treated as owning the asset for income tax purposes, and the recipient spouse effectively has no legal ownership or control of the asset or the ability not to make the transfer to the third party. In other words, you would have the facts of Smaldino v. Commissioner, a recent Tax Court case. In this case, the husband made a gift of an asset to his wife a day before she made the gift to a third party. The Tax Court applied the substance over form doctrine and treated the husband as the one that made the gift to the third party - thus, the unified credit of the wife could not be applied to the gift to reduce or eliminate gift taxes.


There were a number of particular facts that made it easier to sustain the substance over form argument. A review of those facts will help taxpayers avoid the application of the doctrine by avoiding as many of those facts as much as possible:


   a. The transfer to the spouse occurred the day before the transfer to the third party. Clearly, the more time between the transfers, the better.


   b. The recipient spouse did not receive real ownership of the transferred property so that she could have disposed of it other than by a subsequent gift. The court found that since the amount transferred was not even determined, pursuant to a valuation clause, until four months after the transfer, by that time the property had already been transferred by the wife. So the wife never had control of the property. Getting the recipient spouse true and effective ownership of the asset should be done.


   c. The transferred property was an LLC interest, but the tax return of the LLC never reflected even the one day of ownership of the wife. Her ownership was never reflected in an operating agreement, either. Thus, the income tax and gift tax reporting was inconsistent.


    d. Husband and wife had a prearranged plan for her to gift the received property, which the wife admitted.


   e. The gift tax appraisals did not separately value the interest passing from one spouse to the other and onto the recipient from a separate transfer that the husband made directly to the recipient. That is, the wife's ownership and transfer to the recipient was disregarded.

Smaldino v. Commissioner, U.S. Tax Court (November 10, 2021)

Thursday, November 18, 2021

Increases in Estate and Gift Tax Exemption Amounts Announced by IRS

We have gone from scrambling to deal with a decrease in the unified credit under proposed legislation, to now enjoying the 2022 inflation adjustments. Enjoy!

2022 Annual Gift Tax Exclusion - increased to $16,000 from $15,000. Good news, but makes it a little harder to do the math for mutliple gifts in your head.

2022 Estate/Gift/GST Exemption - increased to $12.06 million from $11.7 million.

2022 Annual Exclusion Gift to non-U.S. Citizen Spouse - increased to $164,000.

Let's not forget my favorite annual amount announcement - for calendar year 2022, the tax imposed under§ 4161(b)(2)(A) on the first sale by the manufacturer, producer, or importer of any shaft of a type used in the manufacture of certain arrows is $0.55 per shaft.

Rev.Proc. 2021-45

Clock is Ticking to Request Older Copies of Forms 706 and 709 from the IRS

 The IRS presently has a 75-year retention period for estate tax returns and related gift tax returns. It is going to reduce that period to 40 years. They are advising taxpayers who want copies of returns older than 40 years to request now (more precisely, by Feburary 11, 2022) or forever hold your peace. To obtain a copy, use Form 4506 to make the request. For more on this change of policy, visit the IRS website at