I Want My Exemption Back! Reconsidering Gift Splitting after The American Taxpayer Relief Act of 2012
February 7, 2013
Authored by: Brent Howard and Cynthia D. Kennedy
In 2012, the federal estate and gift tax exemption, which is the amount a person can give in life or pass at death before having to pay estate and gift tax, was $5,120,000 per individual. As the infamous “fiscal cliff” approached, the federal exemption was set to drop back to $1,000,000 per individual on January 1, 2013 if Congress did not pass new tax legislation. At that time, most commentators believed that Congress would compromise by lowering the exemption to $3,500,000, which was part of the Obama Administration’s tax plan.
Based on these assumptions, many clients entered into gifting plans in 2012, the primary goal of which was to use as much of the $5,120,000 exemption, or combined exemption of $10,240,000 for married couples, as possible before it was lost. Many married couples who could not give $10,240,00, transferred assets to a single spouse to allow that spouse to give close to or all of the spouse’s $5,120,000 exemption. This strategy would reduce the couples’ total estate and gift tax exposure if the exemption was reduced.
Then, Congress surprised us and passed The American Taxpayer Relief Act of 2012. After twelve years of temporary tax laws, Congress set a permanent estate and gift tax exemption of $5,000,000 adjusted for inflation from 2010. The exemption amount for 2013 is $5,250,000. Of course, permanence is relative inside the beltway, but at least any future change requires overt action by Congress and not as a result of a passive sunset.
Since the $5,000,000 plus inflation exemption has not been “lost”, many clients may wish they had not made their 2012 gifts. While the client cannot unwind the gifts, there are still options to consider.
First, the 2012 gifts still have the advantage of removing the value of the gifts plus anticipated appreciation out of the client’s estate.
Second, the client may be able to save some of his or her exemption if the client is married and the spouse agrees to split the gifts. A married couple can agree to split the gifts made by each other during a year and treat the total as being made one-half by each spouse. To split the gifts, the couple must: (1) be married at the time of the gift; (2) both be U.S. citizens or U.S. residents, which would subject both to U.S. estate and gift tax; (3) both consent to split all gifts made by each spouse during the year; and (4) demonstrate that the consenting spouse did not receive any part of the gift made by the donor spouse.
Gift splitting applies to all gifts made during a calendar year and makes each spouse jointly and severally liable for all gifts made by both spouses. Thus, the consenting spouse should be fully informed of all the gifts made by the other spouse and the affect the consent will have on his or her lifetime exemption and potential gift tax liability. If the consenting spouse changes his or her mind, a revocation must be filed, in duplicate, by April 15th of the year following the year in which the gift was made.
Gift splitting provides two primary benefits. First, gift splitting allows each spouse to use his or her annual exclusion from gift tax ($13,000 for 2012) for the gift to each person. A person’s life time exemption is only used if a gift is made to a recipient that exceeds the annual exclusion. By splitting the gifts, the couple essentially doubles the annual exclusion applied to each gift, which reduces the total exemption used by each spouse. Second, gift splitting allows each spouse to use an equal amount of the lifetime exemption, which helps keeps an equal amount of remaining lifetime exemption for each spouse. Maintaining an equal exemption along with properly balancing asset ownership by each spouse helps provide equal distributions regardless of which spouse dies first.
As the infamous “fiscal cliff” approached, many couples making gifts of $5,120,000 or less were probably not considering gift spitting. These couples probably assumed one spouse would have zero or little remaining exemption while the other spouse would retrain all of his or her remaining exemption. With the passing of the American Taxpayer Relief Act of 2012, these couples can revisit the idea of gift splitting to help retain an equal exemption. They should also revisit the asset ownership structure to insure a balanced ownership between the spouses.
Going forward, The American Taxpayer Relief Act of 2012 should provide a stable estate and gift tax environment and facilitate the development of long term estate plans without concern or panic about potential expiration of federal exemption amounts.