To split or not to split? That is the question!

Strategy

Evaluate whether gift-splitting consents are advisable for gifts if the donor's gifts for the year include some gifts that may be included in the donor's estate. The following are some situations in which gift-splitting should be closely examined.

* Qualified personal residence trusts (QPRTs).

* Grantor retained annuity trusts (GRATS).

* Grantor retained unitrusts (GRUTS).

* Common-law grantor retained income trusts (GRITS).

Background

If a married couple consents to split its gifts with third parties during a calendar year, all of these gifts are treated as having been made one-half by each spouse. It usually is advantageous to split gifts to capture each spouse's lower brackets and any available unified credit.

Caution

There may be hazards to this technique. If, at the donor's death, the property is included in the donor's estate, gift-splitting could be detrimental to the donor's spouse.

The Code provides for remedies to the donor if property transferred by gift is subsequently included in the donor's estate. But these remedies generally do not apply to the donor's spouse who merely consented to having the gift treated as being made one-half by each. The donor is mad whole, but generally not the donor's spouse.

Example: H, age 70, places $1,000,000 home in a QPRT, retaining the home's use for seven year with the remainder interest to C. and W, his wife, consent under Sec. 2513 to split the $388,880 gift (base on the January 1995 applicable Federal rate). H dies during the trust's term. The full value of the trust's corpus is included in his gross estate under Sec. 2036; gift splitting does not make W "transferor" of half of the property for estate tax purposes.

Since the home is included in H's estate, his portion of the gift, $194,440, is removed from his cumulative tax base under the adjusted taxable gifts exception (Sec. 2001(b)). However, W's portion of this gift is not removed from her cumulative tax base.

While any gift tax paid by W on her split gift will be credited in computing her estate tax, her split gift will push her subsequent taxable gifts and taxable estate into higher marginal rate brackets (or use up her unified transfer tax credit). If the gift were not split, H's entire gift would be eliminated if he died during the trust's term. However, the gift tax on this gift might be somewhat higher.

Further discussion

If the full amount of a split gift is included in the donor-spouse's gross estate, any gift tax paid on that gift by the consenting spouse also is included in the donorspouse's credit for gift taxes, which reduces the donor-spouse's tentative estate tax in arriving at the gross estate tax (Sec. 2001(d)).

In the example, W's estate tax consequences might be different if H died within three years of the gift.

Pursuant to Sec. 2035(d)(2), if a donor gratuitously transfers property within three years of death but retains an interest described in Sec. 2036 (or Sec. 2037, 2038 or 2042), the value of the transferred property is included in the donor's estate under Sec. 2035.

At least one commentator (Bittker & Lokken, Federal Taxation of Income, Estates and Gifts, 91126.4.2) points out that Sec. 2035 might be redundant with Secs. 2036-2038. If so, and the gift is included under both Secs. 2035 and 2036, the split gift might be eliminated from W's adjusted taxable gifts. Also, any gift tax paid by W on this gift is eliminated from W's credit for gift taxes if that tax had been allowed as a credit against H's estate tax. This treatment is provided by Sec. 2001(e), which applies if a split gift is included in the donor-spouse's estate under Sec.2035.

In Rev. Rul. 82-198, the treatment provided by Sec. 2001(e) was applied to a 1979 split gift of property to an irrevocable trust whose income was payable to the donor for life-when the donor died in 1982.

However, this ruling also held that if the nondonor spouse dies within three years of the split gift, any gift tax paid by that spouse on the split gift would be included in the nondonor spouse's gross estate under Sec. 2035(c)

The application of Sec. 2035 to gifts also included in the donor's estate under Sec. 2036, etc. was explained in the Economic Recovery Tax Act of 198 I's "Blue Book" at 262:

The Act contains exceptions which continue the application of section 2035(a) to interests in property included in the value of the gross estate pursuant to sections 2036, 2037, 2038, ... or 2042 (or those interests which would have been included under any of such sections if the interests described in those sections which were created by the decedent had been retained by the decedent until his death). (Emphasis added.)

Nevertheless, since that explanation did not specifically discuss the application of Sec. 2001(e) in this situation, the precise congressional intent regarding such treatment was not expressed.

Therefore, the "potential relief" provided by Sec. 2035 for these gifts (when the donor die within three years of making such gifts) should not be relied on in deciding whether to split gifts Relief might not be available when needed, at the spouse' death, because of administrative judicial or legislative changes.

On the other hand, this approach may have substantial value in pleading after the event if the donor died within three years of making those gifts and had split gifts with his spouse. In that situation, it certainly would be appropriate to assert estate inclusion under- Sec. 2035 and claim relief under Sec. 2001.

If taxpayers decide to split gifts for the year, all gifts for the year must be split. This may create a difficult choice when the taxpayer made $20,000 gifts to third parties and also created a QPRT. If gifts are not split, $10,000 of each gift, intended as an annual exclusion gift, will become taxable. If gifts are split, the risk of the donor dying during the trust term must be faced. (See also Mitchell and Switzer, "Treatment of split gifts under the '76 Act," TTA, Aug. 1978, at 452.) From David S. Rhine, CPA, New York, N. Y.