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. . .