Qualifying Trust Transfers for Split-gift Treatment
Section 2513 of the Internal Revenue Code of 1986, as amended, allows a married couple to treat gifts made by one spouse as if the gift is made one-half by each spouse. These gifts are commonly referred to as split-gifts. In this article, the spouse making the gift or transfer will be referred to as the “donor spouse” while the other spouse will be referred to as the “nondonor spouse.”
Most estate planning practitioners are informed about the application of the split-gift rules to outright or direct gifts, but many are not as familiar with the split-gift rules addressing gifts to trusts. In that regard, the split-gift rules can become quite complicated when the nondonor spouse is a beneficiary of the recipient trust. This article briefly discusses the basic split-gift requirements and then addresses in detail the application of the split-gift rules to transfers to irrevocable trusts. Any reference in this article to a “trust” refers to an irrevocable trust.
There are a number of potential advantages to split-gifts. Split-gifts allow the use of both spouses’ Code §2503(b) annual exclusion amounts (currently $12,000 per donee) even though the gift is made by one spouse. Additionally, a married couple can effectively apply both spouses’ Code §2505(a) lifetime exclusion amount (currently $1,000,000 per donee) to a gift by an individual spouse. Finally, split-gifts can minimize gift tax liability through the use of each spouse’s graduated gift tax rates.
Split-gift Rules: Basic Requirements
All gifts must satisfy certain requirements to qualify for split-gift treatment. First, both spouses must be U.S. citizens or residents.1 Next, the spouses must be married to each other at the time of the gift.2 If the spouses subsequently divorce (or a spouse dies later that year), they are still eligible for split-gifts if neither spouse remarries by the end of that year.3 Additionally, both spouses must consent to treat the transfer as a split-gift on IRS Form 709 (federal gift tax return).4 The split-gift election applies to all gifts made by either spouse during the year and cannot be made on a selective basis.5
Finally, the donor spouse must transfer the subject property to a third party to qualify for split-gift treatment.6 Accordingly, a direct or indirect gift to the donor’s spouse will not qualify for split-gift treatment. This is a fairly easy rule to apply to outright gifts. In that situation, the transfer qualifies for split-gift treatment if the nondonor spouse is not a donee of the transfer. For example, assuming all of the requisite criteria are satisfied, a $24,000 outright or direct gift from father to son qualifies for split-gift treatment. The nondonor spouse is not directly or indirectly a recipient of this gift.
Transfers to Trusts
The requirement that the transfer must be made to a third party to qualify for split-gift treatment also applies to indirect gifts, including transfers to trusts. Does a transfer from the donor spouse to a trust qualify for split-gift treatment? The answer is that it depends entirely on the trust’s terms.
This is a simple determination if the nondonor spouse is not a trust beneficiary. In that circumstance, the donor spouse’s entire transfer to a trust qualifies for split-gift treatment. For example, assume that the donor spouse is the grantor of a trust, and the nondonor spouse is not a trust beneficiary. Assume further that the donor spouse’s three adult children are the trust beneficiaries and that the donor spouse transfers $72,000 to the trust. Again, if all of the necessary requirements are satisfied, the entire $72,000 transfer qualifies for split-gift treatment.
Unfortunately, many trust situations are not that straightforward. Frequently, the donor spouse establishes a trust with multiple beneficiaries and one of the beneficiaries is the nondonor spouse. In that case, the transfer is in part a gift to the nondonor spouse and in part a gift to the third-party beneficiaries.
Treasury Regulations §25.2513-1(b)(4) states that when a spouse transfers property to his or her spouse and to third parties, the transfer qualifies for split-gift treatment only if the interest transferred to third parties is ascertainable and severable from the interest transferred to the spouse. The portion of the transfer allocated to the third-party beneficiaries qualifies for split-gift treatment while the portion allocated to the nondonor spouse does not qualify for split-gift treatment. If the respective portions of the transfer allocable to the nondonor spouse and to the third parties cannot be ascertained, then none of the transfer qualifies for split-gift treatment.
Treasury Regulations §25.2513-1(b)(4) can be easily applied to certain situations when the donor spouse is a trust beneficiary. Assume the same facts set forth above, except that the transfer to the trust is $77,000 and the nondonor spouse has a power to withdraw $5,000 while each child has the power to withdraw $24,000 of the transfer. These trust withdrawal powers are generally structured as Crummey7 powers.
In this case, the interest of the third-party beneficiaries is ascertainable and severable from the interest of the nondonor spouse. Accordingly, the $5,000 that is subject to the nondonor spouse’s withdrawal power is not eligible for split-gift treatment, but the $72,000 that can be withdrawn by the children qualifies for split-gift treatment.8 The portion of the gift allocated to the nondonor spouse might qualify for the Code §2503(b) annual exclusion or for the Code §2523 gift tax marital deduction, but it is not eligible for split-gift treatment.
The analysis becomes significantly more complicated when the nondonor spouse is a trust beneficiary and the trust transfer exceeds the beneficiaries’ withdrawal powers (or the trust does not provide withdrawal powers). This issue frequently arises when funding a trust that holds a life insurance policy with a large death benefit or when the grantor has few beneficiaries to grant withdrawal powers. Additionally, many intentionally defective grantor trusts do not contain beneficiary withdrawal powers, so any transfer to such a trust automatically exceeds the beneficiaries’ withdrawal powers. In that situation, a number of factors must be analyzed to determine whether the portion of the transfer that exceeds the beneficiaries’ withdrawal powers will qualify for split-gift treatment.
Revenue Ruling 56-439
This issue was first addressed in Revenue Ruling 56-439, 1956-2 C.B. 605. There, the Internal Revenue Service addressed whether a spouse’s transfer to a trust qualified for split-gift treatment. In this ruling, the subject trust did not contain any beneficiary withdrawal powers. Additionally, the trustee had the complete discretion to distribute income or principal to the trust beneficiaries, comprised of the donor’s spouse, lineal descendants, and spouses of lineal descendants.
The trustee’s power to distribute income and principal was not limited by any type of standard. The trustee was authorized to distribute income or principal “in such proportions and amounts as he in his sole discretion shall determine.” The IRS ruled that the gift to the donor’s spouse was not severable from the gifts to the third-party beneficiaries, and accordingly, none of the trust transfer qualified for split-gift treatment.
Case Law
There are only three cases that address whether a trust transfer qualifies for split-gift treatment when the nondonor spouse is a trust beneficiary and the transfer exceeds the beneficiaries’ withdrawal powers. The first case to address this issue is Robertson v. Commissioner, 26 T.C. 246 (1956), acq., 1956-2 C.B. 8. In Robertson, the taxpayer created a trust that paid income to his wife for her lifetime. Additionally, the corporate trustee had the power to pay principal to the taxpayer’s wife as deemed necessary for her “maintenance and support,” and “with due regard to her other sources of funds.” At her death, any remaining funds would be distributed to third-party beneficiaries. The taxpayer and spouse elected split-gift treatment regarding the remainder value of the gift.
In Robertson, the Tax Court initially analyzed the scope of the trustee’s distribution power. There, the trustee’s distribution power was limited to the spouse’s “maintenance and support” after taking into account her other sources of funds. The Tax Court stated, “[i]n the instant case we are of the opinion that the power to invade principal is limited by standards by which the possibility of such invasion can be gauged.”9
The Tax Court then engaged in a detailed examination into the income and assets outside the trust available to the taxpayer’s spouse and the funds necessary to maintain her lifestyle. In that regard, the Tax Court stated, “[a] more troublesome question is whether there is likelihood, as disclosed by the facts of the instant case, that the power to invade principal, limited by these standards, will be exercised.”10 Accordingly, the Tax Court’s inquiry was not limited solely to the breadth of the trustee’s distribution power. The Tax Court also required that, based on the nondonor spouse’s financial situation, it was unlikely that the trustee would actually exercise the distribution power.
Based on the limited scope of the distribution power and the wife’s substantial financial resources outside the trust, the Tax Court ruled that there was no likelihood that the trustee would actually exercise the power and distribute principal to the nondonor spouse. Accordingly, the Tax Court in Robertson held that the nondonor spouse’s life interest could be valued and that the value of the remainder interest qualified for split-gift treatment.11
The Tax Court in Robertson effectively applied a two-part test. The first test is whether the trust’s distribution power is sufficiently limited. The second test is: Based on the nondonor spouse’s financial resources and standard of living, what is the likelihood that the trustee will exercise that power and distribute trust property to the nondonor spouse?
The next case to address this issue was Kass v. Commissioner, T.C. Memo 1957-227. There, the Tax Court analyzed whether a spouse’s transfer to a trust qualified for split-gift treatment. In Kass, the taxpayer transferred property to a trust that provided for the payment of income to the taxpayer’s spouse. The trustees also were granted the power to distribute principal to the spouse for her “general welfare.” At the nondonor spouse’s death, any remaining property would be held in trust for the benefit of third-party beneficiaries. The taxpayer and spouse elected to treat the transfer to the trust as a split-gift.
In its analysis, the Tax Court addressed both whether the trustee’s distribution power was sufficiently limited and the probability that the trustee, based on the spouse’s financial situation, would exercise the power and distribute trust property to the spouse. In that regard, the Tax Court stated, “[t]he remoteness of the possibility of the power being exercised is a matter of practicability and depends upon the factual circumstances as well as the language limiting the power.”12 The Tax Court then ruled that it was unnecessary to determine whether the phrase “general welfare” constituted a sufficient limitation on the trustee’s distribution power.
This ruling was based on the taxpayer’s failure to introduce evidence regarding the nondonor spouse’s financial situation and standard of living necessary to establish the probability of the trustee’s exercise of the distribution power. As a result, the Tax Court held that the transfer to the third-party beneficiaries was not severable and ascertainable from the interest of the nondonor spouse, and, therefore, none of the trust transfer qualified for split-gift treatment.13 In this case, the Tax Court effectively determined that the second part of the two-part test articulated in Robertson had not been met, and accordingly, did not rule whether the phrase “general welfare” constituted a sufficiently limited distribution power.
The most recent case to address this issue is Wang v. Commissioner, T.C. Memo 1972-143. In Wang, the taxpayer transferred property to a trust that required the distribution of all trust income to the taxpayer’s spouse for her life. After the taxpayer’s death, the trustees were authorized to distribute principal to the spouse “for her proper support, care and health or for any emergency affecting the [d]onor’s said wife or her family….” Upon the nondonor spouse’s death, the remaining trust assets would be distributed to the taxpayer’s children. The taxpayer and spouse elected split-gift treatment regarding the value of the remainder interest.
The Tax Court determined that when one spouse transfers property in part to his or her spouse and in part to third parties, split-gift treatment is effective only with respect to the value of the interest transferred to third parties and then only to the extent that interest is ascertainable and severable from the nondonor spouse’s interest. In determining whether such interest is ascertainable and severable, the Tax Court analyzed whether the trustee’s power to invade principal is sufficiently limited by the terms of the trust. Accordingly, the Tax Court stated, “[i]n such cases the answer depends upon whether the power to invade principal is limited by ascertainable standards by which the possibility of invasion can be measured or stated in definite terms of money.”14
In Wang, the Tax Court ruled that the distribution standard “for her proper support, care and health, or for any emergency affecting the said donor’s wife or her family…” did not constitute an ascertainable standard. The Tax Court specifically analyzed the term “emergency” and determined that standard was not limited whatsoever, and accordingly, was too broad to constitute an ascertainable standard. Therefore, the Tax Court ruled that the trust did not provide a standard by which the interest transferred to the third-party beneficiaries is ascertainable and severable from the interest transferred to the nondonor spouse. Accordingly, the Tax Court held that none of the trust transfer at issue qualified for split-gift treatment.15
Presumably, the Tax Court in Wang deemed it unnecessary to evaluate the nondonor spouse’s financial situation because the trust distribution power at issue was not sufficiently limited. There, the Tax Court essentially determined that the first part of the two-part test articulated in Robertson was not met. As a result, it did not analyze the nondonor spouse’s finances and standard of living, as the Tax Court did in Robertson and Kass. From a practical perspective, if the trust’s distribution power is not sufficiently limited, there is no need to analyze the nondonor spouse’s finances.
Recent Private Letter Ruling
Although the cases that address this issue are all fairly old, the IRS recently issued a private letter ruling, which addressed whether a trust transfer qualifies for split-gift treatment when the nondonor spouse is a trust beneficiary and the transfer exceeds the beneficiaries’ withdrawal powers. A private letter ruling constitutes binding authority only for the taxpayer requesting the ruling. These rulings, however, can provide valuable insight into the IRS’ analysis regarding a particular issue.
In Private Letter Ruling 200345038, a taxpayer established three identical irrevocable trusts with the taxpayer’s spouse and a different child named as beneficiaries of each respective trust. The trusts did not contain any beneficiary withdrawal powers. Accordingly, the entire transfer to each trust exceeded the beneficiaries’ withdrawal powers, which were zero. The trusts also authorized the trustee to distribute income and principal to the trust beneficiaries for their “health, maintenance, education, and support.” At a child’s death, the remaining trust property was held for that child’s descendants.
The IRS ruled that the trusts’ distribution standard of “health, maintenance, education, and support” constitutes an ascertainable standard, and, therefore, the nondonor spouse’s right to receive distributions of income and principal is capable of determination.16 The IRS relied on Code §2041(b) and Treasury Regulations §20.2041-(1)(c)(2) to determine that the trust distribution power at issue was limited by an ascertainable standard.
Surprisingly, in Private Letter Ruling 200345038, the IRS did not inquire into the nondonor spouse’s financial circumstances. The IRS analyzed only the first part of the two-part test applied by Robertson and Kass and completely ignored the second part of that analysis. After the IRS determined that the subject distribution power was sufficiently limited, it did not consider that spouse’s financial situation to determine the probability of the trustee’s exercise of that power.
This ruling specifically cites Wang (which did not analyze the nondonor spouse’s finances) but does not reference either Robertson or Kass (which both analyzed in detail the nondonor spouse’s finances). In Wang, however, it was unnecessary to examine the nondonor spouse’s financial situation because the Tax Court had already determined that the trust’s distribution power was not sufficiently limited. It is unknown whether the IRS merely overlooked the second part of this previously articulated analysis or whether it intended to eliminate that test as a split-gift requirement.
The IRS then ruled that the portion of the transfer that is attributable to the third-party beneficiaries’ ascertainable and severable interest qualifies for split-gift treatment.17 In that regard, the IRS stated, “[w]e conclude that this standard for invasion is ascertainable, and the spouse’s right to receive income or principal is susceptible of determination…. Accordingly, we conclude that the …transfers…were eligible for gift-splitting for gift tax purposes, to the extent not attributable to Wife’s ascertainable and severable interest.”18 Unfortunately, Private Letter Ruling 200345038 does not provide any guidance in determining the amount of the spouse’s “ascertainable and severable” interest.
The cases discussed above also do not provide any meaningful guidance on this issue. In Kass and Wang, the taxpayer was not allowed to split any portion of the gift, so a calculation of the amount of the spouse’s “ascertainable and severable” interest was unnecessary. Conversely, in Robertson, the Tax Court held that it was extremely unlikely that the trustee would exercise the distribution power in favor of the nondonor spouse, and, therefore, the entire transfer at issue qualified for split-gift treatment. Accordingly, based on the “all or nothing” result in these cases, the Tax Court has not discussed how to calculate the amount of the spouse’s “ascertainable and severable” interest. The IRS, through its rulings, also has not articulated any such guidance.
When the nondonor spouse has substantial financial resources outside the trust, it might be appropriate to assert that there is virtually no possibility of a trust distribution to that spouse, and so the portion of the transfer allocated to the nondonor spouse’s “ascertainable and severable” interest is zero. In that case, the entire trust transfer in excess of the beneficiaries’ withdrawal powers might be eligible for split-gift treatment. That was effectively the result in Robertson. There, the entire remainder interest qualified for split-gift treatment notwithstanding the trustee’s power to distribute trust property to the nondonor spouse. Otherwise, a valuation of the nondonor spouse’s “ascertainable and severable” portion of the transfer might be necessary to support the position asserted on a gift-tax return.
Drafting Trusts to Comply with Split-gift Requirements
Practitioners must carefully draft trust agreements to ensure split-gift treatment when the nondonor spouse is a trust beneficiary and trust transfers exceed the beneficiaries’ withdrawal powers. In that regard, it is critical to sufficiently limit any trustee power to distribute income or principal to the trust beneficiaries. Robertson and Wang both analyzed prior case law addressing the value of a charitable deduction to determine whether the trust’s distribution power was sufficiently limited. This prior case law was decided under a predecessor statute to current Code §2055 and is no longer applicable to valuing the amount of a charitable deduction.
Based on the more recent Private Letter Ruling 200345038, it appears that the IRS will apply Code §2041(b)(1)(A) to determine whether a trustee’s power to distribute trust property is sufficiently limited by an “ascertainable” standard. The same rules addressing whether a particular power is limited by an ascertainable standard are also set forth at Code §2514(c)(1) and the Treasury Regulations promulgated thereunder.19 If the trustee’s distribution power is limited by an “ascertainable” standard, then that distribution power should be sufficiently limited for purposes of satisfying the split-gift requirements.
Code §2041(b)(1)(A) and Treasury Regulations §20.2041-1(c)(2) establish what constitutes a power that is limited by an ascertainable standard. A trust invasion or distribution power limited to “health, education, support, or maintenance” constitutes an ascertainable standard.20 Conversely, a power limited to “comfort, welfare, or happiness” is not limited by an ascertainable standard.21 The Treasury Regulations set forth numerous other phrases that constitute ascertainable standards. These include, but are not limited to, “support in reasonable comfort,” “maintenance in health and reasonable comfort,” and “support in his accustomed manner of living.”22
Practitioners are strongly advised to draft trusts that incorporate the ascertainable standards set forth at Treasury Regulations §20.2041-1(c)(2). When the particular trust terms are not on the “approved” list of ascertainable standards delineated in the Treasury Regulations, state law must be examined to determine whether the power is sufficiently limited to constitute an ascertainable standard. This is a particularly dangerous area that can be completely avoided by utilizing the specific terminology set forth in the Treasury Regulations. Of course, another alternative to effectively address this issue is to draft a trust instrument that completely prohibits principal and income distributions to the nondonor spouse.
Finally, practitioners should maintain detailed file information evidencing the nondonor spouse’s financial situation. This is to establish that, based on the nondonor spouse’s substantial financial resources outside the trust, it is highly unlikely that the trustee would actually exercise the power and distribute trust property to that spouse. Although the IRS did not require evidence regarding the nondonor spouse’s financial situation in Private Letter Ruling 200345038, both Robertson and Kass specifically incorporated that evidence into their respective analysis and holdings.
Robertson and Kass constitute binding authority, while Private Letter Ruling 200345038 has no precedential value, except to the taxpayer that received the ruling. As a result, practitioners should assume that evidence of the nondonor spouse’s financial situation will be necessary to satisfy the split-gift requirements in this area. These financial factors include the nondonor spouse’s assets, income, other means of support, spousal income and assets, living expenses, other debts and expenses, age of both spouses, and standard of living.23
Conclusion
Practitioners should be aware of the detailed split-gift requirements that apply to transfers to trusts. These rules are fairly straightforward when the nondonor spouse is not a trust beneficiary or when the trust transfer does not exceed the beneficiaries’ withdrawal powers. These requirements, however, can become complicated when the nondonor spouse is a trust beneficiary and the trust transfers exceed the beneficiaries’ withdrawal powers.
In that situation, to qualify the transfer for split-gift treatment, the trustee’s power to distribute trust property should be limited by an ascertainable standard. Additionally, the nondonor spouse should have access to sufficient financial resources outside the trust so that it is highly unlikely that the trustee would exercise the power and distribute trust property to that spouse. If those requirements are met, then the interest of the nondonor spouse should be ascertainable and severable from the interest of the third-party trust beneficiaries, and the transfer allocated to the third party beneficiaries will qualify for split-gift treatment.
1 I.R.C. §2513(a)(1); Treas. Reg. §25.2513-1(a).
2 Id.
3 Id.
4 I.R.C. §2513(b); Treas. Reg. §25.2513-2(a)(1).
5 I.R.C. §2513(a)(2); Treas. Reg. §25.2513-1(b)(5).
6 I.R.C. §2513(a)(1); Treas. Reg. §25-2513-1(b)(5).
7 Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968).
8 See PLR 200130030.
9 Robertson, 26 T.C. 246 at 251.
10 Id.
11 Id. at 252.
12 Kass, T.C. Memo 1957-227 at 876.
13 Id. at 877.
14 Wang, T.C. Memo 1972-143 at 754.
15 Id.
16 P.L.R. 200345038.
17 Id.
18 Id.
19 Treas. Reg. §25.2514-1(c)(2).
20 Treas. Reg. §20.2041-1(c)(2).
21 Id.
22 Id.
23 Robertson, 26 T.C. 246 at 251-252; Kass, T.C. Memo 1957-227 at 876.
William R. Swindle is the national tax director and a senior vice president at Wachovia Wealth Management. He is board certified in taxation and wills, trusts, and estates. Mr. Swindle received his J.D. and LL.M. in taxation from the University of Florida. He frequently publishes and lectures on tax and estate planning issues.
This column is submitted on behalf of the Tax Section, Edward E. Sawyer, chair, and Michael D. Miller and Benjamin A. Jablow, editors.
