Federal Gift Tax Returns: Are You Signing Away the Store?
It’s almost too simple. Every year at Christmas or Hannukah or Kwanzaa the family gathers around the tree or the seven or nine candles and celebrates the season of giving by making the annual tax-exempt gifts. These are the ones that are supposed to come wrapped in IRS Form 709; the United States Gift Tax Return. The season tis’ approaching so we write about it and how things can go awry.
Assume for the moment that you and your spouse are doing well. Well enough that the focus is not on accumulating wealth but making certain that Uncle Sam gets as little of it as possible through those ominous death taxes. So, every year as candles are lit and presents are wrapped, parents are reaching into their sack of appreciating assets and looking at what can be transmitted to the next generation without burning the unified credit of $26,000,000 ($13million per spouse) today or half of that amount in 2026. The easy way is annual gifting which allows a taxpayer to give away $17,000 each year without burning any of their lifetime credit. Any if your loving spouse joins in the gift the tax exempt amount is doubled to $34,000.
In the divorce world, there are lots of gifting ploys. A few years ago, we had a matter where the holiday gift was a fractional share of paintings by a world famous artist. The art never left the walls of the parents, but the ownership did. In today’s dollars, mom and dad had $900,000 hanging over the fireplace so they would give $34,000 of the painting to each loving family member. Lawyers would prepare the gift letter and accountants would prepare the Form 709. The beauty was not only in the painting but in the fact that now the appreciating artwork was out of mom and dad’s estate and in that of the next generation. Barry Manilow wrote a song about it back when the annual gift exclusion was $3,000. “Could It Be Magic?”
Here’s where the fun or the tragedy begins. You and your spouse are married for 20 years. As a couple you are financially doing well, such that your lawyers and accountants are hounding you to give money to the kids. Your house at the shore is increasing 12% a year and they want that house off your ledger and into the next generation. This makes perfect sense IF you are in a long-term intact marriage and expecting to be buried next to that spouse.
Alas, that is not a certainty. In recent years we have seen spouses gifting their wealth to the next generation; lots of it. And since 2017, when the gift tax exclusion was increased to over $11 million per person, there has been lots of gifting triggered by the fact that after 2025 the tax exemption reverts to what it was before “tax reform” doubled it.
Many spouses are making “gifts” without even knowing it. As we said, individuals can give away $17,000 a year without a spouse’s consent, but if the spouse joins, the tax free gift doubles to $34,000 a year. What we have seen in recent years is Mr. Moneybucks gives away $34,000 in marital assets without securing a spousal written consent. He either doesn’t file a Form 709 or takes the liberty of signing for the spouse. When that kind of gift is made annually to two children each year for a decade, the marital estate has lost $680,000 + any investment experience on the gifted assets. We are oversimplifying this analysis but suffice to say the marital estate may have been drained by $1 million. Meanwhile, the asset is gone. The Divorce Code excludes assets sold for value and a gift is not a sale for value. But do you want to sue your kids to get back gifts where there are federal returns that say you joined in the gift? This writer’s experience is that the betrayed client is mortified to say to his or her children: “You are the beneficiary of your father’s/mother’s fraudulent gifts intended to rob me to pay you.”
How could this happen? A fair question. Twenty years ago, I started a business making widgets. It was enormously successful. Our kids now work for the business, something my spouse never did. I don’t like the missus anymore. So rather than divorce her and pay her immense sums for the value of “my” business, I started a decade ago to gift interests in the business to our kids. I used lowball appraised values to maximize the value transmitted to the children. Now the kids own 40% of the widget business and I own the remaining 60%. They never paid a nickel for what they got. All gifted to them by me and I signed the IRS Forms 709 stating that my spouse joined in the gifts. So, when I do file for divorce and the business gets a value of $5 million, I can turn to my spouse and say, only $3,000,000 is available to divide with you because our kids own the other $2,000,000 in interests. Your lawyer may say this is a fraud and that the kids’ interests need to be clawed back. I tell you, “Go ahead and you tell our kids they don’t own anything even though they have been working the business with me for a decade and you have done nothing.”
The challenge here is that not many parents have the gumption to wage the war required to reverse what the shareholder ledger says. And, incidentally, it’s not uncommon for the children who got the business interests to be children of a prior marriage. The business did not even exist when they were growing up. But they were hired to work in the business and they have been involved for the past decade. Now, even if you get a 60/40 split of the assets, unless you declare war on the gift transactions, you will get $1,800,000 in value, your spouse will get $1,200,000 and the kids from the prior marriage will get $2,000,000 without risking a dime.
The Form devised by the IRS doesn’t help the situation.
Under state laws, property belongs to the person who is the named owner until there is a divorce. If the property was acquired during the marriage it is property subject to division no matter how it was titled. But until someone files for divorce, the spouse with ownership can sell or give it away without the non-owner’s knowledge or permission. The Form 709 suggests that to utilize the right to give away an interest on a tax free basis, both spouses need to sign the forms. But, this writer has seen the monied spouse come to the non monied spouse with a stack of federal tax forms on the eve of April 15 and say: “We need to file these tomorrow or pay penalties and interest.” Not many spouses have the chutzpah to respond: “Let me take it to my accountant and I’ll get back to you next month.” Then there are the families where a spouse will inform us as lawyers that they have never seen or signed a tax return since the marriage began. They solicit us, as lawyers, to advocate for them in a world where Pennsylvania adopted an equal rights amendment in 1971 and the Pennsylvania Supreme Court held in Simeone v. Simeone that paternalistic ideas of marriage had no place in the judicial landscape. That case was published 33 years ago.
There is no clear path here except for a non-owning spouse to be vigilant. We have seen a spouse transfer tens of millions of business value to a child in a transaction called a Grantor Retained Annuity Trust (GRAT) and then turn to a spouse and argue: “All gone except for the payments due under the GRAT.” The only practical solution is to file for divorce; an unsavory choice for many. Alas, it is the only one if you want to unwind a gift or sale for less than fair or fair market value.
