September 20, 2012 – Step Transaction Gifts, the Other Step Transaction Doctrine, Gift Splitting and the 2519 Shuffle


There are 102 days left before January 1, 2013

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With only 102 days left before the gift and estate tax exemption goes back down to $1,000,000, we wanted to cover four vitally important items that many advisors do not understand or are not aware of.

As advisors look for things to gift, they may not have thought about having a surviving spouse who is the beneficiary of a QTIP Trust make a partial release of QTIP Trust rights as a reportable gift.

This takes some time to do and is further described below.

In addition, when clients add assets to a limited partnership or LLC before gifting ownership interests, the step transaction doctrine cases need to be reviewed because the IRS has argued successfully that this could be treated as an undiscounted gift of the underlying assets in the entity if sufficient time has not passed between funding and entity interest transfer.

A different “step transaction” analysis applies where one spouse may transfer assets to the other spouse, who will in turn gift them.


Many affluent clients are still trying to make $5,000,000 of gifts before January 1st when the gift tax exemption goes down to $1,000,000.

Oftentimes one spouse has most of the assets and would like to give $5,000,000 worth of assets to the other spouse, who can in turn make a gift to use his or her $5,000,000 exemption. For example, Husband (H) has a $10,000,000 asset. H and Wife (W) each wish to use the $5,000,000 gifting exclusion. H could transfer $5,000,000 of the asset to W, who can in turn gift this portion of the asset, thus maximizing both spouses’ exemptions.

Unfortunately, the IRS, under the “step transaction” doctrine, may characterize a grantee-spouse’s gift as coming from the originating spouse, particularly if a significant amount of time does not pass between the first transfer and the second transfer. “The ‘step-transaction’ doctrine collapses ‘formally distinct steps in an integrated transaction’ in order to assess federal tax liability on the basis of a ‘realistic view of the entire transaction.’” Brown v. U.S., 329 F.3d 664 at 671 (9th Cir. 2003) (quoting Comr. v. Clark, 489 U.S. 726, 738 (1989)).

For example, a transfer from B to C, followed by a transfer from C to D may be considered as a transfer directly from B to D. The step transaction doctrine was developed under the common law to provide that the substance of a transfer or transaction will be considered to have occurred, notwithstanding intermediary steps for predetermined intermediary structuring.

To avoid application of the step transaction doctrine, the assets and the economic risk associated therewith should be owned and held exclusively by the grantor for a reasonable period of time. In case the IRS argues that the contribution to the trust was really made by the grantor’s spouse (in which case even the grantor’s spouse may be subject to federal estate tax under I.R.C. § 2306(a)(1) – retained life interests), it may be important to have trust language providing that any trust assets considered as transferred to the trust by the spouse/beneficiary will be held in a separate subtrust of which the spouse will not be a beneficiary.

Our Estate Tax Planning in 2011 and 2012: Recent Developments and 2012 Supplement contains a more in-depth discussion of this issue as well as sample trust language, and can be accessed by clicking here.

Here we are with only 102 days remaining in 2012, so it may be too late to be completely safe from avoiding application of the step transaction doctrine. If in doubt and the transfer is going to take place, make it happen now!

The Trick: Get transfers done now if you want to have any hope of avoiding the step transaction doctrine.

The Trap: Do not forget to make every piece of paper and document involved with the transfer completely sound and to follow up to make sure that any and all transfers or documentation that clients or other third parties were to provide have already been handled.


What about transferring assets to a limited partnership and LLC and then transferring the limited partnership or LLC interests by gift and expecting to be able to take a discount for lack of marketability and lack of control?

Do not forget the line of cases described by the chart that you can view by clicking here, which has basically found that no such discount can be taken if sufficient time does not pass between the date of funding the entity and the date of the gift or sale of entity interests.

For instance, in Senda v. Commissioner of Internal Revenue, the court found that an indirect gift was made when taxpayers transferred stock to a partnership and then transferred partnership interests to their children. Regardless of the characterization of the transactions, because the transactions were integrated and, in effect simultaneous, application of the step transaction doctrine made the transfers indirect gifts.

Conversely, in Holman v. Commissioner of Internal Revenue, the court held that the step transaction doctrine did not apply to a similar transaction as in Senda, primarily because the transactions took place six days apart. The petitioners, at least for the six days, bore the risk of changes in value to the interest in question, thus giving the transfers independent significance.

The Trick

To avoid application of the step transaction doctrine, an estate planner should ensure that each transaction in a multiple-step transfer has independent legal significance as under Holman. Fortunately, Holman creates a simple two-step blueprint for ensuring independent legal significance. First, ensure that any interests being transferred are held for a reasonable amount of time between transfers. While a minimum holding period has not been established, a six day period was sufficient in Holman. Second, ensure that during the intermediate holding period, any transferred interests could potentially change in value.

The Trap

The trap is relying on the form of the transaction instead of the substance. Application of the step transaction doctrine is made on a factual basis, and the circumstances in which it will be applied are “notably abstruse.” Estate planners should be wary of transactions that could appear to be integrated, mutually dependent, simultaneous, and/or focused towards a particular result.


Affluent clients may want to make a $10,000,000 gift to fully utilize both spouses $5,000,000 gift tax exemption. However, in some cases the asset may be titled in one client’s name. Rather than having to re-title the asset, the clients may want to consider splitting the gift so that each client’s lifetime gift exemption will be utilized.

Gift splitting under I.R.C. § 2513(a)(1) can be a viable alternative to two-step gifting between spouses. One spouse can make the gift and the other spouse can sign a gift tax return whereby all gifts made by both spouses during the year are considered to come one-half (½) from each spouse for gift tax purposes.

The conditions for gift splitting are as follows: (1) both spouses must be U.S. citizens or residents; (2) the spouses must be married at the time of the gift, and if they later divorce, neither spouse remarries before the end of the calendar year; (3) both spouses consent to gift splitting and indicate such on their returns; and (4) the donor spouse does not create in the other spouse a general power of appointment over the gift property.

If the wealthier spouse makes a transfer to the less wealthy spouse and the less wealthy spouse makes a gift and no gift splitting occurs, then the wealthier spouse might be considered to have made a $10,000,000 gift if he or she also gifted $5,000,000 for other family members.

The Trick

Gift splitting works even if a spouse is the beneficiary of a trust that receives gifts from the wealthier spouse, unless: (1) the trustee’s power to distribute property for the benefit of the spouse is not limited by an ascertainable standard; and (2) the spouse does not have sufficient financial assets outside of the trust and therefore it is likely that the trustee will distribute assets from the trust for the benefit of the spouse.

The Traps

There are a number of errors that can be made in the world of gift splitting. To avoid the potential pitfalls, see Ken Crotty’s 9 Common Mistakes related to Spousal Gift Splitting, which was presented for Bloomberg BNA Dynasty Webinar on June 20, 2012, and are profiled in the attachment that you can view by clicking here.

Examples of three common mistakes are as follows:

Trap No. 1: Not Making the Election Correctly

If the spouses agree to split the gifts, Box 12 of Part 1 – General Information of the Form 709 should be checked. The consenting spouse’s name should be entered in Box 13, and his or her Social Security number should be entered in Box 14. The consenting spouse must also sign the Form 709 where indicated in Box 18. The spouses should file both of the individual gift tax returns together in one envelope to help the IRS process the returns and to avoid correspondence from the IRS.

Trap No. 2: Thinking the Election Is Irrevocable

Many practitioners believe that the election to split gifts is irrevocable. Generally this is true, but there is one exception. Either spouse may rescind the election to split gifts if: (1) the consent was originally made on a return filed before April 15th of the year after the gifts were made; and (2) the consent is rescinded before April 15th of the year after the gifts were made.

Trap No. 3: Not reviewing Ken Crotty’s other common split gift mistakes by clicking here or where indicated above.


Qualified terminable interest property (QTIP) trusts allow a decedent to use the unlimited marital deduction to leave any assets that exceed the unified credit to a spouse without triggering federal estate taxes.

In order to qualify as a QTIP, the trust must provide that: (1) the surviving spouse is entitled to all of the income from the property, payable annually or at more frequent intervals; and (2) no person can have a power to appoint any part of the property to any person other than the surviving spouse during the surviving spouse’s life.

One of the primary goals of estate planning is to maximize the unified credit against estate and gift tax. However, the QTIP trust regulations can create some difficulty in this regard. Transfer of any portion of a QTIP trust results in imposition of gift tax upon all trust property regardless of the percentage of trust actually transferred.

This rule is particularly problematic when the surviving spouse has not maximized his or her unified credit and is not able to through his or her own existing assets. A surviving spouse will not be able to gift a portion of the assets from a QTIP trust to maximize his or her unified credit without triggering tax on the entire QTIP trust. There is, however, a simple way around this penalty: division of the QTIP trust.

The Trick

To prevent the taxation of the complete trust upon the transfer of an income interest, the trick is to divide the trust into two separate trusts. The trustees may have the right to divide a trust into two or more trusts without a court proceeding, provided the division does not negatively impact a beneficial interest or the purposes of the trust as outlined by the trust instrument. However, it is safer to obtain a court order dividing the QTIP into two separate trusts. After division of the QTIP into two separate trusts, the surviving spouse can then gift one of the QTIP trusts utilizing his or her lifetime gift exemption while retaining the income stream from the second QTIP trust and will not have the adverse gift tax consequences that would apply under Section 2519 as described above.

The Trap

Under Code Section 2519, any disposition of all or part of the surviving spouse’s interest under a QTIP trust, is taxed as a transfer of all interests in such property other than the qualifying income interest. Upon disposition of any portion of a QTIP trust beneficiary’s interest, the beneficiary will be taxed for the current, fair market value of all of the assets in the QTIP trust minus the value of the qualifying income interest on the day of the disposition. In addition, the transfer of the qualifying income interest is a taxable gift under Code Section 2511.

In other words, upon any qualified income interest transfer, regardless of amount or percentage, tax will be imposed upon the surviving spouse for the value of the entire QTIP trust.

Applicable Federal Rates

The Thursday Report now includes this month, last month, and the preceding month’s applicable federal rates, because for a sale you can use the lowest of the 3.


The 7520 Rate for September is 1.0% and for August was 1.0%.


SATURDAY, SEPTEMBER 22, 2012 10:30 a.m. – 11:45 a.m.
Renowned author and speaker, Dr. Srikumar Rao will be in Clearwater working with us and we have arranged for him to provide a free lecture at 10:30 am on Saturday, September 22, 2012 at the Holiday Inn Express in Clearwater, Florida on the topic of Good Thing – Bad Thing – Who Knows? Changing Your Immediate and Long-Term Responses to Events and Challenges. All Thursday Report recipients, friends and colleagues are invited. Dr. Rao will also be providing an afternoon workshop. For more information please click here.

WEDNESDAY, SEPTEMBER 26, 2012 12:30 p.m. – 2:00 p.m.
Alan S. Gassman, Esq., Kenneth J. Crotty, Esq. and Christopher J. Denicolo, Esq. will be speaking on a Bloomberg BNA Webinar entitled How to Design, Explain, and Implement Dynasty Trusts and Asset Protection Trusts.

THURSDAY, SEPTEMBER 27, 2012, 4:00 p.m. – 4:50 p.m.
Please join us for The 4-4-4 Show, a monthly Clearwater Bar Association continuing education webinar series that qualifies for 1 hour of continuing education credit and is moderated by Alan S. Gassman, Esq. This month’s topic is “Florida LLC and Limited Partnership Law and Strategies Update” with well known expert Tom Wells, Esquire of Coral Gables, Florida.

MONDAY, OCTOBER 1, 2012 12:30 p.m. – 1:00 p.m.
Please join us for Lunch Talk, a free monthly webinar from the Clearwater Bar Association and moderated by Alan S. Gassman, Esq. Each month we feature topics of interest to attorneys and legal staff. This month’s topic is “Learn About Features of The Florida Bar’s Law Office Management Assistance Service (LOMAS). A Wealth of Information Awaits You by Accessing the Benefits You Have Coming to You Through The Florida Bar” with guest speaker Judith D. Equels, Director, The Florida Bar’s Law Office Management Assistance Service (LOMAS).

WEDNESDAY, OCTOBER 17, 2012 12:30 p.m. – 2:00 p.m.
Professor Jerry Hesch, Alan Gassman, Esq. and Christopher Denicolo, Esq. will be speaking on a Bloomberg BNA webinar entitled Interesting Interest. To register please contact Janine Ruggiero via email at

Alan S. Gassman, Esq. will speak at the The Tampa Bay Research Institute, Inc. 2nd Annual Estate Planning Seminar, in partnership with the Pinellas Community Foundation. Alan Gassman’s topic is Trust Planning for 2013 and Beyond – How to Keep Wealth in the Family. The seminar will take place at TBRI, 10900 Roosevelt Boulevard in St. Petersburg, Florida. Additional Topics and presenters include, Panel Discussion on Conflict of Interest Issues for Estate Planning Professionals. The moderator for the panel discussion is Sandra F. Diamond, J.D., and the panel consists of Angela Adams and Jeffrey Goethe; and Charitable Estate Planning in a Changing Tax Environment by Christopher Pegg, J.D., LL.M., Taxation. For more information please contact Tom Taggart at


TUESDAY, OCTOBER 2, 2012 5:00 p.m.
Alan Gassman and nationally known author and business coach Dan Sullivan will be presenting a free webinar beginning at 5:00 p.m. on Tuesday, October 2, 2012 on “Why 20% of the Doctors Make 80% of the Money (and Enjoy What They Are Doing!)”. This 1-hour program qualifies for continuing education credit for Florida lawyers and CPAs, and will include live discussions with successful physicians who will share what they have done in their practices to enhance income and their enjoyment of practicing medicine. Please click here to view the announcement. Complimentary replays and audio downloads will also be available. To register for this event please email

Christopher Denicolo, J.D., LL.M. is a partner at the Clearwater, Florida law firm of Gassman, Crotty & Denicolo, P.A., where he practices in the areas of estate tax and trust planning, taxation, physician representation, and corporate and business law. He has co-authored several handbooks that have been featured in Bloomberg BNA Tax & Accounting, Steve Leimberg’s Estate Planning and Asset Protection Planning Newsletters and the Florida Bar Journal. is also the author of the Federal Income Taxation of the Business Entity Chapter of the Florida Bar’s Florida Small Business Practice, Seventh Edition Mr. Denicolo received his B.A. and B.S. degrees from Florida State University, his J.D. from Stetson University College of Law and his LL.M. (Estate Planning) from the University of Miami.

Kenneth J. Crotty, J.D., LL.M., is a partner at the Clearwater, Florida law firm of Gassman, Crotty & Denicolo, P.A., where he practices in the areas of estate tax and trust planning, taxation, physician representation, and corporate and business law. Mr. Crotty has co-authored several handbooks that have been published in BNA Tax & Accounting, Estate Planning, Steve Leimberg’s Estate Planning and Asset Protection Planning Newsletters, Estate Planning magazine, and Practial Tax Strategies. Mr. Crotty is also the author of the Limited Liability Company Chapter of the Florida Bar’s Florida Small Business Practice, Seventh Edition. He, Alan Gassman and Christopher Denicolo are the co-authors of the BNA book Estate Tax Planning in 2011 & 2012. His email address is

Thank you to our law clerks who assisted us in preparing this report:

Kacie Hohnadell is a third-year law student at Stetson University College of Law and is considering pursuing an LL.M. in taxation upon graduation. Kacie is also the Executive Editor of Stetson Law Review and is actively involved in Stetson’s chapter of the Student Animal Legal Defense Fund. In 2010, she received her B.A. from the University of Central Florida in Advertising and Public Relations with a minor in Marketing, and moved to St. Petersburg shortly after graduation to pursue her Juris Doctor. Her email address is

Alexandra Fugate earned her B.A. in English from the University of Florida in 2008, and J.D. from Stetson University College of Law in 2012. She has been a Guardian ad Litem for the past two years, a judicial intern for the Twelfth Circuit in Bradenton, and is currently seeking admission to the Florida Bar. She wants to pursue a career in Business, Employment, and Property law.

Eric Moody is a third-year law student, scheduled to graduate in December 2012, at Stetson University College of Law and is considering pursuing an LLM in estate planning upon graduation. Eric is also an Articles and Symposia Editor for Stetson Law Review. In 2009, Eric received a B.S. in Business Management from the University of South Florida. Eric’s email address is