Spousal Gifts/Divorce

[ElephanHat]

A friend of mine recently had a really good question that I didn't know the answer to and was curious as well. Let's say someone wanted to give someone all their assets but they weren't married. What's stopping them from marrying them, gifting everything tax-free, and then getting a divorce?

Obviously, this is a terrible idea but I thought it was an interesting question which might help me better understand tax law. The possible real world example someone thought up was: what if you were married to someone and had a step son/daughter. Your spouse died and you wanted to give everything to their child tax-free. What is stopping you from doing what I laid out above?

FWIW I'm happily married to an M4 with no plans for divorce. :P  I'm in the engineering discipline and am going to try to get a jump on our financial future.

 

[Zaphod]

Why wouldnt this be covered in the will/estate plan. I mean unless we're talking more than 5.54M dollars.

[ElephanHat]

Yeah, let's say the person has like 100M. They're going to be looking for any way to reduce taxes.

To us, it seemed like an obvious exploitable loophole so we were curious if that was actually the case.

[Zaphod]

ElephanHat wrote:

Yeah, let’s say the person has like 100M. They’re going to be looking for any way to reduce taxes.

To us, it seemed like an obvious exploitable loophole so we were curious if that was actually the case.

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If you simply wanted to avoid having trusts and such I guess its possible, but in the divorce half of it would go back anyway!

[Donnie]

Gosh, don't let this exploitable secret get out or everyone is going to be marrying people with step children so that they can get to better know that step child in order to someday marry the step child once their spouse dies then subsequently get a divorce so that the step child can take all their assets tax free!

[jfoxcpacfp]

I don't know of anything but this would have to be a very, very unusual situation. The typical version is trying to keep your wealth out of the hands of your stepchild. Otherwise, the step-parent would have provided for leaving assets to the surviving spouse and let the surviving spouse make the appropriate provisions.

Remember, to make a "completed" gift, there can be no strings attached. Therefore, the stepparent would have to be willing to simply hand over $100M to a stepchild and walk away with nothing in the divorce and no control. I also wonder if the IRS would attack it as a sham.

In another context, gifts made within 5 years of entering a nursing home will be treated as having been retained by the donor for Medicaid purposes.

[ElephanHat]

Thanks for the dose of sarcasm Donnie, a warm welcome to the forums... I can come up with more examples where someone might think this was a good idea but I don't think it would add anything to the conversation. Do you?

[Donnie]

ElephanHat wrote:

Thanks for the dose of sarcasm Donnie, a warm welcome to the forums… I can come up with more examples where someone might think this was a good idea but I don’t think it would add anything to the conversation. Do you?

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Please don't take offense.  I was just joking, but I was struggling to come up with scenarios where someone would want to give a large chunk of assets to a non-family member prior to death.

[q-school]

i'm not sure i understand the question.  why does someone want to get a divorce after gifting them everything they have?  what's the need for the divorce?

i'm not sure why everything is different in the real world example.  why couldn't it just be my own kid i wanted to give everything tax free to?  or if i don't have any kids, my cat?  is the tax free the issue or the recipient the issue?

confused.

 

[ElephanHat]

It's a hypothetical situation so I don't want to come up with some elaborate narrative. I'm just wondering because it seemed like a really gray area and I wanted to validate that.

[Donnie]

q-school wrote:

i’m not sure i understand the question.  why does someone want to get a divorce after gifting them everything they have?  what’s the need for the divorce?

i’m not sure why everything is different in the real world example.  why couldn’t it just be my own kid i wanted to give everything tax free to?  or if i don’t have any kids, my cat?  is the tax free the issue or the recipient the issue?

confused.

 

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I believe the point was to marry someone, then get divorced, dividing the assets upon divorce in such a way that one party received most or all of the assets, thereby bypassing estate and gift taxes.

Johanna makes a good point that the IRS will likely view this as a sham transaction.  I think the IRS has previously viewed situations where people who get divorced at year end only to get remarried early the next year to avoid the marriage tax penalty as sham transactions.  If it is a big dollar amount like $100M, you can bet the IRS will take a look at it to determine the intent of the marriage and divorce when assets are divided in such a way.

[ElephanHat]

Thanks for the help!  After reading up it seems like the sham transaction doctrine covers it. Thanks Johanna and Donnie. And thanks for the other anecdote about people who divorce at year end to avoid the marriage penalty to tie it all together.

I'm probably on the IRS's "people to audit" list after this

[jfoxcpacfp]

ElephanHat wrote:.

I’m probably on the IRS’s “people to audit” list after this

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I'm pretty sure you're joking but jic, I want to soothe your psyche that you have no idea of the crap that is floating around in tax land that is not picked up. I think we all get a bit paranoid at times, but it's truly a looooooong shot to be audited and even more unlikely that you will ever throw up a "red flag" or whatever you're afraid of, especially if you have not done anything out of bounds. But I strongly believe that the IRS makes the most of the reputation that you are at risk. Actually, a lot of tax pro's play on your emotions about this fear, also. Too bad.