Some United States taxpayers are married to individuals who are not residents of the United States, and not otherwise a citizen or subject to United States tax laws. We believe it is clear that there is no income recognized when a United States citizen gifts appreciated securities to his or her non-resident alien spouse. While we believed that to be the case before the recent United States Tax Court decision, the Hughes case made clear that a United States taxpayer’s gift of securities, for nothing in return, is not subject to income recognition.
In Hughes v. Comm’r, T.C. Memo. 2015-89 (May 11, 2015), the Tax Court held that the gift of appreciated shares to the donor’s non-citizen and non-resident wife was not a taxable event for income tax purposes (and there was no adjustment to the shares as a result of the gift). The Tax Court made clear “[s]ection 1041(d) simply restores the status quo when the recipient spouse is a non-resident alien, such that ordinary recognition rules apply to the transferor and transferee. If the transferor spouse has a realized gain or loss, and no other Code section provides for nonrecognition, then that gain or loss must be recognized.” Hughes at 22 (emphasis added).
The key point made by the court in Hughes is that ordinary recognition rules continue to apply under Section 1041(d). “Where, as here, an interspousal property transfer takes the form of a gift, no gain is realized, so regardless of whether Section 1041(a) applies, there is no gain to be recognized.” Hughes at 23. The Code imposes income tax on an individual’s taxable income. “As a general matter, a donor does not realize income from making a gift.” Id. The Tax Court then concluded that in the case of Mr. Hughes’ gift of appreciated stock to his non-resident, non-citizen spouse that “neither spouse realized income, and thus neither spouse could recognize income. The gifts were not income taxable events.” Hughes at 24-25.
The Internal Revenue Service argued (and the Tax Court agreed) that the gifts did not result in taxable income. Hughes at 19. The taxpayer in Hughes argued Davis applied, which entitled the taxpayer to a basis adjustment in the gifted shares. The Tax Court disagreed. Hughes at 21-22.
Despite the above cases, the Internal Revenue Service has, on occasion, taken the position that a gift of appreciated securities from a United States taxpayer to a non-resident alien spouse is a taxable event under Davis. Apart from this being a complete contradiction to the arguments made by the Internal Revenue Service in Hughes, it is clear from the Tax Court that Davis does not apply. See Id. Specifically, the Tax Court stated “…Davis is inapposite because it involved an exchange, not a gift...” Hughes at 22. The primary distinction practitioners must look for is a gift versus an exchange. A practitioner must be aware of a taxpayer that gives shares to his or her spouse, whereas Davis involved an exchange incident to divorce. Hughes at 25. As the Tax Court stated in Hughes, these factual distinctions are material. Hughes at 27.