TSG (Tax Specialist Group) - Tax-Free Spousal Transfer (Spousal Transfer)

Tax-Free Spousal Transfer

Subject: Spousal Transfer
Number: 05-08
Date: 3/11/2005

In order for a special transfer to be tax-free, the assets must vest in the surviving spouse.

Generally speaking, a transfer to a spouse after an individual passes away occurs on a tax-free basis. However, for the transfer to be tax-free, the assets being transferred must "vest indefeasibly" with the surviving spouse within 36 months of the date of death. This could be an issue in situations where the surviving spouse is forced to sell shares in a private corporation. It is very common for shareholder agreements to provide that, when the original shareholder passes away, the surviving spouse must dispose of his/her shares either to the corporation or to another shareholder. In that case, the shares would not vest indefeasibly with the surviving spouse, and there would not be a tax-free rollover. Consequently, the deceased individual's terminal return would have to include the deemed proceeds of the assets at their fair market value at the date of death. This could be an unexpected result.

One way to avoid this problem is to use "Put/Call Options" within the shareholder agreement. It must be clear in the agreement that there is no obligation on either side to purchase or sell. The "put option" allows the surviving spouse to offer the shares either to the company or to the other shareholders at his/her discretion. The "call option" allows the other shareholders or the corporation to buy back the shares. However, there is no guarantee that the put or call option will be exercised. The shares transferred to the surviving spouse will therefore vest indefeasibly, as the surviving spouse is under no obligation to sell the shares. Even though this will alleviate any tax issues, there are significant business issues that must be analyzed to determine if this is a practical solution.

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