During most divorce proceedings, the legal focus tends to center on important topics such as child custody, spousal support, and the equitable distribution of marital assets. However, for clients of significant wealth, there is an often-overlooked pitfall lurking in the background: gift tax exposure. IRC § 2516 provides a safe harbor that can be critical for high-net-worth individuals who typically want to protect as much of their federal gift tax exclusion as possible for future gifting and inheritance.
What is “gift tax” and how does it relate to IRC § 2516?
A federal gift tax is imposed when an individual transfers property in excess of their lifetime Estate and Gift Tax Exclusion ($15 million per individual in 2026). Typically, gifts and transfers between spouses who are both U.S. citizens are unlimited and not subject to federal gift tax, and accordingly, do not utilize any gift tax exclusion. However, when spouses get divorced, that changes, and transfers of high-valued assets could certainly impact the taxpayer and their future ability to gift or leave assets to children and other beneficiaries without a significant tax burden.
This is where IRC § 2516 comes in. It provides a safe harbor from gift tax for transfers of funds or property between spouses that are made pursuant to a written divorce agreement, so long as certain conditions and timelines are met.
For example, if a divorcing spouse who has $50 million in net assets chooses to transfer a $10 million ownership interest in a high-valued business to the other spouse without properly invoking IRC § 2516, the spouse transferring the interest would only be left with a lifetime exemption of roughly $5 million (2026). Any attempt to transfer wealth beyond that remaining exemption could be subject to a 40% gift or estate tax being imposed. However, with the benefit of compliance with IRC § 2516, no exemption would be wasted, and the taxpayer could have their entire unused exemption available for future tax-exempt wealth transfers.
It follows that properly invoking IRC § 2516 can help divorce attorneys and estate planners avoid unintended tax consequences, preserve lifetime gift tax exemptions, and structure divorce settlements in an optimal way that protects both parties and their intended beneficiaries from unnecessary future taxes.
