Value of Gift Properly Reduced by Actuarial Valuation of Potential Reimbursement of Estate for Additional Tax Due if §2035(b) Triggered by Death Within 3 Years of Gift

The Tax Court in Steinberg v. Commissioner, 141 TC No.8 (referred to as Steinberg I), reversing the position it had previously taken, held that the value of a gift could be reduced when the recipients of the gift agreed to assume any potential estate tax if the donor died within three years. 

Generally if a donor dies within 3 years of the date of a gift, the value of the gift and the resulting gift tax is added back to the donor’s estate pursuant to IRC §2035(b).  While the estate gets credit for the gift tax paid, the inclusion of the gift tax in the estate results in a transfer tax being imposed on both the gift in question and the gift tax itself.  In the absence of such a provision, a tax could dramatically reduce his/her transfer taxes by making deathbed gifts.

In the case of McCord v. Commissioner, 120 TC 258 (2003) the Tax Court had held that the potential gift tax was “too speculative” to be considered in valuing a gift.  However, on appeal the Fifth Circuit Court of Appeals reversed that holding.  Nevertheless, the position was still one that the Tax Court could find applicable outside of that circuit.

In the case in question, appealable to the Second Circuit, the Tax Court again visited the issue.  In this case the donees had agreed to pay the gift tax imposed on the gift, creating a traditional “net gift” which, the IRS agreed, mean that the gross amount of the gift could be reduced by the gift tax paid.

However, the donees also agreed, if the donor died within three years, to assume the additional estate tax that would be due pursuant to IRC §2035(b).  On the Form 709 reporting the gift, the gifts were further reduced based on an actuarial computation of the “expected” amount of such tax.

While recognizing the tax might never be paid, the Court nevertheless noted that a willing buyer would have demanded some reduction in a purchase price to compensate for the risk of having to pay the additional estate tax.  The Court also found that it was clearly a risk that could be valued.  Thus, the Court refused to continue to follow the McCord holding, and instead allowed a reduction in the value of the gift for the possibility that an additional estate tax might be paid by the donees.

The original decision dealt with the question of whether a reduction in the value of the gift would be available but not what it was.  In 2015 the Tax Court decided that second issue in another reported case, Steinberg v. Commissioner, 145 TC No. 7 (Steinberg II).

In this case the IRS raised another objection that was specific to this case—that New York state law would have required the recipients to have paid the applicable estate tax anyway had it come back into the estate, so the provision in the gift had no effect.  The Court noted first that, at time of the gift it was possible the donor could have changed her domicile prior to her death, thus there was no assurance New York law would apply—but this liability provision would.

As well, the donor could change her will at any time to change the allocation of liability for estate taxes.  In fact the donor had changed her will in the past and if she did so she could have removed the applicability of that New York law provision.