Tax Court Holds Assumption of Estate Tax Liability May Reduce Value of Gift

Holding that there was a genuine issue of material fact, the Tax Court on Monday denied an IRS motion for summary judgment in an estate and gift tax case where the 89-year-old taxpayer, Jean Steinberg, made gifts to her daughters while requiring them to pay any tax liability that would have been due if the taxpayer had died within three years of making the gifts (Steinberg, 141 T.C. No. 8 (2013)). In calculating the value of the gifts for gift tax purposes, Steinberg reduced their value by the amount of the assumed tax liability. The IRS disallowed this reduction in value.

As the Tax Court characterized the case, the fundamental question was the value of the property transferred under the “net gift agreement” (which required paying gift tax as well as any estate tax due because of the operation of Sec. 2035(b)). The agreement to pay the taxes was enforceable and resulted from several months of negotiation, during which Steinberg and her daughters were represented by separate lawyers.

Under Sec. 2035(b), an estate is increased by the amount of any gift tax paid on any gift made by the decedent during the three-year period preceding the decedent’s death. The IRS claimed that the value of the agreement to pay the Sec. 2035(b) tax was worthless and cited a Tax Court case, McCord, 120 T.C. 358 (2003), to support its argument. (The Fifth Circuit reversed McCord, but the Tax Court continued to follow it outside that circuit.)

In McCord, the taxpayers transferred property to their sons, who agreed to pay all transfer taxes, i.e., estate, gift, generation-skipping transfer taxes, etc. When the taxpayers reported the gifts to their sons, they reduced the value of the gifts by the amount of tax liability the sons had assumed. The Tax Court agreed with the IRS that, before death, the value of the estate taxes the sons agreed to pay was too speculative to be used to reduce the value of the gift for gift tax purposes.

In Steinberg, the IRS argued that McCord applied to disallow the reduction in value for the Sec. 2035(b) tax, but the Tax Court found that its holding in McCord was wrongly decided. The Tax Court observed that determining the amount of an estate tax that may be in effect when the taxpayer dies is no more speculative than determining the amount of capital gains tax that should be applied to reduce the value of stock in an estate and that the Tax Court and many other courts had held that the value of stock for gift or estate tax purposes should be reduced by capital gains tax. Therefore, the Tax Court will no longer follow its McCord decision.

The Tax Court also rejected the argument that under the estate-depletion theory, any benefit in money that might arise from a donee’s assumption of the Sec. 2035(b) tax accrued to the benefit of the donor’s estate rather than to the donor and thus could not be used to reduce the value of the gift.

Summary judgment in the case was denied because there were genuine issues of material fact whether the daughters’ assumptions of Sec. 2035(b) “liability constituted consideration in money or money’s worth.”