Tax Court Upholds Reduction in Value of Gifts to Adult Children by the Estate and Gift Tax They AssumedNovember 15, 2013
Michele DeNuzzo Loughlin
The Tax Court has rejected the IRS's motion for summary judgment in a gift tax case involving a woman's transfer of property to her adult daughters. The daughters had promised to assume any federal gift tax liability on the gifts and any federal or state estate tax liability if the mother died within three years of the gifts. Accordingly, the mother reduced the value of the gifts by the projected amount of tax liability that each daughter would assume.
The Tax Court concluded that the value of a mother's gift for tax purposes can be reduced by the value of her daughters' (the donees) promises to pay the estate tax liability that could result. Therefore, court found that there was an issue of fact over whether or not the donees' assumption of the donor's potential estate tax liability had any value.
In its ruling, the Tax Court reversed its prior holding in a similar case McCord v. Commissioner, 120 TC 358 (2003). The Tax Court based its reversal on the Fifth Circuit's opinion on the appeal in Succession of McCord v. Commissioner 461 F.3d 614 [98 AFTR 2d 2006-6147] (5th Circuit 2006). The Tax Court found that the value of the obligation assumed by the daughters was not barred as a matter of law from being treated as monetary consideration that reduced the value of the gift.
The donor, an 89-year-old woman, entered into a net gift agreement with her four adult daughters (the donees). The mother agreed to make gifts of cash and securities to the daughters. The value of the property she transferred was $77.4 million.
The donees agreed to pay any federal gift tax liability from the gifts. The donees also agreed to pay any federal or state estate tax liability that could be imposed under Code Sec. 2035(b) if the donor died within three years of the gifts. (Code Sec. 2035(b) requires that the gross estate be increased by the gift taxes paid on any gift made by the decedent within three years of death.)
An independent appraiser determined that the value of the net gift was $71.6 million, which included a reduction in value because the value of the donees' assumption of the potential estate tax liability was $5.8 million. The taxpayer reported taxable gifts of $71.6 million for 2007.
Code Sec. 2512(b) applies the gift tax to the value of the property transferred less the value of any monetary consideration received, otherwise known as the net gift. The fundamental question is was the fair market value of the property rights transferred under the net gift agreement. Fair market value is the price at which the property would change hands between a willing buyer and a willing seller. The IRS claimed that the donees' assumption of the potential estate tax liability was worthless and should not reduce the amount of the gift for gift tax purposes.
The Tax Court noted that the donees' agreement to assume the donor's gift tax liability clearly had value, since it relieved the donor of an immediate and definite liability. The court also found that the donees' assumption of the potential estate tax liability could have value and could reduce the amount of the gift.
The donees' agreement to assume the potential estate tax liability was contingent on a future event that was speculative (the death of the donor within three years). To determine whether this agreement had value, it was necessary to decide whether the contingency was too speculative to have any value.
The court concluded that it was possible for the contingency to have value and to reduce the amount of the gift, and that the contingency was not too speculative as a matter of law. Furthermore, whether the contingency actually had value was a factual issue that should not be resolved on a motion for summary judgment.
The court found that the donees' assumption of potential estate tax liability may provide a tangible benefit to the donor's estate and could meet the requirements of the estate depletion theory. Under this theory, a promise has value if it would replenish the donor's assets. Here, the assumption of potential liability may be quantifiable and reducible to monetary value.
If you have any questions on the estate or gift tax in general, or specifically as related to whether the technique used in this recent court decision might work within your overall estate plan, please contact Michelle Loughlin at email@example.com.