In Steinberg v. Commissioner, 141 T.C. No. 8 (Sept. 30, 2013), the Tax Court answered the following question: Does a donee’s promise to pay any federal or state estate tax liability that may arise under Internal Revenue Code Section 2035(b), if the donor dies within three years of the gift, constitute consideration in money or money’s worth within the meaning of IRC Section 2512(b)? “Yes,” said the Tax Court, denying the Internal Revenue Service’s motion for summary judgment and announcing it would no longer follow McCord v. Comm’r, 120 T.C. 358 (2003), rev’d and remanded sub nom; Succession of McCord v. Comm’r, 461 F.3d 614 (5th Cir. 2006). The Tax Court held that the value of an obligation assumed by the petitioner’s daughters (that is, her donees) isn’t barred as a matter of law from being consideration in money or money’s worth, within the meaning of Section 2512(b). As such, the fair market value (FMV) of the petitioner’s taxable gift to her daughters may be determined with reference to her daughters’ assumption of the potential Section 2035(b) estate tax liability.
Appraised Value of the Gift
In 2007, 89-year-old Jean Steinberg entered into an agreement (the gift agreement) with her four daughters. In the gift agreement, Jean agreed to make gifts of cash and securities to her daughters. In exchange, her daughters agreed to assume and pay any federal gift tax liability, as well as federal and state estate tax liability that may arise under Section 2035(b), should Jean pass away within three years of making the gift. Under the terms of the gift agreement, if any daughter failed to pay her part of the estate tax, her cash distribution would be delivered to the executor in satisfaction of the daughter’s default amount.
Jean hired an appraiser to determine the FMV of the property that she transferred to her daughters. The appraiser also calculated the FMV of the net gift (that is, he reduced the FMV of the cash and securities by: 1) the gift tax the daughters paid, and 2) the actuarial value of the daughters’ assumption of potential Section 2035(b) estate tax. To ascertain the actuarial value of the daughters’ assumption of the potential Section 2035(b) estate tax, the appraiser calculated Jean’s annual mortality rate for the three years after the gift (that is, the probability that Jean would die within one year, two years, or three years from the date of the gift). The appraiser determined that the aggregate FMV of the net gift was $71,598,056, as of the date of the gift. Jean valued her daughters’ assumption of the potential Section 2035(b) estate tax liability at $5,838,540.
In 2008, Jean timely filed her gift tax return (Form 709) for tax year 2007. She reported taxable gifts of $71,598,056 and a total gift tax of $32,034,311. She also attached to Form 709 a summary of the net gift agreement, which included a description of the appraiser’s determination of the value of the net gifts.
In 2011, the IRS mailed a notice of deficiency that increased the aggregate value of Jean’s net gifts to her daughters, from $71,598,056 to $75,608,963, for a total gift tax increase of $1,804,908. The IRS disallowed the discount Jean made for her daughters’ assumption of the potential Section 2035(b) estate tax liability. In response, Jean filed a petition, and the IRS filed this motion for summary judgment. The IRS’ only claim is that the daughters’ assumption of the potential Section 2035(b) estate tax liability didn’t increase the value of Jean’s estate, and therefore, didn’t constitute consideration in money or money’s worth, within the meaning of Section 2512(b) in exchange for the gifts. The Tax Court disagreed, denying summary judgment and finding that there were genuine factual disputes surrounding the assumption of potential Section 2035(b) liability.
The Gift Tax/”Gross-Up” Rules
Under IRC Section 2502(c), a donor is responsible for paying the gift tax. The gift tax is imposed on the donor’s act of making the transfer, rather than on receipt by the donee. It’s measured by the value of the property passing from the donor, rather than the value of enrichment resulting to the donee (Treasury Regulations Section 25.2511-2(a)). The amount of a gift of property is generally the value of the property on the date of the gift (IRC Section 2512(a)). If a donor makes a gift subject to the condition that the donee pay the resulting gift tax, the amount of the gift is reduced by the amount of the gift tax. This type of gift is commonly referred to as a “net gift.”
Under Section 2035, a decedent’s gross estate is increased by the amount of any gift tax paid by the decedent or the decedent’s estate on any gift made by the decedent during the three-year period preceding the decedent’s death. When a net gift occurs, a donor calculates her gift tax liability by reducing the amount of the gift by the amount of the gift tax. That’s because the donor has received consideration for a part of the gift equal to the amount of the applicable gift tax.
Assuming Gift Tax Liability
The issue posed in the instant case related to the FMV of the property rights transferred under the gift agreement. Applying the willing buyer/willing seller test, the Tax Court had to determine what property rights were being transferred and on what price a willing buyer/willing seller would agree for those property rights.
The IRS argued that Jean’s daughters’ assumption of the potential Section 2035(b) estate tax was worthless because the assumption provided no benefit (monetary or otherwise) to Jean, other than some peace of mind. It further claimed that the daughters’ assumption failed to replenish Jean’s estate, thus failing as consideration for a gift under the “estate depletion” theory of the gift tax. The Tax Court disagreed.
In its motion for summary judgment, the IRS relied on McCord v. Comm’r, 120 T.C. 358 (2003), rev’d and remanded sub nom; Succession of McCord v. Comm’r, 461 F.3d 614 (5th Cir. 2006), a case focusing on whether taxpayers were allowed to treat mortality-adjusted present values as consideration received for gifts. The Fifth Circuit in McCord court ruled, among other things, that that there was nothing “too speculative” about the McCord sons’ legally binding assumption of the potential Section 2035(b) estate taxat the time of the gift. To determine whether something was speculative, the McCord court identified three major types of conditions subsequent along the “speculative continuum”: (1) a future event that’s absolutely certain to occur, such as the passage of time; (2) a future event that’s not absolutely certain to occur, but nevertheless may be a more certain prophecy; and (3) a possible, but low-odds, future event, which is undeniably a less certain prophecy.
The Tax Court in the instant case agreed with the Fifth Circuit in McCord that a willing buyer/willing seller in appropriate circumstances may take into account a donee’s assumption of potential Section 2035(b) estate tax liability in arriving at a sales price. However, the Tax Court noted that Jean’s case wasn’t appealable to the Fifth Circuit and as such, it wasn’t required to follow McCord. In any event, argued Jean,McCord was decided incorrectly, and thus, her daughters’ assumption of estate tax liability wasn’t worthless.
Relying on Robinette
The Tax Court instead relied on Robinette v. Helvering, 318 U.S. 184 (1943), a case in which the U.S. Supreme Court determined that taxpayers couldn’t reduce the value of certain gifts by the values of their reversionary remainder interests. The Supreme Court reasoned that there was no recognized method for determining the values of the contingent reversionary remainders, which, in the case of the taxpayer mother’s trust in Robinette, depended on not only the possibility of her daughter’s survivorship, but also on the death of her daughter without issue who failed to reach the age of 21. The Supreme Court distinguished this type of contingent reversionary interest with the reversionary interest in Smith v. Shaughnessy, 318 U.S. 176 (1943), the companion case to Robinette. The Supreme Court expressly distinguished a simple contingency based on the possibility of survivorship, which the court implied is ascertainable by recognized actuarial methods, from a complex contingency based on the possibility of survivorship, plus the possibility that the unmarried daughter might die without issue who reach the age of 21 years, which was highly remote.
The Tax Court in the instant case noted that the contingency at issue was whether Jean would survive three years after the date of the gift. This contingency, noted the court, was simple and based on the possibility of survivorship; it wasn’t a complex contingency that depended on multiple occurrences. Jean’s survivorship was thus speculative and whether it was too speculative or highly remote was a factual issue.
Distinguishing Murray and Armstrong
In reaching its decision not to followMcCord, the Tax Court also considered Murray v. United States, 687 F.2d 386 (Ct. Cl. 1982) and Armstrong Trust v. U.S., 132 F. Supp.2d 421 (W.D. Va. 2001), affng sub nom Estate of Armstrong v. U.S., 277 F.3d 490 (4th Cir. 2002). Noting that neither Murray nor Armstrong were binding on the Tax Court, and each case contained facts different from the instant case, it:
. . . agree[d] with what we believe[d] to be the basis of those two opinions, i.e., that, in advance of the death of a person, no recognized method exists for approximating the burden of the estate tax with a Federal gift tax purposes.
The Tax Court, however, stated that its reliance on Murray and Armstrong was inapposite to the instant case. Murray was distinguishable from the facts in the instant case because unlike the donor in Murray (who didn’t intend to reduce the gifts by the amount of estate tax liability), Jean expressly intended to reduce the value of her gifts by the amount of estate tax liability assumed by her daughters. And, her daughters assumed only the portion of Jean’s estate tax liability that could be incurred over a three-year span. The value of the amount of Section 2035(b) estate tax liability in the instant case was thus potentially predictable.
In Armstrong, the donor’s children expressly declined to assume gift tax liability or potential Section 2035(b) estate tax liability with respect to the gifts and were secondarily liable (after the donor’s trust) for estate tax. In the instant case, the daughters expressly agreed to pay both the gift tax liability and potential Section 2035(b) estate tax liability.
Fluctuating Rates and Exemptions
The Tax Court in McCord had implied that because estate tax rates and amounts can change, it would be difficult to determine the amount of potential Section 2035(b) estate tax liability. The Fifth Circuit in McCord and other cases, however, rejected the McCord Tax Court’s reasoning and instead concluded that it’s possible to determine FMV despite fluctuations in capital gains tax rates; the potential for capital gains tax to disappear; the fact that there’s no indication of when capital gains tax will be triggered by a done or beneficiary, if ever; and the fact that it’s unknown at the time of a gift what amount of capital gains tax a donee would pay, if any. “We cannot foreclose the possibility that an appropriate method likewise may exist to fix the value of the potential section 2035(b) estate tax liability assumed by the donees in this case,” said the Tax Court in the instant case.
According to the estate depletion theory, whether a donor receives consideration is measured by the extent to which a donor’s estate is replenished by the consideration. The Tax Court noted that a donee’s assumption of potential Section 2035(b) estate tax liability may provide a tangible benefit to a donor’s estate, and therefore, as a matter of law could meet the requirements of the estate depletion theory. When Jean’s daughters assumed the gift tax liability, Jean’s assets were relieved of the gift tax liability and were replenished. Similarly, when the daughters assumed the potential Section 2035(b) estate tax liability, Jean’s assets may have been relieved of the potential estate tax liability. This assumption may be reducible to a monetary value, and also may have replenished Jean’s assets.
Relying on Comm’r v. Wemyss, 324 U.S. 303 (1945) and other cases, the IRS argued that because the entire net gift agreement was a family-type transaction, the daughters’ assumption of the potential Section 2035(b) estate tax liability didn’t replenish Jean’s estate. The Tax Court rejected the IRS’ argument, holding that the “[r]espondent’s comparison of the case at hand to Wemyss thus falls flat,” because the daughters’ assumption of potential Section 2035(b) estate tax liability may be quantifiable and reducible to monetary value.
Because the IRS failed to show as a matter of law that the daughters’ assumption of Jean’s potential Section 2035(b) estate tax liability couldn’t be consideration in money or money’s worth within the meaning of Section 2512(b), its motion for summary judgment was denied. The Tax Court further found that nothing in the record indicated that the net gift agreement wasn’t bona fide or made at arm’s length. Because there were genuine disputes of material fact as to whether the daughters’ assumption of Jean’s potential Section 2035(b) estate tax liability constituted consideration in money or money’s worth, the IRS wasn’t entitled to summary judgment.