Tax Liability for Net, Net Gifts
In Steinberg v. Commissioner, 145 T.C. No. 7 (September 16, 2015), an 89 year old donor made a $109 million taxable gift to her four daughters. The gift was made after the donor and the daughters entered into a gifting agreement that obligated the daughters to pay (1) the donor's gift tax, and (2) any additional estate tax resulting from Section 2035(b). The gift was a net gift in two respects. First, the daughters were legally obligated to pay their mother's $32.4 million gift tax. Second, the daughters were legally obligated to pay any additional estate tax that would be assessed against their mother's estate pursuant to Section 2035(b).
The donor reported the value of the gift as a net, net gift taking into account both the gift tax that the daughters would definitely have to pay and the Section 2035(b) estate tax that the daughters would have to pay if the donor didn't survive at least three years following the gift. The IRS issued a notice of deficiency that disallowed the donor's entire $5.84 million discount for the donees' assumption of the Section 2035(b) estate tax liability.
The Tax Court agreed with the donor's argument that the gift was a "net, net gift" and that the daughters' assumption of the Section 2035(b) estate tax liability should be treated similarly to a donee's assumption of the gift tax liability.
Individuals who are considering a substantial gift in 2016 should carefully consider whether the "net, net gift" technique validated in Steinberg is worth the gamble. A donee's assumption of the contingent 2035(b) estate tax liability in the case of an older donor may be particularly attractive because it would result in a larger reduction in the gift value than when a younger donor is involved; but that is because the older donor is less likely to live for three years after having made the gift. If the donor manages to survive the requisite three years, the reduction in value is achieved even though the Section 2035(b) estate tax is not incurred. However, if the donor survives less than three years following the gift, not only is there 2035(b) estate tax due (payable by the donee), but the donor's gross estate is also increased by a new asset: the donee's obligation to pay that estate tax, the date of death value of which would seem to be the dollar amount of the tax—not the present value of the contingent estate tax liability as of the date of the gift.
Clary Redd is a member of the firm's Tax, Trusts and Estates practice group. His practice focuses on wills, trust instruments, durable powers of attorney, marital agreements and other estate planning documents. Clary works from the firm's St. Louis office.
Dylan Metzner is a member of the firm's Tax, Trusts and Estates practice group. His practice focuses on designing taxed advantaged entity structures including, family limited partnerships and limited liability companies, and complex trusts. Dylan works from the firm's Denver office.