Gift determined with reference to assumption of potential estate tax liability.

• Author: Beavers, James A.

In a departure from its own precedent, the Tax Court held that the fair market value (FMV) of a donor's taxable gift may be determined with reference to the donee's assumption of the potential Sec. 2035(b) estate tax liability for the gift.

Background

On April 17, 2007, Jean Steinberg, a resident of New York, entered into a binding gift agreement (net gift agreement) with her four adult daughters. At that time Steinberg was 89 years old. In the net gift agreement she agreed to make gifts of cash and securities to her daughters. In exchange, they agreed to assume and to pay any federal gift tax liability imposed as a result of the gifts. The daughters also agreed to assume and to pay any federal or state estate tax liability imposed under Sec. 2035(b) as a result of the gifts in the event that Steinberg passed away within three years of the gifts. The net gift agreement was the result of several months of negotiation between Steinberg and her daughters, who were represented by separate counsel.

Steinberg retained an appraiser to calculate the gross FMV of the property transferred. The appraiser also calculated the aggregate FMV of the "net gift." The appraiser determined the value of the net gift by reducing the FMV of the cash and securities by both (1) the gift tax the daughters paid and (2) the actuarial value of their assumption of the potential Sec. 2035( b) tax liability. The appraiser determined the actuarial value of the daughters' assumption of the potential Sec. 2035(b) tax liability by calculating Steinberg's annual mortality rate for the three years after the gift (i.e., the probability that Steinberg would die within one year, two years, or three years of the gift), among other things. The appraiser determined that the aggregate FMV of the net gift was $71,598,056, as of the date of the gift. Steinberg valued her daughters' assumption of the potential Sec. 2035(b) tax liability at $5,838,540.

On Oct. 15, 2008, Steinberg timely filed a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for tax year 2007. On the Form 709, Steinberg reported taxable gifts of $71,598,056 and total gift tax of $32,034,311. Steinberg attached a summary of the net gift agreement, which included a description of the appraiser's determination of the value of the net gifts, to the Form 709.

On July 25, 2011, the IRS mailed the notice of deficiency, which increased the aggregate value of Steinberg'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 Steinberg made for her daughters' assumption of the potential Sec. 2035(b) tax liability. In response, Steinberg filed a petition in Tax Court contesting the IRS's determination, and the IRS filed a motion for summary judgment.

Net Gift

When a donor makes a gift subject to the condition that the donee pay the resulting gift tax, the gift amount is reduced by the amount of the gift...