Gifts and Bequests

Author:Deborah A. Geier
Pages:185-214
 
FREE EXCERPT
Chapter 7: Gifts and Bequests
Recall from Chapter 1 that a fundamental precept of an income tax is that the same dollars
should not be taxed to the same taxpayer more than once and that we use “basisas the tool to
keep track of previously taxed dollars to implement this precept.
Do not be lulled into thinking that the same dollars cannot be taxed to the same taxpayer more
than once under two separate tax systems, however. It happens routinely. For example, the same
dollar of labor income is commonly taxed twice to the same taxpayer at the Federal level: once
under the payroll taxes (the Social Security and Medicare Taxes described in Chapter 3) and once
under the income tax.
Moreover, even if we limit our focus to the Federal income tax itself, the same dollar is
commonly taxed to more than one taxpayer as it is transferred from taxpayer to taxpayer in the
economy. For example, Doris earns wages from her job as a store clerk, and she includes those
wages in her Gross Income under § 61(a)(1). Doris then pays some of her after-tax dollars to her
window washer, David, for washing the windows of her home. They are after-tax dollars because,
as a personal expense, Doris cannot deduct the outlay, which means that the amount that she pays
to David effectively remains in her tax base and is taxed to her. David cannot claim that his receipt
should be free of Federal income tax in his hands because those dollars were already taxed once
(to Doris) under the Federal income tax. Thus, the same dollars are includable in Gross Income by
both Doris and David and are taxed twice under the income tax as they move from Doris to David.
What if Doris simply makes a gift of those dollars to David during life or leaves a bequest to
David at her death instead of paying them as wages to David?
Possible taxation approaches to the transfer and receipt of gifts and bequests
When we think about gratuitous transfers, whether an inter vivos gift (during life) or a death-
time bequest, we have two taxpayers to consider—the donor and the donee—and we have two
possible tax systems to consider at the Federal level: the Federal income tax and the Federal wealth
transfer taxes, consisting of an integrated system composed of the estate tax, the gift tax, and the
generation-skipping transfer tax, each of which is legally imposed on the donor. Unlike wealth
taxes, which tax the fair market value of assets again and again, year after year, the wealth transfer
taxes are excise taxes imposed on the donor only on the act of transfer, whether during life or at
death. The wealth transfer taxes are the subject of a separate tax course and are not examined here
in any detail except to the extent that their mere existence may help us to think about how
gratuitous transfers should be treated under the income tax.
Should the income tax treatment of inter vivos gifts and death-time bequests be integrated with
the wealth transfer taxes so that the same dollars are not taxed under both Federal tax systems? If
the answer to that is yes,should the payroll taxes (Social Security Tax and Medicare Tax) on
wages be integrated with the income tax on wages so that the same dollars are not taxed under
both Federal tax systems, as well?1 If the answer to the latter is “no” because the income tax and
payroll taxes serve different purposes, should the answer to the former also be “no” for the same
reason? Should the income and wealth transfer tax systems ensure that a dollar is taxed at least
1 See, e.g., Deborah A. Geier, Integrating the Tax Burdens of the Federal Income and Payroll Taxes on Labor
Income, 22 VA. TAX REV. 1 (2002).
Chapter 7 Gifts and Bequests Chapter 7
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once between the two systems rather than escaping tax entirely under both, as is not uncommon
today (particularly because of the combination of the realization requirement, the high estate tax
exemption, and § 1014, described below)?
Under the Federal income taxviewed alone and without regard to any possible treatment
under the estate taxshould amounts transferred as inter vivos gifts or bequests be effectively
taxed to both the donor and the donee, just as both David, the window washer, and Doris were
effectively taxed on the same dollars under the income tax when she paid them to David as wages?
The making of a gift is clearly a personal expense of the donor, so it would generally be
nondeductible (unless contributed to a charity, considered in Chapter 17). Thus, the issue boils
down to whether it ought to be included in the donee’s Gross Income when received. And what if
property (instead of cash) is transferred, and the property has unrealized built-in gain at the time
of transfer? Should the gift or bequest qualify as a realization event under § 1001? At what basis
should the donee take the property?
To help us to think about these questions, consider the story appearing in the Los Angeles Times
in 2010, which reported that Christie’s New York sold Pablo Picasso’s 1932 portrait of his mistress
entitled “Nude, Green Leaves and Bust” for $106.5 million. Bidders came from all over the world,
including Asia, the U.S., Europe, and Russia, although the winning bidder (by telephone) was not
identified. The article relates the following:
The painting came from the estate of Frances Brody, the Los Angeles arts patron
who died last year [2009] at age 93. Her husband Sidney, a real estate developer,
died in 1983. The estate consigned this Picasso to Christie’s along with some 80
other artworks. The most valuable pieces, including sculptures by Alberto
Giacometti, went up for auction Tuesday night; the remainder are slated for
Wednesday morning…. The Brodys originally bought “Nude, Green Leaves and
Bust” in January 1951 from Paul Rosenberg’s New York gallery for $19,800 (about
$166,000 in today’s dollars).2
When an individual dies, a new taxpayer autom atically springs into existence called an “estate,”
which in essence takes the place of the decedent. The estate owes income tax on any income
realized by it during its existence, using the rate schedule found in § 1(e) (reprinted in Chapter 8).
For example, when the estate receives an interest payment on a corporate bond that the decedent
owned before death, the estate must include that interest payment in its Gross Income under §
61(a)(4), just as the decedent would have included it had she not died. At some point, the estate
will distribute all of its (after-tax) cash and other assets to the estate beneficiaries as described in
the decedents will or under the laws of intestacy and cease to exist. Thus, the cash collected by
the Brody estate on the sale described above, as well as any other cash and property owned by the
estate, less any income tax (and estate tax, if any) owed, would be distributed to Mrs. Brody’s
2 Jori Finkel, Picasso Sets Record Sales Price, http://articles.latimes.com/2010/may/05/entertainment/la-et-brody-
picasso-20100505. At the time, this sale represented the highest price ever obtained for an artwork. That record has
since been broken multiple times, most recently in 2017, when a work attributed (though no unequivocally) to
Leonardo da Vinci sold at auction for $450.3 million. See Robin Pogrebin & Scott Reyburn, Leonardo da Vinci
Painting Sells for $450.3 Million, Shattering Auction Highs,
at https://www.nytimes.com/2017/11/15/arts/design/leonardo-da-vinci-salvator-mundi-christies-auction.html.
Trivia tidbit: After Frances Brody’s death, the talk show host Ellen DeGeneres bought the house from the estate
for $40 million before it officially was listed for sale. See Ste ven Kurutz, The Unsettling Thing About Ellen, at
www.nytimes.com/2014/04/24/garden/the-unsettling-thing-about-ellen.html?hpw&rref=garden.

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