SCOTUS Reports

Tag: Net Gifts

  • Steinberg v. Commissioner, 145 T.C. 184 (2015): Valuation of Net Gifts and Consideration for Estate Tax Liability

    Steinberg v. Commissioner, 145 T. C. 184 (2015) (United States Tax Court)

    In Steinberg v. Commissioner, the U. S. Tax Court ruled that when calculating gift tax, the value of gifts can be reduced by the donees’ assumption of potential estate tax liabilities under I. R. C. sec. 2035(b). Jean Steinberg’s daughters agreed to pay any such taxes if she died within three years of the gifts. The court determined this promise constituted a detriment to the daughters and a benefit to Steinberg, impacting the gift’s fair market value. The ruling clarifies how contingent liabilities should be considered in gift tax valuation, affecting estate planning strategies involving net gifts.

    Parties

    Jean Steinberg, the Petitioner, was the donor in the case. The Respondent was the Commissioner of Internal Revenue. The daughters of Jean Steinberg, Susan Green, Bonnie Englebardt, Carol Weisman, and Lois Zaro, were involved as donees but were not formally parties to the litigation.

    Facts

    Jean Steinberg, after the death of her husband Meyer Steinberg, inherited a marital trust valued at $122,850,623. In 2007, at the age of 89, she entered into a binding net gift agreement with her four daughters. Under this agreement, Steinberg transferred assets valued at $109,449,307 to her daughters. In exchange, the daughters agreed to assume and pay any resulting Federal gift tax and any Federal or State estate tax liability under I. R. C. sec. 2035(b) should Steinberg die within three years of the gifts. The daughters set aside $40 million in escrow, with $32,437,261 used to pay the gift tax and the remainder held for potential estate tax liabilities. Steinberg reported a net gift value of $71,598,056 on her gift tax return after accounting for the daughters’ assumptions of tax liabilities.

    Procedural History

    The Commissioner of Internal Revenue issued a notice of deficiency to Steinberg, increasing her reported gift tax liability by $1,804,908 for tax year 2007. The Commissioner disallowed Steinberg’s discount for her daughters’ assumption of the potential I. R. C. sec. 2035(b) estate tax liability. Steinberg petitioned the United States Tax Court for review. The court had previously addressed a similar issue in Steinberg v. Commissioner, 141 T. C. 258 (2013) (Steinberg I), denying the Commissioner’s motion for summary judgment and holding that the daughters’ assumption of estate tax liability could be quantifiable and considered in determining the gift’s value. The current case proceeded to trial to establish the relevant facts and calculate the value of the gift.

    Issue(s)

    Whether a donee’s promise to pay any Federal or State estate tax liability that may arise under I. R. C. sec. 2035(b) if the donor dies within three years of the gift should be considered in determining the fair market value of the gift?

    If so, what is the amount, if any, that the promise to pay reduces the fair market value of the gift?

    Rule(s) of Law

    The fair market value of a gift for gift tax purposes is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. I. R. C. sec. 2512(a); Treas. Reg. sec. 25. 2512-1. The gift tax is imposed on the transfer of property by gift and is measured by the value of the property passing from the donor, not the value of enrichment to the donee. I. R. C. sec. 2501(a); Treas. Reg. sec. 25. 2511-2(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, creating a “net gift”. I. R. C. sec. 2512(b); Treas. Reg. sec. 25. 2512-8.

    Holding

    The U. S. Tax Court held that the daughters’ assumption of potential I. R. C. sec. 2035(b) estate tax liability should be considered in determining the fair market value of the gift. The court further held that the value of the daughters’ assumption of the estate tax liability reduced the value of Steinberg’s gift to her daughters by $5,838,540.

    Reasoning

    The court’s reasoning focused on the “willing buyer/willing seller” test for determining fair market value. It reasoned that a hypothetical willing buyer would consider the daughters’ assumption of both gift tax and potential I. R. C. sec. 2035(b) estate tax liabilities as a detriment to the donees and a benefit to Steinberg, justifying a reduction in the gift’s value. The court rejected the Commissioner’s argument that the daughters’ assumption of estate tax liability did not constitute consideration in money or money’s worth under I. R. C. sec. 2512(b), citing the estate depletion theory. This theory posits that a donor receives consideration to the extent that their estate is replenished by the donee’s assumption of liabilities. The court also found that the net gift agreement did not duplicate New York law’s apportionment of estate taxes, as it provided a guaranteed mechanism for the daughters to assume the estate tax liability, which was not certain under state law. The court accepted the valuation methodology provided by Steinberg’s expert, William Frazier, who used the Commissioner’s mortality tables and I. R. C. sec. 7520 interest rates to calculate the present value of the daughters’ contingent liability. The Commissioner’s arguments against this methodology were deemed unpersuasive, leading to the court’s conclusion that the valuation was proper.

    Disposition

    The court entered a decision for the petitioner, Jean Steinberg, affirming the reduction of the gift’s value by $5,838,540 due to the daughters’ assumption of the I. R. C. sec. 2035(b) estate tax liability.

    Significance/Impact

    The Steinberg case is significant for clarifying the treatment of contingent liabilities in the valuation of gifts for gift tax purposes. It establishes that a donee’s assumption of potential estate tax liabilities under I. R. C. sec. 2035(b) can be considered as consideration in money or money’s worth, reducing the taxable value of the gift. This ruling impacts estate planning strategies involving net gifts, particularly in scenarios where donors seek to minimize their gift tax liability by conditioning gifts on the donees’ assumption of tax liabilities. The case also underscores the importance of the “willing buyer/willing seller” test in determining fair market value and the use of actuarial tables and statutory interest rates in calculating the value of contingent liabilities. Subsequent cases and practitioners have referenced Steinberg in addressing similar issues, influencing how net gifts are structured and valued.

  • Estate of Sachs v. Commissioner, 88 T.C. 769 (1987): Inclusion of Gift Tax in Gross Estate and Deductibility of Retroactively Waived Income Tax

    Estate of Samuel C. Sachs, Deceased, Stephen C. Sachs, Sophia R. Sachs, Coexecutors, Petitioners v. Commissioner of Internal Revenue, Respondent, 88 T. C. 769 (1987)

    Gift tax paid by donees on a net gift within three years of the decedent’s death is includable in the gross estate, and a retroactively waived income tax liability is deductible under certain conditions.

    Summary

    Samuel C. Sachs made net gifts to trusts within three years of his death. The Commissioner argued that the gift tax paid by the trusts should be included in Sachs’ gross estate under section 2035(c), and that a retroactively waived income tax liability should not be deductible. The Tax Court held that the gift tax paid by the trusts was indeed includable in the estate, reasoning that the statute’s purpose was to prevent tax avoidance by including all gift taxes in the estate. However, the court allowed a deduction for the income tax liability, which had been paid due to a Supreme Court decision but was later waived by Congress. The court valued certain Treasury bonds at par for estate tax purposes. This case clarifies the treatment of net gifts and retroactive tax waivers in estate tax calculations.

    Facts

    In 1978, Samuel C. Sachs made net gifts of shares to trusts for his grandchildren’s benefit, with the trusts paying the gift tax. Sachs died in 1980, and his estate included the shares at their date of death value, reduced by the gift tax paid by the trusts. The estate also paid additional income tax and interest due to a Supreme Court decision, but this liability was later waived by Congress in 1984. The Commissioner determined a deficiency in the estate tax, arguing that the gift tax paid by the trusts should be included in the gross estate and that the waived income tax liability should not be deductible.

    Procedural History

    The estate filed a tax return and the Commissioner determined a deficiency. The estate petitioned the Tax Court, which heard the case and issued its opinion in 1987, affirming in part and reversing in part the Commissioner’s determinations. The decision was later affirmed in part and reversed in part by an appellate court in 1988.

    Issue(s)

    1. Whether gift tax paid by donees on a net gift within three years of the decedent’s death is includable in the decedent’s gross estate under section 2035(c)?
    2. Whether the estate is entitled to a deduction under section 2053(a) for a Federal income tax claim arising from the net gift when the claim was retroactively waived by the Tax Reform Act of 1984?
    3. Whether certain “flower bonds” included in the gross estate should be valued at par?

    Holding

    1. Yes, because the purpose of section 2035(c) is to prevent tax avoidance by including all gift taxes paid on gifts made within three years of death in the gross estate, regardless of who paid the tax.
    2. Yes, because the income tax liability was valid and enforceable at the time of death, and the retroactive waiver by Congress did not affect its deductibility under section 2053(a).
    3. Yes, because flower bonds are valued at par to the extent they are available to pay estate tax and interest.

    Court’s Reasoning

    The Tax Court reasoned that the literal language of section 2035(c) would lead to a result inconsistent with the overall purpose of the transfer tax system. The court relied on legislative history showing Congress’s intent to prevent tax avoidance by including all gift taxes in the estate, regardless of who paid them. The court rejected the estate’s argument that the gift tax was not paid by the decedent or his estate, focusing on the substance of the transaction where the decedent was primarily liable for the tax.

    For the income tax deduction, the court applied the principle from Ithaca Trust Co. v. United States that the estate’s tax liability should be determined as of the date of death. The court found that the income tax liability was valid and enforceable at that time, and subsequent retroactive legislation did not affect its deductibility.

    On the valuation of flower bonds, the court followed precedent that such bonds should be valued at par if available to pay estate tax and interest, as they were in this case.

    Practical Implications

    This decision impacts estate planning by clarifying that gift tax paid by donees on net gifts within three years of death must be included in the gross estate, potentially increasing estate tax liability. Estate planners must consider this when advising clients on the timing and structure of gifts. The ruling also affects the deductibility of income tax liabilities that are later waived, suggesting that such liabilities should be treated as valid at the time of death for estate tax purposes.

    The decision may influence future cases involving the valuation of assets for estate tax purposes, particularly where assets like flower bonds are used to pay estate taxes. It also underscores the importance of considering the potential impact of legislative changes on estate tax calculations, especially when they occur after the decedent’s death.

  • Estate of Henry v. Commissioner, 69 T.C. 665 (1978): No Taxable Gain from ‘Net Gifts’ Where Donee Pays Gift Tax

    Estate of Douglas Henry, Deceased, Third National Bank, et al. , Co-Executors, and Kathryn C. Henry, Surviving Wife, Petitioners v. Commissioner of Internal Revenue, Respondent; Kathryn C. Henry, Petitioner v. Commissioner of Internal Revenue, Respondent, 69 T. C. 665 (1978)

    A donor does not realize taxable income from a ‘net gift’ where the donee pays the gift tax, provided the donor does not receive any benefit from the tax payment.

    Summary

    Kathryn Henry transferred securities to trusts for her grandchildren, stipulating that the trusts would pay the resulting gift taxes. The IRS argued that this transaction should be treated as a part-sale, part-gift, resulting in taxable gain to Henry. The Tax Court, following precedent from Turner v. Commissioner, held that no taxable gain was realized by Henry because the transaction was a ‘net gift’ and she did not receive any benefit from the tax payment. The court reaffirmed its position that such arrangements do not generate taxable income for the donor, emphasizing the importance of stare decisis and reliance on prior judicial decisions.

    Facts

    In 1971, Kathryn Henry created eight irrevocable trusts for her grandchildren, transferring securities valued at $6,682,572 with a basis of $114,940. 97. The trust agreements required the trusts to pay all resulting gift taxes, which amounted to $2,085,967. 26, using borrowed funds. Henry did not report any income from these transfers on her tax returns for 1971 or 1972. The IRS contended that the gift tax payments by the trusts constituted income to Henry, arguing that the transaction should be treated as part-sale and part-gift.

    Procedural History

    The IRS determined deficiencies in Henry’s federal income tax for 1971 and 1972, asserting that she realized a taxable gain from the gift tax payments made by the trusts. Henry filed petitions with the U. S. Tax Court to contest these deficiencies. The Tax Court, following its prior rulings in cases like Turner v. Commissioner, ruled in favor of Henry, holding that no taxable gain was realized from the ‘net gift’ arrangement.

    Issue(s)

    1. Whether Kathryn Henry realized taxable gain from the payment of gift taxes by the trusts to which she had transferred securities.
    2. If taxable gain was realized, whether such gain was realized in 1971 or 1972.

    Holding

    1. No, because the transaction was a ‘net gift’ and Henry did not receive any benefit from the tax payment, following the precedent set in Turner v. Commissioner.
    2. This issue became moot since the court determined that no taxable gain was realized in either year.

    Court’s Reasoning

    The Tax Court relied on a long line of cases, including Turner v. Commissioner, which established that a donor does not realize taxable income from a ‘net gift’ where the donee pays the gift tax. The court emphasized that Henry did not intend to sell her stock and did not receive any benefit from the tax payment, thus distinguishing the case from Johnson v. Commissioner, where the donor received cash prior to the transfer. The court also highlighted the principle of stare decisis, noting that Henry had relied on prior court decisions in structuring the gifts. The court quoted from its Hirst v. Commissioner opinion, stating, “Things have gone too far by now to wipe the slate clean and start all over again,” underscoring the importance of consistency in judicial decisions.

    Practical Implications

    This decision reinforces the validity of ‘net gift’ arrangements in estate planning, allowing donors to transfer assets to trusts or individuals without incurring immediate taxable income, as long as they do not receive any benefit from the gift tax payment. Estate planners should continue to structure such transactions carefully, ensuring that the donor does not receive any cash or other benefits from the tax payment. This ruling also underscores the importance of reliance on judicial precedent in tax planning, as the court emphasized that Henry had justifiably relied on prior decisions in making her gifts. Subsequent cases have continued to follow this precedent, maintaining the tax treatment of ‘net gifts’ as established in Turner and reaffirmed in Henry.