Maybe Sometimes You Should
That’s Judge Kerrigan’s message to the daughters of Jean Steinberg, Donor, in 141 T. C. 8, filed 9/30/13.
Jean made a deal with her four adult daughters, and does a lot better than King Lear did when he made a deal with his three.
Jean, aged 89, gifts her daughters a girnormous wad of cash and marketable securities, on two conditions, and it’s a double-whammy: the kids have to stump up any Federal gift tax Mama would be hit with, and, if Mama shuffles off this mortal coil during the three-year death-gift penumbra, the daughters get to pay the estate tax as well. Cf. poor old Doc Shel Sommers and his wife Bernice, stars of my blogpost “Artistically Gifted”, 1/11/13, when IRS tries to slug Bernice with the same story.
IRS claims Jean understated her gift tax by better than $1.8 million, because she deducted the value of the daughters’ undertakings to front the taxes.
But Jean’s lawyers drew up a tough agreement, with the daughters losing their right to further distributions if they didn’t pay up. And there was a lot of negotiation between Jean’s lawyers and the daughters’ lawyers.
Each had separate counsel. Reminds me of the New Yorker cartoon showing a bunch of people leaving the conference room, each accompanied by a gentleman in a suit with a bowtie, glasses and a briefcase, but one such is standing in a corner. Caption: “Has everybody got a lawyer? I seem to have an extra.”
Anyway, Jean and the daughters got an appraisal. The appraiser took the mortality tables to figure out how much more mileage Jean has before she goes to the great Garage in the Sky, and the numbers derived go into the Form 709.
“Petitioner 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.” 141 T. C. 8, at p. 6.
IRS disallows the estate tax guesstimate, and Jean petitions.
IRS moves for summary judgment (no facts disputed, so no trial necessary).
Judge Kerrigan: “…respondent [IRS] does not dispute (1) the value of the cash and securities transferred; (2) whether petitioner properly reduced her gift tax liability by the amount of gift tax the donees assumed; or (3) whether the donees’ assumption of the section 2035(b) estate tax liability is enforceable under local law. Respondent’s sole claim is that the donees’ assumption of the potential section 2035(b) estate tax liability did not increase the value of petitioner’s estate and therefore did not constitute consideration in money or money’s worth within the meaning of section 2512(b) in exchange for the gifts.” 141 T. C. 8, at p. 8.
Now gift tax paid on gifts made within three years of death get added back to the estate for estate tax, because formerly the tax paid was both a credit against estate tax and a reduction of the tax base, making deathbed gifts a good tax deal. No more; and even net gift tax (gift tax paid by donee) goes back into the estate.
IRS claims that the undertaking to pay estate tax if Jean buckets within three years is worthless. All Jean gets is peace of mind. Therefore her estate is not depleted, as it would be if she had to pay gift tax.
The question is whether Jean got anything determinable in money or money’s worth when the daughters agreed to pick up the taxes. Whether the daughters lost in the deal is irrelevant; the test is did Jean benefit.
Yes, as to the gift tax clearly, because the gift tax would have reduced Jean’s available cash.
Now, all the way back in McCord v. Com’r., 120 T.C. 358 (2003), rev’d and remanded sub nom. Succession of McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006) , Tax Court held “in advance of the death of a person, no recognized method exists for approximating the burden of the estate tax with a sufficient degree of certitude to be effective for Federal gift tax purposes.” 120 T. C. at p. 402, cited at 141 T.C. 8, at p. 17.
At best, said the McCord Tax Court, the mortality tables prove what premium an insurer would take to cover the risk. Moreover, “the dollar amount of a potential liability to pay the 2035 tax is by no means fixed; rather, such amount depends on factors that are subject to change, including estate tax rates and exemption amounts (not to mention the continued existence of the estate tax itself).” Citing McCord, 120 T. C. 402, at 141 T. C. 8, at p. 17.
Prescient of Tax Court to see, in 2006, the expiry of the estate tax in 2010.
Anyway, McCord was reversed and remanded by Fifth Circuit, but that doesn’t matter, as Jean is a New Yorker and Fifth Circuit doesn’t apply to New York. (Might be time for a Federal Tax Circuit, so we get one nationwide rule for a nationwide tax.)
And cases involving multiple contingencies don’t count, because here there’s only the chance of Jean checking out in the three years following the gift. And the fluctuation in tax rates is a given, but every willing buyer and willing seller (those imaginary chaps) reckons his price based upon today’s tax rates. And courts have recognized that the value of an appreciated gift must be reduced by capital gains taxes payable by the donee, even if the donee doesn’t immediately sell.
IRS argues that Jean’s death in the three-year gulch is too speculative to fix a value. No, says Judge Kerrigan, the cases say that just because something is not inevitable, it’s not too speculative.
And just because the estate tax benefit was to the estate of the donor (she being dead at the time the estate would come into being), and not to the donor herself, doesn’t get it. Tax Court thought so in McCord, but now agrees with Fifth Circuit. In this case, the donor and her estate are inextricably bound.
So the assumption by the daughters of the estate tax liability may have enough worth to give rise to reduction in gift tax.
IRS claims this is not a business deal, but it is an intrafamily deal, and therefore not made for consideration. Wrong, says Judge Kerrigan. The gift tax deal wasn’t a business deal and it was intrafamily, but that’s OK, so this should be too. Besides, they all had lawyers, they negotiated for months, and nothing suggests this was a “sweetheart” deal.
But we have a real issue of fact on the appraisal. Was the assumption of estate tax liability consideration in money or money’s worth? Go to trial, guys.