In Steinberg v. Commissioner, 141 T.C. No.8 (2013), the U.S. Tax Court reversed a position it had previously taken, and held that the value of a taxable gift could be reduced when the recipients of the gift agreed to assume any potential estate tax liability if the donor died within three years of the gift.
If a donor of a taxable gift (one which requires the actual payment of a gift tax, not just one that requires the filing of a gift tax return to report a gift sheltered by the donor’s exemption) dies within 3 years of the date of a gift, the resulting gift tax is added back to the donor’s taxable estate, pursuant to IRC §2035(b). Had the donor survived the 3-year period, not only the gift but also the gift tax he/she paid would have been out of the donor’s taxable estate at death. In inserting this provision, Congress felt that deathbed gifts of a donor’s entire estate would result in a massive loss of death tax revenue.
In the case of McCord v. Commissioner, 120 T.C. 258 (2003), the Tax Court held that this recapture of the paid gift tax was “too speculative” to be considered in valuing a gift. However, on appeal, the Fifth Circuit Court of Appeal reversed that result. Nevertheless, the IRS continues to hold the Tax Court’s position when the donor was not within the purview of the Fifth Circuit.
In Steinberg, however (which is appealable to the Second Circuit), the Tax Court reconsidered its earlier position. In that case, the donees agreed in writing that, if the donor died within three years, that each donee would pay any additional estate tax resulting because the gift tax paid would be includable in the taxable estate of the donor pursuant to IRC §2035(b). On the donor’s gift tax return, Form 709, the donor reported the gifts, but reduced their value based on an actuarial computation of the “expected” amount of such additional tax, considering the likelihood that the donor would die within those 3 years. In so doing, the donor’s preparer tried to estimate the probability and expected value of the additional taxes as liability being assumed by the donees, thereby reducing the value of the gifts.
While recognizing the tax might never be paid, the Steinberg Court nevertheless noted that a willing buyer would have demanded some reduction in a purchase price to compensate for the risk of having to pay the additional estate taxes. The Court also found that it was clearly a risk that could be valued. Thus, the Court refused to continue to follow the McCord holding, and instead allowed a reduction in the value of the gift for the possibility that an additional estate tax might be paid by the donees.
The actuarial value of survival for 3 years will always depend upon the age of the donor at the time of the gift. For example, a 60 year-old donor has about a 3% chance of not surviving to age 63. On the other hand, a 90 year-old donor has a more than a 50% chance of not surviving to age 93. Accordingly, this discount technique should be considered mostly for older donors.