Case — Gift Valuation

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TL Case Summ

THE QUESTION

Can the value of a gift be reduced by the amount of tax an estate would have to pay if the donor dies within three years of making the gift?

THE DISPUTE

Taxpayer Says: The fair market value of the gift should be reduced by the amount of tax her daughters would have to pay if she dies within three years of making the gift, and the gift is included in the estate.

Internal Revenue Service Says: The daughters’ promise to pay any required estate tax was of no value to the taxpayer, and the value of the gift should not have been reduced.

THE LAW

From Internal Revenue Code Section 2501(a): Imposes a tax on the transfer of property by gift.

From Internal Revenue Code Section 2502(c): The donor is primarily responsible for paying the gift tax.

From Internal Revenue Code Section 2512(b): The amount of the gift is the amount by which the value of the property transferred exceeds the value of consideration received in money or money’s worth.

From Internal Revenue Code Section 2035(b): A decedent’s gross estate is increased by the amount of any gift tax paid by the decedent or the decedent’s estate on any gift made by the decedent during the three-year period preceding the decedent’s death. 

THE CAUSE OF THE DISPUTE

When you give someone a taxable gift, you’re generally responsible for paying the gift tax. If the person to whom you give the gift agrees to pay the tax, the value of your gift is reduced, because the person paying the tax receives only the net amount. The payment of the tax is “consideration”, because you have received something of value.

As an illustration, say you make a taxable gift of $10,000. If the gift tax rate is 40%, you would owe $4,000, which you would pay out of funds separate from the gift. The recipient receives the full $10,000, and you have expended $14,000. If the recipient of the gift pays the tax, you have, in effect, made a gift of $6,000 instead of $10,000. You are out of pocket $10,000, not $14,000, giving their promise a value to you of $4,000.

In this case, the question is whether the value of the gift can also be reduced by estate tax that might be due if the donor dies within three years of making the gift, when the recipient agrees to pay that amount. (Gift tax paid, either by the donor or the recipient, is included in your estate if you die within three years of making the gift. See the ‘Law’ section above.) Restated, the question is, does the promise to pay potential estate tax qualify as consideration?

The taxpayer, who was 89 years old, made gifts to her four daughters. The daughters signed a valid written agreement stating they would pay the gift tax. They also agreed to pay any estate tax that might be due if the taxpayer died within three years of making the gift.

An appraiser determined the gross fair market value of the gifts. He reduced that value by the amount of the gift tax the daughters had agreed to pay, as well as by the present value of the estimated estate tax due if the gift tax had to be included in the taxpayer’s estate.

The taxpayer filed a gift tax return reporting the net amount of the gifts as $71,598,056. The taxpayer valued the gift tax paid by the daughters at $32,034,311. He valued the estimated estate tax due that the daughters promised to pay, if required, at $5,838,540.

The IRS increased the value of the gifts by the $5,838,540 of estimated estate tax, and assessed additional gift tax of $1,804,908. The IRS says the assumption of the potential estate tax liability by the daughters was worthless, because it did not increase the value of the taxpayer’s estate, and is therefore not consideration.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 247KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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For the taxpayer. To qualify as consideration in money or money’s worth, the consideration received must be reducible to value in money or money’s worth; consideration consisting of something unquantifiable, such as love and affection or the promise of marriage, is wholly disregarded. Because the value of the obligation assumed by the daughters is not barred as a matter of law from being consideration in money or money’s worth within the meaning of IRC section 2512(b), the fair market value of the taxable gift may be determined with reference to the daughters’ assumption of the potential IRC section 2035(b) estate tax liability.
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