Anne Morgens and her husband established a revocable inter vivos trust in a community- property state. After Mr. Morgens’ death, the portion of the trust representing his one-half of the community property was allocated to a residual trust for Mrs. Morgens, for which a QTIP election was made. During Mrs. Morgens’ lifetime, the residual QTIP trust was divided into two trusts, and Mrs. Morgens made gifts of her qualifying income interests to both trusts, which, in turn, triggered deemed transfers of the remainder interests under Section 2519. The Trustees of the QTIP trusts paid the gift taxes on these deemed transfers.
Mrs. Morgens died within three years of the transfers. Her Executor did not include the amounts of gift tax paid by the Trustees of the QTIP trusts on her estate tax return on the theory that those amounts were not gift tax paid by Mrs. Morgens within three years of her death. The IRS audited the return and determined an estate tax deficiency of approximately $4.6 million.
The IRS argued that the gift tax amounts were includible in Mrs. Morgens’ gross estate under Section 2035(b) because Mrs. Morgens was personally liable for the gift tax as the deemed donor of the QTIP, even though she would have a right of recovery from the Trustees who paid it under Section 2207A(b). The Estate argued that applying Section 2035(b) to the gift tax paid by the Trustees would result in an increased estate tax burden contrary to the legislative intent of the QTIP regime. More specifically, the Estate contended that because the ultimate responsibility for paying the gift tax on the Section 2519 deemed transfers lies with the Trustees of the QTIP trusts, Section 2035(b) does not apply.
The Tax Court agreed that Congress intended that, as between QTIP recipients and the surviving spouse, it is the QTIP recipient who should bear the ultimate financial burden for the transfer taxes. However, the Court does not believe that, by allocating the financial burden for gift tax to the recipients of the QTIP Congress shifted to them liability for the gift tax. Section 2207A(b) does not provide that the donees of the QTIP are liable for the applicable gift tax – rather, it refers to the surviving spouse’s right to recover from the donees the gift tax paid. The gift tax liability remains with the donor, and, because the QTIP regime treats the surviving spouse as the deemed donor of the QTIP, the gift tax liability attributable to a Section 2519 deemed transfer remains with the surviving spouse.
Over the Estate’s objections, the court found that for purposes of Section 2035(b) the deemed transfer of the QTIP is in this case similar to a net gift. The Tax Court previously held in Estate of Sachs v. Commissioner that the phrase “gift tax paid by the decedent or his estate” in Section 2035(c) included gift tax attributable to net gifts made by a decedent during the three-year period before his death, even though the donees of the net gift are contractually obligated to pay the gift tax.
The court also noted that if, as a result of a lifetime disposition of the qualifying income interest, the inclusion of the QTIP uses up some or all of the surviving spouse’s unified credit, the surviving spouse may not recover the credit amount from the remaindermen. The court states that Congress’ refusal to restore the surviving spouse’s unified credit undercuts the Estate’s argument that Congress intended to hold the donees liable for the gift tax on gifts of QTIP interests under Section 2519.
The court holds that an exception from Section 2035(b) for gift tax paid on QTIP transfers would encourage transfers of QTIP property in contemplation of the surviving spouse’s death, which is inconsistent with the goal of Section 2035(b). Without a clear legislative mandate to except gift tax liability of the surviving spouse on Section 2519 transfers from the application of Section 2035(b), the court would not infer such an exception.