In Steinberg v. Commissioner (September 2013), the Tax Court changed a position it had maintained since 2003 in connection with “net gifts.” In a net gift transfer, the donee agrees to pay the donor’s gift tax that results from the gift. It is well established that this assumption by the donee reduces the amount of the gift being made and therefore also reduces the amount of the gift tax.
In some net gift transfers, the donee also assumes the obligation to pay any estate tax that may become due under IRC Section 2035(b) as a result of the gift. Section 2035(b) provides that if someone makes a gift and then dies within three years of making the gift, any gift tax that was paid by the decedent or his estate in connection with the gift is brought back into the donor’s estate for Federal estate tax purposes. The courts have held that gift tax paid by the donee is deemed to have been paid by the donor for this purpose.
In the McCord case in 2003, the Tax Court held that the amount of the gift could not be reduced by the actuarial value of the estate tax that would be payable if the decedent dies within three years of making the gift. Since it was not known whether the taxpayer would die within three years and whether any additional estate tax would even be payable, the court did not believe it was appropriate to reduce the gift amount by some amount of hypothetical estate tax that may never be paid.
The Tax Court’s position in the McCord case was reversed, however, by the Fifth Circuit on appeal. In the Steinberg case, the Tax Court decided that the Fifth Circuit was correct and that the liability for the contingent tax could be valued using recognized actuarial methods and mortality tables.