When a Gift Is Not a Gift

BY JAMES OZELLO

TAX BRIEF

When a Gift Is Not a Gift

The Second Circuit Court of Appeals recently held that a person could not reduce her estate by writing checks to family and friends before her death. Because the checks were paid after she died, the gifts were not completed. Furthermore, the court said, the “relation-back” doctrine did not apply and thus could not be used to complete these gifts.

Facts. Before her death, Mary Rosano wrote checks for less than $10,000 each to numerous relatives and friends. However, the checks were not paid until after her death.

Rosano’s executor did not include the amount of these checks in the taxable estate. On audit the IRS increased the value of the estate by these amounts, which resulted in additional taxes of nearly $300,000. The IRS also imposed penalties and interest of almost $100,000. The estate paid these amounts and filed for a refund. When the IRS denied the refund, the estate filed suit.

Issue. Under federal law, a gift is completed when the donor no longer has “dominion and control” over it. The IRS argued that the gifts were incomplete at the time of death, while the estate claimed they were completed. The estate also argued the relation-back doctrine should apply. Under this doctrine, checks delivered to charities prior to a donor’s death, but not paid until after death, are gifts considered completed on the delivery date. The doctrine also applies to situations involving a yearend gift by check to a noncharitable donee, treating the gift as complete in the year of delivery if certain conditions are met.

Held. The district court determined that under New York law, Rosano had the ability, at any time until the checks were paid, to order that payment be stopped. Therefore, she retained dominion and control over the checks until her death, and the gifts were not completed.

The Second Circuit upheld the district court on the gift issue and determined that the relation-back doctrine did not apply. It noted that other courts had refused to apply this doctrine under similar circumstances and cited two reasons. First, the doctrine applies in charitable situations because, if a check delivered to a charity prior to death is included in the estate, this would generate a deduction for the estate. But for practical purposes, it makes more sense to consider these gifts as outside the estate. No such offsetting deduction exists for gifts to noncharitable donees, so there is no rationale to apply the doctrine.

Second, the court reasoned that extending the doctrine to noncharitable donees would encourage tax avoidance. By issuing a check to a noncharitable donee with the understanding that it will not be cashed until after the donor’s death, a decedent could effectively bequeath up to $10,000 per donee, avoiding the estate tax consequences normally attending such transactions.

Observation. To avoid confusion, such gifts should be made while the donor is healthy and should be by certified check or other to ensure they are completed before the donor’s death. Rosano v. United States, 87 AFTR2d 2001-1619 (2001), affirming 84 AFTR2d 99-6483 (DC NY 1999), adopting 84 AFTR2d 99-5686, 67 F Supp 113.

—James Ozello, JD, Ozello Tax and
Legal Consulting, Ringwood, New Jersey.

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