The Tax Court agreed with the IRS that gift tax of approximately $10 million resulting from the gift of qualified terminable interest property (QTIP) by a decedent within three years before her death was includible in her gross estate under IRC § 2035(b). Even though the gift tax on the QTIP gift was paid by the trustees of two trusts, the court held that the gift was considered to be the liability of the decedent for purposes of section 2035(b).
The gross estate of a decedent includes the fair value of all property owned at death and any gift tax paid by the decedent from gifts made within three years of death. A married person’s estate is allowed an unlimited marital deduction for the value of property transferred to the surviving spouse at death. No marital deduction is allowed for terminable interest property; however, an exception exists for property transferred from the decedent in which the surviving spouse has a qualifying income interest for life that is designated by the executor of the estate as QTIP by an affirmative election. If the spouse who received the QTIP later gifts all or part of the income interest, that spouse is deemed to have transferred all interests in that property other than the income interest. If a gift tax liability exists due to the deemed transfer, section 2207A(b) permits the donor to recover that tax from the QTIP’s recipients.
In 2000, Anne Morgens had the right to the income of two trusts that were created from property transferred from a trust established in 1991 by her and her late husband. The property that funded the trusts had been designated as QTIP by the executor of her late husband’s estate. On Dec. 8, 2000, Morgens gifted her income interest from one of the trusts to the remainder interest beneficiaries, resulting in a deemed transfer with a gift tax liability of $2,287,309, which, due to a prior agreement, was paid by the trustees of that trust. On Jan. 10, 2001, she made a similar transfer of her interest in the second trust, resulting in another deemed transfer and a gift tax liability of $7,692,502, which again, due to a prior agreement, was paid by the trustees. On her estate tax return, the executor omitted the gift tax paid by the trustees related to the 2000 and 2001 gifts. As the result of an IRS audit, the IRS included the gift tax in her gross estate and issued a deficiency notice. The estate petitioned the Tax Court for relief.
The estate argued the gift tax was the responsibility of the trustees and was paid by them, not Morgens, and therefore section 2035(b) should not apply. The court disagreed, stating the QTIP provisions treated the QTIP as passing to Morgens from her late husband; thus, she was the deemed donor of the gift despite never having control of the ultimate disposition of the QTIP. As the deemed owner, she was liable for the tax, and her right to recover that tax from the gift’s recipients only shifted its financial burden, not the initial responsibility for reporting and paying the tax, according to the court.
The parties also disagreed whether the deemed transfer of QTIP was a net gift or was just reported as a net gift. A net gift is a gift of property subject to the condition that the donee will pay the gift tax. In Estate of Sachs v. Commissioner, 88 TC 769, the Tax Court previously held that when a donor of a net gift died within three years of making that gift, the gross estate must include the gift tax paid by a donee. Since Morgens was deemed to have received the QTIP and then gifted that property with the condition that the trustees pay any gift tax, the court held the deemed transfer of the QTIP was similar to a net gift.
The court also rejected the estate’s argument that the differences in the language “gift tax paid by the decedent” in section 2035(b), compared with “gift tax paid with respect to any person” in section 2207A(b), imply that Congress intended a different treatment of those taxes. It also rejected the estate’s argument that when Congress enacted section 2207A, it “silently amended” section 2035(b) by creating an exception for QTIP transfers within three years of death. The court stated such an exception would create an incentive to make a deathbed transfer of QTIP and thus would be contrary to the intent of section 2035(b), which is to discourage deathbed transfers.
Estate of Anne W. Morgens v. Commissioner , 133 TC no. 17
By Charles J. Reichert, CPA, professor of accounting, University of Wisconsin–Superior.