Good news, bad news. The Tax Court has approved a gift tax avoidance scheme, but there’s a catch.
In Jean Steinberg (2013) 141 TC No. 8, the Tax Court gave preliminary approval to a gift tax avoidance scheme the court had previously disallowed. Here’s how it works:
Under IRC §2035(b), gift tax paid within 3 years of death is included in the donor’s estate. For example, Donor makes a $1 million gift and pays $400,000 of gift tax. A variation on this approach uses a “net gift” of $1 million when Donor makes a gift of $1,400,000 and Donees agree to pay the gift tax. Either way, $400,000 is added back to the estate if Donor dies within 3 years.
Now suppose Donees agree to pay the gift tax and the estate tax on the gift tax. In the Steinberg decision, the Tax Court held that Donor could probably deduct the value of their promise to pay the estate tax in calculating the amount of the gift.
For example, Donor makes a gift of $1,500,000 but the “net, net gift” is only $1 million because the value of the promise to pay the estate tax of $160,000 on the $400,000 gift tax is determined to be $100,000 (saving $28,000 in gift tax on a net gift of $72,000), based on the assumed probability that Donor will die within 3 years.
Is this scheme too good to be true? Of course, there’s a catch: If Donor dies within 3 years, the promise to pay $160,000 will be added to the estate, triggering an additional $64,000 of estate tax (40 percent of $160,000). As illustrated by this example, the additional estate tax if you die is always much greater than the gift tax saving if you don’t.
For more on the Steinberg decision, see the December 2013 issue of CEB’s Estate Planning & California Probate Reporter., a must-have for estate planning practitioners. And for a more detailed explanation of “net gift” tax consequences, turn to CEB’s Drafting California Irrevocable Trusts §§2.4, 2.31-2.32, 2.64.
Related CEB blog posts:
- The Gift That Keeps on Giving: Property Tax Information on Parent-Child Transfers May Reveal Unreported Gifts
- Portability—Game Changer for Estate Planning or More of the Same?
- IRS is Very Strict When It Comes to Charitable Contribution Rules
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