The Assumption of Estate Tax Liability May Reduce the Value of a Gift: The Tax Court Overrules McCord

January 15, 2014Articles

In Steinberg, the United States Tax Court held that the fair market value of a gift may be reduced by the donees’ assumption of the donor’s potential estate tax liability attributable to the gift. With this decision, the Tax Court overruled its previous decision in McCord.

In Steinberg, Mrs. Steinberg made gifts to her 4 daughters. The daughters, under a "net gift agreement", agreed to pay the gift tax associated with the gift. In addition, they also agreed that, if their mother died within 3 years, they would pay the resulting additional estate tax liability that would be due because the gift tax paid would be added back to their mother's gross estate under Section 2035(b) of the Code.

In reporting the gifts to her daughters on her gift tax return, the mother subtracted not only the amount of the gift tax of $32 million, but also the present value of the daughters' obligation to pay the contingent additional estate tax of roughly $4 million, resulting in a net gift of $72 million. The Service disallowed the reduction for the assumption of the contingent estate tax liability and assessed a deficiency of $1.8 million in gift tax. The Service based its disallowance on McCord, a case in which the Tax Court found that a contingent estate tax liability could be not be deducted from the value of a gift because it is subject to too many variable factors and therefore too speculative to quantify.

In Steinberg, the Tax Court reversed its decision in McCord and held that Mrs. Steinberg's daughters' commitment to pay the contingent estate tax liability was not too speculative to be reduced to a monetary value and, in fact, was actuarially ascertainable. The Tax Court reasoned that determining the amount of an estate tax that may be in effect when the taxpayer dies is no more speculative than determining the amount of capital gains tax that should be applied to reduce the value of stock in an estate, a concept which the Tax Court and many other courts have accepted.

So does this mean that clients entering into "net gift agreements" should make sure those agreements include a provision similar to what we saw in Steinberg? If the cost of the appraisal is less than the potential estate tax savings, then it's something to consider.