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The U.S. Tax Court Creates New Estate Planning Channel for Older Individuals


December 28, 2015
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New estate planning channel for older demographic?

A recent decision by the U.S. Tax Court affirmed the estate planning opportunity for older individuals that was perceived by some as being safely available in the Fifth Circuit where the Tax Court’s McCord decision, that was adverse to the taxpayer, was reversed.

According to a Law 360 report, the Tax Court ruled that the taxable value of a multimillion-dollar gift was decreased by a commitment from her daughters to pay additional estate taxes in the event their mother died within a three-year period.

The Tax Court rejected its previous decision in McCord v. Commissioner, the Tax Court stated that the IRS was not owed the gift tax amount they demanded from Jean Steinberg’s $123 million estate, according to Bloomberg BNA. This was due to the fact that Steinberg’s daughters entered into an agreement to pay an additional tax to be assessed on their mother’s estate if she died within a three-year period of making the gift to her daughters. However, despite their agreement, the Tax Court ruled that the estate tax decreased the gift value by $5.8 million due to the probability of mother’s death based on federal mortality tables.  Presumably, taxpayers residing outside the Fifth Circuit may take comfort from this decision.

The gift tax exclusion

In accordance with Section 2035 of IRS tax code, if gifts are given that qualify for gift taxes, and the donor happens to die within a three-year period, then the taxes paid on the gift are added back to the value of the estate for tax purposes. According to a Law 360 interview with David A. Handler, a partner with Kirkland & Ellis LLP, Section 2035 was designed to discourage donors from giving deathbed gifts as a way to manipulate state and federal tax laws.

“This is good, we have a court confirming that we can reduce the value of the gift if we want to do this, but it’s not necessarily something we do every time,” Handler stated. “It’s not just free money. The client might be on the hook for a real check. That’s why it’s not a home run.”

The case

The Tax Court case concerned the estate of Meyer Steinberg, who left a marital trust with $123 million in assets, with his wife Jean as trustee. The marital trust would then transfer the estate to their four daughters. The daughters then requested that the marital trust be terminated so they could receive the assets, but they just needed to pay the resulting gift and estate taxes if their mother died within three years.

Following the agreement, Steinberg reported $72 million in taxable gifts and $32 million in gift tax liabilities on her 2008 tax return. An appraiser then asserted that the value of the assets should be cut by $5.8 million because the daughters agreed to pay the estate taxes if they arise. However, the IRS took exception to this and issued Steinberg a notice of deficiency that determined the asset value to be $4 million higher than the appraisal and that a $1.8 million additional gift tax should be applied.

The Tax Court agreed with Steinberg in that the taxable value of the assets must be decreased. This was due to the fact that the agreement between Steinberg and her daughters was a contract of willing buyers and sellers. Therefore, the estate taxes would be detrimental to the buyer, and would certainly have caused them to request that the estate valuation be reduced.

The significance of the decision

The Tax Court’s decision opened up a new opportunity for gift valuation discounts as they relate to estate planning. However, this new opportunity is best applicable for older individuals because the tax reduction is directly related to the probability of the death of the donor.

It is also important to note that the decision could make any gift tax savings a moot point due to the potentially staggering estate tax obligations if the donor dies within the three-year period of the gift. Therefore, according to a separate Law 360 interview with Steve R. Akers, senior fiduciary counsel at Bessemer Trust, the new channel for estate tax planning is mainly geared toward older individuals in their 80s as the odds of death are higher within three years.

“If someone in their 60s does this, the likelihood of dying within three years is pretty low,” Akers explained. “It’s a gamble, and it’s really almost a meaningless effort to do this unless someone is in their 80s.”