Tax Court Provides Help for Estate Planning Using Gift Tax Valuation

In this case, the taxpayer was a wealthy 89-year-old woman who made substantial lifetime gifts to her four daughters. Because her age made the possibility of reversion under the three-year rule very likely, the family negotiated a complex agreement pursuant to which the donees agree to pay not only the gift tax on the gifts but also any estate tax liability that would accrue should the taxpayer die within three years of making the gifts. If any donee failed to satisfy her obligations under the agreement, all other distributions that she might otherwise be entitled to receive from the estate would revert back to the estate.

Pursuant to the agreement, an appraiser was hired to determine the value of the net gift, which was the fair market value of the gift reduced by the gift taxes paid and the actuarial value of the potential liability under the three-year rule assumed by each donee.

Despite the fact that the potential estate tax liability was computed using a formula that considered the probability that the taxpayer would die within each of the three years following the gift (based on her age and IRS mortality tables), the IRS argued that the value of the gifts could not be reduced because the assumption of liability provided no concrete benefit to the taxpayer. Noting that the value could not be accurately determined using this method, the IRS found that the assumption of liability provided nothing but unquantifiable peace of mind to the taxpayer.

The Tax Court disagreed, finding that the value of the donees' assumption of the potential estate tax liability could be determined in this manner and that the taxpayer had intended to reduce the value of the gifts by the amount of any estate tax liability assumed at the time the gifts were made.

Conclusion

The use of lifetime gifts can play a powerful role in your clients' estate planning strategies, and any high net worth taxpayer who wishes to make large lifetime gifts in order to reduce the taxable estate should be made aware of this strategy for potentially mitigating the nullifying impact of the three-year bringback rule.