Steinberg v. Commissioner

JEAN STEINBERG, DONOR, PETITIONER v. COMMISSIONER

OF INTERNAL REVENUE, RESPONDENT

Docket No. 23865–11. Filed September 30, 2013.

P entered into a binding gift agreement with her daughters

under which P gave her daughters cash and securities and in

exchange the daughters agreed to assume and to pay, among

other things, any estate tax liability imposed under I.R.C. sec.

2035(b) as a result of the gifts in the event that P passed

away within three years of the gifts. In calculating for gift

tax purposes the gross fair market value of the property

transferred to the daughters, P reduced the fair market value

of the cash and securities by an amount representing the

value of the daughters’ assumption of the potential I.R.C. sec.

2035(b) estate tax liability, among other things. Held: Because

the value of the obligation assumed by the daughters is not

barred as a matter of law from being consideration in money

or money’s worth within the meaning of I.R.C. sec. 2512(b),

the fair market value of P’s taxable gift may be determined

with reference to the daughters’ assumption of the potential

I.R.C. sec. 2035(b) estate tax liability. We will deny R’s motion

for summary judgment, and we will no longer follow McCord

v. Commissioner, 120 T.C. 358 (2003), rev’d and remanded sub

nom. Succession of McCord v. Commissioner, 461 F.3d 614

(5th Cir. 2006), to the extent it provides otherwise.

John W. Porter, Keri D. Brown, Michael S. Arlein, and Jef-

frey D. Watters, Jr., for petitioner.

John V. Cardone and Jane J. Kim, for respondent.

OPINION

KERRIGAN, Judge: This gift tax case is before the Court on

respondent’s motion for summary judgment filed under Rule

121. Petitioner objects to the motion.

Respondent issued petitioner a notice of deficiency,

increasing petitioner’s gift tax liability by $1,804,908 for tax

year 2007. Regarding the motion for summary judgment,

respondent disputes only one issue: whether a donee’s

promise to pay any Federal or State estate tax liability that

may arise under section 2035(b) if the donor dies within

three years of the gift may constitute consideration in money

or money’s worth within the meaning of section 2512(b).

Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the year in issue, and all

Rule references are to the Tax Court Rules of Practice and

258

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(258) STEINBERG v. COMMISSIONER 259

Procedure. We round all monetary amounts to the nearest

dollar.

Background

The following facts are not in dispute. Petitioner resided in

New York when she filed the petition.

On April 17, 2007, petitioner entered into a binding gift

agreement (net gift agreement) with her four adult daughters

(collectively, donees). At that time petitioner was 89 years

old. In the net gift agreement petitioner agreed to make gifts

of cash and securities to the donees. In exchange, the donees

agreed to assume and to pay any Federal gift tax liability

imposed as a result of the gifts. The donees also agreed to

assume and to pay any Federal or State estate tax liability

imposed under section 2035(b) as a result of the gifts in the

event that petitioner passed away within three years of the

gifts. Section 2035(b) provides that the amount of a gross

estate shall be increased by the amount of gift taxes paid on

any gift made by the decedent during the three-year period

preceding the decedent’s date of death. Section 3, Federal

and State Estate Tax, of the net gift agreement provides in

pertinent part:

a. Assumption of Federal and State Estate Tax Liability. Each Donee

hereby agrees to assume, pay and indemnify the Executor against all

additional federal and state estate tax liability assessed pursuant to

Code Section 2035(b) (i) if Mrs. Steinberg [petitioner] does not survive

for three years following the Effective Date and (ii) that is directly

attributable to Mrs. Steinberg’s transfer of the Gift Property made under

the Instruments of Transfer, including all penalties and interest which

accrue upon such estate tax liability except such penalties and interest

that are directly attributable to actions or delays committed by the

Executor or another Donee (the Estate Tax Liability). For purposes of

determining and allocating the Estate Tax Liability, (i) the value of all

additional tax shall be as finally determined for federal estate tax pur-

poses, (ii) the only gift tax taken into account in the calculation shall be

the gift tax on Mrs. Steinberg’s transfers of the Gift Property to the

Donees made under the Instruments of Transfer, and (iii) the amount

of the Estate Tax Liability each Donee shall bear shall be an amount

equal to the Estate Tax Liability attributable to the Donee’s Gift Tax

Share A and the Donee’s Gift Tax Share B (in each case, collectively, the

Donee’s Estate Tax Share).

* * * * * * *

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260 141 UNITED STATES TAX COURT REPORTS (258)

c. Payment of Estate Tax Liability.

i. Donees’ Payment to Executor. Each Donee shall deliver to the

Executor an amount equal to the Donee’s Estate Tax Share by certified

check made payable to the United States Treasury, no later than thirty

days before the due date for payment of the Estate Tax Liability, or, if

later, as soon thereafter as the Executor notifies the Donee of the

amount of the Estate Tax Liability.

The net gift agreement also provides remedies if any

daughter fails to pay her share of any section 2035(b) estate

tax liability. Section 7(c), Remedy Available in Event of

Default, of the net gift agreement provides in pertinent part:

ii. Default in Payment of Estate Tax Liability. If the Executor deter-

mines that a Donee is in default * * * the Executor shall give notice to

the Donee that the Donee is in default (Estate Tax Default Notice and

Estate Tax Default Notice Date, respectively). If the Donee fails within

10 business days after the Default Notice Date to deliver to the Executor

the remaining balance of the Donee’s Estate Tax Share of the Estate Tax

Liability (Donee’s Estate Tax Balance), all Cash Distributions [i.e., cer-

tain quarterly distributions to which the donees are entitled] otherwise

distributable to a Donee shall be delivered directly to the Executor

* * *. Each Donee agrees that, upon the date on which the Executor

gives an Estate Tax Default Notice to a Donee, the Executor also shall

deliver a duplicate copy of the Estate Tax Default Notice to the Man-

ager, and the Donee shall be deemed to have directed the Manager to

deliver the Cash Distribution otherwise distributable to the Donee

directly to the Executor in satisfaction of the Donee’s Estate Tax Balance

as provided in this paragraph. Each Donee agrees to perform any and

all acts necessary as a shareholder, partner, member, manager or

director of any entity governed by an Applicable Agreement to effect the

payment of the Donee’s Estate Tax Balance to the Executor.

The net gift agreement was the result of several months of

negotiation between petitioner and the donees. Petitioner

and the donees were represented by separate counsel.

Petitioner retained an appraiser to calculate the gross fair

market value of the property transferred to the donees. The

appraiser also calculated the aggregate fair market value of

the ‘‘net gift’’. The appraiser determined the value of the net

gift by reducing the fair market value of the cash and securi-

ties by both (1) the gift tax the donees paid and (2) the actu-

arial value of the donees’ assumption of potential section

2035(b) estate tax. The appraiser determined the actuarial

value of the donees’ assumption of the potential section

2035(b) estate tax by calculating petitioner’s annual mor-

tality rate for the three years after the gift (i.e., the prob-

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(258) STEINBERG v. COMMISSIONER 261

ability that petitioner would pass away within one year, two

years, or three years of the gift), among other things. The

appraiser determined that the aggregate fair market value of

the net gift was $71,598,056, as of the date of the gift. Peti-

tioner valued the donees’ assumption of the potential section

2035(b) estate tax liability at $5,838,540.

On October 15, 2008, petitioner timely filed a Form 709,

United States Gift (and Generation-Skipping Transfer) Tax

Return, for tax year 2007. On the Form 709 petitioner

reported taxable gifts of $71,598,056 and total gift tax of

$32,034,311. Petitioner attached a summary of the net gift

agreement, which included a description of the appraiser’s

determination of the value of the net gifts, to the Form 709.

On July 25, 2011, respondent mailed the notice of defi-

ciency, which increased the aggregate value of petitioner’s

net gifts to the donees from $71,598,056 to $75,608,963, for

a total gift tax increase of $1,804,908. Respondent disallowed

the discount petitioner made for the donees’ assumption of

the potential section 2035(b) estate tax liability. 1 In

response, petitioner filed a petition, and respondent filed a

motion for summary judgment.

Discussion

I. Summary Judgment

Summary judgment may be granted where the pleadings

and other materials show that there is no genuine dispute as

to any material fact and that a decision may be rendered as

a matter of law. Rule 121(b); Sundstrand Corp. v. Commis-

sioner, 98 T.C. 518, 520 (1992), aff ’d, 17 F.3d 965 (7th Cir.

1994). The burden is on the moving party (in this case,

respondent) to demonstrate that there is no genuine dispute

as to any material fact and that he or she is entitled to judg-

ment as a matter of law. FPL Grp., Inc. & Subs. v. Commis-

sioner, 116 T.C. 73, 74–75 (2001). In considering a motion for

summary judgment, evidence is viewed in the light most

favorable to the nonmoving party. Bond v. Commissioner,

1 The

notice of deficiency increased the value of petitioner’s total gifts for

tax year 2007 by $4,010,907 because of ‘‘net gifts to donor’s four daugh-

ters’’. Nonetheless, both respondent and petitioner claim that the notice of

deficiency disallowed petitioner’s entire $5,838,540 discount for the donees’

assumption of the potential sec. 2035(b) estate tax liability.

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262 141 UNITED STATES TAX COURT REPORTS (258)

100 T.C. 32, 36 (1993). The nonmoving party may not rest

upon the mere allegations or denials of his or her pleading

but must set forth specific facts showing there is a genuine

dispute for trial. Sundstrand Corp. v. Commissioner, 98 T.C.

at 520.

For purposes of respondent’s motion, respondent does not

dispute (1) the value of the cash and securities transferred;

(2) whether petitioner properly reduced her gift tax liability

by the amount of gift tax the donees assumed; or (3) whether

the donees’ assumption of the section 2035(b) estate tax

liability is enforceable under local law. Respondent’s sole

claim is that the donees’ assumption of the potential section

2035(b) estate tax liability did not increase the value of peti-

tioner’s estate and therefore did not constitute consideration

in money or money’s worth within the meaning of section

2512(b) in exchange for the gifts. For the following reasons

we conclude that there are genuine factual disputes about

the issue.

II. Statutory Framework

A. Gift Tax Generally

Section 2501(a) imposes a tax on the transfer of property

by gift. The donor is primarily responsible for paying the gift

tax. Sec. 2502(c); see also sec. 25.2502–2, Gift Tax Regs. The

gift tax is imposed upon the donor’s act of making the

transfer, rather than upon receipt by the donee, and it is

measured by the value of the property passing from the

donor, rather than the value of enrichment resulting to the

donee. Sec. 25.2511–2(a), Gift Tax Regs. Donative intent on

the part of the donor is not an essential element for gift tax

purposes; the application of gift tax is based on the objective

facts and circumstances of the transfer rather than the

subjective motives of the donor. Sec. 25.2511–1(g)(1), Gift

Tax Regs.

The amount of gift tax is based on the aggregate value of

taxable gifts made during the year, among other things. See

sec. 2502(a) (imposing the gift tax on a cumulative basis).

Taxable gifts are the total amount of gifts made during the

year, less certain deductions. 2 Sec. 2503(a). The amount of a

2 Sec. 2503 also enumerates a handful of exclusions, none of which are

relevant in this case.

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(258) STEINBERG v. COMMISSIONER 263

gift of property is generally the value of the property on the

date of the gift. Sec. 2512(a). The gift is complete when the

property has left the donor’s dominion and control. See sec.

25.2511–2(b), Gift Tax Regs. The value of the property is the

price at which it would change hands between a willing

buyer and a willing seller, neither being under any compul-

sion to buy or to sell and both having reasonable knowledge

of the relevant facts. Sec. 25.2512–1, Gift Tax Regs.

The amount of the gift is the amount by which the value

of the property transferred exceeds the value of consideration

received in money or money’s worth. See sec. 2512(b); secs.

25.2511–1(g)(1), 25.2512–8, Gift Tax Regs.; see also Commis-

sioner v. Wemyss, 324 U.S. 303, 306–307 (1945). Thus, if a

donor makes a gift subject to the condition that the donee

pay the resulting gift tax, the amount of the gift is reduced

by the amount of the gift tax. See Harrison v. Commissioner,

17 T.C. 1350, 1357 (1952). Such a gift is commonly referred

to as a ‘‘net gift’’.

B. Section 2035(b) ‘‘Gross-Up’’ Provision

Under section 2035(b) (formerly section 2035(c), see Tax-

payer Relief Act of 1997, Pub. L. No. 105–34, sec. 1310(a),

111 Stat. at 1043), a decedent’s gross estate is increased by

the amount of any gift tax paid by the decedent or the

decedent’s estate on any gift made by the decedent during

the three-year period preceding the decedent’s death. For

purposes of this ‘‘gross-up’’ provision, we have deemed that

the phrase ‘‘gift tax paid by the decedent or the decedent’s

estate’’ during the relevant three-year period includes gift tax

attributable to a net gift the decedent made during that

period (despite the fact that the donee is responsible for

paying the gift tax in that situation). Estate of Sachs v.

Commissioner, 88 T.C. 769, 777–778 (1987), aff ’d in part,

rev’d in part on other grounds, 856 F.2d 1158, 1164 (8th Cir.

1988). We note that the inclusion of the gift tax paid is a

computational element only.

Congress enacted what is now section 2035(b) as part of an

effort to mitigate the disparity of treatment between the tax-

ation of lifetime transfers and transfers at death. See H.R.

Rept. No. 94–1380, at 11 (1976), 1976–3 C.B. (Vol. 3) 735,

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264 141 UNITED STATES TAX COURT REPORTS (258)

745. 3 Congress imposed the gross-up provision on gift tax

paid within three years of death because ‘‘the gift tax paid

on a lifetime transfer which is included in a decedent’s gross

estate is taken into account both as a credit against the

estate tax and also as a reduction in the estate tax base, [so]

substantial tax savings can be derived under present law by

making so-called ‘deathbed gifts’ even though the transfer is

subject to both taxes.’’ Id. at 12, 1976–3 C.B. (Vol. 3) at 746.

Congress intended the gross-up rule to ‘‘eliminate any incen-

tive to make deathbed transfers to remove an amount equal

to the gift taxes from the transfer tax base.’’ Id.

C. Net Gifts

The net gift rationale flows from the basic premise that the

gift tax applies to transfers of property only to the extent

that the value of the property transferred exceeds the value

in money or money’s worth of any consideration received in

exchange therefor. See sec. 2512(b); sec. 25.2512–8, Gift Tax

Regs. When a net gift occurs, the donor calculates his or her

gift tax liability by reducing the amount of the gift by the

amount of the gift tax. Estate of Morgens v. Commissioner,

133 T.C. 402, 417 (2009), aff ’d, 678 F.3d 769 (9th Cir. 2012).

The rationale is that ‘‘because the donee incurred the obliga-

tion to pay the tax as a condition of the gift, ‘the donor did

not have the intent to make other than a net gift.’ ’’ Id.

(quoting Turner v. Commissioner, 49 T.C. 356, 360–361

(1968), aff ’d per curiam, 410 F.2d 752 (6th Cir. 1969)). In

other words the donor reduces the value of the gift by the

amount of the tax because the donor has received consider-

ation for a part of the gift equal to the amount of the

applicable gift tax. Id.

Petitioner’s gift may be best described as a ‘‘net, net gift’’

because the donees agreed to pay both the resulting gift tax

and any potential section 2035(b) estate tax. We will refer to

petitioner’s gift in its entirety as a net gift.

3 Before

the enactment gifts made within three years of the donor’s

death were merely presumed to be in contemplation of death. See H.R.

Rept. No. 94–1380, at 12 (1976), 1976–3 C.B. (Vol. 3) 735, 746. Congress

opted for a bright-line test in sec. 2035(b) to end the ‘‘considerable litiga-

tion concerning the motives of decedents in making gifts.’’ Id.

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(258) STEINBERG v. COMMISSIONER 265

III. The Value of the Donees’ Assumption of the Potential

Section 2035(b) Estate Tax

The fundamental question posed by this case is the fair

market value of the property rights transferred under the net

gift agreement. Pursuant to section 25.2512–1, Gift Tax

Regs., fair market value is the price at which such property

would change hands between a willing buyer and a willing

seller, neither being under any compulsion to buy or to sell

and both having reasonable knowledge of relevant facts. All

relevant facts and elements of value as of the time of the gift

must be considered. Sec. 25.2512–1, Gift Tax Regs. The

‘‘willing buyer/willing seller’’ test is the bedrock of transfer

tax valuation. It requires us to determine what property

rights are being transferred and on what price a willing

buyer and a willing seller would agree for those property

rights.

Respondent claims that the donees’ assumption of the

potential section 2035(b) estate tax is worthless. In particular

respondent contends that the donees’ assumption provided no

benefit (monetary or otherwise) to petitioner other than some

peace of mind. Respondent thus claims that the donees’

assumption failed to replenish petitioner’s estate and there-

fore failed as consideration for a gift under the ‘‘estate deple-

tion’’ theory of the gift tax. Respondent rests these claims in

part on our holding in McCord v. Commissioner, 120 T.C. 358

(2003), rev’d and remanded sub nom. Succession of McCord

v. Commissioner, 461 F.3d 614 (5th Cir. 2006). For the fol-

lowing reasons we conclude that respondent is not entitled to

summary judgment with respect to these claims.

A. Background: Consideration and the Estate Depletion

Theory

As noted above, a donor need only pay gift tax on a

transfer to the extent that the value of the property trans-

ferred exceeds the value of any consideration in money or

money’s worth that the donor receives in exchange. To

qualify as consideration in money or money’s worth, the

consideration received must be reducible to value in money

or money’s worth; consideration consisting of something

unquantifiable, such as love and affection or the promise of

marriage, is wholly disregarded. Sec. 25.2512–8, Gift Tax

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266 141 UNITED STATES TAX COURT REPORTS (258)

Regs. Similarly, the relinquishment of dower, curtesy, or any

other marital right in a spouse’s estate is not considered

consideration in money or money’s worth. Id. A transfer

made during the ordinary course of business, however, is per

se made for consideration in money or money’s worth and

thus is not subject to gift tax. See id.; see also sec. 25.2511–

1(g)(1), Gift Tax Regs. (gift tax is not applicable to ordinary

business transactions).

The estate depletion theory of gift tax can be applied to

determine what constitutes consideration in money or

money’s worth. Under the estate depletion theory, a donor

receives consideration in money or money’s worth only to the

extent that the donor’s estate has been replenished. See

Commissioner v. Wemyss, 324 U.S. at 307–308; 2 Randolph

E. Paul, Federal Estate and Gift Taxation, para. 16.14, at

1114–1115 (1942). The Paul treatise, cited twice with

approval by the Supreme Court in Wemyss, further notes:

‘‘The consideration may thus augment * * * [the donor’s]

estate, give * * * [the donor] a new right or privilege, or dis-

charge him from liability.’’ Paul, supra, at 1115. Thus, the

benefit to the donor in money or money’s worth, rather than

the detriment to the donee, determines the existence and

amount of any consideration offset in the context of an other-

wise gratuitous transfer. See Commissioner v. Wemyss, 324

U.S. at 307–308.

B. McCord v. Commissioner

Respondent’s claims rely heavily on our reasoning and

holding in McCord. In McCord the taxpayers (husband and

wife) formed McCord Interests, Ltd., L.L.P. (MIL). The tax-

payers were both class A limited partners and class B limited

partners in MIL. The taxpayers’ four adult sons were class

B limited partners and general partners. On formation MIL

held stocks, bonds, real estate, oil and gas investments, and

other closely held business interests.

On November 20, 1995, the taxpayers assigned their

respective class A limited partnership interests in MIL to a

charitable organization. On January 12, 1996 (valuation

date), the taxpayers entered into an assignment agreement,

in which the taxpayers relinquished all dominion and control

over their class B limited partnership interests in MIL to

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(258) STEINBERG v. COMMISSIONER 267

(1) their four sons, (2) four trusts for the benefit of their sons,

and (3) two charitable organizations.

Under the terms of the ‘‘formula clause’’ contained in the

assignment agreement, the four sons and the four trusts

were to receive the portion of the gift interest having an

aggregate fair market value of $6,910,933. If the fair market

value of the gift interest exceeded $6,910,933, the excess was

to be allocated to the two charitable organizations. Impor-

tantly, the four sons—individually and as trustees of the four

trusts—agreed to be liable for all transfer taxes (Federal gift,

estate, and generation-skipping transfer taxes and any

resulting State taxes) imposed on the taxpayers as a result

of the gifts.

On their Forms 709 for tax year 1996 both taxpayers

reduced the gross value amounts of their respective shares of

the gifts by the amount of Federal and State gift tax gen-

erated by the transfer, which the four sons had agreed to pay

as a condition of the gifts. Each taxpayer further reduced

that gross value amount by the actuarially determined value

of the four sons’ contingent obligation to pay any estate tax

that would result from the transaction if that taxpayer were

to pass away within three years of the valuation date.

The Commissioner determined, among other things, that

the taxpayers had improperly reduced their gross value

amounts by the actuarial value of the four sons’ obligation to

pay any potential estate taxes arising from the transactions.

We agreed with the Commissioner in McCord, holding that

‘‘in advance of the death of a person, no recognized method

exists for approximating the burden of the estate tax with a

sufficient degree of certitude to be effective for Federal gift

tax purposes’’. McCord v. Commissioner, 120 T.C. at 402. We

reasoned that the taxpayers’ computation of the mortality-

adjusted present value of the sons’ obligation merely dem-

onstrated that ‘‘if one assumes a fixed dollar amount to be

paid, contingent on a person of an assumed age not surviving

a three-year period, one can use mortality tables and interest

assumptions to calculate the amount that * * * an insurance

company might demand to bear the risk that the assumed

amount has to be paid.’’ Id. We further noted that ‘‘the dollar

amount of a potential liability to pay the 2035 tax is by no

means fixed; rather, such amount depends on factors that are

subject to change, including estate tax rates and exemption

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268 141 UNITED STATES TAX COURT REPORTS (258)

amounts (not to mention the continued existence of the

estate tax itself).’’ Id. (fn. ref. omitted).

We thus concluded that the taxpayers were not entitled to

treat the mortality-adjusted present values as consideration

received for the gifts. Id. at 402–403. To support this propo-

sition, we cited Robinette v. Helvering, 318 U.S. 184, 188–189

(1943), which we described as holding that a ‘‘donor’s rever-

sionary interest, contingent not only on [the] donor outliving

[her] 30-year old daughter, but also on the failure of any

issue of the daughter to attain the age of 21 years, is dis-

regarded as an offset in determining the value of the gift;

actuarial science cannot establish the probability of whether

the daughter would marry and have children’’. McCord v.

Commissioner, 120 T.C. at 403.

Additionally, we suggested that the taxpayers’ reduction of

the value of their gift failed under the estate depletion

theory. We pointed out that a donee’s assumption of gift tax

liability resulting from a gift provides a benefit to the donor

in money or money’s worth that ‘‘is readily apparent and

ascertainable, since the donor is relieved of an immediate

and definite liability to pay such tax.’’ Id. We observed that

‘‘[i]f that donee further agrees to pay the potential 2035 tax

that may result from the gift, then any benefit in money or

money’s worth from the arrangement arguably would accrue

to the benefit of the donor’s estate (and the beneficiaries

thereof) rather than the donor’’, and that ‘‘[t]he donor in that

situation might receive peace of mind, but that is not the

type of tangible benefit required to invoke net gift prin-

ciples.’’ Id.

C. Succession of McCord v. Commissioner

The taxpayers appealed McCord to the Court of Appeals

for the Fifth Circuit, resulting in Succession of McCord v.

Commissioner, 461 F.3d 614. The Court of Appeals reversed

and remanded McCord, holding, among other things, that

there was nothing too speculative about the McCord sons’

legally binding assumption of the potential section 2035(b)

estate tax 4 at the time of the gift. Id. at 629. The Court of

Appeals noted:

4 The taxpayer husband did in fact pass away within three years of the

gift. Succession of McCord v. Commissioner, 461 F.3d 614, 629 (5th Cir.

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(258) STEINBERG v. COMMISSIONER 269

It is axiomatic contract law that a present obligation may be, and fre-

quently is, performable at a future date. It is also axiomatic that respon-

sibility for the future performance of such a present obligation may be

either firmly fixed or conditional, i.e., either absolute or contingent on

the occurrence of a future event, a ‘‘condition subsequent.’’ And, it is

axiomatic that any conditional liability for the future performance of a

present obligation is—to a greater or lesser degree—‘‘speculative.’’ The

issue here, though, is not whether § 2035’s condition subsequent is

speculative vel non, but whether it is too speculative to be applicable, a

very elastic yardstick indeed. [Id.]

The Court of Appeals reasoned that there are three major

types of conditions subsequent along the ‘‘speculative con-

tinuum’’: (1) a future event that is absolutely certain to

occur, such as the passage of time; (2) a future event that is

not absolutely certain to occur but nevertheless may be a

‘‘ ‘more . . . certain prophec[y]’ ’’; and (3) a possible, but low-

odds, future event, which is undeniably a ‘‘ ‘less . . . certain

prophec[y]’ ’’, such as ‘‘[a] reversion of an interest in property

if the unmarried and childless life tenant not only survives

the transferor, but herself bears children who live to the age

of majority and at least one of whom survives the transferor,

as in Robinette v. Helvering’’. Id.; see also Ithaca Trust Co.

v. United States, 279 U.S. 151, 155 (1929) (‘‘Like all values

* * * [the value of a remainder interest] depends largely on

more or less certain prophecies of the future[.]’’).

The Court of Appeals concluded that in order to determine

whether any conditions subsequent inherent in the McCord

sons’ assumption were too speculative, one would have to

identify which factors ‘‘a willing buyer would * * * take into

consideration in deciding whether it is too speculative for

him to insist on its being used in reaching a price that the

seller is willing to accept.’’ Succession of McCord v. Commis-

sioner, 461 F.3d at 629. The Court of Appeals noted that if

a condition subsequent is too speculative, then a willing

buyer would not insist that a willing seller provide a discount

with respect to that condition subsequent. Id. at 630.

The Court of Appeals held, as a matter of law: ‘‘[A] willing

buyer would insist on the willing seller’s recognition that

* * * the effect of the three-year exposure to § 2035 estate

taxes was sufficiently determinable as of the date of the gifts

to be taken into account.’’ Id. at 631. In particular, the Court

2006), rev’g McCord v. Commissioner, 120 T.C. 358 (2003).

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270 141 UNITED STATES TAX COURT REPORTS (258)

of Appeals noted that, even though estate tax rates have

changed and likely will change, the estate tax has not been

repealed. The Court of Appeals thus concluded: ‘‘[T]he

transfer tax law and its rates that were in effect when the

gifts were made are the ones that a willing buyer would

insist on applying in determining whether to insist on, and

calculate, a discount for § 2035 estate tax liability.’’ Id. at

630.

The Court of Appeals observed that the Commissioner did

not object to the taxpayers’ arithmetic in calculating the dis-

count for the potential section 2035(b) estate tax liability and

that the Commissioner did not dispute (1) the estate and gift

tax laws and rates that were so applied, (2) the interest rate

used to discount to present value, (3) the ages used for the

taxpayers, or (4) the actuarially determined mortality factors

used for determining the likelihood of the taxpayers’ deaths

within three years of the gift. Id.

D. Departure From McCord

Petitioner contends that McCord was decided incorrectly

and that the donees’ assumption of the potential section

2035(b) estate tax liability is not worthless. We note that this

case is not appealable to the Court of Appeals for the Fifth

Circuit, so we are not bound to follow the Court of Appeals’

decision in Succession of McCord. See Golsen v. Commis-

sioner, 54 T.C. 742, 757 (1970), aff ’d, 445 F.2d 985 (10th Cir.

1971). 5

1. Whether the Donees’ Assumption is ‘‘Too Speculative’’ as

a Matter of Law

a. Our Reliance on Robinette v. Helvering

In McCord we concluded that the McCord sons’ assumption

of the taxpayers’ potential section 2035(b) estate tax liability

was too speculative to be reduced to a monetary value. In

particular, we likened the uncertainty in the McCord tax-

payers’ situation—i.e., the fact that the dollar amount of the

potential estate tax liability is not fixed because factors such

5 This

case addresses only the issue discussed in section VII of McCord,

which pertains to the effect of the McCord sons’ agreement to pay any sec.

2035(b) estate tax liability incurred by their parents as a result of the

McCord gift.

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(258) STEINBERG v. COMMISSIONER 271

as estate tax rates and exemption amounts are subject to

change—to the uncertainty at the heart of Robinette v.

Helvering, 318 U.S. 184.

In Robinette a daughter (at the time childless and

unmarried) and her mother set up two trusts. The daughter

placed her property in a trust, creating a life estate for her-

self and a secondary life estate for her mother and step-

father, should she predecease them. The remainder was to go

to the daughter’s then-unborn issue upon reaching the age of

21; if no issue existed, the property would be distributed via

the will of the last surviving life tenant. The mother set up

a similar trust, giving herself a life tenancy in the trust prop-

erty and giving her daughter a secondary life tenancy, should

she predecease her daughter. She assigned the remainder to

her daughter’s issue upon that issue’s reaching the age of 21;

if no issue existed, the property would be distributed via the

will of the last surviving life tenant. The daughter and her

mother, as the taxpayers, conceded that the secondary life

estates were gifts but argued that the values of the gifts

should be reduced by the values of the remainders to the

daughter’s unborn issue.

The Supreme Court held that the taxpayers could not

reduce the values of the gifts by the values of the rever-

sionary remainder interest. See Robinette v. Helvering, 318

U.S. at 188–189. The Supreme Court reasoned that there

was no recognized method for determining the values of the

contingent reversionary remainders, which, in the case

of the mother’s trust, depended on not only the possibility of

the daughter’s survivorship, but also on the death of the

daughter without issue who failed to reach the age of 21. Id.

at 188. The Supreme Court noted that the factors to be

considered in fixing the values of the contingent remainders

on the date of the gifts included: (1) whether the daughter

would marry; (2) whether the daughter would have children;

and (3) whether those children would reach the age of 21. Id.

at 189. The Supreme Court concluded: ‘‘[W]e have no reason

to believe from this record that even the actuarial art could

do more than guess at the value here in question.’’ Id.

Notably, the Supreme Court juxtaposed the complex

contingent reversionary remainders in Robinette with a

simple reversionary interest in Smith v. Shaughnessy, 318

U.S. 176 (1943), the companion case to Robinette. In Smith

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272 141 UNITED STATES TAX COURT REPORTS (258)

the taxpayer placed stock into a trust and then granted a life

estate in the trust to his wife. The taxpayer set up a sec-

ondary life estate in the trust for himself should his wife pre-

decease him. The Government conceded that the taxpayer’s

reversionary interest, contingent on his outliving his wife,

should be excluded from the gift as ‘‘having value which can

be calculated by an actuarial device, and that it is immune

from the gift tax.’’ Smith, 318 U.S. at 178.

In Robinette the Supreme Court drew a distinction between

the reversionary interest in Smith and the contingent rever-

sionary remainder in Robinette, noting:

Here unlike the Smith case the government does not concede that the

reversionary interest of the petitioner should be deducted from the total

value. In the Smith case, the grantor had a reversionary interest which

depended only upon his surviving his wife, and the government conceded

that the value was therefore capable of ascertainment by recognized

actuarial methods. In this case, however, the reversionary interest of the

grantor depends not alone upon the possibility of survivorship but also

upon the death of the daughter without issue who should reach the age

of 21 years. The petitioner does not refer us to any recognized method

by which it would be possible to determine the value of such a contin-

gent reversionary remainder. * * * [Robinette v. Helvering, 318 U.S. at

188.]

Thus, the Supreme Court expressly distinguished a simple

contingency based on the possibility of survivorship, which

the Court implied is ascertainable by recognized actuarial

methods, from the complex contingency based on the possi-

bility of survivorship plus the possibility that the unmarried

daughter might die without issue who reach the age of 21

years, which ‘‘was highly remote’’. Harrison v. Commissioner,

17 T.C. at 1355 (discussing Robinette); see also Succession of

McCord v. Commissioner, 461 F.3d at 632 n.47.

In this case, as in McCord, the contingency in issue is

whether petitioner would survive three years after the date

of the gift. Like the contingency in Smith, this contingency

is simple and based on the possibility of survivorship; it is

not complex like the contingency in Robinette, which

depended on multiple occurrences. The event of petitioner’s

survival three years after the date of the gift is speculative,

and whether it is too speculative or highly remote is a factual

issue.

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(258) STEINBERG v. COMMISSIONER 273

b. Comparison to Murray v. United States and Estate of

Armstrong v. United States

In reaching our conclusion in McCord, we also considered

Murray v. United States, 687 F.2d 386 (Ct. Cl. 1982), and

Armstrong Trust v. United States, 132 F. Supp. 2d 421 (W.D.

Va. 2001), aff ’d sub nom. Estate of Armstrong v. United

States, 277 F.3d 490 (4th Cir. 2002). See McCord v. Commis-

sioner, 120 T.C. at 400–402. We noted that neither case was

binding on us and that the facts of both cases were ‘‘some-

what different’’ from the facts in McCord. Id. at 402. We

‘‘agree[d] with what we believe[d] to be the basis of those two

opinions, i.e., that, in advance of the death of a person, no

recognized method exists for approximating the burden of the

estate tax with a sufficient degree of certitude to be effective

for Federal gift tax purposes.’’ Id. Our reliance on Murray

and Estate of Armstrong is inapposite with respect to the

case at hand.

In Murray, a donor placed shares of stock into several rev-

ocable trusts pursuant to an instrument (dated November 29,

1969) that obligated the trustees to pay, among other debts,

the donor’s estate and death tax liabilities. The instrument

stated that the trusts were revocable ‘‘ ‘during the lifetime of

the Donor, and prior to January 2, 1970.’ ’’ Murray, 687 F.2d

at 388. The donor passed away on January 2, 1970.

The executors of the donor’s estate (the plaintiffs in

Murray) argued that the obligation to pay the donor’s estate

and death taxes rendered the gifts completely without value

when made. The Court of Claims disagreed, reasoning that

although the trusts’ obligation to pay the donor’s estate and

death taxes generally could reduce the value of the gifts, the

value of the gifts in this situation was not reducible. Id. at

394 (citing Harrison v. Commissioner, 17 T.C. at 1354–1355).

The Court of Claims further reasoned: ‘‘[I]t was not * * *

[the donor’s] intent to limit the value of the gifts passing in

trust to only that amount exceeding the value of the assets

necessary to pay [the donor’s] estate tax liability. * * * As

drafted, the trust agreement does not evidence any clear

intention that the entire value of the trust assets were not

to be considered as property passing from the donor.’’ Id. at

394 n.13.

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274 141 UNITED STATES TAX COURT REPORTS (258)

The Court of Claims concluded that the value of the

donor’s estate and death taxes was ‘‘highly conjectural’’ at

the time of the gift, reasoning that (1) had the donor lived

until 1971, the value of his estate would have reduced

significantly because the three-year inclusion period under

section 2035(b) would have lapsed for a particular gift made

in 1968 and (2) for every extra year the donor lived after

1971, the size of his estate would continue to diminish. 6 Id.

at 394–395.

Murray is distinguishable from the case at hand and there-

fore is not persuasive. Unlike the donor in Murray, who did

not intend to reduce the value of the gifts by the amount of

the estate tax liability, petitioner expressly intended to

reduce the value of her gifts by the amount of estate tax

liability assumed by the donees. Furthermore, the trusts in

Murray assumed the donor’s entire estate tax liability that

was to be paid at an indefinite time in the future, during

which the donor’s estate could decrease an indefinite amount.

The donees in this case, however, assumed only the portion

of petitioner’s estate tax liability that could be incurred over

a three-year span. The value of the amount of section 2035(b)

estate tax liability in this case may be predictable.

In Estate of Armstrong, a donor made inter vivos gifts of

nearly all of his assets to his children. His children expressly

declined to assume gift tax liability or potential section

2035(b) estate tax liability with respect to the gifts. After the

donor made the gifts, he created an irrevocable grantor trust

(donor’s trust), from which he (as the sole beneficiary)

received income payments. The donor’s trust assumed and

paid all gift tax liability with respect to the gifts. The chil-

dren then entered into a transferee liability agreement, in

which they agreed to pay any additional gift tax liability

resulting from ‘‘ ‘any proposed adjustment to the amount of

the * * * gifts.’ ’’ Estate of Armstrong, 277 F.3d at 493.

Although the agreement ‘‘appeared to impose on the children

the obligation to pay any additional gift taxes’’ if the Internal

Revenue Service (IRS) revalued the gifts, the parties actually

6 The

Court of Claims also noted that the executors did not present any

evidence showing that it was possible to approximate the value of the obli-

gation at the time of the gift. Murray v. United States, 687 F.2d 386, 395

(Ct. Cl. 1982).

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(258) STEINBERG v. COMMISSIONER 275

agreed that the donor’s trust would pay any additional gift

taxes, while the children would be only secondarily liable. Id.

The donor passed away within three years of granting the

inter vivos gifts. After the donor’s death, the IRS revalued

the gifts and increased the gift tax owed. Once again, the

donor’s trust paid the gift tax owed and the children paid

nothing. The IRS also determined that when the executor

computed the value of the donor’s estate, the executor failed

to include the gift tax paid by the donor and the donor’s trust

with respect to the inter vivos gifts, which resulted in a siz-

able estate tax deficiency. Because the inter vivos gifts had

depleted the estate’s assets, the estate was unable to pay the

estate tax owed. Under section 6324(a)(2), the IRS assessed

the children (as donees of the inter vivos gifts) with the

estate tax liability to the extent of the values of the gifts they

received. 7 The estate and the donor’s trust filed for refund,

contending that the children’s obligation to pay additional

gift and estate taxes as a condition of the gift substantially

reduced the values of the gifts and thus the gift taxes owed.

The Court of Appeals for the Fourth Circuit rejected the

contentions of the estate and the donor’s trust. The estate

and the donor’s trust claimed that they engaged in a net gift

transaction when the children agreed to pay all additional

gift taxes. The Court of Appeals distinguished the facts in

Estate of Armstrong, 277 F.3d at 496, from a typical net gift

agreement, in which there is no dispute that the donee is

liable for all resulting gift taxes. The Court noted that the

children ‘‘fully expected and intended * * * that they were

protected from ‘having to pay taxes and expenses incurred as

a result’ of the transactions.’’ Id. The Court of Appeals rea-

soned: ‘‘Any obligation of the donee to pay gift taxes that is

speculative or illusory evidences that the obligation was not

a true condition of the gift at the time of transfer’’. Id. at

495. The Court of Appeals concluded that even if the chil-

dren’s obligation was not speculative, the children’s agree-

ment to pay additional gift taxes was illusory because the

donor’s trust paid all of the gift taxes. Id. at 496.

7 Presumably, the IRS assessed the children with the estate tax liability

only after issuing transferee liability notices, which were petitioned to this

Court. See Armstrong v. Commissioner, 114 T.C. 94 (2000).

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276 141 UNITED STATES TAX COURT REPORTS (258)

The estate and the donor’s trust also contended that the

amounts of the gifts should be reduced by ‘‘the amount of

estate taxes attributable to the gift taxes that the children

may be called upon to pay’’ because they knew at the time

of the gift that the donor’s estate would be unable to pay the

estate tax owed. Id. at 497–498. The Court of Appeals dis-

agreed, concluding: ‘‘[T]here is no evidence that the children

agreed to pay the resulting estate taxes—in the event there

were any—as a condition of the stock transfers. Rather, the

evidence instead shows that they intended to be protected

from any tax liability stemming from the transfers.’’ Id. at

498.

Estate of Armstrong is distinguishable on its facts from the

case at hand and therefore is not persuasive. Unlike the chil-

dren in Estate of Armstrong, the donees in this case expressly

agreed to pay both the resulting gift tax liability and any

potential section 2035(b) estate tax liability arising from the

net gift agreement. Moreover, unlike the Armstrong children,

the donees in this case engaged in a bona fide net gift agree-

ment.

c. Fluctuation of Estate Tax Rates and Exemption Amounts

Finally, we implied in McCord that because estate tax

rates and exemption amounts are subject to change (and rev-

ocation altogether), it would be difficult to determine the

amount of the potential section 2035(b) estate tax liability.

See McCord v. Commissioner, 120 T.C. at 402–403.

The estate tax rate (and the accompanying exemption

amounts) is not the only tax rate subject to change. Com-

paring the estate tax to the capital gains tax, the Court of

Appeals for the Fifth Circuit in Succession of McCord wrote:

For purposes of our willing buyer/willing seller analysis, we perceive no

distinguishable difference between the nature of the capital gains tax

and its rates on the one hand and the nature of the estate tax and its

rates on the other hand. Rates and particular features of both the capital

gains tax and the estate tax have changed and likely will continue to

change with irregular frequency; likewise, despite considerable and

repeated outcries and many aborted attempts, neither tax has been

repealed. Even though the final amount owed by the Taxpayer as gift

tax * * * has yet to be finally determined (depending, as it does, on the

final results of this case), we are satisfied that the transfer tax law and

its rates that were in effect when the gifts were made are the ones that

a willing buyer would insist on applying in determining whether to

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(258) STEINBERG v. COMMISSIONER 277

insist on, and calculate, a discount for § 2035 estate tax liability.

[Succession of McCord v. Commissioner, 461 F.3d at 630.]

The fact that the estate tax lapsed in 2010 does not under-

mine the Court of Appeals’ reasoning, especially given that

the estate tax was reinstated in December 2010, see Tax

Relief, Unemployment Insurance Reauthorization, and Job

Creation Act of 2010, Pub. L. No. 111–312, sec. 101(a)(1), 124

Stat. at 3298, and was extended permanently in 2012, see

American Taxpayer Relief Act of 2012, Pub. L. No. 112–240,

sec. 101(a)(3), (c), 126 Stat. at 2316–2318.

Both capital gains tax rates and estate tax rates have

changed since their introduction and are likely to change in

the future. Just this year the capital gains tax rates for

adjusted net capital gains changed from 15% to 20% for cer-

tain high-income individuals. See American Taxpayer Relief

Act of 2012 sec. 102(b), 126 Stat. at 2318. Yet many courts

have held that the fair market value of stock received by gift

or bequest must be reduced by capital gains tax, even if there

is no indication that the capital gains tax will be triggered

by the donee or beneficiary in the near future. See, e.g.,

Estate of Jelke v. Commissioner, 507 F.3d 1317, 1319, 1333

(11th Cir. 2007) (finding that the Tax Court erred by

allowing only a partial discount for built-in capital gains tax

liability inherent in a bequest of stock instead of allowing a

dollar-for-dollar discount of the entire built-in capital gains

tax ‘‘under the arbitrary assumption that * * * [the under-

lying corporation] is liquidated on * * * [the date of the

bequest]’’), vacating and remanding T.C. Memo. 2005–131;

Estate of Dunn v. Commissioner, 301 F.3d 339 (5th Cir. 2002)

(finding that when valuing a bequest of stock, a hypothetical

willing buyer and willing seller must assume that the under-

lying corporation has been liquidated on the valuation date,

even if an actual liquidation is speculative), rev’g and

remanding T.C. Memo. 2000–12; Estate of Jameson v.

Commissioner, 267 F.3d 366 (5th Cir. 2001) (finding that the

Tax Court improperly determined only a partial discount for

capital gains tax liability inherent in a bequest of stock

because the Tax Court failed to use a truly hypothetical

willing buyer), vacating and remanding T.C. Memo. 1999–43;

Eisenberg v. Commissioner, 155 F.3d 50 (2d Cir. 1998)

(reducing a gift of stock by potential capital gains tax liabil-

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278 141 UNITED STATES TAX COURT REPORTS (258)

ities even though no liquidation or sale of the corporation

was planned and finding that potential capital gains tax is

not too speculative to be valued because the stock will be

subject to capital gains tax on disposition), vacating and

remanding T.C. Memo. 1997–483. 8 This Court likewise held

in Estate of Davis v. Commissioner, 110 T.C. 530 (1998), that

the value of a gift of stock should be discounted for lack of

marketability (attributed to inherent capital gains tax)

because a willing buyer and a willing seller would take the

built-in capital gains tax into account, even if no liquidation

or sale of the underlying assets was contemplated at the time

of the gift. These cases show that it is possible to fix the

value of built-in capital gains tax on the valuation date,

despite (1) fluctuations in the capital gains tax rates; (2) the

potential for the capital gains tax to disappear; (3) the fact

that there is no indication of when capital gains tax will be

triggered by the donee or beneficiary, if ever; and (4) the fact

that it is unknown at the time of the gift what actual amount

of capital gains tax the donee or beneficiary would pay, if

any. 9 We cannot foreclose the possibility that an appropriate

8 Respondent contends that the Court of Appeals for the Second Circuit,

to which an appeal in this case would lie, would find the donees’ assump-

tion of petitioner’s potential sec. 2035(b) estate tax to be too speculative

because of the Court of Appeals’ conclusion in Eisenberg v. Commissioner,

155 F.3d 50 (2d Cir. 1998), vacating and remanding T.C. Memo. 1997–483.

As discussed above, in Eisenberg the Court of Appeals for the Second

Circuit held that the value of stock in a particular corporation should be

reduced by potential capital gains tax liabilities for gift tax purposes, even

though no liquidation or sale of the corporation was planned at the time

of the gift. Id. at 59. The Court of Appeals determined that it was inevi-

table that the stock would be subject to capital gains tax, so the potential

capital gains tax was not too speculative to be valued. See id. at 55–56,

58–59.

Respondent claims that because petitioner’s potential sec. 2035(b) estate

tax liability is not inevitable, the Court of Appeals would hold that it is

too speculative to be reduced to a monetary value. We disagree. As dis-

cussed in detail above, simply because a contingency is not inevitable does

not make the contingency too speculative to be reduced to a monetary

value.

9 Sec. 1(h)(1) imposes tax on a taxpayer’s net capital gains for any tax-

able year. Sec. 1222(11) defines the phrase ‘‘net capital gains’’ as the ex-

cess of net long-term capital gain over the net short-term capital loss for

the taxable year. Thus, a taxpayer’s net capital gains depends on the inter-

play between the taxpayer’s long-term capital gains and losses (which

make up net long-term capital gains) as well as the taxpayer’s short-term

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(258) STEINBERG v. COMMISSIONER 279

method likewise may exist to fix the value of the potential

section 2035(b) estate tax liability assumed by the donees in

this case.

We note that the Court of Appeals for the Fifth Circuit is

not alone in considering potential tax liability in valuation

cases. In Estate of Jelke v. Commissioner, 507 F.3d 1317, the

Court of Appeals for the Eleventh Circuit ended a historical

overview of discounts for built-in capital gains with a discus-

sion of Succession of McCord. 10 Id. at 1329. Referring to

Succession of McCord as part of the ‘‘trend’’ of cases that con-

sider potential tax liability, the Court of Appeals wrote: ‘‘The

Fifth Circuit [in Succession of McCord] thereby extended the

rationale of Estate of Davis to a gift tax case involving

contingent estate taxes.’’ Id. at 1329–1330.

Accordingly, we agree with the conclusion of the Court of

Appeals for the Fifth Circuit in Succession of McCord that a

willing buyer and a willing seller in appropriate cir-

cumstances may take into account a donee’s assumption of

potential section 2035(b) estate tax liability in arriving at a

sale price.

2. Estate Depletion Theory

In McCord we also suggested that the McCord sons’

assumption of the potential section 2035(b) estate tax failed

as consideration for a gift under the estate depletion theory.

See McCord v. Commissioner, 120 T.C. at 403. In particular

we pointed out that any benefit in money or money’s worth

that might arise from a donee’s assumption of potential sec-

tion 2035(b) estate tax ‘‘arguably would accrue to the benefit

of the donor’s estate (and the beneficiaries thereof) rather

than the donor.’’ Id.

Our distinction between a benefit to the donor’s estate and

a benefit to the donor was incorrect. For purposes of the

capital gains and losses (which make up net short-term capital losses). See

sec. 1222(6), (8). The actual amount of net capital gain that a donee or

beneficiary will have when capital gains tax is actually triggered is there-

fore difficult to determine at the time of the gift or bequest.

Furthermore, the rate of capital gains tax is based on the taxpayer’s tax-

able income for the tax year, which cannot be precisely determined at the

time of gift. See sec. 1(h)(1).

10 The Court of Appeals for the Eleventh Circuit referred to Succession

of McCord as ‘‘Estate of McCord’’.

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280 141 UNITED STATES TAX COURT REPORTS (258)

estate depletion theory, the donor and the donor’s estate are

inextricably bound. According to the estate depletion theory,

whether a donor receives consideration is measured by the

extent to which the donor’s estate is replenished by the

consideration. See Paul, supra, at 1115.

A donee’s assumption of potential section 2035(b) estate

tax liability may provide a tangible benefit to the donor’s

estate, and therefore as a matter of law it could meet the

requirements of the estate depletion theory. Under Federal

tax law the cost of any section 2035(b) estate tax liability is

generally borne by the donor’s estate and not the donee of

the gift. See secs. 2001, 2002, 2035(b), 2501. When petitioner

gave the gifts to the donees, petitioner’s assets accrued both

gift tax liability and potential section 2035(b) estate tax

liability. When the donees assumed the gift tax liability, peti-

tioner’s assets were relieved of the gift tax liability and

therefore were replenished. Likewise, when the donees

assumed the potential section 2035(b) estate tax liability,

petitioner’s assets may have been relieved of the potential

estate tax liability. This assumption, which we have deter-

mined may be reducible to a monetary value, also may have

replenished petitioner’s assets. See Paul, supra, at 1115 (ade-

quate and full consideration may, among other things, ‘‘dis-

charge * * * [the donor] from liability’’).

Respondent claims that because the entire net gift agree-

ment was a ‘‘family type transaction’’, the donees’ assumption

of the potential section 2035(b) estate tax liability did not

replenish petitioner’s estate. To support this claim,

respondent compares the situation in this case with that of

Wemyss. 11

In Wemyss the taxpayer wished to marry a widow. The

widow’s deceased husband had set up a trust for her on the

condition that if she remarried, she would lose all income

from the trust. In order to induce the widow to marry, the

taxpayer transferred blocks of shares to her. The couple mar-

11 Respondent also attempts to equate the case at hand to Merrill v.

Fahs, 324 U.S. 308 (1945), a companion case to Wemyss, and to Commis-

sioner v. Bristol, 121 F.2d 129 (1st Cir. 1941), vacating and remanding 42

B.T.A. 263 (1940), a case from the Court of Appeals for the First Circuit

and a precursor to Wemyss. Both cases dealt with transfers of assets in ex-

change for the relinquishment of dower and other marital rights. The rea-

soning and conclusions in both cases are similar to those in Wemyss.

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(258) STEINBERG v. COMMISSIONER 281

ried shortly thereafter. The Supreme Court found that the

transfer of shares was a gift. Importantly, the Supreme

Court noted that ‘‘money consideration must benefit the

donor to relieve a transfer by him from being a gift’’ and that

‘‘[t]he section taxing as gifts transfers that are not made for

‘adequate and full (money) consideration’ aims to reach those

transfers which are withdrawn from the donor’s estate.’’

Commissioner v. Wemyss, 324 U.S. at 307.

Unlike the taxpayer in Wemyss, petitioner may have

received consideration—the donees’ assumption of the poten-

tial section 2035(b) estate tax liability, among other things,

in exchange for gifts of cash and securities—that is not

expressly excluded or otherwise disregarded from consider-

ation by the applicable regulations. Today, section 25.2512–

8, Gift Tax Regs., expressly excludes the relinquishment of

dower, curtesy, or any other marital right in a spouse’s

estate from consideration. 12 It also expressly disregards

consideration consisting of a promise of marriage, which was

at the heart of Wemyss, see, e.g., Estate of D’Ambrosio v.

Commissioner, 101 F.3d 309, 315 (3d Cir. 1996) (describing

Wemyss as determining that a ‘‘promise of marriage [is]

insufficient consideration, for gift tax purposes, for tax-free

transfer of property’’), rev’g and remanding, 105 T.C. 252

(1995), because a promise of marriage is unquantifiable and

therefore not reducible to monetary value.

Respondent’s comparison of the case at hand to Wemyss

thus falls flat. The donees’ assumption of potential section

2035(b) estate tax liability may be quantifiable and reducible

to monetary value.

E. Conclusion

Respondent has failed to show as a matter of law that the

donees’ assumption of petitioner’s potential section 2035(b)

estate tax liability cannot be consideration in money or

money’s worth within the meaning of section 2512(b).

12 When Wemyss was decided, the Revenue Act of 1932, ch. 209, 47 Stat.

169, expressly excluded the relinquishment of dower and marital rights

from consideration in money or money’s worth for estate tax purposes. See

Merrill, 324 U.S. at 313. The Supreme Court in Merrill concluded that the

exclusion applied to the gift tax as well because the gift tax and estate tax

are ‘‘in pari materia’’ (i.e., they must be construed together). Id. at 311,

313.

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282 141 UNITED STATES TAX COURT REPORTS (258)

IV. Donees’ Assumption as Outside the Ordinary Course of

Business

Transactions within a family group are subject to special

scrutiny, and the presumption is that a transfer between

family members is a gift. Harwood v. Commissioner, 82 T.C.

239, 258 (1984), aff ’d without published opinion, 786 F.2d

1174 (9th Cir. 1986). Respondent contends that the donees’

assumption of the potential section 2035(b) estate tax

liability was itself a gift because (1) the net gift agreement

was between family members, and (2) the net gift agreement

was not in the ordinary course of business. Respondent fur-

ther claims that no part of the net gift agreement, presum-

ably including the donees’ assumptions of the gift tax

liability and the potential section 2035(b) estate tax liability,

was ‘‘bona fide, at arm’s length, and free from any donative

intent’’.

Respondent’s claim that a transfer between family mem-

bers is necessarily a gift unless it was in the ordinary course

of business is erroneous. A transfer between family members

that is not in the ordinary course of business may still avoid

gift tax to the extent it is made for consideration in money

or money’s worth. Pursuant to section 25.2512–8, Gift Tax

Regs., a transfer made in the ordinary course of business is

necessarily a transfer made for consideration; 13 however, not

all transfers made for consideration are made in the ordinary

course of business. Section 25.2511–1(g)(1), Gift Tax Regs.,

distinguishes the two: ‘‘The gift tax is not applicable to a

transfer for a full and adequate consideration in money or

money’s worth, or to ordinary business transactions’’.

(Emphasis added.) Thus, a transfer not in the ordinary

course of business may still avoid gift tax to the extent it is

made for full and adequate consideration, regardless of

whether the transfer was between family members.

Additionally, respondent’s argument is undermined by

respondent’s concession that the donees’ assumption of gift

tax is not subject to gift tax. See also Rev. Rul. 75–72, 1975–

13 ‘‘[A]

sale, exchange, or other transfer of property made in the ordinary

course of business (a transaction which is bona fide, at arm’s length, and

free from any donative intent), will be considered as made for an adequate

and full consideration in money or money’s worth.’’ Sec. 25.2512–8, Gift

Tax Regs.

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(258) STEINBERG v. COMMISSIONER 283

1 C.B. 310 (providing an algebraic formula for determining

the amount of gift tax owed on a net gift). The donees’

assumption of gift tax was between family members and was

not made in the ordinary course of business, but respondent

concedes that it was consideration in money or money’s

worth given in exchange for petitioner’s gifts.

We further note that nothing in the record indicates that

the net gift agreement was not bona fide or made at arm’s

length. Petitioner and the donees were represented by sepa-

rate counsel, and the net gift agreement was the culmination

of months of negotiation.

V. Conclusion

There are genuine disputes of material fact as to whether

the donees’ assumption of petitioner’s potential section

2035(b) estate tax liability constituted consideration in

money or money’s worth. Respondent is not entitled to sum-

mary judgment on this issue.

An appropriate order will be issued.

Reviewed by the Court.

COLVIN, FOLEY, VASQUEZ, WHERRY, HOLMES, PARIS, and

BUCH, JJ ., agree with this opinion of the Court.

GALE, GOEKE, KROUPA, GUSTAFSON, MORRISON, and

LAUBER, JJ., concur in the result only.

GOEKE, J., concurring: I agree with Judge Lauber’s concur-

ring opinion and write separately only to point out a foresee-

able valuation issue that may result from the strategy in this

case at the time of a donor’s death.

The Code is clear that ‘‘[t]he value of the gross estate of

the decedent shall be determined by including * * * the

value at the time of his death of all property, real or per-

sonal, tangible or intangible, wherever situated.’’ Sec.

2031(a). Petitioner recognized that the donor’s legal right to

have the donees pay any section 2035(b) estate tax liability

is a new asset of the donor that must be included in her

gross estate like any other contract right, indemnity right, or

similar claim she owned at death. Petitioner’s position pre-

sumes the value of this obligation at death is the same as the

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284 141 UNITED STATES TAX COURT REPORTS (258)

calculated value at the time the asset is created. This

presumption is illogical.

The estate tax liability, and therefore the indemnity right,

is going to depend on the facts and circumstances. If the

donor dies after three years have passed since the date of the

gift transaction, then the value of that ‘‘new asset’’ will be

zero (i.e., no estate tax liability arises by virtue of section

2035(b)). If, however, the donor dies within that three-year

period, then the indemnity right will be equal to whatever

the estate tax liability actually is. This is in contrast to the

value petitioner estimates with mortality table calculations.

Consequently, the donees either could get a windfall (i.e.,

getting a gift tax discount and not paying any estate tax) or

may end up suffering some serious repercussions neces-

sitated by finding consideration (i.e., potentially paying a lot

more in estate tax than is in accord with the discount they

received). This issue is not before us now, but we should rec-

ognize the issue we create in finding the present promise to

pay contingent estate tax may be consideration to the donor.

LAUBER, J., agrees with this concurring opinion.

LAUBER, J., concurring: I agree that the motion for sum-

mary judgment filed by respondent (IRS or respondent)

should be denied, and I concur in the opinion of the Court.

I write separately to express my views on two points.

As a condition of receiving the gifts at issue, the donor’s

four daughters assumed an obligation to pay any additional

estate tax that might arise by virtue of the section 2035(b)

‘‘gross-up’’—that is, the possibility that the gift taxes paid on

their gifts would be included in the gross estate if the donor

died within three years of making the gifts. I will refer to

this contingent liability as an ‘‘obligation to pay the section

2035(b) tax.’’ The IRS seeks summary judgment on the

ground that the donees’ assumption of an obligation to pay

the section 2035(b) tax cannot, as a matter of law, constitute

‘‘consideration’’ received by the donor in exchange for the

gifts. See sec. 2512(b). According to the IRS, therefore, the

donees’ assumption of this liability cannot be considered as

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(258) STEINBERG v. COMMISSIONER 285

an offset in determining the value of the gifts for Federal gift

tax purposes. 1

In McCord v. Commissioner, 120 T.C. 358 (2003), rev’d and

remanded sub nom. Succession of McCord v. Commissioner,

461 F.3d 614 (5th Cir. 2006), we resolved this issue in favor

of the Commissioner, holding after a lengthy trial that the

donees’ assumption of an obligation to pay the section

2035(b) tax did not constitute ‘‘consideration’’ within the

meaning of section 2512(b). We offered two rationales for this

holding. First, we determined that ‘‘no recognized method

exists for approximating the burden of the estate tax with a

sufficient degree of certitude to be effective for Federal gift

tax purposes.’’ McCord, 120 T.C. at 402. We analogized the

donees’ assumption of an obligation to pay the section

2035(b) tax to the donor’s contingent reversionary interest in

Robinette v. Helvering, 318 U.S. 184, 188–189 (1943), which

the Supreme Court deemed too speculative to be treated as

an offset in determining the value of a gift. See McCord, 120

T.C. at 401 n.49, 403. Second, we cited ‘‘the ‘estate depletion’

theory of the gift tax’’ as additional support for our holding.

Id. at 403 (citing Commissioner v. Wemyss, 324 U.S. 303,

307–308 (1945)). We reasoned that any value derived from

the donees’ satisfaction of their obligation to pay the section

2035(b) tax ‘‘would accrue to the benefit of the donor’s estate

(and the beneficiaries thereof) rather than the donor.’’ Id.

‘‘The donor in that situation,’’ we concluded, ‘‘might receive

peace of mind, but that is not the type of tangible benefit

required to invoke net gift principles.’’ Ibid.

The Court’s opinion discusses at length both rationales

advanced in McCord—the ‘‘too speculative’’ theory and the

‘‘estate depletion’’ theory. The Court finds neither rationale

persuasive and appears to overrule McCord, at least to the

1 The IRS frames the question as whether the donees’ assumption of an

obligation to pay the section 2035(b) tax constitutes ‘‘adequate and full con-

sideration in money or money’s worth’’ within the meaning of section

2512(b). But if the donees’ assumption of this liability represented ‘‘an ade-

quate and full consideration,’’ there would be no gift at all. Where, as here,

the donor receives in exchange something less than ‘‘an adequate and full

consideration,’’ we are required to determine ‘‘the amount by which the

value of the [gifted] property exceed[s] the value of the consideration’’ that

the donor actually receives. Sec. 2512(b). I will refer to the latter as ‘‘con-

sideration’’ or ‘‘return consideration.’’

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286 141 UNITED STATES TAX COURT REPORTS (258)

extent it addresses the former. As explained more fully

below, I agree that the IRS’ motion for summary judgment

should be denied, but I disagree with the Court’s treatment

of McCord.

A. The ‘‘Too Speculative’’ Theory

The argument respondent advances in support of his sum-

mary judgment motion is as follows: ‘‘The daughters’ assump-

tion of the section 2035(b) liability does not constitute * * *

consideration * * * within the meaning of section 2512(b)

because it does not increase the value of petitioner’s taxable

estate. Commissioner v. Wemyss, 324 U.S. 303, 307 (1945).’’

Absent from this argument is any contention that the daugh-

ters’ assumption of the section 2035(b) tax is ‘‘too specula-

tive’’ to be considered for Federal gift tax purposes. Indeed,

in a footnote, respondent explicitly ‘‘reserves the issue of

whether the donees’ exposure to the executor is too specula-

tive to quantify as a matter of law.’’ ‘‘[A]ddressing the ‘too

speculative’ issue,’’ respondent assures us, ‘‘is not necessary’’

for purposes of ruling on his motion for summary judgment.

At the summary judgment stage of this case, the Court

thus confronts a scenario in which neither party is asking us

to consider, or reconsider, the ‘‘too speculative’’ rationale

articulated in McCord. By ‘‘reserving’’ this issue, respondent

has preserved the option of advancing this argument in his

posttrial briefs, after all evidence in the case has been heard.

Because respondent does not urge the ‘‘too speculative’’

theory in support of his motion for summary judgment, and

because respondent may end up never advancing this theory

at all, I believe that the Court’s discussion of this point is

premature.

Familiar principles of judicial restraint counsel that courts

refrain from deciding complex questions until it is absolutely

necessary to do so. That admonition applies with particular

force where (as here) the consequence of a premature deci-

sion would be to overrule a binding precedent. Under the

doctrine of stare decisis, this Court should be reluctant under

any circumstances to overrule a binding precedent. When we

face a motion for summary judgment in which the moving

party explicitly disclaims reliance on the rationale embraced

by that precedent, the force of stare decisis is quite compel-

ling.

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(258) STEINBERG v. COMMISSIONER 287

For these reasons, I believe that the Court’s lengthy

discussion of the ‘‘too speculative’’ theory is unnecessary at

the summary judgment stage of this case. I also think it

improper to consider overruling McCord, insofar as it

embraces the ‘‘too speculative’’ theory, until a party has

squarely presented this issue for resolution. There is no need

to address either of these questions in order to dispose of

respondent’s pending motion for summary judgment. Both

questions may appropriately be addressed, if necessary, in

the posttrial opinion. 2

B. The ‘‘Estate Depletion’’ Theory

To the extent that respondent relies on McCord at all in

support of his motion for summary judgment, it is for the

second rationale articulated in McCord—namely, the ‘‘estate

depletion’’ theory. Here, as in McCord, respondent contends

that the donees’ assumption of an obligation to pay the sec-

tion 2035(b) tax ‘‘does not increase the value of petitioner’s

taxable estate.’’ Because ‘‘an heir’s agreement to pay the por-

tion of the estate tax allocable to the property received by

that heir does not affect the size of the taxable estate,’’ that

agreement, according to respondent, cannot constitute

‘‘consideration,’’ as a matter of law, within the meaning of

section 2512(b).

In McCord v. Commissioner, 120 T.C. at 403, we reasoned

that the only value derived by the donor (as opposed to her

estate) from the donees’ promise was ‘‘peace of mind,’’ and we

held that this intangible benefit was insufficient to constitute

‘‘consideration’’ that could serve to offset the face value of the

gifts. Here, respondent frames his ‘‘estate depletion’’ argu-

ment quite differently. In this case, respondent contends that

the donees’ agreement to pay the section 2035(b) tax does not

increase the value of petitioner’s taxable estate because that

agreement operates merely as an ‘‘agreement to apportion

the burden of the tax within the estate and, in effect, among

the estate’s beneficiaries.’’ I will refer to this contention as

respondent’s ‘‘apportionment clause’’ argument.

2 While

I cannot join the Court’s decision to overrule McCord at this

stage of this case, I agree that the characterization of the valuation exer-

cise as ‘‘too speculative or highly remote is a factual issue’’ properly re-

solved at trial, should respondent ultimately advance this contention. See

op. Ct. p. 272.

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288 141 UNITED STATES TAX COURT REPORTS (258)

The Court properly refrains from granting summary judg-

ment to respondent on the ‘‘estate depletion’’ issue. In the

course of its opinion, however, the Court does not mention

respondent’s ‘‘apportionment clause’’ argument. Because

respondent’s ‘‘estate depletion’’ and ‘‘apportionment clause’’

arguments are closely intertwined, the Court’s opinion war-

rants clarification.

According to respondent, the estate tax ultimately due

from petitioner’s estate, and the assets out of which that tax

will be paid, will be exactly the same regardless of the

donees’ agreement to pay the section 2035(b) tax. The only

effect of that agreement is that a portion of the estate tax—

namely, the portion attributable to any section 2035(b) inclu-

sion—will be paid by the donees rather than by the executor.

But if the daughters receiving the inter vivos gifts are also

beneficiaries of petitioner’s estate, they will bear the eco-

nomic burden of the estate tax either way. They will pay the

section 2035(b) portion of the tax under the agreement or,

absent the agreement, they will receive a proportionately

smaller inheritance because the section 2035(b) portion of the

tax will have been paid by the executor. In neither case is

the estate ‘‘replenished.’’

Respondent bolsters his ‘‘estate depletion’’ theory by ref-

erence to New York trust and estate law. According to

respondent, New York statutory law would apportion the

Federal estate tax attributable to the section 2035(b) gross-

up to the persons benefited by the gifts, and the statute

would require those persons to pay that portion of the estate

tax. The daughters’ assumption of the obligation to pay the

section 2035(b) tax, in respondent’s view, simply memorial-

izes an obligation they would have anyway under New York

law. If that is true, their contractual assumption of this

obligation arguably confers no benefit on the donor or her

estate—respondent calls it ‘‘a worthless piece of paper,’’ and

hence it does not constitute ‘‘consideration’’ to either of them.

Stated differently, a ‘‘willing buyer’’ of the gifted assets

would not regard as a negative the condition that she assume

contingent liability for the section 2035(b) tax if she already

bore contingent liability for the section 2035(b) tax under

New York law. Rather, a ‘‘willing buyer’’ would agree to pay

face value for the gifted assets, unreduced by the notional

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(258) STEINBERG v. COMMISSIONER 289

‘‘encumbrance’’ represented by the contingent section 2035(b)

liability.

Petitioner responds to respondent’s ‘‘apportionment clause’’

argument on several levels. Petitioner points out, correctly,

that ‘‘[t]he Commissioner’s argument is grounded in his

assumption that the [d]aughters are the beneficiaries of Mrs.

Steinberg’s estate.’’ According to petitioner, this assumption

‘‘is not supported by any evidence in the record and is

entirely speculative,’’ since ‘‘the beneficiaries of Mrs. Stein-

berg’s estate will not be known until she dies and there is

an estate.’’ If the daughters are beneficiaries of Mrs. Stein-

berg’s estate, petitioner seems to acknowledge that the

apportionment provisions of New York law would impose on

them the same obligation to pay the section 2035(b) tax that

they assumed contractually in the net gift agreement. But

petitioner contends that the donees’ contractual assumption

of this liability nevertheless benefits the estate because the

net gift agreement ‘‘provides an effective enforcement mecha-

nism that does not exist under the [New York] statute.’’

I agree that respondent’s motion for summary judgment

should be denied because the proper disposition of his

‘‘apportionment clause’’ argument hinges on resolution of dis-

puted issues of material fact. See op. Ct. p. 283. These facts

may include the following: (1) whether petitioner’s daughters,

at the time of the gifts, were beneficiaries under her will; (2)

whether petitioner’s daughters, if not then beneficiaries

under her will, should be regarded as such because they were

the natural objects of her affection and bounty; (3) whether

petitioner, a New York resident when she made the gifts,

should be deemed a New York domiciliary for purposes of

applying the New York apportionment statute; (4) whether

the net gift agreement, as petitioner contends, ‘‘provides an

effective enforcement mechanism that does not exist under

the [New York] statute’’; (5) whether the bulk of petitioner’s

assets will be subject to probate or will pass by trust or other

nonprobate mechanism, which might affect ease of enforce-

ment; and (6) whether any incremental enforcement benefit

is substantial enough to constitute ‘‘consideration’’ within the

meaning of section 2512(b).

The Court appears to recognize that respondent, while not

entitled to summary judgment on his ‘‘estate depletion’’

theory, could prevail on this theory at trial if the requisite

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290 141 UNITED STATES TAX COURT REPORTS (258)

facts are resolved in his favor. Indeed, the proper disposition

at trial of respondent’s ‘‘apportionment clause’’ argument

may determine not only whether the donees’ agreement to

pay the section 2035(b) tax constitutes ‘‘consideration,’’ but

also the nature and outcome of the valuation exercise. If the

only benefit accruing to petitioner and her estate from the

donees’ agreement to pay the section 2035(b) tax is the incre-

mental benefit the executor derives from having a contrac-

tual as well as a statutory enforcement mechanism against

the daughters, the actuarial value of their assumption of the

contingent section 2035(b) liability becomes essentially irrele-

vant. The thing to be valued in that event—the ‘‘consider-

ation’’ received by petitioner’s estate—will be this incre-

mental enforcement capacity enjoyed by the executor. As

Judge Raum noted 50 years ago, we should be cautious in

treating as statutory ‘‘consideration’’ obligations assumed in

‘‘an intrafamily transaction’’ under ‘‘ ‘colorable family con-

tracts.’ ’’ Estate of Woody v. Commissioner, 36 T.C. 900, 903

(1961) (quoting Carney v. Benz, 90 F.2d 747, 749 (1st Cir.

1937)). Assuming arguendo that the actuarial value of the

daughters’ assumption of the contingent section 2035(b)

liability is $5,838,540, as petitioner contends, the value of the

incremental enforcement capacity enjoyed by the executor

may be substantially less than that.

In sum, the Court properly leaves the evaluation and dis-

position of respondent’s ‘‘apportionment clause’’ argument for

a posttrial opinion after all the evidence in this case has been

heard. Respondent’s motion for summary judgment should be

denied, not because his ‘‘estate depletion’’ theory is wrong,

but because the proper resolution of the ‘‘apportionment

clause’’ argument underlying his ‘‘estate depletion’’ theory

hinges on disputed issues of material fact. Because

respondent could ultimately prevail on his ‘‘estate depletion’’

theory if the trial establishes the requisite facts in his favor,

it would clearly be premature to overrule this aspect of

McCord at the present stage of this case. That is a question

for another day.

GALE, GOEKE, KROUPA, GUSTAFSON, and MORRISON, JJ.,

agree with this concurring opinion.

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(258) STEINBERG v. COMMISSIONER 291

HALPERN, J., dissenting:

I. Introduction

Respondent has moved for summary adjudication that, in

computing the amount of a gift, a donee’s promise to pay the

additional Federal and State estate taxes that might arise by

virtue of the application of section 2035(b) does not constitute

adequate and full consideration in money or money’s worth

within the meaning of section 2512(b). As respondent makes

clear in replying to petitioner’s response to his motion:

‘‘Respondent is challenging the nature of the consideration in

this motion, * * * not the fair market value of that consider-

ation’’. Because it is only the nature of the consideration that

respondent is challenging, I agree with Judge Lauber that

the discussion of the ‘‘too speculative’’ theory is unnecessary

at this stage of this case. I further agree with him that it is

at this time improper to consider overruling McCord v.

Commissioner, 120 T.C. 358 (2003), rev’d and remanded sub

nom. Succession of McCord v. Commissioner, 461 F.3d 614

(5th Cir. 2006), insofar as it embraces that theory. I do

believe that we should grant respondent’s motion on the

ground that allowing a reduction of an otherwise taxable

transfer by an actuarial estimate of the value of the estate

tax that might result because of the application of section

2035(b) is inconsistent with Congress’ purpose in enacting

section 2035(b).

II. Some Background

Congress enacted the predecessor of section 2035(b) to

mitigate in part a disparity between the tax bases subject to

the gift tax and the estate tax, respectively. The gift tax base

is ‘‘tax exclusive’’, while the estate tax base is ‘‘tax inclusive’’.

Thus, assume a wealth transfer tax system that, from the

first dollar, taxes all gratuitous transfers of wealth at a

single rate, say 45%. Under such a system, the $15 million

taxable estate of a decedent (let’s call her ‘‘mother’’) will bear

a tax of $6,750,000, which will leave $8,250,000 to distribute

to the decedent’s heir (daughter). The tax base against which

the hypothetical 45% flat-rate estate tax is applied is inclu-

sive of the tax to be paid, so that the whole of mother’s tax-

able estate, whether going to daughter or going to the tax

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292 141 UNITED STATES TAX COURT REPORTS (258)

collector, is subject to that 45% flat-rate estate tax. On the

other hand, if, before she died, mother decided to rid herself

of her $15 million by making a gift to daughter, she could,

from $15 million, make a gift of $10,344,828, paying a gift

tax of $4,655,172. Daughter would receive $2,094,828 more,

and the tax collector would receive an equal amount less,

than either would receive were mother to let the $15 million

pass through her estate to daughter. The reason for the dif-

ference in result is that the gift tax base excludes the tax to

be paid, so that only the amount of the gift is taxed, while

the estate tax base includes the amount of tax to be paid.

Congress was fully aware of the disparity in the transfer tax

bases applicable for the gift tax and the estate tax when it

enacted the predecessor of section 2035(b). See H.R. Rept.

No. 94–1380, at 11–12 (1976), 1976–3 C.B. (Vol. 3) 735, 745–

746. It chose to mitigate that disparity only with respect to

gifts made within three years of death. Id. The mitigation

mechanism is the so-called section 2035(b) gross-up rule, by

which any gift tax paid on gifts made within three years

before death is added to the gross estate. The report of the

Committee on Ways and Means puts it this way: ‘‘This

‘gross-up’ rule will eliminate any incentive to make deathbed

tranfers [sic] to remove an amount equal to the gift taxes

from the transfer tax base.’’ H.R. Rept. No. 94–1380, supra

at 12, 1976–3 C.B. (Vol. 3) at 746.

The section 2035(b) gross-up rule accomplishes Congress’

purpose by subjecting any gift made within the statutory

period to taxation exactly as it would have been taxed had

the transferred amount been part of the decedent’s gross

estate. Thus, assume that mother had opted for a lifetime

transfer, paying $4,655,172 in gift tax and making a gift to

daughter of $10,344,828. Assume further that mother dies

within three years of making the gift. Section 2035(b) would

include in her gross estate the $4,655,172 paid in gift tax,

which, assuming that her taxable estate equaled her gross

estate, would attract an estate tax of $2,094,828. The sum of

the prior gift tax paid by mother, $4,655,172, and the current

estate tax borne by her estate, $2,094,828, equals $6,750,000,

which is exactly what it would have been had mother made

no gift and died possessed of $15 million. 1 Moreover, dying

1 The following table shows the gift tax and the equivalency between a

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(258) STEINBERG v. COMMISSIONER 293

penniless (she either paid in tax or gave to daughter all of

her $15 million), mother’s estate would have no funds to bear

the estate tax, which, pursuant to section 6324(a)(2), would

be borne by daughter, who, in effect, would have to return

$2,094,828, to the estate to pay the estate tax, reducing

daughter’s net benefit received from mother to $8,250,000, as

shown supra note 1. That sum, $8,250,000, is exactly the

sum that she would have received had mother made no life-

time gifts and had she named daughter sole beneficiary of

her estate. Of course, if mother survives her gifts by more

than three years, the more lenient gift tax result prevails.

If mother opts for a lifetime transfer, she has two choices

with respect to paying the resulting $4,655,172 gift tax: She

can pay the tax herself, giving daughter a straight gift of

$10,344,828, or she can make what the opinion of the Court

describes as a net gift, giving daughter $15 million on the

condition that daughter pay the $4,655,172 gift tax. Whether

mother chooses to make a straight gift or she chooses to

make a net gift, the amount of of the gift tax is the same,

as is the amount of mother’s gift to daughter. Put generally,

the proposition is that, in the case of a donor with a given

sum of pretax wealth out of which she would like to make

the maximum gift, the calculation of the maximum gift and

the determination of the resulting gift tax is the same

whether the donor intends a straight gift or a net gift. The

calculation need not be difficult. The donor with some gross

amount, G, wishing to determine the net amount, N, that,

after paying tax at rate t, will, along with the tax, add up

to G, can express her problem as follows:

N + tN = G

This equation can be restated as:

lifetime gift subject to a sec. 2035(b) gross up and solely a testamentary

transfer.

Estate tax Estate tax (sec.

Gift tax (no prior gifts) 2035(b) applies)

Wealth $15,000,000 $15,000,000 $15,000,000

Gift tax 4,655,172 --- 4,655,172

Estate tax --- 6,750,000 2,094,828

Total transfer taxes 4,655,172 6,750,000 6,750,000

Wealth to donee/heir 10,344,828 8,250,000 8,250,000

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294 141 UNITED STATES TAX COURT REPORTS (258)

N (1 + t) = G

and restated again as: 2

N = G/(1 + t)

Thus, setting G equal to $15 million, N is $10,344,828, and

by subtracting N from G, the gift tax is $4,655,172. The

procedure described is solely about determining how much

one can give away under a tax-exclusive gift tax at rate t. It

is also useful to illustrate that, at any positive tax rate, t,

and for any gross amount, G, the amount that can be given

by gift, G/(1 + t), will always exceed the amount that can be

transferred at death, G (1 – t). 3

III. Donee’s Agreement To Pay Section 2035(b) Liability

Now let us suppose that mother, having opted for a life-

time transfer, transfers to daughter the whole $15 million,

obligating daughter to pay the resulting gift tax and, further,

making her promise to pay the estate tax that will result on

account of section 2035(b) if mother should die within three

years of making the gift. Has the calculus of the gift and the

resulting gift tax changed? Certainly not because of daugh-

ter’s obligation to pay any gift tax, but what about because

of her promise to pay any estate tax? An actuarial value can

be assigned to that obligation. Petitioner’s attorney and her

appraiser have written an article setting forth a method for

valuing a donee’s obligation to pay the estate tax resulting

from a section 2035(b) gross-up. Michael S. Arlein & William

H. Frazier, ‘‘The Net, Net Gift’’, 147 Tr. & Est. (Arlein &

Frazier) 25 (2008). They assume an 85-year-old donor,

transferring $15 million to her son, the donee, on December

31, 2007, who, in addition to agreeing to pay the gift tax,

agrees to pay any estate tax resulting from any section

2035(b) gross-up. They call the arrangement a net, net gift.

—————–

2 The procedure is elaborated on in Rev. Rul. 75–72, 1975–1 C.B. 310.

3 The amount that can be given by gift, G/(1 + t), will always exceed the

amount that can be transferred at death, G (1 – t), since:

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(258) STEINBERG v. COMMISSIONER 295

Calculating an estate tax of $2,214,990, and taking into

account mortality and present value factors, they assign a

value of $700,515 to the donee’s obligation to pay the estate

tax. Dividing $700,515 by $2,214,990, I calculate a discount

factor of 31.63%, which, for convenience, I will adopt for my

calculations.

So, if the net, net gift form is respected, the net amount

of mother’s lifetime transfer to daughter would be calculated

by subtracting from the $15 million the actuarial value of

daughter’s obligation to pay the estate tax liability resulting

from a section 2035(b) gross-up. The calculation of the poten-

tial section 2035(b) liability is somewhat complex, because it

is dependent on the amount of the gift tax (which determines

the potential section 2035(b) liability), which, in turn, is

dependent on the actuarial value of daughter’s obligation to

pay that liability. A good idea of how the relevant calcula-

tions are done can be obtained from Arlein & Frazier, supra,

at 31 (‘‘Valuing the IRC Section 2035(b) Liability’’). If the

net, net gift form is respected, I calculate that, on the

transfer of $15 million to daughter (subject to her obligation

to pay any resulting section 2035(b) liability), the resulting

net, net gift and net, net gift tax would be $9,907,198 and

$4,458,239, respectively. The section 2035(b) gross-up

amount would be $4,458,239 (the gift tax paid), giving rise

to $2,006,208 of potential estate tax. Taking 31.63% of that

amount results in an actuarial value of $634,563 for daugh-

ter’s obligation to pay that tax. The gift tax savings from the

net, net gift would be $196,933. 4 If mother should die within

three years of making the gift, the estate tax savings would

4 The following table compares a gift (or a net gift) to a net, net gift.

Gift tax Net, net gift tax Difference

Wealth $15,000,000 $15,000,000 ---

Sec. 2035(b) obligation --- 634,563 ---

Net transfer 15,000,000 14,365,437 ---

Gift tax 4,655,172 4,458,239 1$196,933

Gift 10,344,828 9,907,198 ---

Wealth to donee/heir 10,344,828 10,541,761 2 –196,933

1Reduction in the amount of the gift tax.

2Increase in the amount of wealth to donee/heir.

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