• Tax Court rules on deductibility of gift tax liability in net gift, relation of marital deduction and expenses and estate tax apportionment—In Estate of Sheldon C. Sommers v. Commissioner, 149 T.C. No. 8, (Aug. 22, 2017), the Tax Court ruled on several issues relating to an estate’s federal estate tax liability, continuing litigation with the Internal Revenue Service that began years ago.
In 2001, Sheldon Sommers established a limited liability company (LLC) to hold certain works of art from his collection. He then gave interests in the LLC to his nieces in 2001 and 2002, each gift subject to written agreements in which the nieces agreed to pay the gift taxes, if any, relating to the gifts. The agreements only included provisions relating to gift tax liability and related penalties and interest, but didn’t address potential estate tax.
After making the gifts, in June 2002, Sheldon remarried his ex-spouse, Bernice, and then sued his nieces seeking rescission of the gifts and return of the artwork. That suit wasn’t successful; New Jersey courts upheld the gifts to the nieces. Sheldon died several months later, in November 2002.
Sheldon’s will left his estate, after payment of debts and expenses, to Bernice. She was also the surviving joint tenant of property that constituted a significant portion of his taxable estate.
In 2013, the Tax Court ruled on several motions for summary judgment and held that the gifts to the nieces were complete for gift tax purposes, but the court didn’t address further estate tax issues (now raised in the current case). After the parties agreed to the amount of gift tax due ($273,990), the nieces paid the gift tax.
The gift tax on the gifts of LLC units was includible in Sheldon’s taxable estate under Internal Revenue Code Section 2035(b) because the gifts were made within three years of death. However, the estate requested summary judgment that the gift tax liability relating to the gifts was deductible under IRC Section 2053 because gift taxes owed by an estate (that is, unpaid on decedent’s death) are generally deductible under that section. If the deduction was allowed, the estate acknowledged that it would eliminate the effect of Section 2035(b), but argued that net gifts allow the removal of that amount from the transfer tax base.
The court held for the IRS, explaining that the estate couldn’t deduct an expense or claim against the estate for which the estate had a right of reimbursement. The nieces had assumed liability for the gift tax liability under the agreements. The court concluded that even though the obligation to pay the tax remained with the decedent, in a net gift setting, the estate could seek full reimbursement from the nieces for the gift taxes paid if the nieces hadn’t paid them. That right of reimbursement precluded the deduction under Section 2053. The opinion analyzed the purpose of Section 2035(b) and precedent, concluding that, as a policy matter, it wouldn’t make sense for deductions under Section 2053 to nullify the function of Section 2035(b) for net gifts.
Another issue concerned estate tax apportionment. The estate moved for summary judgment requesting a ruling that the estate tax relating to the gifts of LLC units was apportionable to the nieces. The estate argued that the nieces were “transferees” under New Jersey law to whom the tax was apportionable because the gross estate figured in the gifts as adjusted taxable gifts. In the alternative, the estate argued that the value of the gift tax was added back into the estate under Section 2035(b), bringing the gifts into the gross taxable estate for New Jersey’s apportionment purposes. The IRS agreed with the estate on the motion that the estate tax should be apportioned to the nieces.
The court also analyzed issues relating to the marital deduction for property that passed to Bernice but that ultimately might have to be used to pay expenses. Bernice received the bulk of the estate in assets held jointly and as tenants by the entirety, and these assets, under New Jersey law, were exempt from the estate’s debts and expenses. However, other assets weren’t sufficient to pay the debts and expenses. So, although Bernice was entitled to certain property, some portion of it might have to be sold or used to pay expenses.
The estate filed for summary judgment, arguing that it was entitled to a marital deduction for all of the non-probate property passing to Bernice because state law protected such property from claims and expenses. However, the court noted that there was an inconsistency in the estate’s calculations of deductions because the estate also deducted expenses in an amount that exceeded what was permissible under Section 2053. Section 2053 limits deductions to only those for expenses that are paid from property subject to claims unless paid before the estate tax return is filed. “Property subject to claims” means property that’s includible in the gross estate and which, under state law, would bear the burden of those claims and expenses. If the estate was correct in the amount of property payable to Bernice, there wasn’t sufficient remaining property subject to claims eligible for deducting the rest of the expenses. If Bernice opted to pay certain expenses out of non-probate marital property, the marital deduction had to be reduced; otherwise, the expenses and debts weren’t fully deductible under Section 2053. So, the court denied the estate’s request for summary judgment on the value of property eligible for the marital deduction.
However, the nieces intervened and filed their own motion for summary judgment to establish that they weren’t “transferees” under the apportionment statute and that their net gift agreements limited their liability to gift taxes only.
The court held for the nieces and interpreted the New Jersey apportionment statute to apportion federal estate tax to recipients of non-probate property included in the gross estate, not to recipients of lifetime gifts that were included in the calculation of the estate tax.
Further, the court reasoned, the property the nieces received consisted of the LLC units received as gifts prior to Sheldon’s death. Those LLC units themselves weren’t included in Sheldon’s estate. While the amount of the gift tax attributable to the gifts of the LLC units was included in the taxable estate, the court held that the amount of the gift tax wasn’t “property,” and the nieces weren’t transferees for purposes of the New Jersey apportionment statute. Therefore, no estate tax could be apportioned to the nieces. The court examined other states’ laws that required apportionment to donees of lifetime gifts and concluded that there weren’t sufficient policy grounds to expand the application of the New Jersey apportionment statute further.
Lastly, the estate asked for partial summary judgment that any federal estate tax owed wouldn’t reduce the marital deduction. But, the court was unable to confirm this for the estate without further details as to which property was in fact used to pay the estate taxes and other expenses.
• New rates for special use valuation under 2032A—Revenue Ruling 2017-16 (Aug. 28, 2017) published new annual effective interest rates for new loans under the Farm Credit System. These rates are also used to compute the special use value of real property used as a farm for which an election is under Section 2032A. The new rates provided in the ruling are applicable to estates valuing farmland under Section 2032A as of a date in 2017.