In Demuth v. Commissioner (T.C. Memo 2022-72), the Tax Court held that certain checks issued and deposited before, but paid after, a decedent’s passing weren’t includable in the decedent’s taxable estate, based on the misuse of terms of art by counsel for both the taxpayer and the Internal Revenue Service.
Good Facts Make Good Law. Sometimes.
The Father in the case executed a power of attorney in 2007, appointing Son as his agent. Pursuant to the power of attorney, Son made annual exclusion gifts to Father’s descendants from 2007 through 2014.
Father and Son were both residents of Pennsylvania.
In the summer of 2015, Father’s health began to fail. By September, Father was suffering from an end-stage medical condition. On Sept. 6, 2015, Son, as agent, wrote 11 checks from Father’s investment account (the Investment Account) at Investment Company which featured a checking function. Ten of the checks were for amounts eligible for the annual gift tax exclusion. In total, $464,000 was transferred by the 11 checks.
One check was paid by Investment Company on Sept. 9, 2015. Three checks (1215, 1219 and 1221) were deposited on Sept. 9 and paid by Investment Company on Sept. 14.
On Sept. 11, Father died.
The remaining checks were deposited after Father’s death and paid by Investment Company between Sept.15 and Sept. 30.
Son, acting as Father’s executor, timely filed an Estate Tax Return on which he excluded the value of the 11 checks in reporting the value of the Investment Account. On audit, the IRS issued a notice of deficiency determining that the value of the Investment Account was understated by the value of the 10 checks paid by Investment Company after Father’s death (i.e., $436,000).
Beware of Grantors Bearing Checks
Internal Revenue Code Section 2033 includes in a decedent’s gross estate the value of the decedent’s interest in property at the time of the decedent’s death. The related regulations specifically include cash belonging to the decedent at his death “whether in his possession or in the possession of another, or deposited with a bank.” The value of a check is included in the writer’s gross estate unless such check constitutes a completed gift during the writer’s life.
A gift isn’t considered complete unless the donor has “parted with dominion and control as to leave him no power to change its disposition.” (Reg. § 25.2511-2(b)). State law determines when a decedent parts with dominion and control of funds in an account after a check is drawn. (See Burnet v. Harmel, 287 U.S. 103, 100 (1932)).
A valid inter vivos gift requires the following under Pennsylvania law: (1) unmistakable intent of the giver to part with the subject of the gift, (2) an intent by the giver to invest the donee with the right of disposition beyond recall, and (3) actual or constructive irrevocable delivery. (Packer v. Clemson, 112 A. 107, 107 (Pa. 1920)).
Pennsylvania Commercial Code
The Pennsylvania Commercial Code allows the signer of a check (the drawer) to stop payment of an item drawn on the drawer’s account by an order to the drawer’s bank (drawee bank) affording the drawee bank a reasonable opportunity to act on it. A drawer can issue a stop-payment order on a check after delivery to a donee; therefore, delivery of a check doesn’t complete a gift under Pennsylvania law. In contrast, a gift of a check becomes irrevocable and complete at the point where a charge might validly be made against the drawer’s account despite the drawer issuing a stop-payment order.
The Pennsylvania Commercial Code dictates that a stop-payment order may no longer be made at the earliest of five specified stages in processing by the drawee bank. Under this statute, the first possibility for a check to be considered a completed gift is when the drawee bank accepts, certifies or makes a final payment on a check, irrevocably settles for a check, becomes accountable due to late return for an item, or at a specified time on the business day following the date on which the bank receives the check.
In this case, the Court concluded that the Investment Company didn’t accept, certify or make a final payment on any of the 10 checks at issue before Father’s death. Therefore, a stop-payment order could have been placed on any of those checks before Father’s death and none of the 10 checks constitute a completed gift under Pennsylvania law. Therefore, under relevant law, all 10 checks are properly included within Father’s taxable estate.
A Depository Bank by Any Name Won’t Smell as Sweet
The Tax Court begins the more annotative part of its analysis as follows:
In all matters before the Court, the use of proper terminology is of the utmost importance. In the instant case, both parties have seemingly misconstrued the term “drawee bank” to mean “depository bank.”
The Court proceeds to emphasize the distinction between the “drawee bank,” the entity ordered to make payment by the drawer as described above, and the “depository bank” where the payee deposits the check. The Court notes the parties’ repeated misuse of these terms.
In the Joint Stipulation of Facts, the parties stipulated that on Sept. 11, 2015 (i.e., Father’s date of death), checks were “deposited and credited to the accounts of the following payees by their respective drawee banks.”
The Court notes that “seemingly on the basis that the checks had been ‘credited by the drawee banks’ before decedent’s death,” the IRS conceded in its Simultaneous Opening Brief that the three checks deposited on Father’s date of death weren’t includable in his gross estate. As noted above, such checks were in fact deposited with the respective “depository banks” of the payees before Father’s death but credited by the drawee bank, namely Investment Company, after Father’s death.
The Court was therefore faced with a dilemma: the IRS’ concession on brief in a case submitted for decision without trial was inconsistent with applicable law. Based on the taxpayer’s reliance on the concession, the Court held that the three checks numbered 1215, 1219 and 1221 wouldn’t be included in Father’s taxable estate while the other seven checks at issue would be included.
Through the Looking Glass
The analysis of the Court seems sound, and its critique of counsels’ misuse of statutory terms seems appropriate. That is, until one starts digging into the factual nuggets tucked away in the footnotes.
Footnote 9 concedes that the checks numbered 1215 and 1219 were “seemingly” deposited at Investment Company by the payees. The Court disregards the (inconvenient?) fact that the checks were in fact deposited at the “drawee bank” before Father’s death by emphasizing that “there is nothing in the record” indicating that Investment Company, in the capacity of drawee bank, “either formally accepted or certified the checks before final payment.”
As mentioned above, the Pennsylvania Commercial Code quoted at length in the decision specifies five specified stages, the earliest to occur of which marks the cutoff by which a stop-payment order may no longer be made. One stage is the banking day following the date on which the drawee bank receives the check.
Here, payees deposited checks numbered 1215 and 1219 at their depository bank, which was Investment Company on Sept. 9, 2015, which fell out on a Wednesday. The following banking day—Thursday, Sept. 10, the day before Father’s death—seemingly should constitute Father’s final opportunity to issue a stop-payment order. Based on these facts, Father made a completed gift of the checks numbered 1215 and 1219 the day before his death, and such checks were properly excluded from his taxable estate.
This presents an interesting scenario where the Court excludes the value of two checks from Father’s taxable estate based on missteps by government attorneys, where the exclusion would seemingly be more properly based on the relevant underlying law.