“Estate of Sommers v. Commissioner, 149 T.C. No. 8, is a prime example of when an estate planning technique — net gifting — proved harmful by increasing the value of the gross estate, even though net gifting seemed entirely appropriate to the client’s facts and circumstances existing on the date of execution.”
Even with a solid estate plan, fluctuating family relationships or unexpected illness or death can hamper an estate plan and result in undesirable transfer tax consequences, reports BNA Bloomberg in its recent article “Net Gifts: When Estate Planning Goes Wrong.”
In Estate of Sommers, the decedent made lifetime gifts to his three nieces by transferring artwork to an LLC and then membership interests to the nieces over a two-year period to take advantage of valuation discounts and annual exclusion amounts. The nieces signed an agreement stating that they’d be responsible for any gift taxes on the gifts of membership interests (otherwise known as a net gift). The decedent then remarried his ex-wife and died five months later.
Before his death, the decedent started a lawsuit against his nieces arguing that the gifts were not completed gifts. After the court held that the decedent made completed gifts, the nieces paid the gift tax liability of $274,000. Because he gifted the membership interests within three years of his death, both the value of the membership interests and the $274,000 gift tax payment was included in the value of the decedent’s gross estate. But the executor of the decedent’s estate, the surviving spouse, claimed that the gift tax payment was deductible.
The court held that the gift tax payment wasn’t deductible because “an estate is entitled to deduct a claim under §2053(a)(3) only to the extent that the amount owed exceeds any right to reimbursement to which payment of the claim would give rise.” The court found that the estate would have had an enforceable right to reimbursement from the nieces, if they hadn’t paid the gift tax. The court found that the nieces served only as conduits, and the decedent was the ultimate gift tax payer. If not for the three-year claw back, the decedent would’ve withdrawn from his potential estate, the value of the taxable gifts and the amount of tax on the gifts. The gross-up rule is necessary to prevent such excess value (the gift tax on the net gift) from escaping, and, therefore, the decedent’s estate from circumventing, the transfer tax system.
Net gifting can be a very valuable and effective estate planning tool, if done correctly. Talk with your estate planning attorney to understand the potential for risks involved in making net gifts.
Reference: BNA Bloomberg (September 14, 2017) “Net Gifts: When Estate Planning Goes Wrong”