The busy season has begun and The Tax Warriors® are in the thick of it. And since now is the time when tax tips matter most, we’ve called some friends to share their tax-related expertise. In this blog post, Hempstead & Company shares its insight on how a 2015 Tax Court case may help you determine the value of a gift.
Steinberg v. Commissioner, 145 T.C. No. 7 (Sept. 16, 2015) explores how a contingent liability accepted by a donee can affect the value of a gift for gift tax purposes.
In 2007, Petitioner Jean Steinberg, age 89, entered into a net gift agreement under which she gave her four daughters a gift of $109.4 million. In exchange, her daughters agreed to assume and pay any Federal gift tax liability imposed because of the gifts. The daughters also agreed to assume and to pay any Federal or State estate tax liability imposed under Section 2035 (b) because of the gifts, if their mother passed away within three years of the gifts.
Petitioner retained an appraiser to determine the value of the net gifts on the date they were made, April 17, 2007. The appraiser determined that the value of the net gifts was the fair market value of the assets conveyed by transfer from the donor less the gift tax and estate tax liabilities assumed by the donees. This calculation produced a net value for the gifts of $71.6 million, which produced a total gift tax obligation of $32 million.
The IRS, in 2011, mailed a notice of deficiency to the Petitioner. The notice increased the aggregate value of Petitioner’s net gifts to her daughters from $71.6 million to $75.6 million, producing a total gift tax increase of $1.8 million.
The Parties Go to Tax Court
The heart of the disagreement between the Petitioner and the IRS was over whether it was proper to deduct the value of the daughters’ contingent liability to pay estate taxes under Section 2035 (b) if mother died within three years of the gift.
The IRS contended that it is not proper to reduce the size of the gift by the value of the daughters’ obligation to pay estate taxes, maintaining this liability does not constitute money or money’s worth.
The Petitioner and her appraiser believed that the assumption of the Section 2035 (b) estate tax liability was quantifiable and reducible to monetary value and that a willing buyer and a willing seller would take the daughters’ assumption of this liability into account in determining a sale price or value of the net gift.
In calculating the value of the estate tax liability, the appraiser used actuarial tables promulgated by the IRS to calculate the probability that the Petitioner would die within each of the three years after the gift. The result was a mortality rate for years one, two and three of 13.85%, 13.04% and 12.13%, respectively. The appraiser then determined the present value factor for each of the three years, using the Section 7520 interest rate.
The appraiser then took the effective State and Federal estate tax rates for each of the three years and multiplied them by the gift tax in the estate under Section 2035 (b). Using this methodology, the appraiser calculated that the daughters’ assumption of the Section 2035 (b) liability reduced the value of the combined gift by $5.8 million
The IRS did not put on a valuation expert. They quibbled over the IRS actuarial tables, contending that they did not give effect to the state of the health of the Petitioner. They also questioned the appraiser’s use of Section 7520 interest rates.
The Court Decides
The Court found itself convinced by most of Petitioner’s arguments, settling on the appraiser’s value for the contingent estate tax liability of $5.8 million. Petitioner (and appraiser) had a good day.
Hempstead & Company provides quality valuation services and has done so for over 30 years. Based in Haddonfield, NJ, Hempstead provides corporate valuations, fairness opinions, merger and acquisition advisory services and economic damages analysis to clients across multiple industries. Contact J. Mark Penny with questions about their suite of services.