Decedent made substantial gifts and paid gift taxes thereon within three years of his death. Under IRC §2035, the gift taxes are brought back into the estate for estate tax purposes. Who should bear the burden of those additional estate taxes, the donees of the lifetime gift, or the decedent’s estate? This was one of the questions facing Surrogate Scarpino in a recent case in Westchester County Surrogate’s Court.   In Matter of Rhodes 208 NY Slip Op 28472  December 1, 2008 (NY Law Journal), the Court found that the burden fell on the donees. 

While Congress eliminated the old “contemplation of death” rules for gifts within three years of death, a last vestige remains and that is that the gift taxes on gifts made within three years of death are recaptured into the decedent’s gross estate for estate tax purposes. This provision was meant to eliminate the perceived abuse of people making large death time gifts, which because of the tax inclusive nature of the estate tax versus the tax exclusive nature of the gift tax, would allow the gift tax on assets transferred lifetime to escape the transfer tax  system, a result which would not happen if the transfer were made on death by Will.

Here are the facts. Mr. Rhodes died on June 18, 2007 survived by three sons and two grandchildren who were issue of a predeceased son. Decedent’s will had a number of pre-residuary bequests both of real property and money and left her residuary estate in equal shares to his three sons. The tax clause in his will provided that taxes on his probate assets would be paid from his residuary estate and that estate taxes on property passing outside his will would be apportioned in accordance with New York State law. The decedent’s federal estate tax return disclosed that a number of lifetime gifts had been made and that gift tax of $1,144,277 had been paid during the three year period prior to his death which tax was accordingly included in his gross estate under IRC § 2035(b). It appears there was a shortfall in the residuary estate and an initial question arose as to whether the shortfall should be borne by the pre-residuary bequests in the Will (which the Will specifically exonerated from taxes) or against the recipients of the gift. The Court found that any shortfall of the residuary estate to cover the estate tax should be paid from the interests bequeathed under Article Fourth of the Will, i.e., the pre-residuary bequests. 

With respect to the question of whether the donees of gifts made within three years of death are responsible for paying estate tax attributable to the inclusion of the gift tax paid on those transfers, the Court held that while the phrase gross taxable estate does not technically include adjusted taxable gifts because such gifts are added after the tax computation schedule, gift taxes paid are treated differently and are a component of the gross estate as defined by IRC § 2035 and as such are subject to apportionment under EPTL 2-1.8. The Court thus found that the donees of the gifts made within three years of decedent’s death were responsible for paying their ratable share of the estate tax attributable to the inclusion of the gift tax paid.