Estate was entitled to deductions for reimbursed gift taxes that heirs paid.

In November 1987, T and her husband H gave voting and nonvoting stock in the T Steel Company to their children and grandchildren. T and H timely filed gift tax returns for these gifts, valuing the stock pursuant to a 1951 buy-sell agreement. The value of the stock was based on the option price at which T and H could sell the stock; the prices had been set in 1976.

In 1988, H died. In 1990, the IRS audited H's estate tax return, examining the 1987 gift tax returns and the buy-sell agreement.

The limitation period for assessing gift taxes against T and H for their 1987 gifts ended on April 15, 1991. At no point before this date did the Service assess any gift taxes.

In September 1991, the IRS appraised the T Steel stock and determined that it was worth approximately seven times as much as stated on T's and H's 1987 gift tax returns. In April 1992, the Service asserted transferee liability against the donees of the 1987 gifts and issued liability notices totaling over $9 million in taxes and penalties. In May 1992, the donees made partial payments to the IRS and filed claims against H's estate in probate court, seeking reimbursement for any taxes, additions or interest arising from the 1987 gifts.

In July 1992, the donees brought suit in Tax Court, seeking a redetermination of their transferee tax liabilities. In 1998, the Tax Court ruled for the Service, holding that the IRS could revalue the 1987 gifts and that the donees could be personally liable for the transferee tax liability.

In 1994, T died. In August 1994, the donees filed claims in probate court against T's estate, seeking reimbursement for any gift taxes, additions and interest they might be required to pay for the 1987 gifts.

In April 1995, the Service and the donees settled the valuation issue, increasing the stock's value and thereby increasing the gift tax due from T and H.

In 1996, the probate court held that the donees' claims against T's and H's estates were valid, and that they were entitled to recover the taxes and interest paid as a result of the 1987 gifts. T's estate paid these amounts to the donees and, in 1996, filed an amended estate tax return, reducing the deduction for the donees' claims (based on the IRS settlement) and claiming a refund for estate taxes overpaid. The Service did not respond to the refund claim; T's estate filed suit in August 1997.

After 1995, T's estate tax return was audited; the IRS challenged the estate's deduction for the donees' claims. In 1998, the Service issued a deficiency notice to T's estate, disallowing the refund claim.

In 1999, the Tax Court specifically identified the transferee gift tax liability and interest for which each of the donees was liable; the amount due had been paid in full by the donees to the IRS in 1992. T's estate then filed suit to obtain a refund of the estate taxes and interest the Service collected, arguing that T's estate was entitled to a deduction for the donees' claims for reimbursement of their transferee liability arising from T's gifts to them. The district court (opinion Johnson, J.) holds for T's estate; the estate is entitled to a deduction for the claims for the gift taxes paid by the heirs and reimbursed by the estate.

Sec. 2501(a) imposes a tax on the transfer of property by gift. Sec. 2502(c) imposes the obligation to pay gift tax on the donor, stating "the [gift] tax imposed by section 2501 shall be paid by the donor." This was done by T. The donor must file a gift tax return and pay the tax on or before April 15 of the year following that in which the gift was made. Any gift tax must be assessed against a donor within three years after the gift tax return is filed. Regs. Sec. 25.2505-2 interprets Sec. 2502(c) as follows:

Donor Primarily Liable for Tax. Section 2502(d) provides that the donor shall pay the tax. If the donor dies before the tax is paid the amount of the tax is a debt due the United States from the decedent's estate and his executor or administrator is responsible for its payment out of the estate.

Troubling this court is the fact that the donor, T, paid all the taxes due on the gifts at the time she made them. Clearly, if T had paid nothing, the tax would be payable out of her estate. The IRS argues that T singly (or she and H jointly) did not own enough T Steel stock to change the option prices from the 1951 buy-sell agreement. As such, the stock price used to determine the gift tax paid was the price at which T would have had to sell her stock if she chose to do so rather than give it away. As such, T used the only market available to her at the time the gift tax was paid.

The reference to a liability being placed on a donee for gift tax is found in Sec. 6324(b), which provides:

(b) Lien for Gift Tax.

Except as otherwise provided in subsection (c), unless the gift tax imposed by chapter 12 is sooner paid in full or becomes unenforceable by reason of lapse of time, such tax shall be a lien upon all gifts made during the period for which the return was filed, for 10 years from the date the gifts are made. If the tax is not paid when due, the donee of any gift shall be personally liable for such tax to the extent of the value of such gift.

Sec. 6324(b) addresses taxes "not paid when due." However, that is not the situation before this court. No allegation is made that T improperly calculated the taxes due on the gifts she made. Rather, after the gifts were given, the Service determined that a different, higher and previously nonexistent value should have been attached to those gifts, even though the shares did not have that value to T at the time she made the gifts.

Under Sec. 6324(b), a donee is liable as a transferee at law, regardless of whether gift tax deficiencies were assessed against the donor. Thus, if the donor had failed to pay the gift taxes when due, the donee is rendered liable as a transferee at law for such taxes to the extent of the gift's value. A donee's liability under Sec. 6324(b) for unpaid gift taxes exists separate and apart from the donor's liability for unpaid gift taxes. However, that liability only arises if the tax is not paid when due.

Regs. Sec. 25.2511-2 provides:

Cessation of Donor's Dominion and Control. The gift tax is not imposed upon the receipt of the property by the donee, nor is it necessarily determined by the measure of enrichment resulting to the donee from the transfer, nor is it conditioned upon ability to identify the donee at the time of the transfer. On the contrary, the tax is a primary and personal liability of the donor, is an excise upon his act of making the transfer, is measured by the value of the property passing from the donor, and attaches regardless of the fact that the identity of the donee may not then be known or ascertainable.

Moreover, payment or discharge of a transferor's liability extinguishes the liability of transferees.

The donees' liabilities did not arise until the IRS revalued the stock in 1991, when it could no longer collect additional gift taxes from T. If the IRS had asserted the additional gift tax liability against T in a timely fashion, T's estate would have been reduced by the gift tax payment and the estate tax due would have been reduced correspondingly.

The Service, however, failed to assert the additional gift tax liability against T, but instead asserted a transferee liability against the donees. Unless the amount of the transferee liability is allowed as a valid claim against T's estate, the estate will not get an estate tax deduction for the gift tax paid or owed. The IRS will receive estate taxes on the additional value in T's estate due to its own lack of diligence. By its failure to assert timely the liability against T, the Service argues it may collect both the gift tax and the estate tax on the amount of the gift tax.

The IRS cannot be put in a better position due to its dilatory conduct, by asserting a tax liability on the donees without a corresponding deduction for the probate court-ordered reimbursement of the gift tax paid by the donees. T's estate is entitled to a deduction for the amounts of restitution paid to the donees. By limiting the deduction to the amount of the claims actually paid, the parties are placed in the same position they would have been in had the Service timely assessed the taxes against T in the amount that the parties ultimately compromised on as the correct amount. Allowing the donees to be reimbursed by the estate for the additional gift taxes they paid places the parties in the positions they would have been in had the IRS not been dilatory in its duties.

This is the conclusion mandated when Regs. Sec. 25.2502-2 (which states that, if a donor dies before the tax is paid, the amount of the tax is a debt due the U.S. from the decedent's estate) and his executor or administrator is responsible for paying it out of the estate, is read in pari materia with Sec. 2502(c), stating that the donor shall pay the tax. Further, while Sec. 6901 allows the Service an additional year to collect gift taxes from donees after the statute of limitations has expired against the donors, nowhere does the statute regulate what may be deducted from a decedent's estate. Thus, this court concludes that, if the additional tax would have been borne by T or her estate had the IRS made a timely assessment, the same should be allowable as the donees' claim against the estate.

In addition, if an estate was not allowed to be reduced through a deduction of additional gift taxes, the Service would have the ability (by deciding whether to assert a gift tax deficiency) to determine the distribution of wealth among a family--an area traditionally left to wills and probate courts.

As previously discussed, an obligation to pay gift tax is imposed on a donor. Regs. Sec. 25.2502-2 states that the donor is primarily liable for the gift tax. A donee is liable only if the donor does not pay the gift tax when due (and then, only to the extent of the value of the gift received). Regs. Sec. 25.2502-2 states in relevant part: "Section 2502(d) [now(c)] provides that the donor shall pay the tax. If the donor dies before the tax is paid the amount of the tax is a debt due the United States from the decedent's estate and his executor or administrator is responsible for its payment out of the estate."

Thus, the primary gift tax liability under both state and Federal law rests with the donor or his estate. The gift tax is not imposed when a donee receives property; rather, it is imposed when a donor makes a transfer.

Because gift tax is primarily chargeable to a donor or his estate, the most appropriate interpretation of the statute is that the donees are responsible for payment of the tax only if it is not paid by the party primarily liable--the donor.

ESTATE OF E.P. O'NEAL, DC ALA, 11/12/99