A deathbed purchase of GRAT remainders did not supply adequate consideration

Plain-English summary

A donor purchased the remainder interests in two grantor retained annuity trusts using unsecured promissory notes and died the next day while the annuity terms were still running. The trust property was already includible in the donor's gross estate under section 2036 because the donor retained the annuity interests. Counsel concluded that receiving the remainders therefore did not replenish the donor's taxable estate and was not adequate and full consideration for gift tax purposes. The transfer of the notes was a completed gift to the remainder beneficiaries. Counsel also concluded that the estate could not deduct the outstanding notes as claims because they were not supported by adequate and full consideration and were effectively a cloak for a gift.

Ruling snapshot

• Question: Did the deathbed purchase of GRAT remainders provide adequate consideration for gift tax purposes and support an estate tax deduction for the notes?
• Outcome: Advice given: no on both issues.
• Key authorities: IRC §§ 2036(a)(1), 2053(c)(1)(A), 2512(b); Treas. Reg. §§ 20.2053-1, 20.2053-4, 25.2512-8; Merrill v. Fahs

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           Memorandum
           Number: 201745012
           Release Date: 11/9/2017
           CC:PSI:B04:JDMacEachen                          Third Party Communication: None
           POSTF-114042-17                                 Date of Communication: Not Applicable

 UILC:     2512.13-01, 2053.09-09

  date:    August 04, 2017

     to:   Associate Area Counsel (Manhattan, Group 1)
           (Small Business/Self-Employed)
           Attn: Jane J. Kim

  from:    Senior Technician Reviewer, Branch 4
           Office of the Associate Chief Counsel
           (Passthroughs & Special Industries)


subject:   Deathbed Purchase of Remainder Interest in a Grantor Retained Annuity Trust

           This Chief Counsel Advice responds to your request for assistance dated May 5, 2017.
           This advice may not be used or cited as precedent.

           LEGEND

           Donor      = ---------------------
           Spouse     = ----------------------
           Trust 1    = ---------------------------------------------------
           Trust 2    = -------------------------------------------------------------------------------------------------
                        ------------------------------------------
                        -------------------------------
           Trust 3    = -------------------------------------------------------------------------------------------------
                        -----------------------------------------------------------
                        -------------------------------------------
           Date 1     = ---------------------------
           Date 2     = --------------------
           Date 3     = --------------------
           Date 4     = --------------------
POSTF-114042-17                            2

ISSUES

      (1) Whether the remainder interest in transferred property in which the donor has
          retained an annuity replenishes the donor’s taxable estate so as to constitute
          adequate and full consideration in money or money’s worth for gift tax
          purposes where the purchase of the remainder occurs on the donor’s
          deathbed during the term of the annuity.
      (2) Whether a note given in exchange for property that does not constitute
          adequate and full consideration in money or money’s worth for gift tax
          purposes is deductible as a claim against the estate.

CONCLUSIONS

      (1) Where the purchase of the remainder occurs on the donor’s deathbed during
          the term of the annuity, the remainder does not replenish the donor’s taxable
          estate. Accordingly, the remainder does not constitute adequate and full
          consideration in money or money’s worth for gift tax purposes. Merrill v.
          Fahs, 324 U.S. 308 (1945).

      (2) A note given in exchange for property that does not constitute adequate and
          full consideration in money or money’s worth for gift tax purposes is not
          deductible as a claim against the estate.

FACTS

On Date 1, Donor formed Trust 1, an irrevocable discretionary trust for the benefit of
Donor’s first spouse and issue. Trust 1 terminates on the later of the death of Donor or
his first spouse, at which time the principal and any accumulated income are distributed
outright to Donor’s issue per stirpes. Donor’s first spouse predeceased him; Donor then
married Spouse.

On Date 2, Donor formed Trust 2, an irrevocable trust for the benefit of Donor and his
issue. Under the terms of Trust 2, an annuity is payable to Donor for the term of the
trust, and the remainder is payable under the terms of Trust 1.

On Date 3, Donor formed Trust 3, an irrevocable trust for the benefit of Donor and his
issue. Under the terms of Trust 3, an annuity is payable to Donor for the term of the
trust, and the remainder is payable under the terms of Trust 1.

On Date 4, a date before the expiration of the respective terms of Trusts 2 and 3, Donor
purchased the remainder interests in Trusts 2 and 3 from the trustees of Trust 1. Donor
paid the purchase price with two unsecured promissory notes. Donor died the following
day.

Donor’s executor filed Form 709, United States Gift (and Generation-Skipping Transfer)
Tax Return, and reported the purchases of the remainder interests as non-gift transfers,
POSTF-114042-17                               3

asserting that Donor received adequate and full consideration in money or money’s
worth in the form of the remainder interests in Trusts 2 and 3. Spouse elected to split
gifts with Donor.

Donor’s death occurred prior to the expiration of the respective terms of the annuities
payable from the assets transferred to Trusts 2 and 3. Donor’s executor filed Form 706,
United States Estate (and Generation-Skipping Transfer) Tax Return, and included the
corpus of Trusts 2 and 3 in the gross estate. I.R.C. § 2036(a)(1); Treas. Reg.
§ 20.2036-1(c)(2). Donor’s executor deducted the value of the outstanding promissory
notes payable to the trustees of Trust 1 as claims against the estate.

LAW AND ANALYSIS

Adequate and Full Consideration for Purposes of § 2512(b)

I.R.C. § 2501 imposes a tax on the transfer of property by gift by an individual. Section
2511(a) provides that the tax shall apply whether the transfer is in trust or otherwise,
whether the gift is direct or indirect, and whether the property is real or personal,
tangible or intangible.

Section 2512(a) provides that, if the gift is made in property, the value of the property at
the date of the gift is considered the amount of the gift.

Treas. Reg. § 25.2511-1(c)(1) provides, in part, that the gift tax also applies to gifts
indirectly made. Thus, any transaction in which an interest in property is gratuitously
passed or conferred upon another, regardless of the means or device employed,
constitutes a gift subject to tax. See Treas. Reg. § 25.2512-8 (relating to transfers for
insufficient consideration).

Treas. Reg. § 25.2511-1(g)(1) provides, in part, that donative intent on the part of the
transferor is not an essential element in the application of the gift tax to the transfer.
The application of the tax is based on the objective facts of the transfer and the
circumstances under which it is made, rather than on the subjective motives of the
donor.

Section 25.2511-2(a) provides that 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.

Treas. Reg. § 25.2511-2(b) provides, in part, that as to any property, or part thereof or
interest therein, of which the donor has so parted with dominion and control as to leave
POSTF-114042-17                              4

in him no power to change its disposition, whether for his own benefit or for the benefit
of another, the gift is complete.

Section 2512(b) provides that the amount of the gift is the value of the property
transferred for less than an adequate and full consideration in money or money’s worth
on the date of the gift.

Treas. Reg. § 25.2512-8 provides, in part, that transfers reached by the gift tax are not
confined to those only which, being without a valuable consideration, accord with the
common law concept of gifts, but embrace as well sales, exchanges, and other
dispositions of property for a consideration to the extent that the value of the property
transferred by the donor exceeds the value in money or money’s worth of the
consideration given therefor. However, a sale, exchange, or other transfer of property
made in the ordinary course of business (a transaction which is bona fide, at arm’s
length, and free from any donative intent), will be considered as made for an adequate
and full consideration in money or money’s worth. A consideration not reducible to a
value in money or money’s worth, as love and affection, promise of marriage, etc., is to
be wholly disregarded, and the entire value of the property transferred constitutes the
amount of the gift. Similarly, a relinquishment or promised relinquishment of dower or
curtesy, or of a statutory estate created in lieu of dower or curtesy, or of other marital
rights in the spouse’s property or estate, shall not be considered to any extent a
consideration “in money or money’s worth.”

In Commissioner v. Wemyss, 324 U.S. 303 (1945), the Supreme Court considered the
meaning of the term “adequate and full consideration in money or money’s worth” for
gift tax purposes. There, the donor transferred assets to his fiancé to compensate her
for the loss of an income interest that would terminate upon her marriage to him. There
was no dispute that both a promise of marriage and detriment to a contracting party
constituted valuable consideration for purposes of the law of contracts. The Tax Court
had held that if the promise of marriage was the consideration, it was not one reducible
to a money value and if the fiancé’s loss of the income interest was the consideration, it
did not constitute consideration in the hands of the donor.

       If we are to isolate as an independently reviewable question of law the
       view of the Tax Court that money consideration must benefit the donor to
       relieve a transfer by him from being a gift, we think the Tax Court was
       correct. . . . The section taxing as gifts transfers that are not made for
       ‘adequate and full (money) consideration’ aims to reach those transfers
       which are withdrawn from the donor’s estate. To allow detriment to the
       donee to satisfy the requirement of ‘adequate and full consideration’ would
       violate the purpose of the statute and open wide the door for evasion of
       the gift tax.
POSTF-114042-17                                     5

Wemyss, 324 U.S. at 307-08. In other words, valuable contractual consideration in the
hands of the donor is not sufficient; adequate and full consideration is that which
replenishes, or augments, the donor’s taxable estate.

Wemyss had a companion case, Merrill v. Fahs, 324 U.S. 308 (1945), which was also a
gift tax case. Merrill and its predecessors likewise involved situations where A
transferred property to B, A’s fiancé or spouse, in exchange for B’s relinquishment of
marital rights in A’s remaining property. Both Wemyss and Merrill have come to stand
for the general proposition that “adequate and full consideration in money or money’s
worth” for gift tax purposes is that which replenishes, or augments, the donor’s taxable
estate. See Steinberg v. Commissioner, 141 T.C. 258, 266 (2013) (noting that under
the estate depletion theory, a donor receives consideration in money or money’s worth
only to the extent that the donor’s estate has been replenished), citing Wemyss, at
307-08, and Randolph E. Paul, Federal Estate and Gift Taxation, para. 16.14, at
1114-15 (1942).1 See also I.R.C. § 2043(b)(1) (“Transfers for Insufficient
Consideration”). Thus, B’s relinquishment of marital rights in A’s property will have no
effect on the includible value of that property in A’s gross estate. Accordingly, the
relinquishment of marital rights cannot replenish a donor’s gross estate for estate tax
purposes, and thus cannot constitute adequate and full consideration for gift tax
purposes. See also Commissioner v. Bristol, 121 F.2d 129, 136 (1st Cir. 1941).

It is important to keep in mind that in each of the above cases, the relinquishment of the
marital rights in the donor’s remaining assets did constitute valuable contractual
consideration in the hands of the donor, and did benefit the donor. It enabled the donor
to dispose of that property free of the spousal claims of the second marriage. See
Merrill v. Fahs, 324 U.S. at 309. For instance, Bristol involved the waiver of spousal
claims against a family business that the donor wished to bequeath to the children of his
first marriage. Bristol, 121 F.2d at 131. Indeed, in each of these cases, it was the
prospective husband’s desire to dispose of his property as he chose that was the basis
of the ante-nuptial agreement. This freedom did not constitute adequate and full
consideration, however, because it did not augment the husband’s taxable estate.

Here, it cannot be disputed that Donor’s liability on the promissory notes depleted
Donor’s taxable estate. However, in the context of a deathbed purchase of a remainder
interest in transferred property in which a donor has retained a § 2036 “string,” the
receipt of the remainder does not increase the value of the donor’s taxable estate,
because the value of the entire property, including that of the remainder, will be
includible in the donor’s gross estate pursuant to § 2036(a)(1). Thus, Donor’s receipt of
the remainder interests cannot constitute adequate and full consideration within the
meaning of § 2512(b). Commissioner v. Wemyss, 324 U.S., at 307-08. Cf. Rev. Rul.
98-8, 1998-1 C.B. 541 (reaching a similar conclusion for gift tax purposes in the context
1
  The Steinberg court relied upon Wemyss for the general proposition that consideration is that which
replenishes the donor’s estate for transfer tax purposes, and found as a factual matter that the donees’
assumption of the donor’s potential liability constituted adequate and full consideration in money or
money’s worth. Steinberg v. Commissioner, 145 T.C. 184,196 (2015) (supp. op.).
POSTF-114042-17                              6

of §§ 2519 and 2044.) Accordingly, Donor has made a completed gift to the
beneficiaries of Trust 1 in the amount of the value of the promissory notes transferred to
Trust 1.

Adequate and Full Consideration for Purposes of § 2053(c)(1)(A)

Section 2053(a) provides, in part, that the value of the taxable estate shall be
determined by deducting from the value of the gross estate such amounts
for funeral expenses, administration expenses, claims against the estate, and unpaid
mortgages on, or any indebtedness in respect of, property where the value of the
decedent’s interest therein, undiminished by such mortgage or indebtedness, is
included in the value of the gross estate, as are allowable by the laws of the jurisdiction,
whether within or without the United States, under which the estate is being
administered.

Section 2053(c)(1)(A) provides, in part, that the deduction allowed in the case of claims
against the estate, unpaid mortgages, or any indebtedness shall, when founded on a
promise or agreement, be limited to the extent that they were contracted bona fide and
for an adequate and full consideration in money or money’s worth.

Treas. Reg. § 20.2053-1(b)(2)(i) provides, in part, that amounts allowed as deductions
under § 2053 must be expenses and claims that are bona fide in nature. No deduction
is permissible to the extent it is founded on a transfer that is essentially donative in
character (a mere cloak for a gift or bequest).

Treas. Reg. § 20.2053-1(b)(2)(ii) provides, in part, that factors indicative (but not
necessarily determinative) of the bona fide nature of a claim or expense involving a
family member of a decedent, or a beneficiary of a decedent’s estate or revocable trust,
may include, but are not limited to: (A) the transaction underlying the claim or expense
occurs in the ordinary course of business, is negotiated at arm’s length, and is free from
donative intent; (B) the claim or expense is not related to an expectation or claim of
inheritance; (C) the claim or expense originates pursuant to an agreement between the
decedent and the family member or beneficiary, and the agreement is substantiated
with contemporaneous evidence; (D) performance by the claimant is pursuant to the
terms of an agreement between the decedent and the family member or beneficiary and
the performance and the agreement can be substantiated; (E) all amounts paid in
satisfaction or settlement of a claim or expense are reported by each party for Federal
income and employment tax purposes, to the extent appropriate, in a manner that is
consistent with the reported nature of the claim or expense.

Treas. Reg. § 20.2053-1(b)(2)(iii) provides, in part, that for purposes of the foregoing,
family members include the spouse of the decedent; the grandparents, parents,
siblings, and lineal descendants of the decedent or of the decedent’s spouse; and the
spouse and lineal descendants of any such grandparent, parent, and sibling. Family
POSTF-114042-17                             7

members include adopted individuals. Beneficiaries of a decedent’s estate include
beneficiaries of a trust of the decedent.

Treas. Reg. § 20.2053-4(a)(1) provides, in part, that a claim against a decedent’s estate
must represent a personal obligation of the decedent existing at the time of the
decedent’s death.

Treas. Reg. § 20.2053-4(d)(5) provides in part, that the deduction for a claim founded
upon a promise or agreement is limited to the extent that the promise or agreement was
bona fide and in exchange for adequate and full consideration in money or money’s
worth; that is, the promise or agreement must have been bargained for at arm’s length
and the price must have been an adequate and full equivalent reducible to a money
value.

As discussed above in Merrill v. Fahs, supra, the Court considered the correlation of the
estate tax and the gift tax, finding that the estate and gift tax statutes should be
interpreted “harmoniously.” Id. at 313. The Court held that the phrase “adequate and
full consideration” should be deemed to have the same meaning in both statutes.
Consideration is that which replenishes the donor’s taxable estate for transfer tax
purposes. Commissioner v. Wemyss, 324 U.S., at 307-08.

In Estate of Goetchius v. Commissioner, 17 T.C. 495, 503 (1951), the Tax Court
considered the meaning of the phrase “adequate and full consideration” in the context of
the estate tax:

      This Court and other courts, and the Treasury in its estate and gift tax
      regulations, had taken the view that the phrase ‘a bona fide sale for an
      adequate and full consideration in money or money’s worth‘ means that
      there must be the kind of consideration which in an arm’s length business
      transaction provides the transferor of property with the full value thereof, in
      exchange; and that if the consideration is not paid in money, property, or
      services, but is represented by some benefit, then the benefit must be of
      the equivalent money value in order to constitute the required ‘adequate
      and full consideration.’ The Supreme Court approved that view in
      Commissioner v. Wemyss, supra. Accordingly, the exemption from tax is
      limited to those transfers of property where the transferor or donor has
      received benefit in full consideration in a genuine arm’s length transaction;
      and the exemption is not to be allowed in a case where there is only
      contractual consideration but not ‘adequate and full consideration in
      money or money’s worth.’ (Citations and footnotes omitted).

Cf. U.S. v. Stapf, 375 U.S. 118 (1963) (noting that a deduction should not be predicated
solely on the finding that a promise or claim is legally enforceable under the state laws
governing the validity of contracts and wills).
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Where the purchase of the remainder occurs on the donor’s deathbed while he is
holding a § 2036 “string” to the transferred property, the remainder does not increase
the value of the donor’s taxable estate. That is because the entire value of the
transferred property, including that of the remainder, will be includible in the donor’s
gross estate pursuant to § 2036(a)(1). Estate of Goetchius v. Commissioner, supra.
For the same reason, Donor’s deathbed receipt of the remainder interests cannot
constitute adequate and full consideration within the meaning of § 2053(c)(1)(A). On
these facts, the promissory notes are a mere cloak for a gift. Treas. Reg.
§ 20.2053-1(b)(2)(i); Estate of Tiffany v. Commissioner, 47 T.C. 491 (1967); Estate of
Davis v. Commissioner, 57 T.C. 833 (1972). Accordingly, no deduction is allowable for
Donor’s liability on the outstanding promissory notes.

Please call (202) 317-6859 if you have any further questions.