No Cap on Donee Liability for Interest on Unpaid Gift Tax
In Marshall,1 the Fifth Circuit considered transferee liability in a gift tax case arising as a result of a taxpayer who sold stock to a corporation for less than fair market value. The Fifth Circuit held that the donees were personally liable for the gift tax and for the interest imposed on the gift tax without any ceiling on the interest owed.
In 1995, J. Howard Marshall, II sold his stock in a corporation back to the corporation for less than its fair market value. The corporation had five other shareholders besides Marshall:
1. A grantor who retained income trust (GRIT) for the benefit of Marshall's former wife.
2. Marshall's son.
3. Marshall's son's wife.
4. A trust for the benefit of one of Marshall's grandsons.
5. A trust for the benefit of Marshall's other grandson.
The IRS determined that Marshall's sale was an indirect gift to the other five shareholders of the corporation. In 2002, after Marshall's death, his estate and the IRS entered into a stipulation that determined the value and recipients of the indirect gifts. The estate did not pay the gift tax, and under Section 6324(b), in 2008 the IRS assessed gift tax liability for Marshall's unpaid gift taxes against the donees. In 2007, Marshall's former wife died. In 2010, the government brought suit against the donees under Section 7402 in a federal district court in Texas. The district court made a series of rulings, and the donees appealed those rulings to the Fifth Circuit.
The Fifth Circuit began its opinion with an examination of Section 6324(b), which states:
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.
The IRS argued that Sections 6324(b), 6601, and 6901 impose interest on the donees' liability from the date that the donor's gift tax becomes due. The IRS contended there were two separate obligations:
1. The obligation of the donor.
2. The obligation of the donees.
The IRS reasoned that Section 6324(b) only limited the obligation of the donor, and so the donees' liability for the unpaid gift tax was not capped under Section 6324(b). The IRS contended that to understand the donees' liability for the unpaid gift tax, the court must look beyond Section 6324(b) and read it in conjunction with Sections 6601 and 6901. The IRS further stated that 6901 provides that the amount of a donee's personal liability under 6324(b) is subject to the same provisions as the underlying gift tax, and that one provision to which the underlying gift tax is subject is Section 6601. Section 6601 provides for the payment of interest on underpayments of tax.
The IRS asserted that Section 6901 demonstrates that Congress intended for the government to be able to collect interest on the donee's unpaid, personal liability under Section 6324(b). The IRS argued this congressional intent should guide the decision of the court regardless of whether the IRS collects the tax under Section 7402 or Section 6901.
The donees argued that the plain language of Section 6324(b) capped all donee liability at the value of the gift received, and so the donees could not incur unlimited interest on any separate donee liability. In [pg. 41] addition, the donees argued that because the government did not assess transferee liability under Section 6901 but instead sought a personal judgment against the donees under Section 7402, Section 6901 is irrelevant in this case.
The court rejected each of the donees arguments and held that interest accrued on the donees' liability for the unpaid gift taxes and that such interest was not limited to the extent of the value of the gift received. The court found that the plain language of Section 6324(b) did not resolve the issue because the court held that the liability limitation applies only to the donor's unpaid gift tax. The court also held that Section 6324(b) provides no limit on the donee's liability nor the IRS' ability to assess interest when the donee fails to fulfill his or her obligation to pay the donor's unpaid gift tax. The court, therefore, found that it was proper to examine Sections 6601 and 6901 in deciding this issue. The court held that, "nothing in Section 6901 - which says that transferee liability is subject to the same provisions and limitations as in the case of the taxes with respect to which the liabilities were incurred - imposes that liability only when the government collects under Section 6901."
One provision that the underlying gift tax is subject to is Section 6601, which imposes interest when a tax is unpaid. The court held that, therefore, read together, Sections 6601 and 6901 explain that the donees' personal, independent liability for the unpaid gift tax is subject to the interest provisions of Section 6601. The court also stated that "it is possible to hold that under Section 6324(b) the donees have a personal liability, which accrues interest that is not limited by Section 6324(b), even without relying on Section 6901."
There was a dissenting opinion in this case. The dissenting opinion noted that the government was seeking to hold the donees liable for almost $75 million more than the value of the gifts, most of which was interest. The dissenting judge argued that the plain language of Section 6324(b) limited the gift tax and interest liability to no more than the value of the gift. The dissent also noted that its interpretation was consistent with the Third Circuit and Eighth Circuit.
Next, the court examined the arguments of the estate of Marshall's former wife. First, her estate argued that the GRIT did not receive a present interest in the property because the GRIT could not access the increased value of the shares it received. The IRS responded that it is well-settled law that a transfer of property to a corporation for less than adequate consideration is to be treated as a gift to the shareholders to the extent of their proportionate interests in the corporation. The court agreed with the IRS' finding that Marshall's indirect gift was a transfer of a present interest because the court found that a transfer of property to a corporation for less than full consideration generally is considered a gift to the individual shareholders.
The estate of Marshall's former wife also argued that she was not a donee of the gift because she did not personally own any stock in the corporation at the time of the gift. The estate argued that the GRIT or the remainder beneficiaries of the GRIT were the donees of the gift and, therefore, should be liable for any gift tax. The IRS argued that it was well established that for gift tax purposes, trust beneficiaries holding a beneficial interest in trust property are treated as donees of gratuitous transfers of property to the trust. The court, relying on Helvering v. Hutchings,2 held that Marshall's former wife was a donee. In Helvering, the Supreme Court held that gifts to a trust were gifts to the trust beneficiaries and that the trust beneficiaries were eligible for a gift tax exclusion under Section 2503(b).
This case illustrates one of the consequences of delaying payment of a tax liability while the taxpayer challenges the basis of that liability. As a result of the court's decision, the donees' gift tax liability, including interest, exceeded by almost $75 million the value of the gift received, and most of the excess consisted of interest. It can only be hoped that the rate of return on investments that the donees were able to earn exceeded the interest rate on tax underpayments.
1 114 AFTR 2d 2014-6578 771 F3d 854 (CA-5, 2014).
2 25 AFTR 1188 312 US 393 85 L Ed 909 41-1 USTC ¶10026 1941-1 CB 438 (1941).
Frank Baldino is an estate planning attorney who co-chairs Lerch, Early & Brewer’s Estate Planning & Probate group in Bethesda, Maryland. His focus is on protecting the assets of high net worth individuals to minimize federal and state tax liability. For more on gift taxes, contact Frank at (301) 657-0175 or firstname.lastname@example.org.
This article originally appeared in the April 2015 edition of Estate Planning, a monthly periodical directed to estate planning professionals that offers readers the newest and most innovative strategies for saving taxes, building wealth, and managing assets.