Estate of Sachs v. Commissioner

(c) Inclusion of Gift Tax on Certain Gifts Made During 3 Years Before Decedent's*50 Death. -- The amount of the gross estate (determined without regard to this subsection) shall be increased by the amount of any tax paid under chapter 12 by the decedent or his estate on any gift made by the decedent or his spouse after December 31, 1976, and during the 3-year period ending on the date of the decedent's death.

Petitioners contend that section 2035(c) does not "gross-up" decedent's estate to include gift tax paid by the donee on a net gift made within 3 years of decedent's death. Petitioners maintain that gift tax paid by the donee trusts is not tax paid by "the decedent*51 or his estate" and argue that the "concise and unambiguous" language of the statute thus dictates our decision.

Respondent contends that section 2035(c) reaches gift tax paid by the donee of any gift included in decedent's gross estate pursuant to section 2035(a). Respondent argues that the legislative history of section 2035(c) supports this construction of the statute.

The Supreme Court has stated:

*773 There is, of course, no more persuasive evidence of the purpose of a statute than the words by which the legislature undertook to give expression to its wishes. Often these words are sufficient in and of themselves to determine the purpose of the legislation. In such cases we have followed their plain meaning. When that meaning has led to absurd or futile results, however, this Court has looked beyond the words to the purpose of the act. Frequently, however, even when the plain meaning did not produce absurd results but merely an unreasonable one "plainly at variance with the policy of the legislation as a whole" this Court has followed that purpose, rather than the literal words. * * * [United States v. American Trucking Associations, 310 U.S. 534, 543 (1940),*52 quoting Ozawa v. United States, 260 U.S. 178, 194 (1922). Fn. refs. omitted.]

The Supreme Court has recently reaffirmed this "familiar rule, that a thing may be within the letter of the statute and yet not within the statute, because not within its spirit, nor within the intention of its makers." California Federal Savings & Loan Association, et al. v. Mark Guerra, Director, Department of Fair Employment and Housing, et al., 479 U.S.    (1987), quoting Steelworkers v. Weber, 443 U.S. 193, 201 (1979), and Church of the Holy Trinity v. United States, 143 U.S. 457, 459 (1892).

Thus, although we are not "free * * * to twist [the Code] beyond the contours of its plain and unambiguous language in order to comport with good policy" ( Badaracco v. Commissioner, 464 U.S. 386, 398 (1984)), we may go beyond the literal language of the Code if reliance on that language would defeat the plain purpose of Congress. Bob Jones University v. United States, 461 U.S. 574, 586 (1983); see Church of the Holy Trinity v. United States, 143 U.S. 457, 459 (1892);*53 Abdalla v. Commissioner, 647 F.2d 487, 496 (5th Cir. 1981), and cases cited therein. Because "words do not have an immutable meaning," we have interpreted the Code in a manner contrary to its literal wording where necessary to implement clearly expressed congressional intent. Carson v. Commissioner, 71 T.C. 252, 262 (1978), affd. 641 F.2d 864 (10th Cir. 1979); Focht v. Commissioner, 68 T.C. 223 (1977); Carasso v. Commissioner, 34 T.C. 1139, 1142 (1960), affd. 292 F.2d 367 (2d Cir. 1961). In the absence of "unequivocal evidence of legislative purpose," we have applied the law as written. Huntsberry v. Commissioner, 83 T.C. 742, 747-748 (1984).

*774 Application of the literal language of section 2035(c) would dictate a result inconsistent with the architecture of the transfer tax system. This case thus presents circumstances "plainly at variance with the policy of the legislation as a whole" that warrant our search for unequivocal evidence of the purpose of section 2035(c).

*54 In 1916, when the Federal estate tax was first enacted, there was no Federal gift tax. As a result, property given away during a decedent's life would escape the estate tax if not somehow brought back into the gross estate for tax purposes. Congress attempted to prevent depletion of the estate tax base by including certain types of lifetime gifts in the gross estate. See 5 B. Bittker, Federal Taxation of Income, Estates, and Gifts 126-133 (1984). The 1916 estate tax thus reached all transfers of property "intended to take effect in possession or enjoyment" at or after the decedent's death: this clause was the predecessor of sections 2036-2038. Sec. 202(b), Revenue Act of 1916, ch. 463, 39 Stat. 777, 778; see B. Bittker, supra. The tax was also imposed on all transfers made "in contemplation of * * * death"; this clause was the predecessor of section 2035. Revenue Act of 1916, supra; B. Bittker, supra at 126-134.

In 1932, the predecessor of the current Federal gift tax was first enacted. Sec. 501, Revenue Act of 1932, ch. 209, 47 Stat. 245. An important purpose of the gift tax was to prevent or compensate for avoidance of the estate tax. Sanford's Estate v. Commissioner, 308 U.S. 39, 44 (1939);*55 S. Rept. 665, 72d Cong., 1st Sess. (1932), 1939-1 C.B. (Part 2) 496, 525. In its report, the Senate Finance Committee stated that "the design is to impose a tax which measurably approaches the estate tax which would have been payable on the donor's death had the gifts not been made." S. Rept. 665, supra. The gift tax was thus said to supplement the estate tax. Merrill v. Fahs, 324 U.S. 308, 311 (1945); Smith v. Shaughnessy, 318 U.S. 176, 179 (1943); Sanford's Estate v. Commissioner, supra.The draftsmen of the 1932 legislation realized that the new gift tax would reach lifetime transfers included in the decedent's gross estate under the predecessors of sections 2035-2038 and authorized an estate tax credit for the gift tax paid on such *775 transfers. Sec. 402, Revenue Act of 1932, ch. 209, 47 Stat. 245; S. Rept. 665, supra, 1939-1 C.B. (Part 2) at 424; see B. Bittker, supra at 126-134.

The gift tax did not live up to congressional expectations. Lawmakers identified three factors that allowed taxpayers to reduce overall*56 transfer tax liability by making lifetime gifts. H. Rept. 94-1380 (1976), 1976-3 C.B. (Vol. 3) 735, 742, 745; Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1976, 1976-3 C.B. (Vol. 2) 1, 538. ³ First, gift tax rates were consistently lower than estate tax rates. Second, estate taxes and gift taxes considered together were noncumulative; the estate remaining at death was subject to tax at the lowest rates of a schedule entirely separate from the gift tax schedule. Taxpayers could thus reduce the progressivity of the estate tax by making lifetime gifts. Finally, funds used to pay gift tax were not included in either tax base. Although funds used to pay gift tax were not included in the gift tax base and reduced the value of the estate retained by the donor, the estate tax base included the full value of all property retained until death, even though a portion might be required to pay estate tax. "Thus, even if the applicable transfer tax rates were the same, the net amount transferred to a beneficiary from a given pre-tax amount of property was greater for a lifetime transfer solely because*57 of the difference in the tax bases." General Explanation, supra, 1976-3 C.B. (Vol. 2) at 538.

The 1976 Tax Reform Act, Pub. L. 94-445, 90 Stat. 1525 (the 1976 Act), did much to reduce the disparity of treatment between lifetime gifts and transfers at death. The act established a unified cumulative rate schedule and a unified credit to replace the separate rate schedules and exemptions of prior law. Under current law, gift tax payable in any given period is determined by applying the unified rate schedule to the donor's cumulative lifetime taxable gifts and then subtracting the taxes payable for previous taxable periods. *58 Sec. 2502. Estate tax payable is determined by applying the unified rate schedule to the aggregate sum *776 of lifetime and "deathtime" transfers and then subtracting the gift taxes payable on the lifetime transfers. Sec. 2001. Gift taxes are thus, in a sense, "downpayments" on the taxpayer's ultimate transfer tax liability, which is not determined until after the taxpayer's death.

The 1976 Act also sharpened the distinction between lifetime gifts and "deathbed" gifts, i.e., gifts made within 3 years of the taxpayer's demise. Lifetime transfers included in the tax base as gifts are described as "adjusted taxable gifts," in section 2001(b). Lifetime transfers included in the tax base as part of decedent's gross estate (i.e., transfers described in sections 2035 through 2038) are not "adjusted taxable gifts." Sec. 2001(b). Under prior law, gifts made within 3 years of death were presumed to be made "in contemplation of death" and were included in the gross estate unless the executor could prove otherwise. Sec. 2035(a), I.R.C. 1939. The 1976 Act eliminated this rebuttable presumption and amended section 2035(a) to provide that the gross estate shall include all gifts*59 made within 3 years of death. Tax Reform Act of 1976, supra, section 2001(a)(5).

Congress carefully distinguished "deathbed" gifts from other lifetime gifts because, although the 1976 Act reduced the disparity of treatment between gifts and transfers at death, the act retained several provisions favoring lifetime gifts. See H. Rept. 94-1380, supra, 1976-3 C.B. (Vol. 3) at 745-746; General Explanation, supra, 1976-3 C.B. (Vol. 2) 1, 538. The annual gift tax exclusion of $ 3,000 per donee was retained. Donors of lifetime gifts continued to avoid tax on appreciation that might accrue between the date of a gift and the date of the taxpayer's death. The 1976 Act also left undisturbed prior law under which funds used to pay gift tax are not included in the transfer tax base. Sec. 2512; see Rev. Rul. 75-72, 1975-1 C. B. 310 (1975); Rev. Rul. 81-223, 1981-2 C.B. 189 (1981).

The provisions that favor other lifetime gifts are not generally applicable to gifts made within 3 years of death. Although the annual gift tax exclusion of $ 3,000*60 per donee is available to the taxpayer in the year of gift, the benefit of the exclusion is in many cases eliminated by section 2035, which can bring the entire amount of the taxable *777 deathbed gift into the estate tax base. Section 2035(a) also eliminates the possibility of avoiding tax on appreciation that might accrue between the date of gift and the date of death; gifts are included in the gross estate at date of death value. Section 2035(c) includes in the tax base funds used by the donor or his estate to pay the gift tax.

Insistence on the literal language of section 2035(c) would distort the framework erected by the Tax Reform Act of 1976. The act retained some of the prior law's preferences for lifetime gifts; however, these preferences were not made available to deathbed gifts. Petitioners' construction of section 2035(c) extends the benefit of one such preference to deathbed net gifts. Mechanical application of section 2035(c) would completely remove from the transfer tax base all funds used to pay gift tax on such gifts. This interpretation of the statute is wholly inconsistent with Congress' goal of sharply distinguishing deathbed gifts from other gifts*61 and eliminating the disparity of treatment between deathbed gifts and transfers at death.

The legislative history of section 2035(c) confirms our analysis. The House Committee on Ways and Means stated:

Since the gift tax paid on a lifetime transfer which is included in a decedent's gross estate is taken into account both as a credit against the estate tax and also as a reduction in the estate tax base, substantial tax savings can be derived under present law by making so-called "deathbed gifts" even though the transfer is subject to both taxes. To eliminate this tax avoidance technique, the committee believes that the gift tax paid on transfers made within 3 years of death should in all cases be included in the decedent's gross estate. This "gross-up" rule will eliminate any incentive to make deathbed transfers to remove an amount equal to the gift taxes from the transfer tax base. [H. Rept. 94-1380, supra, 1976-3 C.B. (Vol. 3) at 746. Emphasis supplied.]

Our analysis is also consistent with the Supreme Court's holding in Diedrich v. Commissioner, 457 U.S. 191 (1982). In Diedrich, the Court held that a donor's*62 gross income includes the excess of gift tax paid by the donee over the donor's basis in the given property. The Court noted that the donor is liable for payment of gift tax and held that under O1d Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929), and Crane v. Commissioner, 331 U.S. 1 (1947), relief of the donor's liability to the Government must be treated as indirect income. Diedrich v. Commissioner, 457 U.S. at *778 195; see sec. 2502(d). In this case, as in Diedrich, O1d Colony, and Crane, the substance of decedent's transaction dictates our decision. Decedent was primarily liable for payment of the gift tax. As donor of a net gift, he may be deemed to have paid the tax by ordering the donee to pay it over to the Internal Revenue Service on his behalf in satisfaction of his gift tax liability. Decedent gave property worth $ 2,399,044 to the trusts. Because the trusts paid gift tax in the amount of $ 612,700, decedent and his wife reported the three net gifts at an aggregate value of $ 1,786,340 (sic). The funds used to pay the gift tax were thus excluded from *63 the transfer tax base pursuant to section 2512(a). When decedent died, the shares transferred to the trusts were included in his estate at date of death value reduced by the amount of gift tax paid by the donee trusts. But for section 2035(c), $ 612,700 transferred within 3 years of decedent's death would escape the transfer tax system altogether.

Section 2035(c) speaks of gift taxes "paid * * * by the decedent or his estate" rather than gift taxes "paid" without modification because payment of tax on gifts described in section 2035(a) does not always remove funds from the transfer tax base. The House Committee on Ways and Means explained as follows:

[The] amount of gift tax paid with respect to transfers made within 3 years of death are to be includable in a decedent's gross estate. This "gross-up" rule for gift taxes eliminates any incentive to make deathbed transfers to remove an amount equal to the gift taxes from the transfer tax base. The amount of gift tax subject to this rule would include tax paid by the decedent or his estate on any gift made by the decedent or his spouse after December 31, 1976. It would not, however, include any gift tax paid by the spouse on a *64 gift made by the decedent within 3 years of death which is treated as made one-half by the spouse, since the spouse's payment of such tax would not reduce the decedent's estate at the time of death. [H. Rept. 94-1380, supra, 1976-3 (Vol. 3) C.B. at 748.]

The draftsmen of section 2035(c) thus tailored the statute to accommodate gifts split under section 2513. Although the language selected for this purpose does not, in isolation, describe net deathbed gifts, our analysis of section 2035(c), its legislative history, and the framework erected by the 1976 Act persuades us that Congress did not intend to distinguish net deathbed gifts from other deathbed gifts.

Section 2053(a)(3) provides that the value of the taxable estate shall be determined by deducting claims against the estate allowable by the laws under which the estate is administered. Taxes that are unpaid on the date of death are deductible under section 2053(a)(3). Sec. 20.2053-6(a), Estate Tax Regs.

Decedent made a substantial net gift in 1978. Decedent died in 1980 and his estate tax return was filed in 1981. In 1982, the Supreme Court held that the donor of a net gift realizes taxable*65 income to the extent that gift tax paid by the donee exceeds the donor's adjusted basis in the property given. Diedrich v. Commissioner, 457 U.S. 191 (1982). Petitioners consequently agreed to recognize additional income attributable to decedent's net gift. The estate paid the additional income tax plus interest, and respondent, in his notice of estate tax deficiency, allowed an additional estate tax deduction under section 2053(a)(3).

Petitioners' entitlement to a deduction under section 2053(a) is contingent upon the retroactive effect of the 1984 Tax Reform Act. Section 1026 of the act provides that, for gifts made before March 4, 1981, the donor's income shall not include any amount attributable to the donee's payment of gift tax. Sec. 1026, Tax Reform Act of 1984, Pub. L. 98-369, 98 Stat. 1031. Pursuant to this law, petitioners claimed that they were entitled to a refund of the 1978 income tax paid under Diedrich. In a related case involving decedent's 1978 income tax liability, respondent agreed that decedent's 1978 gross income did not include any amount attributable to the net gift. In an amended answer, respondent asserted an increased*66 estate tax deficiency and claimed that the estate's section 2053(a)(3) deduction for the additional 1978 income tax and interest should be disallowed.

Petitioners note that the predecessor of section 2035 authorized deduction of claims "allowed" by the law under which the estate is administered and make much of the current Code's substitution of "allowable" for "allowed." See sec. 812(b)(3), I.R.C. 1939. Petitioners contend that "Events subsequent to death which change 'allowable' claims to claims which ultimately are not 'allowed' are irrelevant." We do not believe that the substitution of *780