Section 2035 Transfers (Portfolio 818)

Tax Management Portfolio, Section 2035 Transfers, No. 818-3rd, explains in detail the federal estate tax treatment of gifts made within three years of death.

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Tax Management Portfolio, Section 2035 Transfers, No. 818-3rd, explains in detail the federal estate tax treatment of gifts made within three years of death. Under §2035(a), certain gifts made within three years of the donor's death are included in the donor's gross estate. This rule minimizes the incentive for a decedent to transfer property shortly before death and thereby reduce federal estate taxes. It also prevents transfers within three years of death from qualifying an estate for favorable tax treatment such as deferral of estate tax under §6166. The rule generally does not apply to transfers for adequate consideration or to gifts, other than with respect to life insurance policies that do not have to be reported on gift tax returns.
For decedents dying after 1981, §2035(a) restricts application of the three-year rule (for purposes of computing the amount of a decedent's federal estate tax liability) to property interests or powers that would have been includible in the gross estate under §§2036 (transfers with retained life estate), 2037 (transfers taking effect at death), 2038 (revocable transfers), and 2042 (proceeds of life insurance), if the interests or powers had been retained by the decedent. Section 2035(e), effective for estates of decedents dying after August 5, 1997, makes an exception for transfers out of a revocable grantor trust. Such transfers are not includible under §2035, even if made within three years of death.
Despite these limitations on the application of §2035, the rule still applies for purposes of §§303 (redemptions to pay death tax), 2032A (special use valuation), subchapter C of chapter 64 (liens for taxes), and 6166 (under which an estate can only defer estate tax if it satisfies the 35% test both with and without application of the three-year rule). This prevents decedents from intentionally making gratuitous transfers within three years of death in order to gain favorable tax treatment under one of these special relief provisions.
For decedents dying after 1976 and before 1982, the three-year inclusionary rule was much broader in scope because it applied without the §2035(a) restriction. For decedents who died before 1977, a facts and circumstances “contemplation of death” test (the predecessor to the three-year rule) applied to determine whether gifts were includible under §2035.
This Portfolio may be cited as Brody and English, 818-3rd T.M., Section 2035 Transfers.
This Bloomberg BNA Portfolio is not intended to provide legal, accounting, or tax advice for any purpose and does not apply to any particular person or factual situation. Neither the author nor the publisher assumes responsibility for the reader's reliance on information or opinions expressed in it, and the reader is encouraged to verify all items by reviewing the original sources.

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Lawrence Brody, B.S., University of Pennsylvania (Wharton) (1964); J.D., Washington University School of Law (1967); LL.M. in Taxation, New York University School of Law (1968); Partner, Bryan Cave LLP, an international law firm, resident in the St. Louis office, and member of its Private Client Service Group and its Technology, Entrepreneurial & Commercial Practice Client Service Group; adjunct professor, Washington University School of Law, teaching Estate Planning and Drafting; visiting adjunct professor, the University of Miami Law School, teaching a course on Life Insurance; author or co-author, numerous articles and books on the use of life insurance in estate and employee benefit planning, including two BNA Tax Management Portfolios, two books for the National Underwriter Company, and a number of volumes in the ABA Insurance Counselor Series; fellow, American College of Trust and Estate Counsel (ACTEC) and American College of Tax Counsel; frequent participant, ALI-ABA programs and Society of Financial Professionals programs and teleconferences; speaker, all major life insurance industry programs (including the MDRT, the Top of the Table, AALU and the International Forum), many local estate planning council meetings, a number of state bar association conferences, and many national estate planning programs; member, Advisory Committee for the Philip E. Heckerling Institute on Estate Planning of the University of Miami School of Law; member, Editorial Boards of BNA Tax Management's Estates, Gifts, and Trusts Journal, and the Society of Financial Service Professionals Journal of Financial Services Professionals; designated, Accredited Estate Planner by the National Association of Estate Planners and Councils, and one of 10 individuals awarded its Distinguished Accredited Estate Planner designation in the initial class, in 2004; co-creator and co-editor, AALU WRNewswire.

Richard L. English, A.B., Washington University (1982); J.D., University of Kansas (1985); Partner and Tax, Trusts and Estates Division Co-Chair, Stinson Leonard Street LLP; fellow, American College of Trusts and Estates Counsel; member, Missouri Bar; past President and director, Estate Planning Society of Kansas City; Kansas City Metropolitan Bar Association; frequent lecturer at State and local CLE programs; contributing author, Techniques for Estate Planning with Life Insurance (Research Institute of America).


Detailed Analysis

I. Introduction

A. Background

B. Statutory History

C. Regulations

II. Section 2035(a)

Introductory Material

A. Property That Would Have Been Included Under § 2036, § 2037, or § 2038

1. Overview of § § 2036, 2037, and 2038

a. Section 2036

b. Section 2037

c. Section 2038

2. Has an Interest in Property Been Transferred or a Power Relinquished?

a. Termination of a Trust

b. Distributions from a Trust

c. Power of Direction Over Land Trust

d. Disclaimer of an Interest in Trust

e. Creation of Joint Tenancy

f. Pledging Assets for a Loan

g. Payment on a Loan

h. Appointment of Trustees

i. Reciprocal Transactions

j. Stock Options

k. UGMA/UTMA Accounts

B. Property That Would Have Been Included Under § 2042 - Transfers Involving Life Insurance

1. Overview of § 2042

2. Payment of Premiums as a Transfer - Pre-ERTA

3. Payment of Premiums as a Transfer - Post-ERTA

4. Transfers or Relinquishments of Incidents of Ownership

a. Incidents of Ownership - In General

b. Powers Held as a Fiduciary

c. Policy Application

d. Life Insurance Policies Owned by Corporations

(1) Controlled Corporations

(2) Non-Controlled Corporations

e. Group Term Life Insurance

III. Section 2035(b), Requiring Inclusion of Gift Tax on Gifts Made During the Three Years Before Decedent's Death

A. Background

B. Analysis

1. State vs. Federal Gift Taxes

2. "Net" Gifts

3. Application to Split Gifts

IV. Section 2035(c), Other Rules Relating to Transfers Within Three Years of Death

A. Introduction

B. Analysis

1. Section 2035(c)(1)

2. Section 2035(c)(1)(A)

3. Section 2035(c)(1)(B)

4. Section 2035(c)(1)(C)

5. Section 2035(c)(2)

6. Section 2035(c)(3)

V. The § 2035(d) Exception for Bona Fide Sales

A. Background of the Exception

B. Analysis

1. Qualifying for the Exception

2. When Is the Adequacy of the Consideration Measured?

3. Application of the Exception to Life Insurance Policies

a. Generally

b. Valuation Rules for Life Insurance Policies

4. Transfers of Partial Interests

C. Relationship to § 2043

VI. Section 2035(e) - Treatment of Certain Transfers from Revocable Trusts


Working Papers

Table of Worksheets

Worksheet 1 Section 2035 - Adjustments for Certain Gifts Made Within 3 Years of Decedent's Death (Current Version)

Worksheet 2 Section 2035 - Previous Versions

Worksheet 3 Regs. § 20.2035-1 Transactions in Contemplation of Death (Revoked)

Worksheet 4 Excerpt from General Explanation of the Economic Recovery Tax Act of 1981 Prepared by the Staff of the Joint Committee on Taxation (H.R. 4242, 97th Cong., P.L. 97-34) 261 (Dec. 31, 1981)

Worksheet 5 Excerpt from H.R. Rep. 220, 105th Cong., 1st. Sess. (1997) (Conference Report for Taxpayer Relief Act of 1997)

Worksheet 6 Examination Technique Handbook for Estate Tax Examiners I.R.M. 4350, § § (9)00, (12)00 et seq.

Worksheet 7 Examples of Inclusionary Transfers Under Sections Enumerated in § 2035(a)





Legislative History:

Treasury Rulings: