Section 2035 Transfers 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.  Written by Lawrence Brody, Esq., Bryan Cave LLP, and Richard L. English, Esq., Stinson Morrison Hecker LLP, this Portfolio analyzes

• Property That Would Have Been Included Under §2036, §2037, or §2038 — Transferred Interests or Relinquished Powers
• Property That Would Have Been Included Under §2042 — Transfers Involving Life Insurance
• Section 2035(b), Requiring Inclusion of Gift Tax on Gifts Made During the Three Years Before Decedent's Death
• Section 2035(c), Other Rules Relating to Transfers Within Three Years of Death
• The §2035(d) Exception for Bona Fide Sales
• Section 2035(e) — Treatment of Certain Transfers from Revocable Trusts

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 three-year 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.

Section 2035 Transfers allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents including tables, charts and lists
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
• Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the Estates, Gifts and Trusts Portfolios Library, a comprehensive series containing more than 80 Portfolios, which covers critical transactions in estate, gifts and trusts planning. This highly-regarded resource library offers commentary on a wide range of estate planning topics including: Generation Skipping Tax, Family Limited Partnerships, Charitable Remainder Trusts, Estate Planning for Closely-Held Businesses, Exempt Organizations and Private Foundations, Life Insurance, Valuation, and more.

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)

Bibliography

OFFICIAL

Statutes:

Regulations:

Legislative History:

Treasury Rulings:

Cases:

UNOFFICIAL

Treatise:

Periodicals:

1977

1978

1979

1980

1982

1983

1984

1985

1986

1988

1989

1990

1995

1996

1999

2000

2003

2005