Section 2035 Transfers (Portfolio 818)

Description

Tax Management Portfolio, Section 2035 Transfers, No. 818, 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 T.M., Section 2035 Transfers.

Table of Contents

I. Introduction
II. Section 2035(a)
III. Section 2035(b), Requiring Inclusion of Gift Tax on Gifts Made During the Three Years Before Decedent’s Death
IV. Section 2035(c), Other Rules Relating to Transfers Within Three Years of Death
V. The § 2035(d) Exception for Bona Fide Sales
VI. Section 2035(e) – Treatment of Certain Transfers from Revocable Trusts