827 / When are gifts made within three years of death includable in a decedent’s gross estate under IRC Section 2035?

Gift tax paid by the decedent or the estate on any gifts made by the decedent or spouse within three years of the decedent’s death is includable in the gross estate in any case, regardless of whether the value of the gift itself is includable under IRC Section 2035 or any other IRC section.¹ Gift tax paid by the decedent’s spouse on a split-gift within three years of the decedent’s death was included in the decedent’s estate where the decedent had funneled money to his spouse who then transferred the money to a life insurance trust (and to the IRS to pay gift tax); the transfers were treated as collapsed into one transaction under the step-transaction doctrine.²

Under Section 2035, the value of the gross estate also includes the value of property to the extent a donor gratuitously transferred property within three years of death but retained an interest in that property described in IRC Section 2036 (transfer with a retained life estate), 2037 (transfer taking effect at death with reversionary interest retained), 2038 (transfer with power retained to revoke or amend), or 2042 (incidents of ownership in insurance on life of donor); or if a donor transferred property subject to such retained interests more than three years before death, but relinquishes that interest within three years of death. The three-year rule applies to these transfers whether or not a gift tax return was required to be filed.³ The entire value of the property transferred under this exception is includable in the decedent’s gross estate, including the value of the property, if any, transferred by the decedent’s consenting spouse (i.e., a split gift–see Q 904). If the consenting spouse dies within three years of the gift and the entire value of the gift was includable in the donor spouse’s estate under IRC Section 2035, the consenting spouse’s portion of the gift is not an adjusted taxable gift and is not includable in the consenting spouse’s gross estate.⁴ The gift tax paid by the donor spouse or the estate is includable in the donor spouse’s estate, and the gift tax paid by the consenting spouse or her estate is includable in the consenting spouse’s estate.⁵ However, gift tax paid by a decedent’s spouse on a gift split between the spouses within three years of the decedent’s death was included in the decedent’s estate where the spouse did not have sufficient assets to pay the spouse’s share of the gift tax and the decedent transferred assets to the spouse to pay the taxes.⁶

A transfer from a revocable trust is treated as made directly by the grantor and therefore included in the gross estate.⁷ Such a transfer will generally be subject to the Section 2035 inclusion rule also with respect to gift tax paid within three years of death and for the limited purpose of the second exception below.