Opinion ID: 773481
Heading Depth: 1
Heading Rank: 3

Heading: Reciprocal Gifts

Text: 10 The Internal Revenue Code imposes a tax on the transfer of property by gift, I.R.C. 2501(a), whether the gift is direct or indirect, I.R.C. 2511(a). The first $10,000 worth of gifts of a present interest made to any person in a calendar year is excluded from the definition of a taxable gift. I.R.C. 2503(b). Thus, it is not uncommon for taxpayers to avoid the gift tax by structuring gifts just below the $10,000 exclusion limit. This case requires us to determine whether the gifts in this case, similar gifts made by the donors to each other's children, are really cross-gifts, that is, indirect gifts to their own children. 11 The tax court found that the cumulative transfers at issue lacked economic substance, relying on the reciprocal trust doctrine. The Sathers argue that there is economic substance to the transactions as a whole when Rodney's gifts to the nieces and nephews are considered, as is required by the step-transaction doctrine. Whether a transaction lacks economic substance, and whether several transactions should be considered integrated steps of a single transaction, are both fact questions which we review for clear error. See Lee v. Comm'r, 155 F.3d 584, 586 (2d Cir. 1998) (reviewing economic substance); Robino, Inc. Pension Trust v. Comm'r, 894 F.2d 342, 344 (9th Cir. 1990) (reviewing step-transaction doctrine). 12 The reciprocal trust doctrine, a variation of the substance over form concept, see Exch. Bank and Trust Co. of Fla. v. United States, 694 F.2d 1261, 1265 (Fed. Cir. 1982), was developed in the context of trusts to prevent taxpayers from transferring similar property in trust to each other as life tenants, thus removing the property from the settlor's estate and avoiding estate taxes, while receiving identical property for their lifetime enjoyment that would likewise not be included in their estate. See United States v. Grace, 395 U.S. 316, 320 (1969). The Supreme Court held that the reciprocal trust doctrine applies to multiple transactions when the transactions are interrelated and, to the extent of mutual value, leave[] the settlors in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries. Id. at 324. The doctrine seeks to discern the reality of the transaction; 'the fact that the trusts are reciprocated or 'crossed' is a trifle, quite lacking in practical or legal significance.' Id. at 321 (quoting Lehman v. Comm'r, 109 F.2d 99, 100 (2d Cir.), cert. denied, 310 U.S. 637 (1940)). 13 Substance over form analysis applies equally to gift tax cases. See, e.g., Heyen v. United States, 945 F.2d 359, 363 (10th Cir. 1991); Chanin v. United States, 393 F.2d 972, 979-80 (Ct. Cl. 1968). It is impliedly included in the gift tax statute itself--including indirect transfers within the definition of a taxable gift. See I.R.C. 2511(a). 'The terms 'property,' 'transfer,' 'gift,' and 'indirectly' are used in the broadest and most comprehensive sense; . . . . The words 'transfer . . . by gift' and 'whether . . . direct or indirect' are designed to cover and comprehend all transactions . . . whereby . . . property or a property right is donatively passed . . . .' Dickman v. Comm'r, 465 U.S. 330, 334 (1984) (quoting H.R.Rep. No. 708, 72nd Cong., 1st Sess., 27-28 (1932) and S.Rep. No. 665, 72nd Cong., 1st Sess., 39 (1932)) (some alterations in original). Application of the reciprocal trust doctrine 5 is likewise appropriate in the gift tax context as a method for discerning the substance of gift transfers. 'The purpose of the doctrine is merely to identify the transferor of property.' Exchange Bank, 694 F.2d at 1267 (quoting Bischoff v. Comm'r, 69 T.C. 32, 45-46 (1977)). Once the transferor is identified, the tax code determines whether the transfer is subject to tax. Id. 14 Applying the reciprocal trust doctrine to this case, there can be no doubt that the gifts were interrelated. The Sather brothers together sought advice on how to transfer the stock to the next generation of Sathers. The transfers to all the children were made on the same days and were for the same amounts of stock. We cannot say that the tax court erred--clearly or otherwise--in determining that the transfers were interrelated. 15 The second prong of the Grace analysis requires that the settlors [be left] in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries. Grace, 395 U.S. at 324. We do not believe that the Supreme Court meant to limit the doctrine to cases involving life estate trusts, or even to cases where the donor retains an economic interest, but used that language in the context of the specific facts of the case. See, e.g., Exchange Bank, 694 F.2d at 1268-69 (holding that the doctrine applies to transfers made under the Florida Gifts to Minors Act, wherein each spouse transferred equal amounts of property to their children, naming the other spouse as custodian). Grace does not speak in terms of a retained economic interest--rather, that the arrangement 'leaves the settlors in approximately the same economic position . . . .' Id. at 1268. In this case, the parents transferred stock to their nieces and nephews in exchange for transfers to their own children by the nieces' and nephews' parents. Though the Sathers received no direct economic value in the exchange, they did receive an economic benefit by indirectly benefitting their own children. The donors were in the same economic position--the position of passing their assets to their children--by entering the cross-transactions as if they had made direct gifts of all of their stock to their own children. 6 Applying the analysis of the reciprocal trust doctrine, we hold that these interrelated gifts were reciprocal transactions that must be uncrossed to reach the substance of the transactions. See Schultz v. United States, 493 F.2d 1225, 1226 (4th Cir. 1974) (disallowing gift tax exclusions where two brothers made gifts to each other's children as well as their own). 16 The purpose of the second Grace prong is to discern the taxability of the transactions as uncrossed in the context of a particular set of facts. See Exchange Bank, 694 F.2d at 1267 (discussing Bischoff). Uncrossing the gifts in the present case, the tax court made the factual finding that each immediate family was in the same position as if each donor had made gifts only to the donor's own children. Thus, using the reciprocal trust doctrine to identify the actual transferor, each donor made transfers to each of his or her own children but no gifts to any of the nieces and nephews. See Schultz, 493 F.2d at 1226. We cannot say that the tax court clearly erred in making this factual finding. Under I.R.C. 2503(b), each transferor--Larry, Kathy, John, Sandra, Duane, and Diane--was entitled to one $10,000 exclusion for gifts made to each uncrossed donee, their own children, for each year in which gifts were made. Because each transferor has only three children but claimed nine exclusions, the IRS correctly determined that the transferors understated their gift tax liabilities. 17 The Sathers argue that the step-transaction doctrine requires us to consider the gifts made by Rodney to each of his nieces and nephews, and that in so doing, we will find economic substance in the whole transaction. Each of Larry's, John's, and Duane's immediate families had a net increase in economic value, while Rodney's immediate family (consisting only of himself) had a net decrease in economic value. True as this may be, it does not change the fact that uncrossing the reciprocal gifts leaves each of the transferors in the same position as if he or she had transferred stock only to his or her own children. The purpose of the reciprocal trust doctrine is to discern the actual transferor--Rodney's transfers do not affect the reality of the other transferors' gifts, which amounted to a transfer of their own stock to their own children. 18 The Sathers also argue that the tax court erred in excluding evidence of their intent, which was purportedly to transfer the stock to the next generation of Sathers, not to avoid taxes. Noting that the subjective intent of the parties, particularly when the parties are related, creates substantial obstacles to the proper application of the federal estate tax laws, the Supreme Court held that 'taxability . . . depends on the nature and operative effect of the trust transfer.' Grace, 395 U.S. at 323 (quoting Estate of Speigel v. Comm'r, 335 U.S. 701, 705 (1949)). The same holds true for federal gift tax laws. It is not necessary to prove the existence of a tax-avoidance motive. Id. at 324. Rather, an objective analysis of the parties' economic positions should predominate. Exchange Bank, 694 F.2d at 1266. Thus, the Sathers' argument regarding their intent is only marginally, if at all, relevant. Additionally, the tax court did consider the stated intent in its opinion, but dismissed it as irrelevant. (See Add. A. at 5, 13.) Thus, the tax court did not abuse its discretion in excluding any evidence regarding the Sathers' subjective intent. See Little v. Comm'r, 106 F.3d 1445, 1449 (9th Cir. 1997) (standard of review for exclusion of evidence in appeal from tax court).