Lifetime gifts are often used to reduce estate and inheritance taxes. Currently, only estates worth $12.92 million or more are subject to the federal estate tax. However, twelve states and the District of Columbia levy an additional estate or inheritance tax.
To lower the value of the estate that is taxable at death, an individual may consider giving lifetime gifts to friends and family members. The timing and form of gifts have important estate planning implications, however, as a recent opinion from the United States Court of Appeals for the Third Circuit demonstrates. In that case, the failure to complete gifts in the form of checks prior to the donor’s death cost his estate—and ultimately, his heirs—a significant sum of money.
We have historically high lifetime estate and gift tax provisions in place currently. However, they are set to expire at the end of 2025. So now is a very good time to consider gifts.
William DeMuth, Jr. of Pennsylvania executed a power of attorney (PoA) in January 2007, appointing his son Donald DeMuth as his agent. As PoA, Donald made annual monetary gifts to family members from 2007 to 2014.
On September 6, 2015, William was diagnosed with an end-stage medical condition. Shortly later, Donald signed and delivered seven checks to family members worth $464,000. William passed away on September 11, 2015. At the time of his death, just one of the eleven checks had been paid and cleared from his account. Ten of the eleven checks, totaling $436,000, had not been paid before William’s death, although three of them were deposited on the day of his death.
Donald, the executor of William’s estate, excluded the value of all eleven checks from William’s account when reporting the gross estate. The Internal Revenue Service (IRS), however, concluded that the value of the account had been underreported by the $436,000 value of the ten checks and issued a notice of estate tax deficiency in the amount of $179,130.
Donald filed an appeal with the Tax Court, where the IRS agreed to exclude the three checks deposited on the day William died. This reduced the tax deficiency to $131,774; but the Tax Court held that the funds from the remaining seven checks were part of William’s estate because, under Pennsylvania law, they were not completed gifts prior to his death.
The estate appealed to the Third Circuit, arguing that the gifts were completed gifts in contemplation of William’s death, and as a result were completed gifts in “causa mortis.” In Pennsylvania, gifts causa mortis are treated differently than gifts made during someone’s lifetime. A gift by check deemed to be a gift causa mortis is complete when the check is delivered to the recipient—not when the recipient deposits the check.
Donald lost the appeal, with the court ruling that the estate did not show William wrote the checks as gifts in causa mortis. The court determined that the value of the seven remaining checks was improperly excluded from the gross estate.
Estate Planning Takeaways
With the seven checks being included in William’s estate, the estate tax increased by more than $130,000. The estate also incurred additional legal and court fees paid to litigate the case in a losing effort, with nearly eight years of dealing with the courts and the IRS.
With better planning, the money paid in taxes and court costs could have instead been passed on to Donald and other heirs. The estate also faced taxes owed in Pennsylvania, which imposes an inheritance tax that ranges from 4.5 to 15 percent on eligible transfers.
Other estate planning takeaways from DeMuth v. Commissioner include the following:
- If the deathbed gifts made by Donald DeMuth on behalf of his father had been made by a bank check or wire—rather than a personal check—they could have been excluded from the taxable estate because a bank checkor wire represents funds already withdrawn from the payer’s account.
- US Code and Treasury Regulations were relevant to DeMuth v. Commissioner, but state law dictates that property law rules. In this case, the distinction in Pennsylvania law between gifts lifetime and gifts causa mortis was critical.
- Knowing that his father was in poor health, Donald should have ensured that the gift checks were received and deposited before William died.
- A similar mistake is made when checks are written at the end of the year for the purpose of taking advantage of the annual gift exclusion amount ($17,000 per person in 2023). If the check is not cashed or deposited by the year’s end, it is not considered complete until the following year and therefore is not a gift made in the year the check is written. This could result in a doubling up on gifts, the required filing of a gift tax return, and a reduction in the lifetime exemption amount.
- State tax laws should also be accounted for in the timing of gifts. Pennsylvania, for example, does not have a gift tax, but all gifts greater than $3,000 made within 12 months of the decedent’s date of death are pulled back into the estate and subject to Pennsylvania inheritance taxes.
Putting Off Estate Planning Can Have Unintended Consequences
DeMuth v. Commissioners is a lesson in what can happen when estate planning is put off to the last minute. Gifting can be an effective strategy for reducing estate and inheritance taxes resulting in more money for heirs—but to maximize the unified estate and gift tax exclusions, gifting should be a long-term strategy.
Today’s all-time high exclusion levels are set to be cut in half in 2026. With this drastic change on the horizon, families should revisit their estate plan now and consider actions such as creating a family trust. An estate plan should also consider expected asset appreciation that could put an estate over the exemption amount by 2026.
Even if you do not think upcoming changes in the tax law will affect your estate plan, it is still important to review your plan every few years. Changes in your life and the lives of loved ones can make it necessary to modify your will or trust terms or reconsider trustees and executors. Like William DeMuth, you could also face a terminal medical condition that forces you to accelerate certain aspects of your plan.
We Can Help
Whatever your plan is, do not delay in making it official. Putting off estate planning can affect your estate, your heirs, and your legacy. When your plans change, we are here to help. Call or contact us to schedule an appointment.