FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
ESTATE OF ANNE W. MORGENS,
DECEASED, James H. Morgens,
Executor, No. 10-73698
Petitioner-Appellant,
v. Tax Ct. No.
26212-06
COMMISSIONER OF INTERNAL OPINION
REVENUE,
Respondent-Appellee.
Appeal from a Decision of the
United States Tax Court
Argued and Submitted
December 8, 2011—San Francisco, California
Filed May 3, 2012
Before: Marsha S. Berzon and Carlos T. Bea, Circuit Judges,
and Lloyd D. George, Senior District Judge.*
Opinion by Judge Bea
*The Honorable Lloyd D. George, Senior District Judge for the U.S.
District Court for Nevada, sitting by designation.
4651
ESTATE OF MORGENS v. CIR 4653
COUNSEL
John W. Porter, Keri D. Brown, and Jeffrey D. Watters, Jr.,
Baker Botts L.L.P., Houston, Texas, for the petitioner-
appellant.
Gilbert S. Rothenberg, Acting Deputy Assistant Attorney
General, Jonathan S. Cohen, and Bethany B. Hauser, Wash-
ington, District of Columbia, for the respondent-appellee.
4654 ESTATE OF MORGENS v. CIR
OPINION
BEA, Circuit Judge:
The Estate of Anne W. Morgens (“the Estate”) appeals the
United States Tax Court’s decision that it owed additional
estate taxes. This case presents the question whether gift taxes
paid by the donee trustees of a Qualifying Terminable Interest
in Property (QTIP) trust, based on a 26 U.S.C. § 25191
deemed inter vivos transfer of the QTIP property within three
years of the donor’s death, must be included in the transfer-
or’s gross estate under the so-called “gross-up rule” of
§ 2035(b). We hold that it does. We have jurisdiction under
§ 7482, and we affirm.
I. Statutory Background
This case turns on two statutory schemes within the Inter-
nal Revenue Code. The first is § 2035(b), the “gross-up rule,”
which requires that a gross estate be increased by the amount
of gift taxes paid by the decedent or her estate within three
years of her death. Section 2035 states, in relevant part:
§ 2035. Adjustments for certain gifts made within 3
years of decedent’s death.
...
(b) Inclusion of gift tax on gifts made during 3 years
before decedent’s death
The amount of the gross estate (determined without
regard to this subsection) shall be increased by the
amount of any tax paid under chapter 12 by the
decedent or his estate on any gift made by the dece-
1
All subsequent Code citations are to 26 U.S.C. unless indicated other-
wise.
ESTATE OF MORGENS v. CIR 4655
dent or his spouse during the 3-year period ending
on the date of the decedent’s death.
(emphasis added). We have explained before the purpose and
structure of the gross-up rule of § 2035(b).
Section 2035[(b)] is designed to recoup any advan-
tage gained by so-called “death-bed” transfers in
which a taxpayer, cognizant of impending mortality,
transfers property out of her estate in order to reduce
estate tax liability. Although these inter vivos trans-
fers incur gift tax liability, opting to transfer assets
prior to death still carries a tax advantage. Gift tax
is calculated using a tax exclusive method (the appli-
cable rate is applied to the net gift, exclusive of gift
taxes), whereas estate taxes are calculated on a tax
inclusive method (the applicable rate is applied to
the gross estate, before taxes are deducted). Section
2035[(b)] presumes that gifts made within three
years of death are made with tax-avoidance motives
and eliminates the tax advantage for those death bed
transactions.
Brown v. United States, 329 F.3d 664, 667-68 (9th Cir. 2003)
(citations omitted).
The second statutory scheme in this case is the QTIP
regime. The QTIP is an exception to an exception to an
exception. In general, a tax is levied on the transfer of estates.
§ 2001. However, the marital deduction is an exception to this
rule, and any interest in property which passes to a surviving
spouse is not considered part of the decedent’s gross estate.
§ 2056(a). Life estates and other terminable interests are an
exception to the marital deduction. § 2056(b)(1). Finally, the
QTIP regime is an exception to the terminable interest excep-
tion to the marital deduction. A QTIP is a terminable interest
in property which has certain limiting characteristics: (1) the
surviving spouse receives all of the income from the property
4656 ESTATE OF MORGENS v. CIR
for life, distributed at least annually (a “qualifying income
interest”); (2) no person can appoint any part of the property
to any person other than the surviving spouse; and (3) the
decedent’s estate elects to treat the interest as a QTIP.
§ 2056(b)(7)(B). If an interest is a QTIP, the regime estab-
lishes a legal fiction: for the purposes of estate taxes, the
entire property is treated as if it passed to the surviving spouse
(and, consequently, nothing to the remaindermen)—even
though the surviving spouse actually possesses only the
income interest. § 2056(b)(7)(A). Therefore, the marital
deduction of § 2056(a) applies to the entire QTIP property
and the property is not included in the gross estate of the
decedent.
The underlying premise of the QTIP regime is that the sur-
viving spouse is deemed to receive and then give the entire
QTIP property, rather than just the income interest. The pur-
pose of the QTIP regime is to treat the two spouses as a single
economic unit with respect to the QTIP property while still
allowing the first-to-die spouse to control the eventual dispo-
sition of the property.
When all or part of the QTIP’s qualifying income interest
is transferred—by death of the surviving spouse (§ 2044) or
by inter vivos transfer (§ 2519)—such a transfer is deemed to
transfer the entire QTIP property, except the qualifying
income interest, which is an ordinary transfer under § 2511.
In the context of gift taxes or estate taxes, the donor is
responsible for paying the tax. § 2502. In the context of a
QTIP deemed transfer, the donor (the surviving spouse) by
definition does not possess the remainder interest in the QTIP
property; the donor possesses only the qualifying income
interest. Therefore, § 2207A gives the donor the right to
recover the tax from the QTIP beneficiaries who receive the
QTIP property transfer.
ESTATE OF MORGENS v. CIR 4657
II. Facts and Procedural History
Anne Morgens, the decedent in this case, married Howard
Morgens when she was 26 and remained married to him until
his death in January 2000. In 1991, when Mrs. Morgens was
81, she and Mr. Morgens entered into the Morgens Family
Living Trust Agreement. Under that agreement, Mr. and Mrs.
Morgens each contributed assets to a Living Trust.
At Mr. Morgens’ death, the one-half of the community
property in the Living Trust attributable to Mrs. Morgens was
allocated to a Survivor’s Trust, and the remaining one-half
was allocated to a Residual Trust. After certain specific gifts,
the remainder of the Residual Trust was held in trust for Mrs.
Morgens’ benefit. She had the right to income for life from
the Residual Trust. The Living Trust Agreement provided
that, upon Mrs. Morgens’ death, the remainder of the Residual
Trust was to be divided into shares for the Morgens’ children
and grandchildren.
In October 2000, Mr. Morgens’ estate tax return was filed.
On its estate tax return, Mr. Morgens’ estate satisfied the
criteria for and elected QTIP treatment for the property pass-
ing to the Residual Trust. See § 2056(b)(7). The Residual
Trust therefore qualified for the marital deduction for federal
estate tax purposes; its value was not taxed in Mr. Morgens’
estate.
Shortly thereafter, the Residual Trust was divided into two
trusts, Residual Trust A, worth approximately $8.3 million,
and Residual Trust B, worth over $28 million. Mrs. Morgens
maintained a right to the income from both Residual Trusts,
paid at least annually. This division was not a taxable event.
However, on December 8, 2000, Mrs. Morgens relin-
quished her lifetime interest in the income from Residual
Trust A. The income interest vested in the trust beneficiaries,
Mrs. Morgens’ sons. Because Mr. Morgens’ estate had
4658 ESTATE OF MORGENS v. CIR
elected QTIP treatment for the Residual Trust, Mrs. Morgens’
gift of her lifetime income interest in Residual Trust A trig-
gered a gift tax on the deemed transfer of the remainder inter-
est in the trust to the remainder beneficiaries: the Morgens’
children and grandchildren. The gross value of the property
“treated as . . . transfer[red]” under § 2519(a)—i.e., the accel-
erated remainder interest in Residual Trust A—was computed
as $6,398,901. Mrs. Morgens filed a gift tax return with
respect to this transaction, reporting a net taxable gift of
$4,111,592. The remainder of the gross transfer, $2,287,309,
was paid to the Internal Revenue Service as gift tax by the
trustees of Trust A (Mrs. Morgens’ sons).
On January 10, 2001, Mrs. Morgens relinquished her life-
time interest in the income from Residual Trust B. Like the
disposition of her interest in Residual Trust A, this gift of
Mrs. Morgens’ interest in the trust was subject to tax as a
transfer of the remainder interests in the trust to the remainder
beneficiaries. §§ 2519(a), (b)(1). The gross value of the trans-
ferred accelerated remainder interest in Residual Trust B was
computed as $21,676,289. Mrs. Morgens filed a gift tax return
with respect to this transaction, reporting a net gift of
$13,983,787. The remainder of the gross transfer, $7,692,502,
was paid as gift tax by the trustees of Trust B (again, Mrs.
Morgens’ sons).2
Mrs. Morgens died on August 25, 2002, within three years
of both her 2000 and 2001 transfers of her lifetime income
interests in each of the trusts. Her estate tax return was timely
filed (on extension) on November 24, 2003. Under the “gross-
up rule,” a decedent’s gross estate includes all gift taxes paid
by the decedent within three years of her death. § 2035(b).
However, the return filed by the Estate did not include, as part
of the gross estate, the gift taxes shown as paid on Mrs. Mor-
gens’ 2000 and 2001 gift tax returns. The Commissioner
2
These amounts were later revised to $21,623,964, $13,937,756, and
$7,686,208, respectively.
ESTATE OF MORGENS v. CIR 4659
determined a deficiency based on the failure to include the
gift tax in the gross estate, and issued a notice of deficiency
accordingly. The Estate petitioned the Tax Court for a redeter-
mination.
Before the Tax Court, the Estate argued that the trustees
paid the gift tax on the § 2519 deemed transfers, and that
Congressional intent in enacting the QTIP regime was to shift
both the primary and the ultimate liability for the transfer
taxes from the QTIP donor to the donees. The Commissioner
argued that the transfer taxes were paid indirectly by Mrs.
Morgens for the purposes of § 2035(b), and that therefore the
taxes must be included in the gross estate. The Tax Court held
that the gift taxes paid pursuant to the QTIP rules on the gift
of QTIP property were includible in Mrs. Morgens’ estate
under § 2035(b). The Estate appealed.
III. Analysis
This court reviews de novo the Tax Court’s conclusions of
law, including its construction of the Internal Revenue Code.
Biehl v. Comm’r, 351 F.3d 982, 985 (9th Cir. 2003).
[1] For § 2035(b) to apply to gift taxes paid on § 2519
“deemed” transfers, those taxes must be paid “by the
decedent”—that is, by Mrs. Morgens—under the language of
§ 2035(b). We conclude that they were.
[2] One possible reading of § 2035(b) suggests, at first, the
opposite conclusion. Gift taxes are included in the estate
under § 2035(b) only if they are “paid . . . by the decedent.”
If taxes are “paid by” the person who sent the check, our anal-
ysis would be simple. The Joint Stipulation of Facts, to which
the parties agreed, states that “the trustees of [the] Residual
Trust[s] paid the . . . gift tax” due on the § 2519 deemed trans-
fers. Thus under this reading of § 2035(b), as the trustees paid
the gift tax, then the gift tax could not have been paid by the
decedent. But we are foreclosed from this analysis by Died-
4660 ESTATE OF MORGENS v. CIR
rich v. Comm’r, 457 U.S. 191 (1982) and by our own prior
opinion in Brown v. United States, 329 F.3d 664 (2003).
Instead, we turn for guidance to the analogous situation of the
“net gift.”
[3] A “net gift” is an arrangement where “the donor
[makes] the gift subject to the condition that the donee pay the
resulting gift tax.3 Diedrich, 457 U.S. at 196-97. For the pur-
poses of calculating the gift tax, the value of the gift is deter-
mined by reducing the total amount transferred by the amount
of gift taxes owed. The gift tax is due only on the gift, rather
than on the gross value of the property transferred. This is
because the property is transferred with the intent and require-
ment that the donee pay the gift tax obligation incurred by the
donor. Accordingly, only that portion of the amount trans-
ferred that is net of the gift tax is actually intended as a gift
by the donor. Turner v. Comm’r, 49 T.C. 356, 360-61 (1968),
aff’d per curiam, 410 F.2d 752 (6th Cir. 1969).
[4] “When a gift is made, the gift tax liability falls on the
donor . . . When a donor makes a gift to a donee, a ‘debt’ to
the United States for the amount of the gift tax is incurred by
the donor. Those taxes are as much the legal obligation of the
donor as the donor’s income taxes . . .” Diedrich, 457 U.S. at
197. The payment of the gift taxes by the donee is taxable
income to the donor (to the extent the gift taxes paid exceed
the donor’s adjusted basis in the property). Id. at 200-01.
The Eighth Circuit considered the interaction of net gifts
with § 2035(b)4 in Estate of Sachs v. Comm’r, 856 F.2d 1158
3
After the events in this case, the Commissioner promulgated a regula-
tion confirming that QTIP transfers are normally taxed as net gifts. See 26
C.F.R. § 25.2519-1(c)(4). Although that regulation did not apply to this
case, both parties agree that the QTIP transfer was properly taxed as a net
gift.
4
At the time Sachs was decided, § 2035(b) was codified as § 2035(c).
For ease of reading, the statutory section will be listed as 2035(b) through-
out this opinion.
ESTATE OF MORGENS v. CIR 4661
(8th Cir. 1988). In that case, in 1978 Sachs and his wife gave
$2,399,044 of stock to three irrevocable trusts established for
their grandchildren. Id. at 1159. The donation was designed
as a net gift; the trust instrument required as a condition of the
gift that the trustees satisfy all gift-tax liability. Id. Accord-
ingly, the donee trusts paid a gift tax of $612,700, while Sachs
and his wife reported the gift at a value of $1,786,340. Id.
Sachs died within three years of having made the gifts to the
trusts. Id. The estate recognized the value of the gift as part
of the estate under § 2035(a), which requires that the gross
estate be increased by the value of gifts made within three
years of death. Id. However, the estate did not include the
value of the gift tax paid as part of the estate.5 Id. The Com-
missioner took the position that the $612,700 gift tax paid by
the donee trusts should be included in the estate, and the Tax
Court agreed. Id. at 1159-60.
In a parallel argument to that of Mrs. Morgens’ estate
before us, Sachs’ estate argued to the Eighth Circuit that “the
donee’s payment of the gift tax on the . . . gift should not be
included in the gross estate under § 2035(b), on the ground
that this was not ‘a tax paid . . . by decedent or his estate.’ ”
Id. at 1163. The Eighth Circuit rejected this argument because
“the distinction between tax payments made by donees of net
gifts and tax payments made directly by decedent-donors . . .
has little force after Diedrich.” Id.
[5] The Eighth Circuit thus applied a substance-over-form
analysis to conclude that “the fact that the Internal Revenue
Service received the payment for the decedent’s gift-tax lia-
bility via the donee does not make it any less a ‘tax paid . . .
5
Initially, the estate included the gift tax paid as income to the estate
under Diedrich. Sachs, 856 F.2d at 1159. However, the Tax Reform Act
of 1984, Pub. L. 98-390, § 1026(a) forgave income tax due on gift taxes
on property transfers made before March 4, 1981. Id. Therefore, the estate
received a full refund of the income tax it had paid on the gift taxes paid
by the donee trusts. Id.
4662 ESTATE OF MORGENS v. CIR
by the decedent or his estate’ within the meaning of
§ 2035(b).” Id. at 1164. In a net gift, “the payment of the gift
tax is (or can be) made with funds from the donor’s gift, and
pursuant to the donor’s condition. The donee’s payment of the
gift tax under these circumstances is not an independent act
of gratitude or reciprocity,” as it was not in Diedrich. Id.
Thus, “the donor of a net gift uses the donee as a conduit for
the payment of the tax liability, and as donor of a net gift, he
may be deemed to have paid the tax by ordering the donee to
pay it over.” Id. (citation and quotation marks omitted). Gift
taxes paid by the donee of a net gift must be included in the
donor’s taxable income under Diedrich; similarly, gift taxes
paid by the donee of a gift made within three years of the
donor’s death must be included within the donor’s gross
estate under § 2035(b). Id. at 1164.
The Eighth Circuit also noted the purpose of § 2035(b)—to
prevent deathbed transfers from decreasing the taxable estate
—and stated that because “[t]he assets which were used to
pay the gift tax would have been part of the gross estate if the
gift had never been made . . . the entire amount of the gift tax
[is] properly included [in the estate] under § 2035(b).” Id. at
1165. Thus, that court concluded that gift tax paid by a donee
under a net gift arrangement—where the donee was obligated
to pay the gift tax—was nonetheless paid by the decedent for
the purposes of § 2035(b)’s gross-up rule.
[6] We have applied similar reasoning about a conduit of
funds in Brown v. United States, holding that when a husband
gave his wife money to pay gift taxes on an insurance trust
and the husband died within three years, the taxes were “paid
by” the husband within the meaning of § 2035(b) and thus
includible in the husband’s estate. 329 F.3d at 674. We stated
that “had [the wife] truly paid the gift tax from her own funds,
§ 2035 would not apply to Betty’s payments of the gift tax.”
Id. The source of the funds mattered, we held, because
Ҥ 2035(b) was designed to reverse the effect of funds trans-
ferred out of an estate within three years of death.” Id. The
ESTATE OF MORGENS v. CIR 4663
husband’s transfer of funds to his wife for payment of the gift
tax reduced his estate, and thus his estate would “escape
estate tax liability on the funds if he outlives the three-year
reach of § 2035(b). Accordingly, it is his estate that must
reverse the effect of the transfer if he dies within the three-
year period.” Id.
[7] We find the net gift analogy persuasive. As in a net
gift, the financial responsibility for the gift taxes on a QTIP
transfer rests on the donees rather than the donor, even though
the shift occurs by contract in a net gift and by the operation
of § 2207A in a QTIP transfer.6 However, as in a net gift, the
liability for the gift taxes remains with the donor. Diedrich,
457 U.S. at 197.
[8] We find unpersuasive the Estate’s argument that
§ 2207A evinces Congressional intent to shift not only the
ultimate financial responsibility for QTIP transfers, but also
the initial tax liability for the gift tax. This argument is fore-
closed both by the language of § 2207A and by the reasoning
of Diedrich. Section 2207A states that if “tax is paid . . . with
respect to any person by reason of property treated as trans-
ferred by such person under section 2519, such person shall
be entitled to recover from the person receiving the property
the amount [of tax paid].” The section does not state that tax
liability is transferred, merely that the donor, who is liable for
the tax, may recover the amount of the tax paid from the ben-
eficiary of the deemed transfer. This is because the donor is
treated as owning the QTIP property but, pursuant to the
terms of the trust, does not fully control it, and thus cannot
6
We take no position here on whether § 2207A provides a right of
recovery for the additional estate taxes owed due to the inclusion of the
gift taxes on the § 2519 deemed transfer in the gross estate under
§ 2035(b).
We note that here, in addition to the statutory right of recovery provided
by § 2207A, the QTIP gifts here were made pursuant to indemnification
agreements which provided a contractual right of recovery, as in a net gift.
4664 ESTATE OF MORGENS v. CIR
use part of it to pay gift taxes. Absent explicit statutory revi-
sion, the liability is the donor’s no matter the transfer of the
final economic responsibility. As the Supreme Court stated in
Diedrich: “When a gift is made, the gift tax liability falls on
the donor . . . When a donor makes a gift to a donee, a ‘debt’
to the United States for the amount of the gift tax is incurred
by the donor. Those taxes are as much the legal obligation of
the donor as the donor’s income taxes.” 457 U.S. 196-97.
Whether the ability to recover funds is statutory or contractual
makes no difference as to whether the original tax liability
Diedrich’s “debt to the United States”—shifts from the donor
to a different party.
[9] As in a net gift, the QTIP trustees here paid the taxes
on the § 2519 deemed transfers of the QTIP trusts. But in so
doing, the trustees satisfied the tax liability incurred by Mrs.
Morgens in making the transfer. See Diedrich, 457 U.S. at
197. Thus, under the logic of Diedrich, as elucidated by Sachs
and Brown, the trustees acted as a conduit of funds for Mrs.
Morgens, who actually paid the gift tax for the purposes of
§ 2035(b).
This conclusion is supported by the source-of-funds logic
of Brown. Had Mrs. Morgens not made the deemed transfers
under § 2519, the entire value of the trusts—income and
remainder—would have been included in her estate under
§ 2044.7 Therefore, our conclusion that the gift taxes were
paid by Mrs. Morgens for the purposes of § 2035(b) is consis-
tent with Brown.
7
The estate also argues that the analogy to a net gift is inapposite
because the property taxed was originally Mr. Morgens’ property rather
than Mrs. Morgens’. This argument ignores the underlying premise of the
QTIP regime, that the entire QTIP property, rather than just the income
interest, is deemed to pass to, and then from, the surviving spouse. Thus,
the two spouses are treated as a single economic unit with respect to the
QTIP property while still allowing the first-to-die spouse to control the
eventual disposition of the property. The Estate cannot first use that favor-
able tax deferral (the § 2056 marital deduction) and then claim that the
property never actually passed to Mrs. Morgens.
ESTATE OF MORGENS v. CIR 4665
[10] Thus, we hold Mrs. Morgens paid the gift tax on the
§ 2519 deemed transfers of the Residual Trusts and that her
estate should be increased under the gross-up rule of
§ 2035(b) by the value of the gift taxes paid.
AFFIRMED.