April 2000


By Mark Stone, CFP, CPA, and Margolin, Winer & Evens LLP

One of the most basic planning techniques utilized to reduce transfer taxes is the $10,000 (as indexed) annual gift exclusion. The importance of planning for gift giving was recently illustrated by the U.S. District Court in Robert Rosano vs. Comm'r, where a New York taxpayer was unable to utilize the annual exclusion for a gift given by check.

As analyzed in Rosano, several factors are used to determine when a gift in the form of a personal check occurs. These factors include the date the check is presented to the bank, the date the check clears the bank, and whether the donor is alive when the check clears. For example, let's say that Gift Giving Harry, a New York State resident, issues a $10,000 check on December 22, 1999, to Gift Taking Henry, who presents the check to his bank on December 31, 1999, and the check clears on January 5, 2000. Based on these circumstances, will this gift qualify for the annual exclusion for 1999? To answer this question, we need to determine whether Federal or New York State law controls in determining when the gift is complete and the effect that the relation-back doctrine has on this determination.

Treasury Regulations section 25.2511-2(b) says the date that the donor has so parted with "dominion and control" as to leave in the donor "no power to change its disposition, whether for his own benefit or for the benefit of another" is when a gift is complete. To determine whether the donor parted with dominion and control is a matter of state law. According to the U.S. Supreme Court (United States vs. Irvine [114 S. Ct. 1473, 1481(1994)]), "state law creates legal interests and rights in property, [and] Federal law determines whether and to what extent those interests will be taxed." Since state law determines the rights in property, it governs when a gift is complete.

Under New York law, there are four elements that must be demonstrated in order to prove a valid gift. These elements are

1) mental capacity of the donor,
2) the donor's intention to make a gift,
3) the completed delivery of the gift, and
4) acceptance of the gift by the donee. The essential requirements, according to
Avery's Estate [76 NYS 2d 790, 795 (1948)], are donative intent and executed delivery. Under New York law, a gift is complete when the check is paid during the lifetime of the maker. Payment is critical because the donor retains control to stop payment until paid by the bank.

Estate of Metzger vs. Comm'r (38 F.3d 118), a 1994 Fourth Circuit Court of Appeals case, challenged the position that state law controls when a gift is complete. In that case, the court concluded that state law may not determine when a gift is complete for Federal transfer tax purposes if the donor is alive when the check clears. The IRS presented its position as to the applicability of state law in Revenue Ruling 96-56.

In Metzger, the donor gifted (by power of attorney) a series of checks equal to the annual exclusion to his son and his daughter-in-law. Two of these checks were drawn on December 14, 1985, deposited on December 31, 1985, and cleared by the bank on January 2, 1986. In 1986, another series of checks were issued and paid to the same donees, each in the amount of the annual exclusion. Upon the donor's death in 1987, the estate return reported that the decedent made no taxable gifts within his lifetime. The IRS, however, argued that the 1985 gifts were not eligible for the annual exclusion in 1985, because the gifts were not "complete" in 1985 under applicable state (Maryland) law. Although the Tax Court agreed with this analysis, it ultimately concluded the gifts were made in 1985. Despite the clear language of Regulations section 25.2511-2(b), the court came to this determination by applying the relation-back doctrine to gift taxes, which bases the transfer date on when the check was drawn.

Prior to this case, the relation-back doctrine allowed a charitable deduction for a gift made to a charitable donee at the time the check was drawn, provided that the check was subsequently paid. Under Metzger, the relation-back doctrine could be utilized for noncharitable gifts when the taxpayer is able to establish
1) the donor's intent is to make a gift,
2) unconditional delivery of the check, and 3) presentation of the check within the year for which favorable tax treatment is sought and within a reasonable time of issuance. The court allowed the relation-back doctrine to be applied, since it felt there was no attempt to avoid estate taxes.

As a result of Metzger, the IRS issued Revenue Ruling 96-56. Under this ruling, a completed gift occurs on the earlier of 1) the date that the donor has so parted with dominion and control under local law as to leave in the donor no power to change its disposition [as defined in Treasury Regulations section 25.2511-2(b)] or 2) the date the donee deposits the check, cashes the check, or presents the check for payment, if it is established that

1) the check was paid by the drawee bank when first presented for payment,
2) the donor was alive when the check was paid,
3) the donor intended to make a gift,
4) delivery of the check by the donor was unconditional, and
5) the check was deposited, cashed, or presented in the calendar year for which the completed gift treatment is sought and within a reasonable time of issuance.

Assuming in the above example that Gift Giving Harry was alive when the check was paid and he had the funds in the bank to cover the check, then the gift will qualify for the annual exclusion in 1999. Let's modify our example, adding that Gift Giving Harry dies on January 1, 2000. As before, the check clears on January 5, 2000. Will this gift qualify for the annual exclusion for 1999?

The District Court in New York faced this issue in the 1999 Rosano case. The decedent had written 43 checks before her death, but the checks cleared the bank after her death. The petitioner argued that the relation-back doctrine applied. Citing Estate of Newman vs. Comm'r [111 T.C. No. 3 (1998)], the district court declined to extend the relation-back doctrine to noncharitable gifts where the donor had died prior to the payment of the checks. The court indicated that there is a "very real danger of fostering estate tax avoidance in cases in which checks are not cashed until after the donor dies." In its analysis of Avery's Estate, the court concluded that these gifts were incomplete under New York State law because the checks didn't clear before the donor died. As a result of this case, the Second Circuit District Court joins the Tax Court in concluding that the relation-back doctrine applies only when the donor is alive at the time the check clears.

Learn the lesson that Gift Giving Harry learned: When planning for gift giving, don't hold on to the checks! Emphasize to the donee the importance of depositing the check in time to be paid by the donor's bank before the end of the year. If this is not possible, the donor can have the check certified before it is delivered to the donee, which also meets the completed delivery requirement. *

Lawrence M. Lipoff, CPA
Deloitte & Touche LLP

Alan D. Kahn, CPA
The AJK Financial Group

Contributing Editors:
Jerome Landau, CPA

Debra M. Simon, CPA
Merdinger Sruchter Rosen &
Corso P.C.

Richard H. Sonet, JD, CPA
Marks Paneth & Shron LLP

Peter Brizard, CPA

Ellen G. Gordon, CPA
Margolin Winer & Evens LLP

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