Reg. § 25.2701-5 Adjustments to mitigate double taxation.
(a) Reduction of transfer tax base
(1) In general This section provides rules under which an individual (the initial transferor) making a transfer subject to section (the initial transfer) is entitled to reduce his or her taxable gifts or adjusted taxable gifts (the reduction). The amount of the reduction is determined under of this section. See of this section if section (split gifts) applied to the initial transfer.
(2) Federal gift tax modification If, during the lifetime of the initial transferor, the holder of a section interest (as defined in of this section) transfers the interest to or for the benefit of an individual other than the initial transferor or an applicable family member of the initial transferor in a transfer subject to Federal estate or gift tax, the initial transferor may reduce the amount on which the initial transferor's tentative tax is computed under section . The reduction is first applied on any gift tax return required to be filed for the calendar year in which the section interest is transferred; any excess reduction is carried forward and applied in each succeeding calendar year until the reduction is exhausted. The amount of the reduction that is used in a calendar year is the amount of the initial transferor's taxable gifts for that year. Any excess reduction remaining at the death of the initial transferor may be applied by the executor of the initial transferor's estate as provided under of this section. See of this section for the definition of a section interest. See for rules relating to indirect ownership of equity interests transferred to trusts and other entities.
(3) Federal estate tax modification Except as otherwise provided in this , in determining the Federal estate tax with respect to an initial transferor, the executor of the initial transferor's estate may reduce the amount on which the decedent's tentative tax is computed under section (or section ) by the amount of the reduction (including any excess reduction carried forward under of this section). The amount of the reduction under this is limited to the amount that results in zero Federal estate tax with respect to the estate of the initial transferor.
(4) Section 2701 interest A section interest is an applicable retained interest that was valued using the special valuation rules of section at the time of the initial transfer. However, an interest is a section interest only to the extent the transfer of that interest effectively reduces the aggregate ownership of such class of interest by the initial transferor and applicable family members of the initial transferor below that held by such persons at the time of the initial transfer (or the remaining portion thereof).
(b) Amount of reduction Except as otherwise provided in paragraphs (c)(3)(iv) (pertaining to transfers of partial interests) and (e) (pertaining to initial split gifts) of this section, the amount of the reduction is the lesser of—
(1) The amount by which the initial transferor's taxable gifts were increased as a result of the application of section to the initial transfer; or
(2) The amount (determined under of this section) duplicated in the transfer tax base at the time of the transfer of the section interest (the duplicated amount).
(c) Duplicated amount
(1) In general The duplicated amount is the amount by which the transfer tax value of the section interest at the time of the subsequent transfer exceeds the value of that interest determined under section at the time of the initial transfer. If, at the time of the initial transfer, the amount allocated to the transferred interest under (Step 3 of the valuation methodology) is less than the entire amount available for allocation at that time, the duplicated amount is a fraction of the amount described in the preceding sentence. The numerator of the fraction is the amount allocated to the transferred interest at the time of the initial transfer (pursuant to ) and the denominator of the fraction is the amount available for allocation at the time of the initial transfer (determined after application of ).
(2) Transfer tax value—in general Except as provided in of this section, for purposes of of this section the transfer tax value of a section interest is the value of that interest as finally determined for Federal transfer tax purposes under chapter 11 or chapter 12, as the case may be (including the right to receive any distributions thereon (other than qualified payments)), reduced by the amount of any deduction allowed with respect to the section interest to the extent that the deduction would not have been allowed if the section interest were not included in the transferor's total amount of gifts for the calendar year or the transferor's gross estate, as the case may be. Rules similar to the rules of section are applicable to determine the extent that a deduction would not be allowed if the section interest were not so included.
(3) Special transfer tax value rules
(i) Transfers for consideration Except as provided in of this section, if, during the life of the initial transferor, a section interest is transferred to or for the benefit of an individual other than the initial transferor or an applicable family member of the initial transferor for consideration in money or money's worth, or in a transfer that is treated as a transfer for consideration in money or money's worth, the transfer of the section interest is deemed to occur at the death of the initial transferor. In this case, the estate of the initial transferor is entitled to a reduction in the same manner as if the initial transferor's gross estate included a section interest having a chapter 11 value equal to the amount of consideration in money or money's worth received in the exchange (determined as of the time of the exchange).
(ii) Interests held by applicable family members at date of initial transferor's death If a section interest in existence on the date of the initial transferor's death is held by an applicable family member and, therefore, is not included in the gross estate of the initial transferor, the section interest is deemed to be transferred at the death of the initial transferor to or for the benefit of an individual other than the initial transferor or an applicable family member of the initial transferor. In this case, the transfer tax value of that interest is the value that the executor of the initial transferor's estate can demonstrate would be determined under chapter 12 if the interest were transferred immediately prior to the death of the initial transferor.
(iii) Nonrecognition transactions If an individual exchanges a section interest in a nonrecognition transaction (within the meaning of section ), the exchange is not treated as a transfer of a section interest and the transfer tax value of that interest is determined as if the interest received in exchange is the section interest.
(iv) Transfer of less than the entire section 2701 interest If a transfer is a transfer of less than the entire section interest, the amount of the reduction under or of this section is reduced proportionately.
(v) Multiple classes of section 2701 interest For purposes of of this section, if more than one class of section interest exists, the amount of the reduction is determined separately with respect to each such class.
(vi) Multiple initial transfers If an initial transferor has made more than one initial transfer, the amount of the reduction with respect to any section interest is the sum of the reductions computed under of this section with respect to each such initial transfer.
(d) Examples The following examples illustrate the provisions of through of this section.
Facts—(1) In general. (i) P, an individual, holds 1,500 shares of $1,000 par value preferred stock of X corporation (bearing an annual noncumulative dividend of $100 per share that may be put to X at any time for par value) and 1,000 shares of voting common stock of X. There is no other outstanding common stock of X.
(ii) On January 15, 1991, when the aggregate fair market value of the preferred stock is $1,500,000 and the aggregate fair market value of the common stock is $500,000, P transfers common stock to P's child. The fair market value of P's interest in X (common and preferred) immediately prior to the transfer is $2,000,000, and the section value of the preferred stock (the section interest) is zero. Neither P nor P's spouse, S, made gifts prior to 1991.
(2) Additional facts applicable to Examples 1 through 3. P's transfer consists of all 1,000 shares of P's common stock. With respect to the initial transfer, the amount remaining after Step 2 of the subtraction method of is $2,000,000 ($2,000,000 minus zero), all of which is allocated to the transferred stock. P's aggregate taxable gifts for 1991 (including the section transfer) equal $2,500,000.
(3) Additional facts applicable to Examples 4 and 5. P's initial transfer consists of one-half of P's common stock. With respect to the initial transfer in this case, only $1,000,000 (one-half of the amount remaining after Step 2 of the subtraction method of ) is allocated to the transferred stock. P's aggregate taxable gifts for 1991 (the section transfer and P's other transfers) equal $2,500,000.
Example 1. Inter vivos transfer of entire section 2701 interest,
(i) On October 1, 1994, at a time when the value of P's preferred stock is $1,400,000, P transfers all of the preferred stock to P's child. In computing P's 1994 gift tax, P, as the initial transferor, is entitled to reduce the amount on which P's tentative tax is computed under section by $1,400,000.
(ii) The amount of the reduction computed under of this section is the lesser of $1,500,000 (the amount by which the initial transferor's taxable gifts were increased as a result of the application of section to the initial transfer) or $1,400,000 (the duplicated amount). The duplicated amount is 100 percent (the portion of the section interest subsequently transferred) times $1,400,000 (the amount by which the gift tax value of the preferred stock ($1,400,000 at the time of the subsequent transfer) exceeds zero (the section value of the preferred stock at the time of the initial transfer)).
(iii) The result would be the same if the preferred stock had been held by P's parent, GM, and GM had, on October 1, 1994, transferred the preferred stock to or for the benefit of an individual other than P or an applicable family member of P. In that case, in computing the tax on P's 1994 and subsequent transfers, P would be entitled to reduce the amount on which P's tentative tax is computed under section by $1,400,000. If the value of P's 1994 gifts is less than $1,400,000, P is entitled to claim the excess adjustment in computing the tax with respect to P's subsequent transfers.
Example 2. Transfer of section 2701 interest at death of initial transferor,
(i) P continues to hold the preferred stock until P's death. The chapter 11 value of the preferred stock at the date of P's death is the same as the fair market value of the preferred stock at the time of the initial transfer. In computing the Federal estate tax with respect to P's estate, P's executor is entitled to a reduction of $1,500,000 under of this section.
(ii) The result would be the same if P had sold the preferred stock to any individual other than an applicable family member at a time when the value of the preferred stock was $1,500,000. In that case, the amount of the reduction is computed as if the preferred stock were included in P's gross estate at a fair market value equal to the sales price. If the value of P's taxable estate is less than $1,500,000, the amount of the adjustment available to P's executor is limited to the actual value of P's taxable estate.
(iii) The result would also be the same if the preferred stock had been held by P's parent, GM, and at the time of P's death, GM had not transferred the preferred stock.
Example 3. Transfer of after-acquired preferred stock, On September 1, 1992, P purchases 100 shares of X preferred stock from an unrelated party. On October 1, 1994, P transfers 100 shares of X preferred stock to P's child. In computing P's 1994 gift tax, P is not entitled to reduce the amount on which P's tentative tax is computed under section because the 1994 transfer does not reduce P's preferred stock holding below that held at the time of the initial transfer. See of this section.
Example 4. Inter vivos transfer of entire section 2701 interest,
(i) On October 1, 1994, at a time when the value of P's preferred stock is $1,400,000, P transfers all of the preferred stock to P's child. In computing P's 1994 gift tax, P, as the initial transferor, is entitled to reduce the amount on which P's tentative tax is computed under section by $700,000.
(ii) The amount of the reduction computed under of this section is the lesser of $750,000 (($1,500,000 × .5 ($1,000,000 over $2,000,000)) the amount by which the initial transferor's taxable gifts were increased as a result of the application of section to the initial transfer) or $700,000 (($1,400,000 × .5) the duplicated amount). The duplicated amount is 100 percent (the portion of the section interest subsequently transferred) times $700,000; e.g., one-half (the fraction representing the portion of the common stock transferred in the initial transfer ($1,000,000/$2,000,000)) of the amount by which the gift tax value of the preferred stock at the time of the subsequent transfer ($1,400,000) exceeds zero (the section value of the preferred stock at the time of the initial transfer).
Example 5. Subsequent transfer of less than the entire section 2701 interest, On October 1, 1994, at a time when the value of P's preferred stock is $1,400,000, P transfers only 250 of P's 1,000 shares of preferred stock to P's child. In this case, the amount of the reduction computed under paragraph (b) is $175,000 (one-fourth (250/1,000) of the amount of the reduction available if P had transferred all 1,000 shares of preferred stock).
(e) Computation of reduction if initial transfer is split under section 2513
(1) In general If section applies to the initial transfer (a split initial transfer), the special rules of this apply.
(2) Transfers during joint lives If there is a split initial transfer and the corresponding section interest is transferred during the joint lives of the donor and the consenting spouse, for purposes of determining the reduction under of this section each spouse is treated as if the spouse was the initial transferor of one-half of the split initial transfer.
(3) Transfers at or after death of either spouse
(i) In general If there is a split initial transfer and the corresponding section interest is transferred at or after the death of the first spouse to die, the reduction under or of this section is determined as if the donor spouse was the initial transferor of the entire initial transfer.
(ii) Death of donor spouse Except as provided in of this section, the executor of the estate of the donor spouse in a split initial transfer is entitled to compute the reduction as if the donor spouse was the initial transferor of the section interest otherwise attributable to the consenting spouse. In this case, if the consenting spouse survives the donor spouse—
(A) The consenting spouse's aggregate sum of taxable gifts used in computing each tentative tax under section (and, therefore, adjusted taxable gifts under section (or section ) and the tax payable on the consenting spouse's prior taxable gifts under section (or section )) is reduced to eliminate the remaining effect of the section interest; and
(B) Except with respect to any excess reduction carried forward under of this section, the consenting spouse ceases to be treated as the initial transferor of the section interest.
(iii) Death of consenting spouse If the consenting spouse predeceases the donor spouse, except for any excess reduction carried forward under of this section, the reduction with respect to any section interest in the split initial transfer is not available to the estate of the consenting spouse (regardless of whether the interest is included in the consenting spouse's gross estate). Similarly, if the consenting spouse predeceases the donor spouse, no reduction is available to the consenting spouse's adjusted taxable gifts under section (or section ) or to the consenting spouse's gift tax payable under section (or section ). See of this section for rules involving transfers by an applicable family member during the life of the initial transferor.
(iv) Additional limitation on reduction If the donor spouse (or the estate of the donor spouse) is treated under this as the initial transferor of the section interest otherwise attributable to the consenting spouse, the amount of additional reduction determined under of this section is the amount determined under that paragraph with respect to the consenting spouse. If a reduction was previously available to the consenting spouse under this , the amount determined under this with respect to the consenting spouse is determined as if the consenting spouse's taxable gifts in the split initial transfer had been increased only by that portion of the increase that corresponds to the remaining portion of the section interest. The amount of the additional reduction (i.e., the amount determined with respect to the consenting spouse) is limited to the amount that results in a reduction in the donor spouse's Federal transfer tax no greater than the amount of the increase in the consenting spouse's gift tax incurred by reason of the section interest (or the remaining portion thereof).
(f) Examples The following examples illustrate the provisions of of this section. The examples assume the facts set out in this .
Facts. (1) In each example assume that P, an individual, holds 1,500 shares of $1,000 par value preferred stock of X corporation (bearing an annual noncumulative dividend of $100 per share that may be put to X at any time for par value) and 1,000 shares of voting common stock of X. There is no other outstanding stock of X. The annual exclusion under section is not allowable with respect to any gift.
(2) On January 15, 1991, when the aggregate fair market value of the preferred stock is $1,500,000 and the aggregate fair market value of the common stock is $500,000, P transfers all 1,000 shares of the common stock to P's child. Section applies to the initial transfer because P transferred an equity interest (the common stock) to a member of P's family and immediately thereafter held an applicable retained interest (the preferred stock). The fair market value of P's interest in X immediately prior to the transfer is $2,000,000 and the section value of the preferred stock (the section interest) is zero. With respect to the initial transfer, the amount remaining after Step 2 of the subtraction method of was $2,000,000 ($2,000,000 minus zero), all of which is allocated to the transferred stock. P had made no gifts prior to 1991. The sum of P's aggregate taxable gifts for the calendar year 1991 (including the section transfer) is $2,500,000. P's spouse, S, made no gifts prior to 1991.
(3) P and S elected pursuant to section to treat one- half of their 1991 gifts as having been made by each spouse. Without the application of section , P and S's aggregate gifts would have been $500,000 and each spouse would have paid no gift tax because of the application of the unified credit under section . However, because of the application of section , both P and S are each treated as the initial transferor of aggregate taxable gifts in the amount of $1,250,000 and, after the application of the unified credit under section , each paid $255,500 in gift tax with respect to their 1991 transfers. On October 1, 1994, at a time when the value of the preferred stock is the same as at the time of the initial transfer, P transfers the preferred stock (the section interest) to P's child.
Example 1. Inter vivos transfer of entire section 2701 interest, P transfers all of the preferred stock to P's child. P and S are each entitled to a reduction of $750,000 in computing their 1994 gift tax. P is entitled to the reduction because P subsequently transferred the one-half share of the section interest as to which P was the initial transferor to an individual who was not an applicable family member of P. S is entitled to the reduction because P, an applicable family member with respect to S, transferred the one-half share of the section interest as to which S was the initial transferor to an individual other than S or an applicable family member of S. S may claim the reduction against S's 1994 gifts. If S's 1994 taxable gifts are less than $750,000, S may claim the remaining amount of the reduction against S's next succeeding lifetime transfers.
Example 2. Inter vivos transfer of portion of section 2701 interest, P transfers one-fourth of the preferred stock to P's child. In this case, P and S are each entitled to a reduction of $187,500, the corresponding portion of the reduction otherwise available to each spouse (one-fourth of $750,000).
Example 3. Transfer at death of donor spouse, P, the donor spouse in the section election, dies on October 1, 1994, while holding all of the preferred stock. The executor of P's estate is entitled to a reduction in the computation of the tentative tax under section . Since no reduction had been previously available with respect to the section interest, P's estate is entitled to a full reduction of $750,000 with respect to the one-half share of the preferred stock as to which P was the initial transferor. In addition, P's estate is entitled to an additional reduction of up to $750,000 for the remaining section interest as to which S was the initial transferor. The reduction for the consenting spouse's remaining section interest is limited to that amount that will produce a tax saving in P's Federal estate tax of $255,500, the amount of gift tax incurred by S by reason of the application of section to the split initial transfer.
Example 4. Transfer after death of donor spouse, The facts are the same as in Example 3, except that S acquires the preferred stock from P's estate and subsequently transfers the preferred stock to S's child. S is not entitled to a reduction because S ceased to be an initial transferor upon P's death (and S's prior taxable gifts were automatically adjusted at that time to the level that would have existed had the split initial transfer not been subject to section ).
Example 5. Death of donor spouse after inter vivos transfer,
(i) P transfers one-fourth of the preferred stock to P's child. In this case, P and S are each entitled to a reduction of $187,500, the corresponding portion of the reduction otherwise available to each spouse (one-fourth of $750,000). S may claim the reduction against S's 1994 or subsequent transfers. P dies on November 1, 1994.
(ii) P's executor is entitled to include, in computing the reduction available to P's estate, the remaining reduction to which P is entitled and an additional amount of up to $562,500 ($750,000 minus $187,500, the amount of the remaining reduction attributable to the consenting spouse determined immediately prior to P's death). The amount of additional reduction available to P's estate cannot exceed the amount that will reduce P's estate tax by $178,625, the amount that S's 1991 gift tax would have been increased if the application of section had increased S's taxable gifts by only $562,500 ($750,000 − $187,500).
(g) Double taxation otherwise avoided No reduction is available under this section if—
(1) Double taxation is otherwise avoided in the computation of the estate tax under section (or section ); or
(2) A reduction was previously taken under the provisions of section with respect to the same section interest and the same initial transfer.
(h) Effective date This section is effective for transfers of section interests after May 4, 1994. If the transfer of a section interest occurred on or before May 4, 1994, the initial transferor may rely on either this section, project PS-30-91 (1991-2 C.B. 1118, and 1992-1 C.B. 1239 (see )) or any other reasonable interpretation of the statute.
[T.D. 8536, 59 FR 23154, May 5, 1994]