Rev. Rul. 84-25

ISSUE

What are the gift and estate tax consequences if a donor/decedent gratuitously transfers a legally binding promissory note that has not been satisfied at the decedent's death?

FACTS

On August 1, 1977, D gratuitously transferred to A a promissory note in which D promised to pay A a sum of money on December 31, 1982. The note was legally enforceable under state law.

On May 30, 1982, D died. The note had not been satisfied at D's death.

LAW AND ANALYSIS

In the case of a legally enforceable promise for less than an adequate and full consideration in money or money's worth, the promisor makes a completed gift under section 2511 of the Internal Revenue Code on the date when the promise is binding and determinable in value rather than when the promised payment is actually made. Commissioner v. Copley's Estate, 194 F.2d 364 (7th Cir. 1952), aff'g 15 T.C. 17 (1950), acq., 1965-2 C.B. 4; Harris v. Commissioner, 178 F.2d 861 (2d Cir. 1949), reversed on other grounds, 340 U.S. 106 (1950), 1950-2 C.B. 77; Rev. Rul. 81-110, 1981-1 C.B. 479, Rev. Rul. 79-384, 1972-2 C.B. 344; Rev. Rul. 69-347, 1969-1 C.B. 227. In such a case, the amount of the gift is the fair market value of the contractual promise on the date it is binding. Section 25.2512-4 of the Gift Tax Regulations. See also Rev. Rul. 81-286, 1981-2 C.B. 177.

Section 2053(a)(3) of the Code provides for an estate tax deduction for the amount of claims against the estate as are allowable by the laws of the state under which the estate is being administered. These deductions, when founded on a promise or agreement, are limited by section 2053(c)(1) to the extent that the obligations are contracted bona fide and for an adequate and full consideration in money or money's worth. See Estate of Feinburg v. Commissioner, T.C.M. 1976-396; Estate of Davis v. Commissioner, 57 T.C. 833 (1972).

Under section 2001(b) of the Code, the estate tax is computed by determining a tentative tax on the sum of the taxable estate and the adjusted taxable gifts (section 2001(b)(1)) and subtracting from that amount the tax payable, calculated as provided in section 2001(b)(2), with respect to gifts made after 1976. The adjusted taxable gifts include only the value of the taxable gifts made by the decedent after 1976 that are not includible in the decedent's gross estate.

In this case, D made a completed gift under section 2511 of the Code on August 1, 1977, the date on which D's promise was legally binding and determinable in value. See Copley's Estate and Harris, cited above. Compare, Rev. Rul. 67-396, 1967-2 C.B. 351, which provides that the transfer of a promissory note that is unenforceable under state law is not a completed gift.

No deduction is allowable under section 2053 of the Code for A's claim as promisee on D's note, because the note was not contracted for an adequate and full consideration in money or money's worth. Section 2053(c)(1).

Since the note has not been paid, the assets that are to be used to satisfy D's promissory note are a part of D's gross estate. Therefore, D's 1977 gift to A is deemed to be includible in D's gross estate for purposes of section 2001 of the Code. Thus, D's 1977 gift is not an adjusted taxable gift as defined in section 2001(b) of the Code. Consequently, the value of D's 1977 gift is not added under section 2001(b)(1)(B) to D's adjusted taxable gifts in computing the tentative estate tax under section 2001(b)(1).

Of course, a different situation would be presented had the note been partially satisfied prior to D's death. To the extent that the note had been paid, the assets used to satisfy the note would not be included in D's estate and hence there would be no reason not to treat the satisfied portion of the note as an adjusted taxable gift. Therefore, the holding of this ruling applies only to the extent the promissory note remains unsatisfied at D's death.

HOLDING

The gratuitous transfer of a legally binding promissory note is a completed gift under section 2511 of the Code. If the note has not been satisfied at the promisor's death, no deduction is allowable under section 2053(a)(3) for the promisee's claim with respect to the note. The completed gift is not treated as an adjusted taxable gift in computing the tentative estate tax under section 2001(b)(1).

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 67-396 is clarified to the extent that it implies that the transfer of a legally enforceable promissory note is an incomplete gift. The promissory notes in the court cases cited in Rev. Rul. 67-396 were unenforceable. Rev. Rul. 67-396 is clarified to hold that the transfer of a legally unenforceable promissory note is an incomplete gift.