## Facts

- Willet H. Brown died in 1993, leaving an estate of approximately $180 million that was treated as his separate property under a prenuptial agreement.
- Willet’s estate plan placed his net estate into a marital trust for his wife, Betty Brown, giving her income for life with the remainder to heirs, aiming to maximize the estate-tax marital deduction.
- To fund anticipated estate tax due at Betty’s later death, Willet created an insurance trust holding life-insurance policies on Betty’s life.
- Transfers of the policies were taxable gifts; Willet and Betty elected split-gift treatment, making both liable for gift tax.
- Because former 26 U.S.C. § 2035(c) required inclusion in a decedent’s gross estate of gift taxes paid within three years of death, Willet and Betty sought to have Betty pay the gift tax to avoid inclusion in Willet’s estate if he died within three years.
- Betty lacked sufficient funds, so Willet made a marital gift of cash to her; she then used those funds to pay the gift tax.
- Willet died within three years of the transaction, and the estate tax return did not include the gift taxes Betty paid.
- The IRS increased the estate’s tax liability by (1) treating Betty’s gift-tax payment as Willet’s payment under a step-transaction theory for § 2035(c) gross-up purposes, and (2) requiring that increased administration-expense deductions under § 2053(a)(2) reduce the marital deduction under § 2056 to the extent the expenses were paid from property otherwise allocable to the marital trust.
- The district court ruled for the United States on both issues; the estate appealed.

## Issues

1. Whether the IRS could apply the step-transaction doctrine to treat gift taxes nominally paid by the surviving spouse as paid by the decedent for purposes of former 26 U.S.C. § 2035(c), thereby increasing the decedent’s gross estate.
2. Whether an estate that increases its administration-expense deduction under 26 U.S.C. § 2053(a)(2) must reduce its marital deduction under § 2056 to the extent the additional expenses were paid from assets otherwise passing to the marital trust.

## Decision

- The Ninth Circuit affirmed the district court’s judgment in full.
- The court held that the IRS properly applied the step-transaction doctrine to treat the spouse’s gift-tax payment as the decedent’s payment for § 2035(c) gross-up purposes.
- The court held that increased administration-expense deductions under § 2053(a)(2) required a corresponding reduction in the marital deduction under § 2056 to the extent the expenses were paid from marital-share property.

## Legal Principles

- Courts may collapse formally separate steps into a single transaction for federal tax purposes when the steps are prearranged and interdependent parts of one plan; tax consequences follow the transaction’s substance rather than the nominal identity of the payor.
- For former § 2035(c), gift taxes paid within three years of death may be included in the decedent’s gross estate when, in substance, the decedent funded and effectuated the payment as part of an integrated plan.
- The marital deduction under § 2056 is limited to the value of property that actually passes to the surviving spouse (including via a qualifying marital trust), net of obligations and expenses charged against that property.
- An estate may deduct administration expenses under § 2053(a)(2), but it cannot obtain both an increased § 2053 deduction and an unreduced § 2056 deduction where the additional expenses were paid from assets otherwise allocable to the marital share.

## Conclusion

The Ninth Circuit upheld the IRS’s inclusion of gift taxes in the decedent’s gross estate by treating the spouse’s tax payment as the decedent’s payment under the step-transaction doctrine, and it required coordination of deductions so that added administration-expense deductions reduced the marital deduction when paid from marital-share assets.


Brown v. United States, 329 F.3d 664 (9th Cir. 2003)