## Facts

- Victor P. and Frances Diedrich transferred appreciated stock to their children as inter vivos gifts conditioned on the children paying the resulting federal gift tax (a “net gift”).
- The donors’ adjusted basis in the stock was about $51,073.
- The children paid $62,992 in federal gift tax attributable to the transfers.
- The IRS treated the donees’ payment of the donors’ gift tax as discharge of the donors’ legal obligation, producing taxable gain to the extent the tax paid exceeded basis.
- The Tax Court ruled for the donors; the Eighth Circuit reversed; the Supreme Court granted review to resolve a circuit conflict.

## Issues

1. Whether a donor who makes a gift of appreciated property on condition that the donee pay the resulting federal gift tax realizes taxable income to the extent the donee-paid gift tax exceeds the donor’s adjusted basis.

## Decision

- The Supreme Court affirmed the Eighth Circuit.
- A donor who makes a net gift realizes taxable gain to the extent the gift tax paid by the donee exceeds the donor’s adjusted basis in the transferred property.
- The donee’s assumption and payment of the donor’s gift tax liability is treated as consideration included in the donor’s “amount realized” under I.R.C. § 1001.
- For income tax purposes, the transfer is treated as part sale (to the extent of the assumed tax) and part gift.

## Legal Principles

- The tax consequences of a transaction turn on its economic substance; discharge of a taxpayer’s legal obligation by another can constitute taxable economic benefit.
- Under I.R.C. § 1001, gain from a disposition equals the excess of the amount realized over adjusted basis; assumed liabilities may be included in the amount realized.
- In a net gift, the donee’s payment of the donor’s gift tax is consideration in money or money’s worth received in exchange for the property, supporting part-sale treatment for income tax purposes.
- Donative intent does not prevent income recognition where the donor receives an economic benefit from shifting a legal obligation.
- The transaction remains a gift for gift tax valuation (taxable gift equals property value reduced by the gift tax paid by the donee), while still generating income-tax gain where the assumed tax exceeds basis.

## Conclusion

A donor who conditions a gift of appreciated property on the donee’s payment of the donor’s gift tax must recognize income-tax gain under § 1001 to the extent the donee-paid gift tax exceeds the donor’s adjusted basis, even though the transfer retains its gift character for gift tax purposes.


Diedrich v. Commissioner, 457 U.S. 191 (1982)