## Facts

- From 1970 through 1972, Lulu K. Flandreau transferred a total of $102,000 to her two sons and their wives.
- Flandreau reported the transfers on federal gift-tax returns and paid only $126 in gift tax because most transfers fell within the annual gift-tax exclusion then in effect.
- After each transfer, the recipient returned the same amount of cash to Flandreau.
- In exchange for the returned cash, Flandreau executed a promissory note to the recipient for the same amount.
- In total, Flandreau executed fourteen promissory notes in December 1970, January 1971, and January 1972.
- The notes were non-interest-bearing and unsecured.
- Each note was payable in 1995 (when Flandreau would have been 95 years old) or earlier upon her death.
- Flandreau died on February 20, 1986, without having repaid any portion of the notes.
- The estate claimed an estate-tax deduction of $102,000 as “claims against the estate” under I.R.C. § 2053(a)(3) based on the face amount of the notes.
- The Commissioner disallowed the deduction, asserting the obligations were not bona fide debts supported by adequate and full consideration in money or money’s worth under I.R.C. § 2053(c)(1).
- The Tax Court ruled for the Commissioner, characterizing the transactions as circular transfers and the notes as gratuitous promises; the estate appealed.

## Issues

1. Whether promissory notes issued to family members are deductible as “claims against the estate” under I.R.C. § 2053(a)(3) when each note arose from a prearranged gift of cash by the decedent followed by the recipient’s immediate return of the same cash to the decedent.
2. Whether such intrafamily notes were “contracted bona fide and for an adequate and full consideration in money or money’s worth” within the meaning of I.R.C. § 2053(c)(1).

## Decision

- The Second Circuit affirmed the Tax Court.
- The estate was not entitled to a § 2053 deduction for the $102,000 face amount of the notes.
- The court agreed that the transactions were circular transfers in substance and that the notes amounted to gratuitous promises rather than enforceable indebtedness supported by adequate consideration.
- Given the family context, the estate did not carry its burden to show a real debtor-creditor relationship, including a legitimate expectation of repayment and an intent to enforce repayment.
- The court relied in part on its earlier reasoning in Johnson v. Commissioner, 98 F.2d 62 (2d Cir. 1938), rejecting similar gift-and-loan-back arrangements as a basis for an estate-tax debt deduction.

## Legal Principles

- I.R.C. § 2053(a)(3) allows an estate-tax deduction for “claims against the estate,” but I.R.C. § 2053(c)(1) restricts deductions for claims founded on a promise or agreement unless the obligation was contracted in good faith and supported by adequate and full consideration in money or money’s worth.
- Courts examine the substance of an arrangement; formal notes and tax filings do not by themselves establish deductible debt.
- In intrafamily transactions labeled as loans, the estate bears a heavy burden to prove a real debtor-creditor relationship, including a genuine expectation of repayment and an intent to enforce the obligation.
- When a “loan” is funded by the decedent’s own cash through a coordinated gift followed by an immediate return of the same funds, the purported lender has not provided independent consideration in money or money’s worth.
- Loan terms inconsistent with arm’s-length dealing—such as no interest, no security, long or death-tied maturity, and no repayments—support a finding that the obligation is a non-deductible gift promise rather than a bona fide claim.

## Conclusion

The Second Circuit held that the estate could not deduct the face amount of promissory notes issued to the decedent’s sons and daughters-in-law because the notes arose from circular gift-and-return transfers and were not bona fide obligations supported by adequate and full consideration in money or money’s worth under I.R.C. § 2053(c)(1), so they did not qualify as deductible “claims against the estate” under § 2053(a)(3).


Estate of Flandreau v. Commissioner, 994 F.2d 91 (1993)