• Intrafamily loan upheld—In Estate of Barbara Galli v. Commissioner, Docket Nos. 7003-20 and 7005-20 (March 5, 2025), the Tax Court held for the taxpayer that an intrafamily interest-only loan at the applicable federal rate (AFR) wasn’t a gift. Barbara made a $2.3 million loan to her son Stephen in 2013, three years before her death, documented with a note. The loan called for annual interest payments at the midterm AFR of 1.01%. Stephen paid the interest each year, and Barbara reported it on her income tax return. No gift tax return was filed. On the estate tax return, the unpaid portion of the loan was included as an asset.
The Internal Revenue Service issued notices of deficiency asserting that there was a gift because the unsecured loan didn’t have terms that would have made it enforceable in the commercial marketplace. The IRS also stated that Stephen had no intent or ability to pay it and that Barbara didn’t expect repayment. The IRS applied a discount when determining the note’s fair market value (FMV) for gift tax purposes to account for the risk of nonpayment. As a result, the IRS concluded that the loan’s principal amount, less the note’s FMV, was a gift. Alternatively, the IRS claimed that the estate tax value of the note should be determined by discounting the value of the future payments and applying the current AFR rate, which would increase the value of the estate by $544,000.
However, the court found that the IRS didn’t allege or show any facts supporting its claim that Stephen didn’t have the ability or intent to repay the loan.
Further, the court held the loan can’t be recharacterized as a gift if it was made using the AFR because under Internal Revenue Code Section 7872,
a loan bearing interest at the AFR isn’t a “below-market loan” to which IRC Section 7872 applies. In Frazee v. Comm’r, 98 T.C. 554, 588 (1992), the Tax Court held that Section 7872 provides “comprehensive treatment of below-market loans for income and gift tax purposes,” explaining that by enacting Section 7872, Congress intended the discounting methodology to fully replace the traditional fair market methodology of valuation of below-market loans.
This case helps cement the position that a note bearing interest at AFR, which the parties respect and intend to pay/collect, will be valued at the amount of outstanding principal for gift and estate tax purposes.
• Valuation of qualified terminable interest property (QTIP) trust isn’t adjusted for liability—In Kalikow v. Comm’r, 135 A.F.T.R.2d 2025-831 (March 4, 2025), the U.S. Court of Appeals for the Second Circuit upheld the Tax Court’s ruling on summary judgment motions regarding the estate tax treatment of a settlement payment owed by a QTIP marital trust to the estate of the beneficiary widow.
Pearl Kalikow survived her husband, Sidney. Sidney’s will established a QTIP marital trust that held 10 properties. After Pearl’s death, the trustees of the QTIP trust reorganized the 10 properties into a family limited partnership. On Pearl’s death, the QTIP trust assets passed to her two children.
Meanwhile, Pearl’s estate ultimately passed to charity. On her death, her estate made a claim against the QTIP trust, asserting that she hadn’t been properly paid the net income from the QTIP trust, as required. The issue was settled, and the QTIP trust agreed to pay over $6 million to Pearl’s estate to satisfy the claim.
The taxpayers argued that the value of the QTIP trust should be reduced by the claim payable to Pearl’s estate. However, the court explained that the QTIP trust assets were includible in Pearl’s estate, not the QTIP trust entity itself. The assets of the QTIP trust weren’t encumbered by the putative claim as of the date of death. A hypothetical purchaser of the assets of the QTIP trust wouldn’t reduce the purchase price of those assets by the QTIP trust’s obligation to back pay the net income. Because the liability didn’t affect the value of the underlying partnership owning the 10 properties, it wasn’t relevant to the valuation of the assets included in Pearl’s estate.
In the alternative, the taxpayers argued that the estates should deduct the $6 million settlement payment as an administrative expense. However, this argument wasn’t successful. The court held that, as to the estate, the $6 million payment was an asset or receivable, not an expense.
So, no adjustment was made to the QTIP trust, valued at almost $55 million, for estate tax purposes in Pearl’s estate.
Had the estate prevailed in this case, the QTIP trust would have been reduced by $6 million for estate tax purposes, and the $6 million received by Pearl’s estate would have qualified for the estate tax charitable deduction.
