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Abstract

This Article takes a more sanguine approach: it acknowledges the utility of certain portions of these provisions to a functioning transfer tax system, but ultimately concludes that the current statutory scheme is overbroad in reach, clumsy in application, and therefore should be replaced with a single, stand-alone provision. Such a provision would require inclusion of property irrevocably transferred during life in which (a) the transferor retains an economic interest in the property, such as the right to use the property or to receive the income generated by the property, (b) the transferor pays gift tax at the time of transfer on less than the full fair market value of the property and (c) the retained interest does not constitute a “qualified interest,” or involve the use of a “personal residence,” as those terms are used in Section 2702 of the Internal Revenue Code. Put simply, this Article advocates limiting inclusion to lifetime transfers to which Section 2036(a)(1) currently applies but only when the transferor values her retained interest at an amount other than zero for purposes of calculating the applicable gift tax except when the retained interest can be accurately measured on an actuarial basis. In addition, this Article advocates, by extension, that lifetime transfers in which the transferor retains control of the beneficial interests of others (such as the ability to designate additional or different beneficiaries or to determine the amounts that each might receive) but relinquishes all financial advantage for herself should be treated as completed gifts when made and thus subject only to gift taxation on the fair market value of the property at the time of transfer. Finally, the Article advocates retention of Section 2037(a), albeit in truncated form and without any threshold requirement regarding the value of the reversionary interest as a condition on inclusion, because the presence of a reversionary interest – however contingent it may be and however de minimis its value may seem – prevents the transferor from washing her hands of the property from an economic perspective. In short, this Article advocates retention of Sections 2036(a)(1) and 2037(a), with certain modifications, and repeal of the remainder of Sections 2036 and 2037 and the entirety of Section 2038.

This Article consists of two main parts. Part II reviews the history and scope of Sections 2036, 2037 and 2038 of the Internal Revenue Code. This part shows that these provisions are not an integrated whole but rather seriatim responses to judicial decisions about estate taxation with which Congress disagreed. This part contends that Congress’ hurried efforts to respond to perceived judicial mistakes resulted in statutory provisions that are difficult to understand and even more difficult to apply. Part III proposes an alternative approach to transfer taxation of retained interests and powers of the type covered by Sections 2036, 2037 and 2038. This part advocates repeal of these provisions and replacement with a stand-alone provision that preserves estate taxation when the transferor retains a financial interest in the property, but values her interest at an amount other than zero for gift tax purposes, except when her interest involves payment of specific amounts, at specific times, or the use of a personal residence. In addition, this part includes suggested text for such a statutory provision, provides commentary regarding various aspects of the suggested provision and explains why this approach is preferable to current law. Lastly, Part IV summarizes these arguments and briefly concludes.

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