OPINION
Thе Estate of Anne W. Morgens (“the Estate”) appeals the United States Tax Court’s decision that it owed additional estate taxes. This case presents the question whether gift taxes paid by the donee trustees of a Qualifying Terminable Interest in Property (QTIP) trust, based on a 26 U.S.C. § 2519 1 deemed inter vivos transfer of the QTIP property within three years of the donor’s death, must be included in the transferor’s gross estate under the so-called “gross-up rule” of § 2035(b). We hold that it does. We have jurisdiction under § 7482, and we affirm.
I. Statutory Background
This case turns on two statutory schemes within the Internal Revenue Code. The first is § 2035(b), the “gross-up rule,” which requires that a gross estate be increased by the amount of gift taxes paid by the decedent or her estate within three years of her death. Section 2035 states, in relevant part:
§ 2035. Adjustments for certain gifts made within 3 years of decedent’s death.
(b) Inclusion of gift tax on gifts made during 3 years before decedent’s death The amount of the gross estate (determined without regard to this subsection) shall be increased by the amount of any tax paid under chapter 12 by the decedent or his estate on any gift made by the decedent or his spouse during the 3-year period ending on the date of the decedent’s death.
(emphasis added). We hаve explained before the purpose and structure of the gross-up rule of § 2035(b).
*771 Section 2035[ (b) ] is designed to recoup any advantage gained by so-called “death-bed” transfers in which a taxpayer, cognizant of impending mortality, transfers property out of her estate in order to reduce estate tax liability. Although these inter vivos transfers incur gift tax liability, opting to transfer assets prior to death still carries a tax advantage. Gift tax is calculated using a tax exclusive method (the applicable rate is applied to the net gift, exclusive of gift taxes), whereas estate taxes are calculated on a tax inclusive method (the applicable rate is applied to the gross estate, before taxes are deducted). Section 2035[ (b) ] presumes that gifts made within three years of death are made with tax-avoidance motives and eliminates the tax advantage for those death bed transactions.
Brown v. United States,
The second statutory scheme in this case is the QTIP regime. The QTIP is an exception to an exception to an exception. In general, a tax is levied on the transfer of estates. § 2001. However, the marital deduction is an exception to this rule, and any interest in property which passes to a surviving spouse is not considered part of the decedent’s gross estate. § 2056(a). Life estates and other terminable interests are an exception to the marital deduction. § 2056(b)(1). Finally, the QTIP regime is an exception to the terminable interest exception to the marital deduction. A QTIP is a terminable interest in property which has certain limiting characteristics: (1) the surviving spouse receives all of the income from the property for life, distributed at least annually (a “qualifying income interest”); (2) no person can appoint any part of the property to any person other than the surviving spouse; and (3) the decedent’s estate elects to treat the interest as a QTIP. § 2056(b)(7)(B). If an interest is a QTIP, the regime establishes a legal fiction: for the purposes of estate taxes, the entire property is treated as if it passed to the surviving spouse (and, consequently, nothing to the remaindermen)— even though the surviving spouse actually possesses only the income interest. § 2056(b)(7)(A). Therefore, the marital deduction of § 2056(a) applies to the entire QTIP property and the property is not included in the gross estate of the decedent.
The underlying premise of the QTIP regime is that the surviving spouse is deemed to receive and then give the entire QTIP property, rather than just the income interest. The purpose of the QTIP regime is to treat the two spouses as a singlе economic unit with respect to the QTIP property while still allowing the first-to-die spouse to control the eventual disposition of the property.
When all or part of the QTIP’s qualifying income interest is transferred — by death of the surviving spouse (§ 2044) or by inter vivos transfer (§ 2519) — such a transfer is deemed to transfer the entire QTIP property, except the qualifying income interest, which is an ordinary transfer undеr § 2511.
In the context of gift taxes or estate taxes, the donor is responsible for paying the tax. § 2502. In the context of a QTIP deemed transfer, the donor (the surviving spouse) by definition does not possess the remainder interest in the QTIP property; the donor possesses only the qualifying income interest. Therefore, § 2207A gives the donor the right to recover the tax from the QTIP beneficiariеs who receive the QTIP property transfer.
II. Facts and Procedural History
Anne- Morgens, the decedent in this case, married Howard Morgens when she *772 was 26 and remained married to him until his death in January 2000. In 1991, when Mrs. Morgens was 81, she and Mr. Morgens entered into the Morgens Family Living Trust Agreement. Under that agreement, Mr. and Mrs. Morgens each contributed assets to a Living Trust.
At Mr. Morgens’ death, the one-half of the community property in the Living Trust attributаble to Mrs. Morgens was allocated to a Survivor’s Trust, and the remaining one-half was allocated to a Residual Trust. After certain specific gifts, the remainder of the Residual Trust was held in trust for Mrs. Morgens’ benefit. She had the right to income for life from the Residual Trust. The Living Trust Agreement provided that, upon Mrs. Morgens’ death, the remainder of the Residual Trust was to be divided into shares for the Morgens’ сhildren and grandchildren.
In October 2000, Mr. Morgens’ estate tax return was filed. On its estate tax return, Mr. Morgens’ estate satisfied the criteria for and elected QTIP treatment for the property passing to the Residual Trust. See § 2056(b)(7). The Residual Trust therefore qualified for the marital deduction for federal estate tax purposes; its value was not taxed in Mr. Morgens’ estate.
Shortly thereafter, the Rеsidual Trust was divided into two trusts, Residual Trust A, worth approximately $8.3 million, and Residual Trust B, worth over $28 million. Mrs. Morgens maintained a right to the income from both Residual Trusts, paid at least annually. This division was not a taxable event.
However, on December 8, 2000, Mrs. Morgens relinquished her lifetime interest in the income from Residual Trust A. The income interest vested in the trust beneficiaries, Mrs. Morgens’ sons. Because Mr. Morgеns’ estate had elected QTIP treatment for the Residual Trust, Mrs. Morgens’ gift of her lifetime income interest in Residual Trust A triggered a gift tax on the deemed transfer of the remainder interest in the trust to the remainder beneficiaries: the Morgens’ children and grandchildren. The gross value of the property “treated as ... transferred]” under § 2519(a) — ie., the accelerated remainder interest in Residual Trust A — was computed as $6,398,901. Mrs. Morgens filed a gift tax return with respect to this transaction, reporting a net taxable gift of $4,111,592. The remainder of the gross transfer, $2,287,309, was paid to the Internal Revenue Service as gift tax by the trustees of Trust A (Mrs. Morgens’ sons).
On January 10, 2001, Mrs. Morgens relinquished her lifetime interest in the income from Residual Trust B. Like the disposition of her interest in Residual Trust A, this gift of Mrs. Morgens’ interest in the trust was subject tо tax as a transfer of the remainder interests in the trust to the remainder beneficiaries. § 2519(a), (b)(1). The gross value of the transferred accelerated remainder interest in Residual Trust B was computed as $21,676,289. Mrs. Morgens filed a gift tax return with respect to this transaction, reporting a net gift of $13,983,787. The remainder of the gross transfer, $7,692,502, was paid as gift tax by the trustees of Trust B(again, Mrs. Morgens’ sons). 2
Mrs. Morgens died on August 25, 2002, within three years of both her 2000 and 2001 transfers of her lifetime income interests in each of the trusts. Her estate tax return was timely filed (on extension) on November 24, 2003. Under the “grossup *773 rule,” a decedent’s gross estate includes all gift taxes paid by the decedent within three years of her death. § 2035(b). However, the return filed by the Estate did not include, as part of the gross estate, the gift taxes shown as paid on Mrs. Morgens’ 2000 and 2001 gift tax returns. The Commissioner determined a deficiency based on the failure to include the gift tax in the gross estate, and issued a notice of deficiency accordingly. The Estate petitioned the Tax Court for a redetermination.
Before the Tax Court, the Estate argued that the trustees paid the gift tax on the § 2519 deemed transfers, and that Congressional intent in enacting the QTIP regime was to shift both the primary and the ultimate liability for the transfer taxes from the QTIP donor to the donees. The Commissioner argued that the transfer taxes were paid indirectly by Mrs. Morgens for the purposes of § 2035(b), and that therefore the taxes must be included in the gross estate. The Tax Court held that the gift taxes paid pursuant to the QTIP rules on the gift of QTIP property were includible in Mrs. Morgens’ estate under § 2035(b). The Estate appealed.
III. Analysis
This court reviews
de novo
the Tax Court’s conclusions of law, including its construction of the Internal Revenue Code.
Biehl v. Comm’r,
For § 2035(b) to apply to gift taxes paid on § 2519 “deemed” transfers, those taxes must be paid “by the decedent”— that is, by Mrs. Morgens — -under the language of § 2035(b). We conclude that they were.
One possible reading of § 2035(b) suggests, at first, the оpposite conclusion. Gift taxes are included in the estate under § 2035(b) only if they are “paid ... by the decedent.” If taxes are “paid by” the person who sent the check, our analysis would be simple. The Joint Stipulation of Facts, to which the parties agreed, states that “the trustees of [the] Residual Trust[s] paid the ... gift tax” due on the § 2519 deemed transfers. Thus under this reading of § 2035(b), as the trusteеs paid the gift tax, then the gift tax could not have been paid by the decedent. But we are foreclosed from this analysis by
Diedrich v. Comm’r,
A “net gift” is an arrangement where “the donor [makes] the gift subject to the condition that the donee pay the resulting gift tax.”
3
Diedrich,
*774
“When a gift is made, the gift tax liability falls on the donor ... When a donor makes a gift to a donee, a ‘debt’ to the United States for the amount of the gift tax is incurred by the donor. Those taxes are as much the legal obligation of the donor as the donor’s income taxes ...”
Diedrich,
The Eighth Circuit considered the interaction of net gifts with § 2035(b)
4
in
Estate of Sachs v. Comm’r,
In a parallel argument to that of Mrs. Morgens’ estate before us, Sachs’ estate argued to the Eighth Circuit that “the donee’s payment of the gift tax on the ... gift should not be included in the gross estate under § 2035(b), on the ground that this was not ‘a tax paid ... by decedent or his estate.’ ” Id. at 1163. The Eighth Circuit rejected this argument because “the distinction between tax payments made by donees of net gifts and tax payments made directly by decedent-donors ... has little force after Diedrich.” Id.
The Eighth Circuit thus applied a substance-over-form analysis to conclude that “the fact that the Internal Revenue Service received the payment for the decedent’s gift-tax liability via the donee does not make it any less a ‘tax paid ... by the decedent or his estate’ within the meaning of § 2035(b).” Id. at 1164. In a net gift, “the payment of the gift tax is (or can be) made with funds from the donor’s gift, and pursuant to the donor’s condition. The donee’s payment of the gift tax under these circumstances is not an indepеndent act of gratitude or reciprocity,” as it was not in Diedrich. Id. Thus, “the donor of a net gift uses the donee as a conduit for the payment of the tax liability, and as donor of a net gift, he may be deemed to have paid the tax by ordering the donee to pay it over.” Id. (citation and quotation marks omitted). Gift taxes paid by the donee of a net gift must be included in the donor’s taxablе income under Diedrich; similarly, gift taxes paid by the donee of a gift made within three years of the donor’s death must be included within the donor’s gross estate under § 2035(b). Id. at 1164.
*775 The Eighth Circuit also noted the purpose of § 2035(b) — to prevent deathbed transfers from decreasing the taxable estate — and stated that because “[t]he assets which were used to pay the gift tax would have been part of the gross estate if the gift had never been made ... the entire amount of the gift tax [is] properly included [in the estate] under § 2035(b).” Id. at 1165. Thus, that court concluded that gift tax paid by a donee under a net gift arrangement — where the donee was obligated to pay the gift tax — was nonetheless paid by the decedent for the purposes of § 2035(b)’s gross-up rule.
We have applied similar rеasoning about a conduit of funds in
Brotm v. United States,
holding that when a husband gave his wife money to pay gift taxes on an insurance trust and the husband died within three years, the taxes were “paid by” the husband within the meaning of § 2035(b) and thus includible in the husband’s estate.
We find the net gift analogy persuasive. As in a net gift, the financial responsibility for the gift taxes on a QTIP transfer rests on the donees rather than the donor, even though the shift occurs by contract in a net gift and by the operation of § 2207A in a QTIP transfer.
6
However, as in a net gift, the liability for the gift taxes remains with the donor.
Diedrich,
We find unpersuasive the Estate’s argument that § 2207A evinces Congressional intent to shift not only the ultimate financial responsibility for QTIP transfers, but also the initial tax liability for the gift tax. This argument is foreclosed both by the language of § 2207A and by the reasoning of
Diedrich.
Section 2207A states that if “tax is paid ... with respect to any person by reason of property treated as transferred by such person under section 2519, such person shall be entitled to recovеr from the person receiving the property the amount [of tax paid].” The section does not state that tax
liability
is transferred, merely that the donor, who is liable for the tax, may recover the amount of the tax paid from the beneficiary of the deemed transfer. This is because the donor is treated as owning the QTIP property but, pursuant to the terms of the trust, does not fully control it, and thus cannot use part of it to pay gift taxes. Absent explicit statutory revision, the liability is the donor’s no matter the transfer of the final economic responsibility. As the Supreme Court stated in
Diedrich:
“When a gift is made, the gift tax liability falls on the donor ... When a donor makes a
gift
to a donee, a ‘debt’ to the United States for the amount of the gift tax is incurred by the donor. Those taxes are as much the legal obligation of the donor as the
*776
donor’s income taxes.”
As in a net gift, the QTIP trustees here paid the taxes on the § 2519 deemed transfers of the QTIP trusts. But in so doing, the trustees satisfied the tax liability incurred by Mrs. Morgens in making the transfer.
See Diedrich,
This conclusion is supported by the source-of-funds logic of Brown. Had Mrs. Morgens not made the deemed transfers under § 2519, the entire value of the trusts — income and remainder — would have been included in her estate under § 2044. 7 Therefore, our conclusion that the gift taxеs were paid by Mrs. Morgens for the purposes of § 2035(b) is consistent with Brown.
Thus, we hold Mrs. Morgens paid the gift tax on the § 2519 deemed transfers of the Residual Trusts and that her estate should be increased under the gross-up rule of § 2035(b) by the value of the gift taxes paid.
AFFIRMED.
Notes
. All subsequent Code citations are to 26 U.S.C. unless indicated otherwise.
. These amounts were later revised to $21,623,964, $13,937,756, and $7,686,208, respectively.
. After the events in this case, the Commissioner promulgated a regulation confirming that QTIP transfers are normally taxed as net gifts. See 26 C.F.R. § 25.2519-1 (c)(4). Although that regulation did not apply to this case, both parties agree that the QTIP transfer was properly taxed as a net gift.
. At the time Sachs was decided, § 2035(b) was codified as § 2035(c). For ease of reading, the statutory section will be listed as 2035(b) throughout this opinion.
. Initially, the estate included the gift tax paid as
income
to the estate under
Diedrich. Sachs,
. We take no position here on whether § 2201k provides a right of recovery for the additional estate taxes owed due to the inclusion of the gift taxes on the § 2519 deemed transfer in the gross estate under § 2035(b).
We note that here, in addition to the statutory right of recovery provided by § 2201k, the QTIP gifts here were made pursuant to indemnification agreements which provided a contractual right of recovery, as in a net gift.
. The estate also argues that the analogy to a net gift is inapposite because the property taxed was originally Mr. Morgens’ property rather than Mrs. Morgens’. This argument ignоres the underlying premise of the QTIP regime, that the entire QTIP property, rather than just the income interest, is deemed to pass to, and then from, the surviving spouse. Thus, the two spouses are treated as a single economic unit with respect to the QTIP property while still allowing the first-to-die spouse to control the eventual disposition of the property. The Estate cannot first use that favorable tax deferral (the § 2056 marital deduction) and then claim that the property never actually passed to Mrs. Morgens.