900 / What are the federal gift tax results if the donee agrees to pay the gift tax?

If a gift is made subject to the express or implied condition that the donee pay the gift tax, the donor may deduct the amount of tax from the gift in determining the value of the gift. In such a transaction, the donor receives consideration for the transfer in the amount of the gift tax paid by the donee. Thus, to the extent of the tax paid, the donee does not receive a gift.¹ Similarly, if the donor makes a gift in trust subject to an agreement that the trustee pay the gift tax, the value of the property transferred is reduced for gift tax purposes by the amount of the
tax.²

The computation of the tax requires the use of an algebraic formula, since the amount of the tax is dependent on the value of the gift which in turn is dependent on the amount of the tax. The formula is as follows:

Tentative Tax	= True Tax
1 plus Rate of Tax

Examples illustrating the use of this formula, with the algebraic method, to determine the tax in a net gift situation are contained in IRS Publication 904 (Rev. May 1985). Three of the examples show the effect of a state gift tax upon the computation.

Although the donee pays the tax, it is the donor’s unified credit that is used in computing the gift tax, not the donee’s.³