Take-Away: Sometimes what we do not treat as property may nonetheless be subject to transfer taxation, which often comes as a surprise to advisors and an even bigger surprise to clients and their heirs who have to pay a transfer tax on what they consider to be a phantom asset.

History Lesson:  The first time this question of what exactly is a taxable property interest came to my attention was back in the mid 1990’s. At that time my early-teens daughter was starting to read a lot books. One author who she voraciously read at the time was V.C. Andrews, who wrote many books about innocent children being trapped in attics, pitted against evil adults. Her biggest seller was Flowers in the Attic. Ms. Andrews writings created a new genre which came to be known as children in jeopardy. The Court Decision described Ms. Andrews’ writing theme as: “Each [book] was written in the first person and featured, as its principal character, a teenager, generally female, who was failed, and in some way hurt by an adult family member with a warped personality.” {I often thought my daughter looked at me somewhat strangely during what I have now come to refer to as her ‘ VC Andrews Years’! } Anyway, the noted author V.C. Andrews died in late 1986. Her estate filed a federal estate tax return, and here is the surprise, the personal representatives of Ms. Andrews’ estate ‘’did not list Andrews’ name as among its asset and consequently none of the estate taxes it paid were based on the value of Andrews’ name.” The IRS issued a notice of deficiency asserting that the Andrews’ name, standing alone, was an asset of the Estate having a value of $1.25 million on the date of her death, and thus the Estate owned an additional $649,201 in federal estate taxes. This was at a time when ghostwriting was in its infancy, and to be clear, it was not as if Ms. Andrews had written a yet-to-be published manuscript which upon publication would be capable of generating a substantial profit for her estate and heirs. Rather, all that was in place at the time of her death was a signed contract with her publisher which permitted the publisher to use Andrews’ name and likeness for advertising in connection with ‘her works.’ After her death the decision was made to hire a ghostwriter to write a book using the Andrews name, leading to the IRS’ claim [ using post-death facts to color date-of-death asset values?] that there was some value in Ms. Andrews’ name, standing alone, on her death. In the end the court applied a 33% valuation discount to the value of Ms. Andrews’ name since it was not clear that after the first publication of a ghostwritten book using her name if the public would find in it the same quality that Ms. Andrew’s name was associated with, so that future profits associated with future ghostwritten books were highly speculative. Consequently, for federal estate tax purposes, the final value of the name V.C. Andrews was set at $703,500,  which still a big phantom number at a time when the estate tax exclusion amount was $600,000, and the idea to hire a ghostwriter was still nothing but an idea on the date of her death. Estate of Andrews v U.S. 850 F. Supp. 1279 (1994)

New Trends in Property?: Why mention the taxation of  what might be termed a phantom asset? We are now speeding into a new era when as a society we engage in accepted activities, but we have yet to decide if those activities are services or property that is subject to transfer taxation. A few examples follow:

• Egg Donor: In 2015 the Tax Court held that compensation received by an egg donor in connection with her consensual performance of services under an egg donation contract with a couple was includable in her gross income under IRC 61(a)(1). This case only addressed the issue if the compensation received by the egg donor was properly characterized as taxable income. The decision was silent on whether the transfer of the eggs and the egg donation to the couple was a taxable. Perez v. Commissioner, 144 T.C. No 4 (January 22, 2015.) The Tax Court went out of its way to confirm that the donor was not being compensated for the sale of property, in connection with her egg donation, just for the services that she rendered in furtherance of the egg donation process. I have to give the donor credit for coming up with a novel, albeit unsuccessful, defense to the IRS’s assertion of income tax- she claimed that the compensation paid to her for her eggs was payment for her pain and suffering, which is non-taxable under IRC 104(a)(2).
• Bodily Fluids: Believe it or not, once upon a time the IRS was asked to comment on the tax treatment of breast milk. The contributor of the breast milk asked whether the donation of the milk to a nonprofit charitable organization qualified for a charitable deduction for income tax purposes. The question turned on whether the donation of breast milk was one of services or one of property. The IRS concluded that the breast milk was a donation of General Counsel Memorandum 36418 (September 15, 1975). But much earlier the IRS had held that a charitable deduction was not available for the fair market value of blood that was donated to a nonprofit organization because the giving of blood was a donation of a personal service rather than a contribution of property. Revenue Ruling 162, 1953-2 C.B. 127 (1953). When the 1975 General Counsel Memo was released it did not even try to distinguish its earlier position on blood donations as a service; it merely said that it did not think its decision in 1953 would be the same if given ‘today’ ( in 1975).
• Gametes: Of course neither of the two official IRS positions just cited were rendered at a time when the modern fertility industry was even imagined. While there is no legal market for the sale of human embryos, the absence of a legal market for such property does not by itself preclude that it is not property subject to transfer taxes. More to the point, other courts, not necessarily the IRS, seem willing  to treat gametes as property. Courts have held that the biological owners retain dispositional authority over stored gametic material, which can become part of the decedent’s estate. In Hall v. Fertility Institute of New Orleans, 647 So. 2d 1348 (La. 1994) the decedent instructed his frozen sperm to be given to his girlfriend on his death. The court held that the frozen semen would become her property and she would have full rights to the property’s Along the same lines, a court in California held that at the time of his death, the decedent had an interest in the nature of ownership, to the extent that he had decision-making authority as to the use of his sperm for reproduction, concluding that such interest was sufficient to constitute property within the meaning of California’s probate code. Hecht v. Superior Court of California, 16 Cal. App. 4^th 836 (Cal. 1993).
• Embryos: Divorce courts  now regularly deal with the disposition of frozen embryos. In in re Marriage of Rooks,  2016 Court of Appeals, 153 (Col. 2016) the divorce judge approached the task to award the couple’s frozen embryos as akin the to the equitable distribution of marital property. In another divorce case, the judge rejected the ex-wife’s argument to treat the frozen embryos as children subject to a ‘best interests’ standard often employed in child custody cases. Wilson v. Delgado, Ga. Sup. Court (S7A0797, April 17, 2017). In yet another decision dealing with frozen embryos, but not a divorce, the frozen embryos were characterized as property in a bailment lawsuit brought by a couple who created embryos for their own use against a clinic that refused to transfer the last remaining frozen embryo to a client in the couple’s new home state. York v. Jones, 717 F. Supp. 421 (E.D. Va, 1989.). The treatment of embryos as property was also the basis of court decisions when actions for property damage were brought against fertility clinics where stored embryos were allegedly harmed. Frisina v. Women& Infants Hospital of Rhode Island, 2002 WL 1288784 (Sup. Ct. R.I. 2002); Jeter v. Mayo Clinic Arizona, 121 P.3d 1256 (Ariz. Cit. App. 2005).

Conclusion: The trend, if the court decisions are any indication, is to treat frozen embryos and other reproductive material as property. Unanswered is if the IRS will start to treat the transfer of embryos and reproductive material as subject to gift or estate taxation. As one court noted: “[G]ametic material, with its potential to produce life, is a unique type of property and thus not governed by the general laws relating to gifts or personal property upon death….The person who provide the gametic material, had at his death an interest, in the nature of ownership, to the extent he had decision-making authority as to the use of the gametic material for reproduction.” Matter of Kievernagel, 166 Cal. App 4^th 1024 (Cal. 2008). Whether the Service will begin to try to place a value on organs, embryos and other gametic materials that are treated as property that are transferred and thus impose some transfer tax is the unanswered question. I guess yet another question is if an organ or embryo or egg is sold, if property, is there any basis in that asset to determine the gain on its sale? Lots of questions, very few answers.