Hi everyone,

I understand this section pretty well but I’ve just realised something doesn’t make sense to me and I can’t get my head around it, if someone could please guide me? It really doesn’t relate to the actual formula but the logic around it.

For a donate now vs bequest @ death situation where the giver (donor) pays the donation tax. Mathematically I understand the formula of why we include the addition of Te.Tg in the numerator. But why does this actually exist in the first place?

Example: giver has $200 and donates$100 now. assume zero return rates to both parties and tax rate of 20% for donations/estate.

When the giver donates now, donations tax is $20, after-tax value donation is$80.
When the giver dies, his estate value is now $100 (200-100) and should pay$20 ($100x20%) in estate duty tax. The formula is implying there a deduction for the donations tax paid of$20, to his estate. I.e. that his estate value is actually now $100-$20 = $80, as a result of the donation. The difference leading to the Te.Tg (20% x 20% = 0.04) I can’t understand why this makes sense or why it should be a deduction to his estate in the first place? Just because he paid donations tax on a previous donation, he now gets to deduct that tax from his estate which already excludes that donated value? Using your example, if donor pays the gift tax: • Donor transfer$100 gift to recipient (Estate value declines from $200 to$100).
• Donor pays the gift tax of 20% \times $100 =$20 from his estate (Estate value declines from $100 to$80; out of pocket expense).

And assuming no further growth in estate value, if the donor dies, the estate tax (assuming 20%) will be applied on the estate value of $80, so the estate tax is$16.

The after-tax value of the estate = $80 -$16 = $64 After-tax value of gift + estate =$100 gift + $64 estate =$164

• Gift = $100 (Donor’s estate value drops from$200 to $100) • Recipient pays 20% gift tax (Gift value declines from$100 to $80) Assuming no further growth, when the donor dies, the estate tax will be 20% \times$100 = $20. After-tax estate value =$100 - $20 =$80
After-tax value of gift + estate = $80 gift +$80 estate = $160 ================ Benefit of donor paying gift tax = Difference in after-tax value of gift & estate (donor pays vs recipient pays gift tax) =$164 - $160 =$4 (which is 20% Te x 20% Tg x $100 gift) Hi Fino, Thank you for your time, quick reply and the thoroughly explained answer. I actually thought of your exact explanation (referring to when the donor pays the gift tax) - but I fell short (or convinced myself otherwise) because the numerator of the formula still includes (1-Tg) right? So if the donations tax is coming from the donor’s “other$100” and doesn’t directly reduce the receiver’s donation, why are we still reducing the receiver’s investment value by the donations tax? Am I making sense?
The numerator would be (1-0.2)*$100 =$80 which is then grown at the recipient’s after-tax return, but you’re saying the recipient actually received \$100? I completely agree though that since we’re not changing the denominator and if we were to exclude 1-Tg in the numerator, we then wouldn’t be showing a necessary tax implication so it has to be accounted for.