Under the federal gift tax system, the donor pays the gift tax on a gift, and not the recipient ("donee") of the gift. In the classic "net gift," the recipient agrees to pay the gift tax on the gift. Because the recipient is paying an obligation of the donor, essentially paying money back to the donor, the value of the gift is reduced by the gift tax that must be paid by the recipient.
The classic net gift does not result in any actual tax savings, because the donor is simply making a smaller gift, and is usually done because the donor is making a gift of real property, a closely held business, or other assets that the donor doesn't wish to sell and the recipient has the cash necessary to pay the gift tax and is willing to pay the gift tax in order to get the property being given.
In a newer form of net gift, usually referred to as a "net-net gift," the recipient agrees to pay not only the gift tax on the gift, but the estate tax that might result if the donor dies within three years of making the gift. (If the donor dies within three years of the gift, then the gift tax that was paid on the gift becomes part of the gross estate for federal estate tax purposes and therefore subject to estate tax. Congress enacted this rule in order to treat gifts made shortly before death as in the same way as gifts made at death, because gift taxes paid on lifetime gifts are obligations of the donor and so reduce the donor's taxable estate while the estate tax does not reduce the taxable estate. See details for a more complete explanation.)
Unlike the classic net gift, the net-net gift produces an actual tax savings, because the value of the gift is being reduced by an amount that the recipients of the gift have not actually paid, and might never pay if the donor survives the three-year period after the death. And, even if the donor does die within the three-year period, the resulting estate tax is still less than it would have otherwise been because the gift tax that was paid was less than it otherwise would have been.
Based on a court opinion upholding the validity of a net-net gift, it would appear that the present value of the estate tax that might be paid should be valued in the same way as a contingent remainder (the present value of $1 payable upon the death of an individual, but only if the individual dies within the three-year period), applying the rules of I.R.C. section 7520, which generally controls the valuation of life estates, remainders, and annuities.
It would also seem to be possible for the recipient of a gift to agree to pay the estate tax that might be owed on the gift tax even though the donor will pay the gift tax and not the donor. (In other words, the donor is willing to pay the gift tax, but wants the recipients to pay the estate tax on the gift tax.) This might be called a "semi-net gift." As explained above, the payment of the gift tax by the recipients does not produce any tax savings, but usually reflects a choice about who is best able to bear the burden of the gift tax that must be paid. A "semi-net gift" should be produce the same gift tax savings as a net-net gift in those cases in which the donor is the one best able to pay the gift tax.
A net-net gift also has income tax consequences: