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2013 Federal Trust and Estate Planning Opportunities - Comments from the 47th Annual Philip E. Heckerling Institute on Estate Planning - Part 1

Jun 9, 2013
  1. Continued Fallout from the 2010 Tax Act and the Impact of the 2012 Tax Act
  2. The Administration's Revenue Proposals
  3. State Estate Taxes
  4. 2012-2013 Treasury and IRS Priority Guidance Plan
  5. Transfer Tax Developments
  6. April 2013 - Fiscal Year 2014 U.S. Treasury Greenbook and President Obama's Budget Proposals – Estate Trust and Gift Provisions
  7. Members of EisnerAmper's  Trust and Estate Planning Group 


The 47th Annual Heckerling Institute ("Institute") on Estate Planning was held in January 2013 in Orlando, Florida. The Institute is one of the largest annual estate and trust planning conferences held in the United States as a forum to discuss current and emerging income and transfer tax planning developments as well as selected topics of interest to tax professionals and financial advisors. The information in this Outline cannot be reproduced or copied in any form without the express permission of the Heckerling Institute on Estate Planning at or via telephone at 305.284.4762.

2013 Heckerling Institute Presenting Panelists Included

  • Dennis I. Belcher, McGuire Woods LLP, Richmond, Virginia
  • Samuel A. Donaldson, Georgia State University of Law, Atlanta, Georgia
  • Beth Shapiro Kaufman, Caplin & Drysdale, Washington, DC

This outline summarizes the 2013 Institute highlights, as well as provides mid-year 2013 observations for consideration by our clients and professional relationships including trust officers and attorneys, family office directors, investment advisors, insurance professionals, and financial advisors. This outline is presented in two sections; the first section summarizes recent developments, and the second section summarizes selected topics that could present significant current and future tax planning opportunities in the current economic climate. This outline focuses on Part I, "2013 Recent Developments." Part II will be released subsequently.

PART I - A Current View: Mid-Year 2013 Observations Federal and State Trust and Estate Planning Opportunities
EisnerAmper Personal Wealth Advisors
Comments from the 47th Annual Philip E. Heckerling Institute on Estate Planning

1. Continued Fallout from the 2010 Tax Act and the Impact of the 2012 Tax Act

Introduction: The panelists opened this session with a discussion of the American Taxpayer Relief Act of 2012 ("2012 Tax Act"), which was signed by President Obama in January 2013 as a proactive remedy to avoid the "fiscal cliff." The panelists mused that since the law was technically enacted in 2013, it was a stretch to include it in their discussions on 2012 recent developments; however, since the law was enacted only a couple of days after December 31, 2012, it was eligible for discussion!

The 2012 Tax Act enacts the first permanent provisions in the estate tax law in twelve years. Prior to this, since 2001, estate and gift tax planners have had to tell their clients of law changes every year or so.  The Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 ("2010 Tax Act") legislated that there would be no estate tax in 2010. However there would be a $5 million unified gift, estate and generation skipping transfer ("GST") tax exclusion available in 2011 and 2012. The 2010 Tax Act extended for two years, to December 31, 2012, the Bush-era tax cuts, and enacted a one-year 2% payroll tax reduction, a 13-month extension of employment benefits, and a 35% top transfer tax rate. Also with the 2010 Act, after 2012 the unified estate and gift tax exemptions were scheduled to revert to $1 million, and the top transfer tax rate would skyrocket to 55%.

The 2010 Act prompted many estate and gift tax professionals to advise their clients to consider making substantial gifts before 2013 in order to avail themselves of the opportunity to transfer large amounts of wealth to younger family members. And indeed many clients did take action before the end of 2012. However the 2012 Tax Act rewarded procrastination; those that did not accomplish trust and estate planning transfers in 2012 did not lose any benefits. And some who did utilize the available exclusion had "donor's remorse" and wondered if they could undo their 2012 gifts.

The fiscal cliff came to a head on December 31, 2012 with the resolution of the related tax issues with the 2012 Tax Act. However, now as we approach mid-year 2013, what remains for 2013 and the issues surrounding the current debt ceiling and sequestration? With the 2012 Tax Act, the estate tax was not really a driver in the process, but the issues were nevertheless debated. President Obama had proposed a $3.5 million exemption and a 45% tax rate, which had set the end point for the negotiation. The 40% estate tax rate seemed to have been a compromise between the 35% and 45% rates, and is close to the top income tax rate of 39.6%. Indexing for inflation of the exclusion amounts was the last issue resolved in the negotiations, and should be helpful in gift planning for future years.

  • The 2012 Tax Act: Provisions Impacting Estate and Gift Planning 
    • The major provisions of the 2012 Tax Act which impact estates and gifts are as follows:
      • The $5 million exclusion is unified for gift and estate tax purposes, indexed for inflation from 2011.  The GST exemption is also set for $5 million and also indexed each year. The 2013 gift, estate and GST exclusion amount for each individual is $5,250,000. The Tax Policy Center stated that this will produce 3,000-4,000 taxable estates per year. The issue of claw back that might have resulted with a reduced exclusion is now off the table.
      • Portability is made permanent. This provision changes everything as provided under the 2010 Tax Act; under the 2010 Act married couples would have had to die within the two-year period ending December 31, 2012 in order to avail oneself of the advantages portability had to offer. Now that portability is here to stay, it should become an important aspect of planning, as cited below.
      • The top rate is 40%; lower rates are applicable for nonresident aliens and estate and gift taxpayers.
      • The state death tax deduction is allowed, but not the state death tax credit.
      • The package of GST provisions was kept intact and now permanent, including the "9100 relief rules" and the allocation rules.
      • The sunset provisions were repealed, so that one will never have to consider what the law would have been if the law had never been enacted.
    • Portability: Portability of any unused applicable exclusion amount for a surviving spouse of a decedent who dies after 2010 if the decedent's executor makes an appropriate election on a timely filed estate tax return that computes the unused exclusion amount is commonly referred to as the "deceased spousal unused exclusion amount" or DSUE amount. The surviving spouse can use the DSUE amount either for gifts or for estate tax purposes at the surviving spouse's subsequent death. An individual can use the DSUE amount only from his or her-last deceased spouse. The Joint Committee Staff Explanation to the 2010 Act provides that this requirement applies even if the last-deceased spouse has no unused exclusion and even if the last-deceased spouse does not make a timely election.

The portability concept was implemented by amending Sec. 2010(c) to provide that the estate tax applicable exclusion amount is (1) the basic exclusion amount of $5 million, indexed from 2010, plus (2) for a surviving spouse the DSUE amount.

The DSUE amount is the lesser of (1) the basic exclusion amount or (2) the basic exclusion amount of (i) the surviving spouse's last-deceased spouse (of such surviving spouse), over (ii) the amount of the deceased spouse's taxable estate, (iii) plus adjusted taxable gifts.

The executor of the first spouse's estate must file an estate tax return on a timely basis and make an election to permit the surviving spouse to utilize the unused exclusion (Sec. 2010(c)(5)(A)). Therefore, even small estates of married persons must consider whether to file an estate tax return on a timely basis and make an election to permit the surviving spouse to utilize the unused exemption.

Temporary Regulations (T.D. 9593, 77 Fed. Reg. 36150 (June 18, 2012) and identical Proposed Regulations (REG-141832-11, id. at 36229) were released on June 15, 2012 and are retroactive to January 1, 2011. The regulations are expected to be finalized by June 15, 2015. The regulations deal with making a timely portability election which is accomplished by merely filing a complete and properly prepared estate tax return, unless the executor states affirmatively on the return or an attachment to the return that the estate is not electing portability. If there is a court-appointed executor, that person may make the election. If there is no appointed executor, any person in actual or constructive possession of property may file the estate tax return on behalf of the decedent and elect whether to have portability apply. Any portability election made in this way cannot be superseded by a subsequent election to opt out of portability by any person or other non-appointed executor (Temp. Reg. Sec. 20.2010-2T(a)(6)(i) and (ii)). There are relaxed requirements for reporting values of certain assets if the estate is not otherwise required to file an estate tax return under Sec. 2018(a). For assets that qualify for a marital or charitable deduction, the return does not have to report the values of such assets, but only the description, ownership, and/or beneficiary of the property together with information to establish the right to the deduction. However, the values of assets passing to a spouse or charity must be reported where the value affects the determination of amounts passing to other beneficiaries, or if only a portion of the property passes to a spouse or charity, or if there is a partial disclaimer or partial QTIP election, or if the value is needed to determine the estate's eligibility for alternate valuation, special use valuation, or section 6166 estate tax deferral (Temp. Reg. Sec. 20.2010-2T(a)(7)(ii)(A)). The executor must exercise due diligence to estimate the fair market value of the gross estate, including the property passing to a spouse or charity. The executor must identify the range of values within which the executor's best estimate of the gross estate falls. Unless the estate tax return was revised to include those ranges of value, the regulations provided that the return must state the executor's best estimate, rounded to the nearest $250,000.

    • Bypass trusts still useful: There are several advantages of continuing to use credit shelter trusts at the first spouse's death, and not relying on portability:
      • There is no assurance that portability will apply in the future, although right now it is permanent.
      • The DSUE amount is not indexed for inflation, and appreciation in the assets is included in the gross estate of the surviving spouse, unlike the growth in a bypass trust which is excluded.
      • There may not be portability of the state estate tax exemption amount (a solution might be to leave the state exemption amount of a credit shelter trust and rely on portability for the balance of the first decedent spouse's estate, which would have the effect of deferring all state taxes until the second spouse's death).
      • The unused exclusion from a particular predeceased spouse will be lost if the surviving spouse remarries and survives his or her next spouse.
      • There is no portability of the GST exemption.
      • There is no statute of limitations on values for purposes of determining the unused exclusion amount which begins to run from the time the first deceased spouse's estate tax return is filed, whereas the statute of limitations does run if a bypass trust is funded at the first spouse's death.
      • Beneficiaries other than just the surviving spouse can use the assets that could be left to a bypass trust.
      • The risk in a "blended family" that the surviving spouse might make gifts to persons other than the first decedent's family is avoided, thereby also avoiding the risk that the QTIP trust for the benefit of the first decedent spouse's family will pay large estate taxes without any benefit of the first decedent spouse's estate tax exclusion.
      • Filing a return for the first estate might be avoided if the estate and credit shelter trust are small enough.
      • It is not clear whether survivorship, and thus eligibility to use the DSUE amount, is governed by a survivorship presumption in the wills or other governing instruments of spouses who die "simultaneously." In contrast, the creation of a credit shelter trust would have certainty.
      • There are other standard benefits of credit shelter trusts including asset protection, providing management of assets, and restricting transfers of assets by the surviving spouse. Portability does not protect against these issues.
    • Portability and qualified retirement plans: For a decedent whose major assets are the principal residence and retirement or IRA benefits, there is often no way to fully fund a bypass trust without using these assets. Optimal income tax deferral typically results from naming the surviving spouse as a beneficiary. The solution might be to leave the retirement and/or IRA benefits directly to the surviving spouse and rely on portability to use the DSUE amount at the surviving spouse's subsequent death.
    • Saving state estate taxes: Using a credit shelter trust at the first spouse's death might generate significant state estate taxes, which could be avoided by using portability. The surviving spouse could make gifts that would not be subject to state estate taxes. Connecticut is the only state that has a state gift tax.
  • Income tax changes under the 2012 Tax Act:
    • Starting January 1, 2013, the top ordinary income tax rate of 39.6% applies to married taxpayers with taxable income of $450,000 ($400,000 for single filers). For trusts, the 39.6% rate applies at taxable income of $11,950; for trusts, this makes planning more important than ever, especially the timing of making distributions to beneficiaries.
    • Capital gains tax rate for high income taxpayers has increased to 20%.
    • Indexing of the alternative minimum tax thresholds are permanently indexed for inflation.
    • Two provisions that shave away exemptions and personal exemptions are reinstated for 2013 and beyond:
      • PEP—personal exemption phaseout
      • PEASE--certain itemized deductions
    • The payroll tax holiday has expired.
    • Extenders for a two-year period through December 31, 2013 were allowed. One such extender is the IRA rollover to charity. There were two options to enjoy this extension for 2012 which needed to have been effectuated by February 1, 2013.
      • If you took a distribution from an IRA in 2012 and in January 2013 you made a cash gift of like amount to charity, it would be treated as an IRA rollover.
      • If you make a distribution to a charity in January 2013, you can treat it as though made in 2012. Supporting organizations, donor-advised funds and private foundations are not eligible.
    • Patient Protection and Affordable Care Act of 2010:The panelists briefly discussed this legislation and the impact of the 3.8% Medicare Contribution Tax which is imposed on unearned income over $250,000 ($200,000 for singles).  This provision also impacts trusts.
  • Extensions of time granted to file Form 8939: Notice 2011-66, 2011-35 I.R.B. 179 (as modified by Notice 2011-76, 2011-40 I.R.B. 479) provided that the Sec. 1022 election must be made by filing Form 8939 on or before January 17, 2012 in order to elect out of filing an estate return, and to make allocations of basis increase to certain assets. There are four relief provisions that might still be available:
    • The executor may file supplemental Forms 8939 to make additional allocations of a spouse's property basis increase, as additional property may be distributed to the surviving spouse. Each such supplemental Form 8939 must be filed no later than 90 days after such distribution.
    • The executor could have made other changes to a timely filed Form 8939 except making or revoking the election itself, on or before July 17, 2012
    • The IRS may grant "9100 Relief" allowing an executor to amend or supplement a Form 8939 to allocate any basis increase that has not been previously allocated if, subsequent to the filing of the original Form 8939, additional assets are discovered or assets are revalued after an IRS audit. Such an audit could occur after the asset is sold many years after the Form 8939 was filed, which means that most attempted "formula" allocations would be ill-advised.
    • The IRS has retained the discretion under "9100 Relief" procedures to allow an executor to amend or supplement a Form 8939 or even to file a Form 8939 late. In fact, we have seen several letter rulings granting extensions of time to file the Form 8939 (PLRs 201231003, 201238011, 201238012, 201238016, 201243010, 201245005, 201245012, 201245013, 201245015, 201245016, 201246017, 201246018, and 201246022). While the IRS has made it clear that it has strict standards for granting relief, there was also concern for a constitutional challenge to what would otherwise have been an unmitigated retroactive reinstatement of the estate tax.
  • Planning in 2013 and future years as a result of the new law:

Now that the 2012 Tax Act is in effect, what should estate and gift tax planners be advising their clients? The panelists offered the following for consideration:

  • While there is permanence in the estate and gift tax law for the first time in twelve years, the current state of the debt ceiling and spending cuts may put some popular estate and gift tax planning techniques in jeopardy.  Discontinuation or restriction of the use of valuation discounts, short-term Grantor Retained Annuity Trusts ("GRATS"), and sales of defective grantor trusts may be instituted in order to raise much needed revenues. Many of these restrictions were proposed in the 2012-2013 Greenbook (see below). Therefore, if clients desire to make use of these techniques in 2013, they should do so as soon as possible.
  • Income tax planning will play a greater part of any trust planning. Because the income tax rates have increased, one will need to consider the income tax implications of having income in a trust, and whether to make distributions to beneficiaries, and thus passing along the income tax implications to them, up to the trust's distributable net income. Also, basis step-up will have an impact on income tax planning.
  • Portability is a game changer. Planning may also focus on whether to use credit shelter trusts, notwithstanding the size of the assets or the tax advantages of portability. Credit shelter trusts offer many non-tax advantages that may be useful in an estate plan.
  • Donor's remorse may be an issue for those who made gifts in 2012 and may want to reverse the gifting. Perhaps consider rescission or disclaimers.
  • Review the implementation of the 2012 gifts and ensure that the transfers were actually made; that the documents and records are in order. Also, it may be necessary to update wills and other documents. Gift tax returns for 2012 should be prepared as soon as possible and gift-splitting should be considered. The panelists expect that there will be a dramatic increase in the number of gift tax returns to be filed in 2013 for the 2012 tax year, and as of the date of this article such is clearly the case. For 2011 there were approximately 220,000 gift tax returns filed; the panelists predict that this number will be about 500,000 for 2012. It is better to file as soon as possible in 2013 so as to start the running of the statute of limitations. Further, the panelists predicted that there may be an increase in gift tax audits starting in 2014.
  • Clients may wish to make additional gifts in subsequent years as the gift exclusion increases due to indexing.
  • Management of wealth may become increasingly important as more gifts are made.

2. The Administration's Revenue Proposals

Introduction:  The Treasury Department's "General Explanations of the Administration's Fiscal Year 2013 Revenue Proposals," also known as the "Greenbook," was released on February 13, 2012 (, with several key proposals:

    • Restore the Estate, Gift, and Generation-skipping Transfer Tax Parameters in Effect in 2009: Consistently with the Obama Administration's previousbudget proposals, the Greenbook had proposed to return the estate, gift, and GST taxes to their 2009 levels, effective January 1, 2013. This would have meant that the parameters would be an essentially flat 45% estate and GST tax above a $3.5 million exemption and an almost flat gift tax starting at 41% for cumulative gifts over an exemption of $1 million.  (See section above for discussion of the 2012 Tax Act)
      • The Greenbook had pointed out that before 2002 the top transfer tax rate was 55% plus a 5% surcharge on the amount of the taxable estate between approximately $10 million and $17.2 million, with an exclusion of $675,000 that was scheduled to rise to $1 million by 2006. It viewed the 2010 Tax Act as a substantial tax cut for the most affluent taxpayers which could not be sustained in the future, and had concluded that a permanent estate tax law is needed in order to provide certainty to taxpayers.
      • The Greenbook also repeated the 2011 proposal to make the portability provisions enacted in 2010 permanent. Without this portability provision, spouses are often required to retitle assets into each spouse's separate name and create complex trusts in order to allow the first spouse to die to take advantage of his or her exclusion. Depending upon the nature of the assets, such division may not be possible. If the division can occur it may be undesirable to effectuate as it may have significant adverse consequences under property law or be inconsistent with how the family would prefer to handle their financial affairs.
      • These proposals proved to be the baseline parameter for the later enacted 2012 Tax Act, which provided for an estimated revenue loss of $3.63 trillion over ten years. Congress is expected to propose spending cuts and revenue raisers, needed in order to offset this cost, over the next few months.
    • Require Consistency in Value for Transfer and Income Tax Purposes: Under Sec. 1014(a)(1), the basis of property acquired from a decedent is the fair market value of the property at the time of the decedent's death, with appropriate adjustments in Sec. 1014 for the alternate valuation date. It is possible for the recipient of property from a decedent to claim, for income tax purposes, that the executor somehow undervalued the estate tax value, and that the heir's basis should be greater than the estate tax value. Such claims may be made after the statute of limitations has run, and can be accompanied by an appraisal or other evidence in support of the revised date of death value. Invoking the principles of privity, the IRS has been able to insist on using the lower estate tax value when the recipient was one of the executors who signed the estate tax return, but otherwise it has no other tool to enforce such consistency. The Greenbook proposal would require the income tax basis of property received from a decedent or donor to be equal to the estate tax value or the donor's basis.
      • On September 8, 2009, the staff of the Joint Committee on Taxation released a publication entitled "Description of Revenue Provisions in President's Fiscal Year 2010 Budget Proposal, Part One: Individual Income Tax, Estate and Gift Tax Provisions (JCS-209)." The JCT stated that this Administration Greenbook proposal requires that the basis of property received by reason of death under Sec. 1014 generally must equal the value of that property claimed by the decedent's estate for estate tax purposes. Under the proposal, there can be situations where the IRS challenges the estate valuation and prevails. If the heirs are not notified of the adjustment they could be overtaxed on a subsequent sale of the asset. Assets may also be sold prior to resolution of an IRS challenge. By requiring the value of an asset reported for transfer tax purposes to be reported and used by the heir or donee in determining basis, however, the proposal effectively encourages a more realistic value determination in the first instance.
      • The Greenbook proposal provides that the executor or donor be required to report the necessary information to both the recipient and the IRS. Regulations could extend this reporting requirement to annual exclusion gifts and estates for which no estate tax return is required and could provide relief for the surviving joint tenant or other recipient who has better information than the executor. It is not clear if subsequent adjustments to basis because of IRS challenges or other matters should also be reported.
    • Modify Rules on Valuation Discounts: The Greenbook recalls that Sec. 2701-2704 was enacted to curb techniques designed to reduce transfer tax values, but not the economic benefit to the recipients. Sec. 2704(b) provides that certain applicable restrictions that would otherwise justify valuation discounts are ignored in intra-family transfers of interests in family-controlled corporations and partnerships, but added that judicial decisions and enactment of new statutes in most states have made Sec. 2704(b) inapplicable in many situations. The Greenbook also stated that the IRS had identified certain arrangements designed to circumvent the application of Sec. 2704.
      • Sec. 2704(b) applies to an "applicable restriction" which Sec. 2704(b)(2) defines as any restriction which effectively limits the ability of the corporation or partnership to liquidate and with respect to which either (1) the restriction lapses, in whole or in part, after the transfer or (2) the transferor or any member of the transferor's family, either alone or collectively, has the right after such transfer to remove in whole or in part the restriction. Sec. 2704(b)(3) provides an exception for any commercially reasonable restriction which arises as part of any financing by the corporation or partnership with a person who is not related to the transferor or transferee, or a member of a family of either. Another exception is for any restriction imposed, or required to be imposed by any federal or state law.
      • Under Sec. 2704(b)(4), Treasury has the authority to provide that other restrictions shall be disregarded in determining the value of the transfer or any interest in a corporation or partnership to a member of the transferor's family if such restriction has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.
      • Since 2003, a guidance project under Sec. 2704 has been on the Treasury-IRS Priority Guidance Plan.
      • The Greenbook proposal would create a more durable category of disregarded restrictions. These would include restrictions on liquidation of an interest that are measured against standards prescribed in the Treasury regulations, not against default state law. Although the Greenbook did not say so, it is possible that the disregarded restrictions in view, which include certain limitations on liquidation, may also include other restrictions, such as restrictions on management, distributions, access to information and transferability. Disregarded restrictions would also include limitations on a transferee's ability to be admitted as a full partner or other holder of an equity interest, thus apparently denying the opportunity to value a transferred interest as a mere assignee interest and possibly applying to "carried interests." Treasury would be empowered by regulations to treat certain interests owned by charities or unspecified "others" as if they were owned by the transferor's family.  The Greenbook proposals refer to entities and not just corporations and partnerships.
      • Treasury might further restrict the marketability discount, but not the minority discount. The September 8, 2009 Joint Committee Staff's publication stated that because the proposal targets only marketability discounts, it would not directly address minority discounts that do not accurately reflect the economics of a transfer.
      • The Greenbook also suggests that regulations could create safe harbors to permit taxpayers to draft the governing documents of a family-controlled entity so as to avoid the application of Sec. 2704 if certain standards are met. No details on this suggestion were made,  and it is unusual  that the writers of such a proposal to limit the opportunities to circumvent Sec. 2704 would  contemplate drafting the governing documents in a particular way in order to avoid the section's application.
      • The proposal promises to make conforming clarifications with regard to the interaction of this proposal with the transfer tax marital and charitable deductions. This could override the harsh "reverse-Chenoweth" result seen in Technical Advice Memoranda 9050004 (Aug. 31, 1990) and 9403005 (Oct. 14, 1993) (all stock owned by the decedent valued as a control block in the gross estate by the marital bequest valued separately for purposes of the marital deduction), relying on Estate of Chenoweth v. Commissioner, 88 T.C. 1577 (1987) (estate of a decedent who owned all the stock of a corporation entitled to prove a control premium for a 51% block bequeathed to the surviving spouse for purposes of the marital deduction), and Ahmanson Foundation v. United States, 674 F.2d 761 (9th Cir. 1981). Such a result would reinforce the fairness of the proposal.
      • The proposal would apply to transfers after the date of enactment and would not apply to restrictions created on or before October 8, 1990. Under Sec. 7805(b)(2), regulations issued within 18 months of the date of enactment could be retroactive to the date of enactment. The proposal is estimated to raise revenue over ten years by $18.079 billion.
    • Require a Minimum Term for Grantor Retained Annuity Trusts (GRATs):
      • The Greenbook notes that taxpayers have become adept at maximizing the benefit of GRATs, often by minimizing the term of the trust to as little as two years, which reduces the risk of the grantor's death during the term. Further, the GRAT retains an annuity interest significant enough to reduce the gift tax value of the remainder interest to zero or to a number small enough to generate only a minimal gift tax liability.
      • Congress in the past has suggested ways to limit the attractiveness of GRATs by imposing a minimum gift tax value for the remainder, such as 10%.
      • The Greenbook proposes to increase the mortality risk of GRATs by requiring a minimum ten-year term. The focus is on increasing the mortality risk of a GRAT, not necessarily its effect in diminishing the upside from volatility. The ten-year minimum might encourage use of the GRAT by younger taxpayers. The Greenbook seemed to allow the zeroed-out GRAT as long as there was a minimum ten-year term. The 2012 Greenbook added an additional requirement of a maximum term equal to the life expectancy of the annuitant plus ten years. This would limit the use of a very long-term Walton-style GRAT with a low annual payout that would result in a reduced inclusion in the gross estate under Regulations Sec. 20.2036-1(c)(2)(i).
      • The proposal would apply to GRATs created after the date of enactment and is estimated to raise revenue over ten years by $3.5 billion.
    • Limit Duration of Generation-Skipping Transfer (GST) Tax Exemption:
      • The 2011 and 2012 Greenbook proposal would limit the duration of the GST exemption to 90 years, requiring the inclusion ratio of a trust to reset to zero on the 90th anniversary of the creation of the trust.
      • The Greenbook cites the repeal or limitation of the Rule Against Perpetuities in many states as the occasion for this proposal. The proposal would presumably prompt a lot of distributions to younger beneficiaries in 90 years. It is difficult to plan for this now, other than to draft trust agreements in a way that will provide trustees with discretion.
      • The proposal would apply to trusts created (and to additions to trusts) after the date of enactment. This would not generate any revenue now—but should do so in 90 years.
    • Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts
      • Most of the rules treating a grantor as the owner of a trust were crafted in the 1930s and 1940s to curb the shifting of taxable income to taxpayers in lower income tax brackets, even to spouses of grantors in common law states before 1948 when joint income tax returns were introduced. Rev. Rul. 85-13, 1985-1 C.B. 184, provides that an apparent sale between a grantor trust and its grantor would not be regarded as a sale for income tax purposes. There is certainly a disconnect between the grantor trust rules and the gift and estate tax rules, which has inspired considerable effective planning with so-called "defective grantor trusts."
      • While it is hard to argue that the grantor's payment of income tax on another's income is not economically equivalent to a gift, but because the tax is the grantor's own obligation under the grantor trust rules, it escapes gift tax. And sales to grantor trusts are often viewed economically equivalent or even superior to GRATs, but without the policing of Sec. 2702 and 2036 or the "ETIP" restrictions of Sec. 2642(f) on allocating g GST exemption.
      • There have been many rulings which seem to support and validate the use of grantor trusts in estate planning.
        • Rev. Rul. 2004-64, 2004-2 C.B. 7 addresses the estate tax consequences of provisions regarding the reimbursement of the grantor for income tax on the grantor's trust income.
        • Rev. Rul. 2007-13, 2007-11 I.R.B. 684 holds that the transfer of life insurance contracts between two grantor trusts treated as owned by the same grantor is not a transfer for valuable consideration for purposes of Sec. 101.
        • Rev. Rul. 2008-22, 2008-16 I.R.B. 796 provides reassurance regarding the estate tax consequences under Sec. 2036 and 2038 of the grantor's retention of a Sec. 675(4)(c) power, exercisable in a nonfiduciary capacity, to acquire property held in trust by substituting property of equivalent value.
        • Rev. Rul. 2011-28, 2011-49 I.R.B. 830 extends the reassurance to Sec. 2042 and cases where the trust property includes policies of insurance on the grantor's life.
        • Rev. Proc. 2008-45, 2008-30 I.R.B. 224 promulgates sample inter vivos charitable lead unitrust forms, including forms for both nongrantor and grantor CLUTs, where the feature used to confer grantor trusts status is such a substitution power in a person other than a grantor.
      • The Greenbook proposal would simply include the date-of-death value of all grantor trusts in the grantor's gross estate and subject that value to estate tax, subject to gift tax on any distributions from the trust to one or more beneficiaries during the grantor's life and subject to gift tax on the remaining trust assets at any time during the grantor's life if the grantor ceases to be treated as the owner of the trust for income tax purposes. The proposal is rather broad and could subject many life insurance trusts to estate tax because the authority to use trust income to pay premiums could confer grantor trust status under Sec. 677(a)(3). However, the introductory language to Sec. 677(a) would provide some workarounds in some cases. The proposal may be perpetuating outdated and sometimes quirky income-shifting restrictions that a more modern approach might reject.
      • The proposal would not change the treatment of any trust that is already includible in the grantor's gross estate under existing provisions of the Code, including grantor retained income trusts (GRITs), grantor retained annuity trusts (GRATs), personal residence trusts (PRTs), and qualified personal residence trusts (QPRTs).
      • Also, if you toggle grantor status off, that would be considered a taxable gift at the date of the toggle. Also, any distributions from a grantor trust to individuals would be considered a taxable gift.
      • The proposal would apply to trusts created on or after the date of enactment and to other trusts to the extent of contributions made on or after the date of enactment. The proposal is estimated to increase revenue over ten years by $910 million.
    • Extend the Lien on Estate Tax Deferral Provided Under Sec. 6166
      • This proposal would extend the ten-year estate tax lien under Sec. 6324(a)(1) to cover the last four years and nine months of the potential deferral period under Sec. 6166. This proposal can be very important to some successors of family businesses.
      • This change would apply both to the estates of decedents dying on or after the date of enactment and the estates of decedents who died before the date of enactment if the ten-year lien under Sec. 6324(a)(1) had not expired before the date of enactment. The proposal is estimated to increase revenue by $160 million over ten years.

Observation: If you wish to avail yourself of any of these planning opportunities, the time to act is now, while the law is still favorable. Many of the panelists thought that the valuation discounts may be the first to be eliminated or curtailed. The GRAT proposal may also be on the chopping block. The government may want to address the defective grantor trusts.

Observation: If you were to total  all of the revenue increases that would come into effect if all of the Greenbook proposals were accepted, that amount would be $24 billion. The panelists noted that this is a small fraction of the $3.63 trillion over ten years needed to offset the revenue loss resulting from the enactment of the 2012 Tax Act. Congress may really focus on other items that could generate more revenues, so some of these items may not be impacted. But Congress may take this opportunity to restrict these techniques and generate some revenue as they are "low-hanging fruit."

3. State Estate Taxes

There are 22 states plus the District of Columbia that have an inheritance or estate tax. Most states have some form of exemption, although not all have adopted the federal exclusion.

While there may not be a federal estate tax in many situations, there could very well be state estate tax implications.

Connecticut is the only state that has a gift tax. There were several developments impacting the taxes that states impose at the death of a resident or at the death of a nonresident with property located in the state:

  • The Hawaii legislation passed HB 2328 on May 2, 2012 which conformed the Hawaii estate tax exemption to the federal estate tax exclusion for decedents dying after January 25, 2012. Prior to this legislation, the Hawaii exemption was $3.5 million.
  • On March 20, 2012 Indiana legislation phased out the inheritance tax over nine years beginning in 2013 and ending December 31, 2021, and increases the inheritance tax exemption amounts retroactive to January 1, 2012.
  • Oregon changed the nature of its state estate tax effective January 1, 2012. The pick-up tax was replaced with a stand-alone estate tax effective January 1, 2012. The new tax has a $1 million threshold with rates increasing from 10% to 16% and between $1 million and $9.5 million. The determination of the taxable estate for Oregon estate tax purposes is based on the federal taxable estate with adjustments.
  • The Tennessee legislation passed HB 3760/SB 3762, which phases out the Tennessee Inheritance tax as of January 1, 2016. The Tennessee Inheritance Tax Exemption is increased to $1.25 million in 2013, $2 million in 2014, and $5 million in 2015. The Tennessee state gift tax was repealed retroactive to January 1, 2012.

4. The 2012-2013 Treasury-IRS Priority Guidance Plan

This plan for the 12 months beginning July 1, 2012 was released on November 19, 2012. It contains 317 projects and describes priorities for allocation of the resources of the IRS during the plan year. The plan listed ten projects under the heading of "Gifts and Estate and Trusts."

  • Final regulations under Sec. 67 regarding miscellaneous itemized deductions of a trust or estate
    • Sec. 67(a) provides that miscellaneous itemized deductions generally may be deducted only to the extent that they exceed 2% of the adjusted gross income (AGI). Sec. 67(e)(1) provides an exception for costs of estates or trusts that would not have been incurred if the property were not held in such estate or trust.
    • In Knight v. Commissioner, 552 U.S. 181 (2008), the Supreme Court indicated that Sec. 679e)(1) should apply to expenses that are not commonly or customarily incurred by individuals. The proposed regulations on Sec. 67(e) were published before the Knight decision, and have since been withdrawn.
    • New proposed regulations were issued, reflecting the following:
      • The allocation of costs of a trust or estate that are subject to the 2% floor is based not on whether the costs are unique to trusts or estates but whether the costs commonly or customarily would be incurred by a hypothetical individual holding the same property.
      • In determining what is commonly or customarily incurred, the type of product or service actually rendered controls rather than the description of the cost.
      • Commonly or customarily incurred expenses that are subject to the 2% floor include costs in defense of a claim against the estate that are unrelated to the existence, validity, or administration of the estate or trust.
      • Ownership costs that apply to any owner of a property are subject to the 2% floor.
      • A safe harbor is provided for tax return preparation costs. The costs of preparing these estate and GST tax returns, fiduciary income tax returns, and the decedent's final income tax return are not subject to the 2% floor. Costs of preparing any other returns would be subject to the 2% floor.
      • Investment advisory fees for trust or estates are generally subject to the 2% floor except for additional fees that are attributable to an unusual investment objective or the need for a specialized balancing of the interests of various parties. However, if an investment advisor charges an extra fee to a trust or estate because of the need to balance the varying interest of current beneficiaries and remaindermen, the fees would be subject to the 2% floor.
      • Bundled fees such as a trustee or executor commissions, attorney's fees, or accountant's fees must be allocated between costs that are subject to the 2% floor and those that are not.
      • A safe harbor is provided in making the allocation of bundled fees. If a bundled fee is not computed on an hourly basis, only the portion of the fee that is attributable to investment advice is subject to the 2% floor.
      • If the recipient of the bundled fee pays a third party or assesses separate fees for purposes that would be subject to the 2% floor, that portion is subject to the floor.
      • Any reasonable method may be used to allocate the bundled fees.
    • The background is as follows:
      • In Rudkin Testamentary Trust v. Commissioner, 467 F. 3d 149 (2d Cir. 2006) the court held that trust investment advisory fees are subject to the 2% floor, with the exception for trusts and estates for any costs that individuals are not able to incur. Such examples were trustee fees, judicial accountings, and fiduciary income tax returns.
      • The IRS issued proposed regulations on July 27, 2007, about a month after the Supreme Court granted certiorari to review Rudkin. The proposed regulations took the position that only costs that are unique to trusts or estates qualify for the exception. It also took the position that there would have to be an unbundling of trustee or executor fees, attorney fees, or accountant fees that related only partly to activities that were unique to trusts or estates.
      • The U.S. Supreme Court affirmed the Rudkin result under the name Knight v. Commissioner, 522 U.S. 181 (2008). Knight held that trust investment advisory fees are generally subject to the 2% floor, but did not agree with the Second Circuit's test that "would" means "could." The Court adopted the unusual or uncommon test used by the Fourth and Federal Circuits and concluded generally that Sec. 67(e)(1) excepts from the 2% floor only those costs that would be uncommon or unusual for such a hypothetical individual to incur. In applying this test to a trust's investment advisory fees, because these costs are often incurred to comply with the prudent investor standard, it is unlikely that such fees would have been incurred by an individual as the trustee or executor is held to a different standard. This may be a reach as many individuals hire investment advisors. However, if a trust has an unusual investment objective or requires a specialized balancing of the interests of various parties, the incremental costs would not be subject to the 2% floor.
      • Following the issuance of the Knight case, the IRS requested comments in Notice 2008-32 regarding the position that regulations should take regarding Sec. 67(e). Comments included the position that trustee fees should not be subject to the 2% floor because of the many duties, responsibilities and services of trustees that are not required for individual clients. Some commentators suggested various safe harbors to determine the fully deductible portion. After receiving comments, the IRS chose to issue another round of proposed regulations and request still more comments.
      • The newly issued proposed regulations do not provide any user-friendly safe harbors, but continue the approach of requiring unbundling of fees based on the type of product or service rendered to the trust and request more comments on reasonable methods of unbundling fees other than numerical or percentage safe harbors.
      • Unbundling of fiduciary fees is not required for taxable years beginning before the date of the issuance of final regulations.
    • Guidance concerning adjustments to sample charitable remainder trusts under Sec. 664
      • This project first appeared in the 2008-09 Priority Guidance Plan, when it published sample charitable lead unitrust forms (see Rev. Proc. 2008-45, 2008-30 I.R.B. 224 and Rev. Rul. 2008-46, 2008-30 I.R.B. 238). This project will look specifically at the forms for charitable remainder trusts.
    • Guidance concerning private trust companies under Sec. 671, 2036, 2038, 2041, 2042, 2511 and 2601
        • Privately owned and operated trust companies are a viable option that families with large trusts are increasingly using. State law authority for such entities is continually refined.
        • This project first appeared in the 2004-5 Priority Guidance Plan.
        • Notice 2008-63, 2008-31 I.R.B. 261 solicited comments on a proposed revenue ruling, which addressed five tax issues faced by trusts of which a private trust company served as trustee:
          • Inclusion of the value of trust assets in a grantor's gross estate by reason of a retained power or interest under Sec. 2036 or 2038.
          • Inclusion of the value of trust assets in a beneficiary's gross estate by reason of a general power of appointment under Sec. 2041.
          • Treatment of transfers to a trust as completed gifts.
          • Effect on a trust's status under the GST tax either as a "grandfather" trust or as a trust to which GST exemption has been allocated.
          • Treatment of a grantor or beneficiary as the owner of a trust for income tax purposes.
        • The proposed revenue ruling posits several trusts, illustrating both the introduction of a private trust company as a trustee of a preexisting trust and the creation of new trusts. The trusts have the following features:
          • The trustee has broad discretionary authority over distributions of both income and principal.
          • Each successive primary beneficiary has a broad testamentary power of appointment, but limited to the beneficiary's estate, creditors, and creditors of the estate.
          • The grantor or primary beneficiary may unilaterally appoint but not remove trustees, with no restriction other than on the ability to appoint oneself.
        • The proposed revenue ruling provides that the hypothetical private trust companies it addresses avoid tax problems by the use of certain "firewall" techniques.
          • The "Discretionary Distribution Committee" (DDC) with exclusive authority to make all decisions regarding discretionary distributions. Anyone can serve on the DDC but no member of the DDC may participate in the activities of the DDC with respect to a trust of which the DDC member or her/her spouse is a grantor or beneficiary or owes an obligation of support.
          • The "Amendment Committee" with exclusive authority to amend the relevant sensitive limitations in the private company's governing documents. A majority of the members of the Amendment Committee must be individuals who are neither members of the relevant family nor persons related or subordinate to any shareholder of the company.
          • Note: the SEC adopted a final Family Office Rule under the Investment Advisors Act of 1940 that exempts certain family offices from the definition of an investment advisor. Although private trust companies and family offices differ, advisors who represent families with such operations should consult the SEC rule, when the IRS releases the private trust company guidance and pay attention to the degree of coordination or deviance between the two pronouncements. 
      • Regulations under Sec. 1041 regarding uniform basis of charitable remainder trusts
        • This project first appeared in the 2008-09 Priority Guidance Plan.
        • Sec. 1001(e) and Regulations Sec. 1.1014-4 & -5 provide that the basis of property held in trust or otherwise shared by holders of term and remainder interest is apportioned among the beneficial interests in proportion to the actuarial value of the interests.
        • Sec. 1001(e) and Regulations Sec. 1.1001-1(f) provide that when an interest in property for life, a term of years, or an income interest in property in a trust is sold, its basis is generally disregarded, unless the sale is a part of a transaction in which the entire interest in property is transferred.
        • It is likely that this project is intended to address the results when both the income and remainder beneficiaries of a charitable remainder trust sell their respective interests in a coordinated sale designed to circumvent the rules governing commutation of a CRT interest. Under the uniform basis rules, the assets inside the charitable trust have been stepped up because they have been sold and reinvested in new securities, and that inside basis would be allocated among the income beneficiaries and the remainder beneficiaries, as a way to avoid the capital gains tax.
        • Notice 2008-99 (2008-47 I.R.B. 1194) described this type of transaction and stated that the IRS and Treasury are concerned about the manipulation of the uniform basis rules to avoid tax on the sale or other disposition of appreciated assets. The Notice identified this type of transaction as a "reportable transaction of interest" for purposes of Sec. 6111 and 6112 and Regulations Sec. 1.6011-4(b)(6).
        • In Rev. Proc. 2010-3, 2010-1 I.R.B. 110, the IRS identified whether the termination of a charitable remainder trust before the end of the trust term as defined in the trust's governing instrument, in a transaction in which the trust beneficiaries receive their actuarial shares of the value of the trust assets, causes the trust to have ceased to qualify as a charitable remainder trust within the meaning of Sec. 664 (see Rev. Proc. 2011-3, 2011-1 I.R.B. 111).
      • Final regulations under Sec. 2032(a) regarding imposition of restrictions on estate assets during the six month valuation period
        • This project first appeared in the 2007-08 Priority Guidance Plan but stalled after April 2008 when the first set of regulations was released. Treasury retracted the original regulations and released a new set of proposed regulations.
        • In Kohler v. Commissioner, T.C. Memo 2006-152, nonacq., 2008-9 I.R.B. 481, the primary transfer issue was the requirement under Sec. 2032 that an asset valued on the alternate valuation date must be the same as the asset that was included in the decedent's gross estate at death. Postmortem changes that alter the nature of the includible asset cannot be reflected in the alternate valuation.
        • The first proposed regulations described postmortem events, including voluntary acts or manipulations that would be ignored in valuing a decedent's gross estate. The revised proposed regulations now essentially abandon that approach to instead describe events that will accelerate the valuation date under Sec. 2032(a)(1). This then triggers valuation at the moment before the acceleration event, which precludes valuations that reflect the postmortem event. The proposed regulations describe several acceleration events, including:
          • Creation, recapitalization, reorganization or merger of an entity
          • Redemptions or other changes in the ownership structure of an entity that alter the value of the decedent's interest in that entity
          • Postmortem distribution of a fractional interest in an asset or in an entity that otherwise would justify a fractional or minority interest discount
          • Entity-level transactions such as disbursements, distributions or reinvestments of an entity's assets that alter the value of the decedent's ownership interest in the entity
        • Proposed Regulation Sec. 20.2032-1(c)(1)(ii) provides an exception to the acceleration rule for same-value transactions, such as an exchange of stock for stock of another class or in another entity, that does not change the value of the decedent's interest by more than 5% of the original fair market value at the date of the decedent's death.
        • The new proposed regulations will apply after they are published as final regulations.


      • Guidance under Sec. 2053 regarding personal guarantees and the application of present value concepts in determining the deductible amounts of expenses and claims against the estate
        • This project first appeared in the 2008-09 Priority Guidance Plan.
        • Present value concepts is focused at the leveraged benefit obtained when a claim or expense is paid long after the due date of the estate tax, but the additional estate tax reduction is credited as of, and earns interest from, that due date.
        • This is evidenced in the calculation of deductions for administrative expenses under Sec. 2053 and is likely to diminish the usefulness of so-called "Graegin loan." An individual dies, the estate owes estate tax and a loan is taken out to pay the estate tax. The interest on that loan is deductible when the interest is paid. In the Graegin case, a corporation lent money to the estate to pay the estate tax. The terms of the loan were for nine years and with no prepayment of principal. The estate was successful in deducting the interest for the entire period. This is an arbitrage of getting an upfront estate tax deduction at 40% vs. getting taxable income later because there is no deduction when the interest is paid. Congress is seeking to shut this down.


      • Regulations under Sec. 2642 regarding the allocation of GST exemption to a pour-over trust at the end of an ETIP
        • This project is new for this year and seeks guidance on the proposed regulations on the election out of deemed allocations of GST exemption under Sec. 2632(c), and its application to a pour-over trust at the end of an ETIP.
        • The AICPA provided comments on the proposed regulations and requested that the regulations include an example addressing the application of the automatic allocation rules for indirect skips in a situation in which a trust subject to an ETIP terminates upon the expiration of the ETIP, at which time the trust assets are distributed to other trusts that may be GST trusts. According to the preamble of the regulations, the Treasury Department and the IRS believed that this issue was outside the scope of the regulation project and they would consider whether to address these issues in separate guidance.


        • Final regulations under Sec. 2642(g) regarding extensions of time to make allocations of the GST tax exemption
          • This project first appeared in the 2007-08 Priority Guidance Plan.
          • Section 564(a) of EGTRRA directed Treasury to publish regulations for extensions of time to allocate GST exemptions or to elect out of statutory allocations of GST exemption when those actions are missed on the applicable return or a return is not filed at all. Before EGTRRA, similar extensions of time under Regulations Sec. 301.9100-3 (so-called "9100 relief") were not available because the deadlines for taking such actions were prescribed by the Internal Revenue Code and not by the regulations.
          • After enactment of EGTRRA, Notice 2001-50, 2001-2 C.B. 189 acknowledged Sec. 2642(g)(1) and stated that taxpayers may seek extensions of time to take those actions under Regulations Sec. 301.9100-3. The IRS has received and granted several requests for such relief over the years since the Notice's publication.
          • Rev. Proc. 2004-46, 2004-2 C.B. 142 provided a simplified method of dealing with pre-2001 gifts that meet the requirements of the annual gift tax exclusion under Sec. 2503(b) but not the special "tax-vesting" requirements applicable for GST tax purposes to gifts in trust under Sec. 2642(c)(2).
          • The proposed regulations were published in 2008 and when they become final they will oust the 9100 relief provisions.


      • Regulations under Sec. 2704 regarding restrictions on the liquidation of an interest in certain corporations and partnerships
        • This project is intended to address Sec. 2704(b)(4) which states, in the context of corporate or partnership restrictions that are disregarded, that the secretary may provide that other restrictions shall be disregarded in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor's family if such restriction has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.


        • Guidance under Sec. 2801 regarding the tax imposed on U.S. citizens and residents who receive gifts or bequests from certain expatriates
          • The Heroes Earnings Assistance and Relief Tax Act of 2008 (the HEART Act) enacted a new income tax mark-to-market rule when someone expatriates on or after June 17, 2008. A new succession tax is imposed on anyone who receives a gift or bequest from someone who expatriates on or after June 17, 2008.
          • Announcement 2009-57 which was released July 16, 2009 stated that the IRS intends to issue guidance under Sec. 2801 as well as the new Form 708 on which to report the receipt of gifts and bequests subject to Sec.2801. The due date for reporting and for paying the tax has not yet been determined.
          • The panelists believe that this is the top priority among the ten items on the list.


      Observation: The 2011-2012 Priority Guidance Plan included a notice on decanting of trusts under Sec. 2501 and 2601. The IRS issued Notice 2011-101, 2011-52 I.R.B. 932 requesting comments on the tax consequences of decanting transactions, which is the transfer by a trustee of trust principal from an irrevocable distributing trust to another receiving trust. The request for comments included the relevance and effect of several facts and circumstances. Apparently, that was the extent of the project because decanting was omitted from the 2012-2013 Plan.

5. Transfer Tax Developments

      • Life Insurance: Rev. Rul. 2011-28, 2011-49 I.R.B. 830
        • An insured grantor's nonfiduciary right to reacquire an insurance policy creates a grantor trust, but no incidents of ownership. Transfer for value rules should be considered.
        • The grantor established and funded an irrevocable trust for the benefit of the grantor's descendants. The grantor contributed cash, and the trustee bought a life insurance policy on the grantor's life. The terms of the trust prohibited the grantor from serving as trustee. The grantor made annual gifts to the trustee to pay premiums on the insurance policy, and the proceeds on the policy were payable to the trust. The governing instrument stated that the grantor may at any time acquire any property held in the trust by substituting other property of equivalent value and that this power of substitution is exercisable in a nonfiduciary capacity without the approval or consent of any person acting in a fiduciary capacity. The grantor can exercise this power by certifying in writing that the substituted property and the trust property for which it is substituted are of equivalent value. Local law imposes on the trustee a fiduciary obligation to ensure that the property that the grantor seeks to substitute is equivalent in value to the property distributed to the grantor. The trustee is also required to act impartially in investing and managing trust assets and the trustee is granted the discretionary power to acquire, invest, reinvest, exchange, sell, etc. trust assets.
        • The IRS ruled that the grantor's right of substitution was not an incident of ownership over the policy. The IRS referred to Rev. Rul. 84-179, 1984-2 C.B. 195 which stated that the incidents of ownership rules were intended to be interpreted like the rules on those powers that would cause other types of property to be included in a decedent's estate under Sec. 2036 and 2038. The ruling stated that the decedent was not considered to possess incidents of ownership in the policy if he could not exercise the powers for his personal benefit, he did not transfer the policy or any of the consideration for purchasing or maintaining the policy to the trust from personal assets, and the devolution of the trust powers to the decedent was not part of a prearranged plan involving his participation. However, the decedent would be deemed to have incidents of ownership over an insurance policy on the decedent's life where his powers were held in a fiduciary capacity and the decedent has transferred the policy or any of the consideration for purchasing and maintaining the policy to the trust. Therefore, if the decedent reacquired powers over insurance policies in an individual capacity, the powers would constitute incidents of ownership even though the decedent was a transferee (Estate of Fruehauf v. Commissioner, 427 F.2d 80(6th Cir. 1970); Estate of Skifter v. Commissioner, 468 F.2d 699(2d Cir. 1972)
        • The IRS also discussed Estate of Jordahl v. Commissioner, 65 T.C. 92(1975), acq. in result, 1977-2 C.B. 1, where the Tax Court held that a reserved power to substitute other assets for securities held in trust, when held in a fiduciary capacity, was not a power to alter, amend, revoke or terminate the trust under Sec. 2038. The IRS argued in Jordahl that the proceeds from insurance policies held by the trust should also be included under Sec. 2042(2) but the Tax Court held that because the decedent was bound by fiduciary standards and was accountable in equity to the succeeding income beneficiary and remainder beneficiary, the decedent could not exercise the power to deplete the trust or to shift trust benefits among the beneficiaries. The Tax Court held that the substitution power was not a power to alter, amend or revoke the trust under Sec. 2038, but merely a power to exchange at arm's length, comparable to a right to buy the policy, and that such a right could not be considered an incident of ownership.
        • The IRS referred to Rev. Rul. 2008-22, 2008-16 I.R.B. 796, in which it had stated that a grantor's nonfiduciary right to substitute assets for property of equivalent value was not a retained power under Sec. 2036 or 2038. If the trustee had a fiduciary obligation under local law or the trust document to ensure the grantor's compliance with the terms of the power by satisfying itself that the properties acquired and substituted by the grantor are in fact of equivalent value and the substitution power could not be exercised in a manner that would cause the shifting of benefits among the trust beneficiaries.
      • Gifts made within three years of Death: Estate of Morgens v. Commissioner, 678 F. 3d 769 (9th Cir. 2012)
        • Amounts of gift tax paid with respect to deemed transfers resulting from disclaimer of interests in QTIP trusts by surviving spouse within three years of death are included in the surviving spouse's gross estate under Sec. 2035(b).
        • California residents Anne and Howard Morgens established a joint revocable trust. After Howard's death, his one-half share of the community property in the joint revocable trust was allocated to a QTIP marital deduction trust for the benefit of Anne during life.  Upon Anne's subsequent death, the QTIP marital deduction trust was to be divided into separate shares for their two surviving children and the children of their deceased daughter.
        • In a series of disclaimers in 2000, Anne disclaimed her right to invasions of principal from the QTIP trust and the surviving children disclaimed their rights. As a result, the children of the deceased daughter became the sole remainder beneficiaries of the QTIP trust. In November 2000, Anne was indemnified against the resulting gift and estate taxes if Anne were to disclaim her income interest in the QTIP trust, resulting in a net gift transaction.
        • In December 2000 the QTIP trust was divided into two separate trusts, one holding Proctor & Gamble stock (Trust A) and the other holding the other assets (Trust B). Anne transferred her life interest in Trust A to the remainder beneficiaries and did the same thing in 2001 with Trust B.  This triggered deemed transfers of the QTIP remainders under Sec. 2519. The trustee of Trust A paid the gift tax for the 2000 transfer and the trustee of Trust B paid the gift tax for the 2001 transfer. Gift tax returns were filed. 
        • Anne died within three years of making the transfers and the IRS determined on audit that the amounts of gift tax paid by the recipients of the QTIP remainder would be includible in Anne's gross assets under Sec. 2035(b). The Tax Court agreed.
        • The issue in this case is Sec. 2035(b) with respect to the inclusion in a decedent's estate of gift tax paid within three years of death and the impact of Sec. 2519 and 2207A(b) when the surviving spouse disclaims an interest in a QTIP trust. Sec. 2035(b) says that the gross estate is to be increased by the amount of any gift tax paid by the decedent or the decedent's estate on any gift made by a decedent or the decedent's spouse within three years of the decedent's death. The IRS argued that Anne was personally liable for the gift tax attributable to the 2000 and 2001 deemed transfers and that Sec. 2207A(b) did not shift her liability to the trustees. Consequently, because Anne died within three years of making the transfers, Sec. 2035(b) would require that the amounts of gift tax paid on the deemed transfers be included in Anne's gross estate as gift tax paid within three years of her death. The estate countered that Sec. 2035(b) did not apply because the ultimate responsibility for paying the gift tax under Sec. 2519 on the deemed transfers lay with the trustees of the two trusts. The Court of Appeals for the Ninth Circuit disagreed with the estate and relied on Estate of Sachs v. Commissioner, 856 F. 2d 1158 (8th Cir. 1988)  and Brown v. United States, 329 F.3d 664 (9th Cir. 2003). The Ninth Circuit held that Sec. 2207A(b) does not shift the gift tax liability to the QTIP recipients. The liability remains with the surviving spouse. Sec. 2207A merely provides that the donor may recover the amount of gift tax paid from the donees.
      • Valuation issues: Gaughen v. United States, 109 A.F.T.R. 2d 2012-752, (N.D. Pa. 2012)
        • Reliance on "credible" appraisal reports to value property on gift tax return was insufficient for a grant of summary judgment to taxpayer on allegation of fraud.
        • Thomas W. Gaughen moved for summary judgment with respect to a gift tax fraud penalty assessed against him. In 2005, he filed a gift tax return which reported gifts of seven parcels of real property. The IRS on audit disputed the values given for three of the parcels. Gaughen had based these values on a restricted use appraisal report prepared by Larry Foote, a "Certified General Appraiser." The IRS appraised the properties at higher value, determined that Gaughen had undervalued the gifts, and assessed an additional gift tax, a fraud penalty and compound interest. Gaughen paid the additional tax and filed a suit for refund.
        • In a motion for summary judgment on the fraud component of the case, Gaughen alleged that the IRS presented insufficient evidence to demonstrate that the alleged underpayment of gift tax was attributable to fraud. The District Court denied Gaughen's motion and found that the three pieces of circumstantial evidence were sufficient to demonstrate a genuine issue of material fact as to Gaughen's state of mind and whether he intended fraud when he filed the gift tax return:
          • The alleged undervaluation of the parcels as demonstrated by the large difference between the values estimated by Gaughen's appraiser and the values estimated by the IRS' appraiser.
          • The County tax assessments for the year prior to the year of the gift showed higher fair market values of the properties than the fair market values reported by Gaughen for gift tax purposes.
          • Contracts for the sale of the parcels that Gaughen had negotiated prior to filing the return had much higher sales prices than those reported for gift tax purposes.
          • Gaughen's reliance on the restricted use appraisal reports prepared by his appraiser was insufficient to overcome the IRS' fraud allegation because it appeared that Gaughen had instructed the appraiser on how to value the properties.
      • Special Use Valuation: Finfrock v. United States, 109 A.F.T.R.2d 2012-1439 (C.D. Ill. March 20, 2012)
        • Regulations barring partial special use valuation election declared invalid.
        • Sec. 2032A allows a personal representation to elect to value qualified real property used for farming purposes or in a trade or business on the basis of the property's actual use rather than its highest and best use.
        • The decedent owned just over 61% of the stock in Finfrock Farms and on the date of the decedent's death in 2008, the corporation owned four parcels of land totaling over 520 acres. The "adjusted value" (gross estate value less directly attributable Sec. 2053(a) deductions) of the gross estate was about $2.6 million and the adjusted value of the real estate held by the corporation was $1.775 million, which was about 68% of the value of the adjusted gross estate.
        • The surviving family members opted to cease farming operations on 3 out of the 4 parcels of land. Therefore, the estate claimed a Sec. 2032A special use valuation only for the fourth parcel of land, the one that would continue farming operations after the decedent's death. The adjusted value of that one parcel was about $403,000 which was only about 15% of the adjusted value of the gross estate. This presented a problem under Regulations Sec. 20.2032A-8(a)(2), which requires not only that the adjusted value of all of the estate's qualifying real property exceed 25% of the adjusted value of the gross estate but also the value of the real property for which the personal representation makes the special use valuation election exceed such threshold. The IRS increased the reported value of the parcel from its special use value of $227,000 to the agreed fair market value of $403,000, and assessed additional tax on the difference.
        • In Miller v. United States, 680 F. Supp. 1269 (C.D. Ill 1988), it was held that the regulation was invalid because there is no requirement in the statute that the value of the real property for which the personal representation makes the special use valuation election exceed 25% of the adjusted value of the gross estate.  But the Miller decision predated the Supreme Court's decision in Chevron v. Natural Resources Defense Council, 467 U.S. 837 (1984), which requires courts to give deference to interpretive regulations. In order for a regulation to get judicial deference, it must be determined whether the statute is silent or ambiguous to the issue. It the intent is clear, the IRS and the courts must give effect to that intent. If there is ambiguity, an interpretation that is a permissible construct of the statute will get deference.
        • The District Court clarified that, in this case, the statute is not ambiguous at all and that the regulation was invalid. The regulation is contrary to the statute and does not clarify an ambiguity because the statute is clear and does not fill any gap.
      • Late special use valuation elections permitted under "9100 Relief." Private letter Rulings 201224019 and 201230023
        • PLR 201224019: the election for special use valuation under Sec. 2032A is to be made on a timely filed federal estate tax return. The executor in this PLR had no knowledge or understanding of estate administration and certain heirs disputed the distribution of the decedent's interest in farm land and related structures. The accountant and attorney discussed whether to make the special use valuation election on the Form 706 but did not do so. Subsequent to filing the Form 706, the accountant informed the executor that the estate could request a 12-month extension of time to make an election for special use valuation pursuant to the relief provisions under Regulations Sec. 301.9100-2. The executor made the request to the IRS, but failed to comply with the requirements of the regulations for requesting such an extension, and as a result, the IRS stated that the special use valuation election was not timely and therefore invalid. The ruling held that the executor nevertheless met the requirements under Regulations Sec. 301.9100-3 for requesting an extension of time longer than 12 months, since the taxpayer acted in good faith and the grant of relief will not prejudice the interest of the government. The regulations specifically provide that a taxpayer is deemed to have acted reasonably and in good faith if the taxpayer reasonably relied upon a qualified tax professional and that tax professional failed to make or advise the taxpayer to make the election. A taxpayer is also deemed to have acted reasonably and in good faith if the taxpayer requests relief under the section before the failure to make the regulatory election is discovered by the IRS.  In this case, the executor relied upon the accountant's advice and believed that a valid election was filed.
        • PLR 201230023: A decedent's estate included farmland and the executor hired an attorney to prepare the Form 706, which was timely filed. However, the return did not reflect the election for the special use valuation for the farmland under Sec. 2032A. A successor executor was appointed who engaged new attorneys to review the estate return. The new attorneys noticed the absence of the election. The executor requested an extension of time to make the section2032A election, which was granted.
      • Defined value clauses not involving charity are upheld by Tax Court: Wandry V. Commissioner, T.C. Memo 2012-88, nonacq., 2012-46 I.R.B.
        • In 1998, Joanne and Dean Wandry formed a Colorado limited partnership to which they contributed cash and marketable securities. They instituted a tax-free gift-giving program through transfers of limited partnership interests utilizing the annual gift tax exclusion as well as additional gifts in excess of the annual exclusion up to $1 million. The Wandrys gave specific dollar amounts rather than a set number of limited partnership units and specified that all gifts should be transferred either December 31 or January 1 of a year so as to avoid mid-year closing of the books.
        • In 2001, the Wandrys and their children started a family business called Norseman Capital LLC. Dean was the initial manager and by 2002 all of the Wandry LP's assets were transferred to Norseman. The gift-giving program was continued through Norseman. On January 1, 2004, Joanne and Dean each transferred $1,099,000 of units to each of the four children and $11,000 of units to each of five grandchildren. The assignment provided that each donor intended to have a good faith determination of the value made by an independent third party professional. If the IRS challenged the valuation and a final determination of a different value was made, the number of gifted units would be adjusted accordingly so that the value of units given to each person equaled the dollar amount specified in the assignment. The assignments specifically stated that the formula was to work in the same manner as a federal estate tax formula marital deduction amount that would be adjusted for a valuation redetermination by the IRS or a court of law.
        • The gift tax return described the gifts in terms of percentages of membership interests in Norseman, which were derived from the value determined by an independent appraiser. The IRS challenged the gifts based on gifts of 2.39% interests to each child and 0.101% interests to each grandchild saying that the membership interest should have been valued at higher amounts. The IRS asserted that the 2.39% was worth $315,000 and the 0.101% was worth $13,346, and that the formula did not work.
        • The court noted that different courts have upheld as valid formulas used to limit the value of the completed transfers (Estate of Christensen v. Commissioner, 586 F.3d 1021 (8th Cir. 2009), Estate of Petter v. Commissioner, T.C. Memo 2009-280, and McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006). In Estate of Petter, the court had examined the difference between savings clauses, which had been rejected by Commissioner v. Proctor, 142 F.2d 824(4th Cir. 1944), which the taxpayer may not use to avoid the gift tax. A savings clause is void because it creates a donor that tries to take the property back. A formula clause is valid because it merely transfers a fixed set of rights with uncertain value. The difference depends on an understanding of exactly what the donor is trying to give away.
        • In Wandry, the donees were entitled to receive predefined percentage interests which were essentially expressed as a mathematical formula in which the one unknown was the value of an LLC unit at the time the transfer documents were executed. However, the value was a constant, even if unknown. The court noted that absent the audit, the donees might never have received the proper percentage interests to which they were entitled.
        • The Court said, when comparing Wandry to the Petter case, that it is inconsequential that the adjustment clause reallocates units amongst the Wandrys and their donees rather than a charitable organization because the reallocations do not alter the transfers. On January 1, 2004, each donee was entitled to a predefined Norseman percentage interest expressed through a formula. The gift documents do not allow for the Wandrys to take the property back. Rather, the gift documents correct the allocation of Norseman units amongst the parties because the appraisal report understated Norseman's value. This is a valid formula clause.
        • The Court also rejected the public policy concerns in Commissioner v. Proctor, 142 F.2d 824 (4th Cir. 1944). The Court held that there is no well-established public policy against formula clauses and that the judgment in favor of the taxpayers would not undo the gift. Also, the lack of a charitable component in this case did not result in a severe and immediate public policy concern.
        • The IRS filed a Notice of Appeal on August 28, 2012, but then subsequently filed a dismissal and dropped the appeal.  The IRS has published a nonacquiescence in the case.
        • Note: the panelists noted that the comparison to Petter is fascinating because it equates the rights of the charitable foundations that were the "pourover" recipients of any value in excess of the stated values with the rights of the children and grandchildren in Wandry who were the primary recipients of the stated values themselves. The impact of the increased value in Petter was an increase in what the charitable foundation received. In contrast, the impact of the increased value in Wandry was a decrease in what the donees received.
        • Note: The panelists also noted that until Wandry, many observers had believed that the courts had approved not "formula transfers" but "formula allocations" of a clearly fixed transfer. Allocation was between the donors and the donees, and in fact it looked a lot like retention of the property by the donors, if not a way to take the property back. The court may very well be suggesting that the distinction between "formula transfers" and "formula allocations" might not be so crucial in the analysis.
        • Other observations (contributed by Steven R. Akers, Bessemer Trust):
          • Wandry is the first reported case to hold that a "formula transfer clause" is valid and does not violate the Proctor analysis. It recognizes the validity of defined value clauses where a charity was not involved in the formula allocation and public policy analysis does not hinder on charity involvement. McCord, Christiansen, Petter and Hendrix have previously recognized defined value clauses but they all involved formula allocation-type clauses where the donor transfers a fixed block of shares or units and the allocation of the transferred units is allocated among multiple donees by formula and all involved charities in the formula.
          • This provides a unique planning opportunity because the formula transfer approach is much simpler than the formula allocation approach. Also, many clients do not desire to make a substantial charitable transfer.
          • Formula assignment in Wandry may become a form template in light of the successful outcome.
          • The lessons learned in gift tax return preparation is to list the value of the gifts as the stated dollar values and the gift description should make clear that the gift is of units of the LLC having the specified value.
          • Planners should consider whether to rely on Wandry in using the simplicity of formula transfer clauses or whether to continue to use formula allocations. The more conservative approach is to use the formula allocation clause with the excess value passing to charity which has been approved in the prior four cases. If the client does not desire to gift to charity, consider using formula allocation clauses where the excess value passes to some entity that does not have gift consequences such as the spouse, a QTIP trust, an incomplete gift trust or a zeroed-out GRAT.
          • Some practitioners using the formula transfer approach recommend that the trust agreement specify that any disclaimed assets remain with the donor and the donees immediately following the transfer execute a formula disclaimed of any portion of the gift in excess of the value that the donor intends to transfer. The regulations have always recognized formula disclaimers as valid, so that even if the formula transfer fails to limit the gift, the formula disclaimer should yield the same result.
          • The basic advantage of using the defined value transfer clause is the ability to make lifetime gifts without the risk of having to pay current gift taxes. The disadvantages include risk of audit, complexities of administering the defined value clause and if the IRS does not respect the clause, there may be an adjustment of assets passing along to family members with no tax benefits.
          • Use of a reputable professional appraiser is key.
        • Definitions
          • Formula Transfer Clause: limits the amount transferred (transfer of a fractional portion of an asset, with the fraction described by a formula).
            • Examples:
              •  "…such interest in X partnership …as has a fair market value of $_____"
              • "…I hereby transfer to the trustees of T Trust a fractional share of the property described in Schedule A. The numerator of the fraction is (a) $100,000 (i.e., the desired dollar value to be transferred by gift) plus (b) 1% of the excess, if any, of the value of the property as finally determined for federal gift tax purposes over $100,000. The denominator of the fraction is the gift tax value of the property."
                • Note: This example produces a small taxable gift if the IRS asserts higher values for gift tax purposes to help counter a Proctor attack.
          • Formula Allocation Clause: allocates the amount transferred among transferees (transfers all of a particular asset and allocate that asset among taxable and non-taxable transferees by a formula). The allocation can be based on values as finally determined for gift or estate tax purposes or based on an agreement among the transferees as to values.
            • Examples of non-taxable transferees are charities, spouses, QTIP trusts, incomplete gift trusts (where there is a retained limited power of appointment or some other retained power so that the gift is not completed for federal gift tax purposes, and zeroed-out GRATs.
        • Family Limited Partnerships: Estate of Stone v. Commissioner, T.C. Memo 2012-48
          • Value of partnership assets not included in the gross estate under Sec. 2036 because the desire to have the assets held and managed as a family asset was a legitimate and actual nontax reason for creating the partnership.
          • The decedent and her spouse owned undeveloped woodlands near a lake. They desired to give real estate to various family members and this was accomplished by using a limited partnership to simplify the gift-giving process and to guard against partitions. The Stones set up the partnership, transferred the assets to the partnership, and then gifted all of the limited partnership interests to their children and their spouses, as well as the grandchildren over a four year period. The gifts were completed about five years prior to the decedent's death. No distributions were ever made from the partnership. Most of the formalities of the partnership were followed. There were some lapses in the formalities, but they were considered benign.
          • The estate contended that there was a nontax motive for transferring the parcels to the partnership and which supported the exception of Sec. 2036. This nontax motive was to create a family asset that could be managed for subsequent development and sale of lakeside homes. The Court also indicated that the second motive of simplifying the gift-giving process was not a good nontax reason in itself.
          • The IRS contended that the portion of the property's value represented by the contribution from the decedent was included in the decedent's gross estate under Sec. 2036. The Court disagreed, finding that the bona fide sale exception of Sec. 2036 applied. The Court rejected the IRS' arguments that the decedent stood on both sides of the transaction and that the full consideration requirement of the bona fide sale exception was not satisfied. The Court stated that there was a legitimate nontax purpose and the decedent received partnership interests proportional to her contributions to the partnership.
          • Note: The Stones did most of the major things needed to have an effective family limited partnership:
            • Retained plenty of assets for living
            • Retained assets to pay all estate taxes
            • Had a nontax reason for the partnership
            • Avoided non pro rata distributions to the parents
            • Avoided personal use of the partnership assets
            • Gave away all of their limited partnership interests more than three years before their deaths, so that Sec. 2035 was not applicable
            • Obtained an appraisal for the property  before they made gifts of limited partnership interests
            • Forgave any discounts for purposes of valuing the limited partnership interest gifts. They received no discounting advantages in transferring 98% interests to their family members either during life or death.
            • Avoided comingling of partnership and personal assets (although the parents continued to pay the $700 annual property taxes directly)
            • Completed all of the planning while the parents were in good health
      • Family Limited Partnerships: Estate of Kelly v. Commissioner, T.C. Memo 2012-73
        • Value of partnership assets  are not included in the gross estate under Sec. 2036 because the desires to provide effective management, avoid controversy by ensuring equal distribution of the estate and protect against liability were legitimate and significant nontax reasons for creating the partnerships.
        • A guardianship court entered an order allowing the decedent's guardianship estate to contribute operating quarries and other real estate to limited partnerships with a corporation owned 100% by the decedent as the sole general partner.
        • The primary concern was to ensure the equal distribution of the decedent's estate thereby avoiding litigation. The other reasons were to provide for effective management of these types of assets and protect against liability. The decedent had retained significant personal assets outside of the partnership.
        • The gifts were made several years prior to the decedent's death.
        • The IRS contended that the decedent continued to enjoy the income from the family limited partnerships and that the partnership assets should be included in the gross estate under Sec. 2036(a)(1).
        • The Tax Court held that the reasons were legitimate and significant nontax reasons and the Sec. 2036 bona fide sale for full consideration exception applied so that the contributions to the partnership were not treated as transfers causing inclusion in the gross estate under Sec. 2036.
        • Note: The family got it right:
          • The partnerships and corporate general partner were respected as separate and distinct legal entities.
          • Partnership formalities were observed.
          • The decedent retained sufficient assets for personal needs.
          • Living expenses were paid from the guardianship account and the management fee was not used to pay these expenses.
          • The general partner's fiduciary duty and contractual terms of the partnerships restricted the decedent from requiring the partnerships to pay more than a reasonable fee to the general partner.
          • The management fee was reasonable and in fact a bit lower than the industry standard. Receiving a management fee was not a retained interest under Sec. 2036(a)(1).
          • There were no distributions from the limited partnerships during the decedent's lifetime.
          • The decedent had a bona fide purpose for creating the corporation to manage the partnerships. Her health prevented her from managing the property and using an entity to act as general partner was a natural choice.
      • Family Limited Partnerships: Keller V. United States, 2012 WL, 4867129 (5th Cir. Sept. 25, 2012) aff'g 2009 WL 2601611, 104 A.F.T.R.2d 2009-6015 (S.D. Tex. 2009)
        • Partnership recognized although not formally funded before the decedent's death. Also interest on the recharacterization loan from the family limited partnership loan to pay estate taxes and other obligations is deductible for estate tax purposes.
        • The decedent signed a partnership agreement but did not formally fund the partnership prior to her unexpected death. About a year after her death, the planners of the estate learned at a seminar about the Church  case (Church v. United States, 268 F.3d 1063 (5th Cir. 2001)), which recognized that under Texas law a partnership could be implied to be funded  based on the intent of the decedent prior to his death. The decedent had planned to transfer a large bond portfolio to the partnership and the estate took the position in this estate tax refund case that the entity actually owned the bonds at the decedent's death and that the estate's interest in the partnership should be valued at a discount.
        • The District Court held that position and valued the estate's limited partnership interest at a 47.5% discount. The court had accepted the estate's appraiser's value, finding that the IRS' appraisal violated several of the tenets of the hypothetical willing buyer-willing seller valuation principle, including considering the true identities of the buyer and seller, speculating as to future events, and aggregating the interest of the various owners.
        • In addition, when the estate realized that it had improperly sold the bonds that it did not really own, the estate retroactively documented that it owed the partnership about $114 million. The District Court ruled that nine years of interest payments on that loan were deductible as necessary expenses of the estate.
        • The IRS appealed to the Fifth Circuit of Appeals on two legal issues:
          • Whether under Texas law the partnership was created and funded prior to the decedent's death because of the decedent's intent to fund the partnership
          • The deductibility of interest on the retroactively structured loan from the partnership
        • Creation and funding of the partnership based on intent: The Fifth Circuit of Appeals affirmed the lower court on both of these issues. The appellate court determined that under Texas law, intent, whether express or implied, determines whether property is owned by the partnership or by a partner individually, regardless of who has legal title. The court also rejected the IRS' argument that the partnership ceased to exist at the decedent's death because her death triggered the termination of the trusts that were limited partners, reasoning that the limited partnership statute provides four exclusive methods of dissolving a limited partnership and the circumstance causing the alleged termination is not one of them.
        • Deductibility of interest on a loan from the partnership: The Fifth Circuit affirmed the deductibility of the loan interest reasoning that the loan was actually and necessarily incurred despite the IRS' assertion that the loan could have as easily been retroactively characterized as a distribution. The Court distinguished Estate of Black, 133 T.C. 340 (2009), which disallowed an interest deduction for a loan from a family limited partnership to a decedent's estate where the partnership's only meaningful asset was stock in the Erie Indemnity Company, in which the family was a large shareholder. In Black, the estate had no ability to pay off the loan without receiving assets from the partnership. The Tax Court viewed the loan structure as an indirect use of the Erie stock in the partnership to generate a tax deduction. The Fifth Circuit reasoned that key was that the Black estate would be essentially insolvent without resorting to the sale of stock or partnership units. The Keller estate is different because it had other illiquid assets that eventually could be used to repay the loan without redeeming partnership units or distributing its assets.
      • Family Limited Partnerships: Estate of Turner v. Commissioner, 138 T.C. N. 14 (2012)
        • The estate is not entitled to a marital deduction with respect to assets attributable under Sec. 2036 to the family limited partnership interests that the decedent gave as gifts during his lifetime.
        • This case arose from a motion for reconsideration of the Tax Court memorandum opinion in Estate of Turner v. Commissioner T.C. Memo 2011-209 ("Turner I"), where the decedent transferred property to a family limited partnership in exchange for limited and general partnership interests. The decedent then transferred portions of the limited partnership interests as gifts during lifetime. The Tax Court held that the lifetime transfers of property to the partnership was subject to Sec. 2036 and would be included in the decedent's estate. The estate requested that the court reconsider and overturn its previous decision, arguing that the estate met the test of a bona fide sale for full and adequate consideration because there was a significant nontax purpose for the creation of the partnership. In addition, the estate also argued that the surviving spouse's right to a pecuniary marital bequest allowed the surviving spouse to receive assets equal to the amount necessary to reduce the estate taxes to zero, since the decedent's property was to pass to the surviving spouse at death.
        • The Tax Court rejected both of these arguments. The Court rejected the estate's argument that the consolidation of asset management was a significant nontax purpose for forming the entity, because this would only apply when there were assets requiring active management or special protection.
        • With respect to the marital deduction issue, the decedent had owned a 27.7554% limited partnership interest and a 0.5% general partnership interest. During his lifetime, he had transferred 21.744% limited partnership interests to the children.
        • Application of Sec. 2036 to a family limited partnership raises two issues with respect to the marital deduction:
          • When family partnership interests which have been discounted for federal estate tax purposes are brought back into the estate at full fair market value, this produces a mismatch between the values being paid since the marital deduction allowed for the family partnership interests is less than the value at which the assets are included in the gross estate. In the instant case, this problem did not result because the IRS allowed an increased marital deduction for the 27.7554% limited partnership interest and the 0.5% general partnership interest held by the decedent on his date of death.
          • The second issue arises when a decedent transfers a portion of the partnership interest during lifetime as a gift to someone other than the spouse and Sec. 2036 pulls the assets underlying the partnership interest back into the gross estate at full date of death fair market value. The assets underlying the transferred partnership interest that is included in the gross estate do not pass to the surviving spouse.
        • The IRS's position is that the estate could not claim a marital deduction for the assets that the decedent transferred as gifts during lifetime. The estate argued that the formula marital deduction clause would permit the full marital deduction for the partnership interests that were transferred.
        • The Court found that in order for the marital deduction to apply, the property must pass from the decedent to the surviving spouse. Since that did not occur in this case, no estate tax marital deduction is allowed.
        • Note: The panelists noted that the "take-away" is that if the assets of the family limited partnership are brought back to the estate under Sec. 2036 and the fair market value of such assets exceeds the available estate tax exclusion, there will be an estate tax.  You have to consider how the estate tax is to be paid. A suggestion was made to use a formula that says that taxes are paid as a cost of administration. If the taxes are paid as a cost of administration, the phantom asset will generate an estate tax, which would come out of the marital trust so that you have a tax on the tax.  It might be better to apportion taxes and modify the document accordingly.
      • Gifts of limited partnership interests meet the requirements for present interest and qualify as annual exclusion gifts. Estate of Wimmer v. Commissioner, T.C. Memo 2012-157
        • The Wimmers created a limited partnership which restricted the transfer of the partnership interests and limited the instances in which a transferee could become a substitute limited partner. The transfer of limited partnership interests required the prior written consent of the general partners and 70% in interest of the limited partners. A transferee could not become a substitute limited partner until certain requirements were met including being accepted as such by the unanimous written consent of the general partners. There was an exception for transfers by gift or as the result of a partner's death if the transfers were to or for the benefit of an incumbent partner or a related party (descendants and ancestors of a partner). Transfers were made to relatives and irrevocable trusts to relatives with Crummey powers.
        • The issue was whether the gifts of the limited partnership interests met the requirement for a present interest and thereby qualified for the gift tax annual exclusion.  The panelists referred to the following cases: Hackl v. Commissioner, 118 T.C. 279(2002), aff'd, 355 F.3d 664 (7th Cir. 2003), Price v. Commissioner, T.C. Memo 2010-2, and Fisher v. United States, 105 A.F.T.R. 2d 2010-1347, 2010-2 USTC ¶60,588 (S.D. Ind. 2010), where gifts of limited partnership (or company) interests, because of various restrictions on them, were held not to be present interests and therefore did not qualify for the annual exclusion.
        • The Court looked at whether the rights to income satisfied the criteria for a present income interest with respect to the part of the transferred value that could be identified as an income interest. Based on Calder v. Commissioner, 85 T.C. 713, 727-28 (1985), the court put forth a three prong test:
          • The partnership would generate income,
          • Some portion of that income would flow steadily to the donee, and
          • That portion of the income flowing to the donee could be readily ascertained.
        • The Court held that all three of these tests were made in this case and the gifts of the limited partnership interests qualified as present interests with respect to the amount of the income that would flow out from the partnership. Distributions were made from the partnership so that the partners can pay their income taxes resulting from their share of the partnership income.
        • Note: The panelists commented that the court worked hard to get to this decision and a similar outcome in a similar future case may not be assured. Planners should make sure that the partnership owns income producing assets, and distribute some of that income. Also watch being too restrictive in the partnership agreement on transferability.
      • Estate Tax Marital Deduction case: Windsor v. United States, 833 F.Supp. 2d 394 (S.D. N.Y. June 6, 2012), aff'd, 2012 WL 4937310 (2d Cir. Oct. 18, 2012)
        • Defense of Marriage Act definition held unconstitutional for purposes of the federal estate tax marital deduction.
        • The District Court and the Court of Appeals held that section 3 of the Defense of Marriage Act ("DOMA") defining marriage as between one man and one woman is unconstitutional.
        • Shortly after 1963, Edie Windsor and Thea Spyer entered into a committed relationship in New York. In 1993, they registered as domestic partners in New York City and in 2007 they married in Canada. Spyer died in 2009 and her estate passed for Windsor's benefit. Spyer's bequest to Windsor did not qualify for the unlimited marital deduction and Spyer's estate was required to pay federal estate tax. New York did not permit same-sex marriages until 2011.
        • Windsor subsequently filed a suit for refund of the federal estate tax on the basis that section 3 of DOMA violates the Equal Protection Clause of the Fifth Amendment of the United States Constitution. In February 2011, the Justice Department announced that it would no longer defend DOMA's constitutionality because of a heightened standard of scrutiny that is now applied to classifications based on sexual orientation. The Bipartisan Legal Advisory Group of the U.S. House of Representatives ("BLAG") moved to intervene in this case to defend the constitutionality of the statute.
        • Windsor moved for summary judgment arguing that DOMA is subject to strict constitutional scrutiny because homosexuals are a suspect class. The U.S. District Court for the Southern District of NY granted summary judgment in favor of Windsor and found that the application of DOMA to deny the estate tax marital deduction was unconstitutional no matter what level of scrutiny is applied.
        • The Court noted that when DOMA was enacted by Congress, it intended to
          • Defend and nurture the traditional institution of marriage
          • Promote heterosexuality
          • Encourage responsible procreation and childrearing
          • Preserve scarce government resources
          • Defend traditional notions of morality
        • BLAG advanced some but not all of these interests and also asserted that the statute was passed to:
          • Nurture the traditional institution of marriage
          • Maintain consistency in citizen's eligibility for federal benefits
          • Promote a social understanding that marriage is related to childrearing
          • Provide children with two parents of the opposite sex
        • The Court held that DOMA did not advance the foundational institution of marriage because it does not affect the state laws that govern marriage, leaving to the states the decision of whether same-sex couples can marry.  The Court also held that DOMA did not promote family values and responsible parenting. These are interests that impact heterosexual couples also, and yet DOMA does not impact them at all. DOMA does not promote consistent application of federal benefits because of the current scenario where people in different states have different eligibility to receive such benefits. Also, DOMA does not conserve government resources because it merely excludes an arbitrary group of individuals from government programs. Further, family law has long been the domain of the states and not the federal government so you may have this inconsistency nevertheless.
        • The Court of Appeals for the Second Circuit affirmed with the intermediate level of scrutiny.
        • BLAG also contended that the couple was married at a time when same-sex marriages were not legal in NYS and therefore they do not meet the standing test.
        • Both of these arguments are currently before the Supreme Court, and a decision may be made during this spring or summer.
        • Note: Planners may need to go back and fix prior documents if the Supreme Court rules DOMA as unconstitutional. For example, do attorneys have an obligation to file refunds for prior estate tax returns and/or income tax returns?  Consider drafting documents with a provision that a trust would qualify for as a QTIP trust so that the election can be made if available.
      • Effect of Administration Expenses: Estate of Gill v. Commissioner, T.C. Memo 2012-7
        • Tax Court determines that the estate is entitled to a deduction for certain expenses relating to post-death litigation and that the amount of the marital deduction should not be reduced by federal estate taxes and state death taxes.
        • Two issues were decided in this case:
          • Whether the estate was entitled to a Sec. 2053 administration expense deduction for litigation of expenses related to litigation between the decedent's second wife and his children
          • Should the marital deduction be reduced by federal and state estate taxes
        • Raymond and Joan Gill were married for 43 years. Joan dies on January 11, 1995. In 1994, the couple executed revocable trusts with mirror A/B plans creating a credit shelter trust and marital trust for the benefit of the surviving spouse and with the property passing to decedent's children and grandchildren. Upon either spouse's death, the other spouse would become the sole trustee of the trusts and the children were named as successor trustees.
        • Raymond remarries a German citizen (Valerie Gill) four months after Joan's death. In August 1995, Raymond amended the terms of his living trust to provide that all of the income of the marital trust created upon his death would be paid to Valerie for life with discretionary payments of trust principal to Valerie. The children are named as remainder beneficiaries of the marital trust. Valerie and SunTrust are co-executors of Raymond's estate and co-trustees of the trust.
        • Raymond dies, and the children filed a claim against his estate which alleged a breach of fiduciary duty on the decedent's part while acting as trustee of Joan's living trust and after her death and the marital and credit shelter trusts created pursuant to that trust. A settlement was reached in 2000.
        • The children also filed a claim against Valerie and SunTrust alleging that Valerie exerted undue influence on the decedent. This claim was also settled in 2002. Valerie requests that the settlement of the undue influence claim be set aside in 2002; this was finally settled in 2007, which provided that the estate would reimburse the children for a portion of the legal and court fees.
        • The estate sought to deduct these expenses as additional legal fees paid by the estate. The IRS objected saying that these expenses were really distributions to beneficiaries rather than administration expenses. The Tax Court found that the fees incurred by the children in the initial litigation should be reimbursed because the litigation resolved the undue influence issue and was essential to the property settlement of the estate as required by Sec. 2053. The fees relating to other aspects of the litigation were not deductible because they were not essential to the property settlement of the estate.
        • With respect to whether the marital deduction should be reduced by estate taxes paid, the IRS argued that the amount of the marital deduction should be reduced by a portion of taxes reimbursed to the estate pursuant to the settlement of the claim regarding Joan Gill's trust. The estate argued that estate and state death taxes were generated by assets passing from the estate and decedent's living trust to the children/grandchildren and that the tax obligation should have fallen on those parties as recipients of the property generating the tax. The estate also contended that the tax burden ultimately did fall on the children because pursuant to the settlement, they reimbursed the estate for previously paying those taxes. Thus, the estate claimed none of the tax burden that fell on the assets passing to the marital deduction and as such the marital trust should not be reduced.
        • The court agreed with the estate. Both the decedent's will and trust provided that increases in estate taxes from the inclusion of property transferred by a
          • Gift before the decedent's death,
          • Property in which the decedent had an income interest, and
          • Property over which the decedent had a power of appointment of control
would be paid by the person holding and receiving that property. The court stated that the appointment or control language placed the burden of paying the federal estate and state death taxes on the recipients of the additional amounts and thus the children ultimately paid the taxes by reimbursing a portion of the settlement amount. Therefore, the marital deduction should not be reduced.
    • A post-mortem reformation of a trust to allow qualified declaimers is not retroactive for tax purposes. Claim of scrivener's error is rejected. Private Letter Ruling 201243001
      • The decedent's spouse had predeceased her and the couple's joint revocable trust was to be divided into a credit shelter trust and a revocable marital trust for the decedent's lifetime benefit. The marital trust adds the remaining trust assets to a trust on the same terms as the credit shelter trust when the decedent dies. The credit shelter trust provides that upon the death of the latter of the grantors to die, x% of the trust will be paid outright to their son. The decedent hired an attorney to prepare an amendment to the marital trust  providing that upon the decedent's death, x% of the marital trust will be paid outright to the son if surviving, but he would have the right to disclaim all or any part of his share of the assets. Any disclaimed assets would be held in another trust which would then be irrevocable. The son would be the trustee of this trust and he and his descendants would be the beneficiaries. The beneficiaries of this new trust would receive net income and principal for their health, education, maintenance and support in reasonable comfort. Upon the son's death, this trust would be distributed to his lineal descendants.
      • The attorney became aware that the requirements of a qualified disclaimer cannot be satisfied by a person who is not the spouse of the grantor if the disclaimed property passes to a trust for the benefit of the person making the disclaimer. More than a year after the decedent's death, the son, acting as trustee for the credit shelter trust and this new trust, petitioned a court to reform the provisions of the marital trust, nunc pro tunc, as of the date of the decedent's death. The reformed agreement would delete the outright distribution to the son and leave the trust assets in trust for the son and his descendants.
      • The court issued the requested order citing a state statute as authority for reforming the trust. Note though that the attorney had no documents or proof supporting the decedent's intent.
      • The IRS ruled that the state order reforming the trust would not be recognized as a retroactive reformation for gift, estate and GST tax purposes. The taxpayer took the position that the amendment created an ambiguity or a scrivener's error due to a mistake of law or fact and therefore the reformation should be recognized retroactively for federal tax purposes. The IRS countered that a state court reformation of a trust agreement has retroactive effect as between the parties to the instrument, and not to third parties who may have already acquired rights under the trust instrument.
      • The IRS concluded that the documentation did not provide clear and convincing evidence that the decedent had intended for her son's share in the marital trust to be distributed to the new trust as reformed by the state court. The reformation was not consistent with applicable state law and would not be recognized as retroactive for federal tax law purposes.
    • State income taxes: Marshall Naify Revocable Trust v. United States, 672 F.3d 620 (9th Cir. Feb. 15, 2012), aff'g 2010 WL 3619813, 106 A.F.T.R.2d 2010-6236 (N.D. Cal., 2010)
      • An estate is permitted to deduct only the amount actually paid to settle a state income tax claim.
      • In 1998, the decedent contributed convertible notes of a closely-held corporation to his wholly-owned investment company. In 1999, the notes were converted to stock in a fully taxable transaction. The decedent died in 2000. When the decedent's 1999 return was filed, the estate took the position that no state income tax was due in California from the conversion of the notes into stock. However, the Form 706 claimed a deduction of $62 million for California income taxes as a claim against the estate.
      • The estate settled with the state and paid $26 million. The IRS allowed the $26 million as a deduction for estate tax purposes but the estate brought a refund action based on the position of its expert that a $47 million deduction was properly given the likelihood of success of the estate's claim as of the date of death.
      • The District Court agreed with the IRS that the amount of California's claim against the estate was not ascertainable with reasonable certainty as of the date of death especially because the decedent had gone to some length to shelter the note conversion transaction from California income tax and there was a chance that his efforts might succeed. Since California's claim to taxes at date of death was in dispute, the court found it proper to follow Propstra v. United States, 680 F.2d 1248, (9th Cir. 1982), to consider post-death events. Since the $26 million settlement could be considered, the court decided that this should be the proper amount of the deduction. The court also held that the estate was stopped from trying to argue for a larger deduction since it had taken the position in its dispute with California that the transaction was not subject to California income tax and that position helped achieve the $26 million settlement.
      • On appeal, the Court of Appeals for the Ninth Circuit affirmed.
    • Incomplete Gifts: Chief Counsel Advice 201208026
      • The IRS provides guidance that retention of testamentary powers of appointment does not make the entire gift incomplete and finds that Crummey powers are illusory and therefore ineffective.
      • Husband and wife create an irrevocable trust for the benefit of their children, other descendants and spouses. One child was named as trustee. The trust was to terminate upon the death of the second donor to die. The donors renounced any power to determine or control the beneficial enjoyment of the trust income or principal. Each donor had a testamentary limited power of appointment. If the donors failed to exercise the testamentary powers of appointment, the property remaining in the trust would be distributed to the children. This was an incomplete non-grantor trust of the kind created in Delaware to avoid the state income tax of the state of the grantor's domicile.
      • The trustee had absolute discretion in administering the trust for the benefit of the children and other beneficiaries. Each beneficiary had a Crummey power of withdrawal over property contributed to the trust. The power could be voided by the trustee for additions made to the trust.
      • The IRS held that the donors had made gifts of the beneficial term interest. The donors countered that the gift of all of the property to the trust was incomplete because of the donors' retained testamentary powers of appointment. The IRS stated that a testamentary limited power of appointment relates only to the remainder interest in a trust. It does not relate to a situation in which there are term interests over which the power holders lack any control. The trust instrument had emphasized that the donors retained no powers or rights to affect the beneficial term interest of the beneficiaries. The IRS opined that the donors had fully divested themselves of control over the term interests and thus the trustee had sole discretion to distribute income and principal to the beneficiaries during the trust's term. The trustee could even terminate the trust by distributing all the property.
      • The IRS also noted that in one provision the donors emphatically renounced any power to determine or control the beneficial enjoyment of the trust but in subsequent provisions the donors retained a testamentary limited power of appointment. Since the two are in conflict and cannot be resolved by governing state law, the latter provision is considered to indicate the grantor's subsequent intention and that prevails.
      • The IRS also stated that the Crummey withdrawal rights were illusionary because they were not legally enforceable. It is noted that if a trust provides withdrawal rights and if the trustee refuses to comply with a beneficiary's withdrawal or demand, the beneficiary must be able to go before a state court to enforce it. This was not the case for this situation.
      • The IRS also ruled that, under Sec. 2702, the value of any retained interest which is not a qualified interest would be treated as being zero. Regulations Sec. 25.2702-2(a)(4) states that an interest in a trust includes a power with respect to the trust if the existence of power would cause any portion of the transfer to be treated as an incomplete gift. The donors retained testamentary powers for the remainder interest. Because it was not a qualified interest, the value of the retuned interest was zero and the value of the gift was the full value of the transferred property.
      • Regulations Sec. 25.2511-2 contains several statements that seem to border on the issue but leave a gap in the analysis of the complete gift issue.
      • Two conclusions seem reliable:
        • To the extent the creation of the trust is not a completed gift, then any trust distribution to anyone other than the settlor is a gift at the time of that distribution, as to which the gift tax annual exclusion should be available without the need of a Crummey power to satisfy the present interest requirement.
        • Retention of sufficient control can prevent complete gift treatment on creation. It is not clear how extensive that retained control needs to be. The regulations seem to suggest that the settlor needs to retain a nonfiduciary power to alter the beneficiaries or their interests during the interval between trust creation and the settlor's death. Consider Sec. 674(a) which provides that retained control over third party enjoyment of trust income or principal is adequate to cause defective grantor trust treatment. That result can be avoided by fitting within the exceptions listed in Sec. 674(b)(5)(A) for distributions of corpus and Sec. 674(d) for distributions of income. The latter provision is not helpful because the power cannot be held by the settlor or her spouse and it must be a fiduciary power. But Sec. 674(b)(5)(A) allows the settlor to hold a nonfiduciary power to distribute corpus and the exception applies if the settlor's retained power is limited by a reasonably definite standard.
      • Comments (as provided by Steve R. Akers, Bessemer Trust):
        • Planners should be aware of the risk that this ruling raises by merely retaining a testamentary limited power of appointment to keep a trust transfer from being a completed gift
        • If the settlor has the power to veto contemplated trust distributions to beneficiaries, the settlor would retain the ability to shift benefits among beneficiaries which should cause the entire transfer to the trust to be incomplete.
        • If the settlor had an inter vivos limited power of appointment that would also cause the gift to be incomplete as to the term interest and the remainder interest. The gift would be completed as to the amount of any distributions to beneficiaries at the time of the respective distributions. However, having a retained inter vivos limited power of appointment would allow the donor's creditors to reach the trust assets in some states.
        • If a person transfers assets to a self-settled trust in a jurisdiction that does not allow creditors to reach the trust assets merely because the settlor is a discretionary beneficiary, the person may wish to create a pool of assets as a protected nest egg in the remote event of a severe financial reversal, but the person does not want to make a completed gift that would be subject to gift taxes. Some planners may have relied upon gifting the donor a testamentary limited power of appointment to avoid making a completed gift, which can now be risky.
        • "Delaware Intentionally Non-Grantor Trusts," also known as DINGS, are used to avoid state income tax by having the trust's situs in a jurisdiction that will not tax the accumulated income in a non-grantor trust. The trust is merely designed to avoid state income tax and the donor most certainly does not want to risk having to pay federal gift taxes. The DING trust typically allows a distribution committee to make distributions to the beneficiaries, including the grantor. The distribution committee typically consists of several beneficiaries other than the grantor. The trust avoids grantor trust treatment under Sec. 674 by requiring the consent of an adverse party to all distributions during the grantor's lifetime. The grantor retains a testamentary limited power of appointment. Several letter rulings have held that the grantor has not made a completed gift upon creating the trust because of the retained testamentary limited power of appointment (Letter Rulings 200148028, 200247013 and 200502014.) CCA 2012 08026 seems inconsistent with that conclusion and commentators are considering abandoning DING trusts in the future.
        • If beneficiaries have a withdrawal right under a Crummey withdrawal power in a particular year exceeding the greater of $5,000 or 5% of the trust corpus, the lapse of the power in excess of that amount would be treated as a release of the power and therefore a gift by the Crummey powerholder if the powerholder is not the sole vested beneficiary of the trust. There are two traditionally used methods of avoiding this result:
          • Give the beneficiary a "hanging power" so that the power will lapse each year only to the extent that the lapse does not exceed the "5 or 5" amount.
          • The Crummey beneficiary would retain a testamentary limited power of appointment so that any lapse in excess of the "5 or 5" amount would not be a completed gift.
    • Shared Lottery Winnings: Dickerson v. Commissioner, T.C. Memo 2012-60
      • Lottery winners made a taxable gift upon contributing a winning lottery ticket to a newly formed corporation in which she owned only 49% of the stock and other family members owned the rest.
      • Tonda Dickerson was a waitress in Alabama. Edward Seward, her regular customer, gave lottery tickets to individuals including Tonda and her co-workers. On March 7, 1999 Mr. Seward gave Tonda a winning Florida lottery ticket, which, if paid over 30 years was valued at a little over $10 million with a cash payout value of a little over $5 million. The winning ticket was a gift, not a tip to Tonda.
      • Tonda wanted to share the winning ticket with her family. Her father contacted the general counsel for the Florida Lottery Commission who advised that Tonda form a single entity to claim the prize for the family. An S corporation, in which Tonda and her husband held 49% of the stock and the other family members held the rest of the stock, was formed.
      • The other waitresses challenged Tonda's right to all of the lottery winnings and Mr. Seward wanted a part of the winnings also. All of this was dismissed.
      • The Tax Court found that Tonda had made a gift of the 51% interest in the lottery winnings to the other family members. Tonda's family countered that there was an enforceable agreement among the family to split the proceeds of any lottery winnings. The court found that there was no evidence of such a contract or agreement.
      • The court applied a discount of 65% to the gift because there were disputes on the ticket. In addition, another 2% discount was applied for the cost of litigation. The result is that the 51% of the undisputed portion that went to the family resulted in a gift of a little over $1.1 million.
      • Note: the IRS initiated this case to collect gift taxes where no return had ever been filed.  The panelists also discussed the John Doe summons against California property tax authorities to find undisclosed gifts. All of this suggests that the IRS is becoming more proactive in the gift tax area.
      • CCA 201249015: it is better to file gift tax returns even for smaller gifts so as to keep track of the running total. Use of the unified credit is mandatory and you must use the credit. But there could be a problem if the statute has run on an earlier year.  
    • Grantor Trust Status Despite Crummey Powers: PLR 201235006
      • The IRS rules that the status of a trust as a grantor trust by reason of the grantor's power to substitute assets is not affected by Crummey powers in others.
      • An irrevocable life insurance trust (Trust A) had previously been established for the benefit of the taxpayer. Trust A owned a life insurance policy on the life of the taxpayer. The taxpayer also created an irrevocable trust (Trust B) for the benefit of his daughter and granddaughter, who were given hanging powers of withdrawal measured with reference to the annual gift tax exclusion, exercisable for 30 days after each contribution (or if earlier, until the end of the calendar year). The taxpayer retained a nonfiduciary power to reacquire the assets of Trust B in exchange for assets of equivalent value. The taxpayer is permitted to exercise the power by certifying in writing that the substituted property and the trust property for which it is substituted are of equivalent value. The trustee has a fiduciary obligation to ensure that the trustee is satisfied of the equivalency in value and this power cannot be exercised in a manner that can shift benefits among the trust beneficiaries. The trustee is prohibited from reimbursing the taxpayer for any income tax imposed on the taxpayer on trust income under the grantor trust rules.
      • The trustee of Trust B wants to purchase the life insurance policy from Trust A for its gift tax value. The trustee of Trust A will obtain from the insurer the interpolated terminal reserve on the policy as of the date of the sale and that amount plus unexpired premium would be used as the sales price for the policy. The taxpayer proposes to transfer cash to Trust B in an amount sufficient to buy the policy from Trust A for its gift tax value and the trustee of Trust B will then be named the owner and beneficiary of the policy. Trust B may incur debt or policy loans as part of the administration of Trust B.
      • The IRS ruled as follows:
        • Trust B will be a grantor trust under Sec. 675(4)(C) because of the taxpayer's retained power to acquire or reacquire trust assets by substituting other property of an equivalent value assuming that, on audit, the circumstances would indicate that the grantor holds that power in a nonfiduciary capacity, based on all the terms of the trust and surrounding circumstances (Regulations Sec. 1.675-1(b)(4)(iii)).
        • The 30-day Crummey withdrawal powers granted to the taxpayer's daughter and granddaughter will not prevent the grantor from being treated as the owner of the trust for income tax purposes because Sec. 678(b) provides that when both the grantor and a beneficiary are deemed to own the same trust or trust portion, the grantor is deemed to own the trust or trust portion and the beneficiary is not.
        • The sale of a grantor trust deemed owned by the insured is not a transfer for value for income tax purposes because it is deemed to be a transfer to the insured within the meaning of Sec. 101(a)(2)(B). Rev. Rul. 85-13, 1985-1 C.B. 184; Rev. Rul. 2007-13, 2007-11 C.B. 684.
        • The taxpayer's power of substitution will not cause the death benefits under the policy to be included in the taxpayer's gross estate under Sec. 2042 because:
          • Local law imposes on the trustee a fiduciary obligation to ensure that the property the grantor seeks to substitute is equivalent in value to the property that the grantor seeks to reacquire from the trustee.
          • Local law requires that the trustee acts impartially in investing and managing the trust assets taking into consideration any differing interests of the beneficiaries.
          • Local law provides without restriction in the trust instrument that the trustee has the discretionary power to acquire, invest, reinvest, exchange, sell, convey, control, divide, partition, and manage the trust property in accordance with the standards provided by law.
          • There will be no shifting of benefits between or among the beneficiaries that could otherwise result from the substitution power (Rev. Rul. 2011-28, 2011-48 C.B. 830; Rev. Rul. 84-179, 1984-2 C.B. 195; Rev. Rul. 2008-22, 2008-16 C.B. 796; Estate of Jordahl v. Commissioner, 65 T.C. 92 (1975), acq. in result, 1977-2 C.B.1).
    • Person Other than the Grantor is Treated as the Owner: PLR 201216034
      • The IRS rules that a beneficiary and holder of a lapsing Crummey power and a power to substitute trust assets can be treated as the owner of a trust.
      • A beneficiary defective trust ruling which seems to be the reverse of PLR 201235006, affirms the beneficiary-powerholder's status as owner of the trust.
      • The ruling involves a U.S. trust created to hold S corporation stock. The trust agreement provides that the grantor may make gifts to the trust and the primary beneficiary, who is also the trustee, can withdraw each contribution. The power of withdrawal is cumulative, but it lapses on a stated date each year to the extent of the greater of $5,000 or 5% of the value of the trust principal on that date.
      • The primary beneficiary/trustee may distribute income or principal to himself under an ascertainable standard. The trust instrument provides that the primary beneficiary has the nonfiducairy power to acquire the trust corpus by substituting other property of an equivalent value as determined by an independent appraiser selected by the trustee. The grantor is not a beneficiary of the trust and has no interest in the trust. Neither the grantor nor his spouse can be the trustee. In addition, neither the grantor nor any other nonadverse party can have the power to purchase, exchange, or otherwise deal with or dispose of all or any part of the principal or income of the trust for less than an adequate consideration in money or money's worth or to enable the grantor or his spouse to borrow all or part of the corpus or income of the trust without adequate interest or security.
      • The IRS ruled that the primary beneficiary will be treated as the owner of the trust under Sec. 671 and 678 assuming that on audit the circumstances surrounding the administration of the trust indicate that the substitution power is exercisable in a nonfiduciary capacity. The IRS noted that Sec. 678(a) makes a person other than the grantor the owner of any portion of a trust with respect to which:
        • That person has a power exercisable solely by himself to vest the corpus or income therefrom in himself, or
        • That person previously partially released or modified such a power and afterwards retained such control as would cause him to be treated and the owner of the trust if he was the grantor.
      • The IRS concluded that the primary beneficiary was the owner of the trust under Sec. 678(a)(1) with respect to that portion of the trust over which the withdrawal power has not lapsed. The IRS also said that to the extent that the primary beneficiary fails to exercise the withdrawal power and it lapses, he will be treated as having released the power while retaining a power of administration, exercisable in a nonfiduciary capacity, to acquire the trust corpus by substituting other property of an equivalent value. Whether such a substitution power held by a grantor would cause a trust to be a grantor trust depends upon facts and circumstances but to the extent that it would do so, the primary beneficiary would own the trust under Sec. 678(a)(2).
      • The IRS also held that to the extent the primary beneficiary has a withdrawal power over all contributions to the trust, the trust will be an eligible S corporation shareholder under Sec. 1361(c)(2)(A)(i).
      • The IRS also explained that the primary beneficiary's withdrawal power is a general power of appointment, but there is no taxable lapse because it lapses only to the extent of the greater of $5,000 or 5% of the trust corpus. At the primary beneficiary's death, his gross estate will include the value of the trust corpus that he could withdraw in that year, less any amount that he actually did withdraw that year. See Regulations Sec. 20.2041-3(d)(3); Estate of Dietz v. Commissioner, T.C. Memo 1996-471.
      • Note: The reasoning underlying the ruling that the primary beneficiary is deemed the owner of the entire trust under Sec. 678 could be questioned based on the following:
        • Sec. 678(a)(2) applies where a withdrawal power is partially released or modified. It is arguable as to whether or not a mere lapse can be such a release or modification. The IRS seems to have conceded this point in PLR 8142061, 8521060, 199936046, 199942037, 200011054, 200011055, 2001056, 200011058, 200949012, and 201216034.
        • The primary beneficiary is not an adverse party with respect to the interests of the grantor in the trust or with respect to his own exercise of the power of substitution. The primary beneficiary is a nonadverse party who holds a power of substitution, which renders the trust a grantor trust as to the grantor, rather than a beneficiary-owned trust as to the primary beneficiary. Rev. Proc. 2007-45, 2007-29 I.R.B. 89; Rev. Proc. 2008-46, 2008-30 I.R.B. 224. Sec. 678(b) says that whenever both the grantor and another party could be deemed to own a trust or portion thereof, the grantor is deemed owner and the other party is not. This trust seems to escape that characterization as a grantor trust only if the primary beneficiary is found incapable of exercising the power except in a fiduciary capacity.
        • Under Sec. 678(a), grantor trust treatment applies to any portion of a trust as to which a power of withdrawal has been released while reserving control that would cause Sec. 671-677 to apply if such person were the grantor of the trust. See Regulations Sec. 1.671-2(e)(6), Example 4, where the beneficiary holds an unrestricted power to withdraw certain amounts contributed to the trust. The beneficiary is treated as an owner of the portion of the trust that is subject to the withdrawal power.
      • Some planners believe that the "portion" refers to a fractional interest rather than an amount, so that if all gifts are subject to withdrawal power by the beneficiary, the entire trust would be treated as owned by the beneficiary under Sec. 678. However, the term "portion" might refer to the amount that can be withdrawn by the beneficiary, which would exclude growth in the trust from the time of the contribution to the time of the lapse of the withdrawal right. So, for example, if the initial contribution of $20,000 is covered by a withdrawal power, but the trust is worth $100,000 at the beginning of year 2, only $20,000/100,000 or 20% of the trust would be treated as owned by the beneficiary in year 2. Under this approach, in all of the PLRs issued treating the Crummey powerholder as the owner of a trust owning S stock, there would no longer be a wholly owned trust if there were any growth in the assets before the withdrawal power lapsed, which would cause the trust no longer to be a qualified S shareholder under the grantor trust exception. Crummey trusts may need to be revalued each year in order to determine the portion of the trust that is attributable to the powerholder and the portion attributable to the trust.
    • Charitable Planning Developments: there have been 14 cases in 2012 in which the IRS contested deductions that taxpayers were taking on conservation and historic façade easements. The IRS contests the valuation of these deductions and how much value is being lost for which the taxpayer claims a charitable deduction.
      • Kaufman V. Commissioner, 687 F.3d 21 (1st Cir. July 19, 2012), vac'g and rem'g 134 T.C. 182(2010), reh'g 136 T.C. 194 (2011)
        • Gordon and Lorna Kaufman transferred a façade easement on their historic Boston row house to the National Architectural Trust (NAT), a tax-exempt conservation organization along with a cash contribution equal to 10% of the value of their deduction. NAT advised the Kaufmans that they needed consent from the holder of any mortgage to do the transaction.  The Kaufmans told the mortgage holder that the restrictions imposed by the easement were essentially the same as the ones imposed by current local ordinances that govern the property; the mortgage holder consented to the subordination of its interest to that of NAT but required that the documents grant it a prior claim to all insurance proceeds as a result of any casualty. The Kaufmans obtained a professional appraisal of the easement and deducted the value of the easement and the cash contribution on their returns. The IRS disallowed both deductions and imposed accuracy-related penalties.
        • The Tax Court granted the IRS a partial summary judgment and denied the deduction for the easement, finding that the taxpayers violated the provision in the regulations requiring that when a change in conditions give rise to the extinguishment of a perpetual conservation restitution, the donee organization on a subsequent sale, exchange, or involuntary conversion of the property must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction unless state law provides that the donor is entitled to the full proceeds from the conversion. Regulation Sec. 1.170A-14(g)(6)(ii).
        • In its second opinion, the court reaffirmed the deduction of the contribution for the easement, and then allowed the cash contribution as a deduction (although in a different year than the year the Kaufmans had claimed the deduction). The court rejected the IRS argument that the cash gift was a fee-for-services because the cash donation could be just intended to cover the expenses related to the easement. The court also rejected the IRS' failure to substantiate argument.
        • The First Circuit vacated and remanded the case to the Tax Court for further factual findings. The court held that the arrangement with the mortgage holder did not violate the requirement of perpetuity on the easement. The regulations contain several provisions relevant to the deductibility of the easement in this case.
      • Scheidelman v. Commissioner, 682 F.3d 189 (2d. Cir. June 15, 2012), vac'g & rem'g T.C. Memo 2010-151
        • Huda Scheidelman and Ethan Perry bought a property in the Fort Greene Historic District in Brooklyn, NY. The taxpayers later contributed a façade easement to the NAT (the application form stated that operating funds come solely from cash donations made by persons donating an easement. The agreed-upon cash donation was 10% of the easement value and was required at the time the easement donation is accepted by NAT).
        • The taxpayers obtained an appraisal estimating the market value of the property and the value of the façade easement. The Scheidelmans  contributed the easement and made the cash contribution. The IRS denied both deductions and assessed an accuracy-related penalty.
        • The Tax Court agreed that neither of these contributions were deductible, but rejected the penalty. The court said that the appraisal which the taxpayers attached to their income tax return was not a qualified appraisal because it did not include the method and specific basis for valuing the easement. The appraiser had used the before-and-after method, stating that there was insufficient market data to support other valuation methods. The court noted that the appraiser did not explain a method for determining the discount and that the appraisal lacked meaningful analysis, failed to explain how the specific attributes of the subject property led to the value assigned and displayed no independent or reliable methodology. The appraisal merely found that a gift to a façade easement resulted in a loss of value of between 10-15%, so it applied an 11.33% discount to the $1,015,000 baseline value for the property. The Tax Court also found the summary appraisal (Form 8283) to be incomplete as to the date and manner the property was acquired and the cost basis was not provided on the form.
        • The Second Circuit vacated and remanded the case, holding that the appraisal was a qualified appraisal. The court noted that the before-and-after method was traditional for conservation easements and that the IRS had not contested that there was no adequate evidence of comparables to use other valuation methods. The appraisal explained how the appraiser got his numbers and that it was irrelevant whether the IRS believed that the appraisal was sloppy.
        • The court also stated that the taxpayer substantially and reasonably complied with the substantiation requirements. The information that was required to be reported on Form 8283 was actually in the return. Two such forms were attached, one completed and signed by the appraiser and the charity and the other completed by the taxpayer. The fact that the material was spread over two forms was excused on the basis of reasonable cause and substantial compliance. Sec. 170(f)(11)(A)(ii)(II); Bond v. Commissioner, 100 T.C. 32, 42 (1993)
        • Note: the taxpayer used an appraiser recommended by the charity to which the easement was contributed. The appraiser did an unsatisfactory job, and it is important to make sure that a qualified appraiser is hired to do the work.
      • Mitchell v.Commissioner,138 T.C. No. 16 (2012)
        • Romona and Charles Mitchell bought a 351-acre parcel in Montezuma County, Colorado in 2001 for $683,000. They paid $83,000 down and gave the seller a note for the rest, which was secured by a recorded deed of trust. They gave the parcel and other real property to a partnership in 2002 and the partnership gave a conservation easement of over 180 acres to the Montezuma Land Conservancy in 2003. The easement was appraised for $504,000, which was deducted as a charitable gift. The property was at the time of the gift subject to a deed of trust securing the debt to the previous owner who had wanted to be paid in installments. The deed of trust was not subordinated to the conservancy until two years after the gift, when the previous owned agreed to subordinate it.
        • The Tax Court held that there was a contribution of a qualified real property interest to a qualified organization but that the failure to subordinate the debt meant that the contribution was not exclusively for conservation purposes in perpetuity. Regulations Sec. 1.170A-14(g)(2) denies a deduction for a conservation easement on mortgaged property unless the mortgagee subordinates his rights to the donee organization to enforce the conservation purposes of the gift in perpetuity. The court held that the subordination agreement did not satisfy this requirement because the easement was not perpetual on the date of the gift. If the taxpayers had defaulted on the mortgage, the mortgagee could have foreclosed on the property and eliminated the conservation easement.
        • The court also held that the deduction was disallowed even if the possibility of default was so remote as to be negligible. Regulations Sec. 1.170A-14(g)(3). The accuracy-related penalty was abated based on good faith and reasonable cause.
        • Note: See Wall v. Commissioner, T.C. Memo 2012-169 (June 18, 2012) disallowing the charitable deduction for a façade easement simply because the lender's claims on the mortgage were not subordinated to the claims and interests of the charity.

6. Fiscal Year 2014 U.S. Treasury Greenbook and President Obama's Budget Proposals:
Estate, Trust and Gift Provisions

The Treasury's Greenbook 2014 provisions follow the President's 2014 budget; both were released in 2013.

A. Modify Estate and Gift Tax Provisions; Restore the Estate, Gift, and GST Parameters in Effect in 2009

Current Law

The current estate, GST, and gift tax rate is 40%, and each individual has a lifetime exclusion for all three types of taxes of $5 million (indexed after 2011 for inflation from 2010). The surviving spouse of a person who dies after December 31, 2010, may be eligible to increase the surviving spouse's exclusion amount for estate and gift tax purposes by the portion of the predeceased spouse's exclusion that remained unused at the predeceased spouse's death (in other words, the exclusion is "portable"). Prior to the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the maximum tax rate was 55%, plus a 5% surcharge on the amount of the taxable estate between approximately $10 million and $17.2 million (designed to recapture the benefit of the lower rate brackets). The exclusion for estate and gift tax purposes was $675,000 and was scheduled to increase to $1 million by 2006. Under EGTRRA, beginning in 2002, the top tax rate for all three types of taxes was reduced incrementally until it was 45% in 2007. In 2004, the exemption for estate taxes (but not for gift taxes) began to increase incrementally until it was $3.5 million in 2009, and the GST tax exemption and rate became unified with the estate tax exemption and rate. During this post-EGTRRA period through 2009, the gift tax exemption remained $1 million. Under EGTRRA, for 2010, the estate tax was to be replaced with carryover basis treatment of bequests, the GST tax was to be not applicable, and the gift tax was to remain in effect with a $1 million exclusion and a 35% tax rate. The EGTRRA provisions were scheduled to expire at the end of 2010, meaning that the estate tax and GST tax would be inapplicable for only one year.

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Act) retroactively changed applicable law for 2010 by providing a top estate tax rate of 35% for taxpayers electing estate tax rather than carryover-basis treatment. It retroactively reinstated the GST tax and unified the exemption for estate, GST, and gift taxes beginning in 2011 with a $5 million total lifetime exclusion for all three taxes (indexed after 2011 for inflation from 2010). It also enacted the portability of the exemption between spouses for both gift and estate tax purposes. The 2010 Tax Act provisions were scheduled to expire at the end of 2012.

The American Taxpayer Relief Act of 2012 (2012 Tax Act) permanently raised the top tax rate for estate, GST, and gift taxes to 40%. It also made permanent all the substantive estate, GST and gift tax provisions as in effect during 2012.

Reasons for Change

The 2012 Tax Act retained a substantial portion of the tax cut provided to the most affluent taxpayers under the 2010 Tax Act that cannot be continued. An estate tax law that is fair and raises an appropriate amount of revenue is desired.


Beginning in 2018, the proposal would make permanent the estate, GST, and gift tax parameters as they applied during 2009. The top tax rate would be 45% and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift taxes. There would be no indexing for inflation. The proposal would confirm that, in computing gift and estate tax liabilities, no estate or gift tax would be incurred by reason of decreases in the applicable exclusion amount with respect to a prior gift that was excluded from tax at the time of the transfer. Finally, portability of unused estate and gift tax exclusions between spouses would be allowed.

The proposal would be effective for the estates of decedents dying, and for transfers made, after December 31, 2017.

B. Require Consistency in Value For Transfer and Income Tax Purposes

Current Law

Section 1014 provides that the basis of property acquired from a decedent generally is the fair market value of the property on the decedent's date of death. Similarly, property included in the decedent's gross estate for estate tax purposes generally must be valued at its fair market value on the date of death. Although the same valuation standard applies to both provisions, current law does not explicitly require that the recipient's basis in that property be the same as the value reported for estate tax purposes.

Section 1015 provides that the donee's basis in property received by gift during the life of the donor generally is the donor's adjusted basis in the property, increased by gift tax paid on the transfer. If, however, the donor's basis exceeds the fair market value of the property on the date of the gift, the donee's basis is limited to that fair market value for purposes of determining any subsequent loss.

Section 1022, applicable to the estates of decedents dying during 2010 if a timely election to that effect was made, provides that the basis of property acquired from such a decedent is the lesser of the fair market value of the property on the decedent's date of death, or the decedent's adjusted basis in that property as increased by the additional basis (if any) allocated to that property by the executor under section 1022.

Section 6034A imposes a consistency requirement – specifically, that the recipient of a distribution of income from a trust or estate must report on the recipient's own income tax return the exact information included on the Schedule K-1 of the trust's or estate's income tax return – but this provision applies only for income tax purposes, and the Schedule K-1 does not include basis information.

Reasons for Change

Taxpayers should be required to take consistent positions in dealing with the Internal Revenue Service. The basis of property acquired from a decedent generally is the fair market value of the property on the decedent's date of death. Consistency requires that the same value be used by the recipient (unless that value is in excess of the accurate value). In the case of property transferred on death or by gift during life, often the executor of the estate or the donor, respectively, will be in the best position to ensure that the recipient receives the information that will be necessary to accurately determine the recipient's basis in the transferred property.


The proposal would impose both a consistency and a reporting requirement. The basis of property received by reason of death under section 1014 must equal the value of that property for estate tax purposes. The basis of property received by gift during the life of the donor must equal the donor's basis determined under section 1015. The basis of property acquired from a decedent to whose estate section 1022 is applicable is the basis of that property, including any additional basis allocated by the executor, as reported on the Form 8939 that the executor filed. The proposal would require that the basis of the property in the hands of the recipient be no greater than the value of that property as determined for estate or gift tax purposes (subject to subsequent adjustments).

A reporting requirement would be imposed on the executor of the decedent's estate and on the donor of a lifetime gift to provide the necessary valuation and basis information to both the recipient and the Internal Revenue Service. A grant of regulatory authority would be included to provide details about the implementation and administration of these requirements, including rules for situations in which no estate tax return is required to be filed or gifts are excluded from gift tax under section 2503, for situations in which the surviving joint tenant or other recipient may have better information than the executor, and for the timing of the required reporting in the event of adjustments to the reported value subsequent to the filing of an estate or gift tax return. The proposal would be effective for transfers on or after the date of enactment.

C. Require a Minimum Term for Grantor Retained Annuity Trusts (GRATS)

Current Law

Section 2702 provides that, if an interest in a trust is transferred to a family member, the value of any interest retained by the grantor is valued at zero for purposes of determining the transfer tax value of the gift to the family member(s). This rule does not apply if the retained interest is a "qualified interest." A fixed annuity, such as the annuity interest retained by the grantor of a GRAT, is one form of qualified interest, so the gift of the remainder interest in the GRAT is determined by deducting the present value of the retained annuity during the GRAT term from the fair market value of the property contributed to the trust.

Generally, a GRAT is an irrevocable trust funded with assets expected to appreciate in value, in which the grantor retains an annuity interest for a term of years that the grantor expects to survive. At the end of that term, the assets then remaining in the trust are transferred to (or held in further trust for) the beneficiaries, who generally are descendants of the grantor. If the grantor dies during the GRAT term, however, the trust assets (at least the portion needed to produce the retained annuity) are included in the grantor's gross estate for estate tax purposes. To this extent, although the beneficiaries will own the remaining trust assets, the estate tax benefit of creating the GRAT (specifically, the tax-free transfer of the appreciation during the GRAT term in excess of the annuity payments) is not realized.

Reasons for Change

GRATs have proven to be a popular and efficient technique for transferring wealth while minimizing the gift tax cost of transfers, providing that the grantor survives the GRAT term and the trust assets do not depreciate in value. The greater the appreciation, the greater the transfer tax benefit achieved. Taxpayers have become adept at maximizing the benefit of this technique, often by minimizing the term of the GRAT (thus reducing the risk of the grantor's death during the term), in many cases to two years, and by retaining annuity interests significant enough to reduce the gift tax value of the remainder interest to zero or to a number small enough to generate only a minimal gift tax liability.


The proposal would require, in effect, some downside risk in the use of this technique by imposing the requirement that a GRAT have a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years. The proposal also would include a requirement that the remainder interest have a value greater than zero at the time the interest is created and would prohibit any decrease in the annuity during the GRAT term. Although a minimum term would not prevent "zeroing-out" the gift tax value of the remainder interest, it would increase the risk that the grantor fails to outlive the GRAT term and the resulting loss of any anticipated transfer tax benefit.

The proposal would apply to trusts created after the date of enactment.

D. Limit Duration of GST Exemption

Current Law

GST tax is imposed on gifts and bequests to transferees who are two or more generations younger than the transferor. The GST tax was enacted to prevent the avoidance of estate and gift taxes through the use of a trust that gives successive life interests to multiple generations of beneficiaries. In such a trust, no estate tax would be incurred as beneficiaries died, because their respective life interests would die with them and thus would cause no inclusion of the trust assets in the deceased beneficiary's gross estate. The GST tax is a flat tax on the value of a transfer at the highest estate tax bracket applicable in that year. Each person has a lifetime GST tax exemption ($5.25 million in 2013) that can be allocated to transfers made, whether directly or in trust, by that person to a grandchild or other "skip person." The allocation of GST exemption to a transfer or to a trust excludes from the GST tax not only the amount of the transfer or trust assets equal to the amount of GST exemption allocated, but also all appreciation and income on that amount during the existence of the trust.

Reasons for Change

At the time of the enactment of the GST provisions, the law of most states included the common law Rule Against Perpetuities (RAP) or some statutory version of it. The RAP generally requires that every trust terminate no later than 21 years after the death of a person who was alive (a life in being) at the time of the creation of the trust.

Many states now either have repealed or limited the application of their RAP statutes, with the effect that trusts created subject to the law of those jurisdictions may continue in perpetuity. (a trust may be sitused anywhere; a grantor is not limited to the jurisdiction of the grantor's domicile for this purpose.) As a result, the transfer tax shield provided by the GST exemption effectively has been expanded from trusts funded with $1 million (the exemption at the time of enactment of the GST tax) and a maximum duration limited by the RAP, to trusts funded with $5.25 million and continuing (and growing) in perpetuity.


The proposal would provide that, on the 90th anniversary of the creation of a trust, the GST exclusion allocated to the trust would terminate. Specifically, this would be achieved by increasing the inclusion ratio of the trust (as defined in section 2642) to one, thereby rendering no part of the trust exempt from GST tax.

Because contributions to a trust from different grantors are deemed to be held in separate trusts under section 2654(b), each such separate trust would be subject to the same 90-year rule, measured from the date of the first contribution by the grantor of that separate trust. The special rule for pour-over trusts under section 2653(b)(2) would continue to apply to pour-over trusts and to trusts created under a decanting authority, and for purposes of this rule, such trusts will be deemed to have the same date of creation as the initial trust, with one exception, as follows. If, prior to the 90th anniversary of the trust, trust property is distributed to a trust for a beneficiary of the initial trust, and the distributee trust is as described in section 2642(c)(2), the inclusion ratio of the distributee trust will not be changed to one (with regard to the distribution from the initial trust) by reason of this rule. This exception is intended to permit an incapacitated beneficiary's share to continue to be held in trust without incurring GST tax on distributions to that beneficiary as long as that trust is to be used for the sole benefit of that beneficiary and any trust balance remaining on that beneficiary's death will be included in that beneficiary's gross estate for federal estate tax purposes. The other rules of section 2653 also would continue to apply, and would be relevant in determining when a taxable distribution or taxable termination occurs after the 90th anniversary of the trust. An express grant of regulatory authority would be included to facilitate the implementation and administration of this provision.

The proposal applies to trusts created after enactment, to the portion of a pre-existing trust attributable to additions to a trust made after that date.

E. Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts

Current Law

A grantor trust is a trust, whether revocable or irrevocable, of which an individual is treated as the owner for income tax purposes. For income tax purposes, a grantor trust is taxed as if the grantor or another person owns the trust assets directly, and the deemed owner and the trust are treated as the same person. Thus, transactions between the trust and the deemed owner are ignored. For transfer tax purposes, however, the trust and the deemed owner are separate persons, and under certain circumstances, the trust is not included in the deemed owner's gross estate for estate tax purposes at the death of the deemed owner.

Reasons for Change

The lack of coordination between the income and transfer tax rules applicable to a grantor trust creates opportunities to structure transactions between the deemed owner and the trust that can result in the transfer of significant wealth by the deemed owner without transfer tax consequences.


If a person who is a deemed owner under the grantor trust rules of all or a portion of a trust engages in a transaction with that trust that constitutes a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person's treatment as a deemed owner of the trust, then the portion of the trust attributable to the property received by the trust in that transaction (including all retained income therefrom, appreciation thereon, and reinvestments thereof, net of the amount of the consideration received by the person in that transaction) will be subject to estate tax as part of the gross estate of the deemed owner. Further, the person would be subject to gift tax at any time during the deemed owner's life when his or her treatment as a deemed owner of the trust is terminated, and will be treated as a gift by the deemed owner to the extent any distribution is made to another person (except in discharge of the deemed owner's obligation to the distributee) during the life of the deemed owner.

The proposal would reduce the amount subject to transfer tax by any portion of that amount that was treated as a prior taxable gift by the deemed owner. The transfer tax imposed by this proposal would be payable from the trust. The proposal would not change the treatment of any trust that is already includible in the grantor's gross estate under existing provisions of the Internal Revenue Code, including without limitation the following: grantor retained income trusts; grantor retained annuity trusts; personal residence trusts; and qualified personal residence trusts. Similarly, it would not apply to any trust having the exclusive purpose of paying deferred compensation under a nonqualified deferred compensation plan if the assets of such trust are available to satisfy claims of general  creditors of the grantor. It also would not apply to any trust that is a grantor trust solely by reason of section 677(a)(3).

The proposal would be effective with regard to trusts that engage in a described transaction on or after the date of enactment. Regulatory authority would be granted, including the ability to create exceptions to this provision.

F. Extend the Lien on Estate Tax Deferrals Provided Under Section 6166 of the Internal  Revenue Code

Current Law

Section 6166 of the Internal Revenue Code allows the deferral of estate tax on certain closely held business interests for up to fourteen years from the (unextended) due date of the estate tax payment (up to fifteen years and three months from date of death). This provision was enacted to reduce the possibility that the payment of the estate tax liability could force the sale or failure of the business. Section 6324(a)(1) imposes a lien on estate assets generally for the ten-year period immediately following the decedent's death to secure the full payment of the estate tax. Thus, the estate tax lien under section 6324(a)(1) expires approximately five years before the due date of the final payment of the deferred estate tax under section 6166.

Reasons for Change

In many cases, the Internal Revenue Service (IRS) has had difficulty collecting the deferred estate tax, often because of business failures during that tax deferral period. The IRS sometimes requires either an additional lien or some form of security, but these security interests generally are prohibitively expensive and damaging to the day-to-day conduct and financing of the business. In addition, unless these other security measures are put in place toward the beginning of the deferral period, there is a risk that other creditors could have a higher priority interest than the government. This proposal is expected to substantially eliminate the need for the IRS to determine whether and when additional security is needed, and the significant burdens on the closely held business from having to provide such additional security.


The proposal would extend the estate tax lien under section 6324(a)(1) throughout the section 6166 deferral period. The proposal would be effective for the estates of all decedents dying on or after the date of enactment, as well as for all estates of decedents dying before the date of enactment as to which the section 6324(a)(1) lien has not then expired.

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