April 2014 Volume 26, Number 4 EDITORS Howard M. Zaritsky Rapidan, Virginia www.howardzaritsky.com S. Alan Medlin University of South Carolina School of Law Columbia, South Carolina F. Ladson Boyle University of South Carolina School of Law Columbia, South Carolina IN THIS ISSUE Probate Report . . . . . . . . . . . . . . . . . 12 Statute Does Not Override Lack of Residuary Clause POA Confidential Relationship Affects Ownership of Bank Accounts Adopted Child Does Not Inherit from Biological Father Tax Report . . . . . . . . . . . . . . . . . . . . 14 Administration’s 2015 Budget Includes New Estate Planning Related Proposals No Advance Estate Tax Deduction of Pending Malpractice Claim 10th Circuit Supports Highest and Best Use of Easement Property and Denies $2.25 Million in Deductions No Deduction for Bargain Sale of Conservation Easement: State Law Prevents Perpetual Easement Transfers Under Premarital Agreement Qualify for Marital Deduction April 2014 Fundamentals of DING Type Trusts: No Gift Not a Grantor Trust By Jonathan G. Blattmachr and William D. Lipkind Introduction The initial reaction and, in some quarters, the continuing reaction of many practitioners is that it is not possible to have lifetime transfers made to a trust be incomplete for federal gift tax purposes and have the trust not be a grantor trust for federal income tax purposes. However, the Internal Revenue Service has issued several private letter rulings that reach the conclusion that such a result can be achieved. The apparent purpose of using such a structure is to attempt to avoid state and local income taxes on taxable income generated on the assets transferred in such an arrangement, although, at least some states are considering legislation that would attempt to foil such a result. New York recently enacted such legislation. A Brief History of Gift and Grantor Trust Rules The current gift tax provisions in the Internal Revenue Code of 1986, as amended, have their origin in 1932 after the gift tax enacted in 1924 was repealed in 1926. It was not enacted or reenacted primarily as a revenue source for the federal government but to prevent avoidance of income and estate taxes. 1 Probate Practice Reporter The grantor trust rules, under which the income, deductions, and credits against tax of the trust are attributed to the trust’s grantor (and, in one instance, to a beneficiary who is not the grantor) for federal income tax purposes, were first issued as regulations in 1946 under the gross income section of the Internal Revenue Code of 1939 to prevent taxpayers from shifting income to trusts as separate taxpayers and thereby reduce overall income taxation by such income “splitting.” These rules were codified, essentially with little change, as subpart E of part 1 of subchapter J of chapter 1 of subtitle A of the Internal Revenue Code of 1954 and are now comprised in sections 671-679 of the Internal Revenue Code of 1986 as amended. Today, the opportunities to reduce federal income taxes by shifting income to a nongrantor trust are so limited that it has been suggested that the grantor trust rules be repealed. See Ascher, The Grantor Trust Rules Should Be Repealed, 96 IOWA LAW REVIEW 885 (2011). Single individuals reach the top federal income tax bracket of 39.6 percent on income a little above $400,000 and for married couples filing jointly a little above $450,000. These taxpayers reach the 3.9% net investment income tax bracket at, respectively, $200,000 and $250,000. Non-grantor trusts reach these top brackets at about $12,000 of income. As a general rule, an individual taxpayer, subject to state (or state and local) income tax may create a non-grantor trust, the income of which avoids such state (or state and local) income taxation. For example, an income tax resident of New York City and State, both of which impose income taxes, may transfer property during his or her lifetime to a trust that is not a grantor trust so that the income avoids such state and local taxes. (As many states do, New York defines a “resident trust” as one created by a New Yorker and imposes its income tax on such resident trusts. See N.Y. Tax Law § 605. However, no tax is imposed if the trust has no New York trustee, no New York source income, and no asset situated in New York.) The basis upon which a state may seek to impose its income tax on income of a non-grantor trust varies significantly from jurisdiction to jurisdiction. (Under California law, for example, the state income tax is imposed if there is a California trustee or a California beneficiary. See Cal. Rev. & Tax Code §17742. The tax residence of the grantor of the trust is not a factor in determining whether California will seek to impose its income tax.) But there seem to be constitutional limitations on the ability of a state to impose its income tax merely on the ground that the trust was created by an income tax resident of the state. Although creating a non-grantor trust can avoid state and local income taxes, there are at least two reasons why that has not been widely done. First, it has been perceived that neither the individual taxpayer Copyright © 2014 by Probate Practice Reporter, LLC. Probate Practice Reporter (USPS 004231) (ISSN 1044-7423) is published monthly for $295.00 a year by Probate Practice Reporter, LLC, USC School of Law, Greene and Main Streets, Columbia, SC, 29208, (803) 777-7465. Periodicals Postage paid at Columbia, SC. Postmaster: Send address changes to Probate Practice Reporter, USC School of Law, Greene and Main Streets, Columbia, SC, 29208. The Probate Practice Reporter welcomes letters from readers. For space reasons, we reserve the right to edit letters we publish. Send your letter to the editors at the University of South Carolina School of Law, Columbia, South Carolina 29208. The editors used Westlaw® to research a portion of this newsletter. We welcome visitors to our website at probatepracticereporter.com and emails to [email protected]. 2 April 2014 Probate Practice Reporter who creates the trust nor his or her spouse may be a trust beneficiary because, as widely believed, if either is a trust beneficiary, the trust will be a grantor trust, meaning the income will be attributed back to the individual taxpayer and, thereby, be subject to the state and local income taxes that would be imposed upon the taxpayer if he or she had directly earned the income. That is because almost all state and local jurisdictions impose their income taxes based essentially, but subject to exceptions and special rules, on the taxpayer’s federal income. Income attributed to the grantor under the grantor trust rules, therefore, would continue to be taxed under the same state and local taxes as would all other income reportable by the grantor. Although by excluding the grantor and the grantor’s spouse as beneficiaries means a non-grantor trust may readily be created, many taxpayers do not want to lose access to the property transferred to a trust as well as the income the property thereafter produces. The second “limitation” is that it is generally perceived that any transfer of property to a nongrantor trust will be a completed gift for federal gift tax purposes resulting in the use of the taxpayer’s lifetime gift tax exemption and, to the extent the gift exceeds the available exemption, resulting in the payment of gift tax. Many taxpayers wish to preserve their exemptions, especially if they anticipate receiving all or a portion of the gifted property back. Moreover, as a general rule, taxpayers wish to avoid paying gift tax. Initial Private Letter Rulings Beginning in the early 2000s, the Service began issuing private letter rulings holding that the transfer of assets to a specifically designed trust would not be a completed gift and the trust would not be a grantor trust even though all the property might be returned to the grantor. See, for example, Private Letter Rulings April 2014 200247013, 200502014, 200612002, 200647001, 200715005 and 200731019. Although under section 6110(k)(3), these private rulings could not be cited or used as precedent, there were so many and so consistent that several practitioners created such arrangements for clients without private letter rulings. The trusts began being called “DING trusts” for “Delaware Incomplete Non-Grantor” trusts, although most of the private letter rulings were issued with respect to trusts governed by Alaska law. The structure of the trusts in these rulings was essentially the same. The trusts were irrevocable and the trustee had no authority to make distributions to any beneficiary during the grantor’s lifetime but only at the direction of a group of individuals, who were beneficiaries in addition to the grantor, and called the “Distribution Committee” either by their unanimous direction or by the direction of the grantor and a member of the Distribution Committee. The grantor also retained a testamentary special power of appointment and, in default of its effectual exercise, the trust remainder would pass to the grantor’s descendants or, if not, to alternate remainder beneficiaries (e.g., charitable organizations). Under this structure, the IRS consistently held that the transfer to the trust was not a completed gift and the trust was not a grantor trust. Eventually, taxpayers began asking for another ruling: that the taxpayers who held the power, in a non-fiduciary capacity, to require the trustee to make distributions (and who comprise the Distribution Committee) would not be treated as making a gift for federal gift tax purposes by directing the trustee to make distributions to a beneficiary other than themselves because the members of the Committee did not hold general powers of appointment described in section 2514. See, for example, Private Letter Ruling 200502014. 3 Probate Practice Reporter IRS Release 2007-127 ruling will not be sought. On July 9, 2007, the IRS issued Release 2007-127 (the “Release”) in which the Chief Counsel of the IRS requested comments on whether the private letter rulings holding that no member of the Distribution Committees held general powers of appointment were consistent with Rev. Rul. 76-503, 1976-2 C.B. 275, and Rev. Rul. 77-158, 1977-1 C.B. 285. Many professional organizations submitted comments with the great number concluding no member of a Distribution Committee held a general power of appointment. Grantor Trust Issues To date, the IRS has not issued any guidance on its position with respect to the issue raised in the Release. But beginning last year, the IRS began again issuing private letter rulings addressing all three issues involving a somewhat different structure that appears to obviate the issue addressed in the Release. The first was Private Letter Ruling 201310002. See also Private Letter Rulings 201310003 — 201310006 and Private Letter Rulings 201410001 — 2014100010. This article examines these rulings and provides a discussion of the reasoning of them on the questions of whether a transfer to such a trust is a completed gift, whether the trust is a grantor trust, and whether any member of the Distribution Committee holds a general power of appointment. It will explain how drafters can navigate around the grantor trust rules and also prevent transfers to the trust from being completed gifts. Many critical aspects of these trusts do not appear from the rulings themselves but can only be derived from the requests for the rulings and the experience of the practitioners who have acquired them. (Co-author Jonathan Blattmachr received most of the pre-Release PLRs. Co-author William Lipkind received the first post-Release PLR and several of the others that have been issued since then.) It will also provide some additional guidance if a private letter 4 A trust may be a grantor trust for one of several reasons, including when it is a foreign trust with an American beneficiary as described in section 679, when certain administrative powers described in section 675 are present, or when certain borrowing of trust property has occurred within the meaning of section 675(3). In each trust that is the subject of one of the private letters rulings, provisions essentially prohibit the trust from being a foreign trust and, to avoid section 677(a)(3), prohibit using income of the trust to pay premiums on a policy insuring the life of the grantor or the grantor’s spouse. Because no beneficiary may unilaterally withdraw all income or corpus from a trust, no trust could be a grantor trust with respect to a beneficiary under section 678. See, generally, Blattmachr, Gans & Lo, A Beneficiary as Trust Owner: Decoding Section 678, 35 ACTEC JOURNAL 35 (Fall 2009). As a general rule, careful drafting of the trust document and administration of the trust may avoid these grantor trust rules. However, other circumstances when grantor trust status is sought to be avoided may be more difficult to find such as when the grantor or the grantor’s spouse holds certain powers over or have interests in the trust. For example, if the grantor (or the grantor’s spouse) holds a reversionary interest in the trust described in section 673, it will be a grantor trust. Similarly, if the grantor (or the grantor’s spouse) holds certain powers to control the beneficial enjoyment of trust property as described in section 674, it will be a grantor trust. Moreover, if income or corpus must or may be distributed to or for the grantor (or the grantor’s spouse) as described in section 676 or 677, it will be a grantor trust. Hence, for the trust not to be a grantor trust (one of the results sought in the private letter rulings), these provisions must be April 2014 Probate Practice Reporter avoided. To begin, it is appropriate to note that many of the powers or interests that would make a trust a grantor trust do not apply if these powers or interests are exercisable or enjoyable only with the consent of an “adverse party.” Section 672(a) defines “adverse party” as any person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or non-exercise of the power which he possesses respecting the trust. Whether an interest is substantial and whether it is adverse are, in general, questions of fact. This is discussed in detail in Boyle & Blattmachr, BLATTMACHR ON INCOME TAXATION OF ESTATES AND TRUSTS (PLI 2014) at 4:2.4[A]. The IRS apparently has concluded that, because the members of the Distribution Committee have absolute discretion to direct distributions from income and principal among themselves, each of the members of the Distribution Committee has a substantial interest in both the income and principal of the trust that would be adversely affected by any decision to accumulate income in the trust rather than distribute the income currently among the members. (Although the current beneficiaries in each of the post-Release PLRs were also the default remainder beneficiaries of the trust, the grantor could appoint the remainder to others pursuant to the testamentary power of appointment.) Because the question of whether an interest is substantial and adverse is one of fact, it is not possible to conclude with certainty that the conclusion of the Service is correct, but it does not seem to be unreasonable. In any case, this determination by the IRS seems critical to the conclusion that the trusts involved in the rulings were not grantor trusts, as discussed below. Section 673. A trust is a grantor trust if the grantor (or the grantor’s spouse) has a reversionary interest in the corpus or income of the trust that, at the trust’s April 2014 inception, has a value of more than five percent of the value of the corpus or income. It does not seem that the grantor (or the grantor’s spouse) has any reversionary interest in the type of trust that has been the subject of the private letter rulings. The trust agreement never provides for a distribution by its trustee to the grantor; the grantor’s testamentary power of appointment cannot be exercised in favor of the grantor, the grantor’s creditors or estate, or the creditors of the grantor’s estate; and, to the extent the power of appointment is not effectually exercised, the trust property passes to other default takers, which do not include the grantor or the grantor’s estate. Perhaps, more critically, a reversion under section 673 apparently can arise only in situations involving a traditional reversion under property law. Under the traditional definition, a reversion arises when a person having a vested estate transfers a lesser vested estate to another. There seems to be no authority, holding, or commentary suggesting that a trustee’s discretionary power to distribute principal or income to the transferor, with the consent of an adverse party, constitutes a reversionary interest under section 673. The IRS itself has acknowledged that “a reversionary interest is the interest a transferor has when less than his entire interest in property is transferred to a trust and which will become possessory at some future date.” TAM 8127004. Similarly, in GCM 36,410, when comparing a possibility of reverter under section 676(a) with a reversion, the Service defined a reversion as “the residue left in the grantor on determination of a particular estate” and stated that “the reversionary interest arises only when the transferor transfers an estate of lesser quantum than he owns.” As mentioned above, the trusts that are the subject of the ruling provide for alternative remainder beneficiaries 5 Probate Practice Reporter so no portion of the trust may ever revert to the grantor or the grantor’s estate. Hence, the IRS seems correct in concluding in the ruling that section 673 does not apply to cause these trusts to be grantor trusts. Section 674. Section 674(a) provides that a trust will be a grantor trust if the beneficial enjoyment of its corpus or the income is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party. The real scope of section 674 is determined by the many exceptions it contains. Some powers of disposition may be held by anyone (including the grantor or the grantor’s spouse) without causing the trust to be a grantor trust. Others may be held only by persons other than the grantor (or the grantor’s spouse) and certain others without causing the trust to be a grantor trust. Still others may be held by anyone other than the grantor (or the grantor’s spouse) without triggering grantor trust status. As mentioned, the only powers retained by the grantor in the trusts were (i) a power to appoint principal exercisable by will, (ii) a power to appoint income (accumulated with the consent of the Distribution Committee, the members of which are adverse parties) exercisable by will, and (iii) a nonfiduciary power to distribute principal limited by a reasonably definite standard. Power to Appoint Corpus and Accumulated Income by Will. Under section 674(b)(3), a trust is not a grantor trust merely because someone (including the grantor) holds a power exercisable only by will, other than a power in the grantor to appoint by will the income of the trust when the income is accumulated for such disposition by the grantor or may be so accumulated in the discretion of the grantor or a nonadverse party, or both, without the approval or 6 consent of any adverse party. Under the trusts involved in the rulings, the grantor has a testamentary power of appointment not just over the original corpus of the trust but accumulated income as well. However, as mentioned above, accumulation of income may occur under the trust only essentially with the consent of at least one member of the Distribution Committee (as the grantor may direct the distribution of trust property only with the consent of at least one member of the committee, each of whom the Service concluded is an adverse party). Hence, accumulation of income may occur only with the consent of an adverse party. Therefore, the section 674(b)(3) exception to the general rule of section 674(a) applies and, as a result, the testamentary power does not trigger grantor trust status. Power to Distribute Principal Pursuant to a Standard. Under section 674(b)(5), a trust is not a grantor trust merely because someone (including the grantor) holds a power to distribute corpus to or for a beneficiary or beneficiaries or to or for a class of beneficiaries (whether or not income beneficiaries) provided that the power is limited by a reasonably definite standard set forth in the trust instrument. (Note that a power does not fall within the powers described in section 674(b)(5) if any person has a power to add to the beneficiary or beneficiaries or to a class of beneficiaries designated to receive the income or corpus, except where such action is to provide for after-born or after-adopted children.) Such a standard is broader than the familiar ascertainable standard relating to health, education, maintenance, and support (HEMS) commonly used to avoid the powerholder from being treated as holding a general power of appointment under sections 2514 and 2041 for gift and estate tax purposes. In any case, a HEMS standard falls within the reasonably definite standard under section 674(b)(3). Hence, the April 2014 Probate Practice Reporter retention of the power by the grantor to appoint the principal of the trust among the beneficiaries (other than the grantor) does not cause a trust to be a grantor trust. Some powers trigger grantor trust status only if held in a non-fiduciary capacity. However, it seems that the “exception” contained in section 674(b)(5) applies whether the power to distribute is held in a fiduciary or non-fiduciary capacity. The reason the section 674(b)(5) power in the post-Release PLRs is held in a non-fiduciary capacity relates to the incomplete gift aspect of the rulings, as discussed below. Sections 676 and 677. Section 676 provides that a trust is a grantor trust when it provides for the possible return to the grantor of the corpus of a trust but only if it does not require the consent of an adverse party. Section 677 triggers grantor trust status in a situation in which the income of a trust may be distributed to or used for the benefit of the grantor or accumulated for the grantor (or the grantor’s spouse) but only if it does not require the consent of an adverse party. Under the terms of the trusts that are the subject of the private letter rulings, all of the income and corpus may be returned to the grantor but only with the consent of at least one member of the Distribution Committee. (In the later rulings, it requires the consent of a majority of the members of the committee with that of the grantor.) As discussed above, the Service has concluded that each member of the Distribution Committee is an adverse party. Hence, the grantor’s power to direct the distribution of income and principal to himself or herself does not cause either section 676 or 677 to apply because that may occur only with the consent of one or more adverse parties. Importance of State Law. As indicated earlier, it April 2014 seems that all of the pre-Release PLRs deal with trusts formed under the laws of Alaska or Delaware. (These trusts are commonly referred to as “AKINGs” or “DINGs,” respectively.) Although not discussed in the rulings, the laws of those states were used because, even though the assets in the trust could be distributed to the grantor, the governing law did not permit creditors to attach the trust assets. If the grantor’s creditors could attach trust property in satisfaction of the grantor’s debts, the trust would be a grantor trust. See Rev. Rul. 54-516, 1954-2 C.B. 54. It is at least arguable that a DING-type trust is not subject to claims of creditors. Although the law in most states essentially provides that a trust a person creates or settles for himself or herself (a so-called “Self-Settled Trust”) is permanently subject to the claims of the settlor’s creditors (see, for example, N.Y. EPTL § 73.1 and RESTATEMENT (THIRD) OF TRUSTS § 60), it seems somewhat uncertain what constitutes a selfsettled trust. For example, under N.Y. EPTL § 7-3.1, a self-settled trust is void with respect to creditors of the settlor. In Herzog v. Commissioner, 116 F. 2d 591 (2d Cir. 1941) with what some view as America’s greatest three-judge panel (Judge Learned Hand, Judge Augustus Hand, and Judge Chase) held that the trust was not subject to the claims of creditors of the settlor because the trustee could distribute income and corpus to persons other than the settlor. Later New York state case law suggests that Herzog was incorrectly decided. See, for example, Vandervilt Credit Corp. v. Chase Manhattan Bank, 100 A.D.2d 544 (1984). The post-Release PLRs have all dealt with trusts formed under Nevada law and are commonly referred to as “NINGs.” Like Alaska and Delaware, Nevada law, as well as several other states, permits individuals to create trusts that are not subject to the claims of the creditors of the grantor. Some states provide this protection only in limited circumstances. For example, in 7 Probate Practice Reporter Arizona and Florida, the assets in an inter vivos QTIP trust are not deemed contributions by the surviving settlor even if the settlor has some interest in the trust after the death of the settlor’s spouse. See, for example, S.C. Code Ann. § 62-7-505(b)(2); see also ACTEC Comparison of the Domestic Asset Protection Trust Statutes, edited by David G. Shaftel, http://www.actec.org/public/Documents/Studies/Sh aftel_DAPT_CHART_06_30_2012.pdf. It is at least arguable that a NING-type trust may be created under the law of any state because a self-settled trust (that is, a trust the assets of which may be attached by the creditors of the settlor) includes only one from which the trustee must or may distribute assets to the settlor. As explained earlier, the trustee of the trusts that were the subject of the private letter rulings did not hold the power to distribute trust property to the grantor. However, the grantor could distribute trust property to himself or herself, which would make it subject to the claims of his or her creditors under the law of virtually all states. However, some states continue to protect the trust’s assets when the grantor’s power of revocation is held only with the consent of an adverse party. See, for example, Alaska Stat. § 34.40.110(b)(2). Thus, the conclusion is that the trust should be formed under the law of a state that protects the trust assets from claims of the creditors of the grantor. A taxpayer makes a gift for federal gift tax purposes to the extent the value of what the taxpayer transfers exceeds the value of what the taxpayer receives in exchange. A gift is complete (and, therefore, potentially subject to gift tax) to the extent the taxpayer has so parted with dominion and control as to leave in him or her no power to change its disposition, whether for his or her own benefit or for the benefit of another. Treas. Reg. § 25.25112(b)(first sentence). See, generally, Zeydel, "When Is a Gift to a Trust Complete: Did CCA 201208026 Get It Right?," JOURNAL OF TAXATION ( September 2012). For example, a gift is incomplete if and to the extent that a reserved power gives the taxpayer the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves, unless the power is a fiduciary power limited by a fixed or ascertainable standard. Treas. Reg. § 25.25112(c)(second sentence). However, Nevada law was chosen over the laws of other states (for example, Alaska or Delaware) because in the ruling process after the Release the IRS insisted that the grantor hold a power described in section 674(b)(5), which is the power to distribute corpus to the beneficiaries pursuant to a reasonably definite standard set forth in the instrument. At the time the original post-Release request for ruling was filed with the Service, only Nevada law expressly permitted a grantor to hold a lifetime special power of appointment without exposing the trust assets to The implication is that if the taxpayer retains a power to distribute property pursuant to a fixed or ascertainable standard (such as a HEMS standard) held in a non-fiduciary capacity, the power renders the gift incomplete. So the section 675(b)(5) power to distribute corpus, which does not trigger grantor trust status whether retained in a fiduciary or non-fiduciary capacity, was retained in the trusts that are the subject of the post-Release PLRs in a non-fiduciary capacity so this power prevented the entire gift with respect to both corpus and accumulated income from being 8 claims of creditors of the grantor. Alaska, Delaware, and other states permit the grantor to hold a testamentary special power of appointment without such exposure but not a lifetime power, although the laws of some states (for example, Alaska and Delaware) have since been amended to permit lifetime powers as well. Gift Tax Issues April 2014 Probate Practice Reporter complete. There is a second power retained by the grantor in all the trusts that are the subject of the private letter rulings and that renders at least part of the transfers to the trust as incomplete for federal gift tax purposes: the testamentary special power of appointment. Although this power could not be exercised in favor of the grantor, the grantor’s creditors or estate, or creditors of the grantor’s estate, such a power may render a gift incomplete. As mentioned above, a gift is incomplete if and to the extent that a reserved power gives the taxpayer the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves (unless the power is a fiduciary power limited by a fixed or ascertainable standard). This regulation seems to reflect the Supreme Court’s decision in Estate of Sanford v. Commissioner, 308 U.S. 39 (1939). In that case, the taxpayer created a trust for the benefit of named beneficiaries, reserving the power to revoke the trust in whole or in part and to designate new beneficiaries other than himself. Six years later, the taxpayer relinquished his power to revoke the trust. However, the taxpayer continued to retain his rights to change the beneficiaries. The taxpayer relinquished his right to change the beneficiaries. The Court held that a donor’s gift is not complete, for purposes of the gift tax, until the donor relinquishes the power to determine those who would ultimately receive the property. Accordingly, the retention of the special power of appointment exercisable by will (falling under the section 674(b)(3) grantor trust exception) together with lifetime power (falling under the section 674(b)(5) grantor trust exception), held in a nonfiduciary capacity, to distribute corpus pursuant to the HEMS standard renders the gifts to the trusts incomplete. Nonetheless, these powers will cause the April 2014 trust to be included in the grantor’s gross estate under sections 2036(a)(2) and 2038. However, avoiding estate tax is not the goal of these trusts which, as mentioned, seems to be to provide a way in which state and local income taxes may be avoided. Under Regulations section 25.2511-2(e), a taxpayer is considered as having a power that would render any gift incomplete even if it is exercisable by the taxpayer in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property or the income therefrom. The Distribution Committee members are not takers in default for purposes of Regulations section 25.2514-3(b)(2). They are merely coholders of the power to distribute to the beneficiaries including the grantor. The Distribution Committee ceases to exist upon the death of Grantor. Under Regulations section 25.2514-3(b)(2), a coholder of a power is only considered as having an adverse interest when he or she may hold the power after the death of the current possessor of the power and the coholder may then exercise it in favor of himself or herself, his or her estate or creditors, or the creditors of his or her estate. The Service concurred in Rev. Rul. 79-63, 1979-1 C.B. 302: “In this case, A is a taker in default not of the lifetime power in which A has a power of consent but rather of the testamentary power exercisable solely by the decedent. In such a situation A would not have necessarily been in a better economic position after the decedent's death by refusing to exercise the power in favor of the decedent during the decedent's lifetime. Thus, the fact that A might survive the decedent and receive an interest in the property, if the decedent failed to exercise the testamentary power in favor of persons other than A, does not elevate A's interest as a consenting party of the lifetime power to a substantial adverse interest.” In the situations involved in the PLRs, the 9 Probate Practice Reporter Distribution Committee ceased to exist upon Grantor's death. Accordingly, the Distribution Committee members do not have interests adverse to the Grantor under Regulations section 25.2514-3(b)(2) and for purposes of section 25.2511-2(e). Therefore, the Grantor is considered as possessing the power to distribute income and principal to any beneficiary himself or herself because he or she retained the power to distribute the trust property (with the consent of a majority of the members of the Distribution Committee). The retention of these powers causes the transfer of property to the trust to be wholly incomplete for federal gift tax purposes. The grantor also retained the power described in section 674(b)(5) over the principal of trust. The grantor retains dominion and control over the income and principal of the trust unless and until the Distribution Committee members exercise their power, which, if the grantor does not consent, must be exercised unanimously to make distributions. This power held by the Distribution Committee does not appear to cause the transfer of property to be complete for federal gift tax purposes. See Goldstein v. Commissioner, 37 T.C. 897 (1962); Estate of Goelet v. Commissioner, 51 T.C. 352 (1968). General Power of Appointment Issue As indicated above, in most of the pre-Release PLRs, the IRS held that no member of the Distribution Committees held general powers of appointment, but in the Release Chief Counsel to the IRS asked for comments of whether those holdings were consistent with Rev. Rul. 76-503 and Rev. Rul. 77-158. The apparent concern of the IRS was whether the powers held by members of the Distribution Committee to distribute corpus to themselves (as well as to the grantor and, perhaps, other beneficiaries) constituted a general power deemed held by each such 10 member. S ections 2514(c)(3)(B) and 2041(b)(1)(C)(ii) essentially provide that an individual is not treated as holding a general power of appointment that is exercisable in his or her own favor if it is only exercisable with the consent of someone with a substantial interest that is adverse to such exercise. Rev. Rul. 76-503 and Rev. Rul. 77-158 (which amplified the 1976 ruling) appear to hold that persons who hold a “joint” power to distribute property to themselves are not adverse to the exercise of the power by the others when surviving powerholders must continue to share the power with someone who succeeds to the joint power when one of the original powerholders dies. A taxpayer is not treated as a general powerholder if it is exercisable only with the consent of the person who granted the power. Sections 2514(c)(3)(A) and 2041(b)(1)(C)(I). As mentioned, one of the powers a member of the Distribution Committee holds is to exercise the power with the consent of the grantor. Hence, that power held by members of the Distribution Committee is not a general power of appointment for gift or estate tax purposes. As mentioned above, almost all of the professional organizations that submitted comments concluded that no member of the Distribution Committees held a general power of appointment. However, the IRS has not issued any official or unofficial statement as to that matter. Nonetheless, the trusts that are the subject of the post-Release PLRs avoid the issue by providing that, at all times, the power of the Distribution Committee to direct distributions (other than with the consent of the grantor) must be exercised unanimously and, although initially there were more than two Distribution Committee members, the trust agreements require that, at all times, there must be at least two individuals (other than the grantor) who are members of the Distribution Committee. Accordingly, the Service has ruled in April 2014 Probate Practice Reporter these post-Release PLRs that the members do not hold a general power of appointment. If trust property is distributed back to the grantor, neither the Distribution Committee members nor the grantor will be deemed to have made a gift but, to the extent any property is distributed to anyone else (even by direction of the Distribution Committee and without the participation by the grantor), the grantor, but not the members of the Distribution Committee, will be deemed to have made a completed gift. Practice Pointers Requesting a ruling is a time consuming and expensive undertaking. Some practitioners and clients may feel that the reasoning expressed in the post-Release PLRs is sufficiently accurate and the rulings so consistent that it is not imprudent to adopt such an arrangement without a ruling. However, no one but the taxpayer who obtained a private letter ruling may rely upon it. Even though practitioners may view the risk of the IRS taking a contrary position, other than on a prospective basis, it may be wise to consider that it could be happen. As indicated above, some practitioners seem to be of the view that it is not possible to create a trust so that gifts to it are incomplete for federal gift tax purposes and for the trust not to be a grantor trust. As a general rule, a trust instrument must be construed to carry out the grantor’s intent, and it appears tax courts will follow that intent in determining the tax effects of the trust. See, for example, Lepore Est., 128 Misc. 2d 250; 492 N.Y.S.2d 689 (Surr. Ct. Kings Cty 1985); compare Reid Est. v. Comm’r, T.C. Memo 1982-532. Accordingly, it seems appropriate to have the trust April 2014 recite that the grantor intends no gift made to the trust be complete for federal gift tax purposes and for the trust not to be a grantor trust, and to direct that the trust instrument be construed to achieve those intentions but, if it is not possible to achieve both, that it be construed so no gift to the trust is a completed gift. If the trust is found to be a grantor trust, the grantor is in the same position as if the transfer had not been made. But if the gift is complete, the result, especially if considerable value has been transferred to the trust, could be viewed as quite adverse. Summary and Conclusions The IRS has consistently ruled that a taxpayer may structure a trust in an appropriate jurisdiction in a manner so that no gift to the trust is complete for federal gift tax purposes and the trust is not a grantor trust. This may provide an opportunity to avoid state and local income taxes. The design of the trust should follow carefully those on which the IRS has issued favorable rulings. Not all of the terms of the trust are recited by the Service in the rulings, so a drafter must be extremely cautious in proceeding to create one. Jonathan Blattmachr is a nationally-renowned expert who writes and lectures extensively on estate and trust taxation and charitable giving. He has authored or co-authored five books and over 500 articles on estate planning topics. Bill Lipkind is a founding member of Lampf, Lipkind, Prupis & Petigrow, specializing in taxation and estate planning. Both Jonathan and Bill have obtained a number of the private letter rulings discussed in the article. 11 Probate Practice Reporter Probate Report Statute Does Not Override Lack of Residuary Clause In Aldrich v. Basie, __ So. 3d __ (Fla. 2014), (2014 Westlaw 1240073), the testator used an “E-Z Legal Form” as her will. The will made specific devises to her sister and alternatively to her brother if her sister predeceased her. The will contained no residuary clause. The testator’s sister predeceased her and devised property to the testator. Although the testator apparently tried to execute a codicil on a document titled “Just a Note,” the note did not attain testamentary validity because it lacked the requisite number of witnesses. The attempted codicil cited the property devised to her by her sister and confirmed that her brother was to receive all her probate assets. However, because the attempted codicil was ineffective, the testator’s estate plan still lacked a residuary disposition. The brother contended that he was entitled to the entire estate. The testator’s nieces through a predeceased brother contended that the residue passed by partial intestacy. The brother cited the state probate code statute providing that a will passes all property owned by a testator at death, even if the property is acquired after the execution of the will, unless the testator indicates a contrary intent. He argued that the statute compensated for the lack of a residuary clause and passed all the testator’s probate estate to him, including the property inherited by the testator from their sister, because she acquired the property after the execution of the will. Noting that the state probate code’s definition of intestacy included all probate property “not effectively disposed of by will,” the court concluded that the statute cited by the brother was not intended to 12 override the lack of a residuary clause. Rather, the statute would include as part of a devised residue any property owned by the testator at death, even if acquired after execution of the will, but that presumed that the will included a residuary clause. However, the statute would not serve as a substitute for the lack of a residuary devise. Although the testator’s will devised all of the property described therein to her brother, the court observed that the testator “did not explicitly state that her identified beneficiaries were to receive all of the property that she owned at her death, only the property that she listed in her will.” The court concluded that the testator’s lack of a residuary clause effectively indicated her intent to devise only the listed property to her brother and would not allow the statute to override that intent. Editors’ Comment: As emphasized in a concurring opinion, the use of a legal form without legal counsel thwarted what the testator apparently meant to do: leave all of her probate assets to her brother. The object lesson of the concurring opinion is that courts have limited tools to fix mistakes made by testators in their wills and, when they make mistakes, particularly by failing to seek legal counsel, statutes not intended for that purpose cannot be used as a patch. Every probate practitioner knows to include a residuary devise in a will, yet this basic device was scuttled by the testator’s uninformed use of a legal form that, according to the concurring opinion, did not contain preprinted residuary language and even lacked the space to write in a residuary devise. Recognizing the obvious dangers of testators making wills without legal advice, the Real Property, Probate and Trust Law Section of the Florida Bar filed an amicus brief supporting the position taken by the court. April 2014 Probate Practice Reporter POA Confidential Relationship Ownership of Bank Accounts Affects In In re Boatwright, 980 N.Y.S.2d 554 (App. Div 2014), the decedent died in 1998, survived by a son and a daughter as her only intestate heirs. The son was appointed as administrator and brought an action to discover assets of the estate, including bank accounts and real estate. The daughter successfully contended that the son had released his interest in the real estate in exchange for $55,000. The Surrogate concluded that the estate owned the bank accounts being held by the daughter and ordered her to turn over half the funds to the son. The appellate court upheld the Surrogate’s ruling that the daughter wrongfully withheld over $100,000 in the bank accounts because she unduly influenced the decedent. The appellate court observed that, although the burden of proof for undue influence generally rests with the party asserting undue influence, the burden shifts to the beneficiary if the beneficiary is in a confidential relationship with the transferor. In that case, the beneficiary must prove by clear and convincing evidence that the transaction was voluntary, knowing, and fair. Because the daughter was the decedent’s attorneyin-fact, the appellate court concluded that a confidential relationship existed. She failed to meet the burden of proof necessary to demonstrate that the decedent intended to make gifts to her upon the creation of the bank accounts. Editors’ Comment: The daughter’s failure to meet the clear and convincing evidentiary standard was not helped by her explanations, which the Surrogate found to be “evasive, dissembling, and incredible.” The appellate court did overrule the Surrogate’s determination that the daughter should transfer half the bank account funds directly to the son. The funds April 2014 belonged to the estate, and the son sought the discovery of those funds as the administrator of the estate. Although the son may eventually end up with the bank account proceeds, those assets are subject to administration and may be fair game for others with a higher priority in estate assets, such as creditors, before he receives the distribution. Boatwright serves as a reminder that a power of attorney creates a fiduciary relationship, which can impact decisions about the validity of lifetime transfers. Adopted Child Does Not Inherit from Biological Father In In re Brockmire, __ S.W.3d __ (Mo. 2014) (2014 Westlaw 946963), the decedent died in 2011, survived by his brother, his only biological child — a daughter — and the daughter’s daughter, the “granddaughter.” When the granddaughter was eight weeks old, the daughter was adopted by her stepfather before the decedent died. The applicable state statutes precluded the daughter from inheriting because she was adopted before the decedent’s death. However, the daughter, acting as guardian for the granddaughter, argued that the statutes effectively treated her as predeceasing the decedent and did not preclude the granddaughter from taking by representation. The court concluded that the statutes clearly contradicted the granddaughter’s position. The court observed that the daughter was alive and the statute did not treat her as predeceased, but rather deemed her not to be the decedent’s child for intestacy purposes because she was adopted by her stepfather. Moreover, the court concluded that, even if the daughter were treated as predeceasing the decedent, the granddaughter’s right to inherit would flow from and through the daughter, who by statute was not a child of the decedent for intestacy. The granddaughter 13 Probate Practice Reporter could not bootstrap her claim to the daughter because the daughter had no claim. Editors’ Comment: The court clearly was not impressed by the granddaughter’s tortuous statutory argument. But Brockmire demonstrates the impact of adoption on a child’s right to inherit. Commonly, intestacy statutes provide that an adopted child is treated for inheritance purposes as the child of the adoptive parent and not of the biological parent. An exception is the so-called stepchild adoption case when, for example, the biological mother marries the adoptive father. The adopted child could inherit from the adoptive father and from the biological mother. Tax Report Administration’s 2015 Budget Includes New Estate Planning Related Proposals The Administration’s 2015 Budget includes several proposals of significance to estate planners. Most of these were included in the 2014 budget, discussed in the May 2013 issue of the REPORTER, and can, therefore, be dealt with rather quickly below, but three were new proposals. Dept. of Treas. “General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals” (March 2014) (“General Explanations”). New Proposals The 2015 budget includes three new proposals of interest to estate planners. Limiting the Annual Exclusion. The 2015 budget would eliminate the present interest requirement for a new category of gifts, so that they qualified for the gift tax annual exclusion without regard to the existence of withdrawal or put rights, but subject to a $50,000 per donor annual limit. Under this proposal, a donor’s gifts in this new category in a single year above $50,000 would be taxable, even if the total gifts to each individual donee were under $14,000. The new category would include transfers in trust (other than to a trust described in section 2642(c)(2)), transfers of interests in passthrough entities, transfers 14 of interests subject to a prohibition on sale, and other transfers of property that, without regard to withdrawal, put, or other such rights in the donee, cannot immediately be liquidated by the donee. The proposal would be effective for gifts made after the year of enactment. Expanding the Term “Executor.” The 2015 budget would expand the definition of "executor" to apply for all tax purposes, rather than just for estate, gift, and generation-skipping transfer tax purposes. The proposal would thus empower an authorized party to act on behalf of the decedent in all matters relating to the decedent’s tax liability, and also authorize an executor to do anything on behalf of the decedent in connection with the decedent’s pre-death tax liabilities or obligations that the decedent could have done if still living. It would also grant regulatory authority to adopt rules to resolve conflicts among multiple executors authorized by this provision. This proposal would apply upon enactment, regardless of a decedent’s date of death. Make Permanent Certain Incentives for Gifts of Conservation Easements. The 2015 budget would make permanent the increases in the percentage-ofincome limitation for gifts of conservation easements enacted as part of the Pension Protection Act of 2006, and the extension of the carryover for such deductions April 2014 Probate Practice Reporter to 15 years. These provisions have been previously extended three times, but they were allowed to expire on December 31, 2013. decedents dying and taxable transfers made after 2017. General Explanations, at 158. Require that Basis Be Based on Transfer Tax Values. As in the 2009 – 2014 budget proposals, the 2015 proposal would require that taxpayers who receive property by gift or from a decedent use the relevant gift or estate tax value as their basis, even if they disagree with the valuation reported for gift or estate tax purposes. General Explanations, at 160. Sales, Exchanges, and Similar Transfers to Grantor Trusts. As in the 2013 and 2014 proposals, the 2015 budget would include in the gross estate of a person deemed to own a trust under the grantor trust rules that portion of the trust attributable to a sale, exchange, or “comparable transaction” between the grantor and the trust, if that transaction was disregarded for income tax purposes. The trust assets would be subject to gift tax when grantor trust status ended, or when the trust made distributions to another person (except in discharge of the deemed owner’s obligation to the distributee) during the life of the deemed owner. General Explanations, at 166. Eliminate Zero-Gift and Short-Term GRATs As it has in the 2010 through 2014 budgets, the Administration’s 2015 budget would: (a) require that all GRATs last for at least 10 years; (b) set a maximum GRAT term of the grantor’s life expectancy plus 10 years; © require that all GRATs have some minimum remainder interest; and (d) preclude decreasing GRAT annuity payments. General Explanations, at 162. GST Tax Treatment of Health and Education Exclusion Trusts (HEETs). As in the 2014 proposals, the 2015 budget would “clarify” that the GST tax exclusion for payments for medical care or tuition applies only to a direct payment by a donor to the provider of medical care or to the school in payment of tuition, and not to trust distributions, even if the distributions are made for those same purposes. See I.R.C. § 2611(b)(1). General Explanations, at 169. 90-Year Limit on GST Inclusion Ratio. As in the 2012 through 2014 budget proposals, the 2015 proposals would provide that an allocation of GST exemption to a transfer protects that transfer from GST tax for no more than 90 years. General Explanations, at 164. Extend the Lien on Estate Tax Deferrals Provided under Section 6166. As in the 2013 and 2014 proposals, the 2015 budget would extend the special lien imposed under section 6324(a)(1) for taxes deferred under section 6166, from ten years to the entire 15-year period of the tax deferral under that section. General Explanations, at 168. Old Friends The following proposals were repeated from the 2014 budget, sometimes with very small technical changes. Reinstate the 2009 Tax Rates and Exemptions. As in the 2011 through 2014 budget proposals, the 2015 proposals would return the estate, gift, and GST rates and exemptions to their 2009 levels (top estate and gift tax rate and sole GST tax rate of 45 percent; $3.5 million estate tax applicable exclusion amount and GST exemption, and $1 million gift tax exemption). This proposal would apply with respect to estates of April 2014 Sales of Life Insurance Contracts. As in the 2010 through 2014 proposals, the 2015 budget would require a person who buys an interest in an existing life insurance contract with a death benefit equal to at least $500,000 to report to the IRS, the insurer, and the seller, the purchase price, and the buyer's and 15 Probate Practice Reporter seller's taxpayer identification numbers (TINs). The proposal would also modify the transfer-for-value rule to ensure that exceptions to that rule would not apply to buyers of policies. General Explanations, at 69. listed in the National Register to comply with the same special rules currently applicable to buildings in a registered historic district. General Explanations, at 196. Eliminating Stretch IRAs. As in the 2014 proposals, the 2015 budget would require that nonspouse beneficiaries of retirement plans and IRAs must take distributions over no more than five years, with an exception for “eligible beneficiaries,” including any beneficiary who, as of the date of death, is disabled, a chronically ill individual, an individual who is not more than 10 years younger than the participant or IRA owner, or a child who has not reached the age of majority. Eligible beneficiaries could take distributions over their life expectancy, beginning in the year following the year of the death of the participant or owner. General Explanations, at 179. Editors’ Comment: The aging stalemate in Congress with respect to most tax matters is unlikely to permit the passage of these proposals, but should the Democrats obtain a majority in both houses and keep the presidency, these proposals will be seriously considered. Limiting Total Accrual of Tax-Favored Retirement Benefits. As in the 2014 proposals, the 2015 budget would provide that a taxpayer who has accumulated amounts within an IRA or qualified plan or other taxfavored retirement plan in excess of the amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan (currently $3.4 million, calculated as $205,000 per year payable as lifetime joint and 100-percent survivor benefit commencing at age 62) could not make additional contributions or receive additional accruals, though the taxpayer’s account balance could continue to grow to reflect earnings and appreciation. General Explanations, at 181. Contributions of Historic Easements Consistent. As in the 2014 proposals, the 2015 budget would: (a) deny the deduction for gifts of a façade easement with respect to any value associated with forgone upward development above a historic building; and (b) require contributions of conservation easements on buildings 16 No Advance Estate Tax Deduction of Pending Malpractice Claim In Estate of Saunders v. Commissioner, ___ F. 3d ___ (9th Cir. March 12, 2014) (2014 Westlaw 949246), aff’g 136 T.C. 406 (2011), the decedent’s late husband was an attorney who represented a client in some extensive tax litigation. After 10 years of litigation, the client sued the decedent’s husband and, later, his estate, for malpractice, breach of confidence, breach of duty of loyalty, and fraudulent concealment, seeking over $90 million in compensatory damages, plus additional punitive damages. A jury held that the decedent’s husband had breached his fiduciary duty and his duties of confidentiality and undivided loyalty, but found no damages. On appeal, the litigation was settled for $250,000. The decedents estate deducted $30 million for the value of the claim outstanding on the date of death, based on an independent professional appraisal. The Tax Court (Judge Cohen) held that the estate could deduct only the amounts it actually paid. See the discussion in the June 2011 issue of the REPORTER. The Ninth Circuit (Judge Smith) affirmed, agreeing that, at the decedent’s death, there was no way to ascertain the value of the ongoing lawsuit with reasonable certainty. The court also held that the IRS properly allowed the estate eventually to April 2014 Probate Practice Reporter deduct $250,000 — the amount the case ultimately settled for. The court stated that case law established a framework for classifying claims as “certain and enforceable” or “disputed or contingent,” and that the consideration of post-death events would be affected by how the claim was classified. Tenth Circuit Supports Tax Court Finding of “Highest and Best Use” of Easement Property and Denies $2.27 Million in Deductions In Esgar Corp. v. Commissioner, ___ F.3d ___ (10th Cir. March 7, 2014) (2014 Westlaw 889614), aff’g T.C. Memo. 2012-35, a corporation and two married couples donated to charity a conservation easement on certain property and claimed deductions of $2.27 million. The properties were zoned irrigatedagricultural and had historically been used as irrigated and non-irrigated farmland. There was physical access to all three properties, but only one had legal access. The properties were not zoned for mining, but the parties stipulated that, absent the donations, permits to mine could have been obtained. The conservation easements specifically prohibited mining or mineral extraction. A report of a geotechnical engineering firm determined significant potential sand and gravel resources, and an appraiser determined that, absent the easements, the best use of the land would have been for gravel extraction and that this resulted in the deductions claimed. The Tax Court (Judge Wherry) held that the best use of the property was agricultural, rather than mining, and that the appraisal had overstated the unencumbered value of the property. The court noted that the use to which the land is currently being put is presumed to be the highest and best use, absent proof to the contrary, and that a hypothetical willing buyer would not have been willing to wait the period required for the markets to align with the new gravel source and to make the property valuable as a gravel April 2014 mine. The court, however, declined to sustain substantial overvaluation or income understatement penalties, finding that the taxpayers reasonably relied on their long-time CPA to put together the transaction, and they obtained a core sampling report of the underlying valuable gravel reserves and a qualified appraisal from a qualified appraiser. The Tenth Circuit (Judge Kelly) affirmed, stating that the Tax Court committed no clear error when it concluded that the highest and best use of the land was agricultural, rather than gravel mining. The court rejected the argument that the Tax Court had improperly applied eminent domain principles in its decision, finding no way in which those principles had tainted the assessment of the properties. The court also affirmed the Tax Court’s decision in a related case holding that state tax credits they received and then sold in connection with the easements had not been held long enough to qualify for long-term capital gains treatment. Tempel v. Comm'r, 136 T.C. 341 (2011). No Deduction Allowed for Bargain Sale of Conservation Easement Because State Law Prevented Easement From Being Perpetual In Wachter v. Commissioner, 142 T.C. 7 (March 11, 2014), the Tax Court held that two couples were not entitled to charitable deductions on a bargain sale of conservation easements because the easements were not qualified interests under tax law. The taxpayers owned interests in two partnerships that made $485,650 in cash charitable contributions and a bargain sale of conservation easements to a charity pursuant to a federal program. The taxpayers deducted $759,050 — the difference between the appraised value of the encumbered parcels as “rural residential sites” and their value as agricultural property under the easements, less the bargain sale price. 17 Probate Practice Reporter The Tax Court (Judge Buch) granted the IRS a partial summary judgment on the deductibility of the conservation easement, noting that North Dakota uniquely limits by statute the duration of real property easements to 99 years. N.D. Cent. Code § 45-07-02.1. The tax law allows a deduction for a conservation easement only if the interest is granted in perpetuity, and the North Dakota law prevents the easement from being perpetual. See I.R.C. § 170(h)(2)©. The taxpayers argued that the possibility of reversion of the property interest to the donors was so remote that it should be ignored, but the court held that the possibility of reversion was not remote, but rather inevitable. The court refused to grant a partial summary judgment regarding whether the couples satisfied the requirement of a contemporaneous written acknowledgment for their cash gifts. The taxpayers argued that checks and letters sent to them in the years of the gifts, together, satisfied the requirements for a contemporaneous written acknowledgment. See Irby v. Commissioner, 139 T.C. 371 (2012) (a series of documents may constitute a contemporaneous written acknowledgment). The court stated that the taxpayers might be able to authenticate disputed documents and provide additional documents to supplement those they have included with the stipulation of facts, and thus refused to grant summary judgment on this issue. Transfers Under Premarital Agreement Qualify for Marital Deduction In Private Letter Ruling 201410011 (March 7, 2014), Taxpayer and Spouse executed a premarital agreement under which each waived their respective right of election to take against the other’s will. The agreement provides that upon Taxpayer’s death, if Spouse survives him and if they are then married and living together, Spouse will receive an outright payment of $w, free and net of any and all estate, 18 transfer, and income taxes, or, if Taxpayer and Spouse were married and living together for at least 10 years when he dies, Spouse will receive a QTIP marital trust with at least x percent of Taxpayer’s taxable estate, before deducting amounts due for federal estate tax purposes under the premarital agreement. Taxpayer established a revocable trust to carry out the provisions of the premarital agreement, providing that if Spouse makes a timely election to waive elective share, the trustee will allocate and make distributions to Spouse as provided in the premarital agreement. The trust provides that the trustee can satisfy the payments under the premarital agreement with preferred non-voting units of LLC. Taxpayer, as trustee of the revocable trust, holds voting and nonvoting common units of LLC and all of the preferred units. The IRS stated that Spouse’s right to elect under the premarital agreement and the revocable trust is not a “contingency” that would disqualify the transfers for the estate tax marital deduction, under section 2056(b)(1). The revocable trust property actually distributed outright to Spouse and to marital trust will be property “passing from the decedent to his surviving spouse” for marital deduction purposes. The IRS discussed several precedents. In Rev. Rul. 54-446, 1954-2 C.B. 303, a couple signed a premarital agreement under which each spouse renounced rights in the other’s estate. The husband died, and his will left the wife more than was required by the premarital agreement, and specified that the dispositions were in lieu of any rights she might have under the premarital agreement. The IRS ruled that the amount left to the wife under the will “passed from the decedent to his surviving spouse” and qualified for the estate tax marital deduction. In Rev. Rul. 68-271, 1968-1 C.B. 409, a wife renounced her marital rights by signing a premarital agreement, in return for a promise of a stated sum from husband’s estate, if she survived him. April 2014 Probate Practice Reporter The husband died and his will made no provision for the wife. The wife put in a claim against the husband’s estate and the estate paid the required sum to the wife. The ruling stated that the interest passing to the wife pursuant to the premarital agreement “passed from the decedent to his surviving spouse” and qualified for the estate tax marital deduction. In Estate of Tompkins v. Commissioner, 68 T.C. 912 (1977), acq., 1982-1 C.B. 1, a decedent gave his widow a life estate in trust, and by codicil provided that she could elect to take an outright cash bequest in lieu of the life estate. To elect the cash bequest, the widow had to file an election with the executor within 60 days after his qualification. The widow elected the cash bequest and the court held that the procedural requirement did not prevent the disposition from qualifying for the estate tax marital deduction and that the cash bequest was a nonterminable interest. In Rev. Rul. 82-184, 1982-2 C.B. 215, the IRS considered a situation similar to that in Tompkins and reached the same conclusion. In the ruling, the IRS stated that the 180-day requirement for Spouse to claim the interests promised by the premarital agreement did not interfere with the estate tax marital deduction and that the QTIP interest would be deductible. The IRS also noted that the terms of the QTIP trust directed the trustee to distribute all net income at least quarter-annually and that the fact the bequest was satisfied by LLC preferred units did not prevent allowance of the marital deduction. The IRS noted that the sale of LLC preferred units was not unreasonably restricted by the LLC agreement, which allowed a member to transfer units to (a) another member, (b) a q ualified institutional transferee, and (c) the husband, his children, and/or any affiliate, without obtaining the prior written consent of a majority in interest of the members. Probate Index Florida Aldrich v. Basie . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Missouri In re Brockmire . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 New York In re Boatwright . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Tax Index Administration’s 2015 Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Esgar Corp. v. Commissioner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Estate of Saunders v. Commissioner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Private Letter Ruling 201410011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Wachter v. Commissioner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 April 2014 19 Probate Practice Reporter ISSN 1044-7423 The Law Center Greene and Main Streets Columbia, SC 29208 20 Columbia, SC 29292 PAID Periodicals Postage Probate Practice Reporter April 2014
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