Estate and Gift Tax Developments

LEGISLATION:

The Tax Relief and Health Care Act of 2006 (Public Law 109-432, December 20, 2006).

On December 20, 2006, President Bush signed the Tax Relief and Health Care Act of 2006, which includes many varied provisions, including extensions of various income tax credits and deductions.  Section 424 of the Act provides that, for all tax years beginning after December 31, 2006, Charitable Remainder Trusts will no longer lose tax-exempt status for any taxable year in which they receive Unrelated Business Taxable Income ("UBTI").  Instead, an excise tax equal to 100% of all UBTI will be imposed on a Charitable Trust that receives UBTI.  As Byrle Abbin emphasized recently, this result may not necessarily be a panacea.  The UBTI realized by the CRT not only is subject to the 100% excise tax (confiscating all return on the investment that generated UBTI) charged to the charitable remainder, but also is subject to another level of tax (both federal and state income tax) paid by the distributee (under the CRT tier income tax system).  It appears possible that the results may not be that much different from simply taxing the CRT as a regular trust without the benefit of its tax exempt status.  As Mr. Abbin noted, it is possible that third-party trustees of CRTs could be sued for dereliction of duty if they invest in assets that generate UBTI.  Moreover, it is plausible in certain situations even where the trustees are the charitable remainder beneficiary, that the relevant state attorney general may become involved since the investment may have resulted in an obvious "negative return."  Thus, careful monitoring of the investment activities and an understanding of what is treated as UBTI is even more necessary for those involved in the administration of CRTs than in the past.

CASES:

Korby v. Commissioner, 98 AFTR 2d 2006-8115 (8th Cir. December 8, 2006).

The United States Court of Appeals for the Eighth Circuit affirmed the Tax Court's decision that the assets transferred to a family limited partnership ("FLP") by Mr. and Mrs. Korby were includible in their estates under Internal Revenue Code ("IRC) § 2036.  The Court of Appeals found no clear error in the Tax Court's determination that (1) the FLP assets were includible in the Korbys' estates pursuant to IRC §2036 because Mr. and Mrs. Korby retained the right to receive the income from the assets transferred to the FLP by means of an implied agreement with the limited partners, and (2) the transfers were not bona fide sales and thus were not excepted from IRC § 2036 pursuant to § 2036(a).

The estates claimed that the distributions of income from the FLP to Mr. and Mrs. Korby, as general partners, were fees for Mr. Korby's management services.  The court disagreed, finding that (1) the lack of a written management agreement, (2) the distribution of funds upon Mr. Korby's request rather than on a regular schedule, and (3) the lack of records of Mr. Korby's time spent managing the FLP assets (among other factors) proved that Mr. and Mrs. Korby and their sons (the limited partners in the FLP) had an implied agreement that the income of the FLP would remain available to the Taxpayers.

The Korbys' estates also argued that the transfers of property to the FLP were bona fide sales for full and adequate consideration, thus meeting the exception found in § 2036(a).  The court found, however, that the estates did not prove a bona fide business reason for forming the FLP.

Glass v. Commissioner, 98 AFTR 2d 2006-8309 (6th Cir. December 21, 2006).

The United States Court of Appeals for the Sixth Circuit affirmed the Tax Court's decision that Mr. and Mrs. Glass were entitled to a deduction for the value of the conservation easements they donated to a nonprofit nature conservancy.  The Internal Revenue Service ("IRS) asserted that the easements were not granted "exclusively for conservation purposes" as required by Code § 170(h)(1).  The Tax Court and Sixth Circuit disagreed with the IRS, finding that Mr. and Mrs. Glass's retained rights, including the right to build certain small structures on the subject property, were consistent with the conservation purposes of the easements and did not disqualify the easements from meeting the Code § 170(h)(1) test for deduction.

Estate of Keeton v. Commissioner, TC Memo 2006-263 (December 13, 2006).

The Tax Court upheld IRS's denial of the § 2057 deduction for qualified family-owned business interests.  Section 2057(a) allowed a deduction from estate taxes for certain interests in family-owned businesses for estates of persons dying after December 31, 1997 and before January 1, 2004.  Mr. Keeton's estate did not meet one of the requirements of § 2057, namely, the requirement of § 2057(b)(1)(C) that the adjusted value of the interests must exceed 50% of the adjusted gross estate.  Mr. Keeton's estate first argued that two separate businesses should be viewed as one business but later conceded that the 50% test was not met even if the interests in the two separate businesses were aggregated.  The estate argued, however, that a previous stipulation by the parties required the court to grant the § 2057 deduction despite the failure to meet the 50% test.  The estate also argued that the IRS waited too late to argue that the 50% test was not met.  The Tax Court disagreed with both contentions and found in favor of the IRS.

Estate of Gimbel v. Commissioner, TC Memo 2006-270 (December 19, 2006).

This case represents a valuable discussion of the most appropriate methodology used for determining the marketability discount applicable to a large block of shares that are not freely tradable.  Also, this case sheds further light on the Tax Court's treatment of post valuation date events.

The Tax Court redetermined the value of 3,601,267 restricted shares of common stock of Reliance Steel and Aluminum Company, a publicly traded company ("Reliance").  3,548,450 shares were included in Mrs. Gimbel's estate by reason of certain trusts created by her late husband.  Mrs. Gimbel owned the remaining shares through Reliance's employee stock ownership plan, her IRA, and in her individual name.  All together, Mrs. Gimbel owned approximately 13% of all outstanding Reliance stock at the time of her death.

Because Mrs. Gimbel was treated as an "affiliate" of Reliance under Federal securities laws, any public sale of her restricted shares was subject to volume and timing restrictions.  Specifically, the estate could sell only 277,860 shares in any 3-month period.  The sale of all 3,601,267 shares to the public would require a minimum of 39 months, which the court referred to as the "dribble-out" period.  A private placement of shares would not be subject to the dribble-out period but the dribble-out rules would be imposed on the purchasers.  The restrictions on resale made the private sale of the shares very unlikely.

The Tax Court determined that, as of the date of Mrs. Gimbel's death, no private market existed for the Reliance stock.  The court found that, on the date of Mrs. Gimbel's death, it was reasonably foreseeable that Reliance would repurchase 20% of Mrs. Gimbel's stock.  (In fact, Reliance repurchased approximately 63% of Mrs. Gimbel's stock 4 months after her death.)  The Tax Court applied a 13.9% discount (the discount used by the IRS's valuation expert) to the 20% of Mrs. Gimbel's stock whose repurchase was foreseeable.  As for the remaining 80% of Mrs. Gimbel's Reliance stock, the court recalculated the dribble-out period for public sales of 80% of the stock and applied a 13.2% discount (as recommended by the estate's valuation expert) to arrive at the value of the shares.

IRS DOCUMENTS:

Notice 2006-109, 2006-51 IRB 1 (December 4, 2006), provides guidance for supporting organizations, donor advised funds and private foundations regarding certain provisions of the Pension Protection Act.

Notice 2007-7, 2007-5 IRB 1 (January 10, 2007), provides guidance on several provisions of the Pension Protection Act, including non-spouse beneficiaries' ability to roll over funds from qualified retirement plans to IRAs and certain taxpayers' temporary, limited ability to make distributions from IRAs directly to charity.

TAM 200648028 (December 1, 2006) discusses various estate and gift tax issues, including the aggregation and valuation of shares of stock held in trust and owned outright by a decedent for purposes of § 2031 and the deductibility of attorneys' fees and expenses incurred by trust beneficiaries.

PLR 200648016 states that a proposed termination of a pre-September 25, 1985 trust will not cause the terminating distributions to the Settlor's granddaughter and other, more remote descendants to be subject to the generation-skipping transfer tax, nor will the terminating distributions be deemed to be gifts by any party.  (See also PLR 200648017).

PLR 200648018 finds that a proposed modification of a pre-September 25, 1985 trust to provide that the shares for certain beneficiaries will be held in trust for a longer period than described in the original instrument "will not shift a beneficial interest in Trust to a beneficiary who occupies a lower generation than the person who held beneficial interests prior to the modification."  (See also PLR 200648019, PLR 200648020, and PLR 200648021).

PLR 200648025 states that the annuity amount to be paid from a Taxpayer's proposed Charitable Lead Annuity Trust ("CLAT") will entitle the Taxpayer to a gift tax charitable deduction under Code § 2522(a) for the value of the annuity amount to be paid to charity during the lead term of the CLAT.  The ruling also states that the assets transferred to the CLAT will not be included in the Taxpayer's estate pursuant to Code §§ 2036, 2038, 2041, 2042 or 2035, the Taxpayer will not own any part of the income or principal transferred to the CLAT due to the application of Code §§ 673-678, and the CLAT will be allowed a deduction for each annuity amount paid from the CLAT to charity.

PLR 200648032 waives the 60-day rollover requirement of Code § 408(d)(3) for a distribution from an IRA where a surviving spouse and the custodian of the IRA experienced a misunderstanding or miscommunication and the IRA proceeds were placed in a non-IRA account for the surviving spouse.

PLR 200648034 waives the Code § 408(d)(3) 60-day rollover requirement where a Taxpayer withdrew funds from an IRA, intending to invest the funds in a new IRA account at a different financial institution, but the financial institution inadvertently opened a non-IRA account.

PLR 200649023 states that a decedent's daughter's proposed disclaimer of her special power of appointment over a certain amount of trust funds will be a qualified disclaimer as defined in Code § 2518.  Pursuant to the terms of the will which created the trust in question, any amounts not appointed by the daughter will be distributed to a Foundation, of which the daughter is the sole Trustee.  If, before disclaiming, the daughter appoints a Co-Trustee and amends the Foundation documents to provide for the disclaimed funds to be held in a special, segregated account to be managed by a Special Trustee of the Foundation (and not by the daughter), the estate will be entitled to a charitable deduction from Federal estate taxes under Code § 2055.

PLR 200649027 rules that a proposed judicial reformation of a charitable remainder trust would violate Code § 664, causing the reformed trust to be disqualified as a charitable remainder trust.  The Taxpayers attempted to turn a net income makeup charitable remainder trust ("NIMCRUT") into a charitable remainder unitrust ("CRUT"), arguing that they were not made aware of the possibility of creating a CRUT rather than a NIMCRUT, and would have opted for a CRUT when creating the trust, if they had been aware of the option.  They also argued that the decreases in interest rates had led to a much lower annual income from the NIMCRUT than intended.  The IRS ruled that the proposed reformation was not due to a scrivener's error; and, therefore, that the reformation would constitute an amendment, alteration or revocation for the beneficial use of someone other than a charitable organization in violation of Treasury Regulation §1.664-3(a)(4).

PLR 200649030 provides that a Foundation's proposed insurance and/or indemnification of its managers for any legal expenses that may be incurred in connection with any civil or administrative proceeding arising from each manager's actions (or failures to act) on behalf of the Foundation will not constitute self-dealing.  (See also PLR 200649031 and PLR 200649032, finding no self-dealing where Foundation's managers will be indemnified with respect to actions in connection with their roles as trustees of charitable trusts created by the founder of the Foundation).

PLR 200649038 waives the 60-day rollover requirement of Code §408(d)(3) where a Taxpayer's bank inadvertently deposited IRA funds to a non-IRA certificate of deposit rather than a certificate of deposit within the Taxpayer's IRA, as the Taxpayer requested.  The Bank admitted the error and the IRS allowed the Taxpayer to redeposit the amount into his IRA.

PLR 200650001 rules that a proposed consolidation and amendment of pre-September 25, 1985 Trusts will not affect the new Trust's generation-skipping transfer tax exemption and will not result in a transfer by any beneficiary or a taxable gift.

PLR 200650018 grants a 5-year extension of time for a private foundation to transfer its excess business holdings under Code § 4943(c)(6).   The foundation inherited interests in a farm and a corporation from its founder.  As required by Code § 4943(c)(7), the foundation proved to the IRS that it has "made diligent efforts to dispose of" the excess business holdings within 5 years but was "unable to do so because of the size and complexity of such holdings," has submitted a plan for disposing of the interests within an additional five years (which plan was also submitted to the state Attorney General).  The IRS determined that the foundation's plan for disposal of its excess business holdings "could reasonably be expected to be carried out before the close of the extension period."

PLR 200650019 waives the Code § 408(d)(3) 60-day rollover requirement where a financial institution failed to follow the Taxpayer's instruction to transfer funds distributed to the Taxpayer from an existing IRA to the Taxpayer's new IRA account at that same financial institution.

PLR 200650020 waives the Code § 408(d)(3) 60-day rollover requirement where a financial institution mistakenly withheld taxes on an amount distributed from one IRA to a new IRA owned by the same Taxpayer.  A deposit in the new IRA in an amount equal to the amount of taxes withheld is deemed to be a rollover contribution.

PLR 200650021 waives the Code § 408(d)(3) 60-day rollover requirement where, due to a miscommunication with the bank, a taxpayer's check failed to clear in time to meet the 60-day deadline.

PLR 200650022 rules that the sole beneficiary of an estate may roll over the proceeds of an IRA received under the terms of the decedent's will to the beneficiary's own IRA and such proceeds will not be includible in the beneficiary's gross income in the year of the transfer; rather, the proceeds will be taxed when distributed pursuant to Code § 408(d)(1).

PLR 200650023 allows a widow to roll over the amounts received from her deceased husband's Code § 401(a) profit-sharing plan, SEP-IRA, and another plan into the widow's IRA and to take distributions before reaching age 59 ½.

PLR 200650024 waives the Code § 408(d)(3) 60-day rollover requirement where the taxpayer stated that she relied upon inaccurate information from her new employer, which maintains the new Plan that was to receive the rollover distribution. 

PLR 200650025 waives the § 408(d)(3) 60-day rollover requirement where the Taxpayer, who suffers from a mental condition which impairs his ability to understand and manage his financial affairs, took a total distribution from his IRA.  The IRS granted 60 days from the date of the PLR for the Taxpayer to deposit the distributed amount in an IRA.

PLR 200651005 rules that a proposed division of a trust into separate trusts with identical provisions but different assets, with each beneficiary receiving a proportionate share of the new trust of his or her choice, will not affect the generation-skipping transfer tax exemptions of the old trust or new trusts and that neither the trust nor any beneficiary will recognize a gain or loss as a result of the division.

PLR 200651028 rules that a proposed partition of a GST-exempt trust to create a new trust for an after-born child pursuant to the provisions of the trust agreement will not affect the allocation of GST exemption to the trust and the new trust will also be exempt from generation-skipping transfer taxes by means of the allocation of GST exemption to the original trust.  (See also PLR 200651029.)

PLR 200651034 waives the § 408(d)(3) 60-day rollover requirement where a legally blind taxpayer verbally requested that an amount be added to an IRA account but, due to a miscommunication, the amount was added to a non-IRA account.

PLR 200651038 rules that a proposed sale of a Trust's LLC interest to the Trustee, with probate court approval, is not an act of self-dealing under Code § 4941 because it meets the requirements of Treasury Regulation § 53.4941(d)-1(b)(3).

PLR 200651040 waives the § 408(d)(3) 60-day rollover requirement where the Taxpayer asserted that the failure to deposit the proceeds of a liquidated IRA into new IRA accounts was due to a miscommunication with her financial institutions.

PLR 200652028 rules that, based on Rev. Rul. 92-47, 1992-1 C.B. 198, distributions from IRAs assigned by a Trust to charities would be income in respect of a decedent ("IRD") that is includable in the charities' gross income for the tax year in which the distributions are received.  The assignment of the IRAs is not a "transfer" within the meaning of Code § 691(a)(2).  Therefore, the Trust will not have to include the IRD in its gross income.

PLR200652040 provides that judicial modifications to a pre-September 25, 1985 Trust to comply with a state income and principal act will not have an effect on the Trust's generation-skipping transfer tax exemption, will not result in a taxable gift under Code § 2501, will not cause the beneficiaries to recognize gain or loss, and will not have an effect on the Trust's sub-trusts' qualification as electing small business trusts.

PLR 200701036 grants a waiver of the Code § 408(d)(3) 60-day rollover deadline for a distribution from an IRA on the basis of the Taxpayer's chronic health problems which rendered the Taxpayer unable to complete the rollover in a timely manner.

PLR 200702002 grants extensions of time to make timely allocations of a husband's and wife's generation-skipping transfer tax exemptions to transfers made to trusts in a previous year.  The Taxpayers' accountant inadvertently failed to allocate GST exemption when preparing the Taxpayers' gift tax returns for the year in question.  The allocations will be effective as of the date of the transfers to the trusts.

PLR 200702004 grants an extension of time to make a timely allocation of GST exemption where Taxpayer's attorney failed to allocate GST exemption when preparing the gift tax return.

PLR 200702007 states that where a qualified terminable interest property trust is the designated beneficiary of an interest in a qualified profit-sharing plan, the surviving spouse will not be required to include amounts of income in respect of a decedent from the profit-sharing plan until the surviving spouse receives a distribution from the trust.

PLR 200702013 states that a Trustee/surviving spouse's conversion pursuant to a state statute of the GST-exempt family trust and GST-exempt marital trust created upon the first spouse's death into total return unitrusts will not change the GST inclusion ratio of the trusts.  The ruling also provides that no beneficiary will be deemed to have made a gift as a result of the trust conversions and the conversion of the marital trust to a total return unitrust will not affect the marital deduction.  Finally, the conversion will not cause any beneficiary to recognize gain or loss.

PLR 200702014 grants an extension of time to a husband and wife to allocate generation-skipping transfer tax exemption to a Trust.  Although, pursuant to Code §2632(c)(1), husband and wife were deemed to have allocated GST exemption to their second gift to the Trust, no actual or deemed allocation was made with respect to the first gift to the Trust, due to the Taxpayers' accountant's inadvertent failure to allocate GST exemption to that gift.

PLR 200702016 grants to a Trust an extension of time to make an election pursuant to Code § 642(c) to claim a deduction in a certain year for distributions made to charities in the following year.

PLR 200702018 allows a surviving spouse's estate to treat as void the erroneous QTIP election made with respect to the first spouse's specific bequests to individuals other than the surviving spouse.  Additionally, the estate is allowed to treat as void the unnecessary QTIP election made by the first spouse's estate with respect to the first spouse's "family trust" property.

PLR 200702036 states that, with regard to the investment by a charitable lead trust in an endowment approved in PLR 200352019, the Service is now "studying whether it remains appropriate to characterize the transaction as a contract when a charitable lead trust is involved and whether it is appropriate to conclude that the charitable lead trust will realize unrelated trade or business income.  Accordingly, the charitable lead trust's investments in the endowment prior to the date of this PLR (October 17, 2006) may continue to be reinvested in the endowment without generating unrelated business taxable income but the same is not true for any investments after October 17, 2006.  (See also PLR 200702040 and PLR 200702041.)

PLR 200702039 refuses a Taxpayer's request to waive the Code § 408(d)(3) 60-day rollover requirement where Taxpayer withdrew an amount from an IRA, used a portion of the funds to purchase a house, and transferred the remainder back to the IRA after 60 days had expired.  The IRS characterized the scenario as a short term, interest-free loan.