• Tax Court analyzes whether trustee's power to make distributions for her own welfare created general power of appointment — In Estate of Ann R. Chancellor v. Commissioner, T.C. Memo. 2011-172 (July 14, 2011), the Tax Court interpreted the terms of a testamentary trust to determine whether the surviving spouse, as a trustee, held a general power of appointment due to the trustees' powers to make distributions to her and other beneficiaries for their welfare.

    The will of Lester M. Chancellor established a credit shelter trust for the benefit of his wife, Ann, their children and grandchildren. Ann and a bank served as co-trustees. The trustees were authorized to distribute trust income among Ann and the other beneficiaries in accordance with their respective needs. The trustees could distribute trust principal for “the necessary maintenance, education, health care, sustenance, welfare or other appropriate expenditures needed by” the beneficiaries, taking into account the standard of living to which they were accustomed. Ann never received any trust principal during her life and on her death, the value of the trust property was over $1.2 million. The Internal Revenue Service issued a notice of deficiency claiming the trust was includible in Ann's estate because she had a general power of appointment over the trust.

    Internal Revenue Code Section 2041(b)(1) generally defines a general power of appointment as “a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate.” However, according to IRC Section 2041(b)(1)(A), a power to consume, invade or appropriate trust income, corpus or both for the decedent's benefit isn't deemed a general power of appointment if it's “limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent.”

    The Tax Court held (and the IRS conceded) that the power of appointment was generally governed by an ascertainable standard. However, the remaining question was whether that ascertainable standard was related solely to the health, education, support or maintenance of the beneficiaries if it included “necessary welfare” (the court noted that the IRS conceded that the will's direction that the trustees consider the standard of living to which the beneficiaries were accustomed didn't prevent the standard from being ascertainable).

    The Tax Court looked to Mississippi law and could find no case in which that state's Supreme Court directly interpreted the term “welfare” in a trust document. But based on more indirect interpretations of case law, the Tax Court concluded that the Mississippi Supreme Court would probably construe the term “welfare” to be related to the physical comfort and well being of the beneficiaries rather than their broader happiness. It further noted that the phrase “other appropriate expenditures needed by” that followed the distribution standard indicated that the phrase “welfare or other appropriate expenditures” would be interpreted to refer to expenditures similar in character to those enumerated items previously listed in the distribution standard: maintenance, education, health care, sustenance and welfare. As a result, Ann's power of appointment was limited and the trust property wasn't includible in her gross estate.

  • Tax Court denies estate tax deductions for home health care services provided to decedent during her son's life — In Estate of Emilia W. Olivio v. Comm'r, T.C. Memo. 2011-163 (July 11, 2011), Emilia Olivio's son, who was executor of her estate, was prohibited from deducting the value of the home care services he provided to her in the years leading up to her death as a claim against the estate under IRC Section 2053. Anthony Olivio was an attorney with his own solo practice. But when his parents' health began to deteriorate, he moved in with them and soon was providing fulltime care to his mother. He helped her with basic hygiene and monitored her many medications and her vital signs. She was diabetic, had hyperparathyroidism, hypertension, chronic deep vein thrombosis, congestive heart failure and coronary artery disease, among other maladies. She had contracted pneumonia periodically and was hospitalized frequently. Anthony maintained that he had a conversation with his mother in which she agreed to pay him $400 per day for his home care services but that the payment would be deferred until her death. The agreement wasn't acknowledged in writing. After Emilia's death, Anthony was appointed administrator and filed the estate tax return. On the return, the estate deducted over $1.2 million as a debt that the estate owed Anthony for providing care to his mother during her life. In addition, the estate claimed deductions for debts that it owed to Anthony as a statutory commission for his services as administrator as well as for attorney's fees and accountant's fees.

    The Tax Court held that the $1.2 million wasn't deductible because the only evidence of the agreement was Anthony's testimony, which the court found improbable (considering that Anthony was an attorney and should have memorialized the agreement in writing), self-serving and uncorroborated. The estate argued in the alternative that Anthony was entitled to a fee for the services he provided under a theory of quantum meruit, if not contract. However, the Tax Court held that this theory didn't apply because New Jersey law presumes that services rendered to a family member living in the same household are rendered gratuitously. In addition, the Tax Court held that Anthony was entitled to the administrator's commission under New Jersey law unless a beneficiary otherwise objected, but that the attorney's fees claimed couldn't be deducted on the estate tax return because they were unsubstantiated: Anthony had kept no records of the hours spent and his estimates of his time were uncorroborated.

  • Distributions of annuity contracts from a trust to a beneficiary won't be treated as a transfer without full and adequate consideration under IRC Section 72 — In Private Letter Ruling 201124008 (June 17, 2011), a husband established a trust for the benefit of his wife and descendants. Upon the husband's death, the trustee of the trust was authorized to pay or use the property to maintain the wife's standard of living and others partly or wholly dependent on the wife for their support and education. On the wife's death, the property of the trust was to be divided in certain proportions among the husband's and wife's descendants.

    The wife, as trustee, intended to purchase deferred annuity contracts, naming each descendant beneficiary as an annuitant on a respective contract (without receiving any consideration from the beneficiary), in relative proportion to each beneficiary's share of the residuary of the trust. The trust would own and be the beneficiary of the annuity contracts during the wife's life. The trustee believed that there would be no need for the trust to take any distributions from the annuity contracts during the wife's life. On the wife's death, each annuity contract would be distributed to the respective beneficiary annuitant.

    IRC Section 72(u) provides that an annuity contract held by a trust or other entity as an agent for a natural person may be treated as an annuity for purposes of federal income tax. Although the rule may not apply in the employment context (that is, if an employer is the nominal owner of an annuity contract, the beneficial owners of which are employees), the ruling confirmed that the annuities held by the trust would be treated as owned by a natural person because the employer/employee context wasn't present. As a result, the annuities wouldn't be subject to IRC Section 72(u)(1)(B), which requires that the income on such a contract (that is, a contract owned by an entity) be treated as ordinary income.

    Under IRC Section 72(e)(4)(C), if an individual transfers an annuity without full and adequate consideration, the individual is treated as receiving an amount equal to the cash surrender value, less the investment in the contract. Such amount may not be treated as amounts received from an annuity so there's no deferral; instead, it's all treated as ordinary income in the year of transfer/receipt. This provision was enacted to preclude the deferred taxation of annuity contracts purchased in an employment context. The legislative history indicates that a change in the annuitant with respect to an entity-owned annuity (rather than an individually owned annuity) is treated as an assignment of the contract. Since the trust's ownership of the contracts was outside the employment context, and more importantly, since the annuitant in each case wouldn't change (each beneficiary was the initial annuitant and would remain so after distribution from the trust), the PLR held that the distribution of the contracts to the beneficiaries on the wife's death wouldn't trigger recognition of income under IRC Section 72(e)(4)(C).

  • IRS rules on disclaimer of retirement benefits — In PLR 201125009 (June 24, 2011), the IRS confirmed that the executor of the estate of a surviving spouse could disclaim certain amounts in retirement accounts even though required minimum distributions (RMDs) had already been transferred to the estate's account.

    In the ruling, RMDs were deposited automatically into a bank account held jointly by the husband and wife. The husband died, and then his wife died less than nine months later. After the wife's death, the brokerage houses maintaining the retirement accounts continued to deposit the RMDs to the same account. The executrix of the wife's estate (the wife's daughter) then transferred the funds received from the RMDs to a new account titled in the name of the wife's estate. Then, the executrix petitioned the local court for authority to disclaim the wife's interest in the balance of the retirement accounts, excluding the RMDs that were distributed and any income attributable to the RMDs. The court approved the petition; under state statute, the wife was treated as predeceasing her husband as a result of the disclaimer.

    Under IRC Section 2518, if a disclaimer is a “qualified disclaimer,” then the disclaimant is treated as never having received the property and therefore the disclaimer shouldn't have any gift or estate tax consequences for the disclaimant. For a disclaimer to be qualified, among other requirements, the disclaimant must not have accepted any interest in the property or any of its benefits. The IRS ruled that the disclaimer would satisfy the requirements of a qualified disclaimer under IRC Section 2518, based on Revenue Ruling 2005-36. That revenue ruling provides that a beneficiary's receipt of an RMD from an individual retirement account constitutes acceptance of that portion of the corpus of the account, plus the income attributable to that amount, but doesn't preclude the beneficiary from making a qualified disclaimer with respect to the balance of the account. The income attributable to the RMD is calculated on a pro rata basis — the total income from the account between the date of death and the disclaimer is apportioned by multiplying it by a fraction of which the numerator is the total amount of RMDs received by the disclaimant during such time, and the denominator is the total value of the account on the date of death.

  • IRS issues Notice 2011-66, providing guidance on the 2010 tax election — Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), there is no estate tax for decedents dying in 2010, but the basis step-up rules of IRC Section 1014 don't apply and instead basis carries over, except for a limited amount of basis increase pursuant to IRC Section 1022. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Act) reinstated the estate tax and unlimited basis step-up for 2010, but with a $5 million estate tax exemption. The 2010 Tax Act also gives an estate the chance to opt out of the estate tax and be limited by the basis increase under Section 1022.

    The IRS has now issued Notice 2011-66, which provides guidance with regard to the time and manner in which an executor of an estate of a decedent who died in 2010 elects to opt out of the estate tax and be subject to the carryover basis rules in Section 1022. The executor makes the election by filing Form 8939 (which hadn't been published at press time) on or before Nov. 15, 2011.

    The 2010 Tax Act also reinstated the generation-skipping transfer (GST) tax, regardless of whether a Section 1022 election is made and increased the GST tax exemption to $5 million. However, the tax rate for a GST occurring during 2010 is still zero. If the executor of an estate of a decedent who died in 2010 makes a Section 1022 election, he may allocate GST tax exemption by attaching Schedule R to Form 8939.

    If a direct skip occurred in 2010, the donor can use the zero GST tax rate by electing out of the automatic GST tax allocation rules by affirmatively doing so on a timely filed Form 709. However, merely reporting a direct skip not in trust on a timely filed Form 709 will also have the effect of electing out of GST allocation.

    The due date to report a direct skip, taxable distribution or taxable termination (including any election required to be made on such return) that occurred on or after Jan. 1, 2010, through Dec. 16, 2010, is Sept. 19, 2011 (including extensions) because Sept. 17, 2011 falls on a Saturday, except in the case of a Schedule R attached to Form 8939, which is due on or before Nov. 15, 2011.