Prior to September 1985, a decedent executed a will directing that on her death, her property be distributed to her surviving spouse, children, grandchildren and charity. After she executed her will, the decedent was declared incompetent. She never regained competency up to and including the date of her death. The decedent’s estate timely filed an estate tax return and attached a copy of the decedent’s judgment of incompetency.
The decedent’s beneficiaries (including the charitable beneficiaries) didn’t agree with the amounts of distributions under the will; the estate thus petitioned the court for construction and reformation to determine the amount each beneficiary was to receive. The court approved a settlement among the beneficiaries, and the estate then asked the Internal Revenue Service to rule on two issues: 1) whether the amounts distributed pursuant to the settlement were subject to the generation-skipping transfer (GST) tax; and 2) whether the estate could receive a charitable deduction for a distribution to charity pursuant to the settlement. On April 19, 2013, the IRS released Private Letter Ruling 201316004, in which it resolved both issues.
GST Tax Inapplicable
Internal Revenue Code Section 2601 imposes a tax on a direct skip transfer made after Oct. 22, 1986. However, IRC Section1433(b)(2)(C) doesn’t impose a GST tax on direct skips if a decedent had a “mental disability to change the disposition of [her] property and did not regain [her] competence to dispose of such property before the date of death.”
The accompanying Treasury regulations to Section 2601 define “mental disability,” require that a order of mental incompetency be filed with the estate tax return and require that any court-approved settlement be at arm’s length and be within the “range of reasonable outcomes” under the will and state law (Treas. Regs. Section 26.2601-1(b)). Applying the Treasury regulations, the IRS found that the decedent was under a mental disability, the estate properly filed the order of incompetency and the settlement was made at arm’s length and provided for a reasonable outcome. Thus, GST tax didn’t apply to any amounts distributed pursuant to the settlement.
Charitable Deduction Approved
IRC Section2055(a)(2) provides for certain deductions of bequests to charities, including to charitable trusts. For guidance, the IRS looked to Revenue Ruling 89-31, 1989-1 C.B. 277, in which an estate was entitled to a charitable deduction under Section 2055(a) for a remainder interest in a split interest trust passing directly to a named charity pursuant to a settlement of a bona fide will contest. Because the settlement in this case was a settlement of a bona fide will contest within the meaning of Rev. Rul. 89-31, the IRS determined that the estate was entitled to a charitable deduction under Section 2055(a) for the amounts passing to charity under the settlement’s terms.