Estate of George H. Wimmer v. Commissioner
Gifts of limited partnership units qualify for gift tax annual exclusion
In Estate of George H. Wimmer v. Commissioner, T.C. Memo. 2012-157 (June 4, 2012), the Tax Court issued a memorandum opinion holding that a gift of limited partnership (LP) interests qualified for the gift tax annual exclusion. The holding was based on a very specific set of facts, but is the first case since Hackl v. Comm’r, 118 T.C. 279 (2002), aff’d, 335 F.3d 664 (7th Cir. 2003) to allow annual exclusions for gifts of limited liability company (LLC) or partnership interests.
George Wimmer and his wife, Ilse, formed a family LP, each as trustees of their respective revocable trusts. At all times after funding, the partnership only owned publicly traded and dividend-paying stock. The purpose of the partnership was to increase family wealth, control the division of family assets, restrict non-family rights to the property and transfer property to younger generations without fractionalizing the assets. The Wimmers gave LP interests to their children and a trust for their grandchildren and reported some or a portion of the gifts as qualifying for the gift tax annual exclusion.
The LP received dividends from the stock and made distributions to its limited partners each year, in proportion to their LP interests. In addition, the limited partners had access to capital account withdrawals, which they used for their benefit, including paying down residential mortgages.
After George’s death, the Internal Revenue Service determined a deficiency in gift tax, asserting that the gifts didn’t qualify for the annual exclusion.
For a gift to qualify for the annual exclusion under Internal Revenue Code Section 2503(b), it must be a gift of a present interest, which Treasury Regulations Section 25.2503-3(b) defines as “an unrestricted right to immediate use, possession, or enjoyment of property or the income from property.” Under Hackl, the “use, possession or enjoyment” of the property or its income, must confer on the donee a “substantial present economic benefit.”
The Tax Court determined that, because the partnership agreement imposed transfer restrictions on the LP interests, the donees didn’t have the “use, possession or enjoyment” of those interests because they weren’t freely alienable.
The next question was whether the donees had the “use, possession or enjoyment” of the income from the property. Under Hackl and Price v. Comm’r, T.C. Memo. 2010-2, to have the “use, possession or enjoyment” of income from gifted property, the taxpayer must prove that: (1) the property (that is, the partnership interest) would generate income; (2) some portion of the income would flow steadily to the donees; and (3) that portion of income could be readily ascertained. The Tax Court held that all these tests were met because the partnership held dividend-paying publicly traded stocks, and the general partners were under a fiduciary duty to the limited partners, which obligated them to distribute at least a portion of the income to the limited partners to satisfy their income tax liabilities (noting that one of the partners was a trust of which the sole asset was the partnership interest, so that it had no other source of income to pay its income tax liability). Also, because the stocks were publicly traded and all distributions had to be made pro rata, the partners could estimate their allocation of the quarterly dividends based on the divided history and their percentage ownership.
The partnership agreement’s provisions regarding income distributions were critical to the decision. The opinion notes in a footnote that, unlike the taxpayers in Hackl and Price, the general partner of the Wimmer partnership made distributions each year of net cash flow (defined as cash on hand after payments of then-due debts, prepayment of debts, reserves held for reasonably necessary expenses and future investment) that the partnership agreement required to be made to the partners in proportion to their respective percentage interests. In Hackl, the LLC operating agreement provided that the manager may distribute available cash (after paying expenses and debts and keeping a capital reserve). In Price, the general partner distributed profits in his discretion, unless directed otherwise by a majority of all partners, and the partnership agreement described distributions as secondary to the primary purpose of achieving long-term returns. In Price, no distributions of income were made to the limited partners in the relevant years, either.
The dividend-paying stock was also a key factor. Wimmer, in this regard, is quite distinct from the other cases, particularly Fisher v. U.S., 105 A.F.T.R.2d 2010-1347 (March 11, 2010). In Fisher, the taxpayers made gifts of interests in an LLC that only owned undeveloped land. The Fishers argued that the children who received the LLC interests: (1) had an unrestricted right to receive distributions from proceeds of the sale of a capital asset; (2) had an unrestricted right to enjoy the land that was owned by the LLC; and (3) could unilaterally transfer their LLC interests. However, the Tax Court found these rights too contingent and granted the IRS’ motion for summary judgment, denying the annual exclusion. Similarly, in Hackl, the LLC’s asset consisted of a tree farm that operated at a loss and generated no income. In Price, the partnership owned commercial real estate that generated income, but, as noted above, no distributions were made to the partners in the years in question.
Interestingly, a footnote in the Wimmer opinion states that the parties stipulated that the gifts of partnership interests to the trust, which granted Crummey rights to the beneficiaries, would qualify as annual exclusion gifts to the trust beneficiaries if the court held that the gifts of LP interests qualified. The IRS apparently conceded that the added layer of a Crummey right within a trust wouldn’t interfere with the annual exclusion.
Portability of Estate Tax Exemption
Treasury Decision 9593
IRS issues temporary regulations regarding portability election
In Treasury Decision 9593 (June 18, 2012), the IRS issued temporary regulations regarding the portability election for a deceased spouse’s unused exclusion (DSUE) amount under IRC Section 2010, effective June 15, 2012.
To elect portability, the executor of an estate (not the surviving spouse) must timely file estate tax return
Form 706. Once the due date of the estate tax return (including any extensions granted) has passed, the election (or non-election) is irrevocable. The portability election isn’t available for the estate of a decedent who was a nonresident alien. Even if the estate isn’t required to file a Form 706 because the value of the gross estate doesn’t exceed the applicable exclusion amount, the estate must timely file the Form 706 to make the election. Therefore, the deadline for filing a Form 706 applies to all estates making the portability election, regardless of the size of the gross estate. To opt out of portability, the executor must state affirmatively on the Form 706 that the estate isn’t electing portability. Or, of course, the estate could simply not file the Form 706, if it’s not otherwise required to do so.
The estate must file a “complete and properly-prepared” Form 706 to be considered to have made the portability election. However, the IRS has relaxed some of the reporting requirements for estates that otherwise wouldn’t have to file because their value is under the applicable exclusion amount. For these estates, the executor doesn’t have to report the value of certain property that qualifies for the marital or charitable deduction and instead, must only report a description, ownership and beneficiary of such property and then estimate the total value of the gross estate. The instructions for the Form 706 will be revised to include ranges of dollar values, and the executor will indicate his estimate of the value of the gross estate based on those ranges.
However, these relaxed reporting rules don’t apply to marital or charitable deduction property if: (1) the value of such property relates to, affects or is needed to determine the value of property passing to another beneficiary; (2) the value of such property is necessary to determine eligibility for the valuation rules or payment deferrals of IRC Sections 2032, 2032A or 6166; (3) less than the entire value of an interest in such property is includible in the decedent’s gross estate; or (4) a partial disclaimer or partial qualified terminable interest property election is made. Essentially, if the value of the marital or charitable deduction property is necessary to determine the value of the taxable estate or a partial interest is involved, the executor will need to provide the value of such property.
The estate tax return must include a computation of the DSUE amount. However, until the Form 706 provides for such computation, a “complete and properly-prepared” Form 706 will be deemed to include such computation. Once the IRS revises the Form 706, the executors of estates that have already filed won’t be required to file any supplemental or revised form.
The decedent’s DSUE amount is equal to the lesser of: (1) the “basic exclusion amount” of the decedent (that is, $5 million in 2011 and adjusted for inflation thereafter), or (2) the “applicable exclusion amount” reduced by the decedent’s taxable estate and the decedent’s adjusted taxable gifts (other than those gifts on which gift tax was paid). The applicable exclusion amount is simply the basic exclusion amount (plus inflation), plus any DSUE that the decedent had accrued himself as a surviving spouse.
The DSUE is calculated differently when a qualified domestic trust (QDOT) is involved. In that case, the
executor still computes the DSUE on the decedent’s Form 706 to make the portability election. However, at the death of a surviving non-citizen spouse, the DSUE is recalculated. Generally, this requires taking into account the value of the property of the QDOT on the death of the surviving non-citizen spouse. This basically means that the DSUE won’t be available to the surviving non-citizen spouse to use for gifts during his life.
The DSUE is defined as the unused portion of the applicable exclusion amount of the most recently deceased individual married to the surviving spouse. Therefore, if a surviving spouse remarries, he’ll continue to have the DSUE of his prior deceased spouse, as long as the current spouse is living. Once the second spouse dies, the DSUE of the first deceased spouse is no longer available.
The DSUE amount is available to the surviving spouse to make taxable gifts. In fact, if a surviving spouse makes taxable gifts, those gifts are deemed to use the DSUE first, before the surviving spouse’s own exemption. Therefore, a surviving spouse who remarries may want to use the DSUE to make taxable gifts, to protect it (that is, use it) before possibly losing it, if the second spouse were to die.
The IRS retains the right to examine the decedent’s Form 706 regarding the computation of the DSUE, even if the statute of limitations has expired for assessing estate tax. This means that even though the IRS may not assess estate tax if the statute of limitations has expired, it could review the decedent’s return and recompute the DSUE on the surviving spouse’s death.
Same-Sex Married Couples
Windsor v. United States
Second Circuit affirms U.S. district court ruling that granted summary judgment to plaintiff seeking refund of estate tax for deceased same-sex spouse
Edie Windsor and her spouse, Thea, were residents of New York. They registered as domestic partners in New York and, after Thea’s health deteriorated due to multiple sclerosis and a heart condition, they married in Canada. Thea died in February 2009. Her estate passed to Edie, but because of Section 3 of the Defense of Marriage Act (DOMA), which requires that the word “marriage” means only a legal union between one man and one woman, the property passing to Edie didn’t qualify for the estate tax marital deduction under IRC Section 2056. As a result, the estate paid $363,053 in estate tax. Then, in 2010, Edie sued for a refund of the federal estate tax.
In February 2011, U.S. Attorney General Eric Holder announced the Department of Justice would no longer defend DOMA’s constitutionality, because he and the president believed that a heightened standard of scrutiny should apply to classifications based on sexual orientation. In June 2011, Edie moved for summary judgment, arguing that a strict scrutiny standard should apply to DOMA, because homosexuals are a suspect class and that DOMA fails under that standard of review.
The district court in Windsor v. U.S., No. 1:10-cv-08435 (June 6, 2012) refused to decide whether homosexuals were a suspect class that justified applying the strict scrutiny standard. Instead, it analyzed whether DOMA violates the Fifth Amendment’s equal protection clause under the rational basis standard, which requires a court to accept legislation that bears a rational relationship to a legitimate government interest. However, the court noted that the rational basis analysis has been heightened when a law exhibits a desire to “harm a politically unpopular group.” While the court didn’t explicitly state that it was applying that more “searching” form of rational basis scrutiny, it did find that DOMA doesn’t bear a rational relationship to legitimate government interests. It held that DOMA doesn’t positively affect state laws that govern marriage (and, therefore, doesn’t “preserve” marriage between a man or a woman), doesn’t promote responsible childrearing among heterosexual couples, impermissibly intrudes on the state’s ability to regulate domestic relations and is an inappropriate attempt to preserve government resources. Therefore, under rational basis review, DOMA violated the equal protection clause, and the estate was entitled to a refund of the estate taxes plus interest.
In October, the U.S. Court of Appeals for the Second Circuit held for the taxpayer and affirmed the district court’s holding that Section 3 of DOMA was unconstitutional (Windsor v. U.S., 110 A.F.T.R.2d 2012-xxxx
(Oct. 18, 2012)).
While the district court applied rational basis review, which only requires that the legislation bear a rational relationship to a legitimate governmental objective, the majority of the Second Circuit found that homosexuals were a quasi-suspect class: (1) that historically have endured persecution and discrimination; (2) whose class characteristic bears no relation to aptitude or ability to contribute to society; (3) that’s a discernible group with non-obvious distinguishing characteristics; and (4) that’s a politically weakened minority. The court then held that a heightened form of scrutiny was justified and, therefore, applied intermediate scrutiny rather than rational basis review. To withstand intermediate scrutiny, a classification must be “substantially related” to an “important” government interest, and the justification for the legislation must be actual and genuine. The Second Circuit held that Section 3 of DOMA doesn’t withstand intermediary scrutiny, because it doesn’t: (1) promote uniformity, due to the discord it creates with the various state statutes defining marriage; (2) save government resources in a permissible fashion; or (3) preserve traditional marriage, because the states are still left to determine who may marry.
One of the three judges dissented, arguing that rational basis review applied. In his dissent, he argued that DOMA withstood rational basis review, because it promoted responsible procreation and childrearing and ensured that federal benefits are accessed uniformly, regardless of state determinations regarding marriage. He concluded that this issue, which is the subject of significant debate, should be resolved by elected representatives, rather than the courts.
On Dec. 7, 2012, the U.S. Supreme Court agreed to review the Second Circuit’s decision.
Estate of Clyde W. Turner, Sr. v. Comm’r
Tax Court rules in favor of IRS on “marital deduction mismatch” issue and IRC Section 2036
In Estate of Clyde W. Turner, Sr. v. Comm’r, 138 T.C. No. 14 (March 29, 2012), the Tax Court analyzed the marital deduction mismatch that may occur when assets are included in the taxable estate under IRC Section 2036, and the estate is allocated using a marital deduction formula.
Clyde W. Turner, Sr. resided in Georgia when he died intestate on Feb. 4, 2004. Two years before his death, Clyde and his wife, Jewell H. Turner, established Turner & Co., a Georgia limited liability partnership (LLP), funding it with cash, Regions Bank common stock, shares of other banks, certificates of deposit and assets held in securities accounts, such as preferred stock and bonds (Clyde and Jewell each contributed $4,333,671, for a total value of $8,667,342). In exchange, Clyde and Jewell each received a 0.5 percent general partnership (GP) interest and a 49 percent LP interest. Clyde then gifted LP interests (21.7446 percent) to family members. On the date of his death, he owned a 0.5 percent GP interest and a 27.7554 percent LP interest.
The parties agreed that as of the date of Clyde’s death, the LLP’s net asset value was $9,580,520. The estate applied discounts for lack of marketability and lack of control and valued the 0.5 percent GP interest at $30,744 and the 27.7554 percent LP interest at $1,578,240.
In a 2011 ruling, Estate of Turner v. Comm’r, T.C. Memo. 2011-209, the Tax Court held that the assets transferred to the LLP were includible in Clyde’s estate under Section 2036(a) because: (1) there was no legitimate and significant non-tax reason for forming the LLP; (2) Clyde retained an interest in the transferred assets; (3) the purpose of Turner & Co. was primarily testamentary; (4) none of the assets contributed to Turner & Co. required active management or special protection; and (5) Clyde didn’t have a distinct investment philosophy that he hoped to perpetuate.
The estate moved for reconsideration, arguing that the Tax Court didn’t consider that even if Section 2036 applies, the estate has no estate tax deficiency, because it’s entitled to an increased marital deduction equal to the increased value of the gross estate.
Of the 27.7554 percent that Clyde owned on the date of his death, the estate reported that an 18.8525 percent LP interest was allocated to Jewell and an 8.9029 percent interest was allocated to a bypass trust. Clyde’s estate claimed a marital deduction of $1,820,435, of which $1,072,000 pertained to the 18.8525 percent interest in Turner & Co. that passed to Jewell. The court noted that the IRS allowed a marital deduction based on the net asset value of the LLP, rather than a reduced marital deduction based on the discounted value of the LLP interests transferred, so there was no “marital deduction mismatch” problem with respect to these interests.
However, the estate claimed a marital deduction for the value of the assets representing the LLP interests gifted to the other family members (not Jewell) during Clyde’s life that were included in his estate under IRC Section 2036, arguing that the will’s formula marital deduction clause required the estate to increase the value of the marital gift. The estate argued that Section 2036 imposes “a legal fiction for purposes of calculating the gross estate, and, for consistency, the marital deduction should also be increased to reflect that fiction.”
The Tax Court disagreed. First, it reasoned that the property gifted to the other family members during Clyde’s life wouldn’t qualify for the marital deduction, because it didn’t “pass from the decedent to his surviving spouse,” as required under IRC Section 2056 and the Treasury regulations. In addition, allowing the marital deduction for such property would violate the public policy behind the marital deduction, which is to defer transfer taxes until the death of the surviving spouse. In this case, if the marital deduction were allowed, the property included in Clyde’s estate would escape tax at his death, but wouldn’t be included in Jewell’s estate at her death. As a result, the court explained, it would “allow the assets to leave Clyde and Jewell’s marital unit without being taxed, thereby frustrating the purpose and the policy underlying the marital deduction.”
Wandry v. Comm’r
Tax Court upholds defined value clause in favor of taxpayer
In Wandry v. Comm’r, T.C. Memo. 2012-88, the Tax Court upheld gifts made using a defined value clause (DVC), applying the holding from a recent case, Estate of Petter v. Comm’r, T.C. Memo. 2009-280, to a set of intra-family gifts.
In 1998, Joanne and Albert Wandry formed a family limited partnership (FLP), Wandry LP, to hold cash and marketable securities. After forming the FLP, they began to make gifts of LP interests to members of their family. On the advice of their tax attorney, the gifts weren’t of a percentage LP interest but, instead, formula gifts based on a certain dollar value. In 2001, the Wandry family began a family business, Norseman Capital LLC (Norseman), and by 2002, all of Wandry LP’s assets had been transferred to Norseman. Joanne and Albert continued their gift-giving program through Norseman and made the gifts based on specific dollar amounts, obtaining valuations to determine the number of units gifted.
On Jan. 1, 2004, the Wandrys executed separate assignments and memoranda of gifts, which provided that they transferred a “sufficient number” of Norseman units so that the “fair market value of such Units for federal gift tax purposes” was equal to $261,000 for each child and $11,000 for each grandchild. This resulted in gifts by both Joanne and Albert of $1.099 million each. The documents provided that:
. . . [a]lthough the number of Units gifted is fixed on the date of the gift, that number is based on the fair market value of the gifted Units, which cannot be known on the date of the gift but must be determined after such date based on all relevant information as of that date.
The fair market value of the units was to be determined by an appraiser as of the date of the gift and, if the IRS or a court determined a different value, the number of gifted units would be adjusted accordingly so that the number of gifted units equaled the dollar value intended. The Wandrys’ tax attorney advised them that if the units were revalued, no membership units would be returned to them. Rather, accounting entries to Norseman’s capital accounts would adjust each member’s membership units to conform to the actual gifts.
An independent appraiser valued a 1 percent membership interest in Norseman’s assets as of Jan. 1, 2004 to be worth $109,000. The Wandrys filed gift tax returns reporting total gifts of $1.099 million for each donor, consistent with the gift documents, but showed the gifts as gifts of percentage interests (2.39 percent to each child and .101 percent to each grandchild) in Norseman.
An undated and handwritten ledger from Norseman’s CPA showed that the Wandrys’ combined capital accounts decreased by $3,603,311 in 2004 by virtue of the gifts; there were corresponding increases to the capital accounts of their children and grandchildren. The K-1s also reflected the transfers consistent with the ledger.
The IRS examined the gift tax returns and determined that the values of the gifts exceeded the Wandrys’ federal gift tax exemptions (valuing the 2.39 percent and .101 percent interests at $366,000 and $15,400, respectively). The IRS and the Wandrys eventually settled on a value of $315,800 and $13,346, respectively.
The IRS argued that the Wandrys made completed gifts of fixed percentage interests in Norseman, the value of which exceeded their federal gift tax exemptions based on three arguments: (1) the gift descriptions, as part of the gift tax returns, were admissions that petitioners transferred fixed Norseman percentage interests to the donees;(2) Norseman’s capital accounts, which reflected values consistent with the gift tax returns, fixed the gifts as percentage interests; and (3) the gift documents themselves transferred fixed percentage interests because the adjustment clause was void in that it created a condition subsequent to the completed gifts and was contrary to public policy.
The court didn’t agree that the gift tax returns were admissions of a gift of a fixed percentage interest. While the gift descriptions used a percentage interest to describe the gift made, the supporting schedules reported net transfers with a value of $261,000 and $11,000 to the children and grandchildren, respectively. The court also noted that the Wandrys had demonstrated a consistent intent to make gifts based on a dollar value.
Nor did the court agree that the capital accounts ledger was determinative of the type of transfer made. It held that “[t]he facts and circumstances determine Norseman’s capital accounts, not the other way around.”
The main issue was whether the DVC used in the gift documents was valid. The court applied the holding of Petter, in which the taxpayer used a DVC to make gifts of LP interests to trusts, with the excess donated to charity. The court recounted the distinction between a savings clause, which is void because it allows a donor “to take property back,” and a formula clause, which is valid because it merely transfers a “fixed set of rights with uncertain value.” It held that the clause the Wandrys used was a valid formula clause because, as of the date of the gift, each donee was entitled to a defined percentage interest expressed through a formula. The Wandrys weren’t entitled to take any portion of the gifts back under the gift documents. Instead, the allocation of membership units was automatically adjusted when the value was ultimately determined. Lastly, the court dismissed the IRS’ public policy arguments against DVCs, explaining that there was no public policy concern “severe and immediate” enough to justify invalidating DVCs.
While Petter upheld a DVC, many practitioners were unsure if the facts in Petter were unique, because the tax-free transfer was a result of charities being the residuary beneficiaries, and there’s a public interest in encouraging gifts to charity. However, in Wandry, the court specifically noted that it made no difference whether a charity was involved. The critical point was that a reallocation based on a corrected valuation didn’t alter the transfers.
The government withdrew its appeal to the Wandry case, and declared that it won’t acquiesce to the decision. (Internal Revenue Bulletin 2012-46, Nov. 13, 2012). It looks like practitioners may have to wait for another case to move up to the circuit level before receiving further assurance.
Estate of Stone v. Comm’r
Tax Court rules that assets contributed to an FLP aren’t includible in decedent’s estate
In Estate of Stone v. Comm’r, T.C. Memo. 2012-48 (Feb. 22, 2012), the Tax Court made a somewhat surprising ruling in favor of the taxpayer that the assets contributed to an FLP shouldn’t be included in the gross estate of the decedent under IRC Section 2036.
Joanne Harrison Stone was a resident of Tennessee when she died in 2005, at the age of 81. The Stone family owned and operated a well-known publishing company, was prominent locally and had held significant amounts of real estate in the area for several generations. Joanne owned, either wholly or in part, approximately 30 parcels of real property in Cumberland County in 1997. Nine of these parcels (totaling approximately 740 acres) were mostly undeveloped woodlands, without utilities or roads and were owned jointly by Joanne and her husband.
Joanne and her husband wanted to make gifts of the property to their children and grandchildren and consulted with an estate-planning attorney who suggested forming an FLP. On Dec. 29, 1997, they formed Stone Family Limited Partnership of Cumberland County, each signing as general partner (1 percent each) and limited partner (49 percent each). They quitclaimed the woodland parcels to the FLP on Dec. 30; these were the only assets of the FLP. An appraiser valued the combined parcels, and Joanne and her husband used the appraisal value as the value of the FLP. On Dec. 31, 1997, they gave LP interests to their children, the spouses of their children and grandchildren. The Stones didn’t apply any discounts when valuing the LP interests given to their family members (that is, the value of the gift was a pro rata share of the value of the combined parcels). By 2000, as a result of their gifts over the three years, Joanne and her husband each owned only the 1 percent general partnership interests and their other family members held the remaining 98 percent LP interests.
The parcels held by the FLP weren’t developed, and the FLP generated no income. The only expenses incurred were property taxes, which Joanne and her husband paid.
The FLP agreement provided that the FLP’s purpose was to hold and manage property for the family members. The FLP could be terminated by written agreement of limited partners owning 67 percent of the FLP or upon sale of all FLP property and distribution of proceeds therefrom. The partners’ ability to transfer their partnership interests was restricted, and the FLP could purchase a partner’s interest on his death.
As general partners, Joanne and her husband had considerable powers, including the rights to: (1) determine whether properties would be sold; (2) manage the day-to-day business of the FLP; and (3) determine the amounts of any distributions to partners. The limited partners owning interests representing 67 percent of the FLP could dismiss a general partner.
The IRS issued a notice of deficiency, stating that the assets of the partnership were includible in Joanne’s estate under IRC Section 2036. The estate argued that the transfer of property to the partnership was a bona fide sale for adequate and full consideration and, therefore, qualified for the exception to IRC Section 2036. Under Bongard v. Comm’r, 124 T.C. 95, 111 (2005), the “bona fide sale” exception requires that the formation and funding of the FLP be “motivated by a legitimate and significant nontax purpose.”
The Tax Court held that the transfer of the property to the FLP was a bona fide sale and, therefore, the parcels weren’t included in Joanne’s estate under IRC Section 2036. The court found that the Stones formed the FLP to facilitate gift giving and to manage the parcels as a family asset. This latter purpose was a legitimate and significant non-tax reason that satisfied the Bongard test. Further, the court explained that even though the Stones stood on both sides of the transaction, the bona fide sale exception could still apply if mutual legitimate and significant non-tax reasons existed for the transaction, and the transaction was carried out in a way in which unrelated parties to a business transaction would deal with each other. The court held that the Stones’ non-tax reason, coupled with the receipt of interests in the FLP proportional to the property contributed, satisfied this requirement.
The court acknowledged that the family failed to respect certain partnership formalities, for example, by paying property taxes out of personal funds, failing to transfer actual FLP interests among the children and their spouses during divorce settlements and using bills of sale to make gifts of FLP interests. However, it noted that there was no commingling of funds (because the FLP had no funds) and that the Stones didn’t rely on distributions from the FLP (because it made no distributions). Lastly, while there was no active management of the parcels, the court held that since there was a legitimate and actual non-tax purpose for transferring the parcels, forming the FLP wasn’t merely an attempt to change the form of property ownership.
The facts of Stone aren’t as egregious as some of the recent “bad fact” FLP cases. However, it does seem surprising that the Tax Court upheld an FLP that owned only non-income-producing woodlands requiring no active management and that didn’t respect some formalities.
The court seemed heavily influenced by the fact that the Stones didn’t apply discounts when making their gifts of FLP interests to their family; this appears to be strong evidence of their non-tax-related motivation to form the FLP. The court noted several times that the “total value of the [FLP] interests was equal to the appraised value of the woodland parcels.” This case shows that the outcomes in FLP cases are fact-specific and not always predictable.
Estate of Beatrice Kelly v. Comm’r
Assets transferred to FLP and gifted interests are excluded from gross estate
In Estate of Beatrice Kelly v. Comm’r, T.C. Memo. 2012-73, the Tax Court ruled in favor of the taxpayer and held that neither the assets contributed to an FLP nor gifted FLP interests were includible in the decedent’s gross estate under IRC Section 2036, due to the bona fide sale exception and the lack of an implied agreement to retain enjoyment.
Beatrice Kelly inherited significant properties relating to a family business from her husband. These included two quarries, real property, promissory notes and stock. She and her children continued to run the family business after her husband’s death. However, Beatrice was eventually diagnosed with Alzheimer’s and unable to manage her assets. Her four children were appointed as her guardians in December 2001 and continued to manage the family business.
Beatrice had signed a will in 1991, which gave various properties and assets to each of her four children and split the residue of her estate equally among them. However, uneven asset appreciation and certain acquisitions would have caused some children to receive disproportionately more than others. While she was alive, Beatrice’s children signed an agreement in which they agreed to split all of her property equally.
In addition to being concerned about how Beatrice’s estate would ultimately be divided, the family was worried about Beatrice’s liabilities as the owner of the various properties. These misgivings were highlighted when an insurance company sued Beatrice in relation to an accident involving a dump truck at one of the quarries. In light of these issues, Beatrice’s children consulted an estate-planning attorney.
On his advice and as approved by the local probate court, in June 2003, Beatrice established four FLPs (three to own assets of equal value and the fourth to own the quarry) and a corporation, KWC Management, Inc. (KWC), to be general partner of the FLPs. This plan, in effect, converted property that was the subject of specific bequests that were unequal, to partnership interests that would pass equally to the children as part of the residue. Beatrice owned all the shares of KWC and elected the children as officers and directors.
KWC was the general partner and a 1 percent owner of the four FLPs; it was entitled to a management fee to pay the operating expenses of the FLPs and compensation for its management duties and responsibilities. The children researched the range of reasonable management fees (between 1.2 percent and 2 percent) and decided that a .7 percent fee would be reasonable.
Beatrice funded the partnerships with stock and real property; she received a 99 percent LP interest in exchange. Beatrice retained over $1.1 million in liquid assets in her own name, including certificates of deposit and investment accounts. After establishing the FLPs, all of decedent’s personal expenses were paid with funds from her guardianship account.
Two weeks after the FLPs were fully funded, in 2003, Beatrice gave LP interests to her children and their descendants. She made similar gifts of LP interests in 2004 and 2005. Beatrice reported all gifts on gift tax returns. She kept all the shares of KWC.
Her children, as co-executors, timely filed her estate tax return, which reported her interests in the various entities. The IRS determined that the value of the assets contributed to the FLPs was includible in her gross estate and issued a notice of deficiency for $2,205,392.
The Tax Court first held that the assets contributed to the FLPs weren’t includible in Beatrice’s gross estate under Section 2036(a). That section includes in the gross estate the value of all property transferred by the decedent (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth) in which she has retained: (1) the possession or enjoyment of, or the right to the income from, the property; or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.
However, the court held that the transfer of assets was a bona fide sale and, therefore, Section 2036 didn’t apply. Under Estate of Bongard v. Comm’r, 124 T.C. 95, the bona fide sale exception requires that: (1) a legitimate and significant non-tax reason actually motivated the formation of the entity; and (2) the decedent received FLP interests proportionate to the value of the assets contributed. The court found there was no evidence that tax savings motivated the decedent. The children consulted the estate-planning attorney because they wanted to ensure that Beatrice’s estate was distributed equitably, to more effectively manage the properties and to limit her liability. These were all valid non-tax reasons to contribute property to the FLPs. And, since Beatrice received partnership interests equal in value to the assets she contributed to the FLPs, which were properly credited to her capital account, the transfer passed the Bongard test.
The IRS also argued that the management fee paid to KWC was an express retention of income by Beatrice in the LP interests she gifted and that the value of those gifted interests was therefore includible in her gross estate under IRC Section 2036(a)(1). However, the court didn’t agree. It explained that the FLP agreements, which were respected by the parties, called for a payment of income to KWC, not Beatrice. She would only receive a payment from KWC if there were funds remaining after it paid for all the other expenses and it elected to make a distribution to her. The court refused to disregard KWC’s existence, KWC’s fiduciary duty to its limited partners and the FLP agreements. The opinion also noted that Beatrice respected the FLPs and KWC as separate and distinct legal entities, observed FLP formalities and retained sufficient assets for personal needs. As a result, the court held that there was no express or implied agreement under Section 2036(a)(1) that Beatrice would retain the enjoyment or income from the LP interests she gifted.
The IRS’ second argument, that the management fee was a “hook” under Section 2036, was an interesting attempt to pull the value of the gifted interests into the estate. Luckily for the taxpayer, it didn’t prevail.
Finfrock v. U.S.
U.S. district court holds Treas. Regs. Section 2032A invalid
In Finfrock v. U.S., 109 A.F.T.R.2d 2012-XXXX (March 20, 2012), the U.S. District Court for the Central District of Illinois held for the taxpayers that the regulations under IRC Section 2032A went beyond the statute and weren’t valid.
Doris Finfrock-Ware died on Jan. 3, 2008, owning 61.05 percent of the issued and outstanding stock in the farm corporation, Finfrock Farms, Inc. Finfrock Farms owned several large parcels of land, all of which had been actively farmed by Doris’ son for the eight years preceding her death.
The estate filed a Form 706 and listed Doris’ share of Finfrock Farm’s interest in all of the real property on Schedule A as “qualified real property,” as that term is used in Section 2032A. These real properties represented approximately 68 percent of the adjusted value of the gross estate.
However, the estate made an election for special valuation for only a portion of the real property. The adjusted value of the portion subject to the election represented approximately 15 percent of the adjusted value of the gross estate. The estate elected only to value this portion of the farmland under the special rules of Section 2032A, because the estate sold the rest of the land owned by Finfrock Farms.
Section 2032A allows an estate to use special valuation rules to value qualified real property if such real property consists of 25 percent or more of the adjusted value of the gross estate. However, under Treas. Regs. Section 20.2032A-8, not only must the adjusted value of all of the estate’s qualifying real property exceed the 25 percent threshold, but also the value of the real property for which the executor makes the special valuation election must exceed 25 percent of the value of the adjusted gross estate.
The parties agreed that the total real property listed on Schedule A was qualified property and represented approximately 68 percent of the adjusted value of the gross estate, meeting the requirements of Section 2032A. However, the IRS denied the special use valuation for the portion of the property for which the executor made the election, citing the Treasury regulations, and the estate sued for a refund.
The court held for the estate and determined that under the statutory interpretation rules of Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), the regulations conflicted with Section 2032A and were invalid. The court noted that the statute unambiguously permitted an executor to make an election for special valuation with respect to a portion of the qualified real property. It found that the restrictions in the statute were related to the definition of “qualified real property,” not the portion subject to the election. Therefore, the additional requirement of the regulations went beyond the scope of the statute and was invalid.
Chief Counsel Advice memorandum 201208026
Testamentary limited power of appointment doesn’t preclude a completed gift; gifts don’t qualify for annual exclusion
In Chief Counsel Advice (CCA) memorandum, CCA 201208026 (Sept. 29, 2011), the taxpayers (apparently spouses) made gifts to an irrevocable trust and designated one of their children as sole trustee. The trustee was given absolute discretion to distribute trust property to the taxpayers’ descendants and their spouses. The taxpayers reserved testamentary powers of appointment (POAs) and, in default of exercise, the trust property would be distributed to their children after both taxpayers’ deaths.
The trust agreement gave the beneficiaries the right to withdraw gifts made to the trust, up to the annual exclusion amount, but the trustee could void this power for any additions made to the trust. The trust provided that its construction, validity and administration were to be determined under relevant state law, but all questions and disputes concerning the trust must be submitted to an “Other Forum” charged with enforcing the trust. Any beneficiary who filed or participated in a civil proceeding to enforce the trust was to be excluded as a beneficiary of the trust in the future. The Chief Counsel held that this provision prevented transfers to the trust from qualifying for the annual exclusion under IRC Section 2503(b). The CCA memorandum stated:
To be a present interest, a withdrawal right must be legally enforceable. For example if a trust provides for withdrawal rights, and the trustee refuses to comply with a beneficiary’s withdrawal demand, the beneficiary must be able to go before a state court to enforce it.
Because the beneficiaries couldn’t enforce their withdrawal rights in court without losing the entitlement to those same rights and any other distributions in the process, gifts to the trusts subject to such withdrawal rights weren’t present interests that qualified for the annual exclusion.
The taxpayers asserted that their gifts to the trust were incomplete because of their testamentary limited POAs. Treas. Regs. Section 25.2511-2(c) provides, in part, that a gift is incomplete to the extent that the donor reserves a power to name new beneficiaries or to change the interests of the beneficiaries as among themselves (unless the power is a fiduciary power limited by a fixed or ascertainable standard). The relinquishment or termination of a power to change the beneficiaries of transferred property, occurring otherwise than by the death of the donor (the statute being confined to transfers by living donors), completes the gift and causes the tax to apply.
The Chief Counsel determined that since the POA was testamentary, it related only to the remainder of the trust and not the preceding term interest, citing Chanler v. Kelsey, 205 U.S. 466 (1907). Since the retained POA couldn’t affect the trust beneficiaries’ rights and interests during the trust term (that is, prior to the taxpayers’ deaths), the taxpayers made a completed gift of the term interests. In addition, the Chief Counsel noted that IRC Section 2702 applied to the transfer. Under Section 2702, the value of any retained interest that’s not a qualified interest is treated as having no value. Therefore, the value of the gift may equal the entire value of property transferred, without any reduction for the retained interest. In this case, the retained testamentary powers would be valued at zero, so the taxpayers would be treated as making a completed gift of all the property transferred to the trust. Lastly, the Chief Counsel advised that since the sole trustee was a beneficiary of the trust, and, as a result, an “adverse party” under IRC Section 672 and the related grantor trust rules, the trust would be a non-grantor trust.
This CCA’s conclusion of a completed gift is consistent with Revenue Ruling 54-537, which held that a gift is incomplete to the extent the donor may revest beneficial title to the property in himself, unless such power is subject to a condition that’s outside the donor’s control. The gift would also be incomplete if the donor retained the power to name new beneficiaries or to change the interest of the beneficiaries among themselves. In this CCA, the taxpayers’ powers to change the interests of the beneficiaries, through their POAs, were subject to a condition they couldn’t control: their deaths.
There are several private letter rulings that came to the opposite conclusion and held that the donor’s testamentary limited POA was a retention of dominion and control over the trust property that prevented transfers to the trust from being completed gifts. These rulings (PLRs 200148028 (Aug. 29, 2001), 200247013
(Aug. 14, 2002) and 200502014 (Sept. 17, 2004)) all involved trusts a donor established for the benefit of himself and his family. A distribution committee managed trust distributions. The committee consisted of beneficiaries that were “adverse parties” under Section 672(a) with respect to the donor, and the trusts’ provisions were otherwise structured to avoid grantor trust status. In these rulings, the IRS determined that no taxable gift would be made until either a distribution was made to a beneficiary (other than the donor) or the donor released the testamentary POA.
The trusts in all of these prior rulings were drafted to avoid a completed gift (and, therefore, the property transferred to the trust would be includible in the donor’s gross estate), but establish the trust as a separate taxpayer for income tax purposes (the so-called “Delaware incomplete non-grantor trusts” or “DING trusts”). When a taxpayer lives in a state where the income tax rates are high (New York, for example), it may be beneficial to establish a non-grantor trust that “resides” in another state to avoid state income tax on the trust’s income and gains, especially for a large portfolio or assets on which the taxpayer would otherwise recognize income. This strategy, however, won’t be viable if the transfer to the trust is now subject to gift tax.
One distinction between the prior rulings and CCA 201208026 is that the donor wasn’t a beneficiary of the trust in the CCA. However, the legal analysis applied to reach the conclusion suggests that wouldn’t have made a difference. Moreover, the CCA is consistent with many prior rulings (PLRs 8727031 (April 3, 1987), 8849067 (Sept. 15, 1988), 9112007 (Dec. 20, 1990), 9049033 (Sept. 10, 1990) and 199908022 (Nov. 25, 1998)), which held a testamentary POA doesn’t make a gift incomplete when the assets could be distributed to other beneficiaries before the grantor’s death. The rulings on this subject aren’t consistent, but if the CCA’s approach holds up, this could be the end of DING trusts.
IRC Section 338(h) election triggers income recognition to qualified subchapter S trust, not beneficiary
In PLR 201232003 (released Aug. 10, 2012), the IRS ruled on the income tax consequences of a sale of S corporation stock owned by a qualified subchapter S trust (QSST) as part of a sale of the S corporation to a purchaser. The beneficiary had filed an election under IRC Section 1361(d)(2) to have the trust treated as a QSST, and, therefore, the beneficiary reported all items of income, deduction and credit allocable to the shares on his income tax return. However, at a later date, the shareholders of the S corporation agreed to sell all of their shares in the S corporation to a purchaser (a C corporation). As part of the stock purchase agreement, the C corporation and the S corporation made an election under IRC Section 338(h)(10). That election allows a transaction that’s a stock purchase to be treated as an asset purchase for federal income tax purposes. The basis of the target corporation’s assets is adjusted to reflect the purchase price, and gain is recognized on the sale.
The regulations provide that if an election is made under Section 338(h)(10), the target corporation is generally deemed to have sold all of its assets and distributed the proceeds in a complete liquidation. This causes gain recognition to the owner of the S corporation stock.
Here, the QSST owned the stock. Under IRC Section 1361(d)(1), the beneficiary of a QSST is treated as the owner of that portion of the trust that consists of S corporation stock. Generally, the beneficiary reports the income and gain of a QSST, potentially resulting in phantom income.
However, Treas. Regs. Section 1.1361-1(j)(8) provides that the beneficiary who’s treated as the owner of the QSST only by reason of Section 1361(d)(1) isn’t treated as the owner with respect to the consequences of a disposition of the stock by the QSST. Therefore, the QSST, rather than the beneficiary, reports any gain or loss on the sale of an S corporation. Applying the Treasury regulations, the IRS ruled that the gain or loss resulting from the Section 338(h)(10) election, which is a deemed sale of the S corporation’s assets, is a tax consequence of a disposition of stock by the QSST that’s taxed to the QSST, not the beneficiary.
When can a person other than a grantor substitute trust property?
In PLR 201216034 (Jan. 11, 2012), a trust was created for the benefit of an individual, who also served as trustee. The grantor intended to transfer S corporation stock and requested a ruling on whether the trust would be a grantor trust to the beneficiary, whether the trust could, therefore, hold S corporation stock and whether the trust property would be includible in the beneficiary’s estate.
The beneficiary had a withdrawal right over the entire value of each contribution. The withdrawal right was cumulative and lapsed each year only to the extent of $5,000 or 5 percent of the value of the trust principal for that year.
The beneficiary, as trustee, could make distributions to himself, subject to ascertainable standards. In addition, he could, in a non-fiduciary capacity, acquire the trust property by substituting other property of an equivalent value as determined by an independent appraiser selected by the trustee.
The grantor wasn’t a beneficiary of the trust. Neither the grantor nor the grantor’s spouse could act as a trustee. Neither the grantor nor any “nonadverse party” (as defined in IRC Section 672(b)) had power to purchase, exchange or otherwise deal with or dispose of all or any part of the principal or income of the trust for less than adequate consideration in money or money’s worth or to enable the grantor or the grantor’s spouse to borrow all or any part of the corpus or income of the trust, directly or indirectly, without adequate interest or security.
IRC Section 675(4)(C) provides that the grantor of a trust is treated as the owner of any portion of a trust with respect to which a power of administration is exercisable in a non-fiduciary capacity by any person without the approval or consent of any person in a fiduciary capacity. The term “power of administration” includes a power to reacquire the trust corpus by substituting other property of an equivalent value.
IRC Section 678(a) provides, in general, that a person other than the grantor shall be treated as the owner of any portion of a trust with respect to which such person: (1) has a power exercisable solely by himself to vest the corpus or the income therefrom in himself; or (2) has previously partially released or otherwise modified such a power and, after the release or modification, retains such control as would, within the principles of IRC Sections 671 to 677, inclusive, subject a grantor of a trust to treatment as the owner thereof. Section 678(b) provides that Section 678(a) shall not apply with respect to a power over income, as originally granted or thereafter modified, if the grantor of the trust or a transferor (to whom Section 679 applies) is otherwise treated as the owner under the provisions of subpart E, other than Section 678.
The PLR concluded that, under Section 678(a)(1), the beneficiary will be treated as the owner of that portion of the trust over which his withdrawal right hasn’t lapsed. Further, to the extent that the beneficiary fails to exercise a withdrawal power and the power lapses, the beneficiary will be treated as having released the power, while retaining a power of administration to acquire trust corpus by substituting other property of equivalent value. The PLR held that facts and circumstances of the trust administration would determine whether that power of administration was exercisable in a fiduciary or non-fiduciary capacity. If the power was held in a non-fiduciary capacity, the PLR concluded that under Section 678(a)(2), the beneficiary would be treated as the owner of the trust over which his powers had lapsed, making the trust a grantor trust to him entirely. If the entire trust was treated as owned by him, it would be a permitted shareholder of an S corporation, and the amounts subject to his withdrawal right on his death would be includible in his gross estate, because his withdrawal rights constituted a general power of appointment.
The PLR on the grantor trust status is surprising. It appears that the trust should be treated as a grantor trust to the grantor under Section 675(4)(C), because of the beneficiary’s power of substitution. That provision applies if the power is held “by any person” in a non-fiduciary capacity. Further, under Section 678(b), if the grantor is treated as the owner of the trust, then Section 678(a) doesn’t apply to make the trust a grantor trust to the beneficiary. It appears that the IRS didn’t correctly interpret how Sections 675(4)(C) and 678(b) would apply in this case.
In the charitable lead annuity trust (CLAT) context, other rulings have reached the opposite conclusion, holding that the grantor is treated as the owner of the trust when another individual who isn’t the grantor, the trustee or an adverse party, holds the power to acquire and substitute trust property in a non-fiduciary capacity. For example, Revenue Procedure 2007-45 contains a form CLAT. In the comments to the form CLAT, it notes that when a person other than the donor, the trustee (who would hold it in a fiduciary capacity) or disqualified person holds a power to substitute trust assets, the CLAT is a grantor CLAT to the grantor under Section 675(4). In PLR 201216034, the person holding the power was both the trustee and the beneficiary, but held the substitution power in a non-fiduciary capacity.
Treasury adopts final regulations regarding income tax consequences of charitable payments
On April 13, 2012, in T.D. 9582, the Treasury adopted as final proposed regulations under IRC Sections 642 and 643 (specifically, 1.642(c)-3 and 1.643(a)-5, which were published in 2008). These regulations confirmed that a provision in a trust or will, or a provision of local law that specifically indicates the source out of which amounts are to be paid, permanently set aside or used for a purpose specified in Section 642(c), must have economic effect independent of income tax consequences to be respected for federal tax purposes. Otherwise, if the provision governing payment sources doesn’t have economic effect independent of income tax consequences, the income will consist of the same proportion of each class of the items of income as the total of each class bears to the total of all classes. Generally, these regulations apply to charitable lead trusts and trusts and estates making payments or permanently setting aside amounts for a charitable purpose.
Cohan v. Comm’r
Charitable deduction denied for bargain sale gift due to incomplete acknowledgment
In Cohan v. Comm’r, T.C. Memo. 2012-8 (Jan. 10, 2012), the Tax Court denied the taxpayers’ charitable deduction, because the taxpayers hadn’t obtained a contemporaneous written acknowledgement that fully described the consideration provided by the charity to the taxpayers.
The taxpayers were members of the Cohan family that had formed HCAC, a Massachusetts LLC. The Cohan family owned a large and unique parcel of farmland on Martha’s Vineyard in Massachusetts. In 1969, they sold the property to the Wallace family, but retained certain neighboring parcels. As part of the sale, the parties entered into an agreement that limited the development of the farm property and granted both parties certain rights of first refusal if either party attempted to sell its property before Jan. 1, 2010. The price set by the agreement for the rights of first refusal was significantly less than the value of the land, so the rights of first refusal effectively foreclosed a sale to a third party. The Wallace family eventually decided that they wanted to develop the property as a residential subdivision and filed a lawsuit seeking to invalidate the 1969 agreement, but the Massachusetts Superior Court upheld it. Meanwhile, the Cohan family transferred their rights under the agreement to HCAC and considered how they could continue to enforce the 1969 agreement or purchase the farm back from the Wallace family before 2010 to ensure that it wasn’t developed.
TNC, an international conservation organization that acquires land to preserve biological diversity, became interested in purchasing the farm from the Wallace family. TNC planned to impose conservation and development restrictions on the farm. To arrange the purchase, TNC had to negotiate with the Cohan family to deal with its rights of first refusal. After significant negotiations, HCAC reached a tentative agreement with TNC and agreed to sell its rights of first refusal to TNC in exchange for certain portions of the farm, leases for certain other portions of the farm, reimbursement for taxes incurred by the members of HCAC and tax indemnifications. TNC was also negotiating with the Wallace family regarding the purchase of the farm and, after extensive negotiations involving several other interested parties, a final agreement was reached, but due to certain terms, it required TNC to renegotiate the deal with HCAC.
In the final deal, HCAC agreed to make a bargain sale gift to TNC of the appraised FMV of its rights under the 1969 agreement in excess of the cash and real estate conveyances by TNC to HCAC. The agreement by TNC to reimburse HCAC for the income tax related to the sale was a critical part of the deal. The parties negotiated a complicated agreement involving several stakeholders. After the closing, TNC sent HCAC a letter related to the transaction, which stated that the difference between the value of the rights of first refusal and the consideration received represented the bargain sale. It listed four properties, cash payments, beach access rights and the release of the rights of first refusal as the consideration received by HCAC and valued the benefits at $11,931,755. It noted that “no other goods or services were provided by TNC to HCAC in connection with this transaction,” but didn’t list other benefits received by HCAC, which included two leases, an easement, an option to buy a certain parcel, a closure and relocation of a road and several other beach access rights. HCAC issued the Cohan family members a K-1 reflecting the transaction, and the family members reported the respective income attributable to sale as long-term capital gain and claimed charitable contribution deductions that collectively exceeded $2 million on their income tax returns.
Under IRC Section 170(f)(8)(A), a taxpayer may not deduct any charitable contribution of $250 or more unless the contribution is substantiated with a contemporaneous written acknowledgement that must include: (1) the amount of cash paid and a description (but not the value) of any property other than cash contributed; (2) whether the donee organization provided any goods or services in consideration for the cash or property contributed; and (3) a description and good faith estimate of the value of any goods or services provided by the done organization.
The court held that the TNC letter didn’t constitute a contemporaneous written acknowledgement, because it omitted several items of consideration received by HCAC. It reasoned that the failure to disclose the consideration benefited both the taxpayers and the charity, because any tax savings resulting from a charitable contribution deduction for HCAC would ultimately benefit TNC by reducing the tax reimbursements it owed to HCAC. It found that the negotiations illustrated the parties’ intent to minimize the taxes that TNC agreed to pay. It wasn’t convinced by the parties’ counsels’ testimony that the items of consideration in question were left out of the letter inadvertently due to the complexity of the negotiations. Instead, it found that the parties specifically negotiated the disclosure of consideration and what to include in the letter. The court further held that the taxpayers didn’t reasonably rely on the gift letter because they knew or should have known that certain items were omitted in calculating the bargain sale gift amount. Lastly, it held that the doctrine of substantial compliance was inapplicable, because there wasn’t enough information in the letter to allow the IRS to determine the amounts of the charitable contributions. As a result, the court affirmed the IRS’ disallowance of the charitable deductions.
The court also addressed the valuation of the various property interests and held for the taxpayer that the amount realized from HCAC’s sale of the property rights under the 1969 agreement was long-term capital gain, rather than ordinary income, but affirmed certain negligence penalties under IRC Section 6662.
2013 Inflation and Other Adjustments
Rev. Proc. 2012-41
IRS sets certain inflation-adjusted tax items for 2013
In Rev. Proc. 2012-41, I.R.B. 2012-45 (Nov. 5, 2012), the IRS set forth certain inflation-adjusted tax items for 2013. The inflation adjustments include the following, which are effective Jan. 1, 2013:
• The annual exclusion increases to $14,000 under IRC Section 2503.
• The first $143,000 (up from $139,000) of qualifying gifts to a non-citizen spouse isn’t included in the year’s total amount of taxable gifts under IRC Sections 2503 and 2523.
• The amount used to calculate the “2 percent portion” for purposes of Section 6166 is now $1.43 million (up from $1.39 million).
• For decedents dying in 2013, if the executor elects to use the special use valuation method under Sec-
tion 2032A for qualified real property, the resulting aggregate decrease in the property’s value of the qualified real property resulting from such election may not exceed $1.07 million (up from $1.04 million).
Other items to change in 2013, absent Congressional action:
• For decedents dying in 2013, the unified credit against estate tax under IRC Section 2010 will be $1 million (down from $5.12 million).
• Because the estate and gift tax exemptions are unified, the unified credit against gift tax under IRC Section 2505 will also be $1 million.
• The generation-skipping transfer tax exemption under IRC Section 2631 decreases to $1.39 million (projected) ($1 million, plus inflation adjustments from 2001).