In Private Letter Ruling 201410011 (March 7, 2014), a taxpayer asked the Internal Revenue Service to rule on two issues related to a marital trust set up by an antenuptial agreement. Specifically, the IRS ruled on whether a spouse’s right to elect under a certain provision in a revocable trust was a “contingency” under Internal Revenue Code Section 2056(b)(1) and whether a marital deduction should be allowed for certain limited liability company (LLC) units distributed to the marital trust. The IRS ruled that the right to receive the elective marital portion wasn’t a contingency and allowed the spouse a marital deduction for the distribution to the marital trust.
The Antenuptial Agreement
The taxpayer and his spouse signed an antenuptial agreement, under which each waived their right of election to take against a will. There were various provisions in the agreement, including one that stated that if, on the taxpayer’s death, the taxpayer and the spouse were still married and the spouse was alive, the spouse would receive a certain sum. This amount would be free of any estate, transfer and income taxes. A different provision provided that if the spouse and the taxpayer were married at least 10 years on the taxpayer’s death, the taxpayer would fund a separate, marital trust, the income of which would be paid to the spouse annually for as long as she lived.
The Revocable Trust
The taxpayer established a revocable trust, of which he was the sole trustee. Pursuant to Section 3A(7), if the spouse survived the taxpayer and they were both married to each other at the time of the taxpayer’s death, the trustee would make distributions to the spouse under the terms of the revocable trust. If the spouse made a timely election under Section 3A(7), the trustee would make distributions pursuant to that section.
The trustee was to make distributions to the marital trust, to be held and distributed as required by the antenuptial agreement. The revocable trust provided that the trustee had the discretion to satisfy distributions to the marital trust with LLC preferred units.
Under Section 3A(7), if the spouse elected to receive a marital portion in lieu of distributions under the antenuptial agreement, the trustee would distribute outright a certain sum and distribute property interests specified in that section to the marital trust and then distribute it as per the marital trust. If the spouse elected the marital portion, the marital trust would still be funded with LLC preferred units.
The Marital Trust
The taxpayer was the sole trustee of the marital trust and intended it to become irrevocable on his death. He also intended that the marital trust qualify as a qualified terminable interest property trust. Under Section 3B(2) of the marital trust, the net income was to be distributed to the spouse in at least quarter-annual installments during her life. Under Section 3B(3), distributions to the marital trust must qualify for the marital deduction. The spouse was to receive beneficial enjoyment of the trust assets, including the right to make a request that the trustee make unproductive or underproductive assets productive. Moreover, the trustee was to manage the trust and receive all property acquired as part of the trust estate, without regard to lack of diversification. The trustee may not exercise any right that would be inconsistent with the qualification of the marital trust deduction. Finally, the income from the LLC preferred units, which was required to be distributed to the spouse, may not be less than the amount required to allow the marital trust to qualify for the marital deduction.
The LLC consisted of voting common units, non-voting common units and preferred non-voting units. It received monthly distributions from a limited partnership engaged in the management of shopping centers. The LLC also held shares in a corporation, which in turn operated as a real estate investment trust.
What Constitutes a Contingency?
Under IRC Section 2056(b)(1), a deduction isn’t allowed if, on the occurrence of an event or contingency, an interest passing to a surviving spouse will terminate and: 1) an interest in the property passes from a decedent to any person other than a surviving spouse, and 2) by reason of such passing, a person may enjoy any part of the property after the termination of the interest passing to the surviving spouse. Under Treasury Regulations Section 20.2056(c)-2(c), a surviving spouse may elect between a property interest under a decedent’s will or a property interest to which she’s otherwise entitled, of which an adverse disposition was attempted by the decedent under his will. If a surviving spouse elects to take against the will, then the property interest offered under the will isn’t considered as having passed from the decedent to the surviving spouse, and the other property interest retained by the surviving spouse is considered as having so passed. If the surviving spouse elects to take under the will, then the other property interest relinquished by her isn’t considered as having passed from the decedent.
The IRS reviewed case law and several revenue rulings in which a decedent and his wife were parties to an antenuptial agreement. The revenue rulings held that an amount bequeathed to a wife under a will passed from the decedent to his surviving spouse and therefore, qualified for the estate tax marital deduction. (See Revenue Ruling 54-446, Rev. Rul. 68-271, Rev. Rul. 82-184.) Applying the revenue rulings and case law to the instant case, the IRS determined that the spouse would receive certain property interests under the terms of the antenuptial agreement pursuant to the terms of the revocable trust, unless she elected under the revocable trust to receive her elective marital portion. In each event, she would have an absolute right to any property passing outright to her, as well as an absolute right to income from any property passing to the marital trust. Thus, the property interest passing outright to the spouse is a nonterminable interest, and the property interest passing to the marital trust is also a nonterminable interest if it satisfies Section 2056(b)(7). “The requirement that Spouse make a timely election is ‘a mere procedural formality’ and is not a contingency within the meaning of [Section] 2056(b)(1),” said the IRS (citations omitted). As such, the spouse’s right to elect under Section 3A(7) of the revocable trust isn’t a contingency under Section 2056(b)(1). Moreover, said the IRS, the revocable trust property actually distributed outright to the spouse and to the marital trust was “property which passes from the decedent to his surviving spouse,” for purposes of Section 2056(b)(1).
Allowance of Marital Deduction
In this case, the marital trust instructed the trustee to distribute the entire net income of the marital trust to the spouse in at least quarter-annual installments during the spouse’s life. Neither the revocable trust nor the marital trust granted to anyone a power to appoint the marital trust estate to someone other than the spouse. The marital trust also directed the trustee to give the spouse a degree of beneficial enjoyment of marital trust assets including, at the spouse’s request, making unproductive or underproductive assets productive. As such, the IRS determined that the marital trust evidenced the taxpayer’s intent to give his spouse, after his death, the beneficial enjoyment of the marital trust estate requisite to a qualifying income interest for life for purposes of Section 2056(b)(7)(B)(ii).
The IRS also found that the circumstances in the instant case manifested the taxpayer’s intent that, after his death, the marital trust should produce for his spouse a degree of beneficial enjoyment of the LLC preferred units as accorded to an individual who’s unqualifiedly designated as a life beneficiary of a trust. Under the terms of the LLC operating agreement, the marital trust, as the owner of preferred units, would be entitled to an 8 percent return on the aggregate face value of its LLC preferred units, payable at least annually. The LLC couldn’t redeem the marital trust’s LLC units for less than greater of their face value or fair market value. Moreover, the sale of the LLC preferred units wasn’t unreasonably restricted. The IRS thus concluded that the spouse would have a qualifying income interest for life in the LLC preferred units. She was therefore allowed to take a marital deduction under Section 2056 for the LLC preferred units distributed at the taxpayer’s death to the marital trust, provided the taxpayer’s executor timely elects under Section 2056(b)(7)(v).