• Revenue Ruling clarifies application of United States v. Windsor (570 U.S. __ (2013))—In Revenue Ruling 2013-17 (Aug. 29, 2013), the U.S. Department of the Treasury and the Internal Revenue Service ruled that same-sex couples will be considered “married” for federal tax purposes if they’re lawfully married under state law based on the state of the “celebration” (that is, the legal ceremony) of their marriage. This means that if a couple legally marries in one state and moves to another state that doesn’t recognize same-sex marriage, the couple will still be considered married for federal tax purposes, regardless of their domicile. The ruling reasoned that this conclusion was a natural development of Rev. Rul. 58-66, which held that a couple married through common law continues to be treated as married for federal purposes, even if they move to a state that doesn’t recognize common law marriages. In addition, the terms “husband” and “wife” will be interpreted in a gender-neutral way to refer to persons married in a same-sex marriage.
However, the ruling also clarifies that the term “marriage” doesn’t include domestic partnerships, civil unions or other formal recognition of relationships that a state may bestow.
The ruling noted that while it will be applied prospectively as of Sept. 16, 2013, taxpayers may file original, amended or adjusted returns declaring their marital status, as long as the statute of limitations hasn’t expired. Therefore, amended returns may generally be filed for 2010, 2011 and 2012. The IRS will issue further guidance regarding employee benefits and plans.
• Revenue ruling consolidates process for requesting relief for late S corporation, ESBT, QSST, QSub and corporate classification elections—Rev. Rul. 2013-30 consolidates the provisions of previous revenue procedures regarding relief requests for late S corporation, electing small business trust (ESBT), qualified subchapter S trust (QSST), qualified subchapter S subsidiary election (QSub) and corporate classification elections, which are usually obtained by requesting a private letter ruling. The ruling provides that the entity may request relief by completing an Election Form and attaching certain supporting documents. The Election Form must include a statement that describes the entity’s reasonable cause for failing to timely file its election or an explanation that the failure was inadvertent, as well as note the action that the entity took to correct the mistake on discovery. The entity may file the Election Form with its tax return or independently, to the applicable IRS Service Center, but in all cases within three years and 75 days of the date on which the election was intended to be effective. Additional requirements or specific documents may be required, depending on the type of election at issue.
• District court holds trustees personally liable for unpaid estate tax—The U.S. District Court of Utah recently ruled on a summary judgment motion that involved the personal liability of trustees and beneficiaries of a revocable trust for the unpaid estate taxes of the decedent (U.S. v. Johnson et al., Case No. 2:11-CV-0087, July 29, 2013). The decedent’s revocable trust directed the trustees to pay several bequests and then settle any and all debts and taxes of the decedent. After providing for such payments, the residue was to be divided among four heirs and four partnerships (one each for the respective benefit of each heir). The estate filed a Form 706 reporting an estate of almost $16 million. The estate elected to defer the estate tax under Internal Revenue Code Section 6166 because most of the estate was comprised of ownership in a hotel valued at almost $11.5 million; this election allowed the estate to spread the payments out between 1997 and 2006. The estate had made payments totaling about $5 million when the hotel went bankrupt in 2002, causing the estate to default on its remaining estate tax balance (about $1.8 million).
The IRS sought to impose transferee liability on the beneficiaries and trustees of the revocable trust under IRC Section 6324(a).
The trust beneficiaries argued they weren’t transferees or beneficiaries under the statute. The term “transferee” is defined as one who “receives, or has on the date of the decedent’s death, property included in the gross estate,” and the court agreed with the heirs that to be a transferee under the statute, the person must have or receive property from the gross estate immediately on the date of the decedent’s death. Here, the trustees, not the beneficiaries, had the immediate right to the property on the decedent’s death (the beneficiaries received their property from the trustees). In addition, under case law, the term “beneficiary” has been limited to beneficiaries of life insurance policies. Therefore, the trust beneficiaries were neither transferees nor beneficiaries under Section 6324 with respect to the trust property.
The trustees admitted that they were “transferees” under the statute. They argued, however, that the IRS action against them was time-barred. The court disagreed. First, the election under IRC Section 6166 tolled the statute of limitations during the extension period, so the government had 13 years to bring a collection action against the estate and its transferees under IRC Sections 6324, 6502 and 6503 (three years to assess and then 10 years to collect). Second, the court held that the government wasn’t limited to proceeding under IRC Section 6901, which permits the government to assess transferees of estate assets (defined more broadly than in Section 6324) within one year of the period of limitations for assessing the transferor (in most cases, four years).
Next, the trustees argued that they shouldn’t be personally liable under IRC Section 3713(b) because the estate had sufficient assets to pay the tax at the time when the distributions to the trust beneficiaries were made. And, the trustees and the trust beneficiaries signed a distribution agreement that provided that the beneficiaries were assuming the estate’s obligations to pay the deferred estate taxes and any adjustments that might be made by the IRS. IRC Section 3713(b) establishes the priority of government claims and imposes liability on a personal representative who pays a debt or claim of the estate before paying the government. However, the court found that there were still unresolved questions of fact relating to whether the agreement provided the estate with proper recourse to enforce payment of the taxes because: (1) most of the assets of the estate had been distributed prior to its signing, and (2) it was signed by the plaintiffs as trustees, not as personal representatives of the estate. These factual questions were sufficient to survive the plaintiffs’ motion to dismiss. If the court ultimately holds for the government on this issue, the trustees would be personally liable to the IRS and would have to try to recover from the beneficiaries themselves under the distribution agreement.
• U.S. Court of Appeals for the Seventh Circuit holds decedent’s failure to submit beneficiary form prevented beneficiary designation—In Minnesota Life Insurance Company v. Kagan, Case No. 12-1840, (7th Cir. July 31, 2013), the Seventh Circuit addressed whether the proceeds of a life insurance policy should pass to the default beneficiary or those the decedent named on a beneficiary designation form that was completed, but not submitted to the insurance company prior to death.
Allen Kagan died on Dec. 2, 2009. In his will, he designated his three children as beneficiaries of most of his assets and left his wife, Arlene, only $100,000 and a gravesite. (Arlene wasn’t even able to collect this bequest because Allen’s estate was insufficient to fund it.) He owned a life insurance policy through Minnesota Life, for which he hadn’t designated a beneficiary. According to the policy, if no beneficiary was designated, the policyholder’s spouse was the default beneficiary.
However, Allen’s children found and submitted within three weeks after his death a signed beneficiary designation form that Allen had completed in August 2008. This form listed the three children as beneficiaries of the policy.
Litigation ensued and the district court ruled in Arlene’s favor on her motion for summary judgment. The children appealed, but the Seventh Circuit affirmed the district court’s holding that Allen hadn’t complied nor substantially complied with the policy requirements for designating the beneficiaries of his policy.
The Seventh Circuit agreed that the policy terms required that the form be completed, signed and submitted to the insurance company. However, under Illinois law, substantial (rather than exact) compliance with policy terms is sufficient to change the beneficiary. Fortunately for Arlene, the Seventh Circuit also agreed with the district court that completing the form without submitting it isn’t enough to meet the standard for substantial compliance, which requires: (1) a “clear expression of the insured’s intention to change beneficiaries,” and (2) a “concrete attempt to carry out his intention as far as was reasonably in his power.” Given that Allen changed the beneficiaries of his other plans and benefits over his lifetime, the court held that the failure to return this form showed that he hadn’t carried out his intention as far as he reasonably could (and, possibly, indicated that he wasn’t sure of his intent to change the beneficiaries in the first place).
• Purchase of insurance policy by grantor trust held to be excluded by exception to transfer-for-value rule—In Private Letter Ruling 201332001 (Aug. 9, 2013), a taxpayer and his wife established a trust that held a survivorship insurance policy on both their lives. Under the terms of the trust, after the death of the survivor, the trustees were to distribute the trust property outright to the couple’s four children. Later, the couple learned that their daughter had a disability that would prevent her from managing her own affairs. To protect the trust property and their daughter, the taxpayer established a second trust that was identical to the first, but included special needs provisions. The second trust was a grantor trust to the taxpayer. The plan was for the second trust to purchase the policy from the first trust. In addition, the taxpayer and his wife established a partnership that held several investments.
The transfer-for-value rule under IRC Section 101(a) requires that if a policy is transferred for valuable consideration, the amounts later received by the purchaser under the policy in excess of the consideration and premiums paid aren’t excluded from gross income. However, the rule doesn’t apply if the transfer is to the insured, a partner of the insured or other certain persons.
Here, to the extent the policy insured the taxpayer, the transfer was “to the insured” because the second trust was a grantor trust to the husband. And, to the extent the policy insured the taxpayer’s wife, the ruling held that the transfer was to a “partner of the insured” because of the taxpayer’s and wife’s interests in the partnership. The taxpayer and the grantor trust are treated as one for income tax purposes; therefore, the trust is a partner of the wife. Thus, the policy was fully covered by the exceptions to the transfer-for-value rule. This ruling illustrates that if a policy insures two lives, one must comply with the transfer-for-value rule for both insureds.