Tax Law Update 2008-05-01 (1)Tax Law Update 2008-05-01 (1)
How much do estate and gift taxes contribute to funding the federal government? A March 19, 2008, Congressional Research Service report said that combined revenues from estate and gift taxes were $26 billion in 2007, constituting 1 percent of total federal revenue. The Congressional Budget Office projects that, if the estate tax were to be reinstated in 2011 as scheduled, revenue from the estate and
May 1, 2008
David A. Handler partner, and Alison E. Loathes, associate, in the Chicago office of Kirkland & E
How much do estate and gift taxes contribute to funding the federal government? A March 19, 2008, Congressional Research Service report said that combined revenues from estate and gift taxes were $26 billion in 2007, constituting 1 percent of total federal revenue. The Congressional Budget Office projects that, if the estate tax were to be reinstated in 2011 as scheduled, “revenue from the estate and gift taxes would climb steadily by about $7 billion per year.”
CRT can split unitrust payments between a grantor and a charity. In Private Letter Ruling 200813023 (issued Nov. 21, 2007 and released March 28, 2008), a taxpayer proposed to established a charitable remainder unitrust (CRUT) under which 50 percent of the unitrust amount would be paid to the taxpayer and 50 percent would go according to a special trustee's discretion to the taxpayer and/or any charities. Under the CRUT's terms, the taxpayer could not act as special trustee, but could remove and appoint successors to the position, as long as the successor was not related or subordinate to the taxpayer, within the meaning of Internal Revenue Code Section 672(c).
Treasury Regulations Section 1.664-1(a)(4) provides that a trust that otherwise qualifies as a CRUT will be treated as a CRUT at the earliest time that neither the grantor nor any other person is treated as the owner of the entire trust under the grantor trust rules. Internal Revenue Code Section 674(a) generally provides that the grantor of a trust is treated as the owner of any portion of the trust of which the grantor or a non-adverse party controls the beneficial enjoyment. But Section 674(a) doesn't apply if the power to control beneficial enjoyment is exercisable only by the trustees, and no more than half of the trustees are related or subordinate to the grantor.
PLR 200813023 held that, because the special trustee was neither related nor subordinate to the grantor, the special trustee's power to allocate 50 percent of the unitrust between the taxpayer and charities did not cause the taxpayer to be treated as the owner of the trust; therefore, the arrangement did not prevent the trust from qualifying as a CRUT. But note — the IRS did say that such a trust would qualify as a CRUT only if a portion of the unitrust must be paid to non-charitable beneficiaries each year, which portion is not de minimis under the facts and circumstances.
A “backwards” QPRT qualifies as a QPRT. In PLR 200814011 (issued Dec. 6, 2007 and released April 4, 2008), the Service found a transfer of a residence to a trust qualified as a personal residence trust (QPRT) even though the QPRT was backwards. Usually, the grantor of the QPRT retains the right to use the residence for a period of a year, and the donee/remainderman receives the residence after that term. In this ruling, the donee received the use of the residence for a term, and the grantors received the residence back after the term.
A mother transferred her residence to a QPRT that ended after 10 years, leaving her children owning the residence and leasing it back to her. The children proposed transferring the residence to a new QPRT with a one-year term. The QPRT would provide that the mother would have the right to use and possess the residence for one year, or until both of the children died, whichever came first. At the end of the year, the residence would revert back to the children. The Service ruled that, assuming the residence meets the requirements of a personal residence under Treas. Regs. Section 25.2702-5(c)(2), the trust qualifies as a QPRT.
This PLR seems to identify a method by which the mother can continue to live in the residence without paying rent and without the children incurring a significant gift tax liability. They made a gift of the right to use the residence for one year, the value of which was determined under the Section 7520 tables. Of course, the gift would have a very small value because the term is so short. For example, if the house was worth $500,000, the 7520 rate was 4 percent and the children 40-years-old, the gift would be only about $19,000. Moreover, the gift would qualify for the gift tax annual exclusion. Treas. Regs. Section 25.2503-3(b) provides that the right to use, possess, or enjoy property for a term is a present interest that qualifies for the annual exclusion.
IRS releases proposed regulations on time extensions for GST exemption allocations. The IRS issued proposed regulations on April 17, 2008 to provide guidance on the application of IRC Section 2642(g)(1). These regs describe when a time extension will be granted to: (1) allocate generation skipping transfer (GST) tax exemption (as defined in IRC Section 2631(a)) to a transfer; (2) elect under Section 2632(b)(3) not to have the deemed allocation of GST exemption apply to a direct skip; (3) elect under Section 2632(c)(5)(A)(i) not to have the deemed allocation of GST exemption apply to an indirect skip or transfers made to a particular trust; and (4) elect under Section 2632(c)(5)(A)(ii) to treat any trust as a GST trust for purposes of IRC Section 2632(c).
In 2001, the IRS issued Notice 2001-50 announcing that transferors may seek an extension of time to make an allocation of GST tax exemption. The notice provides that relief will be granted under Section 301.9100-3 of the Procedure and Administration Regulations (1) if the taxpayer satisfies the requirements of those regulations; (2) if the taxpayer acts reasonably and in good faith; and (3) if granting the requested relief won't prejudice the government's interests. If relief is granted under Section 301.9100-3 and the allocation is made, the amount of GST tax exemption allocated to the transfer is the federal gift or estate tax value of the property as of the transfer date and the allocation is effective as of the transfer date.
In 2004, the IRS issued Revenue Procedure 2004-46 (2004-2 CB 142), which provides a simplified, alternate method to obtain an extension of time to allocate GST exemption in certain situations. Generally, this method is available only for inter vivos transfers to a trust if each of the following requirements is met: (1) the transfer qualifies for the gift tax annual exclusion under Section 2503(b); (2) the sum of the amount of the transfer and all other gifts by the transferor to the donee in the same year do not exceed the applicable annual exclusion amount for that year; (3) no GST exemption is allocated to the transfer; (4) the taxpayer has unused GST exemption to allocate to the transfer as of the filing of the request for relief; and (5) no taxable distributions or taxable terminations have occurred as of the filing of the request for relief.
Under the proposed regulations, Section 301.9100-3 will be amended to provide that relief under Section 2642(g)(1) cannot be obtained through the provisions of Sections 301.9100-1 and 301.9100-3 (rendering Notice 2001-50 obsolete). Relief under Section 301.9100-2(b) (the automatic six-month extension) will continue to be available to transferors or transferor's estates that qualify. In addition, Rev. Proc. 2004-46 will remain effective for transfers that meet the requirements of that revenue procedure.
The amount of GST tax exemption that may be allocated to a transfer pursuant to an extension granted under Section 2642(g)(1) is limited to the amount of the transferor's unused GST tax exemption under Section 2631(c) as of the date of the transfer. Thus, if the amount of GST tax exemption has increased since the date of the transfer, no portion of the increased amount may be applied by reason of the grant of relief under Section 2642(g)(1) to a transfer taking place in an earlier year and prior to the effective date of that increase (Prop. Regs. Section 26.2642-7(c)).
Requests for relief under Section 2642(g)(1) will be granted when the taxpayer establishes to the IRS' satisfaction that the taxpayer acted reasonably and in good faith, and that the grant of relief will not prejudice the government's interests. (Prop. Regs. Section 26.2642-7(d)(1)). The following nonexclusive list of factors will be used to determine whether a transferor or the executor of a transferor's estate acted reasonably and in good faith (Prop. Regs. Section 26.2642-7(d)(2)):
a demonstration of the intent of the transferor or the executor of the transferor's estate to allocate the GST tax exemption or make an election under Sections 2632(b)(3) or (c)(5) in a timely fashion — as evidenced in the trust instrument, instrument of transfer or contemporaneous documents (such as federal gift or estate tax returns or correspondence);
if intervening events beyond the control of the transferor as defined in Section 2652(a), or of the executor of the transferor's estate as defined in Section 2203, caused a failure to allocate GST tax exemption to a transfer or a failure to elect under Section 2632(b)(3) or (c)(5);
if the transferor or the executor of the transferor's estate is unaware of the need to allocate GST tax exemption to a transfer after exercising reasonable diligence (taking into account the experience of the transferor or the executor of the transferor's estate and the complexity of the GST issue);
evidence of consistency by the transferor in allocating (or not allocating) the transferor's GST tax exemption, although evidence of consistency may be less relevant if there is evidence of a change of circumstances or change of trust beneficiaries that would otherwise support a deviation from prior GST tax exemption allocation practices; and
reasonable reliance by the transferor or the executor of the transferor's estate on the advice of a qualified tax professional retained or employed by either (or both) of them, and the failure of the transferor or executor, in reliance on or consistent with that advice, to allocate GST tax exemption to the transfer or to make an election described in Section 2632(b)(3) or (c)(5).
For purposes of Section 2642(g)(1), the following non-exclusive list of factors will be used to determine whether the interests of the government would be prejudiced (Prop. Regs. Section 26.2642-7(d)(3)):
the grant of requested relief would permit the use of hindsight to produce an economic advantage or other benefit that would not have been available had the allocation or election had been made in a timely fashion, or that results from the selection of one out of a number of alternatives (other than whether to make an allocation or election) available at the time the allocation or election could have been made in a timely fashion;
if the transferor or the executor of the transferor's estate delayed the filing of the request for relief with the intent to deprive the IRS of sufficient time (by reason of the expiration or impending expiration of the applicable statute of limitations or otherwise) to challenge the claimed identity of the transferor; the value of the transferred property that is the subject of the requested relief; or any other aspect of the transfer that is relevant for transfer tax purposes; and
a determination by the IRS that a grant of relief under Section 2642(g)(1) would be unreasonably disruptive or make it difficult to adjust the GST tax consequences of a taxable termination or a taxable distribution that occurred between the time for making a timely allocation of GST exemption or a timely election described in Section 2632(b)(3) or (c)(5) and the time at which the request for relief under Section 2642(g)(1) was filed.
The standard of reasonableness, good faith and lack of prejudice to the interests of the government will not be met, and relief will not be granted, in the following situations (Prop. Regs. Section 26.2642-7(e)):
the transferor or the executor of the transferor's estate made an allocation of GST exemption as described in Section 26.2632-1(b)(4)(ii)(A)(1) or made an election under Sections 2632(b)(3) or (c)(5) on a timely filed federal gift or estate tax return — and the relief requested would decrease or revoke that allocation or election;
the transferor or the transferor's executor delayed in requesting relief in order to preclude the IRS, as a practical matter, from challenging the identity of the transferor, the value of the transferred interest on the federal estate or gift tax return, or any other aspect of the transaction that is relevant for federal estate or gift tax purposes;
the action or inaction that is the subject of the request for relief reflected or implemented a decision regarding the allocation of GST exemption or an election described in Section 2632(b)(3) or (c)(5) that was made by the transferor or executor of the transferor's estate who had been accurately informed in all material respects by a qualified tax professional retained or employed by either (or both) of them; and
the IRS determines that the transferor's request is an attempt to benefit from hindsight.
Lastly, if the relief granted under Section 2642(g)(1) results in a potential tax refund claim, no refund will be paid or credited to the taxpayer or the taxpayer's estate if, at the time of filing the request for relief, the period of limitations for filing a claim for a credit or refund of federal gift, estate, or GST tax under Section 6511 on the transfer for which relief is granted has expired. (Prop. Regs. Section 26.2642-7(g))
Score one highly favorable FLP decision for taxpayers. In Estate of Anna Mirowski v. Commissioner, T.C. Memo 2008-74 (March 26, 2008), the Tax Court held that assets Anna Mirowski transferred to her family's limited liability company (LLC) and the LLC interests she gifted to trusts for her daughters' benefits were not includible in her estate — despite the fact that she'd executed the operating agreement and funded the LLC less than two weeks before her unexpected death. Because such decisions are very fact-driven, here are the details of that case:
In the late 1990s, Mirowski had begun to consolidate management of her investment portfolio with Goldman Sachs. At that time, her portfolio consisted primarily of U.S. treasuries held in 84 accounts in 10 institutions. Over time, she diversified into other types of investments based on Goldman's advice.
Mirowski also owned patents developed by her late husband and rights to royalties on those patents under a license agreement. The royalty payments dramatically increased after 1990, generating millions of dollars each year.
The Tax Court went to great lengths to note that Mirowski “was a careful, deliberate and thoughtful decision maker” wh...
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