Tax Law Update 2009-03-01 (1)Tax Law Update 2009-03-01 (1)

Transfers of art to a foreign trust qualify for estate and gift tax deductions. In Private Letter Ruling 200901023 (Sept. 29, 2008), the Internal Revenue Service held that a wife's lifetime and testamentary transfers to a foreign trust to manage, conserve and distribute her deceased husband's works of art would qualify for the estate and gift tax charitable deductions — even if the trust did not apply for tax-exempt status under Internal Revenue Code Section 501(c)(3).

Under its terms, the trust would operate for “purposes, objects or institutions exclusively charitable in law.” The artwork would be made available for exhibition and loan at public galleries and museums anywhere in the world, but principally in “Country B” and the United States. Because the entire collection is unlikely to be on show in public galleries at all times, items not on public exhibition would be available for private study by researchers, artists and others. The trustees may sell items in the collection to provide funding to support future activities and to make grants or loans to other charities in accordance with the trust's charitable purposes.

IRC Section 2055(a) and its regulations generally provide that the value of the taxable estate is determined by deducting from the value of the gross estate the amount of all bequests, legacies, devises or transfers to, or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary or educational purposes, including the encouragement of art.

Treasury Regulations Section 20.2055-1(a) states that the estate tax charitable deduction is not limited to transfers to U.S. corporations or associations, or to trustees for use within the United States. But IRC Section 2055(e)(1) provides that no deduction is allowed for a transfer to an organization or trust described in IRC Sections 508(d) or 4948(c)(4), subject to the conditions specified in such sections.

Section 508(d)(2)(A) disallows a deduction for a gift to a private foundation or an IRC Section 4947 trust in a taxable year for which the foundation or the trust fails to meet the requirements of Section 508(e). Section 508(e)(1) requires a private foundation's governing instruments to: (1) require compliance with the minimum distribution rules under Section 4942; and (2) prohibit the foundation from:

(a) engaging in any act of self-dealing (as defined in IRC Section 4941(d));

(b) retaining any excess business holdings (as defined in IRC Section 4943(c));

(c) making any investments in such manner as to subject the foundation to tax under IRC Section 4944; and

(d) making any taxable expenditures (as defined in IRC Section 4945(d)).

The IRS held that the trust agreement contains these provisions and meets the Section 508(e) requirements. Therefore, it is not described by Section 508(d)(2).

Section 508(d)(2)(B) disallows a charitable deduction for a contribution to any organization during a period in which the organization is not treated as described in Section 501(c)(3) by reason of Section 508(a) (which requires the organization to apply for tax exemption). But under Treas. Regs. Section 1.508-2(b)(1)(viii), contributions to a charitable trust described in Section 4947(a)(1) are not required to file for tax exemption.

The IRS held that the trust is described in IRC Section 4947(a)(1) because:

(a) it is a trust;

(b) it will not be exempt from tax under IRC Section 501(a);

(c) all of the trust's assets will be devoted to charitable purposes; and

(d) a gift tax charitable deduction under IRC Section 2522(a) and an estate tax charitable deduction under Section 2055(a) would be allowed for the transfers to the trust.

Because the trust met the requirements of Section 508(e), the disallowance provisions of Section 508(d)(2)(A) did not apply. Therefore, the estate and gift tax charitable deductions would not be barred by Section 508(d). Moreover, the deductions would not be barred by Section 4948(c)(4), because the trust has not engaged in a “prohibited transaction.”

This ruling also demonstrates that a trust does not need to be tax exempt for contributions to qualify for the gift and estate tax charitable deductions.

Sixth Circuit okays using IRS annuity tables for valuing lottery payments. In Estates of Susteric and Lopatkovich v. United States (Jan. 28, 2009), the U.S. Court of Appeals for the Sixth Circuit reversed the District Court for the Northern District of Ohio, holding that the IRS properly used its annuity tables to value a decedent's remaining lottery payments for estate tax purposes — because the tables do not result in an unrealistic or unreasonable valuation, and departure from the tables is not justified or required.

In 1991, Mildred Lopatkovich and Mary Susteric, along with a third party, jointly won the Ohio Super Lotto jackpot of $20 million. Each winner was entitled to receive 26 annual payments of $256,410.26, totaling $6,666,666.67. Lopatkovich and Susteric both died in 2001 with 15 lottery payments remaining. The payments were not assignable and could not be pledged as collateral. Carol Negron, as executor for both estates, elected for each estate to receive a lump sum cash settlement of $2,275,867 for the remaining payments.

On each estate tax return, Negron reported the value of the lottery winnings as $2,275,867 based upon the lump sum each estate received. The Ohio lottery commission based the settlement on the present value of the remaining lottery payments, using a discount rate of 9 percent from the state valuation tables in effect on Jan. 19, 1991, the date the lottery prize was won.

The IRS determined that the proper present values of the remaining lottery payments were $2,775,209 for Lopatkovich and $2,668,118 for Susteric. To calculate these values, the IRS used discount rates of 5 percent for Lopatkovich and 5.6 percent for Susteric from the IRC Section 7520 annuity tables in effect on the dates of death. Both estates paid the additional tax, with interest, and filed refund claims.

The IRS argued that the annuity tables must be used. Negron argued that an exception was warranted because the tables created unreasonable and unrealistic results.

There is a split among the circuits on whether the annuity tables accurately reflect the fair market value of future lottery payments with marketability restrictions. The Second and Ninth Circuits have held that they do not; and the Fifth Circuit, along with two other district courts, have held that they do. See Cook v. Commissioner, 349 F.3d 850, 851 (5th Cir. 2003); Estate of Gribauskas v. Comm'r, 342 F.3d 85, 89 (2d Cir. 2003); Shackleford v. United States, 262 F.3d 1028, 1029 (9th Cir. 2001); Anthony v. United States, No. Civ.A. 02-304-D-M1, 2005 WL 1670697, at 13 (M.D. La. June 17, 2005); Estate of Donovan v. United States, No. Civ.A. 04-10594-DPW, 2005 WL 958403, at 6 (D. Mass. April 26, 2005).

In this case, the Sixth Circuit held that the non-marketability of annuities is an assumption underlying the annuity tables. Therefore, the annuity tables do not produce an unrealistic and unreasonable result.

Valuation discounts proposed by an estate's expert are upheld, for the most part. In Estate of Litchfield v. Comm'r, T.C. Memo 2009-21 (Jan. 29, 2009), the Tax Court upheld the estate's valuation discounts on interests in two family-owned companies for lack of control and for built-in capital gains, but adjusted the discounts for lack of marketability.