• Tax Court agrees that remainder beneficiaries made gifts in qualified terminable interest property (QTIP) termination—Clotilde McDougall died in December 2011 with an estate of roughly $60 million. Her husband Bruce and two children survived her. Her estate plan directed that the majority of her estate (about $54 million) be held in a marital trust for Bruce, for which a QTIP election was made. Under the terms of the trust, on Bruce’s death, the trust would be divided into equal shares for her children.
Five years later, the trust had doubled in value, and Bruce and his two children executed a nonjudicial agreement to terminate the marital trust. As a result, all the marital trust property was distributed to Bruce. That same day, Bruce then used those assets to make gifts to trusts for the children’s benefit.
The family acknowledged that the termination of the marital trust, under Internal Revenue Code Section 2519, resulted in a deemed transfer of the remainder interest to the children. However, they argued that the children gave Bruce an “offsetting” gift because all the assets were transferred to him.
The family filed gift tax returns and disclosed the transactions, and the Internal Revenue Service issued notices of deficiency, arguing that the two gift transactions aren’t offsetting consideration and don’t negate each other.
In McDougall v. Commissioner, 163 T.C. No. 5 (Sept. 17, 2024), the Tax Court held for the IRS, relying heavily on its precedent of Estate of Anenberg, 162 T.C. No. 9 (May 20, 2024), which had very similar facts. Under IRC Section 2519, any disposition of an income interest in a QTIP trust is treated as if the surviving spouse had made a deemed transfer of the entire remainder interest in the QTIP. However, because Bruce retained all of the property, the court held that he had made no gratuitous gifts because nothing was, in fact, given to the children. The court determined that Bruce gave nothing away as a result of the deemed transfer.
However, the transaction didn’t leave the children in the same place before and after the termination. Prior to the termination, they had remainder interests in the marital trust. After the termination, the two children had no rights to the remainder interests in the QTIP and received nothing in return. These were gratuitous transfers by each child, without any consideration, and subject to gift tax.
Once again, the complicated deemed transfer rules of Section 2519 caught up with the taxpayer.
• Last minute family limited partnership (FLP) is disregarded—In Estate of Fields v. Comm’r (T.C. Memo. 2024-090), the Tax Court affirmed the IRS’ determination that the decedent’s estate included the value of assets transferred to an FLP.
Anne Fields inherited an oil business from her husband when he died in the 1960s and successfully managed it herself for years, growing it significantly. Anne signed a will and durable power of attorney in 2010. In 2011, she was diagnosed with Alzheimer’s and shortly thereafter broke her hip and had multiple surgeries. She named her great nephew, Bryan, in whom she had great confidence, as executor of her estate and durable power of attorney. Under her will, she left specific bequests totaling $1.45 million to various family members and friends, and the balance of her estate went to Bryan.
Several years later, in 2015, Bryan consulted with a friend who was also an attorney about the potential for restructuring Anne’s asset holdings. Under the advice of this attorney, Anne established two limited liability companies (LLCs). She was the sole member of both. Bryan signed all the LLC agreements for her, using the durable power of attorney, and for himself as LLC manager. One LLC held cash, notes and collectible guitars; the other held real estate in Winnsboro, Texas. The LLCs were established and funded entirely by Bryan in May of 2016. One month later, Anne died.
The Tax Court found that Anne didn’t retain sufficient assets outside of the LLCs for her own support and the bequests under her will and determined there was an implied agreement that the partnership would make distributions to Anne for her expenses and, after her death, to fulfill the bequests in her estate plan. As a result, the partnership assets were included in her estate under IRC Section 2036(a)(1). Further, she retained the right to dissolve the partnership in conjunction with Bryan, giving her the right to designate the persons who will enjoy the property, which causes estate tax inclusion under Section 2036(2). Lastly, the court found no evidence of any business purpose for the LLCs: There was no change in her wealth or composition of the estate that would generate a non-tax reason for asset management, the assets transferred didn’t require active management and were all very different, with no obvious synergies from pooling them in a single entity.
Unable to find a clear non-tax business reason for the structure, the court concluded that the transfers to the LLCs weren’t a bona fide sale for full consideration. The Fields case is a classic example of the IRS coming down on an FLP/LLC established by a decedent in an attempt to reduce the estate tax bill.
The court used the formula from Estate of Moore, T.C. Memo. 2020-40, to calculate the amount included in the gross estate on account of IRC Sections 2033, 2036 and 2043, as follows: (1) the date-of-death value of consideration received from the transfer to the LLC that remains in her estate (that is, the value of her LLC units), plus (2) the date-of-death value of the LLC’s assets that were included in her estate under Section 2036, less (3) the value of the consideration received at the time of transfer to the LLC (that is, the value of the LLC units received when the LLC was funded). If the value of her LLC interests in the transaction increased from the date of the gift, her estate would have also increased under this rule. However, as it turns out, the value of Anne’s interests in the LLC didn’t increase between the date of transfer and death (presumably because such a short time elapsed), so (1) and (3) netted each other out.
• IRS releases final regulations implementing IRC Section 1014(f)’s basis consistency rules—The IRS and Treasury released final regulations (final regs) (T.D. 9991) regarding the reporting of basis consistency rules under Sections 1014(f) and 6035. These final regs apply to estate tax returns filed after Sept. 17, 2024.
Under Section 1014(f), the recipient’s basis of property received from a decedent must be the same as the value reported on the federal estate tax return. Section 6035 establishes the method and requirements for reporting the property values for the executor of the estate. The executor of an estate that’s required to file an estate tax return must file a Form 8971 that shows the values of the estate’s assets and send it to the beneficiaries who receive property from the estate.
The final regs have generally streamlined the process and include the following changes:
Reporting deadline extended. The proposed regulations (proposed regs) had required the executor to deliver Form 8971 to each beneficiary within 30 days of filing the estate tax return. That same rule applies if the beneficiaries have already received property by the due date or when
Form 706 is filed. But, if the beneficiaries haven’t yet received property when the estate tax return is due or filed, the executor now has until Jan. 31 of the year following the calendar year in which Form 706 is filed.
Zero basis rule eliminated. The proposed regs had required that any property not reported on an estate tax return within the statute of limitations period have a zero basis. This created a punitive capital gains liability for the beneficiary, who had no responsibility for the initial reporting. Many practitioners objected to the obvious unfairness of this provision, and it was removed in the final regs.
Reduced reporting for subsequent transactions. The proposed regs had required that subsequent transfers after death required further basis reporting. So, if a recipient of estate property later gave that property to another individual, the recipient also had to file Form 8971. The IRS agreed with those who submitted comments that it was too great of an imposition on beneficiaries to have continual reporting obligations. The final regs remove that obligation for everyone other than trustees of certain trusts.
Inclusion of an extensive list of properties that aren’t subject to the reporting requirement:
- Household items and personal effects
- Property wholly qualifying for the marital and charitable deductions is excepted from the reporting requirements. (However, property subject to partial deductions is still subject to the reporting requirements)
- Forgiven notes
- Surviving spouse’s one-half interest in community property
- Cash
- Trust property subject to a taxable termination
