• Redemption agreement doesn’t impact valuation of company—In Estate of Connelly v. United States, No. 23-146 (June 6, 2024), the U.S. Supreme Court agreed with the Internal Revenue Service that life insurance proceeds payable to a business weren’t offset by the business’ obligation to redeem a decedent’s ownership in the company. As a result, the value of the business includes the value of the insurance proceeds for the purpose of calculating estate tax liability.
Two brothers, Michael and Thomas Connelly, were the only shareholders of their building supply business. They had signed an agreement aimed at keeping the business within the family, which provided that on the death of either, the survivor would purchase the deceased brother’s shares, or the business would redeem them. The business purchased life insurance policies on the lives of both brothers to effectuate the plan. When Michael passed away, Thomas chose not to purchase his brother’s shares and therefore, the business was obligated to redeem them.
Both sides agreed that the life insurance proceeds should be included in the value of the business, but Michael’s estate argued that the company’s obligation to redeem Michael’s shares was a liability that should also be taken into account when valuing the business as of Michael’s date of death.
The Supreme Court disagreed. The Court viewed the redemption as a neutral economic event, reasoning that even though the business would have less funds after the buy-back, the interest of the remaining shareholder would correspondingly increase, leaving them in a similar economic position. Additionally, under 26 U.S.C. Section 2033, the gross estate of a decedent is valued “at the time of his death,” and therefore, the valuation shouldn’t hold off until the insurance proceeds are used for the redemption.
• Revenue Procedure 2024-22 provides guidance for Internal Revenue Code Section 501(c)(3) tax-exempt organizations relating to organizational requirements and exempt purposes—To qualify for IRC Section 501(c)(3) tax-exempt status, organizations must ensure that, on dissolution, any remaining assets are distributed for exempt purposes, as opposed to benefiting individuals. Organizations can either establish a qualifying distribution plan in their controlling documents or rely on the operation of state law to meet the federal requirements. An organization’s assets will be considered dedicated to an exempt purpose, if, on dissolution, such assets are distributed: (1) for one or more exempt purposes; (2) to the federal government; (3) to a state or local government; (4) for a public purpose; or (5) by a court to another organization for the dissolving organization’s general purposes.
The IRS reemphasized this crucial point in Rev. Proc. 2024-22. The previous guidelines, Rev. Proc. 82-2, were based on state law and provided a breakdown of the varying outcomes based on different state laws. However, as state laws changed, Rev. Proc. 82-2 was becoming outdated and unwieldy. The new revenue procedure revokes the prior guidelines, highlights the importance of compliance and provides resources for properly drafting controlling documents without all the state-by-state examples. If relying on applicable state law rather than creating a qualifying distribution plan, each organization is responsible for verifying that the requirements are satisfied.
• Nebraska Supreme Court holds that the trust exonerated specific devise of real estate from bearing estate tax—In Shaddick v. Hessler, 316 Neb. 600 (May 10, 2024), the Nebraska Supreme Court decided that explicit tax apportionment provisions in a decedent’s revocable trust trumped the state law rule that all beneficiaries proportionally share in the inheritance tax burden.
Michael Hessler established a revocable trust as part of his initial estate plan. Later, he amended the trust to leave his home outright and free of trust to his girlfriend, Lori J. Miller. The remainder of his estate passed equally to his children. Michael’s children argued that Lori should be responsible for a proportionate share of the estate tax. However, Lori pointed to a provision in the trust that specifically assigned the estate tax burden to the residuary beneficiaries. The court agreed with Lori and affirmed the lower court’s decision.
The default provisions of Nebraska Revised Statutes state that the estate tax is to be proportionally shared by the beneficiaries unless directed otherwise. Michael’s trust stated, in relevant part, that “The Successor Trustee shall pay from this trust all inheritance and estate taxes due by reason of the Settlor’s death irrespective of whether such taxes are in respect of the trust property.” The court found that such direction, coupled with the specific outright distribution of the decedent’s home to Lori, meant that the taxes would be paid from the trust “off the top” and that the home was removed from consideration. The court relied on its 2015 decision in In re Estate of Shell, in which similar language shifted the tax burden to the decedent’s estate.
• Tax Court analyzes gift tax liability under IRC Section 2519 for termination of surviving widow’s qualified terminable interest property (QTIP) trust—In Estate of Sally J. Anenber v. Commissioner, 162 T.C. No. 9 (May 20, 2024), the Tax Court addressed whether Section 2519 applied when a QTIP trust was terminated with the consent of the beneficiaries and the approval of the local superior court pursuant to the local probate code.
The QTIP trust held shares of decedent Sally Anenber’s closely held business. When the local superior court approved the termination, all of the QTIP trust was distributed outright to Sally. Six months later, Sally sold shares of the business to her late husband’s children in exchange for promissory notes.
Under Section 2519, a transfer of the income interest in a QTIP trust is treated as a transfer of the trust principal. Section 2519 is intended to ensure that the QTIP property will be taxed if it passes from the surviving spouse’s hands during life.
The IRS argued that Sally triggered Section 2519 via the termination of the QTIP trust or the sale of the shares as a disposition of her income interest, and, as a result, the transfer is treated as a taxable gift. The decedent’s estate argued that (1) neither event was a “disposition” under Section 2519, and (2) even if so, neither “disposition” was a gift.
The court determined that no gift had been made when Sally terminated the QTIP because she received all of the underlying property. This transfer wasn’t gratuitous, and she never gave up any dominion or control.
The court further rejected the notion that the subsequent transfer of shares triggered Section 2519 because at that point, Sally owned the shares outright and there was no transfer of an income interest in a QTIP. In sum, Sally didn’t make a transfer when QTIP termination occurred and when she did make a transfer later on, she no longer held the income interest. At neither time (the time of the termination or the sale) were both conditions of Section 2519 met. Neither was a disposition by Sally of her income interest in the QTIP trust.
The policy purposes of Section 2519 and Section 2044 are to make sure that transfer tax is imposed when the property leaves the spouse’s hands. When the QTIP trust terminated, no property left Sally’s hands. And when she later sold the shares, she received payment in the form of promissory notes, keeping the value in her taxable estate. The underlying purpose of Section 2519 isn’t relevant here.
Query whether the children made a gift to Sally if they agreed to the court-approved termination and distribution of the QTIP trust to Sally.