In McDougall v. Commissioner, the Tax Court held that commutation of a qualified terminable interest property (QTIP) trust resulted in the children (as remainder beneficiaries of the QTIP trust) making gratuitous transfers and subject to gift tax under Internal Revenue Code Sections 2501 and 2511.
QTIP Trust Commuted
The decedent died in 2011, and her surviving husband, as representative of the decedent’s estate, made a QTIP election under IRC Section 2056(b)(7) to treat a $54 million residuary trust as a QTIP trust. In 2016, the husband and the couple’s two surviving children agreed to commute the QTIP trust and distribute the entirety of its assets to the husband. The husband sold some of the assets received to new trusts for the benefit of the couple’s children in exchange for promissory notes.
Commutation Resulted in Gifts to Husband
The husband and each of the children filed gift tax returns for 2016 reporting no taxable gifts made because of offsetting reciprocal gifts made to one another, and the Internal Revenue Service issued a notice of deficiency claiming: (1) the commutation of the QTIP trust resulted in gifts from husband to the children under IRC Section 2519 and (2) the agreement resulted in gifts from the children to the husband of the remainder interests in the QTIP trust under IRC Section 2511. The Tax Court rejected the former claim but agreed with the latter and held that the agreement to commute the QTIP trust resulted in gifts from the children to the husband under Section 2511.
Anenberg Precedent Applied
The court expressly acknowledged that it was applying the holding in the recent case of Estate of Anenberg v. Commissioner, No. 856-21, 162 T.C. (May 20, 2024) to reach its decision that surviving husband didn’t make a gift as a result of commutation of the QTIP trust because he was put in the same position he had been if the property of the trust been distributed outright to him at his wife’s death rather than to the QTIP trust. However, the court held that the children made gifts to the husband by giving up their remainder interests in the residuary QTIP trust and receiving nothing in return.
The court disagreed with the husband’s argument that no gift occurred because all of the parties were in the same economic position before and after the transactions in question. The court pointed out that the children’s remainder interests in the trust would have been includible in their estates had they not agreed to the commutation, a different economic position that’s illustrative of the transfer by gift they each made when the QTIP trust terminated wholly in favor of the surviving husband.
