IRS, TC bound by revenue ruling.

The Fifth Circuit recently held that a taxpayer could follow a revenue ruling that clearly allowed him to rely on actuarial tables in structuring transfers to his son and a family trust, that the IRS could not ignore its own ruling, and that the Tax Court was also bound to follow the revenue ruling (Estate of McLendon (5th Cir., 3/9/98)).

Through various partnerships, Gordon McLendon was the principal owner of the Liberty Broadcasting System, radio and television stations and movie theaters. In May 1985, McLendon was diagnosed with cancer. While the cancer initially responded to radiation therapy, it recurred by September 1985 and was described as severe and likely terminal (with a 2 to 3% survival rate). McLendon began a series of chemotherapy treatments and showed remarkable improvement; in December 1985 and again in February 1986, doctors reported that the cancer was in complete remission.

On March 5, 1986, despite reports that McLendon required constant pain medication and nutritional supplements, his doctor expressed the opinion that McLendon was markedly improved and in the best condition he had been in since coming under her care in early 1986. (Later, the IRS would present undisputed expert testimony that McLendon's chance of surviving for more than one year from that date was approximately 10%.)

Also on March 5, 1986, McLendon entered into a private annuity transaction with his son and a family trust. McLendon transferred remainder interests in his partnership holdings to his son and the trust in exchange for $250,000 and an annuity to be paid to McLendon for life. The amount of the annuity was based on the present value of the remainder interests, as determined under the Service's actuarial tables for life expectancy found in Regs. Sec. 25.2512-5(f). According to the tables, McLendon's life expectancy as a 65-year-old man in March 1986 was 15 years. As a result, the remainder interests had a value of $5.9 million, and the amount of the annuity had to be about $865,000.

In late March 1986, McLendon completed chemotherapy. Tests in May 1986, however, revealed a major recurrence of the cancer, and McLendon died in September 1986. From the tune of his first treatment to his death, McLendon survived longer than 75% of patients diagnosed with esophageal cancer.

Round One

McLendon's estate tax return relied on the presumption that he had received adequate and full consideration for the assets transferred in the private annuity transaction. The IRS disagreed. Specifically, the Service argued that the actuarial tables should not have been used, as McLendon's life expectancy was sufficiently predictable on March 5, 1986. The IRS asserted deficiencies for several million dollars in gift and estate taxes, and the estate filed a Tax Court petition. The case boiled down to a few questions, the pertinent one being whether McLendon could use the actuarial tables.

The estate relied on Rev. Rul. 80-80 in support of its use of the actuarial tables to value the private annuity. Before being revoked in 1995, Rev. Rul. 80-80 allowed the tables to be applied to the vast majority of individual life interests, regardless of whether the health of a particular annuitant was better or worse than the "average" person of the same age and gender. Even under this broad rationale, the ruling noted that the actual facts of an individual's condition might be so exceptional as to justify nonuse of the tables. To define the boundaries of this exception, Rev. Rul. 80-80 stated that the actuarial tables:

shall be applied ... unless the individual is

known to have been afflicted, at the time

of transfer, with an incurable physical

condition that is in such an advanced stage

that death is clearly imminent. Death is

not clearly imminent if there is a

reasonable possibility of survival for more

than a very brief period. For example,

death is not clearly imminent if the

individual may survive for a year or more

and if such a possibility is not so remote

as to be negligible.

The Service took the position that McLendon's life expectancy was sufficiently predictable on March 5,1986 to make use of the tables erroneous; at the time of the private annuity transaction, his life expectancy was less than one year. The IRS maintained that the private annuity transaction was therefore not for adequate and full consideration, and was in substance a part-gift, part-sale of the annuitized property.

Although it determined that McLendon's life expectancy at March 5, 1986 was approximately one year, the Tax Court nevertheless agreed with the Service that use of the actuarial tables was improper. However, the Fifth Circuit remanded the case, stating that it could not tell whether the Tax Court had applied Rev. Rul. 80-80 and directed the court to clarify whether the revenue ruling applied.

Round Two

On remand, the Tax Court held that it was not obliged to follow Rev. Rul. 80-80, and once again stated that McLendon's use of the actuarial tables had been improper. On appeal, the Fifth Circuit reversed the Tax Court and held in favor of McLendon's estate.

McLendon had followed Rev. Rul. 80-80 in structuring the transfers to his son and the family trust, and the Fifth Circuit concluded that McLendon was clearly allowed to do so. As the appeals court explained, a life expectancy of approximately one year (as determined by the Tax Court) and expert testimony that McLendon had a 10% chance of surviving a year or more meant that, on March 5, 1986, McLendon's death was not "clearly imminent." Thus, under Rev. Rul. 80-80, McLendon could clearly use the actuarial tables. This conclusion, however, raised the question of whether the Tax Court was bound to follow Rev. Rul. 80-80. The IRS argued that, although the revenue ruling was a correct statement of the law, it had to be interpreted in light of case law determining the applicability of the actuarial tables. The Fifth Circuit disagreed, noting that the Tax Court had long ago adopted this position in a losing battle with appeals courts over the proper deference due revenue rulings. Courts of appeals have held that revenue rulings are owed "a bit more deference"; revenue rulings are "odd creatures unconducive to precise categorization in the hierarchy of legal authorities. They are clearly less binding on the courts than treasury regulations or Code provisions, but probably. . . more so than the mere legal conclusions of the parties."

The Fifth Circuit explained that its practice has been to allow taxpayers to rely on published revenue rulings--even rulings that have been abrogated, provided they were not revoked because they were contrary to the Code in determining the tax treatment of their transactions, as long as the facts and circumstances were substantially the same as those that prompted the ruling and the law was unclear. Noting that McLendon went to great lengths to structure the transaction to comply with Rev. Rul. 80-80 in determining the valuation of future and dependent interests--a "murky area"--the Fifth Circuit held that the Service could not ignore the clear language of its own ruling. Moreover, because McLendon was entitled to rely on Rev. Rul. 80-80, the Tax Court was not at liberty to disregard it. To do otherwise, the Fifth Circuit concluded, would be intolerable.

Comment: The Second, Third, Fifth, Sixth and Ninth Circuits give some form of deference to revenue rulings. As such, taxpayers can be reasonably assured that the courts in those circuits will uphold taxpayers' reliance on revenue rulings, unless there is clear statutory language to the contrary. Up to this point, the Tax Court has refused to give this level of deference to revenue rulings.

Interestingly, most questions on the weight of authority to be given revenue rulings involve an argument by the taxpayer that a particular ruling is contrary to law. In Estate of McLendon, it was the IRS that opposed use of the revenue ruling. In the Fifth Circuit, there is a "safe harbor" for taxpayer transactions in which the facts and circumstances are the same as those that prompted a ruling and the law is not settled. In such cases, taxpayers may rely on revenue rulings in structuring their transactions.