Shifting income among family members.

Facts

Greg's mother, who is 67 years old, receives monthly income from Social Security and a retirement fund from her husband's last employer. To help out, Greg gives her an additional $250 per month. Greg and his wife also have children to whom he would like to make substantial gifts.

Issue

Is there a better way for Greg to take care of his mother and transfer some wealth to his children?

Analysis

A better way to accomplish Greg's goals requires the use of a trust and the willingness to set aside a substantial sum of money. Greg could set up a trust, contributing $40,000. The terms of the trust would call for the trustee to distribute all the trust income to his mother for as long as she lives. On her death, the corpus would be distributed to his children in equal shares.

If the trust is structured in this manner, his mother would receive a gift in the amount of the present value of the income stream for her life. This gift would qualify for the $10,000 per donee annual exclusion. The difference between the gift to his mother and the $40,000 represents the amount of the gift to his children. This would be a gift of a future interest, since they could not currently enjoy the use of their remainder. As such, it would not be eligible for the annual exclusion, but the gift tax could be offset by an unused portion of the unified credit.

Assuming the trust is funded May 1, 1991, a discount rate of 9.6% must be used in valuing the gifts to his children and mother. (The taxpayer must use a discount rate equal to 120% of the applicable federal midterm rate (compounded annually) for the month the transfer is made. The actual rate is then rounded to the nearest two-tenths of 1%.) The amount of the gift to Greg's children would be $13,046 ($40,000 transfer x remainder factor of 0.32614).

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Greg's gift to his mother is $26,954 ($40,000 - $ 13,046). If Greg's wife elects to split the gift with Greg, the taxable portion of the gift to his mother would be $6,954 ($26,954 present value of gift - $20,000 annual gift tax exclusion). The gift to the children (that is, the present value of the remainder) would also be a taxable gift. The tax with respect to both these gifts can be offset by any unused unified credit.

Greg will enjoy an income tax benefit from this transfer. Assume that Greg has been earning 9% on the $40,000 while he had it invested in his name. This income, after deducting income tax on the earnings, was not sufficient to cover the money Greg has been sending his mother. (Assume Greg's marginal tax rate is 31% and his mother is in the 15% bracket.) Because the trust would distribute all its income to Greg's mother, she would be taxed on current income. The chart below compares the current situation with the proposed situation.

Both Greg and his mother are better off with the trust arrangement. (Even if Greg were only in the 28% tax bracket, he would still have a negative cash flow of $408.)

Conclusion

The tax adviser should recommend that Greg establish a trust for the current benefit of his mother with a remainder interest to his children. By establishing the trust and funding it with $40,000, Greg is able to provide his mother's support at a lower cost. He also is able to transfer $40,000 out of his estate. Although he will use an amount of his unified credit equal to the gift tax for gifts of $20,000 ($6,954 gift to his mother + $13,046 gift to his children), he has transferred an additional $20,000 without incurring any cost. (Note: The valuation rules under Sec. 2702 are not applicable. Greg's mother has not retained an interest in the trust because she did not hold the interest both before and after the transfer; see Prop. Regs. Sec. 25.2702-2(a)(3) and -2(d), Example 3.)

Regulations

Sec. 338 consistency rules

The IRS has issued proposed regulations that replace the stock and asset consistency rules of Temp. Regs. Secs. 1.338-4T and -5T. The proposed regulations substantially revise and simplify the stock and asset consistency rules and also restate, sim-plify and substantially shoreten most of the other regulations under Sec. 338.

The proposed regulations adopt a narrower set of consistency rules than those contained in the temporary regulations. Under the proposed regulations, the consistency rules generally apply only if the target corporation (T) is a subsidiary in a consolidated group. The rules also apply in certain limited cases in which T pays dividends eligible for a 100% dividends received deduction.

The proposed regulations also simplify the consistency and mitigation ruls. For example, they eliminate the district director's and Commissioner's discretion in applying the rules. They also eliminate the affirmative action carryover, protective carryover, offset prohibition and regular exclusion elections.

Fringe benefits 

The IRS has finalized amendments to two provisions of the fringe benefit regulations on the taxation and valuation of fringe benefits and exclusion from gross income for certain fringe benefits. The final amendments affect any person providing or receiving these fringe benefits and provide these persons with the guidance necessary to comply with the law. The amendments are effective July 1, 1991.

The amendments provide guidance on the tax treatment of certain transportation provided by an employer to or from an employee's workplace due to unsafe conditions surrounding the employee's workplace or residence and increase the dollar amount of the de minimis exclusion for public transit passes provided to employees for commuting on public transit systems.

Leased property rules

The IRS published temporary regulations on the treatment of lessees of luxury atuomobiles and other listed property on Aug. 9, 1988 and published amendments to those rules on Apr. 12, 1990. Now the Service proposes to adopt the temporary regulations as final regulations, which would affect lessees who lease luxury automobiles or other listed property after Dec. 31, 1986.

Sec. 280F limits depreciation deductions for passenger automobiles and for certain other property that is not used predominantly in a taxpayer's trade or business. In the case of leased property, however, the special rules of Sec. 280F(c) apply. In general, these rules provide that the limitations on depreciation do not apply to the lessor of the property. Instead, an equivalent limitation applies to the lessee's rental deductions. The temporary regulations provide rules on the treatment of lessees under Sec. 280F(c).

Special valuation rules

The IRS has amended proposed regulations providing for an adjustment in computing the estate tax imposed on the transfer of interests to which the SEc. 2701 special valuation rules previously applied. Changes to the applicable law were made by the Omnibus Budge Reconciliation Act of 1990. The proposed regulations will provide the guidance taxpayers need to comply with that Act.

Sec. 2701 provides gift tax valuation rules that apply to transfers to certain family members of interests in corporations or partnerships. If Sec. 2701 applies, the amount of an individual's gift is determined using the subtraction method of valuation. Under Sec. 2701(e)(6), regulations are to provide an appropriate adjustment when there is a subsequent transfer or inclusion in the gross estate of an interest valued under these special valuation rules.

The proposed amendments provide for a reduction to a decedent's adjusted taxable gifts. In general, the amount of the reduction is the lesser of (1) the amount by which the transferor's taxable gifts were increased as a result of Sec. 2701 and (2) the increase in the decedent's gross estate (or adjusted taxable gifts) attributable to the portion of the value of the interest that was subject to gift tax at the time of the initial transfer.

The second amount will apply if the fair market value of the decedent's interet has declined between the date of the Sec. 2701 transfer and the date of the subsequent transfer of the interest.

Under certain circumstances, the transferor's spouse is treated as the transferor. The reduction is otherwise not assignable or transferable. Because the transferor will often acquire an applicable retained interest initially held by an applicable family member and because of the administrative complexity inherent in allowing assignability, a reduction in taxable gifts for applicable family members is not proposed.