Valuation discount for property split between QTIP marital trust and surviving spouse presents planning opportunity.

It has become a generally accepted planning technique to make gifts of partial interests in closely held businesses or other property during life to take advantage of fractional interest discounts; see Mehigan and Potter," Lifetime Giving Remains a Powerful Tool for Family Business Owners," TTA, Feb. 1996, page 97. However, many clients are unwilling to give away control of a major asset during their lifetime. This unwillingness limits the effectiveness of the discounts taken on lifetime gifts, since they may be at least partially offset by a control premium on the majority interest remaining in the taxpayer's estate. Even if a taxpayer is willing to give up control during his lifetime, the potential swing vote premium may also offset the discounts taken; see Letter Ruling (TAM) 9436005.

However, the recent decision in Est. of Bonner, 5th Cir., 1996, offers a unique planning opportunity that may allow the taxpayer to retain voting control of the asset while taking full advantage of minority interest discounts. In this case, the Fifth Circuit refused to combine (for valuation purposes) partial interests held by the decedent outright with those held in a qualified terminable interest property (QTIP) marital trust also included in the decedent's gross estate.

Accordingly, a husband and wife could each retain minority interests in an asset which together are sufficient for control. At the first death, the surviving spouse can retain voting control of the decedent's interest as trustee of a QTIP marital trust. In this way, the spouses can ensure that they will retain control, as well as a potentially larger income stream, until the second death, while obtaining minority interest discounts on the property for estate tax purposes.

This result is obviously very advantageous to the taxpayer. However, several caveats must be noted. Most importantly, the Service does not agree with the results of the Bonner case. In fact, two recent letter rulings have held that a QTIP's fractional interest in property must be aggregated with a fractional interest in the same property held by the decedent outright for valuation purposes (see TAMs 9550002 and 9608001). Further, the effect of control premiums and swing vote premiums must be considered when valuing the two separate interests. Finally, a general power of appointment marital trust should not be used in lieu of a QTIP marital trust; the surviving spouse's inability to control the final disposition of the property was a major reason for the Bonner court's holding that the separate interests should not be combined for valuation purposes. One commentator has suggested that one spouse owning a majority interest in an asset could split the asset at death and give a portion to a QTIP marital trust and the remainder outright to the spouse to achieve the same results. This allocation, however, could create a valuation problem at the first death and generate an unexpected estate tax. This result could occur because the entire asset would be included in the gross estate without the benefit of minority interest discounts, while the outright bequest and the bequest to the QTIP may be valued separately at minority interest values. Therefore, the amount of the marital deduction for the property would be less than the amount included in the gross estate; see Letter Ruling (TAM) 9403005 and Ahmanson Foundation, 764 F2d 761 (9th Cir. 1981). This outcome can be avoided by splitting the interest during the lives of both spouses to ensure that the amount held in the gross estate at the first death is a minority interest.

If the ownership of property is properly split between the spouses during life, the Bonner decision offers taxpayers a potential estate tax savings technique to take advantage of fractional interest discounts with minimal loss of control in the property and minimal risk of adverse tax consequences. This split of control has potentially significant consequences. Certainly, the Court of Appeals' decision rested on the fact that the deceased spouse had real control as to what was placed into the QTIP trust. This spouse could have passed this property to anyone, including those other than the surviving spouse.

Caveat: Practitioners should be certain that their clients know all the potential consequences of any gifts to their spouses, including the consequences if and/or when the marriage goes sour.

From Frank L. Washelesky, CPA, J.D., PFS, Ostrow Reisin Berk & Abrams, Ltd., Chicago, Ill.