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IRS acquiesces in Walton.

According to Notice 2003-72, the IRS has decided to follow the Tax Court's holding in Audrey J. Walton, 115 TC 589 (2000), that Regs. Sec. 25.2702-3(e), Example 5, is invalid. (For background, see Whitlock and McNamara. "Significant Recent Developments in Estate Planning (Part II)," TTA, Sept. 2001, p. 618.) Accordingly, on the facts presented in that example, the IRS will treat a retained unitrust interest payable to a taxpayer or his or her estate as a qualified interest payable for a 10-year term.

Overview: Sec. 2702 provides special rules for valuing gifts in trust when the donor or an applicable family member retains a trust interest. If the retained interest is not a "qualified interest," it is valued at zero; the gift is the entire value of the transferred property. If the retained interest is a qualified interest, the interest is valued under Sec. 7520 using the prescribed actuarial tables and interest rates; the gift is the value of the transferred property reduced by the retained interest's value.

Under Sec. 2702(b), a qualified interest is (1) one that consists of a right to receive fixed amounts payable not less frequently than annually (a qualified annuity interest); (2) one that consists of a right--payable at least annually--to receive a fixed percentage of the trust corpus's net fair market value, determined annually (a qualified unitrust interest); and (3) a right to receive a non-contingent remainder interest if all the other interests in the trust are qualified annuity or unitrust interests (a qualified remainder interest). Under Regs. Sec. 25.2702-3(d)(3), the qualified annuity or unitrust interest must be payable "for the life of the term bolder, for a specified term of years, or for the shorter (but not longer) of those periods."

In Regs. Sec. 25.2702-3(e), Example 5, A transfers property to an irrevocable trust, retaining the right to receive a unitrust amount for 10 years. If A dies within the 10-year term, the unitrust amount is to be paid tons estate for the balance of the term. The example concludes that A's interest is a qualified unitrust interest to the extent of the right to receive the unitrust amount for 10 years or until A's prior death. However, the unitrust amount payable to A's estate if A dies within the trust term is not a qualified interest.

In Walton, the grantor established a grantor retained annuity trust, pursuant to which she was to receive an annuity for two years. If the grantor died before the expiration of the two-year term, the annuity was to be paid to her estate for the balance of the term. On expiration of the term, the trust corpus was to be distributed to a designated remainder beneficiary.

After considering Sec. 2702's legislative history and purpose, the Tax Court held that Example 5 is an unreasonable interpretation and invalid extension of Sac. 2702. It concluded that a retained annuity payable for a specified term of years to the grantor (or to the grantor's estate if he or she dies before expiration of the term), is a qualified interest under Sec. 2702 for the specified term of years.

Acquiescence: The IRS acquiesces in the Tax Court's decision. Accordingly, on the facts presented in Regs. Sec. 25.2702-3(e), Example 5, it will treat the retained unitrust interest payable to A or A's estate as a qualified interest payable for a 10-year term. The regulations will be revised to conform to Notice 2003-72.
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Title Annotation:From The IRS
Author:Laffie, Lesli S.
Publication:The Tax Adviser
Date:Dec 1, 2003
Words:580
Previous Article:IRS supplements OIC procedures.
Next Article:Miscellaneous inflation adjustments.


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