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Power to invade principal meant trust fund was includable in estate.

At Walter Kurz's death, his widow, Ethel, was a beneficiary of the Walter Kurz insurance trust. The trust was divided into a marital trust fund and a family trust fund. The trust instrument gave Ethel the following rights during her life with regard to the two trust funds:

* She would receive all the income from both funds.

* She could demand all the principal in the marital trust fund.

* She had the noncumulative right to demand 5% of the principal of the family trust fund during any year, but only if the marital trust fund had been exhausted.

Ethel died in 1986, when the marital fund had assets of $3.5 million and the family fund had $3.4 million. Ethel's executor included the entire value of the marital fund in her gross estate on the estate tax return but did not make any inclusion based on Ethel's right to withdraw 5% of the family fund principal.

The Internal Revenue Service claimed that 5% of the family fund's principal had to be included in Ethel's gross estate because she had a general power of appointment-the power to consume the principal-over 5% of the fund.

Under Internal Revenue Code section 2041(a)(2), property over which the decedent has a general power of appointment usually must be included in the gross estate, even if the power is never exercised. For the property to be includable, the general power must be in existence at the time of death. According to regulations section 20.2041-3(b), if a power of appointment is exercisable only when a specified event occurs and it does not occur during the decedent's life, the power does not arise during the decedent's life and the property to which it is subject is not includable.

The estate argued that under regulations section 20.2041-3(b) the general power was not in existence at Ethel's death because the contingency on which the power to invade principal depended-exhaustion of the marital fund-did not occur. The IRS interpreted the regulation differently. It claimed that since the contingency in this case was in Ethel's control, the power existed at Ethel's death. According to the IRS, the regulation was intended to encompass only contingencies beyond the decedent's control, such as those enumerated in the regulation: reaching a certain age or surviving another person, for example. The estate claimed that the regulation did not require the contingency to be beyond the decedent's control and that the regulation's plain language excluded this power of appointment.

Result: For the IRS. Five percent of the family fund's value must be included in the gross estate. Although the court did not say the required contingency to be beyond a decedent's control, it held t at this general power existed at Ethel's death. The court required the estate to show the stipulation that the family fund's principal could not be invaded until the marital fund had been exhausted had significant nontax consequences. This the estate failed to do. For all practical purposes, Ethel was the owner of 5% of the family fund at her death.
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Publication:Journal of Accountancy
Date:Oct 1, 1993
Words:513
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