Significant recent developments in estate planning.
Powers of Appointment
Developments in the area of powers of appointment included the following.
* An ability to replace a corporate trustee was not a general power of appointment in a pre-Oct. 29, 1979 irrevocable trust.
* A general power of appointment existed in the hands of an incompetent beneficiary/cotrustee since "comfort" was not an ascertainable stan- dard.
* "Care" was deemed an ascertainable standard, thereby resulting in no general power of appointment.
* Power to remove trustees did not result in inclusion under Sec. 2041
In IRS Letter Ruling 911309.6,(46) an irrevocable testamentary trust was established directing that all income be paid at least quarterly to the surviving spouse. On the death of the grantor's spouse, the trust was to be managed for the benefit of their daughter. During the daughter's life, income was payable at the discretion of the trustee based on a standard of care, support, maintenance and welfare. The trust instrument also provided that a majority of the adult, legally competent beneficiaries could remove the trustee at any time and select a successor corporate trustee. The IRS ruled that no portion of the trust was includible in the daughter's gross estate under Sec. 2041(a)(2)]. critique: Sec. 2041(a)(2) provides that a decedent's gross estate will include the value of all property subject to a general power of appointment held at the date of death. A general power of appointment is described in Sec. 2041(b)(1) as a power that is exercisable in favor of the decedent, his estate, his creditors or the creditors of his estate. A power to invade or consume income or principal that is limited by an ascertainable standard relating to health, education, support or maintenance does not fall within the definition of a general power of appointment.
In Rev. Rul. 79-353,(47) the IRS concluded that the beneficiaries of a trust giving broad discretionary powers of invasion to the trustee will be deemed holders of a general power of appointment if they have the unrestricted ability to remove and substitute trustees. The onerous consequences of this ruling were subsequently modified by Rev. Rul. 81-51,(48) in which the IRS said that the provisions of Rev. Rul. 79-353 will not apply to a transfer or an addition to a trust, made before Oct. 29, 1979, if the trust was irrevocable on Oct. 28, 1979.
The IRS addressed two issues. First, was the power of invasion in favor of the daughter a general power within the meaning of Sec. 2041(b)(1).? Second, did Rev. Rul. 79-353 result in inclusion? The trust here provided the trustee with the discretion to distribute income and principal to the daughter based on a standard of care, support, maintenance and welfare. The IRS noted that the terms "care" and "welfare" are broader than those standards enumerated as ascertainable standards in Sec. 2041(b)(1).
However, the testamentary trust was established under the will of the grantor, who died in 1976. Since the trust became irrevocable before the effective date specified in Rev. Rul. 81-51, the IRS stated that it was grandfathered from the application of Rev. Rul. 79-353. Consequently, the unrestricted power to remove one corporate trustee and appoint another would not cause the trust corpus to be includible in the daughter's or the grandchildren's gross estates.
Planning hints: The IRS's position that broad discretionary powers will result in a general power of appointment when trust beneficiaries have an ability to unilaterally remove and substitute corporate trustees continues to be a troubling one. From a practical standpoint, the beneficiaries' ability to remove trustees is often their sole leverage in assuring that adequate or quality service is provided with respect to the trust. It is typically very difficult to establish an objective standard for poor investment performance or insensitivity to the needs of the beneficiary group. Hopefully, this issue will be addressed, and favorably resolved, at the court level. Estate planners should be aware of the IRS's position on this issue, and that Rev. Rul. 81-51 establishes, at least from the IRS's point of view, a firm cutoff and grandfather period with respect to which subsequent trusts will not be protected.
* Incompetent trustee possessed powers causing inclusion under Sec. 2041
In Vissering,(49) the grantor's revocable trust directed that income be payable to her for life and, on her death, payable to her son for life. The instrument also authorized the cotrustees to make distributions of corpus to a class of beneficiaries, including her son, based on a standard of comfort, support, maintenance or education. Her son and a bank were named cotrustees. Finally, the instrument provided that Florida law was to govern the instrument.
The grantor died in 1964 and, in the early 1980s, the decedent/son and his family moved to New Mexico. In 1985, approximately one year before his death, the decedent developed Alzheimer's disease and a finding of incompetency was obtained from a New Mexico court. The Tax Court held that the trust was fully includible in the decedent's gross estate under Sec. 2041.
Critique: Sec. 2041(a)(2) provides that a decedent's gross estate will include the value of any property over which he held a general power of appointment at the time of death. The fact that the decedent holds such a power in a fiduciary capacity as trustee, or that he can exercise it only jointly with another, does not prevent the power from being a general power. There are only two exceptions to this rule. First, a general power of appointment will not exist when the beneficiary can exercise it only jointly with a substantially adverse party, and second, a power to invade or consume based on ascertainable standards of health, maintenance, support and education does not result in a general power of appointment.
With respect to the first exception, the court noted that a co-holder of a discretionary power to distribute trust assets, such as a bank, has no adverse interest merely because of its joint possession of the power. The facts in Vissering did not include any evidence that the bank had a substantial interest in any asset of the family trust. With respect to the second exception, the court noted that the standard of comfort was generally not considered ascertainable within the meaning of Sec. 2041. The court reviewed Florida law in detail and found nothing that would cause the highest court of the state of Florida to hold that "comfort" limits distributions to a standard of health, education, maintenance or support. Therefore, the Tax Court found that the decedent held a general power of appointment.
The final issue addressed was the decedent's incompetency. The Tax Court noted that inclusion under Sec. 2041 is based on the possession of an exercisable general power of appointment. The capacity or incapacity to affect that exercise was irrelevant. As such, includibility rested on whether the decedent remained a cotrustee at the time of death. The Tax Court found that he was a cotrustee at that time. It pointed out that the New Mexico Declaration of Incompetency was not binding on the Florida courts, and that nothing existed in Florida law to indicate that a mere declaration of incompetency resulted in the automatic removal of a trustee. Therefore, since the decedent had not been formally removed as trustee, the value of the trust was includible in his gross estate.
Planning hints: The result in Vissering is unfortunate. The decedent was unable to exercise the power of withdrawal at the time of his death because of the advanced stage of Alzheimer's disease. In light of his medical condition, it should have been relatively simple to petition the Florida courts to remove him as trustee and leave the bank as the sole corporate trustee. This could have achieved exclusion of the trust from his estate, although such action may have been considered a relinquishment of a Sec. 2041 power within three years of death and therefore includible under Sec. 2035(d)(2).
The facts in Vissering once more demonstrate the risks inherent in naming a beneficiary as cotrustee when broad discretionary powers are accorded to the trustees. In addition, as in numerous prior cases reviewed by the authors, the insertion of the word "comfort" in the distribution standards clause has resulted in a tax catastrophe without any perceptible increase in benefits or flexibility granted to the beneficiary class.
* Discretionary distribution subject to standard of "care" not general power of appointment
In IRS Letter Ruling 9148036, (50) the decedent's will established a remainder
trust for the benefit of his four children, two of whom were named as cotrustees. The agreement authorized the cotrustees to pay income for the benefit of the decedent's living children based on a standard of "maintenance, care and support." The IRS ruled that no general power of appointment was created in favor of the cotrustees.
Critique: A general power of appointment will not result when a beneficiary has a power to invade or consume trust property based on an ascertainable standard of health, education, support or maintenance. However, these standards are interpreted quite strictly, and any language having the effect of broadening their application generally results in the imputation of a general power. In this respect, the IRS noted that such words as "comfort," "welfare" or "happiness" are considered to result in a broader standard than is permitted under Sec. 2041. On a review of the instrument, however, the IRS concluded that the word "care" is limiting in nature and wholly consistent with the standards of health, education, support and maintenance. As such, no general power of appointment was held to exist in the children-cotrustees.
Planning hints: The result in this ruling was a happy one for the taxpayers. Notwithstanding, the deviation of the trust language from the standards expressed in Sec. 9.041(b)(1) caused the estate to ask for a private letter ruling on the consequences of the word "care". This action, and the associated costs, could have been avoided had the word simply not been included in the instrument. The uselessness of the word is amply demonstrated by the fact that the IRS found that it added absolutely nothing to the discretionary powers held by the cotrustees.
The taxpayer in IRS Letter Ruling [TAM) 9125002,(51) however, was not so fortunate. The surviving spouse, as cotrustee, was given a discretionary power to invade corpus based on a standard of health, support and reasonable comfort. As in prior instances, the IRS found that the phrase "reasonable comfort" expressed a standard that was broader than that contemplated in Sec. 2041 and that inclusion of the trust within the gross estate was required.
On the other hand, IRS Letter Ruling 9203047(52) involved a power of distribution pursuant to a standard of "maintenance, support and comfort, in order to defray expenses incurred by reason of sickness, accident and disability .... "That language was deemed not to result in a general power of appointment. The IRS noted that while the term "comfort" typically results in a broader standard than one allowed under Sec. 2041, the language of the instrument expressly limited the term in its application to matters related to health. As such, it fell within the ascertainable standards enumerated in Sec. 2041(b)(1).
Miscellaneous Estate Tax Matters
Various miscellaneous developments included the following.
* A durable power of attorney was not sufficient to authorize gifts and resulted in estate inclusion of the transferred property.
* Simultaneous death language caused an additional tax liability.
* Illegal drugs were subject to estate tax and no deduction was allowed for their confiscation.
* Directly and indirectly held undivided interests were aggregated to eliminate valuation discounts.
* Prior transfer tax credit was available for unelected portion of a QTIP at the beneficiary's death.
* A late filing penalty was not abated despite an errant accountant.
* Multiple rental real estate activities qualified for estate tax deferral.
* An estate tax lien did not transfer to property received in exchange for the burdened property.
* Estate taxes were not apportioned to property passing to a surviving spouse under tenancy by the entireties.
* Gifts made under durable power includible in gross estate
In Casey,(53) during the 1960s, the decedent's husband made a series of gifts to their children. The decedent joined in these conveyances to release her dower interests. In 1973, the decedent executed a durable power of attorney and named her son as attorney-in-fact. After her husband's death, the decedent's son, acting under the durable power, made substantial gifts of her assets to himself and other family members.
The durable power authorized the son to "lease, sell, grant, convey, assign, transfer, mortgage and set over to any person, firm or corporation and for such consideration as he may deem advantageous, any and all of my property .... "The Fourth Circuit, reversing the Tax Court, held that the gifts were includible in the decedent's gross estate.
Critique: The sole issue in Casey was whether the son was authorized to make irrevocable and binding gifts of his mother's property to himself and other family members. Citing Morgan,(54) the court acknowledged that local law controlled in defining a power of attorney's scope. As no direct precedent existed in local (Virginia) law, the court was required to speculate as to how the highest court in the jurisdiction would rule with respect to the powers enumerated in the instrument.(55)
The court noted that some jurisdictions impose a flat rule that denies a durable power holder the authority to make gifts of property in the absence of express language to the contrary. A compelling rationale exists for this rule, since the unrestricted power to make gifts provides temptations for serf-dealing that run contrary to the best interests of the power issuer. Virginia, however, did not expressly include such a flat rule in its statute.
Virginia law did indicate, however, a predisposition in the highest court to strictly interpret such instruments in terms of their express language, taking into consideration any extrinsic evidence as to underlying intent. The Fourth Circuit stated that a durable power typically focuses on four principal purposes for asset transfer--sale, lease, mortgage and gift. The decedent's power dealt expressly with the first three of these purposes, but was conspicuously silent with respect to the fourth. Further, the power directed the attorney-in-fact to receive such consideration as was derived from any transaction and see to its reinvestment. This language was deemed to further reinforce the position that the document did not contemplate an authorization to make gifts.
The estate noted that the decedent had joined her husband in making gifts under an established estate plan. It asserted that the attorney-in-fact's actions were consistent with this plan and that the durable power should be interpreted as authorizing the son to continue it.
The Fourth Circuit disagreed. The prior gifts were made exclusively from the husband's assets and while the husband was alive. No actual diminution occurred with respect to the decedent's individual estate. The decedent's anticipated well-being was not in peril in light of her husband's continuing earning capacity. The court stated that a substantial change in circumstances had occurred because of the husband's death and a gift of the decedent's individual assets placed her in a substantially different economic position than was previously the case.
Planning hints: It is hard to find fault with the Fourth Circuit's opinion. Casey reinforces the need to 'state expressly in a durable power of attorney all powers that are intended to be granted. Of singular importance is the power to make gifts. Casey, as well as other decisions in the area,(56) demonstrate that the Federal courts strictly limit the authority of an agent to the letter of his instructions. The courts are reluctant to infer an authorization to make gifts when either the local statute or the instrument is silent about the inclusion of such a power in the general terms of the instrument.
* Simultaneous death language causes inclusion in estate of surviving spouse
In Acord,(57) the decedent's spouse's will bequeathed the majority of his estate to the decedent. However, his will provided that if "my... wife ... dies before I do, at the same time that I do, or under such circumstances as to make it doubtful who died first," the marital bequest would pass to their children equally. The decedent and her husband died as a result of an automobile accident, but she survived her husband by 38 hours.
Arizona law requires a devisee to survive the testator by at least 120 hours unless the will includes "some language dealing explicitly with simultaneous deaths or deaths in a common disaster, or requiring that the devisee survive the testator or survive the testator for a stated period in order to take under the will." The Ninth Circuit held that the bequest passed to the decedent under her husband's will and must be included in her gross estate.
Critique: The estate claimed that the language of the will should not override the Arizona statute. In the estate's view, if the statute applied to this will, no will designating alternative beneficiaries in the event a primary beneficiary predeceased the testator could ever come within the purview of the Arizona statute.
The court disagreed and interpreted the Arizona statute simply to expand the definition of the word "predecease" in the absence of specific language in the will suggesting a different definition. Thus, a will that simply designates alternative beneficiaries who are to take if the primary beneficiary predeceases will trigger the 120-hour requirement. In the present case, the testamentary language concerning simultaneous death rendered the Arizona statute inapplicable.
Planning hints: Simultaneous death clauses frequently are not carefully considered in drafting and reviewing wills. However, they can dramatically affect the economic sharing of estate assets by either overriding passage of such assets to a spouse (or other beneficiary) or allowing them to pass to such beneficiary, to flow under that beneficiary's will.
In Acord, the alternative beneficiaries of the two spouses' wills were identical, so the decision of the court did not alter the ultimate beneficiaries. However, there was an adverse estate tax impact. Although a marital deduction was allowed for the husband's estate, the decedent apparently was in a higher estate tax bracket than would have applied if the assets had passed directly to the alternative beneficiaries from her husband.
Although careful consideration of the simultaneous death provision would have forestalled this litigation, the estate had an alternative to remedy the situation. The decedent's estate could have executed a disclaimer of any rights under the husband's will.
* Confiscated illegal drugs includible in gross estate
In IRS Letter Ruling (TAM) 9207004,(58) the decedent had been suspected of smuggling drugs for several years and had been arrested on several occasions for activities involving airplanes and airplane equipment used in drug smuggling. In 1987, he engaged two accomplices to meet him at a landing site to unload smuggled marijuana. The decedent lost control of his plane and died in a crash landing. The plane contained 459 pounds of marijuana. The IRS ruled that the fair market value of the marijuana was includible in his gross estate under Sec. 2033 and that no deduction is allowed under Sees. 2053 or 2054 for the subsequent confiscation by law enforcement authorities.
Critique: Sec. 2033 provides that a decedent's gross estate will include the value of all property to the extent of any interest held at death. This has been interpreted by the Supreme Court in Safe Deposit & Trust Co. of Baltimore(59) as intending that "the realities of taxpayer's economic interest... should determine the power to tax." Safe Deposit & Trust Co, has been further interpreted as imposing taxability on a decedent when he possessed the economic equivalence of ownership through the possession and control of property such as could allow him to transmit it to himself or his heirs.
The facts in this ruling demonstrate that the decedent considered the marijuana as his own and he had engaged his accomplices solely for the purpose of unloading the cargo. These facts demonstrated that the accomplices had no underlying economic interest in the marijuana and that control over its sale or disposition rested solely with the decedent.(60)
Although the IRS apparently found no judicial authority directly on point, it disallowed any Sec. 2053 or 2054 deduction by analogy to various cases disallowing income tax deductions for confiscation of contraband property.(61) These cases concluded that income tax deductions would frustrate defined public policy against drug trafficking.
* Two undivided interests aggregated in gross estate
In IRS Letter Ruling (TAM) 9140002,(62) at the time of his death, the decedent possessed a 37 1/2% undivided interest in real property that was held in a qualified terminable interest property (QTIP) testamentary trust (created by his wife) and a 62 1/2% fee interest in the same property. The estate argued that each interest should be valued separately and accorded a minority interest discount. The IRS concluded that the two interests should be aggregated in the gross estate and valued as a majority interest.
Critique: Sec. 2031 defines the gross estate as including the value of all property to the extent provided by Sees. 2033 through 2045. Sec. 2044(a) requires the inclusion of property that has been the subject of a QTIP election in a predeceasing spouse's estate tax return. The effect of that section is to cause QTIP property to be treated as passing from the decedent for Federal estate tax purposes.
The IRS cited Rev. Rul. 79-7(63) as establishing the principle that when two separate interests in the same property are includible in the gross estate under different Code sections, they are aggregated as a single interest for valuation purposes. In that ruling, an individual originally owned 60% of the voting stock of a corporation. Within three years of death, he transferred a 30% interest to his child. Therefore, his gross estate included two separate minority blocks of stock: 30% owned outright and the 30% interest that had been transferred within three years of death and brought back under the provisions of Sec. 2035 in effect at that time. The IRS ruled that the two blocks should be treated as a single block of shares for valuation purposes.
Therefore, the IRS said that the undivided 37 1/2% interest in the QTIP trust and the 62 1/2% interest held in fee should be aggregated as a single interest in real estate and valued as such for Federal estate tax purposes. No minority interest discount was allowed.
* Prior transfer tax allowed when partial QTIP election was made
In IRS Letter Ruling (TAM) 9145004,(64) the decedent's spouse's will created a marital trust funded with the amount of property "for which a marital deduction is allowable... [and] shall cause there to be the smallest possible (or no) Federal estate tax payable by my estate taking into account all available credits .... "Under the will, the executors had no authority to reduce the marital deduction amount, but the instrument contained no requirement that the executor elect to take a marital deduction under the QTIP provisions. A residual second trust provided for discretionary income distributions to the decedent and a daughter.
The executor made only a partial QTIP election, thereby creating a taxable estate. The IRS ruled that a prior transfer tax credit was available on the decedent's subsequent death for that portion of the marital trust with respect to which no election was in force.
Critique: Sec. 2013(a) provides an estate tax credit in an amount equal to the Federal estate taxes attributable to a property interest that is both included in the decedent's gross estate and which had been subject to Federal estate tax in a prior estate. The credit is phased out over a 10year interval depending on the length of time between the deaths.
The credit relates to a beneficial interest. Regs. Sec. 20.2013-1(a) indicates there is no requirement that the transferred property be specifically identified in the estate of the present decedent. It is sufficient that the property was subject to Federal estate tax in the estate of the transferor and the transferee died within the prescribed period of time.
Rev. Rul. 67-53(65) stated that no credit will be available when a net income interest is subject to the absolute uncontrolled discretion of the trustee to pay or accumulate income. Therefore, the residual trust in the instant ruling would not qualify for the Sec. 2013(a) credit.
The language of the decedent's will required that a marital trust be established in an amount equal to the maximum marital deduction available, after taking into account various credits and deductions. While this language is apparently very inflexible in tone, the will did not require the executor to make a QTIP election with respect to all property assigned to the marital trust. The absence of this mandate caused the IRS to conclude that the executor did have authorization to make a partial QTIP election. The partial election resulted in the creation of a taxable estate and the payment of Federal estate taxes. Since the surviving spouse had a nondiscretionary net income interest in both portions of the marital trust, the IRS concluded that a prior transfer tax credit was available for the nonelected portion.
Planning hints: The prior transfer tax credit tends to be a trap for the inexperienced or uninitiated estate tax planner. Since a previously taxed income interest qualifies for the credit, and no regulatory requirement exists for a specific tracing of the twice included property, it is not unusual for this credit to be missed when preparing the Federal estate tax return. The amount of credit, subject to certain percentage limitations, is equal to the lower of the Federal estate taxes paid on the interest by the transferor's estate or the Federal estate taxes attributable to the inclusion of the interest in the decedent's estate. In either instance, the amount of credit may be substantial and a failure to claim it can result in a surcharge to the executor and potential liability to the estate tax return preparer.
* Reliance on tax adviser did not result in waiver of late filing penalty
In Russo,(66) the decedent died on July 14, 1982, and his Federal estate tax return was due Apr. 14, 1983. The decedent's two sons were named coexecutors and they engaged the family accountant to prepare the Federal estate tax return. While the attorney for the estate had on three separate occasions prodded the accountant in writing to complete the return, the Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, was not filed until Oct. 15, 1985. The Tax Court concluded that a late filing penalty under Sec. 6651(a)(1) was appropriately assessed by the IRS.
Critique: Sec. 6651(a)(1) provides for a penalty of 5% of the tax required to be shown on the return per month, not to exceed 25%, for the failure to file a Federal estate tax return on a timely basis. This penalty may be waived only on a showing that the failure to file is due to reasonable cause and not due to willful neglect. In Boyle,(67) the Supreme Court held that a failure to make a timely filing of a tax return is not excused by the taxpayer's reliance on an agent, and such reliance is not "reasonable cause" for a late filing under the section.
In light of Boyle, the Tax Court asserted that the decedent's children, as coexecutors, were obligated to familiarize themselves with the basic duties and obligations of that office. The filing of a Federal estate tax return is one of the primary obligations of an executor. Detailed tax knowledge is not needed to ascertain the filing date of the Federal estate tax return, which is clearly reflected in statutes and in the instructions to Form 706. As such, the coexecutors could easily have identified the filing date of the estate tax return and the consequences of a failure to file on a timely basis.
Planning hints: The holding in Russo is one more instance in which a layman has assumed the responsibilities of an executor without fully appreciating the potential consequences of his actions or inaction. The Supreme Court, in its interpretation of Sec. 6651(a)(1), has effectively eliminated many arguments that could be presented as "reasonable cause" for an untimely filing of the Form 706. This position is not unreasonable, as the executors, their attorney or the estate preparer could easily have obtained an extension of time to file. Inexperienced individuals should always think twice before accepting fiduciary or executor responsibility, particularly when an experienced individual or corporation is not also named as cofiduciary.
* Real estate business activities of decedent constitute trade or business under Sec. 6166
In IRS Letter Ruling 9128024,(68) at the time of his death, the decedent owned directly and indirectly 12 real estate properties. Three of these properties were apartment buildings owned in fee. The fourth was a one-third interest in an apartment building, in which the remaining interest was owned by his sons. The remaining apartment buildings were owned by four corporations wholly owned by the decedent and a partnership of which the decedent was a 25% general partner, and his three sons owned the remaining 75%. The decedent personally attended to the day-to-day operations and management of the properties and did not engage an outside manager. Among the duties performed by the decedent were the following.
* Screening prospective tenants.
* Negotiating leases.
* Collecting rents.
* Preparing apartments for new tenants.
* Maintaining all common areas.
* Installing and repairing household fixtures.
* Maintaining water, heating and sewer systems.
* General structural maintenance.
* Paying bills and maintaining financial records.
* Maintaining good tenant relations.
The IRS concluded that all of the properties constituted a trade or business within the meaning of Sec. 6166 and that the installment payment of Federal estate taxes was appropriate.
Critique: Sec. 6166 allows for the installment payment of Federal estate taxes with respect to certain closely held business interests. In order to qualify for installment treatment, the closely held interest must be a proprietorship, corporation or partnership that is actively engaged in a trade or business.
The IRS cited Rev. Ruls. 75-365(69) and 75-367 (70) which denied Sec. 6166 treatment to rental property when the decedent maintained a fully equipped business office, colected rental payments, received payments on notes receivable, negotiated leases and directed the maintenance of his properties by contract. In both instances, the IRS stated that the activities of the decedent were more analogous to the management of an income-producing investment asset than to the conduct of an active trade or business. It also noted that Sec. 6166 was intended to apply only with respect to a business such as a manufacturing, mercantile or service enterprise.
After enumerating the reasons why rental properties do not typically fall within the ambit of Sec. 6166, the IRS addressed the facts in Letter Ruling 9128024. Here the decedent was engaged in a broad range of day-to-day activities that far transcended those associated with the management of investment assets. The IRS concluded that all of the rental units, in their various forms of ownership, represented a single enterprise that constituted an active trade or business within the meaning of Sec. 6166.
Planning hints: The IRS has typically viewed rental properties as investment assets, rather than active trades or businesses, for purposes of See. 6166. The favorable determination in this ruling appears to hinge exclusively on the level of detailed activities performed by the decedent with respect to the rental enterprise. Had these activities been contracted to a professional rental property management firm, and the decedent limited his involvement.to negotiating leases, paying mortgages, collecting rents and other higher level functions, it appears clear that Sec. 6166 treatment would have been denied.
From a practical standpoint, however, this ruling has limited application. It is questionable whether many real estate entrepreneurs would be willing to have the bulk of their day consumed with such a wide array of relatively mundane responsibilities simply to preserve a Sec. 6166 installment opportunity. Many would feel far more comfortable, as well as more productive, if their actions could be devoted toward more strategic investment decisions than were engaged in by the decedent.
* Estate tax lien on partnership interest not transferred to assets
In Beaty,(71) a widow received from her husband's estate a 16.7% interest in a real estate partnership. On her death, her estate exchanged her partnership interest for various parcels of land previously held by the partnership, which were then distributed. Several years after the husband's estate tax return was filed, a deficiency assessment for estate taxes was issued. Pursuant to this assessment, the IRS seized the parcels of land, asserting that they were subject to a lien under Sec. 6324(a)(1). The Sixth Circuit concluded that the lien on the partnership interest did not transfer to property received in return for the partnership interest. Critique: The court noted that Sec. 6324(a)(1) establishes a lien on the gross estate of a decedent for 10 years from the date of death with respect to estate taxes that are not paid or otherwise discharged. This lien differs from the general lien established under Sec. 6321 in that it is valid against bona fide purchasers and attaches to property by operation of law.
The IRS asserted that when the decedent's estate exchanged the encumbered partnership interest for the land held by the partnership, "the lien that had been on the partnership interest (but which was displaced by virtue of the transfer of that interest to the partnership) attached to those three parcels." The court disagreed.
The court recognized the holding in Phelps,(72) which found that when a tax lien is displaced by a transfer, a lien on the proceeds of the transfer results. However, the Phelps decision was based on the general tax lien under Sec. 6321, under which a transfer of encumbered property to a good faith purchaser results in the expiration of the lien. Estate tax liens, however, are stronger in their application than the general tax lien. The exchange of partnership assets for a partnership interest in no way results in the displacement of the preexisting Sec. 6324 lien against the partnership interest. Since no displacement occurred, the Government continued to have a lien against the partnership interest and the parcels transferred to the taxpayer were received free of any lien.
* Estate taxes may not be apportioned to Virginia tenancies by the entirety In Reno,(73) at his death, the decedent left a probate estate of approximately $650,000 in the state of Kentucky and a personal residence and various checking accounts held with his wife in tenancy by the entirety in Virginia. In his will, the decedent directed that Federal estate taxes be charged against the residue of his estate and, if insufficient, against nonprobate assets. His expressed intent was to shield his Kentucky real estate from any apportionment of estate taxes, since he wished to leave it intact to his children.
The IRS asserted that the Federal estate tax return incorrectly failed to reduce the marital deduction on the Virginia properties by its fair share of Federal estate taxes, and the Tax Court agreed. Subsequently, the Fourth Circuit reversed, ruling in favor of the taxpayer.
Critique: The Fourth Circuit acknowledged that the clear language of the decedent's will was intended to shield the Kentucky real estate from a proportionate share of Federal estate taxes. However, the ability of the decedent to successfully achieve this objective rested with Virginia law. The court pointed out that the clear intent of Virginia statutory and judicial law was that a husband may not obligate entireties property, or subject it to his debts, without the consent of his spouse. As such, a purported sale or mortgage of the property with which the wife does not consent is legally ineffective. Further, on the death of one spouse, fee simple title remains in the other by operation of law. A predeceasing spouse has no power to dispose of such property or otherwise alienate the rights of the surviving tenant.
In light of Virginia law, the Fourth Circuit repudiated the IRS's argument that a testator is permitted to alienate a portion of the value of an entirety through the testamentary allocation of Federal estate taxes. If a testator could achieve this result by will, he would be able to attain a result indirectly that could not be achieved directly through a testamentary disposition.
The court relied on the provisions of Virginia law, which directed that taxes should be apportioned to that part of the estate which generates the taxes. Since the decedent's residue and the Kentucky probate property each generated Federal estate taxes, while the Virginia property qualified for the marital deduction, the court held that the entire amount of Federal estate taxes should be borne by the taxable property and that the marital deduction should be reduced only to the extent that such taxes exceed the full amount of Virginia probate and Kentucky assets.
Developments relating to the marital deduction included the following.
* Funding trusts with nondividend paying, closely held stock failed marital deduction qualification.
* IRS granted relief for delinquent QTIP election.
* Deduction denied when potential partial QTIP election would divert property to nonqualifying trust.
* Installment gain triggered if note used to fund pecuniary marital trust.
* Failed election in estate tax return cost marital deduction.
* Automatic QTIP election applied to installment payments from profit-sharing plan.
* Disclaimers prevented marital trust disqualification.
* Marital trusts funded with nondividend paying, closely held stock failed to qualify for marital deduction In IRS Letter Ruling (TAM) 9147065,(74) the decedent established a general power of appointment marital trust that would be funded, in part, by 95% of a closely held corporation's stock. Under the terms of the trust instrument, the surviving spouse was to receive income for life, payable at least quarterly, and discretionary principal distributions. The will directed that "[u]nproductive property shall not be held as an asset of the Trust for more than a reasonable time during the lifetime of [the surviving spouse] without her written consent."
The will expressly authorized the decedent's son to manage the corporation, vote the company stock in the trust, and determine the price or any other conditions concerning any sale of these shares. The trustee was expressly prohibited from exercising these responsibilities during the son's life. Finally, the will contained a provision granting the deeedent's sons an option to purchase the shares at a bargain price exercisable within the first 24 months after his death. This option could be exercised either by a cash purchase or the issuance of an installment note.
In IRS Letter Ruling (TAM) 9139001(75) a comparable fact pattern existed, although a QTIP marital deduction was intended. The managing son was authorized to vote the corporate stock so long as ,he remained active in the day-to-day management of the company. The trustee was prohibited from selling the stock except that if the son stopped actively managing the corporation, he had an option to purchase the stock at book value.
In each ruling, the IRS concluded that no marital deduction was available to the extent of the value of the closely held stock distributed to the marital trust. critique: In Letter Ruling 9147065, the availability of the marital deduction rested on whether the marital trust qualified as a general power of appointment trust since the surviving spouse had the power to appoint trust assets to her estate or herself. In Letter Ruling 9139001, the surviving spouse's interest was limited to a life estate, and marital deduction availability rested on whether QTIP status was possible. In both instances, the principal issue was whether the surviving spouse possessed the requisite income interest for life and whether such interest could be impaired or reduced in favor of a third party during the remaining life of the surviving spouse.
Regs. Sec. 20.2056(b)-5(f)(1) states that a surviving spouse is regarded as "entitled for life to all of the income" from the trust property only if she has that degree of beneficial enjoyment of the property that is accorded a person who is unqualifiably designated as a life beneficiary. In effect, the income interest to the surviving spouse should be commensurate with the value of the corpus and with its preservation.
Regs. Sec. 20.2056(b)-5(f)(4) expressly provides that a trustee's power to retain nonproductive trust assets will not disqualify the spouse's life income interest if local law or the trust instrument allows the surviving spouse to require the trustee to convert unproductive property into productive property within a reasonable period of time. The regulations also state that a surviving spouse's income interest will be disqualified if the primary purpose of the trust is to safeguard nonproductive property, without giving the surviving spouse an opportunity to require its conversion into productive property.
In both rulings, the IRS found that the requisite income interest did not exist. In Letter Ruling 9147065, the IRS stated that the son's exclusive ability to vote the shares held in trust, coupled with his absolute power with respect to the sale or other disposition of corporate stock, acted to deprive the surviving spouse of that degree of beneficial enjoyment required under the regulations. Further, the language in the will providing the surviving spouse with the power to force the trustee to convert the shares into productive property was deemed a nullity, since the son, rather than the trustee, had absolute authority over the sale and dividend payment policy of the shares. In Letter Ruling 9139001, the requisite level of beneficial enjoyment was found not to exist because the trust instrument expressly stated that the shares could not be sold without the son's prior consent.
The IRS in both instances stated that the closely held shares were nonproductive property within the meaning of the regulations, as no dividends had been paid over extended periods of time. However, regardless of whether dividends had been paid, either before or after death, the IRS found that its decision with respect to the shares would not change. The decision either to pay dividends or accumulate income rested solely with the son, who had sole voting power over the shares. Therefore, the IRS found that control over the dividend-paying policy of the corporation was located exclusively outside of the trust.
The options contained in the wills to purchase at a bargain price were deemed an additional disqualifying factor. In both rulings, the son could exercise his purchase option and obtain shares at a price significantly less than fair market value. The IRS equated these options with a power of appointment or withdrawal in favor of the son, exercisable during the life of the surviving spouse. In Letter Ruling 9139001, such a power of withdrawal was a statutorily disqualifying event since, for QTIP purposes, no power of appointment could exist that was exercisable in favor of a third party during the life of the surviving spouse. In Letter Ruling 9147065, this power of withdrawal was viewed as a mechanism by which a substantial impairment or reduction of the marital trust estate could be achieved through the arbitrary exercise of a third party. In each case, the amount of assets initially allocated to the marital trust could be significantly reduced in favor of a third party.
Planning hints: These rulings achieve results that are consistent with the statutory objectives of the marital deduction--a tax deferral, rather than avoidance. This can be achieved only if assets accorded a marital deduction are includible in the surviving spouse's estate. The options, in particular, could result in a significant difference between the amount of the Federal estate tax deduction claimed and the amount of assets remaining in the marital trust at the time of the spouse's death.
The voting control accorded the son in these trusts also frustrated the statutory scheme which requires that the surviving spouse have an income interest for life in both QTIP and general power of appointment marital trusts. The regulations are clear that a meaningful and enforceable power must exist in the surviving spouse to force the trustee to convert nonproductive property to productive property. In both instances, the trustee was effectively denied any ability to achieve such a conversion.
Whenever closely held shares are used to fund a marital deduction, estate planners should be careful to meet the technical requirements of Sec. 2056 and the regulations. Certainly a requirement of consent from a third party, other than the trustee, or an absolute veto power, with respect to sale should be avoided. Consideration should be given to the use of an estate trust if there is a desire to prevent the surviving spouse from exercising a power to compel the trustee to sell marital trust assets. In addition, an option that could result in a bargain price will be fatal to the availability of the marital deduction.
* Extension of QTIP election granted InIRS Letter Ruling (TAM) 9204002,(76) the decedent died on Sept. 19, 1987. Her will provided for a marital trust. The terms of the trust qualified for QTIP status and a Federal estate tax return was filed claiming a marital deduction on Schedule M. While the ruling is unclear as to the specific facts, it appears that either no QTIP election or an imperfect election was made under Sec. 2056(b)(7). The IRS granted an extension of time to file the election under Temp. Regs. Sec. 301.9100-1T.(77) Critique: Providing the other Sec. 2056(b)(7) requirements are met, Sec. 2056(b)(7)(B)(v) requires that a formal election of QTIP status be made on the Federal estate tax return. This election must be reflected on a timely filed Federal estate tax return, with extensions.
Temp. Regs. Sec. 301.9100-IT(a) allows an extension of time for the making of elections under all subtitles of the Code, except subtitles E, G, H and I. QTIP elections fall within the ambit of this regulation. The requirements for such an extension are that (1) the time for making the election is not expressly prescribed by statute, (2) the request for extension is filed with the IRS within a period of time the IRS considers reasonable under the circumstances, and 131 it is shown to the IRS's satisfaction that granting the extension will not jeopardize the interest of the Government. Further, the regulation provides a transitional rule with respect to elections required to be made before Apr. 5, 1991, which covers the instant case. In such circumstances, an extension will be granted provided the period of limitations has not expired under the estate and gift tax chapters and the taxpayer demonstrates clear evidence of an intent to make the specific election at the time it was required to be made. There must also be a showing of good cause with respect to the failure to make the election at its original due date.
Based on a review of the facts and circumstances, the IRS granted an extension of time to file the election until the date on which an amended Schedule M was filed. Planning hints: Regs. Sec. 301.9100-1 now provides a relief mechanism for taxpayers who previously flied Federal estate tax returns intending to achieve QTIP status, but failed to make the appropriate election. This relief can result in substantial benefit to taxpayers who had otherwise thought that significant inadvertent taxes were payable because of a mistake or omission of a tax return preparer. Tax planners having estates that have been filed with problem QTIP elections should ascertain whether relief can be achieved under the above regulation and, where appropriate, take such action as is necessary.
* Potential partial QTIP election disqualified marital deduction
In Clayton,(78) the decedent's will provided that the residue of his estate be allocated between two trusts: the first funded with an amount equal to the unified transfer tax credit equivalent and the second a QTIP marital deduction trust. In the first trust, corpus was to be held for the benefit of the surviving spouse during the remainder of her life and she possessed a lifetime power of appointment to distribute assets to their children. The marital trust complied in all respects with the statutory requirements for a QTIP.
The will also stated that if the executor made a partial QTIP election with respect to the marital trust, the nonelective portion was to be distributed and held by the credit equivalent trust. The instrument contained a section indicating the decedent's intent to qualify the marital trust for the marital deduction and that in no event would the trustees have any authority or power which would disqualify QTIP treatment. The Tax Court held that the marital trust did not qualify as a QTIP and that no marital deduction was available.
Critique: Sec. 2056(b)(7)(B) defines a QTIP as property that passes from the decedent, in which the surviving spouse has a qualifying income interest for life and with respect to which a QTIP election has been made. A qualifying income interest for life is described as one in which the surviving spouse is entitled to all of the income from the property, payable annually or at more frequent intervals, and in which no person has a power to appoint any part of the property to any person other than the surviving spouse.
The court stated that the credit equivalent trust clearly failed to meet the statutory requirements of a QTIP insolaf as the surviving spouse possessed a lifetime power to appoint trust assets to her children. As such, any of the decedent's estate that passed to, or could pass to, the credit equivalent trust would not qualify for QTIP status.
The decedent's will expressly stated that any assets initially allocable to the marital trust, but not subject to the QTIP election, would be allocated to the credit equivalent trust. Since the QTIP election lay solely within the executor's authority, the surviving spouse's interest in any assets allocable to the marital trust was subject to a preexisting power of divestiture based on the actions taken by the executor within the first nine months after the date of death. Accordingly, the surviving spouse's income interest was not determinable as of the date of death since the property allocable to the marital trust was contingent on the scope of the QTIP election.
The Tax Court determined that amounts passing to the marital trust resulted from the executor's actions, rather than passing from the decedent's estate. Since the passing requirement contained in Sec. 2056(b)(7) was not met, the marital deduction failed in its entirety.
A similarly disastrous result occurred in Ellingson.(79) In Ellingson, more than $8 million of estate property was allocable to a marital trust, which expressly stated that net income would be paid to the surviving spouse in at least annual installments. However, if the income so payable at any time or times "exceed[s] the amount which the Trustee deems to be necessary for his or her needs, best interests and welfare, the Trustee may accumulate the same .... "The Tax Court cited the regulation indicating that a qualifying income interest must be provided for the surviving spouse in order for QTIP status to arise. The court noted that language in the instrument expressing the strong desire of the decedent that a marital deduction be available did not act to save or mitigate the unfavorable implications of the dispositive language of the instrument. The powers over income distribution accorded to the trustee were clear, unambiguous and contrary to the requirements of the statute.
The court stated that the surviving spouse's status as cotrustee in no way salvaged the situation as she must always act in concert with a cotrustee and, under the instrument, could never act in a capacity as sole trustee. It is uncertain whether the court would have arrived at a favorable conclusion had the surviving spouse actually been named as sole trustee.
Planning hints: The results in Clayton and Ellingson should never have occurred. In Clayton, a partial or nonelection of QTIP status by the executor would have caused potential marital deduction assets to be allocated to a clearly nonqualifying trust. The IRS has previously indicated, in private letter rulings and technical advice memoranda, that such a dispositive scheme results in loss of the marital deduction. In this instance, the property passing to the marital trust is deemed to derive from the subsequent actions of the executor, rather than to pass directly from the decedent's estate. If it was truly the decedent's objective to obtain a full marital deduction, only poor draftsmanship added an option that was both unintended and resulted in a tax disaster.
The drafting in Ellingson is even more troubling. The clear language of the marital deduction statute indicates that QTIP status rests on providing the surviving spouse with a qualifying income interest. Further, the statute defines clearly what a qualifying income interest is, and one of its elements is a right to trust income payable in at least annual installments. Neither the Code nor the regulations contemplate a power of accumulation in the trustee. The attempt to salvage the deduction by arguing general intent of the decedent and the potential powers of the surviving spouse as cotrustee was futile from the start. In Ellingson, a marital deduction of over $8 million was lost through poor draftsmanship.
* Installment obligation allocated to QTIP or general power o~ appointment trust qualified for marital deduction
In IRS Letter Ruling 919,3036,(80) the decedent left an estate that included an installment obligation arising from the sale of property. Under his will, three separate trusts were established. The first was a family trust that was defined as an amount equal to that portion of his estate that would absorb any unified transfer tax credits available at the time of his death. The balance of his estate was to be allocated among two marital trusts: an amount equal to $1 million and conforming to the requirements of a QTIP (i.e., intending that a reverse QTIP election be made with respect to this trust to absorb the decedent's generation-skipping tax exemption) and the residue distributable to a general power of appointment marital trust.
The will also contained language that authorized the executor to distribute outright the installment obligation to the surviving spouse should its disposition to any of the trusts result in unfavorable income tax consequences. This dispositive option was available to the executor only after the family trust had been fully funded. The IRS concluded that a distribution of the installment obligation would qualify for the marital deduction and that an acceleration of income would occur if it was either distributed to the family trust or to the reverse QTIP election trust.
Critique: The two marital trusts outlined in the instrument were qualifying trusts within the meaning of Sec. 2056. An installment obligation is an asset which, by its nature, is productive of income and meets the requisite requirements of the statute. An election by the executor to distribute the obligation outright to the surviving spouse, rather than to either trust, would also qualify for the marital deduction. As such, the dispositive scheme outlined in the instrument was deemed to result in a valid marital deduction, as long as the executor's option arose only after the family trust had been funded. The IRS did not elaborate as to why this caveat was important to qualification for the deduction.
The IRS then addressed whether income acceleration would occur with respect to a distribution of the note to any of the various potential recipients. The installment obligation resulted in a deferral of income resulting from the sale of property under Sec. 453. Since a portion of that deferral was not reportable in the decedent's final income tax return, and as the obligation represented an estate asset, its income taxability was governed by Sec. 691(a).
Sec. 691(a) provides for the recognition of income to the recipient of the obligation as cash payments are received. Generally, a disposition of a Sec. 691 asset to a devisee or legatee of a decedent will not result in an acceleration of income recognition, but such recipient will stand in the same shoes as the estate. This general rule does not apply, however, when a Sec. 691 asset is distributed by an estate in satisfaction of a right to receive a distribution of a specific dollar amount or of specific property other than that distributed.
Both the family trust and the reverse QTIP trust were expressed in terms of pecuniary amounts that could be satisfied either in cash or in kind. As such, the distribution of the installment obligation to either would constitute a taxable disposition and result in the acceleration of deferred income. However, the outright distribution of the obligation, as authorized under the instrument, or its distribution to the marital trust (which was expressed as a residuary bequest), would not constitute a satisfaction of a bequest expressed in terms of a specific dollar amount. Neither of these latter two distributions would result in an acceleration of Sec. 691 income.
* Failure of election resulted in loss of QTIP
In IRS Letter Ruling (TAM) 9117007,(81) the decedent's will provided that his residuary estate be conveyed into a trust for the benefit of his surviving spouse. The terms of this trust required that net income be distributed to the surviving spouse, at least annually, for the remainder of her life. On her death, the remainder was to be distributed to their children. A subsequent article of the will indicated that the decedent intended that the marital deduction apply with respect to the spousal gift to the extent "permitted by law and to the extent of my executor's election."
On the Federal estate tax return, a box on Schedule M indicating an intention to elect QTIP was not checked and the marital bequest was listed on the wrong part of the schedule. Further, the description of the bequest on Schedule M failed to make any mention that a QTIP election was intended. The IRS ruled that no marital deduction was available to the estate.
Critique: The instructions for Form 706, Schedule M, indicate that to make a QTIP election, the executor must check the box on Line 2 of Schedule M and complete Part 2 of that schedule.
The executor failed to check the box as required in the instructions and listed the property on Part 1 of Schedule M, which expressly refers to property not qualifying for QTIP status. In describing the marital bequest, the language in Part 1 of Schedule M made no mention that the trust was qualified terminable interest property, nor was there an expression of any intent to make an election under Sec. 2056(b)(7).
The estate argued that a marital deduction should be allowed under Sec. 2056(b)(7)even though the executor did not strictly comply with the requirements outlined in the instructions. It further asserted that the executor should be considered to have substantially complied with these requirements so as to qualify the trust property for the marital deduction. In particular, the taxpayer referred to Article 8 of the will, which indicated that a marital deduction was intended to the extent "of my executor's election." The IRS strongly disagreed.
Citing Higgins,(82) the IRS noted that the essence of the election requirement is that the executor unequivocally communicate his election and his implicit agreement to accept the burdens as well as the benefits of the tax treatment afforded by the section. "The section does not permit the taxpayer to wait and later compare the benefits with the burdens." The choice must be unequivocal and reflected on the Federal estate tax return of the first spouse to die. The policy of the section "is furthered by requiring a clear manifestation to the government of taxpayer's election." Any other rule "would leave room for the taxpayer to argue later that it had never intended to make an election." Based on the requirement of a clear manifestation of intent to make the election, the IRS concluded that no deduction was available.
Planning hints: This represents another instance in which an uninformed preparer, or executor, failed to make an election that was clearly required under the Code. The marital bequest language clearly would not have qualified for the marital deduction had not Sec. 2056(b)(7) been passed in 1981. The requirements for a QTIP marital deduction are clearly enumerated in the statute and in the instructions to Form 706.
* Installment payments from profit-sharing plan paid to surviving spouse from trust qualified for QTIP
In IRS Letter Ruling 9204017(83) the decedent was a beneficiary under his employer's qualified profitsharing plan. Under the plan, the decedent made an election to defer benefits under Section 2242(h) of the Tax Equity and Fiscal Responsibility Act of 19 8 9,. Therefore, any benefits payable after the taxpayer's death to the taxpayer's beneficiary would be paid in monthly installments over 15 years.
The decedent's revocable trust provided for the creation, on his death, of a marital trust. Under the terms of this trust, income was to be payable to the surviving spouse for the duration of her life, with the remainder passing to their children. The trust instrument also provided that, if the trust was designated as a beneficiary of a qualified retirement plan, the trustee must distribute any installment payment or other periodic payment received from such plan to or for the benefit of the surviving spouse, regardless of whether such payment was allocated to income or corpus under state law or the instrument. The marital trust was designated as the beneficiary under the decedent's profit-sharing plan. The IRS ruled that the profitsharing annuity qualified for the automatic QTIP election specified in Sec. 2056(b)(7)(C). critique: The effect of naming the marital trust as the qualified profit-sharing plan beneficiary was to entitle the surviving spouse to all installment payments during her life. Any payments remaining to be paid after her death were allocated to corpus and, ultimately, accrued to the benefit of the decedent's children.
Sec. 2056(b)(7)(C) provides for an automatic QTIP election in the limited case of an annuity included in the gross estate of the decedent under Sec. 2039 if the surviving spouse has the sole right to receive payments before the death of such spouse.
The IRS concluded that the automatic election applied. The installment annuity under the decedent's qualified profit-sharing plan was includible in his goss estate under Sec. 2039(a). Further, under the trust instrument, the trust was merely a conduit with respect to such installment payments for the term of the surviving spouse's life. It could only collect the payments received from the profitsharing plan administrator and immediately thereafter redistribute them to the surviving spouse in total. The instrument expressly stated that no trust expenses, including trustees' fees, could be allocated against the profit-sharing plan installment payments.
The effect of the trust instrument was to make the trust a collection agent, on behalf of the surviving spouse, with respect to profit-sharing plan proceeds during her life. The fact that payments received after the surviving spouse's death were allocated to the corpus of the trust, and accrued to the benefit of the decedent's children, was found not inconsistent with the intent of the statute.
Planning hints: It should be noted that the automatic QTIP election accorded the profit-sharing plan proceeds did not extend to any other assets held in the marital trust. As such, in order to achieve a marital deduction for the remainder of the marital trust, the executor was required to make a general QTIP election under Sec. 2056(b)(7).
* Disclaimer of lifetime interest by children saved marital deduction
In IRS Letter Ruling 9148018,(84) the decedent left his residuary estate to a trust which provided that the net income "shall be paid to or used and expended for the benefit of my [spouse] at convenient intervals for and during her lifetime." There was also a provision for discretionary distributions of principal to children based on an ascertainable standard of support, maintenance and education. On the death of the surviving spouse, the remaining principal was payable to the decedent's living children.
After the decedent's death, the estate's personal representative petitioned the probate court to issue an order indicating that income, under the terms of the instrument, should be distributed no less frequently than annually. The order was granted. In addition, the decedent's children concurrently filed a disclaimer of any interest in the income or principal of the residuary estate during the remaining life of the surviving spouse. The IRS held that a valid QTIP election could be made and that the marital deduction was available.
Critique: The IRS indicated that two issues had to be addressed before a marital deduction could be considered. First, the residuary trust language was ambiguous concerning the timing of distributions to the surviving spouse. The trust instrument merely indicated that net income should be paid at "convenient intervals" for and during her lifetime. The IRS ignored the ruling of the probate court that "convenient intervals" was equivalent to at least annually. Citing Bosch,(85) the IRS stated that it was bound by the opinion of the highest court of the jurisdiction in which the trust was administered. A search of Supreme Court decisions of the local jurisdiction indicated that the issue had not been adjudicated. As such, based on a review of common law,(86) the IRS determined that the highest court of the local jurisdiction would have held that the trust language would have required distributions of income at least annually.
Second, the children had an impermissible interest in the marital trust. Should the children properly disclaim their interest in principal distributions during the surviving spouse's life, the IRS found that such action would preserve the marital deduction. This conclusion was based on Regs. Sec. 25.2518-3(a), which recognizes that beneficiaries can disclaim one interest in a trust, without disclaiming other separate interests. Therefore, the children could disclaim a contingent right to principal distributions during the surviving spouse's life, while preserving their right to principal distributions on her death. The IRS ruled that the beneficiaries under the trust could make qualified disclaimers, resulting in a perfecting of the surviving spouse's QTIP interest.
(46) IRS Letter Ruling 9113026 (12/31/90).
(47) Rev. Rul. 79-353, 1979-2 CB 325.
(48) Rev. Rul. 81-15, 1981-1 CB 458.
(49) Est. of Norman H. Vissering, 96 TC 749 (1991).
(50) IRS Letter Ruling 9148036 (8/29/91).
(51) IRS Letter Ruling (TAM) 9125002 (no date given).
(52) IRS Letter Ruling 9203047 (10/23/91).
(53) Est. of Olive D. Casey, 4th Cir., 1991 I68 AFTR2d 91-6060, 91-2 USTC [paragraph]60,091), rev'g TC Memo 1989-511.
(54) Earl Morgan, 309 US 78 (19401(23 AFTR 1046, 40-1 USTC [paragraph] 210).
(55) Est. of Herman J. Bosch, 387 US 4.56 (1967)(19 AFTR2d 1891, 67-2 USTC [paragraph] 12,472)..
(56) See Eitel v. Schmidlapp, 459 F2d 609 (4th Cir, 1972).
(57) Est. of Jean Acord, 946 F2d 1473 (9th Cir. 1991) (68 AFTR2d 91-6071, 91-2 USTC [paragraph] 0,090L
(58) 1RS Letter Ruling (TAM)9207004 (10/21/91).
(59) Safe Deposit & Trust Co. of Baltimore, 316 US 56 (1942)128 AFTR 1256, 42-1 USTC [paragraph] 10,167).
(60) See Sidney A. Erickson, TC Memo 1989-552, all'd, 937 F2d 1548 (10th Cir. 1991)168 AFTR2d 91-5262, 91-2 USTC [paragraph 50,349).
(61) James E. Smith, TC Memo 1990-384, aff'd by court order, 940 F2d 653 (4th Cir. 1991); Glen D. Wood, 863 F2d 417 (5th Cir. 1989)(63 AFTR2d 89-709, 89-1 USTC [paragraph] 143); Filippo Gambina, 91 TC 826(1988); Bill D. Holt, 69 TC 75(1977); James W. Bailey, TC Memo 1989-674, aff'd by court order, 929 F2d 700 (6th Cir. 1991).
(62) IRS Letter Ruling (TAM)9140002 (6/18/91).
(63) Rev. Rul. 79-7, 1979-1 CB 294.
(64) IRS Letter Ruling (TAM) 9145004 (7/12/91).
(65) Rev. Rul. 67-53, 1967-1 CB 265.
(66) Est. of Anthony G. Russo, TC Memo 1991-310,
(67) Robert W. Boyle, 469 US 241 (1985J(55 AFTR2d 85-1535, 85-1 USTC [paragraph] 3,602).
(68) IRS Letter Ruling 9128024 (no date given).
(69) Rev. Rul. 75-365, 1975-2 CB 471.
(70) Rev. Rul. 75-367, 1975-2 CB 472.
(71) Amanda York Beaty, 937 F2d 288 (6th Cir. 1991)(68 AFTR2d 91-6002, 91-2 USTC [paragraph 0,077).
(72)Craig Phelps, 421 US 330 (1975)(35 AFTR2d 75-1505, 75-1 USTC [paragraph] 467L
(73) Est. of William L. Reno, Jr., 945 F2d 733 (4th Cir. 1991)(68 AFTR2d 91-6035, 91-2 USTC [paragraph] 60,083), rev'g 916 F2d 955 (4th Cir. 1990)(66 AFTR2d 90-6018, 90-2 USTC [paragraph] 60,046), aff'g TC Memo 1986-163.
(74) IRS Letter Ruling (TAM) 9147065 (7/12/91).
(75) IRS Letter Ruling (TAM) 9139001 14/30/91).
(76) IRS Letter Ruling (TAM)9204002 (9/4/91). See also IRS Letter Ruling 9203030 (10/22/91), in which comparable relief was provided when the Form 706 originally filed failed to make a QTIP election and failed to submit a schedule for the marital bequest property transferred by the decedent to the marital trust. In this latter ruling, the estate provided written contemporaneous evidence of its original intent to make a QTIP election.
(77) A final version of this regulation, substantially the same as the temporary regulation, was adopted by TD 8378 (12/12/91).
(78) Est. of Arthur M. Clayton, Jr., 97 TC 327 (1991).
(79) Est. of George D. Ellingson, 96 TC 760 (1991), rev'd, 9th Cir., 1992 [69 AFTP2d [paragraph] 149,058, 92-1 USTC [paragraph] 60,101)
(80) IRS Letter Ruling 9123036 (3/12/91).
(81) IRS Letter Ruling (TAM) 9117007 (1/11/91).
(82) Est. of John T. T. Higgins, 91 TC 61 (1988), aft'd, 897 F2d 856 16th Cir. 1990)(65 AFTR2d 90-1231, 90-1 USTC [paragraph] 60,011).
(83) 831RS Letter Ruling 9204017 (10/25/91).
(84) IRS Letter Ruling 9148018 (8/26/91).
(85) Est. of Bosch, note 55.
(86) Scott, The Laws of Trust 2 Scott Trust, 4th ed. 1987, at 184. See also IRS Letter Ruling 9148021 (8/26/91).
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|Title Annotation:||part 2|
|Author:||Nager, Ross W.|
|Publication:||The Tax Adviser|
|Date:||Nov 1, 1992|
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