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Significant recent developments in estate planning.

Once again, we have prepared our annual review of significant recent court decisions and IRS rulings. The results, contained in this issue and the December issue, concern estate planning developments from Apr. 1, 1994 to Mar. 31, 1995. The article begins with "Headlines," which represent the year's most important or controversial developments; the discussion of other developments is then organized by topic. The summaries of developments will be supplemented by editorial comments.

As a general note of caution, the estate planner should determine the current status of a reported development, particularly if the IRS has appealed or otherwise indicated that it will not follow a court decision. In such cases, the estate planner should emphasize to clients that the recommended plan, although supported by a court decision, may lead to litigation in which the IRS may prevail.

Part I, below, will discuss the following topics: gifts, disclaimers, debts, claims and administration expenses, powers of appointment, retained interests, and S corporation issues. In general, no developments occurring after Mar. 31, 1995 are included, unless a case or ruling issued thereafter affected a development covered in this article.

Headlines

The estate and gift tax issues that have attracted the most controversy and attention over the past year include:

* High-payout charitable remainder unitrusts (CRUTs) attacked by the IRS.

* Trust's payment of grantor's income tax on undistributed grantor trust income may constitute a taxable gift.

* Uncertainty created concerning powers of substitution.

* "Swing vote" premium valuation argument launched by the IRS.

* Family partnerships escaped anti-abuse regulations.

* High-payout CRUTs attacked

In July 1994, the IRS issued Notice 94-78,(1) challenging the use of high-payout CRUTs.(2) In the IRS's view, some taxpayers have used CRUTs to convert appreciated assets into cash, while substantially avoiding capital gains tax. The example in the notice assumes that capital assets having a $1 million value and a zero basis are contributed to a trust on january 1, the assets generate no income and a two-year CRUT payment is set at 80% of the annually redetermined fair market value of the trust's assets. Although the year 1 required CRUT payment is $800,000, no actual distributions are made until shortly after year-end, when the assets are sold for $1 million; $800,000 is distributed in year 2 before April 15. The year 2 unitrust amount, $160,000 (0.80 ($1,000,000 - $800,000)) is paid by year-end and the trust terminates, distributing $40,000 to a charitable organization.

Proponents of this technique characterize the year 1 $800,000 CRUT payment as a tax-free corpus distribution under Sec. 664(b)(4), because no income was earned nor assets sold or distributed to the donor during year 1. The year 2 $160,000 CRUT payment is characterized as capital gain, because the property is sold in that year. After capital gains tax of $44,800 ($160,000 x 28%), the donor has a total of $915,200 (($800,000 + $160,000) - $44,800). Had the donor sold the assets directly, there would have been $280,000 of capital gains tax and only $720,000 remaining.

Some commentators believe that the technical arguments in favor of the desired treatment are beyond challenge (i.e., that the transaction and related consequences flow from a literal reading of Sec. 664(b) and Regs. Sec. 1.664-1(d)(4)). Although CRUTs have been permitted for decades, and Sec. 664(d)(2)(a) specifies a 5% minimum payout, the IRS has not previously specified a maximum payout.

Nevertheless, in Notice 94-78, the IRS expressed an intent to challenge the transaction using one or more legal doctrines, depending on the particular facts of each case. Possible challenges include (1) recharacterizing the form of the transaction as a sale by the grantor, due to possible prearrangement by the grantor and trustee,(3) (2) applying the assignment of income doctrine to include the gain in the donor's gross income,(4) (3) challenging the trust's exempt status under Regs. Sec. 1.664-1(a)(4) by asserting that such status was sought solely for the donor's benefit, so that the trust did not operate exclusively as a CRUT from the date of creation and (4) imposing self-dealing and other penalties.

Because Form 5227, Split-interest Trust Information Return, explicitly requires disclosure of the CRUT's payout percentage, it should be easy for the IRS to identify high-payout CRUTs for examination. Due to the substantial tax savings potential when using CRUTs, the authors expect the IRS to challenge such CRUTs vigorously. Taxpayers contemplating using the technique should be prepared for an extended contest and should recognize the potential for a deficiency, interest and sizable penalties if the IRS can convince the courts that high-payout CRUTs are too good to be true.

* Payment of tax on grantor's income may be taxable gift

In Letter Ruling 9444033,(5) the IRS concluded that the grantor of a grantor retained annuity trust (GRAT) was the owner of both principal and income for income tax purposes under Sec. 677(a). The governing instrument required the trust to reimburse the grantor for any income tax liability incurred with respect to trust income received by the trust but not distributed to the grantor. In the ruling, the IRS stated, "[u]nder this provision, a grantor will not make an additional gift to a remainderperson in situations in which a grantor is treated as the owner of a trust under [Sec.] 671 through [Sec.] 679, and the income of the trust exceeds the amount required to satisfy the annuity payable to the grantor .... If there were no reimbursement provision, an additional gift to a remainderperson would occur when the grantor paid tax of [sic] any income that would otherwise be payable from the corpus of the trust."

Although equivalent language may be found in other rulings,(6) the IRS does not cite any authority for its position. It seems bizarre that a taxable gift will occur when an individual pays a tax liability imposed by statute, particularly when nonpayment can lead to civil, and possibly criminal, penalties. Apparently, the IRS now refuses to issue GRAT qualification rulings absent a reimbursement provision. The only apparent rationale for refusing GRAT recognition is obstinacy, since neither Sec. 2702 nor the regulations thereunder require reimbursement. Fortunately, for those who wish to comply, the IRS has ruled that the reimbursement right is not a retained interest resulting in estate inclusion under Sec. 2036(a).(7) Finally, the stakes can grow still higher--imputed gifts can be constructive additions for generation-skipping tax purposes.

* Power of substitution

Taxpayers often require certainty that a trust (e.g., a qualified personal residence trust or qualified subchapter S trust (QSST)) will be treated as a wholly grantor trust under Sec. 671. Until recently, the IRS issued letter rulings that unilaterally concluded, based on the document's language, that a Sec. 675(4) power of substitution of trust property held in a nonfiduciary capacity resulted in wholly grantor status.(8) The IRS has now tightened its ruling policy. In Letter Ruling 9352004,(9) the IRS ruled that the mere existence of such a power in a trust document was insufficient to allow the usual "wholly grantor" conclusion. Rather, grantor trust status could be confirmed only by field examination, which would determine, based on the facts and circumstances, whether the power actually was held in a nonfiduciary capacity. Of course, no indication was provided as to the type of facts that might outweigh the document's clear language. The IRS subsequently ruled on this issue without the field examination proviso.10 However, more recently, the IRS refused to rule on the subject, stating only that the matter is under extensive study.(11)

Regs. Sec. 1.675-1(b)(4)(iii) states that if a power is exercisable by a person as trustee, it is presumed that the power is held in a fiduciary capacity; if a power is not exercisable by a trustee, the determination of whether the power is exercisable in a fiduciary or nonfiduciary capacity is based on the trust terms and the circumstances surrounding trust creation and administration. Therefore, although the IRS has the right to hedge in this manner, it has created uncertainty where none previously existed.

* IRS "swings both ways" on minority stock discounts

It seems like only yesterday that the IRS curtailed its decade-long effort to limit minority interest discounts (MIDs) on intrafamily gifts of stock interests, with the issuance of Rev. Rul. 93-12.(12) In Letter Ruling (TAM) 9449001,(13) the National Office rebuffed an agent's attempt to disallow MIDs when a donor simultaneously gave approximately 9% of a corporation's stock to each of his 11 children. The most interesting part of the ruling is the IRS's analysis of the difference between gift and estate tax valuation. In Rev. Rul. 93-12 and various cases,(14) for gift tax purposes, the stock held by various family members was not aggregated when simultaneous gifts were made; instead, each transferred block was valued separately. Neither the percentage owned by the donor nor the family relationship of the donees was a factor in determining whether a MID was appropriate. However, for estate tax purposes, stock held by a taxpayer at death was valued as a single block even though it might be bequeathed in minority pieces to various legatees.(15)

In Letter Ruling (TAM) 9432001,(16) the IRS concluded that a MID was appropriate for an estate's 48.6% block, even though the decedent's son, who was to receive that block, already owned the remaining 51.4%.

However, the IRS has again focused attention on the "swing vote" premium, which represents a retreat from its position in Rev. Rul. 93-12. In Letter Ruling 9436005,(17) a donor who owned 100% of a corporation's stock transferred 30% to each of his three children. Citing Est. of Winkler,(18) the IRS concluded that, although a MID was appropriate, a premium should be applied in valuing each gift, because the owner of any block could join with the owner of any other block to control the corporation.

If the donor had transferred each 30% block at a different time, the IRS conceded that the first transferred block would have no swing vote premium, because the donor's remaining 70% would control the corporation. However, the second 30% transfer would possess swing vote value and cause an increase in value of the first transferred block, because each would then have swing vote potential. Apparently, the second gift creates an indirect, but taxable, transfer to the first donee. Finally, the IRS stated that the transfer of the final 30% would also have swing vote value, so the total gift value would be the same whether or not the transfers were made simultaneously.

It is unclear whether the IRS will pursue this philosophy; if so, it will be interesting to see how far the courts will go to impute possible strategic alliances into the thought processes of a "hypothetical" buyer. Consistent with its unsuccessful "family unity" rationale, the IRS seems to ignore the fact that there can be a swing vote only if there is harmony between the holder of the swing vote and one or more of the other owners. In addition, a swing vote is meaningless if the other shareholders are all in agreement. Either way, a swing vote buyer risks "striking out."

* Family partnerships avoid partnership anti-abuse rules

Two examples included in the final partnership anti-abuse regulations,(19) Regs. Sec. 1.701-2(b), could have severely affected the use of family limited partnerships for estate planning purposes. The IRS withdrew the examples in Ann. 95-8,(20) which involved new limited partnerships in which the husband (H) was the general partner and the wife (W) the limited partner. They contributed their interests in actively managed rental property (in Example 5) and a vacation home (in Example 6). At a later date, W made a gift of a portion of her limited partnership interest to the couple's two children. With respect to the gift tax valuation discounts, in the first example, a discount was permitted, absent other facts (e.g., the creation of the partnership immediately before the gifts by W). The second example did not qualify for a discount because the partnership was not bona fide and there was no substantial business purpose for the partnership's purported activities.

After significant negative reaction from various commentators, the examples were quickly withdrawn and the regulations amended to provide that they apply solely with respect to income taxes, and not to gift and estate taxes.

Although the IRS and Treasury backed away from using income tax regulations to attack gift tax discounts, we are afraid that they have not given up the battle. The good news is that the examples at least demonstrated that partnership interest discounts exist, subject to an oblique reference to Secs. 2701-2704. The appropriateness of the discounts was challenged only when the partnership was funded with an inherently personal asset or there was simultaneity of entity formation and transfer. These arguments may still be made, through a substance-over-form assertion. However, most commentators believe that, unlike with abusive situations for income tax purposes, the IRS cannot ignore a legally existing partnership for transfer tax valuation purposes. There is no justification for requiring a legitimately formed partnership to be "seasoned" prior to transferring a partnership interest. The donee receives a partnership interest, rather than outright ownership of the underlying assets.

Gift Tax Matters

Developments in gift taxation included the following:

* Gifts arose on the taxpayer's failure to act.

* Taxpayer failed to perfect intended gifts.

* Cross-exercise of powers of appointment resulted in gifts.

* Relation-back doctrine applied to gift checks cashed after year-end.

* Gifts pursuant to a durable power of attorney were excludible.

* Gifts resulted from failure to redeem shares

In Daniels,(21) as a result of a 1982 corporate freeze transaction, a parent owned noncumulative voting preferred stock and his children owned common stock. The corporation never declared or paid any dividends; the IRS asserted that the parent had made a taxable gift of the forgone dividends by failing to exercise his voting control to force payment. The Tax Court found that the corporation had valid needs to accumulate capital for business expansion and for other reasons. As it had noted previously in Hutchens Non-Marital Trust,(22) directors have a fiduciary responsibility to represent the interests of all shareholders and have the discretion not to declare dividends.

However, the IRS remains committed to pursuing the gift tax issue when a taxpayer's failure to act benefits family members. In Letter Ruling (TAM) 9420001,(23) the voting power of common stock gave a parent the ability to redeem her four children's nonvoting preferred stock at par value. If the preferred was not redeemed, the children could convert it to double the amount of common stock, which was worth considerably more. The children converted their stock. The IRS analyzed the corporation's cash position and concluded that there was sufficient cash to make a redemption. Citing Snyder,(24) it concluded that the taxpayer's failure to protect her economic interests by redeeming the children's stock prior to the conversion resulted in a taxable gift of the excess of the value of the common stock over the preferred's redemption price.

* Failure to perfect gifts resulted in estate inclusion

Failure to properly consummate a gift transfer can result in unintended tax consequences. In Autin,(25) the taxpayer purportedly transferred closely held S corporation stock to his; son through the use of a "counter letter" renouncing his ownership interest and stating that he acquired the stock on account of his son. However, virtually no other record was made of the transfer and the taxpayer continued to hold himself out to the corporation's customers as the owner, of the shares; further, he voted the shares and reported the related S income on his returns. No gift tax return was ever filed. Over a decade later, the taxpayer caused the corporation to reissue the shares to the child. The IRS successfully asserted that the gift occurred on the reissuance, because at that point, the taxpayer gave up dominion and control. Presumably, the gift tax burden at reissuance was far greater than at the initially attempted transfer, due to growth in corporate value.

Similarly, in DuBois,(26) the Tax Court included stock in a decedent's estate notwithstanding representations of previous transfers to the decedent's children. Although corporate income tax filings were consistent with the alleged ownership change, the stock certificates were never transferred and gift tax returns were never filed.

* Gifts stemmed from cross-exercise of identical powers of appointment

In Letter Ruling 9451049,(27) a will created two trusts, one for each of the decedent's daughters. Each daughter was named a trustee of her own trust, along with a co-trustee. Distributions were permitted for the daughters' health, support and maintenance, in accordance with their respective standards of living. Each daughter, as co-trustee, had an inter vivos limited power to appoint the trust income and corpus to any descendant and a testamentary power to appoint corpus to any living descendant. A state court ruled that each daughter had the inter vivos power to appoint to the other daughter. The IRS ruled that the inter vivos exercise of the power over trust principal resulted in a taxable gift. Citing Grace,(28) the IRS noted that such transfers could be considered reciprocal in "appropriate circumstances." However, the IRS did not view these facts to indicate reciprocity, nor did it elaborate on facts that would so indicate.

* Gifts completed despite post-year-end bank clearance

In Metzger,(29) the taxpayer signed a power of attorney to his son, who issued checks from his father's account in late 1985 that were deposited by the donees on Dec. 31, 1985. The checks cleared the donor's bank on Jan. 2, 1986. The donor made additional gifts in 1986, then died. Applicable state law treated a check as a completed transfer only on acceptance by the drawee bank. However, the Fourth Circuit affirmed the Tax Court's application of the relation-back doctrine. For Federal gift tax purposes, once the checks were honored by the drawee bank, the gifts related back to the date they were deposited. Consequently, the decedent was allowed annual gift tax exclusions for those gifts in 1985, and in 1986 for the subsequent gifts.

The Fourth Circuit viewed the relation-back doctrine as appropriately applied in this case, because the donor's intent to make a gift was clear, delivery was unconditional and the checks were deposited in the year given. McCarthy(30) and Gagliardi(31) were distinguished, because, in those cases, the checks were not deposited until after the decedent's death. Moreover, unlike the taxpayers in Dillingham,(32) the donees in Metzger timely deposited their checks, thereby avoiding any question whether they were delivered unconditionally to the donees. The courts appear to be drawing very fine lines in these situations. Taxpayers would be well advised to give donees sufficient time prior to year-end to deposit checks and for the checks to clear the donor's bank.

* Durable power of attorney interpreted to permit gifts

We continue to report on disputes concerning whether gifts made pursuant to durable powers of attorney are valid and result in exclusion from decedents' estates.(33) In Ridenour,(34) the power of attorney did not expressly authorize gifts. However, Virginia law was changed retroactively to infer such authorization based on the decedent's history of gift giving. Drafters of powers of attorney should not leave this issue open to dispute. If the principal wishes to permit the attorney-in-fact to make annual exclusion gifts, the document should explicitly so authorize.

Disclaimers

Developments relating to disclaimers included the following:

* Court's grant of extension for disclaimer ruled valid.

* Tenancy by the entirety interest had to be disclaimed within nine months of creation of interest, not at first tenant's death.

* Disclaimer of residuary bequest resulted in disclaimant's inheritance under intestacy law.

* Formula disclaimers permitted.

* State court extension permitted late disclaimer

In Letter Ruling 9436041,(35) a trust was created in 1950. The beneficiaries received income distributions from the trust from 1987 on, but did not learn of their trust interests until 1993 and reached the age of majority in 1994. For pre-1977 transfers, Regs. Sec. 25.2511-1(c)(2) permits a disclaimer within a reasonable period after learning of a transfer. Applicable state law required disclaimers within nine months of attaining age 18, but authorized extensions. The IRS ruled that, if a state court granted an extension to make the proposed disclaimers, the disclaimers would be valid for Federal gift tax purposes.

* Tenancy by entirety disclaimer period determined

In Letter Ruling (TAM) 9427003,(36) years ago, a married couple purchased property as tenants by the entirety and other property as joint tenants with right of survivorship. The decedent's spouse died in August 1990 and the decedent died in January 1991. Within nine months of the spouse's death, the decedent's personal representative filed written disclaimers of the interests passing by operation of law to the decedent. The IRS concluded that the joint tenancy disclaimers were timely, a ruling consistent with the decisions of several circuits,(37) which state that the nine-month disclaimer period begins with the date of a joint tenant's death. The rationale is that, during life, the joint tenancy can be severed unilaterally by either tenant, thereby making the survivorship rights uncertain. However, on the first tenant's death, the survivor's rights become vested, thereby starting the nine-month period.

As to the tenancy by the entirety property, under Maryland law, there can be no unilateral severance of tenancy. Absent divorce or agreement by the spouses, each spouse's survivorship right is vested. Therefore, the nine-month disclaimer period began at the date the interest was created. Thus, a disclaimer made within nine months of the spouse's death was invalid.

* Intestacy rights foiled disclaimer

In Letter Ruling (TAM) 9417002,(38) the decedent's daughter disclaimed her residuary bequest, believing that the disclaimed property would then pass to her children. Under Mississippi law, because the will did not provide for an alternate disposition in the event of a disclaimer, the property would pass by intestate succession. Because the disclaimer failed to explicitly renounce interests that might pass by intestacy, the property came back to the daughter. Thus, the subsequent distribution of the property to her children was a taxable gift.

Fortunately, many states' laws specifically provide for disclaimed property to pass as if the disclaimant had predeceased the decedent. Care must be taken to avoid possible boomerang effects under local law, as well as under testamentary terms. In cases of doubt, the disclaimer should explicitly cover any rights that might surface as a result of its execution.

* Formula disclaimers maximized marital deduction

Among other things, disclaimers can maximize the availability of the marital deduction or increase use of the unified credit when the testamentary document fails to do so. When there are uncertainties as to the amount desired to be covered by a disclaimer, taxpayers may disclaim by formula. The IRS continues to rule favorably on such formula disclaimers.(39)

Debts, Claims and Administrative Expenses

Current developments relating to debts, claims and administrative expenses included:

* Municipal inheritance taxes were not deductible.

* Facts determine deductibility of interest on estate tax-related borrowing.

* No deduction for municipal taxes

Sec. 2011 provides a credit for state inheritance taxes that does not apply to municipal inheritance taxes. Letter Ruling (TAM) 9422002(40) concludes that such municipal taxes likewise do not qualify for deduction under Sec. 2053(a).

* Deductibility of interest on funds borrowed for estate taxes

Letter Ruling 9449011(41) concerned an estate consisting of listed securities, cash and land. The executor secured a 20-year bank loan and the proceeds were used to pay estate taxes, administrative expenses and cash distributions to beneficiaries. The estate contended that the loan was necessary to avoid selling the securities and land at depressed prices.

The IRS concluded that the interest was deductible under Sec. 2053(a)(2), provided the District Director determined that, based on the facts, it was necessary to borrow to avoid a forced sale of assets.(42) Because interest would continue to be paid after the statutory refund period expired, the estate had to file a Form 843, Claim for Refund and Request for Abatement, a protective refund claim, before the expiration of the statute of limitations. In each succeeding year in which interest payments would be made, the estate had to file Form 843 for the interest payments made. The IRS also concluded that the interest would be personal interest and, unlike interest on taxes deferred under Sec. 6166, was not deductible on the estate's income tax returns.

Powers of Appointment and Retained Interests

Developments relating to powers of appointment and retained interests included:

* Surviving spouse's power to mortgage family trust assets resulted in estate inclusion.

* Stock distributed from marital trust and then gifted was not includible in estate.

* Battle continues over gifts from revocable trusts.

* Confirmation of insurance policy assignment was not subject to three-year rule.

* Power of substitution did not cause estate inclusion.

* Insurance incidents of ownership determined.

* Sale of remainder interest was really a gift.

* Retained general partnership interest did not cause estate inclusion of transferred limited partnership interest.

* Ability to mortgage property was a general power

In Letter Ruling (TAM) 9431004,(43) a will created a family trust, which presumably was not intended to be included in the surviving spouse's estate. However, the will permitted the trustee to mortgage property should the surviving spouse deem it necessary or essential for any purpose. The IRS concluded that the provision constituted a power to consume or dispose of the property in favor of the spouse, rather than an administrative power exercisable only to preserve and protect the property; thus, the property was includible in the surviving spouse's estate.

* Marital trust assets given to children not subject to power

In Est. of Hartzell,(44) a testamentary marital trust provided the surviving spouse with a testamentary general power of appointment over the property remaining in the trust at her death. During the surviving spouse's lifetime, the trustees had discretion to distribute principal to continue her standard of living. The trustees made substantial principal distributions to her, which she used to make lifetime gifts. The IRS asserted that the trustees improperly distributed the property. Accordingly, the property was recoverable subject to her testamentary power of appointment, and thus, includible in her estate.

The Tax Court noted the surviving spouse's substantial pattern of lifetime giving, both before and after her death. Citing Est. of Council,(45) the court concluded that the trustees did not abuse their discretion in making distributions for gift purposes, since such gifts essentially constituted part of her standard of living.

* Gifts from revocable trusts

Disputes continue over whether gifts from revocable trusts made within three years of death are includible in the decedent's estate under Secs. 2035 and 2038.(46) In Kisling,(47) during life, the decedent exercised a retained right to divide her revocable trust into irrevocable fractional shares for family members; once divided, the shares irrevocably belonged to the donees. The IRS argued that the transaction should be viewed as a relinquishment of a power to modify a previously transferred interest. The Eighth Circuit, reversing the Tax Court, looked through the form of the transaction(48) and treated the division as a withdrawal of property and a subsequent creation of separate shares. Accordingly, the decedent's death within three years of the transaction did not trigger estate inclusion.

In Letter Ruling (TAM) 9413002,(49) the decedent retained a power to direct the trustees to make distributions from a revocable trust. In the event of the decedent's incompetence, the instrument provided that distributions could be made only to the grantor. Upon the decedent's becoming incompetent, a court-appointed guardian directed the trustees to continue to make gifts from the trust to the decedent's relatives. Because in such case the trust permitted distributions solely to the grantor, the IRS followed Jalkut(50) and concluded that gifts made after the decedent became incompetent were not includible in the estate under Secs. 2035 and 2038.

This area remains very confused. Taxpayers continue to be well advised to steer clear of this issue by first withdrawing property from their revocable trusts and then transferring it to donees. Very subtle differences in document language could result in estate inclusion of gifts made directly from revocable trusts within three years of death.

* Confirmation of insurance assignment did not trigger estate inclusion of insurance proceeds

In Letter Ruling 9436036,(51) within three years of his death, the decedent, a company employee, confirmed an earlier assignment of his interest in a group-term life insurance policy to an irrevocable life insurance trust after the merger and acquisition of the insurance company. The IRS concluded that the confirmation was not an issuance or transfer of a new policy and, therefore, the policy proceeds were not includible in the decedent's estate.

* Power of substitution did not trigger estate inclusion

In Letter Ruling 9413045,(52) the decedent created an inter vivos irrevocable life insurance trust. The trust instrument provided the grantor a right in a nonfiduciary capacity to substitute property of equivalent value for the property held by the trust. Citing Jordahl,(53) the IRS concluded that this Sec. 675(4) power did not result in estate inclusion.

* Incidents of ownership

The IRS did not find incidents of ownership in the following situations.

* In Letter Ruling 9421037,(54) an employee's option to buy a corporation's stock on the sole shareholder's death was facilitated by a trust-owned insurance policy on the shareholder's life. By firing the employee, the shareholder could terminate and effectively acquire the employee's interest in the trust. Despite this power, the IRS concluded that the shareholder did not possess incidents of ownership of the policy in the trust.

* In Letter Ruling 9428010,(55) no incidents of ownership existed just because the insured was chief executive officer, chairman of the board, and a less-than-50% shareholder of the corporate trustee of his life insurance trust.

* In Letter Ruling 9434028,(56) no incidents of ownership arose with respect to policies acquired by a trust after the insured resigned as trustee, even though the insured was an income and discretionary corpus beneficiary. The trust had been created by the insured's parent.

* Sale of remainder interest property was includible

In Pittman,(57) prior to the effective date of Sec. 2702, the taxpayers sold remainder interests in property to their daughter. The consideration was determined using IRS actuarial tables. The IRS sought to include the properties' date-of-death values in the taxpayers' estates.

The district court framed the issue as the adequacy of the consideration received by the transferors. The court noted that consideration for Sec. 2036(a) purposes is measured as of the time of the sale. Further, the meaning of "consideration" under that section is not the same as common law contractual consideration. According to the court, the consideration flowing from the transferor is based on what would otherwise have been included in the estate, not on the interest transferred. In other words, it is the value of the entire property that is measured against the consideration received. Such valuation is necessary to establish an equilibrium for estate tax purposes. Thus, each estate had to be increased by the difference between the consideration received for the remainder interest and each property's date of death value.

* Transferred limited partnership interest was not includible

In Letter Ruling 9415007,58 a taxpayer formed a limited partnership. While he retained the general partnership interest and a limited partnership interest, his wife and children received limited partnership interests. As general partner, he had full management control over the partnership. Although he also controlled distributions, his distribution authority required that all partners be treated equally. The IRS concluded that the fiduciary obligations of a general partner mitigated any assertion that the taxpayer retained rights or powers that would result in estate inclusion under Sec. 2036 or 2038.

S Corporation Issues

Developments relating to S corporations included:

* IRS may grant relief for failure to properly file a QSST election.

* QSST elections

The QSST election is to be made by the trust's beneficiary; if made by the trustee, inadvertent termination relief may be available.(59) Beneficiaries who inadvertently fail to timely file QSST elections may also be able to obtain relief from automatic termination of the S election.(60) The IRS may also grant relief when the failure relates to a transfer of stock in common estate situations, such as a testamentary transfer to a marital trust and an unexpected delay in estate administration.(61) Failures must be inadvertent and timely corrected. Further, the shareholders and the S corporation must be consistent in their treatment of corporate income.(62)

Conclusion

The second part of this article, in the December issue, will cover significant cases and rulings on valuation, charitable giving, marital deduction, generation-skipping tax, Chapter 14 and miscellaneous estate and gift matters.

(1) IRS Notice 94-78, 1994-2 CB 555. (2) For a discussion of various uses of CRUTs, see Gianno, "The Charitable Remainder Unitrust," 26 The Tax Adviser 435 (July 1995).

(1) IRS Notice 94-78, 1994-2 CB 555. (2) For a discussion of various uses of CRUTs, see Gianno, "The Charitable Remainder Unitrust," 26 The Tax Adviser 435 (July 1995). (3) Evelyn F. Gregory v. Helvering, 293 US 465 (1935)(14 AFTR 1191, 35-1 USTC [paragraph] 29043). (4) Court Holding Co., 324 US 331 (1945)(33 AFTR 593, 45-1 USTC [paragraph]19215); Arnold Malkan, 54 TC 1305 (1970), acq. 1971-2 CB 3; Est. of Margita Applestein, 80 TC 331 (1983). (5) IRS Letter Ruling 9444033 (8/5/94). (6) IRS Letter Rulings 9345035 (18/13/93), 9415012 (1/13/94), 9352007 (9/28/93), 9352004 (9/24/93) and 9351005 9/16/93). (7) IRS Letter Ruling 9413045 (1/4/94). (8) IRS Letter Rulings 9227023 (4/2/92), 9037011 (6/14/90) and 9247024 (18/24/92). (9) IRS Letter Ruling 9352004, note 6. See also IRS Letter Rulings 9335028 (6/4/93) and 9352007, note 6. (10) IRS Letter Ruling 9345035, note 6. (11) IRS Letter Ruling 9413045, note 7. (12) Rev. Rul. 93-12, 1993-1 CB 202; see Vorsatz and Woodson, "'Swing Vote' Attributes of Transferred Stock," 26 The Tax Adviser 519 (Sept. 1995). (13) IRS Letter Ruling (TAM) 9449001 (3/11/94). (14) Est. of Mary Frances Smith Bright, 658 F2d 999 (5th Cir. 1981) (48 AFTR2d 81-6292, 81-2 USTC [paragraph]13,436); John A. Propstra, 680 F2d 1248 (9th Cir. 1982)(50 AFTR2d 82-6153, 82-2 USTC [paragraph]13,475); Est. of Woodbury G. Andrews, 79 TC 938 (1982); Est. of Elizabeth M. Lee, 69 TC 860 (1978). (15) The Ahmanson Foundation, 674 F2d 761 (9th Cir. 1981)(48 AFTR2d 81-6317, 81-2 USTC [paragraph]13,438); Ithaca Trust Co., 279 US 151 (1929)(7 AFTR 8856, 1 USTC [paragraph]386); Charles M. Land, 303 F2d 170 (5th Cir. 1962)(9 AFTR2d 1955, 62-1 USTC [paragraph]12,078), cert. denied; Est. of Dean A. Chenoweth, 88 TC 1577 (1987). (16) IRS Letter Ruling (TAM) 9432001 (3/28/94). (17) IRS Letter Ruling 9436005 (5/26/94). See also Vorsatz and Woodson, note 12, p. 520. (18) Est. of Clara S. Roeder Winkler, TC Memo 1989-231. (19) TD 8588 (1/29/94), amended by TD 8592 (4/12/95). (20) Ann. 95-8, IRB 1995-7, 56. (21) Joseph M. Daniels, TC Memo 1994-591. (22) Lewis G. Hutchens Non-Marital Trust, TC Memo 1993-600. (23) IRS Letter Ruling (TAM) 9420001 (12/15/93). (24) Elizabeth W. Snyder, 93 TC 529 (1989); see also Rev. Ruls. 89-3, 1989-1 CB 278, and 84-105, 1984-2 CB 197. (25) Claude J. Autin, 102 TC 760 (1994). (26) Est. of Ruth E. DuBois, TC Memo 1994-210. (27) IRS Letter Ruling 9451049 (9/22/94). (28) Est. of Joseph P. Grace, 395 US 316 (1969)(23 AFTR2d 69-1954, 69-1 USTC [paragraph]12,609). (29) John A. Metzger, 38 F3d 118 (4th Cir. 1994)(74 AFTR2d 94-7486, 94-2 USTC 960,1791, aff'g 100 TC 204 (1993). (30) Daniel F. McCarthy, 806 F2d 129 (7th Cir. 1986)(59 AFTR2d 87-1193, 86-2 USTC [paragraph]13,700). (31) Est. of Joseph M. Gagliardi, 89 TC 1207 (1987). (32) Est. of Elizabeth C. Dillingham, 903 F2d 760 (10th Cir. 1990)(65 AFTR2d 90-1237, 90-1 USTC [paragraph]60,021), aff'g 88 TC 1569 (1987). (33) See Abbin, Carlson and Nager, "Significant Recent Developments in Estate Planning (Part II)," 23 The Tax Adviser 728 (Nov. 1992), p. 730; Abbin, Carlson and Nager, "Significant Recent Developments in Estate Planning (Part I)," 25 The Tax Adviser 587 (Oct. 1994), p. 590. (34) Est. of Joseph E. Ridenour, 36 F2d 332 (4th Cir. 1994)(74 AFTR2d 94-7492, 94-2 USTC [paragraph]60,180), aff'g TC Memo 1993-41. (35) IRS Letter Ruling 9436041 (6/13/94). (36) IRS Letter Ruling (TAM) 9427003 (3/30/94). (37) Est. of Josephine O'Meara Dancy, 872 F2d 84 (4th Cir. 1989)(63 AFTR2d 89-1560, 89-1 USTC [paragraph] 13,800); Gladys L. McDonald, 853 F2d 1494 (8th Cir. 1988)(62 AFTR2d 88-5995, 88-2 USTC [paragraph]13,778); Pearl M. Kennedy, 804 F2d 1332 (7th Cir. 1986)(59 AFTR2d 87-1191, 86-2 USTC [paragraph]13,699). (38) IRS Letter Ruling (TAM) 9417002 (6/23/93). (39) IRS Letter Rulings 9435014 (6/2/94), 9440027 (11/27/94) and 9437029 (6/17/94). (40) IRS Letter Ruling (TAM) 9422002 (3/16/94). (41) IRS Letter Ruling 9449011 (9/9/94). (42) See Rev. Rul. 84-75, 1984-1 CB 193. (43) IRS Letter Ruling (TAM) 9431004 (4/26/94). (44) Est. of Miriam H. Hartzell, TC Memo 1994-576. (45) Est. of Betty D. Council, 65 TC 594 (1975). (46) See Abbin, Carlson and Nager, note 33, Oct. 1994 article, p. 603. (47) Erma M. Kisling, 32 F3d 1222 (8th Cir. 1994)(74 AFTR2d 94-7463, 94-2 USTC [paragraph]60,176), rev'g TC Memo 1993-262. (48) See Harry G. McNeely, 16 F3d 303 (8th Cir. 1994)(73 A-FTR2d 94-2339, 94-1 USTC [paragraph]60,155); Est. of Lee D. Jalkut, 96 TC 675 (1991), acq. 1991-2 CB 1; Est. of Eleanor Barton, TC Memo 1993-583. (49) IRS Letter Ruling (TAM) 9413002 (12/9/93); see also Est. of Anthony J. Frank, Sr., TC Memo 1995-132. (50) Jalkut, note 48. (51) IRS Letter Ruling 943603 6 (6/10/94). (52) IRS Letter Ruling 9413045, note 7. (53) Est. of Anders Jordahl, 65 TC 92 (1975), acq. 1977-1 CB 1. (54) IRS Letter Ruling 9421037 (2/28/94). (55) IRS Letter Ruling 9428010 (4/14/94). (56) IRS Letter Ruling 9434028 (5/31/94). (57) Carmen A. Pittman, 878 F Supp 833 (E.D. N.C. 1994)(175 AFTR2d 95-520, 95-1 USTC [paragraph]60,186). (58) IRS Letter Ruling 9415007 (1/12/94). (59) IRS Letter Rulings 9430009 (4/25/94), 9424044 13/31/94) and 9427013 (4/7/94). (60) IRS Letter Ruling 9425039 (3/30/94); see also Rev. Proc. 94-23, 1994-1 CB 609. (61) IRS Letter Ruling 9424014 13/14/94). (62) See Karlinsky and Burton, "S Corporation Current Developments," 26 The Tax Adviser 590 (Oct. 1995), p. 591.
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Title Annotation:part 1
Author:Abbin, Byrle M.
Publication:The Tax Adviser
Date:Nov 1, 1995
Words:6501
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