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Significant recent developments in estate planning.


* More and more cases are allowing minority interest and LOM discounts on an estate's closely held stock.

* The Service has shifted focus from valuation issues to use of a FLP as a tax-avoidance vehicle that lacks business purpose.

* The Ninth Circuit joined the Third and Fifth Circuits in upholding the exclusion of a remainder interest from an estate.

This article--the second of two parts--examines recent developments in estate and gift taxation. Specifically, this part discusses cases and rulings on, among other items, family limited partnerships, valuation, retained interests, procedural issues (standing, liens and equitable recoupment) and retirement planning.

This two-part article focuses on recent developments in estate, gift and generation-skipping transfer taxes. Part one, in the August issue, focused on current legislative and regulatory developments; this part examines recent cases and rulings on girl and estate taxation.


Family limited partnerships (FLPs) appear to be attracting more attention from the Service, as evidenced by an increased number of rulings. The Service continues to test numerous theories, to persuade practitioners to avoid use of such entities. The Service appears to have shifted focus from valuation issues to use of a FLP as a tax-avoidance vehicle that lacks business purpose.

Gift Tax

Present Interest of FLP Gifts

In Letter Ruling (TAM) 9751003,(15) the Service determined that gifts of limited partnership interests were not present interests under Sec. 2503(b) that qualified for the $10,000 per person annual gift tax exclusion; rather, the general partner's ability to withhold income created a future interest. However, Letter Ruling (TAM) 9944003(16) holds just the opposite, that such a power is a gift of a present interest. This ruling shows the precise circumstances under which a claim of a present interest will prevail.

Educational (Tuition) Exclusion Accelerated

Although taxpayers cannot pre-fund future tuition payments through trusts that would use them for non-educational purposes, Sec. 529 permits pre-funding under qualified state tuition programs. The Service recently permitted a less formal alternative to grandparents seeking to make significant excludible gifts. In Letter Ruling (TAM) 9941013,(17) the Service permitted a grandparent to prepay tuition to a private school (grades kindergarten--12) in which her grandchildren were already enrolled. Under the arrangement, additional tuition would be due if rates increased; if rates decreased or a grandchild ceased attending, the school would keep the excess.

Sale of Remainder Interest

With its decision in Est. of Magnin,(18) the Ninth Circuit joins the Third(19) and Fifth(20) Circuits in upholding the exclusion of a remainder interest from an estate.

Under a written agreement with his father, the decedent had received a life income interest in his father's stock in family corporations and lifetime voting control, in exchange for agreeing to transfer all of his stock to his children. The decedent created three trusts to hold the transferred stock. The value of the income interest and lifetime control in the father's stock was less than the stock the decedent transferred to the trusts. The Tax Court had held that the estate included the value of the trusts, less the value of the life income interest and voting control. Reversing and remanding, the Ninth Circuit held that, to determine whether the decedent received adequate and full consideration from his father, the consideration from the father had to be measured against the actuarial value of the remainder interest in the trusts, rather than the fee-simple value of the property transferred thereto.

Observation: Interfamily transfers of a remainder interest in trust made after the enactment of Sec. 2702 (Oct. 8, 1990) are permitted only for personal residences and to nonapplicable family members (i.e., nephews, nieces, etc.) under Sec. 2702(e) or 2704(c)(2).

Charitable Split-Dollar Insurance

The IRS has targeted split-dollar arrangements between irrevocable life insurance trusts (ILITs) and charities. These agreements have been structured to generate a charitable deduction for a donation to an organization that will independently invest in a life insurance policy on the donor's life. The policy would be held in an ILIT; under the agreement, the charity would ultimately receive all of its premiums back, and the insured family would receive the death benefits in excess of the premiums paid. The IRS will challenge a charitable organization's exempt status, impose excise taxes, assess gift taxes on the premiums paid and subject individual promoters and taxpayers to taxes and penalties.(21)

Rising AFRs

The applicable Federal rates (AFRs) have begun to rise. For example, the June 2000 long-term annual unadjusted AFR was 6.39%; the Sec. 7520 rate rose to 8%, the highest since December 1997.(22) The Sec. 7520 rate rose to 8% (its highest point since December 1997). During the period of lower rates, shareholder loans were refinanced and grantor retained annuity trusts (GRATs) and charitable lead annuity trusts (CLATs) were favored. Over the last 1 1/2 years, rates have steadily increased.

Observation: As rates continue to rise, qualified personal residence trusts (QPRTs) and charitable remainder annuity trusts become favored over GRATs and CLATs. At higher interest rates, it becomes increasingly difficult to find assets with sufficient leverage for a GRAT.

Estate Tax

General Partner's Right to Vote Stock

In Letter Ruling (TAM) 9938005,(23) the IRS National Office applied Sec. 2036(b) and the "anti-Byrum(24) rule" to a FLP. The Service determined that an estate included the value of closely held voting stock the decedent had transferred to a FLP. The decedent "indirectly retained" the power to vote the stock in his capacity as general partner. The anti-Byrum rule is most frequently applied when an individual indirectly retains the power to vote stock in his capacity as a trustee. The fiduciary capacities of a trustee and a general partner are relatively similar.

QPRT Can Hold Beneficial Title to Residence

The IRS held that a trust holding beneficial title to shares in a cooperative housing corporation and related leases pertaining to the grantor's cooperative apartment, met the Sec. 2702 criteria for a QPRT.(25) The grantor intended to transfer legal title to her shares and proprietary leases to the trust. When the cooperative association refused her request for the transfer, she instead transferred beneficial title to the shares and leases to the trust and continued to hold legal tide to them as a nominee.

Foreign Grantor Trust's Payment of Grantor's Income Taxes

The IRS ruled that a foreign trust grantor would not be deemed to have a retained interest under Sec. 2036(a) in a trust that pays his income tax on trust income.(26)

Tax Reimbursement Excluded

Letter Ruling 200001015(27) considered the effect of GRAT language allowing tax payments to be made on income and gain earned and retained in excess of the required annuity payments. The Service ruled that this was not a retained interest under Sec. 2036.

Valuation Issues

The most significant cases and rulings on valuation in the last 12 months have addressed the applicability of minority interest discounts.

No QTIP Aggregation

In the past, the IRS has argued that multiple interests in the same property must be aggregated to determine the value for estate tax purposes. In Mellinger,(28) the Tax Court ruled that a 28% stock interest held in a qualified terminable interest property (QTIP) trust for the decedent's benefit need not be aggregated with the decedent's direct holdings of the same stock. The Service acquiesced.(29)

Controlling Interest in Closely Held Business

The taxpayer and her spouse owned 98% of the stock of a company whose principal asset was 5,405 acres of Louisiana timberland. When the spouse died in 1990, the stock was valued at $86.80 per share on the estate tax return. The taxpayer died in 1991, before the predeceased spouse's credit shelter trust was funded; the taxpayer obtained an appraisal of the same stock at $44.65 per share. The executor of the first estate funded the credit shelter trust using the lower appraised value (i.e., more shares).

The Tax Court required the funding of the credit shelter trust at the value as of the first spouse's date of death, as required under his will. However, the surviving spouse was permitted a small discount for the present value of the built-in gains (BIG) tax that the company would pay on liquidation and the lack of marketability (LOM) of certain company assets.(30)

Observation, While the discount was small, this case is a victory in both the BIG and valuation areas.

ESOP Did Not Preclude Discount

The decedent owned approximately 22% of the outstanding shares of a closely held company. Other family members owned 57%; an employee stock ownership plan (ESOP) held the remaining 21%, by purchase from the decedent during his life. At the time of purchase, an independent valuation report stated that a 40% LOM discount would generally apply, but because the ESOP had a "put" option on the stock, the discount was only 20%. The decedent also sold shares to family members at the report value. Despite the valuation report and the prior sales, the Tax Court allowed a 30% LOM discount at the date of decedent's death.(31)

Discount for Bank Stock

The decedent owned 49.97% of the outstanding shares of a closely held bank located in a rural community of 6,000. Although the Tax Court recognized that the decedent had effective control, he lacked legal control. The court rejected the IRS's attempt to use the capital asset pricing model, holding that the bank had little possibility of going public, and permitted a 30% LOM discount.(32)

Discount for Farmland

The decedent owned one-third of the outstanding shares of a closely held family farm. The Tax Court allowed combined LOM and minority discounts of approximately 70%.(33)

Premium Applied to Voting Stock

In determining the value of voting and nonvoting stock, the Tax Court held that the nonvoting stock would be eligible for a LOM discount, but the voting shares should reflect a premium.(34) The decedent owned 18 out of roughly 76 voting shares (23.55%) and 3,942.048 shares of over 141,000 nonvoting shares (2.79%). The company was a C corporation partially owned by an ESOP.

Observation: The court appears to have been offended by the ratio of the number of outstanding shares of voting stock to that of nonvoting stock (1:1,848). The decision has been appealed. This should give pause to practitioners structuring voting/nonvoting recapitalizations of stock and FLPs. Although 1:100 ratios may not offend a court, higher levels may be dangerous.

Discounts of Limited Partnership Interests

The Service lost its first attempt to apply Sec. 2704(b) to transfer, liquidation and withdrawal restrictions contained in a Texas limited partnership agreement. The Tax Court held that these restrictions were not Sec. 2704(b)(2)(A) "applicable restrictions," as they were substantially identical to provisions permitted under Texas's limited partnership statute.(35)


Environmental Claims

The Court of Federal Claims permitted an estate to claim a Sec. 2053 deduction for potential environmental clean-up costs related to a "superfund site" that was an estate asset. The deduction was permitted even though the total expenses were in excess of the value of the probate asset subject to the claim.(36)

Marital Deduction After Disclaimers

In a recent ruling, the Service permitted an estate to claim a marital deduction for a QTIP trust, provided the trust beneficiaries (the decedent's descendants) filed timely disclaimers.(37) Under the original trust terms, the surviving spouse and descendants both had rights to receive trust distributions of income and corpus during the former's life. The Sec. 2518 qualified disclaimers would permit the trust to qualify under Sec. 2056(b)(7) for the marital deduction.

Executor Can Make QTIP Election for IRA and Trust

The Service ruled that an executor may elect to treat an individual retirement account (IRA) and a trust as QTIP for estate tax marital deduction purposes, if three conditions are met: (1) the trust is the named IRA beneficiary; (2) the spouse can compel distributions of all income earned in excess of required minimum distributions; and (3) no one other than the spouse may have a power of appointment over any portion of the trust property.(38)

Procedural Issues

Nonexecutor Lacked Standing to Claim Refund

A husband and wife died within two weeks of each other in August 1991; their daughter was appointed executor of both estates. Her mother's estate owned 20% of the family business; her father's estate owned 47%. Her brother, who operated the business, owned the remaining 33%. The executor hired an appraiser who claimed no discounts for the stock on the estate tax returns. The brother and the corporation hired a new appraiser, who applied a 67% discount. The IRS rejected that discount because the brother lacked standing. The probate court later closed the estates, but appointed the brother to represent them on tax issues. The IRS refused to reconsider its rejection of the claimed discounts; the brother sued for a refund.

A district court agreed with the IRS that only an executor is legally liable for taxes; thus, only an executor (not another appointee) can file for an estate tax refund.(39)

Observation: What is the reason the sister did not agree to discounts, which would have lowered the estate tax? Did it affect the distribution of the other assets in the estate? Was she feuding with her brother?

Equitable Recoupment for Beneficiary's Income Tax

An estate sold stock for more per share than the value reported on the estate tax return. The capital gain flowed through the fiduciary income tax return to the residuary beneficiary, who paid the capital gains tax. The IRS later adjusted the stock value, creating an estate tax deficiency. The beneficiary was barred by the statute of limitations from filing an amended income tax return and claiming a refund. The Tax Court allowed the estate to offset the beneficiary's income tax overpayment against the estate tax deficiency, under the theory of equitable recoupment.(40)

Disclaimer Did Not Defeat Federal Tax Lien

The Supreme Court affirmed an Eighth Circuit decision holding that a disclaimer could not avoid a Federal tax lien.(41) The taxpayer was the sole heir at law to his mother's estate. He was insolvent and owed the Federal government over $325,000 in back taxes. Valid Federal tax liens were in place before his mother's death. The taxpayer filed a qualified disclaimer under Sec. 2518. Under state law, he was deemed to predecease his mother; his interest would pass to his children. The Supreme Court affirmed that the Federal lien statutes take priority over local law; thus the Federal liens attached at the moment of death and before the disclaimer was filed.

Observation: This result could have been avoided by a will provision leaving the estate to the son and grandchildren in a spendthrift trust.

Divorce Decree Did Not Change Beneficiary Designations

A divorce court awarded an ex-husband ownership of an IRA. He later remarried, but neglected to change the IRA beneficiary designation from his ex-wife to his new wife. After the husband's death, both women claimed his IRA benefits. A state court (Iowa) held that the ownership of the account did not automatically change with divorce.(42)

Observation: The Federal waiver law on spouses as qualified pension plan beneficiaries does not extend to IRAs. Had the case involved a Sec. 401(k) plan, the new spouse would have prevailed, absent a signed waiver of her plan interest.


The IRS issued a number of favorable rulings over the past 12 months that will greatly simplify beneficiary planning for IRAs and other qualified plans.

Multiple Beneficiaries Can Defer IRA Payout

Based on prior rulings, it had been believed that if there were multiple beneficiaries to a single IRA, each could defer taxation. However, it was assumed withdrawals were required to be made over the oldest beneficiary's life expectancy; many advisers thus recommended creating multiple IRA accounts and naming a single beneficiary for each. Under new rulings,(43) if either a trust or multiple (nonspouse) beneficiaries are named to a single IRA, the account can be divided into separate accounts after the holder's death, without income tax consequences. Each separate account beneficiary may then independently elect to withdraw benefits over his individual life expectancy.

Observation: This rule applies only if the original IRA account holder dies before the required beginning date for distributions (i.e., April 1 following the calendar year in which he turned 70 1/2).

Beneficiary's IRA Distributions

The Service held that the beneficiary of an IRA established by her father could receive distributions over her life expectancy--even though her father had not elected, during his life, to stretch the distributions over their joint life expectancy.(44) The Service stated that payments over the daughter's life (after her father's death) would not violate the "at least as rapidly" requirement of Sec. 401(a)(9)(B)(i).

It has been estimated that over $3 trillion of assets are currently held in qualified plans. The income and estate taxes combined could reach 70% on such assets. Clearly, this merits greater study by all tax professionals. The analysis of qualified plan distributions will spawn consulting services that will occupy the time of legions of financial consultants.

Editor's note: Mr. Whitlock is a member of the AICPA Tax Division's Estate Tax Repeal/Carryover Basis Task Force.

(15) IRS Letter Ruling (TAM) 9751003 (4/28/97); see Lipshultz and Zysik, "Significant Recent Developments in Estate Planning," 29 The Tax Adviser 546 (August 1998).

(16) IRS Letter Ruling (TAM) 9944003 (7/2/99).

(17) IRS Letter Ruling (TAM) 9941013 (7/9/99).

(18) Est. of Cyril I. Magnin, 184 F3d 1074 (9th Cir.), rev'g and rem'g TC Memo 1996-125.

(19) Est. of Rose D'Ambrosio, 101 F3d 309 (3d Cir. 1996).

(20) John M. Wheeler, 116 F3d 749 (5th Cir. 1997).

(21) Notice 99-36, IRB 1999-26, 3.

(22) See Rev. Rul. 2000-28, IRB 2000-23, 1157.

(23) IRS Letter Ruling (TAM) 9938005 (6/7/99).

(24) See Marian A. Byrum, 408 US 125 (1972) (right to vote stock was not retained interest).

(25) IRS Letter Ruling 9925027 (3/25/99); see Easton, "Recent Developments in QPRTs and QTIPs," 31 The Tax Adviser 416 (June 2000).

(26) IRS Letter Ruling 9922062 (2/26/99).

(27) IRS Letter Ruling 200001015 (9/30/99).

(28) Est. of Harriet R. Mellinger, 112 TC 26 (1999).

(29) Ann. 99-116, IRB 1999-35, 314.

(30) Est. of Helen Bolton Jameson, TC Memo 199943.

(31) Est. of Sam H. Marmaduke, TC Memo 1999-342.

(32) Est. of James w. Hendrickson, TC Memo 1999-278.

(33) Est. of Helen J. Smith, TC Memo 1999-368.

(34) Est. of Richard R. Simplot, 112 TC 130 (1999).

(35) Baine P. Kerr, 113 TC No. 30 (1999).

(36) Est. of Robert L. Snyder, Ct. Fed. Cls., 8/20/99.

(37) IRS Letter Ruling 9949023 (9/10/99).

(38) Rev. Rul. 2000-2, IRB 2000-3, 305.

(39) Center Heights Lumber Co., DC IN, 5/6/99.

(40) Est. of Frank A. Branson, 113 TC No. 2 (1999).

(41) Rohn F. Drye, Jr., 120 Sup.Ct. 474 (1999), aff'g 152 F3d 892 (8th Cir. 1998); see Tax Trends, "Sup. Ct.: Valid Disclaimer of Inheritance Under State Law Cannot Avoid Federal Tax Lien," 31 The Tax Adviser 274 (April 2000).

(42) Schultz v. Schultz, 591 NW2d 212 (1999).

(43) IRS Letter Rulings 9931048 (5/12/99), 9931049 (5/12/99) and 200008044 (12/3/99).

(44) IRS Letter Ruling 200018057 (2/9/00); see Tax Clinic, "IRA-Designated Beneficiary Not Bound by Owner's Pre-Death Withdrawal Calculations," p. 610, this issue.

Brian T. Whitlock, J.D., LL.M., CPA Partner Blackman Kallick Bartelstein, LLP Chicago, IL
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Article Details
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Title Annotation:part 2
Author:Whitlock, Brian T.
Publication:The Tax Adviser
Geographic Code:1USA
Date:Sep 1, 2000
Previous Article:Basis allocation rules for distributions of multiple assets.
Next Article:Client record retention and tax workpapers.

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