Source: http://www.naepc.org/events/newsletter/2/2019
Timestamp: 2019-04-24 00:49:04+00:00

Document:
In an eagerly anticipated annual tradition, Ronald Aucutt shares with LISI members his "Top Ten" estate planning and estate tax developments of 2018. Ron’s commentary was adapted from a McGuireWoods LLP Legal Alert dated December 21, 2018.
Ronald D. Aucutt is a partner in the Tysons, Virginia, office of McGuireWoods LLP and is the chair emeritus of the firm's Private Wealth Services Group. Ron's career has focused on planning and controversy matters involving the estate, gift, and generation-skipping transfer taxes, the income taxation of trusts and estates, and the rules regarding tax exempt organizations and charitable contributions. He has extensive experience in assisting clients with the transfer of wealth from one generation to another, particularly including the orderly and tax-efficient succession of family-owned businesses. He also advises lawyers and other professionals on tax planning and controversy issues across the entire spectrum of estate planning and charitable giving, including the complex rules governing generation-skipping transfers under chapter 13 and the special valuation rules under chapter 14 of the Internal Revenue Code. He is experienced in resolving tax issues through rulings in the Internal Revenue Service's National Office and in administrative appeals throughout the country. He has contributed to the formation of tax policy through legislation since 1976, as well as in Treasury regulations, has served as an expert witness in estate and gift tax matters, and in 2014 through 2016 served three years as a member of the Internal Revenue Service Advisory Council and two years as chair of its "OPR Subgroup" (working with the IRS Office of Professional Responsibility). He served from 2015 to 2018 as the Reporter for the Uniform Fiduciary Income and Principal Act, which was approved by the Uniform Law Commission in July 2018. Ron was recognized as one of Washington's 31 "Best Lawyers" in the December 2011 issue of Washingtonian and as one of the top 30 "Stars of the Bar" in the December 2009 issue of Washingtonian; he holds Chambers USA's "Band 1" ranking for Wealth Management; and he was elected to the National Association of Estate Planners and Councils Estate Planning Hall of Fame and given the designation of Distinguished Accredited Estate Planner in 2009. He was awarded the 1995-1996 Estate Planner of the Year Award by the Washington, D.C. Estate Planning Council. His biography appears in Who’s Who in America, Who’s Who in American Law, Who’s Who in Finance and Industry, and Who’s Who in the World. He is also listed in the Best Lawyers in America. Ron is a Fellow and former President (2003-04) of The American College of Trust and Estate Counsel, an academician of The International Academy of Estate and Trust Law and former member of its Council (2000-04), a former Vice Chair (Committee Operations) of the American Bar Association’s Section of Taxation (1998-2000), a Fellow of the American College of Tax Counsel and the American Bar Foundation, and a member of the Christian Legal Society. He is also a member of the Advisory Committee of the University of Miami Philip E. Heckerling Institute on Estate Planning, the Advisory Board of the Florida Tax Institute, and Tax Management’s Advisory Board on Estates, Gifts, and Trusts.
In In re Estate of Forgey, 298 Neb. 865 (Feb. 9, 2018), the decedent had died in 1993, survived by three children. A trust into which he had transferred property during his life, with one of his children as the sole trustee, provided specific instructions about the division of the trust assets upon his death, gave the trustee broad discretion in administering the trust in good faith, and required annual reports to the beneficiaries.
unfounded. But the court did find the trustee guilty of some breaches and imposed some remedies.
The beneficiaries (including the widow of one beneficiary) appealed, claiming the remedies were not sufficient. Among other things, they specifically claimed that the trial court erred in not awarding them attorneys’ fees for their partially successful litigation efforts.
The Nebraska Supreme Court generally agreed with the trial court, but did order a larger charge to the trustee’s share of the trust assets with respect to his rent-free use of trust property. Regarding attorneys’ fees, the court was influenced by its view that much of the litigation had been caused by the trustee’s failure to keep the beneficiaries informed for 20 years. The court said that "[w]e understand the county court’s reluctance to award attorney fees, since the majority of the claims against [the trustee] were determined to be unfounded," but noted that in the absence of information "the beneficiary had little choice but to file litigation to resolve any doubts about the trust’s administration." Consistent with this view, the court denied the trustee’s cross-appeal claiming that his attorneys’ fees should have been paid by the trust.
Comment: The trust instrument in Forgey required annual reports to the beneficiaries, although the court indicated that the relevant Nebraska statute also imposed a duty to keep the beneficiaries informed. Section 105(b) of the Uniform Trust Code provides that the terms of a trust prevail over any provision of the Code, with certain enumerated exceptions. One of the enumerated exceptions is the duty under Section 813(b)(2) and (3) to notify qualified beneficiaries who have attained 25 years of age of the existence of the trust, the identity of the trustee, and their right to request a trustee’s reports. Another enumerated exception is the duty under Section 813(a) to respond to a request for a trustee’s reports and other information reasonably related to the administration of the trust. But those two exceptions are placed in brackets, making them optional, explained in the Comment to the 2004 amendment of Section 105 as "a recognition that there is a lack of consensus on the extent to which a settlor ought to be able to waive reporting to beneficiaries, and that there is little chance that the states will enact [these two exceptions] with any uniformity." The explanation is correct in that regard; the versions enacted in the respective states vary greatly.
For example, in 2005 the North Carolina General Assembly enacted the Uniform Trust Code with the exceptions discussed above, thus permitting a grantor to override the default requirements to give notice to qualified beneficiaries and respond to requests from qualified beneficiaries for information. But in Wilson v. Wilson, 690 S.E.2d 710 (N.C. App. 2010), the Court of Appeals invalidated that choice, quoting comment c to Section 173 of the Restatement (Second) of Trusts that "the beneficiary is always entitled to such information as is reasonably necessary to enable him to enforce his rights under the trust or to prevent or redress a breach of trust." The court concluded that the statute "does not override the duty of the trustee to act in good faith, nor can it obstruct the power of the court to take such action as may be necessary in the interests of justice."
Debate continues over the understandable desire of some grantors to create "secret trusts." Cases like Forgey may be invoked by some and distinguished by others, but may not change many minds.
Horgan (Florida). In Horgan v. Cosden, 249 So.3d 683 (Fla. Dist. Ct. App. May 25, 2018), review denied, Docket No. SC18-1112 (Fla. July 30, 2018), a trust had become irrevocable when the grantor died in 2010. The trust was to pay income to the grantor’s son for his life, with the remainder distributed upon the grantor’s son’s death to three institutions of higher education. In 2015, the beneficiaries agreed to terminate the trust and divide the trust assets on an actuarial basis. One cotrustee agreed; the other did not. The trust was silent on early termination, although it contained a spendthrift clause.
occur only for the best interest of the beneficiaries when viewed in the light of the settlor’s intentions, and refused to allow it here.
Shire (Nebraska). In In re Trust of Jennie Shire, 299 Neb. 25, 907 N.W.3d 263 (Feb. 16, 2018), the decedent had died in 1948, and her will created a trust paying $500 per month to the grantor’s daughter (who died in 1983) and then to her granddaughter (who was born in 1945) for life. The remainder beneficiaries will be the residuary beneficiaries of the grantor’s estate, determined when the granddaughter dies.
The granddaughter requested an increase in her distributions, and the corporate trustee petitioned the court for approval. The opinion states that the granddaughter’s annual income was less than $14,000 (including $6,000 from the trust), while the trust assets had a value of just under $1 million with annual income estimated to be from $64,000 to $81,000. The court also noted the introduction of evidence that $500 adjusted for inflation since 1948 would be either $4,997 or $5,400.29. (That would translate to annual distributions of either $59,964 or $64,803.48, which would be comparable to the projected income of the trust.) The trustee had taken measures to identify and notify the contingent beneficiaries, and many of them appeared and supported the granddaughter’s request. Other contingent beneficiaries appeared, but offered no opposition, including the Nebraska Attorney General’s Office on behalf of charitable beneficiaries. The only opposition was the virtually obligatory opposition of the court-appointed counsel for unknown and undiscovered heirs.
The trial court denied the granddaughter’s request because it would adversely affect future beneficiaries. The Nebraska Supreme Court agreed.
Comment. Flexibility in the administration of a trust is a relatively modern, but generally quite welcome, trend. For example, Section 111 of the Uniform Trust Code, completed by the Uniform Law Commission in 2000, provides that "interested persons may enter into a binding nonjudicial settlement agreement with respect to any matter involving a trust … to the extent it does not violate a material purpose of the trust." Section 411(b) provides that "[a] noncharitable irrevocable trust may be modified upon consent of all of the beneficiaries if the court concludes that modification is not inconsistent with a material purpose of the trust." Section 411(c) (not included in the version approved by every state) provides that "[a] spendthrift provision in the terms of the trust is not presumed to constitute a material purpose of the trust."
Now come these two cases. Both requests to the courts seem reasonable, and yet they were turned down. In Horgan just five years had passed, and the beneficiaries were all known and agreed. But it was hard to say that circumstances had unforeseeably changed. In Shire 70 years had passed and the income beneficiary was 73 years old, but the remainder beneficiaries would not be known with certainty until the death of the income beneficiary. Circumstances had obviously changed. There is no evidence that remainder beneficiaries had been anxiously waiting for their shares of the trust for 70 years, or that they generally even knew about the trust until the trustee’s efforts to locate them. There is no reason to assume that they viewed their potential interests in the trust as anything more than a windfall.
Does this mean that the movement toward more trust flexibility is being walked back? Probably not. But cases like Horgan and Shire stand as reminders that nothing should be taken for granted. That is particularly true of drafting long-term trusts with fixed references such as dollar amounts.
Badgley v. United States, 2018 WL 2267566, 121 AFTR 2d 2018-1816 (N.D. Cal. May 17, 2018), app. filed (9th Cir. June 7, 2018), involved a grantor retained annuity trust (GRAT) created on February 1, 1998. The GRAT was to run for the shorter of 15 years or the grantor’s life and was to pay the grantor, in quarterly installments of $75,564.75, an annuity amount of $302,259, defined as 12.5 percent of the initial value of the assets transferred to the GRAT (which therefore must have been about $2,418,072). The grantor died November 2, 2012, after 177 months of the projected 180-months GRAT term.
The grantor’s executor filed an estate tax return showing a total gross estate of about $37 million, including the value of the GRAT assets, and paid estate tax of about $11 million. Later the executor filed a claim, and then a suit, for $3,810,004 she claimed was overpaid by reason of including the full value of the GRAT assets in the gross estate. The executor argued that the annuity payments did not represent "the possession or enjoyment of, or the right to the income from, the property" within the meaning of section 2036(a)(1) because the annuity could have been paid from trust principal, not income. Reg. §20.2036-1(c)(2)(i), which requires a contrary result, she argued, is an unreasonable interpretation of section 2036.
The court held that the retained annuity interest was enough to bring the value of the GRAT into the gross estate under section 2036(a)(1) and that Reg. §20.2036-1(c)(2)(i) is reasonable.
Comment. The argument that a GRAT annuity is not an "income" interest under section 2036(a)(1) has been heard from time to time, but for most estate planners the result in Badgley is absolutely no surprise.
The opinion does not reveal the grantor’s age at the time she created the GRAT on February 1, 1998, but, considering the February 1998 section 7520 rate of 6.8 percent (the lowest it had been for 22 months), it is likely that she was about 65, and therefore was about 80 when she died. It also appears that the value of the GRAT assets was about $2,418,072 (applying a 12.5 percent payout rate) when the GRAT was created and about $10,885,726 (applying a 35 percent estate tax rate) when the grantor died.
Thus the GRAT was "working," having achieved 350 percent growth after paying the annuity amounts, but ultimately the GRAT did not "work," because the grantor lived for only 98 percent of the 15-year GRAT term.
The obvious moral of the story is to consider the consequences when creating a long-term GRAT like a 15-year GRAT. The balancing is not always easy. The 15-year term made possible the relatively low payout of 12.5 percent, which in turn was probably a factor, maybe a crucial factor, in permitting the growth that made the GRAT appear to be "working." A 14½-year GRAT would have "worked"! This is where other techniques, like installment sales with lower interest rates, maybe backloaded principal payments, and no exposure of the appreciation to a mortality risk, frequently are better. But the judgment of hindsight is often cruel.
Family limited partnerships do not seem to be generating as many cases as they once did, but they may come close to making up for it by the length of time the cases seem to take. And the results may still be mixed and sometimes surprising.
to it. An LLC of which she was the manager was the 1 percent general partner, although under the partnership agreement 75 percent of the limited partner interests could remove the general partner, which would terminate the partnership. Also on October 1, 2008, under the power of attorney, the daughter assigned her father’s 88.99 percent limited partner interest to a revocable trust created on the same day, which she described in the assignment document as the "assignee." The decedent died on May 6, 2011, and his daughter as executor, on the federal estate tax return filed on August 9, 2012, applied a 37.2 percent discount in valuing his partnership interest, described as an "assignee interest" held by the revocable trust.
The Tax Court (Judge Kerrigan) held that the interest must be valued as a limited partner interest, not as a mere assignee interest, because it met all the requirements in the partnership agreement for becoming a substituted limited partner. Accordingly, the court gave little weight to the appraisal report by the estate’s expert, because the report had valued the interest as an assignee interest. That left the IRS expert’s determination of an 18 percent discount for lack of marketability, which the court accepted.
Comment: The Bad News. The planning reflected in Streightoff seems both naïve and aggressive. The partnership was evidently funded with, and continued to hold, only marketable assets. Nothing is revealed in the opinion about any alleged business purpose or nontax reason for the partnership. The decedent retained a proportionately large share – 88.99 percent – of the partnership interests, and that share was apparently not even effectively transferred when it was assigned to his revocable trust, because the revocable trust was, indeed, revocable. In fact, that 88.99 percent interest, because it was greater than 75 percent, retained the power to terminate the partnership. And all the transfers, such as they were, occurred on the same day. How could this have worked?
Comment: The Good News. With an undiscounted alternate valuation date value of about $7.3 million, and a 40 percent estate tax rate, the 18 percent discount the court allowed still saved about $526,000 in estate tax. For one day’s work!
motion for summary judgment in October 2016, a trial was held in January 2018, this decision was rendered in October 2018, and the parties have until March 11, 2019, to provide the tax calculations under Rule 155. A large number of other pleadings also appear in the docket entries, many related to the executor’s attempt to get the court to acknowledge a shift of the burden of proof. Was all this hassle and delay worth it?
Turner. In April 2002, Clyde W. Turner, Sr. ("Clyde Sr.) and his wife Jewell formed a limited partnership, each transferred $4,333,671 in cash, CDs, and publicly-traded securities to the partnership, and each took back a 0.5 percent general partner interest and a 49.5 percent limited partner interest. On December 31, 2002, and January 1, 2003, they gave limited partner interests to children and grandchildren and an irrevocable trust for one child. Clyde Sr. became seriously ill and was hospitalized in October 2003 and died on February 4, 2004.
In Estate of Turner v. Commissioner, T.C. Memo. 2011-209 (Aug. 30, 2011) (Turner I), the Tax Court (Judge Marvel) rejected Clyde Sr.’s executor’s claims of nontax purposes of asset management and protection and resolution of family disputes, viewed the creation of the partnership as "a part of a testamentary plan" in which Clyde Sr. retained both enjoyment and control, and thus found that the value of the assets he had transferred to the partnership was included in his gross estate under section 2036(a)(1) and (2).
In Estate of Turner v. Commissioner, 138 T.C. 306 (March 29, 2012) (Turner II), the executor returned to the court to seek reconsideration of its 2011 decision, which the court denied, and to claim in the alternative that a reduce-to-zero pecuniary bequest nevertheless protected the estate from estate tax by providing an increased marital deduction. The court held, in effect, that even though the value of the assets was pulled back into the gross estate, the transferred assets were out of Clyde Sr.’s control and therefore could not pass to Jewell or qualify for a marital deduction.
the estate must pay because the only property available to fund the payments is property that would otherwise pass to Jewell and qualify for the marital deduction."
"(2) Decedent may otherwise direct.—Paragraph (1) shall not apply with respect to any property to the extent that the decedent in his will (or a revocable trust) specifically indicates an intent to waive any right of recovery under this subchapter with respect to such property."
effect to Clyde Sr.’s intention that Jewell receive her share of the estate undiminished by the estate’s tax obligations."
The court also rejected the executor’s contention that the marital deduction should be increased by the amount of income generated after Clyde Sr.’s death by assets attributable to the marital share.
Comment. Turner III is not especially interesting because it tells us rules of law we did not know about. It is interesting because of the peculiar and questionable way in which it applies the rules we do know, and the implications we now see these rules might have beyond their customary context.
First, Turner I provided that the value of the assets Clyde Sr. transferred to the partnership in April 2002 was included in his gross estate, not the value of the gifts of partnership interests he made on December 31, 2002, and January 1, 2003. Who then is "the person receiving the property" from whom section 2207B(a)(1) gives his executor a right of recovery? Isn’t it the partnership? If so, how is recovery obtained? And wouldn’t recovery from the partnership reduce the value of all interests in the partnership, including, after all, Jewell’s interests? Or was the "transfer" contemplated by section 2207B(a)(1) not complete until and to the extent of Clyde Sr.’s gifts, so the recovery, if it comes from the partnership, must somehow come from the partnership interests of those transferees? Wouldn’t that be contrary to the recent application of section 2036 in family limited partnership cases even to the assets represented by the partnership interests the partner retains until death?
Second, the recovery Turner III apparently contemplated, as quoted above, is "the amount of Federal estate and State death taxes [the estate] must pay because the tax liabilities are attributable to the section 2036 assets" (emphasis added). In fact, the opinion uses the phrase "Federal estate and State death taxes" 12 other times, including as the heading for its discussion of the right of recovery. But section 2207B says nothing about state taxes. Clyde Sr. died domiciled in Georgia, a state with an estate tax coupled with the federal credit for state death taxes, and he died in 2004, when the federal state death tax credit had been phased down to 25 percent but not eliminated.
Third, footnote 2 of the Turner III opinion states that Clyde Sr.’s wife Jewell had died on July 8, 2007, and that a related case for her estate (Docket No.
29411-11) was pending in the Tax Court. The petition was filed December 23, 2011, and the IRS’s motion of August 3, 2012, for continuance of the trial was granted August 29, 2012, and there are no entries in the docket since August 29, 2012. We can be sure that if Clyde Sr.’s executor does not seek and obtain the recovery contemplated by section 2207B(a), or if he does anything else in a manner the IRS does not like, Jewell’s estate’s pending matter may give the IRS one more setting in which to raise its concerns, for example by asserting that Jewell was deemed to make a gift or her gross estate is enhanced by the full marital deduction Clyde Sr.’s executor eventually takes into account.
Fourth, if every lifetime transfer potentially subject to section 2036 now carries with it the potential for recovery from the transferee for additional estate taxes that might be paid, who can tell what use could be made of that potential in discounting the value of those transfers even further? A comparison could be made to Steinberg v. Commissioner, 145 T.C. 184 (2015), the "net net gift" case in which the court allowed a reduction in the value of a gift for the actuarially calculated value of the donee’s assumption of the obligation to pay the additional estate tax under section 2035 if the donor died within three years of the gift. The problem is that in Steinberg the taxpayer conceded that there would be an increase in the gross estate under section 2035 if the donor died within three years. It is hard to imagine any donor conceding a section 2036 inclusion at the time of a transaction like the creation of the partnership in Turner III.
Fifth, Clyde Sr. died in February 2004. His executor filed the estate’s Tax Court petition in August 2008. There are a total of 82 entries in the Tax Court docket for the estate over the last ten years, although, curiously, none between February 2013 and April 2017. As with the Streightoff case, one could ask if this hassle and delay is worth it.
The facts in these cases are simple; the consequences could be complex.
surviving spouse’s gross estate – such as a general power of appointment in the case of sections 2056(b)(5) and 2523(e) or payment to the estate in the case of Reg. §20.2056(c)-2(b)(1)(i), (ii), or (iii) – inclusion in the surviving spouse’s gross estate was assured by the contemporaneous enactment of section 2044, providing for inclusion whenever a marital deduction was allowed under section 2056(b)(7) or 2523(f), backstopped by section 2519 in the case of the surviving spouse’s actions during life. Thus was maintained the fundamental character of the marital deduction as a deferral only – the asset escapes tax at the first death but is taxed at the second death. Even if the surviving spouse who is a U.S. citizen moves out of the country, section 2001(a) continues to apply, and if such a surviving spouse with sufficient income or assets also renounces that U.S. citizenship, sections 877 and 2107 ensure continued taxation for 10 years. Meanwhile, the 1981 objective of making the marital deduction unlimited without having to give the surviving spouse control over the disposition of the remainder is fulfilled in the QTIP trust.
Since 2001 and the four-year phase-out of the credit for state death taxes, and especially with state legislatures setting their estate tax exemptions lower than the federal basic exclusion amount, some states that still have an estate tax have provided for a state-only QTIP election, available when the estate is under the federal exclusion amount but not under the state exemption, or applicable to the extent the state exemption is less than the federal exclusion amount. But symmetry is lost to the fact that a state is powerless when the surviving spouse moves out of the state. "Worldwide," or nationwide, taxation is not allowed, and, under Section 1 of the Fourteenth Amendment to the U.S. Constitution, a citizen of a state loses that citizenship merely by moving to another state. That dissymmetry is the backdrop for these cases identified as the sixth top development of 2018.
Taylor (Maryland). In Comptroller of the Treasury v. Taylor, 189 A.3d 799 (Md. Ct. Spec. App. July 25, 2018), the predeceased spouse died domiciled in Michigan and created a trust. Both federal and Michigan QTIP elections were made. The surviving spouse moved to Maryland and died domiciled in Maryland.
Code with regard to any property for which a marital deduction qualified terminable interest property election was made for the decedent’s predeceased spouse on a timely filed Maryland estate tax return."
Seiden (New York). In In re Estate of Seiden, NYLJ 10/12/18 p. 23, col. 5 (N.Y. County Surr. Ct.), the predeceased spouse died domiciled in New York in 2010, when there was no federal estate tax. But New York still had its estate tax, and a New York-only QTIP election was made. The surviving spouse did not move out of the state and died domiciled in New York.
The New York court held that New York cannot tax the QTIP trust because New York totally piggybacks on the federal gross estate, and there was no QTIP trust for federal estate tax purposes. Like the Maryland court in Taylor, the New York court relied on the New York statute, New York Tax Law (TL) §954(a), which provides that "[t]he New York gross estate of a deceased resident means his or her federal gross estate as defined in the internal revenue code (whether or not a federal estate tax return is required to be filed)." Because there was no federal QTIP election, the value of the trust assets was not included in the federal gross estate and hence was not included in the New York gross estate either.
Comment. The outcomes in these cases seem rather random and state-statute-specific. For example, if the surviving spouse of the Michigan decedent in Taylor had moved to New York instead of Maryland, it appears that New York would tax the trust at the surviving spouse’s death, because the federal QTIP election would ensure inclusion in the survivor’s federal gross estate, which would then mean inclusion in the New York gross estate too.
million federal-QTIP trust, but not the $3.66 million New York-only-QTIP trust. A very odd result from the term "New York-only."
The moral of the story is that estate planners have one more complication of clients’ mobility to anticipate and, if possible, plan for.
In addition, we should expect to see some corrective legislation in the states that have estate taxes. On the other hand, legislation might add even more complexity to the context of mobility among states, as in Maryland’s choice, less than four months before Taylor was decided, to add portability to its estate tax law.
Introduction. Split-dollar life insurance arrangements have been in use a long time and were the subject of new Treasury regulations in 2003. Simply put, a split-dollar arrangement is an arrangement by which the cost of life insurance is split between the insured and another party. In a common early use, the payor was the employer of the insured. Then split-dollar arrangements began to be used by individuals or within families for estate planning purposes. A recent variation, the subject of the Cahill and Morrissette cases, involves the payment of premiums by a member of one generation for insurance on the life or lives of members of a younger generation – intergenerational split-dollar arrangements.
In each of these cases a revocable trust, which of course became irrevocable when the grantor died, made payments toward premiums on life insurance owned by irrevocable trusts created by the same grantor and insuring lives of family members in the next generation. (In this discussion, that revocable trust will be called the "premium-paying trust" and that irrevocable trust will be called the "policy-owning trust.") In each of the two 2018 cases, upon the death of an insured, a portion of the death benefit equal to the greater of the total premiums paid or the cash surrender value of the policy immediately before the insured’s death would be payable to the premium-paying trust. Therein lies one perceived benefit of intergenerational split-dollar arrangements: because the insureds are members of the next generation, their deaths are actuarially likely to occur long after the grantor’s death, and this reimbursement right of the premium-paying (now irrevocable) trust is valued for estate tax purposes at a significant discount reflecting the time-value of money.
Each split-dollar agreement in these two cases provided that it could be terminated during the insured’s life by the mutual agreement of the trustees of the premium-paying trust and the policy-owning trust. If one of the split-dollar agreements were terminated during the insured’s life, the policy-owning trust could opt to retain the policy. In that case the policy-owning trust would be obligated to pay the premium-paying trust the greater of the total premiums the premium-paying trust had paid on the policy or the policy’s cash surrender value.
In each case, gift tax returns reported the cost of the life insurance protection as gifts to the policy-owning trusts, in accordance with the favorable "economic benefit regime" for the taxation of split-dollar arrangements under the 2003 regulations, Reg. §1.61-22. In each of these cases the Tax Court agreed that the economic benefit regime was appropriate because the policy-owning trusts received no additional economic benefit beyond the current life insurance protection, as explained in Estate of Morrissette v. Commissioner, 146 T.C. 171 (2016). But that still left open the determination of the amount includable in the grantors’ gross estates with respect to the arrangements, which in turn requires consideration of the basis for inclusion.
Cahill. In the Cahill case, the grantor of the trusts was Richard F. Cahill. His son Patrick was the trustee of the premium-paying trust. In September 2010, Patrick, acting on behalf of Richard pursuant to a power of attorney, created the policy-owning trust, with Patrick’s cousin and business partner as the trustee. The purpose of this policy-owning trust was to take ownership of two insurance policies on Patrick’s life and one policy on the life of Patrick’s wife. Patrick and his cousin, as the respective trustees, executed the governing split-dollar agreements with respect to those policies, reserving for the premium-paying trust a portion of each death benefit equal to the greater of the total premiums paid by the premium-paying trust or the cash surrender value of the policy immediately before the insured’s death. The total of the premiums for the three policies paid by the premium-paying trust was $10 million, the total death benefit was $79.8 million, and the aggregate cash surrender value at the date of Richard’s death in December 2011 (15 months after the split-dollar transactions) was $9,611,624.
lender by Patrick as trustee and guaranteed by Richard through Patrick’s exercise of his power of attorney on Richard’s behalf. If any balance on that loan is outstanding at the death of the insured, the split-dollar agreements provide that the premium-paying trust will be entitled to a portion of the death benefits equal to that outstanding balance, if it is greater than the premiums paid or cash surrender value the premium-paying trust would otherwise be entitled to. If the split-dollar agreements were terminated during the insured’s life and the policy-owning trust did not opt to retain the policy, it would be required to transfer its interest in the policy to that independent lender, and in that case the premium-paying trust would be entitled to any excess of the cash surrender value over the outstanding loan balance with respect to the policy.
For estate tax purposes upon Richard’s death, his executor (Patrick) valued the premium-paying trust’s right to recover death benefits as $183,700, reflecting the deferral of that recovery to the deaths of the younger Patrick and his wife. The IRS asserted that the value should be the cash surrender value at the time of Richard’s death, $9,611,624.
The executor moved for summary judgment that sections 2036, 2038, and 2703 did not apply in valuing Richard’s interests in the split-dollar arrangements and in the premium-paying trust. The Tax Court (Judge Thornton) denied the motion. Estate of Cahill v. Commissioner, T.C. Memo. 2018-84 (June 18, 2018). It viewed the power of the decedent, through the revocable premium-paying trust, to revoke the split-dollar agreement and recover at least the cash surrender value as "clearly rights … both to designate the persons who would possess or enjoy the transferred property under section 2036(a)(2) and to alter, amend, revoke, or terminate the transfer under section 2038(a)(1)." It cited two Tax Court family limited partnership cases that have exasperated estate planners since they were published – Estate of Powell v. Commissioner, 148 T.C. No. 18 (2017) (reviewed by the Court), which was Number Three in last year’s Top Ten, and Estate of Strangi v. Commissioner, T.C. Memo. 2003-145, aff’d, 417 F.3d 468 (5th Cir. 2005).
Patrick stood on both sides of the transaction so as to prevent it from being a "bona fide sale for an adequate and full consideration in money or money’s worth" for purposes of sections 2036(a)(2) and 2038(a)(1), including whether it was "a legitimate and significant nontax reason" for the transaction that "in the view of decedent’s trustee and attorney-in-fact (Patrick Cahill), decedent would have wanted, had he been able to manage his affairs, to ensure sufficient liquidity decades from now when the insured parties (Patrick Cahill and his spouse) die, so as to smooth the transfer of a business (apparently to be owned by Patrick Cahill) to decedent’s grandchildren (Patrick Cahill’s children)."
On the subject of adequate and full consideration, Judge Thornton noted that the executor valued the premium-paying trust’s right of recovery at less than 2 percent of the cash surrender value ($183,700 compared to $9,611,624), meaning that in the initial transaction the premium-paying trust would admittedly have received value less than 2 percent of what it transferred.
The same reasoning about adequate and full consideration led the court to find that the "at a price less than the fair market value" requirement of section 2703(a)(1) was met. In addition, the policy-owning trust’s right to veto any termination of the split-dollar agreement was a "restriction on the right to sell or use any property" that therefore met the requirement of section 2703(a)(2). The court did not consider the exception for a "bona fide business arrangement" under section 2703(b) because the executor and the IRS had not addressed it, although that analysis might have been similar to the court’s analysis of the "bona fide sale" exception in sections 2036(a)(2) and 2038(a)(1).
In a stipulated decision of December 12, 2018, the court approved a settlement of the case by the parties. The decision states the net outcome of the settlement of all issues, not just the split-dollar issues on which the executor had moved for summary judgment. The executor had reportedly accepted the IRS value of $9,611,624, as well as an accuracy-related penalty, and that is consistent with the stipulated decision. And it is not a surprise, in view of the skepticism about the transaction that appears in the court’s opinion.
owned moving and logistics companies with a history going back to 1943. In August 2006, a court appointed a company employee as the conservator of Clara’s estate for a two-month term. Shortly thereafter, Clara’s three sons, who were active in the company, became co-trustees of Clara’s revocable trust, and the conservator established three irrevocable multigenerational trusts, one for each of Clara’s sons and their families. All those trusts, Clara’s sons, and other trusts holding interests in the business executed a shareholders agreement providing, among other things, that upon the death of any of the sons the surviving sons and their respective trusts would purchase the stock held by or for the benefit of the deceased son. On October 4, 2006, the three new irrevocable trusts became the policy-owning trusts by purchasing universal life insurance policies on the lives of the two other sons to fund the trusts’ purchases under the shareholders agreements. On October 31, 2006, Clara’s revocable trust became the premium-paying trust by forming two split-dollar arrangements with each policy-owning trust and contributing a combined $29.9 million to those trusts, which the trusts used to make the lump-sum premium payments on the life insurance policies.
Clara died on September 25, 2009 (almost three years after the split-dollar transactions). Her executors, who were her three sons, reported on the estate tax return a total appraised value of $7,479,000 for the split-dollar receivables.
The IRS asserted that she should have reported the $29.9 million as gifts (rather than the $636,657 of net economic benefit reported as gifts under the economic benefit regime for 2006 through 2009). The executors moved for partial summary judgment that the economic benefit regime applied, which the Tax Court granted pursuant to its 2016 decision.
With regard to the value of the split-dollar receivables included in the gross estate, the executors moved for partial summary judgment that section 2703 did not apply. Three days after the similar summary judgment motion was denied in Cahill, the Tax Court (Judge Goeke), citing Cahill, denied the motion. Estate of Morrissette v. Commissioner, Order, Docket No. 4415-14 (June 21, 2018). The court’s order also notes that the IRS had raised sections 2036 and 2038 as alternative arguments.
motion for partial summary judgment, and on November 27 the court directed the executors to file a response by January 15, 2019.
Comment. If Morrissette is not resolved by summary judgment, which is unlikely, or by settlement, which seems unlikely but is always possible, the trial will be interesting, and the ensuing decision will likely be destined for another Top Ten list. The facts in Morrissette seem better than the facts in Cahill. The context of a family-owned business that has been operating for 75 years should be more supportive of "bona fide sale" arguments under sections 2036(a) and 2038(a)(1) and a "bona fide business arrangement" argument under section 2703(b). An important, perhaps crucial, question will be whether, even if the shareholders agreement is a bona fide business arrangement, the choice of an intergenerational split-dollar arrangement to fund it is so integral to the underlying shareholders agreement that such a favorable characterization will apply to it as well. In any event, 30 years after section 2703 was added to the Code by legislation signed into law by the late President George H.W. Bush in 1990, we may see a significant addition to its exposition.
A similar pending intergenerational split-dollar arrangement case is Estate of Levine v. Commissioner (Docket No. 13370-13, petition filed June 12, 2013), which had been scheduled for trial before Judge Holmes in November 2017.
Proposed Regulations (REG-106706-18) were released on November 20, 2018, and published in the Federal Register on November 23, 2018 (83 FED. REG. 59343), to prevent the "clawback" of the benefits of the doubled federal gift tax exemption during 2018 through 2025 if the "sunset" of those benefits occurs in 2026 as currently scheduled and the donor dies in 2026 or later. Although neither the statute nor the proposed regulations use the word "clawback," the regulations would carry out the mandate of the 2017 Tax Act in new section 2001(g)(2), which provides that Treasury "shall prescribe such regulations as may be necessary or appropriate to carry out this section with respect to any difference between (A) the basic exclusion amount under section 2010(c)(3) applicable at the time of the decedent’s death, and (B) the basic exclusion amount under such section applicable with respect to any gifts made by the decedent."
The proposed regulations would add a new paragraph (c) to Reg. §20.2010-1 (with the current paragraphs (c) through (e) redesignated as (d) through (f)), providing that if the total of the unified credits attributable to the basic exclusion amount that are taken into account in computing the gift tax payable on any post-1976 gift is greater than the unified credit attributable to the basic exclusion amount that would otherwise be used under section 2010(c) in computing the estate tax on the donor’s estate, then the amount of the credit attributable to the basic exclusion amount that is allowable in computing that estate tax is not determined under section 2010(c) but is deemed to be that greater total of gift tax unified credits attributable to the basic exclusion amount.
"Individual A (never married) made cumulative post-1976 taxable gifts of $9 million, all of which were sheltered from gift tax by the cumulative total of $10 million in basic exclusion amount allowable on the dates of the gifts. A dies after 2025 and the basic exclusion amount on A’s date of death is $5 million. A was not eligible for any restored exclusion amount pursuant to Notice 2017-15. Because the total of the amounts allowable as a credit in computing the gift tax payable on A’s post-1976 gifts (based on the $9 million basic exclusion amount used to determine those credits) exceeds the credit based on the $5 million basic exclusion amount applicable on the decedent’s date of death, under paragraph (c)(1) of this section, the credit to be applied for purposes of computing the estate tax is based on a basic exclusion amount of $9 million, the amount used to determine the credits allowable in computing the gift tax payable on the post-1976 gifts made by A."
News Release. Contemporaneously with the release of the proposed regulations, the IRS issued a news release with the reassuring headline of "Treasury, IRS: Making large gifts now won’t harm estates after 2025." The press release includes an even simpler explanation that "the proposed regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the BEA [basic exclusion amount] applicable to gifts made during life or the BEA applicable on the date of death."
Comment. In their practical effect, the proposed regulations do what the statute asks – nothing more, nothing less. The statute compares a transfer at death after 2025 (subparagraph (A)) with a transfer by gift before 2026 (subparagraph (B)). And that’s what the proposed regulation would address. For example, the proposed regulation would not address the similar scenario of gifts both before 2026 and after 2025. If large amounts of the increased credit attributable to the new doubled basic exclusion amount are used to shelter gifts from gift tax before 2026 (like the $9 million gift in the example), then after 2025 the donor might have to wait for decades for the indexed $5 million amount to catch up so there can be more credit available for gift tax purposes.
confirm that the term ‘basic exclusion amount’ referred to in section 2010(c)(4)(A) means the basic exclusion amount in effect in the year of the death of the decedent whose DSUE amount is being computed." That limitation gives effect to the general notion held by congressional drafters that portability should not be allowed to more than double what would otherwise be the survivor’s exemption.
But if the proposed regulations follow the statute very closely as to their practical effect, it is harder to say that they follow the context of the statute as to their approach and form. Before the proposed regulations were released, there was speculation that the regulations under section 2001(g)(2) would mirror section 2001(g)(1) with which their statutory authority is linked and provide, in effect, that in calculating the estate tax the basic exclusion amount in effect at the time of death will be used to calculate the hypothetical "total gift tax paid or payable" on pre-2026 adjusted taxable gifts that is deducted under section 2001(b)(2) on line 7 of Part 2 of the estate tax return. And by increasing the amount on line 7, which is subtracted in line 8, the estate tax would be appropriately reduced to offset the clawback effect.
The proposed regulations take a different approach. The preamble implies that other approaches were considered, but concludes that "in the view of the Treasury Department and the IRS, the most administrable solution would be to adjust the amount of the credit in Step 4 of the estate tax determination required to be applied against the net tentative estate tax." In the context of the new regulation, "Step 4" in the preamble most closely corresponds to line 9a of Part 2 of the estate tax return ("basic exclusion amount"); Step 2 corresponds to line 7.
By increasing the amount on line 9a, rather than the amount on line 7, the proposed regulations would achieve the same result, of course, because both line 7 and lines 9a through 9e produce subtractions in the estate tax calculation. But line 7 already requires three pages of instructions, including a 24-line worksheet, to complete, and an incremental increase of complexity in what already has a reputation for being a tangled morass might be easier to process than adding a new challenge to line 9, which now requires less than one-third of a page of instructions. But, needless to say, IRS personnel see more returns than we do, they see the mistakes, and they hear the complaints. Presumably – hopefully – they contributed to forming the assessment that the line 9 approach is "the most administrable solution."
That approach should work fine if the law is not changed and sunset occurs January 1, 2026. But, although the example in Proposed Reg. §20.2010-1(c)(2) mentions that the donor "dies after 2025," the substantive rule in Proposed Reg. §20.2010-1(c)(1) applies by its terms whenever "[c]hanges in the basic exclusion amount … occur between the date of a donor’s gift and the date of the donor’s death." It is not limited to 2026 or to any other particular time period. The 2010 statutory rule in section 2001(g)(1) and the 2017 statutory rule in section 2001(g)(2) are not limited to any time period either. Therefore, if Congress makes other changes in the law, particularly increases in rates or decreases in exemptions, and doesn’t focus on the potential clawback issue in the context of those changes, the generic anti-clawback regime of section 2001(g)(1) and (2) and these regulations could produce a jigsaw puzzle of adjustments going different directions that may strain the notion of administrability cited in the preamble.
The example in Proposed Reg. §20.2010-1(c)(2) is generally helpful, mainly because it is simpler and more readable than the rule in Proposed Reg. §20.2010-1(c)(1) itself. But, perhaps to help achieve that simplification, the drafters of the example used unindexed basic exclusion amounts of $10 million before 2026 and $5 million after 2025, thereby rendering it an example that could never occur under current law, and possibly causing concern that the proposed anti-clawback rule would apply only to the unindexed basic exclusion amount. Because the inflation adjustment is an integral part of the definition of "basic exclusion amount" in section 2010(c)(3), there should be no question that it is the indexed amount that is contemplated and addressed by the regulation, despite the potential implication of the example.
In any event, the final regulations could benefit from more examples than just one, showing how the outcome would adapt to changes in the assumptions, including examples with indexed numbers, examples with numbers below $5 million (indexed) and above $10 million (indexed), examples with portability elections, and examples with allocations of GST exemption.
estate tax after 2025. But that type of relief would go beyond the objective of preserving the benefits of a 2018-2025 use of the increase in the basic exclusion amount and would, in effect, extend the availability of those benefits beyond 2025. Although the preamble to the proposed regulations does not refer directly to that issue, it appears that it would require a different regulatory analysis to achieve that result.
The growing number of states with legislation authorizing self-settled domestic asset protection trusts (DAPTs) has been a repeat entry in the annual Top Ten summaries – Number Four in 2014 and Number Seven in last year’s Top Ten. Occasionally a case comes along in which a DAPT fails to bail a grantor out of a really "bad-facts" mess, but such cases have not made the Top Ten list since a discussion of In re Huber, 493 B.R. 798 (Bankr. W.D. Wash. 2013), and Mortensen v. Battley, 2011 WL 5025288 (Bankr. D. Alas. 2011), barely made it as part of Number Nine in 2013.

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