Source: https://www.mcguirewoods.com/Client-Resources/Alerts/2015/12/Ron-Aucutt-Top-Ten-Estate-Planning-Tax-Developments-2015.aspx
Timestamp: 2019-12-07 14:23:50
Document Index: 66182575

Matched Legal Cases: ['§2501', '§5', '§664', '§1014', '§2031', '§2512']

Ron Aucutt’s “Top Ten” Estate Planning and Estate Tax Developments of 2015 | McGuireWoods
In 1959, to consolidate their family businesses and make it easier to obtain financing, Michael (“Mickey”) Redstone and his two sons, Sumner and Edward, formed National Amusements, Inc. (NAI). They each contributed to NAI their stock in predecessor entities, and Mickey also contributed $3,000 in cash. Taking the stock contributions into account at their book values, the contributions totaled $33,328 (47.88%) from Mickey, $18,445 (26.49%) from Sumner, and $17,845 (25.63%) from Edward, but 100 shares of NAI common stock was issued to each of them. They all worked in NAI; Mickey was the president, Sumner was the vice president, and Edward was the secretary-treasurer. As the Tax Court described it, “Mickey gave Sumner, his elder son, the more public and glamorous job of working with movie studios and acquiring new theaters. Edward had principal responsibility for operational and back-office functions. His duties included maintaining existing properties and developing new properties.” (Today Sumner is the executive chairman of Viacom and CBS.)
As required by the settlement agreement, Edward contemporaneously executed two irrevocable declarations of trust for the benefit of each of his two children and transferred 16⅔ shares of NAI stock to each of the trusts. Three weeks later, Sumner similarly executed irrevocable declarations of trust for the benefit of each of his two children and transferred 16⅔ shares of NAI stock to each of the trusts. Neither of them filed gift tax returns for the taxable periods (the calendar quarters) in which they made these 1972 transfers.
In 2006, Edward's son and the trustees of certain Redstone family trusts sued Sumner, Edward, and NAI in a Massachusetts court, arguing that additional stock should have been transferred to the trusts in 1972 on the basis of the existence of a prior “oral trust.” In that litigation, Edward testified that he firmly believed that he was entitled to all 100 shares of NAI stock that were originally registered in his name, but that he had accepted his lawyer’s advice that it was in his best interest to agree to the oral trust for his children that Mickey had insisted on, in order to settle the earlier litigation and obtain payment for his remaining 66⅔ shares. Sumner testified that Mickey had never asserted such an oral trust in his case and that he had placed one-third of his stock in trust for his children “voluntarily, not as the result of a lawsuit,” stating that “I just made an outright gift.” In O’Connor v. Redstone, 896 N.E.2d 595 (Mass. 2008), the court held that the plaintiffs had failed to prove that any oral trust ever existed.
Comment: Edward reluctantly agreed to his children’s trusts to settle litigation, and Sumner’s transfers to trusts for his children were admittedly “voluntary.” Nothing more is needed to justify the different outcome in their gift tax cases. But there is still something unsettling about treating these two brothers so differently. Whatever reason there was in 1972 for Edward to accede to, or even for Mickey to assert, an “oral trust” in 1959, it seems that it would have been just as compelling a justification for Sumner to acknowledge such an “oral trust” also, because there is no reason in the Tax Court opinions to assume that in 1959 Mickey did not intend to treat all his grandchildren equally. One can only wonder if the outcome for Sumner would have been different if he had just made other gifts in the third quarter of 1972 and reported those gifts on a gift tax return.
Or one can only wonder what the result would have been if the alleged “oral trusts” for Mickey’s grandchildren had actually been formalized and funded in 1959. The best estate planning is often the planning that is done early. The book values the Tax Court appears to have relied on indicate a total value for NAI in 1959 of about $70,000.
Number Nine: Developments with Crummey Powers: Mikel v. Commissioner, T.C. Memo 2015-64 (April 6, 2015); Administration’s Budget Proposals (Feb. 2, 2015)
And as a third possible development, although it wouldn’t affect the Mikels’ 2007 gifts, the Obama administration’s budget-related revenue proposals would significantly limit the effectiveness of Crummey withdrawal powers. The “General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals” (March 4, 2014), at pages 170-71, and the “General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals” (Feb. 2, 2015), at pages 204-05, include a proposal to “Simplify Gift Tax Treatment for Annual Gifts.” The General Explanations (popularly called “Greenbooks”) note the compliance costs of Crummey powers, including the costs of giving notices, keeping records, and making retroactive changes to the donor’s gift tax profile if an annual exclusion is disallowed, as well as the enforcement costs to the IRS. They also lament the IRS’s lack of success in combating the proliferation of Crummey powers, especially in the hands of persons not likely to ever receive a distribution from the trust, in Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991), and Kohlsaat v. Commissioner, T.C. Memo 1997-212. If its 60 Crummey powers are ultimately upheld, Mikel is likely to be added to that list.
Although the proposal states that it “would eliminate the present interest requirement for gifts that qualify for the gift tax annual exclusion,” what it actually proposes is to limit the annual exclusion (currently $14,000 per donee) to outright gifts, gifts to “tax-vested” trusts exempt from GST tax under section 2642(c)(2), and “a new category of transfers,” up to $50,000 per donor per year, that some interpreted in 2014 to be allowed without tapping into the donor’s $14,000-per-donee annual exclusions. That interpretation was repudiated by a new sentence in the 2015 Greenbook: “This new $50,000 per-donor limit would not provide an exclusion in addition to the annual per-donee exclusion; rather, it would be a further limit on those amounts that otherwise would qualify for the annual per-donee exclusion.” Thus, the compliance burdens of identifying donees would not be eliminated after all, and drafting to take advantage of the $50,000 (indexed) category could be more complex, not less. (The 2015 Greenbook also added that the proposed limit of $50,000 would be indexed for inflation.)
Comment: Although there is little reason to expect this Greenbook proposal to be enacted, the proposal, along with the Mikel decision, does illustrate the continued frustration of Treasury and the IRS with at least some uses of Crummey powers.
Number Eight: Continued Erosion of the Power of States to Tax Trust Income: Kimberly Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue, 12 CVS 8740 (N.C. Sup’r Ct. April 23, 2015); Residuary Trust A u/w/o Kassner v. Director, Division of Taxation, 2015 N.J. Tax LEXIS 11, 2015 WL 2458024 (N.J. Sup’r Ct. App. Div. May 28, 2015), aff’g 27 N.J. Tax 68 (N.J. Tax Ct. Jan. 3, 2013)
Kaestner: In Kaestner, discussed in more detail in our Legal Alert of May 1, 2015, the Superior Court of Wake County, North Carolina, held North Carolina’s income tax on the taxable income of a trust for the benefit of a North Carolina resident unconstitutional as applied to a trust created by a New York resident for the benefit of his descendants. One of the trust beneficiaries had moved to North Carolina. But a New York resident was the trustee, all trust records were maintained in New York, the custodian of the trust investments was in Boston, the trust tax returns were prepared in New York, the trustee did not travel to North Carolina, the trustee did not make any distributions to the North Carolina beneficiary, and the beneficiary could not compel the trustee to make a distribution. The court held that the tax, as applied to this trust in which the trustee had no connections with North Carolina, violates both the due process and commerce clauses of the U.S. Constitution.
Kassner: The trust in Kassner was created by the will of a New Jersey resident who died in 1998. New Jersey law defines a resident trust for income tax purposes to include “a trust, or a portion of a trust, consisting of property transferred by the will of a decedent who at his death was domiciled in this state.” During the tax year at issue (2006), the sole trustee resided in New York and administered the trust outside of New Jersey. The trustee filed a return and paid New Jersey tax only on income of S corporations attributable to the corporations’ activity in New Jersey. The New Jersey Tax Court rejected the New Jersey Division of Taxation’s contention that the trust was taxable on all undistributed income because it held assets in New Jersey, holding that the trust cannot be deemed to own assets in New Jersey merely because it was a shareholder in S corporations that own New Jersey assets.
Comment: These decisions are limited. Kaestner is being appealed by the North Carolina Department of Revenue. Further, while the trust sought a determination that the statute is unconstitutional on its face, the court ruled only that it is unconstitutional as applied to this trust. In Kassner, the appellate court relied as much on New Jersey’s published advice as on constitutional grounds, leaving open the possibility that the result would be different if the instructions and advice had been different. But these cases still represent a continuation of, not a retreat from, the recent trend of limiting a state’s power to tax nonresident trusts. See, for example, Linn v. Department of Revenue, 2013 Ill. App. 4th 121055 (Dec. 18, 2013), and McNeil v. Commonwealth of Pennsylvania, Pa. Comm. Court, No. 651 F.R. 2010, 173 F.R. 2011 (May 24, 2013).
Number Seven: More Flexibility in the Support and Administration of Charities: Protecting Americans from Tax Hikes Act of 2015; Notice 2015-62, 2015-39 I.R.B. 411; Green v. United States, 116 AFTR 2d 2015-6668 (W.D. Okla. Nov. 4, 2015)
Comment: The result in Green might be surprising to some, because, as the government argued, gross income indeed does not include unrealized appreciation. But allowing a deduction of fair market value puts the trust in the same position as if it had sold the property and donated the cash proceeds, while allowing a charitable donee to receive property it can use for its charitable purposes, which at least for some of the transfers was evidently the case in Green.
Trust Decanting: A new Uniform Trust Decanting Act (UTDA) was approved by the National Conference of Commissioners on Uniform State Laws (“Uniform Law Commission”) at its annual conference in Williamsburg, Virginia, July 10-16, 2015. The Act generally allows decanting whenever the trustee has discretion to make principal distributions, or even if the trustee does not have such discretion if it is appropriate to decant into a special-needs trust. UTDA imposes no duty to decant, but requires that, if decanting is done, it must be done in accord with fiduciary duties. Decanting requires notice to beneficiaries, but not court approval, although a fiduciary or beneficiary may ask a court to provide instructions or relief. Generally decanting may not add beneficiaries, and it may not increase the trustee’s compensation without approval of beneficiaries or a court. In addition, UTDA includes extensive explicit safeguards, called “tax-related limitations,” to prevent decanting from jeopardizing any intended beneficial tax treatment of the trust.
The 2011-2012 Treasury-IRS Priority Guidance Plan included, as item 13 under the heading of Gifts and Estates and Trusts, “Notice on decanting of trusts under §§2501 and 2601.” This project was new in 2011-2012, but it had been anticipated for some time, at least since the publication at the beginning of 2011 of Rev. Proc. 2011-3, 2011-1 I.R.B. 111, in which new sections 5.09, 5.16, and 5.17 included decanting among the “areas under study in which rulings or determination letters will not be issued until the Service resolves the issue through publication of a revenue ruling, revenue procedure, regulations or otherwise.” Rev. Proc. 2016-3, 2016-1 I.R.B. 126, §§5.01(11), (16) & (17), continues this designation. On December 20, 2011, the IRS published Notice 2011-101, 2011-52 I.R.B. 932, asking for comments from the public on the tax consequences of decanting transactions. Notice 2011-101 also “encourage[d] the public to suggest a definition for the type of transfer (‘decanting’) this guidance is intended to address” and encouraged responses to consider the contexts of domestic trusts, the domestication of foreign trusts, and transfers to foreign trusts. The Notice also said that the IRS “generally will continue to issue PLRs with respect to such transfers that do not result in a change to any beneficial interests and do not result in a change in the applicable rule against perpetuities period.” There were extensive public comments, and there is no doubt that Treasury and the IRS have continued to study decanting. But decanting was omitted from the 2012-2013 Plan and has been omitted again from the 2013-2014, 2014-2015, and 2015-2016 Plans.
Comment: The publication of UTDA should now pave the way for the long-awaited tax guidance for decantings done under UTDA or substantially identical statutes. And because of the care to avoid tax problems that UTDA exhibits, that guidance should not be as hard to complete or as harsh in its application as many might have feared.
Digital Assets: In January 2012, the Uniform Law Commission authorized the formation of a drafting committee to write model legislation authorizing fiduciaries to access, manage, copy, and delete digital assets. The committee developed a Uniform Fiduciary Access to Digital Assets Act (UFADAA), which the ULC approved at its July 2014 annual meeting in Seattle. Despite introductions and discussions of UFADAA in many states, Delaware is the only state that adopted that version of UFADAA. Indeed, the Delaware legislature had enacted the final draft version of UFADAA even before the July 2014 ULC meeting, and the governor of Delaware signed it into law later in 2014. In other states, enactment of UFADAA was opposed and effectively blocked by a coalition of internet providers and advocates for personal rights and privacy, in many cases by the use of exaggerated horror stories of the breaches of privacy that UFADAA would allow. Some internet service providers even developed and promoted their own very harsh alternative to UFADAA, the Privacy Expectation Afterlife Choices Act (PEAC Act, pronounced “peace act”).
Comment: As RUFADAA catches on among the states, it will behoove estate planners and other advisers to structure estate plans and draft estate planning documents, as well as recommend user actions with respect to service contracts, that will be consistent with RUFADAA and will ensure the orderly transition of necessary access when a user dies or becomes incapacitated or missing.
Section 303 of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Public Law 111-312 (“the 2010 Tax Act”), signed into law on December 17, 2010, authorized the portability of the federal estate tax and gift tax unified credit between spouses. Temporary regulations (T.D. 9593, 77 Fed. Reg. 36150 (June 18, 2012)) and identical proposed regulations (REG-141832-11, 77 Fed. Reg. 36229) were released on Friday, June 15, 2012, just barely 18 months after the enactment of the 2010 Tax Act. Section 7805(b) generally prohibits such regulations from being retroactive, with an exception, in section 7805(b)(2), for regulations issued within 18 months of the enactment of the statute to which they relate, so these temporary regulations just made it and were retroactive to January 1, 2011, when portability took effect. Public comments on the proposed regulations were invited by September 17, 2012, and a public hearing, if requested, was scheduled for October 18, 2012, but no one asked for a hearing and the hearing was cancelled. The final regulations, very similar to the temporary and proposed regulations, were released on June 12, 2015. T.D. 9725, 80 Fed. Reg. 34279 (June 16, 2015). Under section 7805(e)(2), the temporary regulations would have expired after three years, on June 15, 2015, so again the final regulations just made it.
Comment: It is clear that in the intended target case of a married couple with a home, modest tangible personal property, bank account, and perhaps an investment account – all possibly jointly owned – and life insurance and retirement benefits payable to the survivor, the requirements for electing portability have been made relatively manageable, especially considering that the surviving spouse is likely to be the “non-appointed executor” in possession of all the property and therefore the right person to make the portability election. What may be a surprise to the original advocates of portability, including the lawmakers who voted for it, is the degree of “portability planning” in much larger estates.
Comment: The social implications of Obergefell are greater than this short discussion and even its Number Four placement would indicate, and there are complex open issues related to the intersection of the Obergefell result with other liberties, such as religious liberty, and also testamentary freedom. Some of these are included in the discussion of Windsor as item Number Two in the 2013 Top Ten and in our Alert of July 8, 2015, on the Obergefell decision. The two principal implications for estate planning are a short-term acceleration of the transitional issues, including retroactivity, that emerge whenever there is a change like this from one definition to another, and a long-term increase in uniformity and thus in simplification.
This legislation resembles legislative proposals in the Treasury Department’s annual “General Explanations” of revenue proposals associated with the Obama Administration’s budget proposals (“Greenbooks”), including a proposal on pages 195-96 of the 2015 Greenbook. Unlike the Greenbook proposals, however, what Congress enacted applies only to property acquired from a decedent, not to gifts, and, under section 1014(f)(2), applies “only … to any property whose inclusion in the decedent’s estate increased the liability for the tax imposed by chapter 11 (reduced by credits allowable against such tax) on such estate.” In other words, the new consistency rule apparently does not apply to property that passes to a surviving spouse or to charity, or to property that does not pass to the surviving spouse but is reported on an estate tax return filed only to elect portability. (Oddly, there is no corresponding exception to the reporting requirement of section 6035.)
Comment: This notice looks like about the best that could be done in the new form to permit the blast of value information to all beneficiaries long before the recipients of particular assets are identified that the statute seems to require, without unnecessarily alarming or misleading the beneficiaries.
But new leadership in the House of Representatives seems to have had at least a modest effect. The Consolidated Appropriations Act, 2016, enacted on December 18, 2015, and mentioned in the discussion of Number Seven, is an example. There seemed to be more “regular order” participation of lawmakers and committees than we have seen in recent years, and the spending appropriations remained on the basis of the regular fiscal year, rather than ad hoc “fiscal cliffs.” Perhaps as a result, the votes were more bipartisan than we are accustomed to. In the Senate, the final vote was 65-33, with 27 Republicans and 38 Democrats (including one Independent) in favor. The final vote in the House of Representatives was 316-113, with 150 Republicans and 166 Democrats in favor. The final House vote, however, included spending that some Republicans had resisted; a vote in the House the day before, focusing on the tax provisions, had been 318-109, with 241 Republicans and only 77 Democrats in support. The overall impression was one of some compromise, leaving almost everyone unenthusiastic about something; not as robust a compromise as may have been expected a few decades ago, but providing some reason for optimism for the budget process in 2016 – possibly with a budget resolution early in the year and “reconciliation” of the input of many committees later in the summer or early fall.
Comment: Elements of the changes in House leadership with potential implications for tax policy include a Speaker, Congressman Paul Ryan (R-WI), who had briefly been the chair of the Ways and Means Committee, and a new chair of the Ways and Means Committee, Congressman Kevin Brady (R-TX), who has been outspoken about his opposition to the estate tax. It was Congressman Brady who had introduced the Death Tax Repeal Act of 2015 (H.R. 1105), which the House of Representatives approved by a largely party-line vote on April 16, 2015, permanently repealing the estate and GST taxes, retaining the gift tax with a 35 percent rate and an exemption of $5 million indexed for inflation, and retaining a date-of-death-value basis for transfers at death (despite the absence of an estate tax). Certainly his assumption of the chair of the committee somewhat increases the chances of estate tax repeal, but it would be wrong to jump to conclusions about that. Estate tax repeal remains a politically complex issue, and it is not at all clear that the present or future House leadership would be willing to spend its political capital on this objective rather than others, whether in packaging a repeal to avoid a presidential veto or in positioning it to get 60 votes for a Senate cloture motion.
Davidson: In the Davidson case, the decedent had engaged in estate planning transactions, including gifts, substitutions, a five-year GRAT, sales for five-year balloon notes at the applicable federal rate, and sales for five-year balloon self-canceling installment notes (SCINs). The decedent at that time was 86, and his actuarial life expectancy was about five years. He lived for 50 days after making the last transfer and received no payments on the sales. Addressing the sales both in Chief Counsel Advice 201330033 (Feb. 24, 2012), and in its answer in the Tax Court, the IRS believed the notes should be valued, not under section 7520, but under a willing-buyer-willing-seller standard that took account of the decedent’s health. The IRS assessed combined gift and estate tax deficiencies and penalties of about $2.6 billion. On July 6, 2015, the case was settled for just over $550 million.
Woelbing Cases: In the Woelbing cases, the decedent had sold nonvoting stock for a promissory note with a principal amount of $59 million (the appraised value of the stock) and interest at the applicable federal rate (AFR). The purchaser was a trust that owned insurance policies under a split-dollar arrangement with the company. Two of the decedent’s sons, who were beneficiaries of the trust, gave their personal guarantees, apparently for 10 percent of the purchase price. The sale agreement provided for the number of shares sold to be adjusted if the IRS or a court revalued the stock. In its notice of deficiency, the IRS basically ignored the note, essentially treating it as equity rather than debt, and doubled the value of the stock to about $117 million. The IRS ignored the note for estate tax purposes too, but included the value of the stock, which it asserted to then be about $162 million, in the decedent’s gross estate under sections 2036 and 2038. Finally, the IRS asserted gift and estate tax negligence and substantial underpayment penalties. After a rumored settlement apparently fell through, the Tax Court rescheduled the trial for February 29, 2016. That trial date has been cancelled and now the parties are ordered to file status reports in January 2016. If the case does not settle, the Tax Court might be obliged to address the effectiveness of the value adjustment clause, the substance of the notes, the appropriate interest rate and value for the notes, and the possible reliance on life insurance policies and/or guarantees to provide “equity” in the trust to support the purchase.
Legislative Proposals: Meanwhile, the “General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals” (Feb. 2, 2015) (“Greenbook”), at pages 197-99, include a legislative proposal to tighten the tax treatment of all sales to grantor trusts, as did the 2012, 2013, and 2014 Greenbooks. The current proposal would subject to gift or estate tax the portion of any grantor trust that is attributable to property received from a person in “a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person’s treatment as a deemed owner of the trust.”
Administrative Guidance: Finally the Treasury-IRS Priority Guidance Plan for the 12 months beginning July 1, 2015 (released on July 31, 2015), contains 277 projects (down from 317 in 2014), including 12 projects under the heading of “Gifts and Estates and Trusts” (up from 10 in 2014). Four of those projects (an ambitious number) are new in 2015. Item 1 (page 13) is “Guidance on qualified contingencies of charitable remainder annuity trusts under §664.” Item 3 (page 13) is “Guidance on basis of grantor trust assets at death under §1014.” Item 5 (page 13) is “Guidance on the valuation of promissory notes for transfer tax purposes under §§2031, 2033, 2512, and 7872.” And Item 8 (page 14) is “Guidance on the gift tax effect of defined value formula clauses under §§2512 and 2511.” The objective of Item 1, regarding charitable remainder trusts, is not clear. Item 3, regarding basis, might be aimed at trusts created by non-U.S. persons, but it might also have implications for domestic grantor trusts. Items 5 and 8, regarding promissory notes and defined value clauses, sound almost tailored to the facts of Davidson and Woelbing.
Comment: The point is that grantor trusts, including transactions with promissory notes and even defined value clauses, have received a lot of attention from the IRS in recent years, highlighted by the addition in 2015 of multiple guidance projects in the Priority Guidance Plan. On top of that, regulations under section 2704(b)(4) affecting valuation discounts for interests in closely held corporations, partnerships, and similar entities have been the subject of an unprecedented amount of attention and speculation in 2015, even though section 2704(b)(4) has been in the Code since 1990 and this regulations project has been in the Priority Guidance Plan since 2003. No lawyer or other observer has seen all the variations of estate planning techniques using grantor trusts, promissory notes, and valuation formulas. But the IRS has seen many of them. And this surge of IRS interest and activity probably means the IRS sees a lot of variations it does not like.