Court Opinion

ID: 4332849
Source: CourtListenerOpinion
Date Created: 2018-11-14 00:54:01.447192+00
Date Added: 2024-06-11T14:46:52.587402
License: Public Domain

115 T.C. No. 2

                 UNITED STATES TAX COURT

 WILLIAM A. AND GAYLE T. COOK, DONORS, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No.   257-99.                    Filed July 25, 2000.

     H and W, husband and wife, each created two trusts
intended to qualify as grantor retained annuity trusts
(GRAT’s) under sec. 2702, I.R.C. The grantor in each
trust retained an annuity for a stated number of years.
If the grantor dies before the expiration of the stated
term of years and is survived by a spouse, the annuity
continues for the spouse until the earlier of his or
her death or the expiration of an additional specified
term. If the grantor dies before the expiration of the
stated term of years and is not survived by a spouse,
the term of the annuity ends upon the death of the
grantor.

     In each trust, the grantor has reserved the power
to revoke the interest of the spouse.

     Ps contend that the value of the remainder
interest in each GRAT, of which the grantor made a
taxable gift, is the value of the transfer in trust,
reduced by the actuarially determined value of a dual-
life annuity under sec. 7520, I.R.C. R contends that
                               - 2 -

     the remainder value is to be calculated by deducting
     the actuarially determined value of a single-life
     annuity.

           Held: Because the spousal interests in each GRAT
     are not fixed and ascertainable at the inception of the
     GRAT and are therefore contingent, and because the
     retained interests in each GRAT may extend beyond the
     shorter of a term of years or the period ending upon
     the death of the grantor, the retained interests in the
     GRAT’s are to be valued as single-life annuities. See
     secs. 25.2702-3(d)(3) and 25.2702-2(a)(5), Gift Tax
     Regs.

     George N. Harris, Jr., and Juan D. Keller, for petitioners.

     Stewart Todd Hittinger, for respondent.

                              OPINION

     NIMS, Judge:   This matter is before the Court on the

parties’ cross-motions for partial summary judgment, filed

pursuant to Rule 121.   The parties seek a summary adjudication

regarding the same matter; i.e., the proper application of

section 2702 to four grantor retained annuity trusts (GRAT’s).

There is no genuine issue of material fact to preclude a decision

on such matter.   We therefore proceed to decide the legal issues

that the parties’ motions present.

     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code, as amended, and all Rule

references are to the Tax Court Rules of Practice and Procedure.
                                - 3 -

                              Background

     Petitioners resided in Bloomington, Indiana, at the time

their petition was filed with the Court.

     The following is a summary of the relevant facts.   They are

stated solely for the purpose of deciding the pending cross-

motions for partial summary judgment, and they are not findings

of fact for this case.   See Fed. R. Civ. P. 52(a); Rule 1(a).

     The Creation of the Trusts

     On June 7, 1993, petitioner William A. Cook (Mr. Cook)

created the William A. Cook 1993 grantor retained annuity trust

and transferred 12,600 shares of Class A common stock of Cook

Group, Inc., to such trust.    On the same day, petitioner Gayle T.

Cook (Mrs. Cook) created the Gayle T. Cook 1993 grantor retained

annuity trust and transferred 12,600 shares of Class A common

stock of Cook Group, Inc., to such trust.

     On August 30, 1995, Mr. Cook created the William A. Cook

1995 grantor retained annuity trust and transferred 14,360 shares

of Class A common stock of Cook Group, Inc., effective August 31,

1995, to such trust.   On the same day, Mrs. Cook created the

Gayle T. Cook 1995 grantor retained annuity trust and transferred

11,300 shares of Class A common stock of Cook Group, Inc.,

effective August 31, 1995, to such trust.

     Petitioners were named as cotrustees for each of the GRAT’s.

Each GRAT also provides that it is intended to be a grantor
                               - 4 -

retained annuity trust, paying a qualified annuity interest under

section 2702(b)(1), and that the trust instrument should be

interpreted accordingly.   Further, each GRAT specifies that the

trustee shall amend the trust if necessary to satisfy the

requirements of the law in order to ensure that the annuity

interest qualifies as a qualified annuity interest under section

2702(b).

     The 1993 GRAT’s

     Each of the 1993 GRAT’s provides for annual payments equal

to 23.999 percent of the initial value of the trust corpus,

referred to in each GRAT as the Annuity Amount.     The Annuity

Amount is to be paid to the grantor for a term of 5 years or

until the grantor’s earlier death.     During that time, no

distribution of trust income or principal may be made to any

other person.

     Each of the 1993 GRAT’s also provides that if the grantor

survives the 5-year term, then the remaining trust property shall

be used to establish a separate trust for the grantor’s son.

However, if the trust ends by reason of the grantor’s death

before the expiration of the 5-year term, all remaining trust

property shall be disposed of under a Contingent Marital Annuity

Trust (CMAT) intended to qualify for the Federal estate tax

marital deduction for the grantor’s estate.     Under the CMAT, the

grantor’s spouse will receive any Annuity Amount that would have
                               - 5 -

been paid to the grantor if the grantor had survived the

remainder of the 5-year term of the GRAT.   Upon the earlier of

the expiration of the 5-year term or the death of the grantor’s

spouse, the remaining trust assets will be used to establish a

separate trust for the grantor’s son.

     Mr. Cook’s 1993 GRAT provides that Mrs. Cook would have

certain powers to appoint income and principal of the GRAT to and

among the grantor’s son, Carl, members of his family, “and

Charities”, but that any exercise of such powers would not take

effect unless Mr. Cook survived the term of the GRAT.   Mr. Cook’s

1993 GRAT also provides that Mrs. Cook would have certain powers

of appointment with respect to the income and principal of the

CMAT, but the GRAT mandates that no distributions may be made

from the CMAT to any other person during the life of Mrs. Cook.

     Mrs. Cook’s 1993 GRAT provides that Mr. Cook would have

certain powers of appointment with respect to the income and

principal of the CMAT, but the GRAT also states that no

distributions may be made from the CMAT to any other person

during the life of Mr. Cook.

     Each of the 1993 GRAT’s is irrevocable in all respects

except that the grantor retains the right to revoke the

designation of his or her spouse as the successor annuitant.    If
                                - 6 -

the grantor should revoke the spouse’s designation as the

successor annuitant, then the terms of the trust agreement are to

be applied as if the spouse had predeceased the grantor.

     The 1995 GRAT’s

     Each of the 1995 GRAT’s provides for annual payments,

referred to as the Annuity Amount, to be paid to the grantor

during the Annuity Term.   The Annuity Term for Mr. Cook’s 1995

GRAT is 3 years, and the Annuity Term for Mrs. Cook’s 1995 GRAT

is 5 years.   In the case of Mr. Cook’s 1995 GRAT, the Annuity

Amount is the fair market value of the initial assets of such

trust as of the date of transfer, as finally determined for

Federal tax purposes, multiplied by .3175, .3810, and .4572, for

year 1 through year 3, respectively.    In the case of Mrs. Cook’s

1995 GRAT, the Annuity Amount is the fair market value of the

initial assets of such trust as of the date of transfer, as

finally determined for Federal tax purposes, multiplied by

.168940, .202728, .2432736, .2919283, and .3503139, for year 1

through year 5, respectively.

     Each of the 1995 GRAT’s provides that during the Annuity

Term of the trust no distribution of trust income or principal

may be made to any person other than the grantor.

     If the grantor of each 1995 GRAT survives the Annuity Term,

then any remaining trust property, after payment of the Annuity

Amount, shall be used to establish a separate trust for the
                               - 7 -

grantor’s son.   If, however, either of the 1995 GRAT’s ends by

reason of the death of the grantor and the grantor is survived by

his or her spouse, then the remaining trust property shall be

disposed of under a CMAT.

     Each of the 1995 GRAT’s provides for annuity payments under

the CMAT to the grantor’s spouse, referred to as Spousal Annuity

Amounts, for the shorter of a term of years (3 years under Mr.

Cook’s 1995 GRAT and 5 years under Mrs. Cook’s 1995 GRAT) after

the grantor’s death or until the spouse’s earlier death.   The

Spousal Annuity Amount that would be payable to the grantor’s

spouse under the CMAT during the initial 3 years under Mr. Cook’s

1995 GRAT and during the initial 5 years under Mrs. Cook’s 1995

GRAT is the same “Annuity Amount that would have been determined

with respect to * * * [the grantor] if * * * [the grantor] had

survived.”   Under the CMAT provisions, no distributions may be

made from the CMAT to any other person during the spouse’s life.

The spouse has a testamentary power of appointment with respect

to any remaining trust property, including any remaining payments

of the Spousal Annuity Amount or of income.

     Each 1995 GRAT is irrevocable except that the grantor

retains the right to revoke the designation of his or her spouse

as the successor annuitant.   If the grantor revokes the spouse’s
                                 - 8 -

designation as the successor annuitant, then the terms of the

trust agreement are to be applied as if the spouse had

predeceased the grantor.

     Petitioners’ Gift Tax Returns

     Each petitioner timely filed a Federal gift tax return for

the taxable years 1993 and 1995.    Each petitioner reported the

value of the transfers to their respective GRAT’s by subtracting

from the value of the transferred property the value of an

annuity based on two lives successively; i.e., the value of a

stream of fixed annual payments for the shorter of either a term

of years (5 years for both of the 1993 GRAT’s and Mrs. Cook’s

1995 GRAT, and 3 years for Mr. Cook’s 1995 GRAT) or a period

ending upon the death of the last to die of the grantor and the

grantor’s spouse.

     The Notices of Deficiency

     Respondent issued notices of deficiency to Mrs. Cook for the

taxable years 1993 and 1995 determining deficiencies in Federal

gift taxes in the amounts of $2,789,609 and $4,850,271,

respectively.   Respondent issued notices of deficiency to Mr.

Cook for the taxable years 1993 and 1995 determining deficiencies

in Federal gift taxes in the amounts of $3,271,125 and

$4,446,282, respectively.   A portion of the deficiency for each

year and for each petitioner is attributable to respondent’s

analysis of the retained annuity in each trust, and a
                                - 9 -

determination that the value of the annuity retained by each

grantor should be calculated based on the shorter of a fixed term

or the earlier death of the grantor.

                              Discussion

I.   General Rules

     Section 2501 imposes a tax for each calendar year on the

transfer of property by gift by any taxpayer.    Pursuant to

section 2512, the value of the transferred property as of the

date of the gift “shall be considered the amount of the gift”.

Generally, where property is transferred in trust but the donor

retains an interest in such property, the value of the gift is

the value of the property transferred, less the value of the

donor’s retained interest.    See sec. 25.2512-5A(e), Gift Tax

Regs.; sec. 25.2512-5T(d)(2), Temporary Gift Tax Regs., 64 Fed.

Reg. 23224 (Apr. 30, 1999).    However, if the gift in trust is to

a family member (as defined in section 2704(c)(2)), the value of

the gift is determined subject to the limitations of section

2702.   See id.

     In the case at bar, petitioners assert that each grantor’s

retained interest is to be valued as a single annuity based on

two lives, referred to as a dual-life annuity.    Respondent

asserts that each grantor’s retained interest is to be valued as

a single-life annuity.   Valuation of a retained interest as a

dual-life annuity produces a greater retained value than
                                - 10 -

valuation as a single-life annuity, and correspondingly reduces

the amount of the taxable gift of the remainder.     Respondent

disagrees with this result.

     As pertinent herein, section 2702 provides:

     SEC. 2702.    SPECIAL VALUATION RULES IN CASE OF
                   TRANSFERS OF INTERESTS IN TRUSTS.

          (a) Valuation Rules.--

               (1) In general.--Solely for purposes of
          determining whether a transfer of an interest in
          trust to (or for the benefit of) a member of the
          transferor’s family is a gift (and the value of
          such transfer), the value of any interest in such
          trust retained by the transferor or any applicable
          family member * * * shall be determined as
          provided in paragraph (2).

                  (2) Valuation of retained interests.--

                       (A) In general.--The value of any
                  retained interest which is not a qualified
                  interest shall be treated as being zero.

                       (B) Valuation of qualified interest.--
                  The value of any retained interest which is a
                  qualified interest shall be determined under
                  section 7520 [providing for use of valuation
                  tables prescribed by the Secretary for
                  annuities, life interests, etc.].

                  (3) Exceptions.--

                       (A) In general.--This subsection shall
                  not apply to any transfer--

                            (i) if such transfer is an
                       incomplete gift,

                       *    *    *    *    *    *    *

                       (B) Incomplete gift.--For purposes of
                  subparagraph (A), the term “incomplete gift”
                  means any transfer which would not be treated
                              - 11 -

                as a gift whether or not consideration was
                received for such transfer.

          (b) Qualified Interest.--For purposes of this
     section, the term “qualified interest” means--

               (1) any interest which consists of the right
          to receive fixed amounts payable not less
          frequently than annually,

               (2) any interest which consists of the right
          to receive amounts which are payable not less
          frequently than annually and are a fixed
          percentage of the fair market value of the
          property in the trust (determined annually), and

               (3) any noncontingent remainder interest if
          all of the other interests in the trust consist of
          interests described in paragraph (1) or (2).

     Beyond the definitions of “qualified interest” contained in

section 2702(b), regulations promulgated under section 2702

define, and expand, “qualified interest” in the following manner:

     Qualified interest means a qualified annuity interest,
     a qualified unitrust interest, or a qualified remainder
     interest. Retention of a power to revoke a qualified
     annuity interest (or unitrust interest) of the
     transferor’s spouse is treated as the retention of a
     qualified annuity interest (or unitrust interest).
     [Sec. 25.2702-2(a)(5), Gift Tax Regs.; emphasis added.]

     A “qualified annuity interest” is “an irrevocable right to

receive a fixed amount”, “payable to (or for the benefit of) the

holder of the annuity interest for each taxable year of the

term.”   Sec. 25.2702-3(b)(1)(i), Gift Tax Regs.   A fixed amount

is either a stated dollar amount or a fixed fraction or

percentage (not to exceed 120 percent of the fixed fraction or

percentage payable in the preceding year) of the initial fair
                              - 12 -

market value of the property transferred to the trust as finally

determined for Federal tax purposes.   See sec. 25.2702-

3(b)(1)(ii), Gift Tax Regs.   In either case, a fixed amount must

be payable periodically but not less frequently than annually.

See id.

      The trust instrument must also prohibit distributions from

the trust to or for the benefit of any person other than the

holder of the qualified annuity interest during the term of the

qualified interest.   See sec. 25.2702-3(d)(2), Gift Tax Regs.

The term of the annuity interest must be fixed by the trust

instrument for the life of the term holder, for a specified term

of years, or for the shorter (but not the longer) of those

periods.   See sec. 25.2702-3(d)(3), Gift Tax Regs.

      For purposes of section 2702, a transfer of an interest in

property with respect to which there are one or more term

interests is treated as a transfer in trust.   See sec.

2702(c)(1).   A term interest is one of a series of successive (as

contrasted with concurrent) interests.   See sec. 25.2702-4(a),

Gift Tax Regs.

II.   Application

      As previously stated, section 2702 contains special

valuation rules for transfers of interests in trusts to family

members.   In this case, we proceed on the assumption that each

trust creates interests which consist of the right to receive
                             - 13 -

fixed amounts which are payable at least annually, as required by

section 2702(b)(1), and that the remainder interest created for

the son (a “member of the family” under sections 2702(e) and

2704(c)(2)), is noncontingent, as required by section 2702(b)(3).

Consequently, the value of any interest retained by the grantor

or “any applicable family member” must be determined under the

special valuation rules of section 2702.    As provided in section

2702(a)(2)(A), the value of any retained interest “which is not a

qualified interest shall be treated as being zero.”

     Respondent agrees that each grantor’s retained annuity to

the extent it is for a term of years or the grantor’s earlier

death constitutes a qualified interest.    Respondent, however,

challenges the provision of each trust which continues the

annuity for the spouse, if the spouse survives the grantor, for

the remaining term of the trust or until the spouse’s earlier

death.

     We agree with respondent that as to each trust, the interest

retained in favor of the grantor’s spouse, whether viewed as an

independent interest or as an expansion of the grantor’s

interest, is not qualified and therefore must be valued at zero.

Thus, we reject petitioners’ contention that they are entitled to

value each grantor’s retained interest as an annuity based on two

lives.
                                - 14 -

     We first consider the nature of the spousal interests

themselves.    In the trusts before us, the spousal interests are

contingent upon surviving the grantor, so they may never take

effect.   We, however, do not believe section 2702 permits a

transferor to reduce the value of a remainder interest by the

simple expedient of assigning a value to a retained interest

which may, in fact, never take effect.

     As indicated above, the regulations provide that “The

governing instrument must fix the term of the annuity or unitrust

interest.”    Sec. 25.2702-3(d)(3), Gift Tax Regs.   We construe

this language to require that the term be fixed and ascertainable

at the creation of the trust.    The regulations contain two

examples which illustrate this requirement, as follows:

        Example 5. A transfers property to an irrevocable
     trust, retaining the right to receive 5 percent of the
     net fair market value of the trust property, valued
     annually, for 10 years. If A dies within the 10-year
     term, the unitrust amount is to be paid to A’s estate
     for the balance of the term. A’s interest is a
     qualified unitrust interest to the extent of the right
     to receive the unitrust payment for 10 years or until
     A’s prior death.

        Example 6. The facts are the same as in Example 5,
     except that if A dies within the 10-year term the
     unitrust amount will be paid to A’s estate for an
     additional 35 years. The result is the same as in
     Example 5, because the 10-year term is the only term
     that is fixed and ascertainable at the creation of the
     interest. [Sec. 25.2702-3(e), Example (5) and Example
     (6), Gift Tax Regs.]
                               - 15 -

     In each of these examples, only the retained interest for

the shorter of a term of years or the transferor’s life is fixed

and ascertainable at the creation of the interest, and is

therefore a qualified interest under section 2702.   In Example

(5) and Example (6) above, the unitrust interests that may be

paid to A’s estate are both contingent upon A’s death before the

completion of the 10-year fixed term, and are therefore not

qualified interests.   In the trusts before us, the spousal

interests are not fixed and ascertainable at the creation of the

trusts but, rather, are contingent in each case upon the spouse’s

surviving the grantor.   For this reason, the spousal interests

are not qualified interests and therefore must be valued as zero

under section 2702(a)(2)(A).

     Legislative history reflects that Congress was “concerned

about potential estate and gift tax valuation abuses”,

specifically, “undervaluation of gifts valued pursuant to

Treasury tables.”   136 Cong. Rec. S15629, S15680-S15681 (daily

ed. Oct. 18, 1990).    As explained by the lawmakers in the context

of trusts and term interests in property:   “Because the taxpayer

decides what property to give, when to give it, and often

controls the return on the property, use of Treasury tables

undervalues the transferred interests in the aggregate, more
                              - 16 -

often than not.”   Id. at S15681.   Hence, a statute was enacted

which Congress intended would “deter abuse by making unfavorable

assumptions regarding certain retained rights.”    Id. at S15680.

     This congressional purpose is advanced by a rule which

ensures that only value that is fixed and ascertainable at the

creation of the trust, and therefore is not contingent, may

reduce the value of the gift of the remainder.    In contrast, if

gifts in trust may be reduced by the value of spousal interests

which are contingent and which in fact never take effect, the

retained interests have the potential for overvaluation and the

gift of the remainder for undervaluation.    We are satisfied that

such would be contrary to the intent of section 2702.

     Moreover, even if we were to assume that the spousal

interests here, standing alone, were qualified, the retained

annuities to the extent based on two lives would fail to achieve

qualified status for an additional reason.    As previously noted,

the regulations provide that retention of a power to revoke a

qualified annuity interest (or unitrust interest) of the

transferor’s spouse is treated as the retention of a qualified

annuity interest (or unitrust interest).    See sec. 25.2702-

2(a)(5), Gift Tax Regs.   In each of the trusts under scrutiny,

however, if the interest over which the grantor has retained a

power to revoke is treated as an interest retained by the

grantor, the requirement of section 25.2702-3(d)(3), Gift Tax
                                - 17 -

Regs., that the term of the annuity must be the lesser of a term

of years or the life of the term holder has not been met.     Under

the trust terms the spousal interests create the possibility that

the retained annuity will extend beyond the life of the term

holder; i.e., the grantor.    Section 25.2702-3(d)(3), Gift Tax

Regs., precludes this result.

     In contrast, the regulations contain examples of how

revocable spousal annuity or unitrust interests may meet the

standards of qualified interests under section 2702(b)(1) and

sections 25.2702-1 and 25.2702-2, Gift Tax Regs.    Section

25.2702-2(d)(1), Example (6) and Example (7), Gift Tax Regs.

(hereinafter Examples 6 and 7), demonstrates both how a revocable

spousal interest may be properly fixed and ascertainable and how

the total retained interest of the grantor and spouse may satisfy

the durational requirement.    Examples 6 and 7, which illustrate

petitioners’ noncompliance with these standards, are as follows:

        Example 6. A transfers property to an irrevocable
     trust, retaining the right to receive the income for 10
     years. Upon expiration of 10 years, the income of the
     trust is payable to A’s spouse for 10 years if living.
     Upon expiration of the spouse’s interest, the trust
     terminates and the trust corpus is payable to A’s
     child. A retains the right to revoke the spouse’s
     interest. Because the transfer of property to the
     trust is not incomplete as to all interests in the
     property (i.e., A has made a completed gift of the
     remainder interest), section 2702 applies. A’s power
     to revoke the spouse’s term interest is treated as a
     retained interest for purposes of section 2702.
     Because no interest retained by A is a qualified
     interest, the amount of the gift is the fair market
     value of the property transferred to the trust.
                              - 18 -

        Example 7. The facts are the same as in Example 6,
     except that both the term interest retained by A and
     the interest transferred to A’s spouse (subject to A’s
     right of revocation) are qualified annuity or unitrust
     interests. The amount of the gift is the fair market
     value of the property transferred to the trust reduced
     by the value of both A’s qualified interest and the
     value of the qualified interest transferred to A’s
     spouse (subject to A’s power to revoke).

     In Example 6, the transfer of property to the trust is not

incomplete as to all interests in the property and section 2702

therefore applies (i.e., the gift of the remainder is a completed

gift), but the retained interests--both A’s and the spouse’s--are

nevertheless not qualified interests because the retained rights

are rights to receive trust income, not annuity or unitrust

amounts.

     Conversely, in Example 7, A’s interest and the revocable

spousal interest are deemed to meet the requirements for

qualified status.   Under section 25.2702-2(a)(5), Gift Tax Regs.,

A’s power to revoke the spouse’s interest is treated as an

interest retained by A.   The interests of both A and his or her

spouse, at the creation of the trust, are fixed and

ascertainable, and not contingent upon A’s death.   A is deemed to

have retained interests, the total term of which is 20 years.

Both interests are thus properly taken into account in valuing

the remainder.

     Therefore, because the spousal interests in each GRAT in the

case before us are not fixed and ascertainable at the inception
                             - 19 -

of the GRAT, and are therefore contingent, and because the

retained interests may extend beyond the shorter of a term of

years or the period ending upon the death of the grantor, we hold

that the retained interests in the trusts at issue here are to be

valued as single-life annuities.    See secs. 25.2702-3(d)(3) and

25.2702-2(a)(5), Gift Tax Regs.    We sustain respondent’s

determinations to that effect.

     We have considered other arguments made by the parties, and

to the extent not addressed, we find them to be unconvincing,

irrelevant, or moot.

     To reflect the foregoing,

                                          An Order will be issued

                                     denying petitioners’ Motion

                                     for Partial Summary Judgment

                                     and granting respondent’s

                                     Motion for Partial Summary

                                     Judgment.