Recent developments in estate planning.
This article is Part II of a two-part article that examines
developments 1 in
and compliance between June 2011 and
May 2012. Part I, in the September issue, discussed developments
regarding gift tax and trusts, an outlook on estate tax reform, and
annual inflation adjustments for 2011 relevant to estate, gift, and
generation-skipping transfer (
Greenwich sidereal time
(in Australia, New Zealand, and Canada) Goods and Services Tax
) tax. This article covers developments
in estate tax.
Portability of Exemption
The Tax Relief, Unemployment Insurance Reauthorization, and Job
Creation Act of 2010 (1) permits for the first time portability of the
estate tax exemption between spouses so that a surviving spouse may use
the unused estate tax exemption of the first-to-die spouse. If made
permanent, this provision would eliminate the need for spouses to
retitle property and create trusts solely to take full advantage of each
spouse’s estate tax exemption. Currently, this provision is
effective if the first spouse dies after Dec. 31, 2010, and the second
spouse makes gifts or dies before Jan. 1, 2013.
For a surviving spouse to use the deceased spouse’s unused
estate tax exemption, Sec. 2010(c)(5)(A) provides that the
n. the person appointed to administer the estate of a person who has died leaving a will which nominates that person. Unless there is a valid objection, the judge will appoint the person named in the will to be executor.
the deceased spouse must file an estate tax return (Form 706,
officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world’s third largest country in population and the fourth largest country in area.
Estate (and Generation-Skipping Transfer) Tax Return) that
computes the unused estate tax exemption and makes the portability
election. Notice 2011-82 (2) provides guidance on making the election.
Because it is assumed that married couples will want to make the
portability election, Notice 2011-82 provides that by timely filing a
properly prepared and complete Form 706, an estate is considered to have
made the portability election without the need to make an affirmative
statement, check a box, or otherwise affirmatively elect. If the estate
does not want to make the portability election, it can do so by not
filing Form 706. However, if an estate is obligated or chooses to file
Form 706, the instructions for Form 706 provide that the executor can
either attach a statement to Form 706 indicating that the
decedent’s estate is not making the election under Sec. 2010(c)(5)
or enter “No Election under Section 2010(c) (5)” across the
top of the first page of Form 706.
Note: On June 18, 2012, temporary (T.D. 9593) and identical
proposed (REG-141832-11) regulations were issued
and providing guidance on the portability of the deceased spouse’s
unused exemption (DSUE) amount. These regulations address various
aspects of making the portability election and of using the DSUE amount
by the surviving spouse.
Generally the value of property includible in a decedent’s
gross estate is its fair market value (
) on the date of the
decedent’s death. Two special valuation provisions may be
elected–under Sec. 2032, to value the property on the alternate
valuation date (
AVD Academy of Veterinary Dentistry
AVD Audio Video Design
AVD Audio Video Data
AVD Association des Volontaires pour le Développement
), and under Sec. 2032A, to value real estate used in
farming or another business based on its special use, rather than its
highest and best use. Reproposed regulations were issued to limit the
availability of the alternate valuation date provision, and a district
court declared invalid a provision of the special use valuation
Alternate Valuation Date
A decedent’s estate may elect to use the AVD if that date
results in a valuation of the decedent’s estate that is lower than
its date-of-death valuation and results in a combined estate and
generation-skipping transfer (GST) tax liability that would have been
less than such liability on the decedent’s date of death. For
property that is distributed, sold, or otherwise exchanged within six
months of a decedent’s date of death, the AVD is the date of the
distribution, sale, or exchange (the transaction date). For all other
property includible in a decedent’s gross estate, the AVD is the
date that is six months after the decedent’s date of death (the
In 2008, the
issued proposed regulations (3) under Sec. 2032 in
an attempt to change the result in situations similar to Kohler, (4) in
which the Tax Court held that valuation discounts attributable to
restrictions imposed on
stock pursuant to a post-death
reorganization of the
closely held company
should be taken into
consideration in valuing the stock on the AVD. On Nov. 18, 2011, these
regulations were withdrawn and reproposed. (5)
The reproposed regulations would amend Regs. Sec. 2032-1 (c) to
identify transactions that require the use of the transaction date for
purposes of Sec. 2032 (nine types of transactions are listed). If an
estate’s property is subject to such a transaction during the
alternate valuation period, the estate must value that property on the
transaction date. The value included in the gross estate is the FMV of
the property on the date of and immediately before the transaction.
Two exceptions to this general rule would allow the estate to use
the six-month rule. One exception is for exchanges of interests in the
same or different entities provided the FMVs of the interests before and
after the exchange are deemed to be equal. The other exception is for
distributions from a business entity, bank account, or retirement
account in which the
held an interest at death provided the FMV
of the interest immediately before the distribution equals its FMV
immediately after plus the amount of the distribution.
Special Use Valuation
One of the statutory requirements to qualify for the special use
valuation is contained in Sec. 2032A (b)(1) (B), which provides that 25%
of the estate must consist of real property used in farming or another
trade or business. Regs. Sec. 20.2032A-8 (a)(2) provides that while a
Sec. 2032A election need not be made for all property that qualifies for
the election, the property for which the election is made must meet the
25% threshold requirement in Sec. 2032A (b)(1)(B). In Finfrock, (6) more
than 25% of the total value of the gross estate consisted of real estate
used in a farming business, but the estate chose to make the special use
valuation election for only one piece of farmland that, by itself,
represented 15% of the total value of the gross estate. The issue before
the district court was whether the regulation is a valid interpretation
of the statute.
The district court applied the Chevron (7) test to determine
whether Congress has directly spoken to the precise question at issue.
If the intent of Congress is clear, both the court and the agency must
give effect to the expressed intent of Congress. If the statute is
silent or ambiguous about the particular issue, a court must then
determine whether the agency’s interpretation is based on a
construction of the statute.
The district court noted that Sec. 2032A does not require that the
election be made for real property constituting 25% or more of the value
of the gross estate. The 25%-or-more requirement is only a threshold
requirement in order to be able to make the election. Once the threshold
is met, the only other requirement to qualify the property for the
election is to designate the property in a tax
n. in income tax, the requirement that the taxpayer pay the amount of tax savings from past years due to accelerated depreciation or deferred capital gains upon sale of property. (See: income tax)
court concluded that Congress did not require that the designation be of
all or a certain percentage of the real property that otherwise meets
the requirements of Sec. 2032A, so the statute unambiguously provides
that an estate can elect the special use valuation for any portion of
the property that qualifies. Noting that Regs. Sec. 20.2032A-8(a) (2)
imposes an additional requirement to make an election under Sec. 2032A
that is not included in the statute, the court ruled that the regulation
Inclusion of Gift Tax
Sec. 2035 (b) includes in a decedent’s gross estate for estate
tax purposes the amount of gift tax paid by the decedent or the
decedent’s estate on any gift made by the decedent or the
decedent’s spouse during the three years prior to the
decedent’s death. In Estate of
, (8) the Ninth Circuit
affirmed the Tax Court’s decision that gift tax paid within three
years of the decedent’s death on transfers of her interests in a
) trust established upon the
death of her husband was includible in her gross estate under Sec. 2035.
When the decedent’s husband died, an election was made under
Sec. 2056(b) (7) to treat the trust created at his death as a
A marital-deduction trust in which the surviving spouse receives income from the trust’s assets for life but the trust’s principal is left to someone else, usually children.
. Thus, an estate tax
n. when one spouse dies, the survivor may take a tax deduction of half of the value of the estate of the dying spouse. Thus, the minimum value of the estate before there is a possible federal estate tax rises from $600,000 to $1,200,000 at the death
on the husband’s
estate tax return was allowed for the property passing to the trust,
and, when the wife died, the value of the trust would be includible in
the wife’s gross estate under Sec. 2044. Inclusion in the transfer
tax base of the surviving spouse is the
quid pro quo
for allowing the
marital deduction to the estate of the first spouse to die. If the
surviving spouse attempts to terminate a QTIP trust during his or her
life by giving away the income interest, the value of the income
interest is subject to gift tax under Sec. 2511. In addition, Sec. 2519
provides that the surviving spouse is considered to make a gift of the
remainder interest in the property. Sec. 2207A authorizes the surviving
spouse to recover from the person who receives the remainder interest in
the trust the amount of gift tax attributable to the deemed transfer of
the remainder interest.
The decedent made a gift of the income interest, and the trust paid
the resulting gift tax on the transfer of the remainder interest. The
Ninth Circuit agreed with the Tax Court’s conclusion that the
surviving spouse is considered to be the deemed owner of the QTIP and as
such bears the gift tax liability associated with the transfer of the
QTIP. Sec. 2207A does not operate to shift the liability for the gift
tax to the remainder beneficiaries but rather allows the surviving
spouse the right to recover the gift tax from them.
Surviving spouses who do not need the income interest generated by
QTIP trusts may want to give away the income interest during life to
take advantage of the tax-exclusive nature of the gift tax (as opposed
to the tax-inclusive nature of the estate tax). Based on this decision,
the surviving spouse has to live more than three years after the
transfer for this technique to work. Unless the surviving spouse is
, there is nothing lost in trying to
tr.v. out·lived, out·liv·ing, out·lives
1. To live longer than:
three-year period and potentially a lot to gain.
Family Limited Partnerships
The IRS has continued to attack the viability of family limited
partnerships (FLPs) in the estate planning context, usually under Sec.
2036. Sec. 2036 (a) pulls assets that are transferred by a decedent
during his or her lifetime back into the gross estate if the decedent
continued to derive a benefit from the assets and/or continued to
control the beneficial enjoyment of the assets. An exception applies if
the transferred assets are part of a “bona fide sale for adequate
and full consideration in money or money’s worth”(the
“bona fide sale” exception).
In determining whether the exception applies, courts apply the
Bongard (9) test, which requires that: (1) there is a legitimate and
significant nontax reason for creating the
FLP Front de Libération de la Palestine
FLP Fasting Lipid Profile
; and (2) the transferors
receive interests in the FLP
Being in due proportion; proportional.
tr.v. pro·por·tion·at·ed, pro·por·tion·at·ing, pro·por·tion·ates
To make proportionate.
to the value of their
transferred property. Taxpayers who satisfy the Bongard test and follow
n. pl. for·mal·i·ties
1. The quality or condition of being formal.
2. Rigorous or ceremonious adherence to established forms, rules, or customs.
are successful. The IRS, however, is successful
when taxpayers have failed to follow the partnership formalities. In one
case, the facts were so bad that the assets the decedent had transferred
to the FLP were included in her gross estate under Sec. 2033 as assets
she owned at death.
In Estate of Lockett, (10) the decedent’s ex-daughter-in-law
and an estate attorney advised her to establish an FLP with her two
Articles of incorporation
were filed to establish an FLP, but no
decisions were made about what percentage membership each family member
would hold, what assets would be transferred, or even who the members
would be. Finally, a couple of years later, the decedent and a trust
created for her benefit by her deceased husband transferred assets to
the FLP, and the sons claimed they were the general partners.
The Tax Court found that the sons never had an interest in the FLP
because they never contributed assets to the FLP, were not gifted
interests by the decedent, and did not perform services for the FLP in
exchange for interests. A valid partnership was initially formed because
of transfers by two parties to the FLP–the decedent and the trust
created for her benefit. However, prior to her death, the trust was
terminated, and all its assets were transferred to the decedent. At that
point the decedent owned 100% of the interests in the FLP, and the
partnership terminated under local law. The decedent thereafter was the
legal owner of all the assets in the FLP, and
1. As stated or indicated by; on the authority of:
2. In keeping with:
the Tax Court
the assets were includible in her gross estate under Sec. 2033.
In Estate of Turner (Turner I), (11) the decedent and his wife had
accumulated a significant amount of wealth mainly through a family
business, but also held a significant amount of stock in a regional bank
as well as various other marketable securities and real estate. With the
assistance of one of their grandsons, the couple met with estate
planning attorneys who suggested the creation of an FLP to hold the
couple’s investment assets. Shortly thereafter the couple
transferred approximately $8.7 million in cash and marketable securities
to the FLP, while retaining more than $2 million in assets to meet their
living expenses. Over a two-year period before the decedent’s
death, the decedent and his wife gifted limited interests in the FLP to
their surviving children and the two children of their predeceased
The court determined that none of the three reasons advanced by the
estate for the creation of the FLP was a legitimate and significant
nontax reason for its creation. As to the contention that the FLP would
allow the couple’s assets to be managed under a more active and
formal investment strategy, the court concluded that the asset
management did not change in a meaningful way, as the FLP continued to
hold assets contributed to the FLP. As to the contention that the FLP
would facilitate resolution of family disputes, the court found that the
reason for family
See also Confusion.
demon of discord. [Occultism: Jobes, 93]
discord, apple of
caused conflict among goddesses; Trojan War ultimate result. [Gk. Myth.
had nothing to do with money. As to the
contention that the FLP would protect the family assets and the
decedent’s wife from a grandson (who had an addiction problem) and
protect the grandson from himself, the court concluded that the creation
of the FLP did little to protect the decedent’s wife, as she still
had access to assets not transferred to the FLP to give to her troubled
grandson, and the FLP added no more protection for the grandson than the
trust that had already been created to help him.
In addition, the court cited the following reasons indicating the
transfers were not bona fide sales: (1) The decedent stood on both sides
of the transaction, as there was no meaningful bargaining with the
decedent’s wife or other anticipated limited partners;(2) the
decedent commingled personal and partnership funds; and (3) the transfer
of assets to the FLP was not completed until eight months after the
creation of the FLP. Because there was not a legitimate and significant
nontax reason for the decedent’s transfers to the FLP, the court
concluded that the bona fide sale exception did not apply.
The Tax Court concluded that under Sec. 2036 (a) (1) there was an
express agreement that the decedent would continue to enjoy the assets
transferred to the FLP because (1) the FLP agreement provided that the
general partners would receive a reasonable management fee, but the fee
the couple chose to receive was not reasonable given their involvement
with the management of the FLP; and (2) the FLP agreement could be
amended by the general partners at any time without the consent of the
limited partners. The court also concluded that there was an implied
agreement because of (1) the failure to sell a large block of bank stock
due to the couple’s sentimental attachment to it; (2) the receipt
of management fees from the FLP for no services and the taking of
distributions from the FLP at will; (3) the
of personal and
partnership funds; (4) the
Out of proportion, as in size, shape, or amount.
distributions from the FLP;
and (5) the creation of the FLP as a testamentary device given the role
it played in the decedent’s estate planning.
The Tax Court concluded that, under Sec. 2036 (a) (2), the decedent
retained the right to designate who would control the income from the
FLP because the decedent (1) was,
for all intents and purposes
, the sole
general partner and the FLP agreement gave him broad authority to manage
FLP assets; (2) had the sole discretion to make FLP distributions; (3)
could amend the FLP agreement without the consent of the limited
partners; and (4) effectively owned more than 50% of the FLP at his
death (taking into consideration his wife’s interests) and,
therefore, could make any decision requiring a majority vote of the
limited partners. Having determined that the bona fide sale exception
had not been met and that the decedent retained the enjoyment of and
control over the assets he transferred to the FLP, the court determined
that the FMV of the assets he transferred to the FLP were includible in
It seems that this case may have gone the other way if it was
decided by a different judge. Nonetheless, this case reflects the
IRS’s continuing success challenging FLPs even though there is a
large body of law creating a blueprint for how to properly structure and
operate an FLP to withstand an IRS challenge. The factors cited in this
case as to why the taxpayer lost are similar to factors cited in prior
The estate then sought to claim an increased marital deduction
based on the formula clause in the decedent’s will to avoid the
imposition of estate tax on the underlying transferred assets in the
gross estate. In Estate of Turner (Turner II), (12) the Tax Court
addressed the problems created for a normal estate plan by the inclusion
in the decedent’s gross estate of assets given away during the
decedent’s lifetime to persons other than the decedent’s
spouse. Although assets underlying the FLP interests transferred as
gifts during the decedent’s life are included in the gross estate
under Sec. 2036, neither those assets nor the corresponding FLP
interests pass to the surviving spouse. Therefore, the estate was not
tr.v. re·cal·cu·lat·ed, re·cal·cu·lat·ing, re·cal·cu·lates
To calculate again, especially in order to eliminate errors or to incorporate additional factors or data.
the marital deduction to include the FLP
interests transferred to persons other than the spouse or the assets
underlying those transferred interests.
In Estate of Liljestrand, (13) the decedent owned (through his
) interests in numerous pieces of real estate. Most of
the real estate was directly managed by local companies, but the
decedent’s son provided overall management of all the properties.
The decedent wanted to leave his property equally to his four children
but wanted to ensure that the one son would continue to manage the
property. On the advice of his estate planning attorney, he formed an
FLP and transferred his real estate to the FLP in return for a 99.98%
interest, with his son receiving the rest. Later, the decedent gifted
some FLP interests to trusts established for the benefit of each of his
Even after the creation of the FLP and the transfer of the real
estate to the FLP, the parties continued to treat the real estate as if
it was owned directly by the decedent’s revocable trust. The FLP
did not have a bank account for the first two years of its existence and
did not file partnership tax returns. Rather, the income from the real
estate was reported directly on the decedent’s income tax return.
His son continued to manage the real estate just as he had done before
the FLP’s creation. Because the decedent had transferred almost all
his assets to the trust, his retained assets were insufficient to pay
his personal expenses. After it obtained its own bank account, the FLP
made disproportionate distributions to the decedent and in some
instances directly paid his personal expenses.
The Tax Court determined that none of the three reasons advanced by
the estate for the FLP’s creation was a legitimate and significant
nontax reason. As to the claim that the FLP allowed the son to
v. cen·tral·ized, cen·tral·iz·ing, cen·tral·iz·es
1. To draw into or toward a center; consolidate.
his management of the real estate, the court concluded that
the son managed the real estate both before and after it was transferred
to the FLP, so nothing changed. As to the claim that the FLP would
ensure that the real estate would not be subject to
division under Hawaii law, the court concluded that because most of the
real estate was not located in Hawaii, the Hawaii statutes did not
apply; that no inquiry was made into the laws of the states in which the
real estate was located before the FLP’s creation; that after the
decedent’s death the children had only beneficial interests in the
trusts and would not have had outright ownership of the real estate; and
that there was no evidence that the children had any interest in seeking
a partition. As to the claim that the FLP would protect the real estate
from creditors, the court concluded that there was no evidence of any
concern about potential creditors.
The Tax Court then cited the following reasons indicating that the
transfers were not bona fide sales: (1) The FLP failed to follow even
the most basic partnership formalities–no bank account for the first
two years, only one partnership meeting, direct payment of
decedent’s personal expenses, disproportionate distributions, and
the decedent’s financial dependence on FLP distributions; and (2)
the decedent was on both sides of the transaction, and there was no
arm’s-length bargaining. The court next determined that there was
not adequate and full consideration for the transactions because (1) the
interests credited to each partner were not proportionate to the FMV of
the assets each partner contributed to the FLP and (2) the contributions
of each partner were not properly credited to their capital accounts. As
a result of this analysis, the court concluded that the bona fide sale
exception did not apply.
The Tax Court concluded that, under Sec. 2036 (a) (1), there was an
implied agreement that the decedent retained enjoyment of the assets
transferred to the FLP because there was no change in the
decedent’s relationship with the assets once the assets were
contributed to the FLP. The decedent received a disproportionate share
of the partnership distributions, engineered a guaranteed payment from
the FLP equal to the FLP’s expected annual income, and benefited
from the sale of the partnership assets to repay his own personal loan.
Having determined that the bona fide sale exception had not been met and
that the decedent retained the enjoyment of and control over the assets
he transferred to the FLP, the court determined that the FMV of the
assets he transferred to the FLP were includible in his gross estate.
This is another case in which partnership formalities were not followed,
generating predictably disastrous results for the estate.
In Estate of Kelly, (14) the decedent, after the death of her
husband, owned two quarries, rental real estate, and stocks and bonds.
The quarries and the rental real estate required active management,
which the decedent’s husband had done while he was alive, and which
was taken over by their children after his death. The decedent developed
, degenerative disease of nerve cells in the cerebral cortex that leads to atrophy of the brain and senile dementia.
, and eventually a court appointed the children
Before that and without knowing what was in the decedent’s
will, the children signed a settlement agreement under which the
decedent’s estate would be distributed equally among the children.
Once they received a copy of the will, they realized that because of
uneven appreciation in the value of the decedent’s assets and the
acquisition of additional stock, the will no longer provided equally for
the children. The children then signed a second settlement agreement
agreeing to honor all the specific bequests to anyone who was not a
child and then to distribute the remainder equally among the children.
The children began to be concerned about potential liability for
the real estate after a lawsuit was filed against the decedent when a
dump truck going to the quarry was involved in an accident resulting in
significant injuries and bullets were found in a campsite at the
decedent’s rural property that also contained a large
a sudden unsupported drop in a stream. It is formed when the stream course is interrupted as when a stream passes over a layer of harder rock—often igneous—to an area of softer and therefore more easily eroded rock; the edge of a cliff or
picnic facilities. The children consulted an estate planning lawyer who
discussed the nature of the decedent’s assets; the difficulty
managing the assets as guardians; their desire that each child share
equally in the decedent’s estate; and the liability concerns for
the real estate.
The proposed plan was for the decedent, acting through her
guardians and with court approval, to create FLPs and transfer her
assets to them while retaining
amounting to $1.1 million.
Over the next three years, the decedent made gifts of FLP interests to
the children and their
. After the creation of the FLPs, the
decedent’s expenses were paid by the funds retained in her
guardianship account. Each of the children provided services to the FLPs
and received a management fee.
The Tax Court determined that the decedent’s primary desire
was to ensure her assets were equally distributed to her children and to
over the estate, which was also the purpose of the
settlement agreements the children signed. In addition, the decedent was
legitimately concerned about the effective management of and potential
liability for her assets. The court noted that any prudent person would
want these assets to be managed in the form of an entity. It determined
that because the decedent had valid nontax reasons to contribute
property to the FLPs, had received FLP interests equal in value to the
assets she contributed, and her contributions were properly credited to
her capital account, the value of the property transferred to the FLPs
was not includible in her gross estate under Sec. 2036 (a)
The IRS also argued that the FLP interests transferred by gift to
the children and their descendants should be includible in the
decedent’s gross estate under Sec. 2036 (a) because there was an
implied agreement that the decedent would continue to enjoy the income
from the FLPs. The Tax Court disagreed. It noted that the decedent
respected the FLPs as separate and distinct legal entities, observed
partnership formalities, and retained sufficient assets for personal
needs. The court also concluded that the decedent did not retain the
income from the FLPs merely because the corporate general partner, of
which she owned 100% of the stock, was paid a management fee. The Tax
Court stated that the IRS’s position would require the court to
disregard the corporation’s existence, the general partner’s
, and the partnership agreements–which the court would
In Estate of Stone, (15) the decedent and her husband owned 740
acres of mostly undeveloped woodlands. Their son acquired real estate
near the woodlands parcel and executed an agreement with the local water
company to construct a dam on his property in exchange for using a
portion of his property for a water treatment plant. The construction of
the dam created a man-made lake, and a portion of the woodland parcels
was now lakefront property. The decedent and her husband decided they
wanted the woodland parcels to become a family asset with the hope that
eventually the family would be able to develop and sell homes near the
lake. But before the land could be developed, some issues needed to be
resolved. The shallow soil depth would make it difficult to connect
sewage systems for any potential homes near the lake. In addition, the
water company’s operations significantly reduced the level of the
lake water during the summer months.
In 1997, the decedent and her husband formed an FLP to hold and
manage the woodland parcels. Over a three-year period, the decedent and
her husband transferred all the limited FLP units to their 21 children,
children’s spouses, and grandchildren. Thereafter, the decedent and
her husband each owned a 1% general FLP interest. The decedent died in
2005. At the time of the 2011 trial, the FLP had yet to develop or
otherwise improve the woodlands parcels.
The Tax Court determined that the decedent’s desire to have
the woodlands parcels held and managed as a family asset so the family
could work together to develop and sell homes near the lake constituted
a legitimate and significant nontax reason for creating the FLP. The IRS
pointed to some instances in which the partnership formalities were not
followed, namely: (1) To settle a divorce proceeding, two of the
children quitclaimed their interests in the real estate rather than
transferring FLP interests; (2) there was some inadequate documentation
for the FLP; and (3) the decedent and her husband paid the $700 annual
real property taxes out of their personal funds each year.
The Tax Court listed other factors that supported the estate’s
contention that a bona fide sale occurred: (1) The decedent and her
husband did not depend on distributions from the FLP as no distributions
were ever made; (2) the decedent and her husband actually transferred
the woodlands parcels to the FLP; (3) there was no commingling of FLP
and personal funds; (4) no discounts were claimed in valuing the FLP
interests for gift tax purposes; and (5) the decedent and her husband
were in good health at the time the FLP was created. The decedent lived
eight years after its creation and was healthy enough to teach
institution for instruction in religion and morals, usually conducted in churches as part of the church organization but sometimes maintained by other religious or philanthropic bodies.
In England during the 18th cent.
the Sunday before she died, and her husband, even though he was
over 80 when the FLP was created, was still alive at the time of the
The Tax Court next determined that the full and adequate
consideration criteria had been met because, having concluded that the
decedent had a legitimate nontax purpose for transferring the woodland
parcels to the FLP, the transaction was not merely an attempt to change
the form in which the decedent held the parcels.
Retained Graduated Interest
The IRS issued final regulations (16) in 2008 providing that when a
transfers property to a trust and retains an annuity, unitrust,
or income interest for life, the amount includible in the grantor’s
gross estate under Sec. 2036 is the portion of the trust corpus
necessary to generate a return sufficient to pay the grantor’s
interest. Left unanswered in those regulations was the portion of the
trust includible if the grantor’s
time. For example, the retained annuity interest in a grantor retained
annuity trust (
) each year may be 120% of the previous year’s
The final regulations the IRS issued in November 2011 address the
issue of the graduated retained interest. (18) The basic premise in
determining the portion of the trust subject to inclusion is that the
trust portion must be sufficient to generate the income necessary to pay
off the retained amount for the entire period over which the retained
interest is payable without reducing or
v. in·vad·ed, in·vad·ing, in·vades
1. To enter by force in order to conquer or pillage.
principal. As an
example, if a decedent dies with three years remaining on the term of
the GRAT, the portion of the trust includible in the decedent’s
gross estate would be the corpus necessary to generate income sufficient
to pay the current annuity amount for the remaining three years plus the
corpus necessary to generate income sufficient to pay the increases in
the annuity amount, taking into account the delay in time for which the
increases will be paid. The amount of the trust includible under this
mathematical formula cannot exceed the FMV of the trust on the valuation
date for federal estate tax purposes. When the retained interest is
payable to the decedent’s estate after the decedent’s death,
the final regulations specifically provide that payments that become
payable to the decedent’s estate after the decedent’s death
(as opposed to payments that are payable to the decedent before the
decedent’s death, which are not paid until after) are not subject
to inclusion under Sec. 2033, if Sec. 2036 is applied to include all or
a portion of the trust corpus in the gross estate.
Substitution Power Over Life Insurance Policy
Many trusts are grantor trusts because the grantor or another
person has the power under Sec. 675 (4) (C) to reacquire trust property
by substituting other property of an equivalent value in a nonfiduciary
capacity. There has always been a concern about whether this
substitution power would cause the trust’s assets to be included in
the grantor’s gross estate under Sec. 2036, 2038, or 2042.
That matter was partially addressed in Rev. Rul. 2008-22, (19)
which concludes that a grantor’s power, exercisable in a
nonfiduciary capacity, to acquire property held in a trust by
substituting property of equivalent value will not, by itself, cause the
value of the trust’s assets to be includible in the grantor’s
estate under Sec. 2036 or 2038. The revenue ruling, however, did not
address the application of Sec. 2042 to situations where a
held life insurance policies on the life of the grantor.
Rev. Rul. 2011-28 (20) addresses the Sec. 2042 issue. Under the
facts of the revenue ruling, a grantor establishes an
for the benefit of his descendants with cash. The trust uses the cash to
purchase a life insurance policy on the grantor’s life. The terms
of the trust prohibit the grantor from serving as trustee of the trust.
The grantor makes gifts every year to the trust, and the trust pays the
premium on the insurance policy. The proceeds of the policy are payable
to the trust upon the grantor’s death. The terms of the trust give
the grantor the power, in a nonfiduciary capacity, to reacquire any
property held in the trust by substituting other property of an
The revenue ruling concludes that the grantor’s retention of
the substitution power will not, by itself, cause the value of the
insurance policy to be includible in the grantor’s gross estate
under Sec. 2042. However, the revenue ruling requires (similar to the
requirements in Rev. Rul. 2008-22) that (1) the trustee have a fiduciary
obligation to ensure the grantor’s compliance with the terms of the
power of substitution by satisfying itself that the property acquired
and the property substituted by the grantor are of equivalent value; and
(2) the power of substitution cannot be exercised in a manner that
shifts benefits among trust beneficiaries. It further states that a
power of substitution will not be deemed to be exercised in a manner
that can shift benefits among trust beneficiaries if (1) the trustee has
both a power to
tr.v. re·in·vest·ed, re·in·vest·ing, re·in·vests
To invest (capital or earnings) again, especially to invest (income from securities or funds) in additional shares.
trust corpus and a duty of
Not partial or biased; unprejudiced. See Synonyms at fair1.
trust beneficiaries; or (2) the nature of the trust’s investments
or level of income produced by any or all of the trust’s
investments does not affect the beneficiaries’ respective
Claims Against the Estate
Under Sec. 2053 (a), the value of the taxable estate is determined
by deducting certain amounts, including administration expenses and
claims against the estate, from the value of the gross estate. Estate of
Duncan (21) addressed the deductibility of interest on a loan to pay
estate taxes, while Rev. Proc. 2011-48 (22) provides guidance on filing
protective claims for refund for contested or contingent claims against
the estate that are unresolved when the estate tax return is filed.
In Duncan, the decedent’s estate, held in a revocable trust
prior to death, consisted primarily of interests in partnerships that
owned oil and gas businesses and commercial real estate. The trust sold
all its marketable assets but still needed substantial additional cash
to pay its expenses and estate taxes. The trust borrowed money from a
trust created for the decedent’s benefit by his father. The loan
called for interest at the rate a bank said was the current market rate
(a rate in excess of the applicable federal rate (
AFR Air France
AFR Alternate Frame Rendering
AFR Applicable Federal Rate
) but less than
prime). All interest and principal on the loan were due in 15 years and
could not be
tr.v. pre·paid, pre·pay·ing, pre·pays
To pay or pay for beforehand.
. The estate deducted the interest on the loan as an
administrative expense under Sec. 2053.
In dismissing the IRS’s first challenge that the loan was not
a bona fide debt, the Tax Court stated that the IRS’s argument
ignored federal tax law and state law. Even though the same individual
and bank were the trustees of both the decedent’s trust and the
father’s trust, they were required by state law to maintain the two
trusts as separate entities and, therefore, would be required to demand
repayment of the loan from the decedent’s trust to the
father’s trust. In addition, there is no basis in federal tax law
to treat the two trusts as a single trust.
As for whether the loan was actually and reasonably necessary, the
Tax Court concluded that the loan was necessary to avoid the
decedent’s trust’s selling of
assets (either the
partnership interests or the underlying illiquid assets in the
partnership). In Estate of Black, (23) the case the IRS relied on in
making its argument, the decedent’s estate borrowed money from an
FLP that, to raise cash, had sold its marketable securities. That
situation was not present in this case because the father’s trust
was able to lend the decedent’s estate money without such a sale.
The Tax Court also concluded that the terms of the loan were reasonable
in part because the volatility of the oil and gas business meant there
was no assurance that a shorter term would have been workable and
because the use of the lower AFR would not have been a true
representation of the decedent’s trust’s cost of borrowing.
Because the loan was a bona fide debt, the interest expense was actually
and necessarily incurred in the administration of the estate, and the
amount of interest was ascertainable with reasonable certainty, the Tax
Court held that the estate was
tr.v. en·ti·tled, en·ti·tling, en·ti·tles
1. To give a name or title to.
2. To furnish with a right or claim to something:
v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.
2. To derive by deduction; deduce.
the interest expense
under Sec. 2053.
This strategy is often used by an estate if it can obtain a loan at
a reasonable rate. It works best if the loan comes from the same
economic unit (i.e., an entity owned by the decedent’s estate). The
estate tax benefit results from the ability to deduct the interest on
the decedent’s estate tax return. This strategy is generally
preferable to the deferral/installment method of estate tax payment
allowed under Sec. 6166 because the interest paid under Sec. 6166 is not
on the decedent’s estate tax return. However, this
strategy generally does not work if the decedent’s estate has
sufficient liquid assets to pay the estate tax when it is due, because
the IRS will challenge the loan as unnecessary and the courts generally
agree with the IRS in those situations (see, e.g., Estate of Stick
Rev. Proc. 2011-48
To determine the value of claims against the estate, final
regulations (25) issued in October 2009 adopt
on the premise
that an estate may deduct only amounts actually paid in settlement of a
claim. Because the amount ultimately payable may not be known when the
estate tax return is filed, the estate may need to file a protective
claim for refund. Rev. Proc. 2011-48 provides guidance on filing such
Under Rev. Proc. 2011-48, the estate must file the protective claim
for refund before the expiration of the period of limitation–generally
within three years after the return was filed or two years after the
estate tax was paid, whichever is later. For estates of decedents dying
on or after Jan. 1, 2012, the claim may be filed by attaching Schedule
PC to Form 706. Schedule PC is a new schedule and is expected to be
available as part of the 2012 Form 706.
In the alternative, Form 843, Claim for Refund and Request for
Abatement, may be filed in the same location where Form 706 was filed
see arithmetic and musical notation.
How a system of numbers, phrases, words or quantities is written or expressed. Positional notation is the location and value of digits in a numbering system, such as the decimal or binary system.
at the top of the first page, stating “Protective
Claim for Refund under Section 2053.” The estate must file a
separate protective claim for each claim or expense for which a
deduction may be claimed in the future under Sec. 2053 and must include
considerable detail concerning the claim or expense.
The IRS will provide written
in law, formal declaration or admission by a person who executed an instrument (e.g., a will or a deed) that the instrument is his. The acknowledgment is made before a court, a notary public, or any other authorized person.
that the claim has been
received. If the estate does not receive such an acknowledgment, the
fiduciary is required to
v. in·quired, in·quir·ing, in·quires
1. To seek information by asking a question:
whether the IRS received and processed
the protective claim within 180 days of filing the claim on Schedule PC
of Form 706 or within 60 days of filing the claim on Form 843. A
Uninsured first-class mail for which proof of delivery is obtained.
(US) n →
receipt or other evidence of delivery of the form to the
IRS is not sufficient to ensure and confirm the IRS’s receipt and
processing of the protective claim.
Within 90 days after the claim or expense is actually paid or
becomes certain and no longer subject to any contingency, whichever
occurs late; the fiduciary must notify the IRS that the protective claim
for refund is now ready for consideration. The notification may be made
by filing a supplemental Form 706 or Form 843.
RELATED ARTICLE: EXECUTIVE SUMMARY
* To use the portability election, which allows a spouse to use the
unused estate tax exemption of the first spouse to die, the estate of
the first spouse to die must file an estate tax return.
* Property in an estate is usually valued on the date of the
decedent’s death. Other valuation methods that may apply include
the alternate valuation date and the special use valuation. The IRS
reproposed regulations that would limit the use of the alternate
valuation date, and a district court ruled that a regulation regarding
when a taxpayer can make the special use valuation election was invalid.
* Family limited partnerships (FLPs) are popular tools to remove
assets from decedents’ estates through lifetime transfers. The IRS,
however, is aggressive in challenging the use of FLPs to create estate
tax benefits. In a number of cases, taxpayers successfully withstood IRS
challenge by demonstrating nontax reasons for forming the partnerships.
(1.) The Tax Relief, Unemployment Insurance Reauthorization, and
Job Creation Act of 2010, P.L. 111-312
(2.) Notice 2011-82, 2011-42 I.R.B. 516.
(3.) REG-112196-07, 73 Fed. Reg. 22300 (4/25/08).
(4.) Kohler, T.C. Memo. 2006-152.
(5.) REG-112196-07, 76 Fed. Reg. 71491 (11/18/11).
(6.) Finfrock, No. 3:11-cv-03052 (C.D. III. 3/20/12).
(7.) Chevron U.S.A. v.
Natural Resources Defense Council
, Inc., 467
U.S. 837 (1984).
(8.) Estate of Morgens, 678 E3d 769 (9rh Cir. 2012), aff’g 133
T.C. 402 (2009).
(9.) Estate of Bongard, 124 T.C. 95 (2005).
(10.) Estate of Lockett, T.C. Memo. 2012-123.
(11.) Estate of Turner (Turner I), T.C. Memo. 2011-209.
(12.) Estate of Turner (Turner II), 138 T.C. No. 14 (2012).
(13) Estate of Liljestrand, T.C. Memo. 2011-259.
(14.) Estate of Kelly, T.C. Memo. 2012-73.
(15.) Estate of Stone, T.C. Memo. 2012-48.
(16.) See Regs. Sec. 20.2036-1 (c) (2); T.D. 9414, 73 Fed. Reg.
(17.) See Regs. Sec. 25.2702-3 (b) (1) 00 (B).
(18.) See Regs. Sec. 20.2036-1 (c) (2) (iii); T.D. MS, 76 Fed. Reg.
(19.) Rev. Rul. 2008-22, 2008-1 C.B. 796.
(20.) Rev. Rul. 2011-28, 2011-49 I.R.B. 830.
(21.) Estate of Duncan, T.C. Memo. 2011-255.
(22.) Rev. Proc. 2011-48, 2011-42 I.R.B. 527.
(23.) Estate of Black, 133 T.C. 340 (2009).
(24.) Estate of Stick, T.C. Memo. 2010-192.
(25.) T.D. 9468, 74 Fed. Reg. 53652 (10/20/09).
By: Justin P. Ransome, J.D.,
, MBA Frances Schafer, J.D.
Justin Ransome is a partner and Frances Schafer is a retired
managing director in the National Tax Office of
Grant Thornton LLP
Washington, D.C. For more information about this article contact Mr.
Ransome at email@example.com.