Charitable Deductions
Estate of Miriam Warne v. Commissioner
Tax Court rules on estate tax charitable deduction for limited liability company (LLC) interests
In Estate of Miriam Warne v. Comm’r, T.C. Memo. 2021-17 (Feb. 18, 2021), the Tax Court ruled on valuation issues for both gift and estate tax purposes.
Miriam Warne and her husband, Thomas, had two sons and three grandchildren. Together, they had established a joint revocable trust known as the “Family Trust” in the early 1980s. Over time, the Family Trust became the majority interest holder of five LLCs that owned interests in real estate leases and holding companies. After Thomas died, Miriam remained the trustee of the Family Trust, and she was the managing member of the LLCs.
In 2012, Miriam gave interests in one of the LLCs to her two sons and her granddaughters. However, she didn’t file any gift tax returns, and she died in 2014. In 2015, the estate filed gift tax returns reporting the 2012 gifts, along with the estate tax return. The estate tax return reported a charitable deduction for 100% of the value of one of the LLCs, which had passed 75% to a public charity and 25% to a family foundation pursuant to the terms of the Family Trust.
The Internal Revenue Service issued notices of deficiencies for both returns, disputing the valuation of the LLC interests given to Miriam’s sons and grandchildren in 2012 and decreasing the charitable deduction for the LLC interests left to charity on her death. The IRS also imposed penalties for failure to file the gift tax returns.
The Tax Court agreed with the estate’s expert’s valuations of the underlying property interests, finding his evidence and arguments more compelling. With respect to the discounts for marketability and control, both were minor because: (1) the interests being valued held significant control; (2) it was likely the controlling member could have dissolved the LLCs because there was no evidence that the family would have pursued litigation if dissolution were attempted; and (3) the companies were real estate holding companies. These discounts for lack of marketability and control were determined to be 5% and 4%, respectively.
Perhaps the more interesting issue in the case was the valuation of the charitable deduction. The estate held a 100% interest in one of the LLCs. The Family Trust directed a 75% interest to a public charity and a 25% interest to a family foundation. On the estate tax return, the Family Trust included the value of the 100% interest and then claimed a charitable deduction for the full value of that 100% interest.
The court disagreed and held that the charitable contribution had to be valued with respect to what each of the charities received, not what the estate held. It valued the 75% and 25% interests separately, applying the discounts to which the parties had stipulated (over 27% for the 25% interest and a 4% discount for the 75% interest). The Tax Court reached a similar conclusion in the Estate of DiSanto, T.C. Memo. 1999-421, involving a marital deduction. See also Chenoweth v. Comm’r, 88 T.C. 1577 (1987).
Estate Tax
Estate of Clara M. Morrissette v. Comm’r
Split-dollar premium payments not included in decedent’s estate
In Estate of Clara M. Morrissette v. Comm’r, T.C. Memo. 2021-60 (May 13, 2021), the Tax Court ruled on whether premium payments on split-dollar life insurance policies would be included in the estate under Internal Revenue Code Sections 2036 and 2038, and if not, how to determine the fair market value (FMV) of the split-dollar rights in the estate.
Clara Morrissette’s husband, Arthur, established a large family business involved in moving, relocation and storage. Arthur’s three sons worked in the business with him. Unfortunately, tension increased among the family members, in part because of a lack of a viable succession plan and sufficient liquidity to pay estate taxes.
After Arthur’s death, the family decided to purchase life insurance using split-dollar agreements as part of a cross-purchase plan. Clara’s revocable trust paid approximately $30 million in premiums for policies on her children’s lives. In exchange, her trust was entitled to receive the greater of the premiums paid or the cash value of the policies at the insureds’ deaths. When Clara’s estate tax return was later filed, the IRS and estate disagreed on whether the premium payments should be included in Clara’s estate under IRC Sections 2036 and 2038 and how to value the split-dollar rights.
Sections 2036 and 2038 include property transferred during life if the decedent retained certain rights or powers over the transferred property; however, Sections 2036 and 2038 don’t apply if the transfer was a bona fide sale for full and adequate consideration. The Tax Court has interpreted this exception to mean that a transfer must have a legitimate and significant nontax purpose and adequate and full consideration for money or money’s worth to avoid inclusion.
The Tax Court found that the $30 million of premiums weren’t includible in Clara’s gross estate because the transfers were bona fide sales for full and adequate consideration. The premium payments served the legitimate nontax purpose of financing the stock purchases to keep the business in the family, paying estate taxes without forcing a sale of the business and allowing for a smooth management transition. The additional purpose of reducing estate taxes didn’t preclude the finding of a bona fide sale because it was a secondary motive. The premium payments were made for full and adequate consideration because Clara’s revocable trust received financial benefits of retained family control over the business, a smooth management transition, organizational stability and protection of capital by funding estate taxes. The Tax Court noted that these financial benefits were significant considering Clara’s strong desire to keep the business in the family.
Although both parties agreed that the split-dollar rights were includible in Clara’s gross estate, they varied greatly on the valuation. The Tax Court discussed two factors of valuation: (1) whether the special rules of valuation under Section IRC 2703 applied; and (2) the appropriate discounts to apply.
Section 2703 requires that the value of any asset in the estate is includible without discounting the value for certain restrictive agreements; however, that rule doesn’t apply if the restrictive agreement was a bona fide business agreement and not a device to transfer property to the decedent’s family for less than adequate and full consideration. The Tax Court found that Section 2703 didn’t apply because the split-dollar agreements were entered into for the valid business purpose of resolving current and future management issues, keeping the business in the family and planning for future liquidity to pay estate taxes. Further, the split-dollar agreements weren’t a device to transfer property for less than full and adequate consideration because the split-dollar agreements allowed repayment terms that a reasonable investor would accept, provided for tax deferral and allowed for the additional financial benefits of continued family control, management succession and avoiding uncertainty. The Tax Court was also confident that split-dollar agreements in similar businesses could contain the similar restrictions on similar employees even if the employees weren’t family members.
In assessing the FMV of the split-dollar rights, the Tax Court applied two discounts. The Tax Court discounted the values of the cash flows and repayment schedule of the split-dollar rights. The cash flows were discounted based on returns on corporate bonds and the debt of each insurance company. The repayment schedule was discounted based on the termination time frame, which the Tax Court ruled was approximately four years because the parties who could terminate the agreement were on both sides of the transaction. This was significantly shorter than that claimed by the estate, pushing the value from $7.48 million to $28 million.
Leighton v. United States
Estate seeks refund for penalties assessed on late filed return
In Leighton v. U.S. (unpublished, Court of Federal Claims (Aug. 9, 2021)), the executor of a decedent’s estate sought a refund for penalties imposed by the IRS for late filing penalties and interest. The decedent’s son was the executor of the estate, and he worked with an attorney, a family office and an accounting firm. The attorney advised the executor that an estate tax return need only be filed if the value of the estate exceeded the filing threshold of $5.49 million. The family office had the accounting firm complete a questionnaire, and after some review, the whole team concluded the value of the estate was between $1 million and $2 million, and there was no need to file a return. The team worked together throughout the administration of the estate and had a good working relationship.
Two years after the decedent’s death, the decedent’s son mentioned to the attorney the existence of certain irrevocable trusts. The attorney inquired of the accountant and learned that there had been a gift tax return filed in 2012. When taking into account the value of the lifetime gifts, the value of the estate now exceeded the filing threshold, and a federal estate tax return should have been filed (and tax was due). The estate filed the return and paid the tax, penalties and interest.
The estate filed an amended return and claimed a refund for the penalty because its failure to file was due to reasonable cause and not willful neglect. The United States moved to dismiss the claims, alleging that the lawyer’s advice was unreasonable, the executor remained responsible for filing the return on time and the unavailability of the 2012 gift tax return was unreasonable.
Treasury Regulations Section 301.6651-1(c)(1) provides that: “If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return [or pay the tax] within the prescribed time, then the delay is due to a reasonable cause.” The court stated: “Generally, a taxpayer may establish reasonable cause for failing to file a timely return to avoid penalty by establishing reasonable reliance on the advice of an accountant or attorney, even if it is later established that such advice was erroneous or mistaken. Thomas v. Comm’r, 82 T.C.M. (CCH) 449 (T.C. 2001), 2001 WL 919858 (citing 26 U.S.C. § 6651(a)(1)).” The court held that the taxpayer’s claim for refund couldn’t be dismissed because further evidence was required, as the complaint alleged sufficient facts on which it could succeed.
Semone Grossman v. Comm’r
Decedent’s second wife was a surviving spouse eligible for marital deduction
In Semone Grossman v. Comm’r, T.C. Memo. 2021-065 (May 27, 2021), the Tax Court ruled on whether the decedent’s second marriage was valid for purposes of the marital deduction by assessing the marriage under New York law; however, the Tax Court noted that it wasn’t deciding whether it was required to apply New York Law, a revenue ruling or a decision by the U.S. Court of Appeals for the Second Circuit.
The question of validity developed from the decedent’s multiple divorce attempts before his second marriage. After a New York court declared the decedent’s Mexican divorce invalid, the decedent obtained a religious divorce under rabbinical law. The decedent then married his second wife in Israel under Jewish law. The Israeli marriage certificate noted that the decedent was free to re-marry because he was divorced.
The IRS argued that the Tax Court should apply New York law to determine whether the second marriage was valid. The estate asserted that revenue rulings and a Second Circuit decision was the determinative law. Without indicating which standard was correct, the Tax Court briefly explained the three proposed tests for determining whether a marriage is valid. Under New York law, a marriage is valid as long as it’s valid in the place where it was celebrated, unless the marriage is contrary to public policy or it violates “positive law” (for example, a statute). (See Van Voorhis v. Brintnall, 86 N.Y. 18, 24–26 (1881)). Under IRS revenue rulings, as long as the marriage is valid in the place of celebration, the marriage is valid regardless of the law in the state where the parties lived.
The court applied New York law without deciding which standard was correct. Under New York law, the second marriage was valid because it was recognized in Israel, wasn’t contrary to public policy and didn’t violate any New York statute; therefore, the second wife qualified as a surviving spouse eligible for the marital deduction.
Connelly v. U.S.
U.S. district court upholds IRS motion for summary judgment on valuation of shares in family business for estate tax purposes
In Connelly v. U.S., 4:19-cv-01410-SRC (E.D. Mo. Sept. 21, 2021), both the estate and IRS filed for summary judgment on whether life insurance proceeds payable to a closely held company to fund a buyback of shares on a shareholder’s death should be included in the value of the company.
Brothers Michael and Thomas Connelly ran and owned Crown C Supply, Inc., a closely held family business that sold roofing and siding materials. Michael was the president, CEO and majority shareholder, owning 385.90 shares; Thomas owned the remaining 114.10 shares. As part of their estate and business succession planning, the brothers entered into a stock purchase agreement (SPA) providing that Crown C would buy back the shares of the first brother to die, and Crown C would buy life insurance to finance the buyback. The SPA included specific provisions requiring that the brothers determine the agreed share value each year by issuing a new “Certificate of Agreed Value.” If they failed to do so, the SPA required them to determine share value by obtaining multiple appraisals.
After Michael’s death, Crown C used the life insurance proceeds to complete the buyback. The brothers had never executed a single Certificate of Agreed Value. They didn’t obtain multiple appraisals as required by the SPA either. Instead, the brothers chose to come up with their own ad hocvaluation of $3 million for Michael’s shares; Crown C purchased his shares in a sale agreement for that amount; and the estate reported that amount as the value on the estate tax return.
On audit, the IRS determined the additional $3 million of life insurance proceeds used to buy back Michael’s shares should have been included in the value of Crown C for estate tax purposes and assessed an additional $1 million in estate taxes. The estate sought a refund.
The issue was whether the SPA was relevant in determining the FMV of the shares. Under 26 U.S.C. Section 2703(b), relevant case law and regulations, the IRS will only consider a buy-sell agreement when valuing property in the decedent’s estate if the buy-sell agreement meets all of the following requirements:
- It’s a bona fide business arrangement;
- It’s not a device to transfer property to the decedent’s family for less than full and adequate consideration;
- Its terms are comparable to similar arm’s-length agreements;
- The offering price must be fixed and determinable; and
- The agreement is legally binding on the parties during life and after death.
If a buy-sell agreement doesn’t meet all of the requirements, the FMV of the shares is used for estate tax purposes under 26 C.F.R. Sections 25.2703-1(b)(2) and 20.2031-2(h).
The court agreed with the estate that the brothers entered into the SPA for the bona fide business purpose of ensuring their family’s continued ownership of Crown C; however, the issue was ultimately unnecessary because the SPA didn’t meet any other requirements necessary to factor the SPA into the stock valuation.
For a number of reasons, the court held for the IRS that the $3 million sale agreement was a testamentary device used to transfer wealth to Michael’s family for less than full and adequate consideration. Most importantly, the court noted that the brothers disregarded the terms of the SPA and didn’t follow its requirements regarding valuation of the shares. If the brothers weren’t bound by the SPA, the court noted, the IRS shouldn’t be either. Secondly, the court found that the SPA wasn’t comparable to similar agreements negotiated at arm’s length; in particular, the valuation of Michael’s shares didn’t include any control premiums, which wasn’t reasonable.
After concluding that the SPA didn’t dictate the share value, the court next determined the FMV of the shares. Because the redemption obligation didn’t offset the insurance proceeds, the FMV of the shares included those proceeds.
Fiduciary Duty
U.S. v. Estate of Kelley
Executrix found personally liable as transferee and fiduciary
In U.S. v. Estate of Kelley, 2020 U.S. Dist. LEXIS 196336 (D.N.J. Oct. 22, 2020), the decedent’s brother was appointed as co-executor. The estate incurred an estate tax liability of over $688,000. The brother transferred all the assets to himself as sole beneficiary, rendering the estate insolvent. Subsequently, the brother entered into an installment agreement with the IRS to pay the estate tax due. Before full payment, the brother died, and his daughter was appointed executrix of his estate. She distributed all assets to herself, leaving no assets in the estate. The court granted the government’s motions for summary judgment against the daughter as executrix of her father’s estate for transferee liability and for fiduciary liability. Even though the daughter wasn’t the executrix of the first estate, she was found to have knowledge of the outstanding tax liability and, therefore, the court was able to find her personally liable.
Estate of Lindvig v. Jellum
Gifts and authority under a power of attorney
During his life, Ralph Lindvig executed a durable power of attorney (POA) naming his wife, Dorothy, as the attorney-in-fact. Years later, Ralph had an accident requiring significant care until his passing a couple years later. During that time, Dorothy sold portions of his land and conveyed other parcels of land to herself. In Estate of Lindvig v. Jellum, 951 N.W.2d 214 (2020), the personal representatives of Ralph’s estate sued Dorothy’s estate alleging that she breached her fiduciary duty and acted beyond her authority under the POA. The court held that Dorothy had the authority to make the transfers under the real estate transfer provisions of the POA. The court didn’t need to rely on the POA’s gifting provisions, which were a consideration of the lower court’s findings.
Note: The above two cases under “Fiduciary Duty” were originally discussed in an article by Joshua S. Miller and Michael Sneeringer, which appeared in our May 2021 issue.
GST Trusts
Private Letter Rulings 202116002, 202116003 and 202116004
State court properly reformed grandfathered generation-skipping transfer (GST) trusts without adverse tax consequences
In a series of PLRs (PLRs 202116002, 202116003 and 202116004 (April 23, 2021)), the IRS confirmed that a state court’s reformation of a trust instrument to clarify ambiguities and correct scrivener’s errors wouldn’t interfere with the grandfathered GST tax status of three trusts established by the trust instrument.
The original trust instrument created three trusts, one for each of the grantor’s three children’s respective family lines. Later, the grantor signed a second amendment that changed the disposition of the trust property on the death of a child. However, the language of the second amendment was ambiguous and unclear and could have caused the property held in one child’s trust to be paid to the other children’s trusts, even while there were descendants of that child still living.
The trustees petitioned the local probate court for a judicial construction of the trust and to reform its terms to conform with the grantor’s intent. The reformation was contingent on a favorable ruling from the IRS. The local court construed the trust to reform its language and approved clarifying language that resolved the ambiguities, which included keeping the trust property within a family line as long as descendants in that line were living.
The IRS agreed that there were no adverse GST, gift or estate tax consequences to the reformation. The PLRs confirmed that the judicial action involved a bona fide issue, and the construction was consistent with applicable state law that would be applied by the highest court of the state. Because it met the requirements of the GST tax regulations, there was no change to the grandfathered GST tax status of the trust.
In addition, because the construction clarified the terms of the trust to conform with the donor’s intent, no beneficiary was treated as making a taxable gift. Because no beneficiary transferred any property to the trust, and no beneficiary was granted any power or right over the trust, no portion of the trust (prior to termination) would be included in a beneficiary’s taxable estate.
Further, because the construction was a clarification and correction of the terms of the trust to effectuate the original intent of the donor, there was no exchange or material difference in the beneficiaries’ interests in the trust before and after the correction of the errors. As a result, it wasn’t an income taxable event that caused recognition of gains to any beneficiary.
PLR 202133005
IRS approves early division of trust without income or GST tax consequences
In PLR 202133005 (Aug. 20, 2021), the trustee of an irrevocable trust petitioned a local state court for an early division of an irrevocable spray trust a married couple had established for the benefit of their children and more remote descendants. The trust was entirely GST tax exempt through the application of the couple’s GST tax exemption.
The trust provided that on the death of the surviving grantor, the trust would split into equal shares for each child who was living or had descendants living. Each share would be held in a separate ongoing trust for the benefit of the child and/or their descendants. One of the grantors died, but during the survivor’s life, due to the growing number of family members and divergent financial and personal needs of the beneficiaries, the trustees decided it would be beneficial to administer the trusts separately for each family line. The trust instrument itself didn’t explicitly permit early division, but state law allowed division of trusts as long as it wasn’t prohibited by the trust instrument. The beneficiaries and trustees entered into a settlement agreement, and the court approved the trustees’ petition for reformation to structure the early division, pending IRS approval.
The IRS ruled that the early division of the trust assets, pro rata, into separate subtrusts for each family line wouldn’t have any income tax or GST tax consequences: The subtrusts would keep the basis of the assets as they were prior to the trust funding, there would be no recognition of gain, the holding period would remain the same and the GST tax status would be unaffected. The GST ruling was dependent on the holding that beneficial interests weren’t shifted to lower generations or wouldn’t extend the time for vesting (because the original rule against perpetuities (RAP) period was retained in the subtrusts). There was little explanation for the income tax rulings, just a confirmation that division into separate trusts for each family line didn’t cause a material change in the beneficiaries’ interests. The court noted that the assets were allocated pro rata to the equal shares for each family line’s subtrust.
PLR 202108001
PLR on local court modifications to GST grandfathered trust
In PLR 202108001 (Feb. 26, 2021), the taxpayer sought a local court ruling to modify and construe the decedent’s will, which exercised a testamentary power of appointment over his father’s trust. The decedent’s father had established a testamentary trust for the benefit of the decedent and his descendants. Initially, the decedent had executed a will that exercised the power to direct the trust property to be held in further trust for his descendants. Later, he executed several codicils, which unfortunately had several incorrect Article references and appeared to rescind the exercise of that power.
There were two main issues with the will and codicils. First, the decedent’s will included a RAP section that referred to the “applicable rules governing perpetuities,” but it didn’t explicitly reference the period applicable to the decedent’s father’s testamentary trust. Second, the codicils revoked the Article in which the decedent exercised the power and then later attempted to correct the mistaken revocation but, due to various scrivener’s errors, introduced ambiguity.
The local court construed the will to retain the exercise of the power, concluding that the decedent intended to exercise it and that the revocation in the codicils was a scrivener’s error. It also held that the RAP period under the decedent’s will was properly limited by the period originally applicable to the decedent’s father’s will. The court’s declaratory judgment was contingent on a favorable ruling by the IRS.
The PLR confirmed that because the local court was construing the will and codicils’ ambiguities created by scrivener’s errors, which were bona fide issues of law, and such construction was proper under state law, the declaratory judgment entered by the court didn’t interfere with the property’s GST tax-exempt grandfathered status and that there were no adverse GST, gift, estate or income tax consequences to the court ruling.
QTIP Trusts
Shaffer v. Comm’r
Massachusetts rules on interstate effects of qualified terminable interest property (QTIP) election
In Shaffer v. Comm’r (SJC-2812 (July 10, 2020)), the Supreme Judicial Court (SJC) of Massachusetts reviewed a claim by a surviving spouse’s estate that a QTIP trust established by her predeceased husband shouldn’t be includible in the Massachusetts taxable estate.
Adelaide Chuckrow was the beneficiary of a QTIP trust established by her late husband Robert under his estate plan. Robert died as a New York resident. Robert’s estate tax returns made a QTIP election both federally and under New York law. The QTIP trust held intangible assets only (shares in various companies and a limited partnership interest). Adelaide died as a Massachusetts resident in 2011.
The QTIP trust assets were included as part of Adelaide’s federal estate on the Form 706, but the QTIP trust assets weren’t included on her Massachusetts estate tax return. Her estate didn’t file any estate tax return in New York. The Massachusetts taxing authority audited the return and assessed an additional tax of nearly $2 million relating to the value of the QTIP trust, and the estate appealed.
Massachusetts estate tax is calculated with reference to the federal estate tax in effect on Dec. 31, 2000, originally known as a “sponge tax.” The statute provides that a tax is imposed on “the transfer of the estate of each person dying …. a resident of the commonwealth.” The estate argued that there was no “transfer” on Adelaide’s death and that the only transfer was on Robert’s death. As a result, the estate alleged, it was a violation of constitutional principles to tax the QTIP at her death.
However, the Appellate Tax Board and the SJC disagreed, holding that there’s a transfer on the death of the surviving spouse. The SJC relied on case law (both from other states as well as federal courts) to determine that a transfer occurs whether there’s a change in the legal and economic relationships to the property at issue. It concluded that a transfer had occurred on Adelaide’s death with respect to the QTIP trust property because there was a change in the legal and economic relationships to the QTIP trust property.
The definitions section of the Massachusetts statute defines the “Massachusetts gross estate” as the federal gross estate plus property for which a QTIP election had previously been made on a Massachusetts estate tax return. However, the term “Massachusetts gross estate” isn’t used in the section of Massachusetts law imposing the estate tax, and the SJC agreed with the Appellate Tax Board that it wasn’t relevant to the operative tax provision.
The case illustrates the disjointed nature of the statute governing the calculation of the Massachusetts estate tax and highlights the complexity of interstate estate planning. The estate has petitioned for writ of certiorari to the U.S. Supreme Court, alleging that Massachusetts is violating the due process clause of the U.S. Constitution by taxing the QTIP trust.
Estate of Evans v. Dept. of Revenue
Oregon Supreme Court upholds including out-of-state QTIP trust in surviving spouse’s estate
In Estate of Evans v. Dept. of Rev. (368 OR 430, July 29, 2021), the estate of Helene Evans appealed from the Oregon Tax Court’s determination that a qualified QTIP trust established by Helene’s late husband in Montana was taxable in her estate.
Helene had moved to Oregon one month before her husband Gillam passed away in 2012. Gillam’s will provided for a testamentary trust for Helene and other beneficiaries. The trust was governed by Montana law and administered by Gillam’s son, a Montana resident. Originally, the will provided that the trust was for the benefit of multiple beneficiaries. However, the executor petitioned a Montana court to modify the trust to allow for a QTIP election. The court approved, and the trust was reformed so that Helene was entitled to the trust income during her life, and principal could be distributed to her in the trustee’s discretion for her health, education, maintenance and support in her accustomed manner of living. She didn’t have a power of appointment.
Gillam’s estate filed a federal estate tax return and made a QTIP election for the trust. Montana didn’t have an estate tax. The trust was administered for Helene’s benefit, but in 2014, she sought additional distributions and, under Montana law, settled with the trustee for one lump sum payment and then a fixed monthly annuity.
When Helene died in 2015, her estate filed an Oregon estate tax return and included the value of the QTIP trust on the return, as required by Oregon law. However, later, the estate sought to exclude the value of the trust assets and filed for a refund. The estate claimed that Oregon’s tax on the trust assets violated the due process clause.
The Tax Court disagreed, and the estate appealed to the Oregon Supreme Court. For estate tax purposes, the due process clause requires that a state have a minimum connection to the person or property it’s taxing. Helene’s estate argued that the due process clause doesn’t permit a state to impose estate tax on a trust holding intangible assets solely because the resident of the state was an income beneficiary during her life, without any practical control of the trust assets.
The court confirmed that the question of whether a state has necessary connections depends on the nature of the resident’s interest in the intangible property. The court distinguished the recent case of North Carolina Dept. of Revenue v. Kimberley Rice Kaestner 1992 Family Trusts, 139 S. Ct. 2213 (2019), in which the U.S. Supreme Court held that North Carolina couldn’t, under the due process clause, tax trust income over a 4-year period when: (1) the trust was administered under New York law by a New York trustee, and (2) all beneficiaries lived in North Carolina but no distributions were actually made to any beneficiaries. Other cases the court reviewed involved trusts in which the beneficiaries had some form of power—which was determined to be sufficient control to allow the beneficiary’s state of residence to tax the trust.
Ultimately, the Oregon Supreme Court held that while a power may be sufficient to establish a connection that permits taxation, it’s not a prerequisite. Other forms of “possession, control or enjoyment” may also satisfy the due process clause. It found that Helene’s beneficial interest in the trust, both income and principal, qualified as a substantial measure of enjoyment that allowed Oregon to tax the trust as part of her estate.
Settlement Agreements
In re Trust created by Clifford Allen McGregor
State court sets aside nonjudicial settlement agreement
In In re Trust created by Clifford Allen McGregor (308 Neb. 405, Feb. 12, 2021), a beneficiary sought to enforce a nonjudicial settlement agreement with his sister regarding his father’s trust by appealing to the Supreme Court of Nebraska.
Clifford McGregor’s family trust became irrevocable on his death, and his wife, Evelyn, became the sole trustee. The trust directed that on Evelyn’s death, the trust property, which included real estate, be held in continuing trusts for his son Allen and daughter Debra. The trust states that it should be construed as a “non-support discretionary spendthrift trust that may not be reached by the beneficiaries’ creditors for any reason.” However, after Clifford’s death, in 2011, Evelyn, Allen and Debra signed a nonjudicial settlement agreement that directed the distribution of the family trust directly to Allen and Debra, outright and free of trust.
Six years later, in 2017, Evelyn attempted to revoke the nonjudicial settlement agreement. Allen sued in the county court to enforce the agreement.
In Nebraska, a nonjudicial settlement agreement is valid only to the extent it doesn’t violate a material purpose of the trust, and it must be consented to by all “interested persons.”
The Supreme Court of Nebraska upheld the county court’s determination that the nonjudicial settlement agreement wasn’t binding because it violated a material purpose of the trust, namely the spendthrift protections. It also noted two other significant parts of the agreement that may have violated the original purpose of the trust: Allen was to receive an additional tract of land, and the two siblings were required to equalize their distributions through cash or debt settlement.
The court indicated, as an aside, that the agreement might also have been unenforceable if Allen and Debra were the only signatories, because their descendants might be “interested persons” who would have had to consent agreement. However, it didn’t rule on that point.
Valuations
Nelson v. Comm’r
U.S. Court of Appeals for the Fifth Circuit rules on formula clause gift
In Nelson v. Comm’r (5th Cir. No. 20-61068, Nov. 3, 2021), the Fifth Circuit upheld the Tax Court in favor of the IRS on a formula gift. The taxpayer, Mary Pat Nelson, made a gift of limited partnership interests. The transfer agreement provided that she was transferring limited partnership interests having an FMV of $2.096 million as determined by a qualified appraiser within 90 days of the assignment. The IRS audited and re-determined the value of the limited partnership interests and assessed additional tax. The taxpayer appealed, arguing that their original appraisal was correct, and even if the valuation was adjusted, the percentage interests transferred would be reduced, regardless, so that only the stated value was transferred.
The Tax Court and the Fifth Circuit disagreed. They noted that the assignment stated the appraisal determined the percentage interests transferred. Once the appraisal was complete, that locked the percentage partnership interests transferred. The transfer agreement didn’t include any provision causing the percentage interests transferred to be dependent on the FMV as determined for federal gift or estate tax purposes or subject to adjustment for revaluation on audit. Nor was there any provision for reallocation of excess units if the valuation changed. Further, because the transfer agreement wasn’t ambiguous, the court didn’t consider any extrinsic evidence.
2022 Inflation & Other Adjustments
Revenue Procedure 2021-45
What’s new for the 2022 tax year
- The IRS has released Rev. Proc. 2021-45, with inflation adjustments for 2022:
- The federal estate tax exclusion amount will be $12.06 million for 2022, up from $11.70 million in 2021.
- The annual gift tax exclusion will be $16,000, up from $15,000 in 2021.
- The annual gift tax exclusion for a noncitizen spouse will be $164,000 (up from $159,000).
- The special use valuation limitation will be $1.23 million (up from $1.19 million).
- The IRC Section 6166 2% portion will be $1.64 million (up from $1.59 million).