| Case Analysis Newsletter - August 2009 |
The Tenth Circuit Court of Appeals agreed with the lower court’s ruling that the contribution of files from the well-known case involving Timothy McVeigh by his attorney to a university library could not be considered a charitable donation. According to Oklahoma law, the client is the owner of the case file. Mr. McVeigh’s attorney had no ownership in the materials that were donated (or, if he did, his basis was zero) such that a charitable deduction was precluded. |
The estate appealed the lower court’s denial of a 44% fractional-interest discount based on the estate’s undivided interest in an art collection. At trial, the estate failed to provide evidence for such a discount. The lack of evidence for partial sales of art, along with the appraiser’s unwarranted emphasis on fractional interest discounts for real estate and limited partnerships, were cited by the court in its decision, though the court upheld the lower court's 5% discount for costs of partition, an amount the government conceded. |
A married couple created various FLPs as part of their estate planning, and to which they contributed primarily marketable securities. The surviving spouse (now deceased) had little involvement in the establishment or management of the partnerships; the apparent purpose of the arrangement was to allow both spouses to benefit from a valuation discount on the transferred interests while reducing estate taxes for the benefit of their children and grandchildren. Following the survivor's death, the Service assessed a nearly $800,000 estate tax deficiency based on the inclusion of the decedent’s FLP assets in her gross estate. The estate asserted that the transaction constituted a “bona fide sale” (protected under Section 2036(a) of the Code) and were made for a “legitimate and significant nontax purpose.” The Court disagreed, citing the decedent’s motivation for discounted asset valuation, the passive nature of the business, and her personal use of the FLP assets to make gifts and loans. The estate requested recoupment for income tax paid on the sale of securities distributed to the beneficiaries and for which a refund request was time-barred. The Court agreed that the value of the securities had been included in the decedent’s gross estate such that two separate taxes were assessed on the same asset. Accordingly, the Court credited the estate for the excess income tax. |
The residue of the decedent’s estate was to pass through a revocable living trust for the benefit of the decedent’s surviving spouse and other non-marital beneficiaries. Under the terms of the original trust, estate taxes were to be taken out of the interests of the non-marital beneficiaries, but the decedent had later revised the trust so that all estate taxes would come out of the general residue of the trust estate. Because of ambiguity in the apportionment of taxes under the revised trust, the will’s executor equitably charged estate taxes to the non-marital beneficiaries and claimed a marital deduction of nearly $4 million. The Service determined the marital deduction to be less than that claimed by the estate, and based on the terms of the amended trust noted a deficiency in estate taxes allocable to that portion of the residue belonging to the surviving spouse. Generally, when there is ambiguity surrounding the apportionment of estate taxes the state’s equitable apportionment statute is to be applied. The Tax Court disagreed with the Service by finding ambiguity in the terms of the amended trust, which failed to adequately identify the party(s) responsible for payment of estate taxes. Unlike similar cases cited by the Service in its argument, there was no mention in either the decedent’s will or trust regarding payment “without apportionment.” Thus the Court ruled in the estate’s favor allowing the marital deduction to remain as originally calculated. |
This opinion stemmed from a number of related cases regarding the use of tax shelters and associated misconduct by counsel representing the Commissioner. The protracted proceedings involved the Commissioner’s disallowance of interest deductions on tax shelters that had been widely promoted; test case procedures had been enlisted to accommodate the number of related petitions. After trial of the test cases, counsel for the Commissioner was found to have committed “fraud on the court” by way of a pre-trial settlement. In this opinion the Court considered whether the Commissioner could be required to pay fees and expenses attributable to services provided by the taxpayers’ counsel pro bono. In response to the Commissioner’s argument regarding the imposition of “reasonable” fees, the Court cited Section 6673(a)(2), which it said applied to fees and expenses incurred by the taxpayers’ attorneys. The Commissioner argued that use of the term “incurred” should be consistent with Section 7430, but the Court disagreed pointing out that Section 7430 was intended to be compensatory rather than punitive. In this matter, fees were incurred as a result of misconduct perpetuated by the Government’s attorneys, therefore, Section 6673(a)(2) applied. That public service attorneys were not compensated at market rates was irrelevant according to the Court, thus hourly market rates were to apply. Fees in excess of $1 million plus interest were to be awarded to counsel without obligation to taxpayers. |
The decedent’s surviving spouse was named both personal representative of her husband’s estate and sole trustee for a residuary trust; the trust was the sole beneficiary of the decedent’s retirement plan. Under the terms of the trust, the survivor had unrestricted power of amendment, which she exercised by terminating the trust and directing distributions from the retirement plan to her IRA. However, the plan administrator erroneously sent the distribution check to the estate instead of to the trust where it was received by the survivor as the estate’s representative. She deposited the funds directly into her personal IRA altogether bypassing the residuary trust. Generally, when an IRA amount is passed through a third party such as an estate or trust, the survivor’s receipt and transfer of the funds would not be classified as a valid rollover. The Service ruled, however, that the survivor’s authority under the trust permitted her to direct distribution of the funds to her IRA, and that the plan administrator’s error in sending the check to the estate did not impede the survivor’s ability to make a tax-free rollover. |
The decedent’s will provided for his wife, a non-citizen, to receive the least amount which qualified for the marital deduction so that the estate would incur the least amount of tax liability. The surviving spouse retained an attorney who filed an estate tax return (Form 706) for the property transferred from the estate; a marital deduction was claimed on this return. A subsequent attorney retained by the spouse advised her to create a Qualified Domestic Trust (QDOT) because of the uncertainty attributable to some property jointly-owned by the decedent and his wife; the estate would then request a protective election under Regulation §20.2056A-3(c). The ruling request was for extensions related to the QDOT elections which would permit the marital deduction and allow property assigned to the QDOT to be included in the estate’s assets. A marital deduction for a non-citizen spouse is permitted if the property is first passed through a QDOT. In this case, the QDOT election was made after the filing of the federal estate tax return. The Service concluded that the extension request met the rules for relief under Section 9100. This ruling allowed the estate to make a protective assignment of property to the spouse’s QDOT, thereby permitting the estate to take the marital extension. |
Prior to their deaths, a married couple executed a revocable trust to which each spouse’s residuary estate would pass upon their respective deaths. Upon the death of the first grantor, the trust estate was divided into four separate trusts. An accountant filed the estate’s tax return and made a QTIP election and reverse QTIP election for the two resultant marital trusts. However, the values of the assets listed for each were incorrect, and GST Exemption was allocated on the Form 706 in these incorrect amounts. Upon the death of the second spouse, the previous accountant’s errors were discovered. A ruling was requested to permit correction of the amount allocated under the reverse QTIP election to the Exempt Marital Trust, leaving some GST exemption to be automatically allocated to the Family Trust, giving it an inclusion ratio of zero. The Service consented to the corrections based on the amounts originally passing under the terms of the revocable trust (but required the amounts remaining in each trust to be adjusted correspondingly). |
An irrevocable trust was established for the benefit of the decedent’s family and a separate identical trust was later established for the decedent’s daughter. The trustees collectively sought IRS guidance through a private letter ruling, which permitted the identical trusts to be merged into a single trust without loss of the GST exemption. The resultant trust then became an ESBT (Electing Small Business Trust) and a shareholder in an S corporation. In this ruling request, the trustees sought to split the ESBT into separate trusts to allow for the possibility of a nonresident alien as beneficiary; nonresident aliens are prohibited from holding shares in an S corporation according to Section 1361(b)(1) of the Code. Specifically, the trustees sought to preserve the GST exemption and the ESBT election as a result of the proposed split. The Service agreed that the proposed division of the ESBT would not result in a shift of beneficial interests to a lower generation beneficiary nor would the split extend the vesting period. Accordingly, the Service permitted the trust to make an ESBT election on the portion holding only S corporation shares as long as the trust terms, as modified, prohibited distributions to nonresident alien beneficiaries. |
Income from the decedent’s trust was to be distributed with regular frequency to the grantor’s son, the primary beneficiary. Under the terms of the trust, the son had discretionary authority to direct such distributions not to exceed the larger value of $5,000 or 5% of the trust principal. The co-trustees proposed to modify the trust to limit the timeframe in which the son was able to exercise this power. The parties requested that modification of the trust would not constitute a transfer by the son that would otherwise be subject to the gift tax, and that the trust would maintain its grandfathered status for GST tax purposes. The Service indicated that such modification would not shift beneficial interests to a lower generation beneficiary thus the gift tax would not apply. In addition, the proposed changes would not extend the time for vesting, so the GST exemption would be retained. |
The Grantor established a revocable trust to provide for his children and their children, referred to in the trust as “lawful issue.” The trust specified that the term did not include adopted children. As several of the Grantor’s grandchildren were adopted, the trustee sought to amend the trust to include the adopted grandchildren as “lawful issue” without removing the GST exemption status. The inclusion of adopted children as beneficiaries would, under the proposed modification, decrease distributions otherwise due the natural grandchildren and great-grandchildren of the grantor. The Service cited Example 7 of §26.2601-1(b)(4)(i)(E) for the proposition that a modification that does not shift interests from a higher generation beneficiary to a lower generation beneficiary, and that does not extend a vesting period, will not affect the trust's existing exempt status. Unfortunately, the Service carried that example too far and stated that the grantor's natural-born descendants would have made a taxable gift to their adopted counterparts. This silly result ignores the involuntary application of the lower court's ruling to their interests, and presumes a donative intent. It is, however, what the ruling held. |
The decedent bequeathed the residue of his estate to a trust for the benefit of the surviving spouse. Though the trust itself did not provide for its interests to be split, the relevant state statute permitted the creation of two or more trusts to enable property otherwise exempt from the GST tax to have an inclusion rate of zero. A law firm representing the estate had filed the Form 706 making a QTIP election on the entire property, but had inadvertently failed to advise the estate to split the trust into an exempt and non-exempt QTIP trust. A ruling request was made to allow for an extension of time under §9100 rules to sever the property and to make a reverse QTIP election on the resulting exempt trust. The Service permitted the extension. |
Charitable Deduction of Case Files Deemed Inappropriate by Court of Appeals
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