Split-dollar Life Insurance Arrangement Successfully Excluded From Estates (Ltr Rul 200728015)

Parents established a trust for each of their four children (collectively, the “trusts”).  A separate trust created for the benefit of the father then loaned money to the trusts, money that was used to purchase a second-to-die life insurance policy on the parents.  Through a limited partnership arrangement between the parents and the trusts, the parties entered into a split-dollar life insurance agreement to cover payment of the life insurance premiums during the remainder of the parents’ lives.  On a date after 09/17/03, the date of publication of Final Rule 54336, the parents terminated the above agreement; the policy at the time of cancellation had no cash value.  Immediately thereafter, the insurance policy was replaced with one that was paid in full and that carried a significantly lower death benefit.   At issue was whether the payment of premiums by the trusts on the original policy should be treated as gifts from the parents in keeping with the new rules versus guidance previously applicable under Notice 2002-8.  It was also requested that, despite the parents’ 1% general partnership interest and 47% limited partnership interest, the proceeds of the policy be excluded from the estates.

Final Rule 54336 applies to any split-dollar agreements entered into after 9/17/03, or agreements entered into before 09/17/03 in which the agreement is materially modified after that date.  In this case, the split-dollar arrangement was entered into prior to 9/17/03, and while the insurance policy was replaced after 9/17, it was determined that the new policy did not materially modify the original.  Therefore, premiums paid by the partnership were not viewed as a gift.

As to the inclusion of proceeds in the estates, the Service determined the parents to have no ownership in either the original or subsequent policy such that the proceeds were excluded as requested.

Estate Taxes Not Applicable to Special Needs Trust (TC Memo 2007-182/Estate of Hicks v. Comm)

Following a multi-million dollar settlement involving a toddler who became severely disabled in a car versus train collision, the father of the victim established a Management Trust for the benefit of his severely injured daughter.  With the approval of the Probate Court, one million dollars from the settlement amount was to be directed to the daughter’s Management Trust.  The toddler died before the one million dollars was needed.  The question pondered by this case was whether the trust money could be deducted as a loan owed from the taxable value of the child’s estate.  Under the terms of the loan, the note was callable only if the child died or if she failed to be eligible for Medicaid upon turning 18 years old.  The child died at age eleven. 

The Commissioner previously denied the bona fides of the loan based on the father having never had ownership of the million dollars.  The Tax Court’s opinion was in contrast and permitted the one million to be deducted from the child’s estate.  In the latter decision, the Court gave considerable weight to the role played by the Ohio Probate Court in the creation and subsequent handling of the trust arrangement.

GST-Exempt Status Preserved despite Judicial Reformation (Ltr Rul 200728033)

Three separate irrevocable trusts were established by parents for the benefit of their various descendents prior to the effective date of the Generation Skipping Transfer (GST) tax.  Upon the death of one parent, an event which prompted certain benefits to be realized, questions arose concerning the application of benefits to a particular grandchild whose parents were not married.  One of the three trusts contained references to certain generational beneficiaries as “lawful issue.”  Both the wife and trustee assert that the use of such terminology was in error, prompting the request for judicial reformation without negative impact to the GST exemption.  The Service concurred that corrective language was consistent with State law and constituted a bona fide issue under GST regulations, which permit the preservation of the tax exemption under certain circumstances.

Interest Remaining after Sale of QPRT Residence is Determined Excludable from Gift Tax (Ltr Rul 200728018)

A couple sought to transfer the value of their residence, which included a guest cottage, pool house, garage and barn, to a nominee trust from which they would benefit.  Upon transfer of title, the couple planned to sell the property and transfer remaining actuarial value to a Purchasing Trust established by the husband.  The couple requested the property be treated as a “personal residence” under both trust agreements, and the transfer of value be considered a sale as opposed to a gift.  The Service ruled that the residence and surrounding structures met the definition of personal residence as described under §2702.   Additionally, the transfer of interest was determined not to be a gift since the exchange was based on the actuarial value of the property.

Termination of CRUT Results in Determination of Capital Gain (Ltr Rul 200733014)

A charitable remainder unitrust (CRUT) was formed by a couple who were to receive income from the arrangement throughout their combined lives; upon the death of the last grantor, the remaining principal was to be distributed to charity.  The trustee proposed early termination of the trust agreement, resulting in an assignment of the couple’s interests directly to the charity in exchange for a lump sum payment equal to the present value of the grantors’ rights to receive lifetime income payments.

Despite early termination, the Service ruled that the trustee’s proposal would not disqualify the trust as a CRUT, and that neither the charity nor grantors would be taxed for self-dealing.  However, the couple’s receipt of a lump sum payment resulting from the assignment of interest to charity would constitute long-term capital gain on which taxes would be due in accordance with §1015.

Appeals Court Substitutes its own Valuation and Reverses TC’s Decision to Excuse Underpayment Penalty (Thompson v. Comm; CA 2, 8/23/07)

Upon her death, the heir to a successful publishing company was determined by her estate to have held a $1.75 million interest in the company.  This amount was derived from the estate’s presumption that future corporate income would be negatively impacted by the advent of technological innovations.   By the Service’s estimations, the decedent’s value was significantly higher at $32 million, an amount subsequently rejected by the Tax Court.  At issue was the Court’s substitution of its own determined value over automatic acceptance of the Estate’s calculations. 

The Court of Appeals denied the Estate’s claim that the Tax Court was under any obligation to accept the Estate’s original valuation particularly because there was sufficient evidence to reject the Estate’s proposal.

An equally interesting point made by the higher court related to the imposition of an underpayment penalty on the Estate when the lower court had not itself imposed one.  The New York City-based publishing house employed an appraiser in Alaska presumably to ensure that the corporation’s stock would receive a more favorable valuation than if the appraisal was conducted by the NY office.   Such tactics were dismissed and formed the basis for the penalty reversal.

Discount Dismissed in Taxation of Property Owned by FLP due to Implied Retention of Interest (Estate of Bigelow v. Comm, No. 05-05957 (CA 9 Sept. 14, 2007))

Among the assets of a Family Limited Partnership (FLP) was a beach house, which the Service determined should be taxable at its fair market value.  The Service’s opinion was upheld both by the Tax Court and the Court of Appeals relying upon the rationale that the decedent transferred ownership of the house to the partnership with the full expectation that rental income from the property would cover her expenses.  The decedent had retained responsibility for the mortgage on the house such that it was reasonable that she would have expected to rely upon rental income to cover the monthly payments.

The decedent’s heir also claimed that the partnership agreement was entered into for non-tax business purposes designed to protect the family from liabilities that may have stemmed from environmental torts (see Kimbell, 371 F3d 257 (CA 5 2004)).  However, liabilities of this or a similar nature were determined to be unlikely in the management of the aforementioned beach house such that the property was taxable to the Estate at its full market value.