Apr 1, 2006 12:00 PM, Rorie M. Sherman Editor in Chief

By: Rorie M. Sherman Editor in Chief

David A. Handler, partner in the Chicago office of Kirkland & Ellis LLP, reports:

• A citizen of a U.S. possession is not a U.S. citizen for estate-tax purposes. In Private Letter Ruling 200603011 (issued Oct. 12, 2005, released Jan. 23, 2006), the Internal Revenue Service held that a decedent who derived U.S. citizenship solely from being a citizen of a U.S. possession is treated as a “nonresident not a citizen” of the United States for purposes of the federal estate tax under Internal Revenue Code Section 2209.

  IRC Sections 2208 and 2209 provide that a decedent who acquired U. S. citizenship solely because (1) he was a citizen of a U.S. possession, or (2) was born or a resident in the U.S. possession, is not a U.S. “citizen” for purposes of the estate tax, and instead, for the purposes of this tax, is considered a “nonresident not a citizen of the United States.”

  The decedent in question became a Puerto Rican citizen under the Foraker Act and a U.S. citizen by operation of the Jones Act. He therefore derived U.S. citizenship solely from being a citizen of a U.S. possession, and is considered a “nonresident not a citizen of the United States” for purposes of IRC Sections 2209 and 2101.

  Such persons are still subject to U.S. estate tax, but different rules apply. Also, different rules apply for leaving assets to such persons as surviving spouses.

  Other U.S. possessions to which this PLR applies include: American Samoa, Baker Island, Guam, Howland island, Northern Marianna Islands, Palmyra Island, Puerto Rico, U.S. Virgin Islands, Wake Island, Jarvis Island, Johnson Atoll, Kingman Reef, Midway, Rota, Saipan and Tinian.

• Termination of a foundation under state law does not end its status as a private foundation under federal law. In PLR 200607027 (issued Nov. 23, 2005, released Feb. 17, 2006), a nonprofit corporation (P) classified as a private foundation failed to file annual reports for a number of years, as required under state law, and its corporate status was administratively terminated. P continued to operate and file timely information returns (Forms 990-PF) with the IRS. More than five years had passed when the board of directors became aware of the administrative termination, and it was too late to apply to the state for reinstatement.

  So a new nonprofit corporation (N) was formed with the same officers and directors as P; the bylaws were essentially the same. N applied for and received status as a tax-exempt private foundation. P transferred all of its assets to N and intended to terminate private foundation status of P.

  The IRS explained that, under Treasury Regulations Sections. 301.7701-2(b)(2) and 301.7701-3(c)(v), P is treated as having elected to be classified as an association taxable as a corporation as of the date that P applied to the IRS for classification as a tax-exempt entity. The IRS said that this election will remain in effect, unless P makes a check-the-box election under Treas. Reg. Section 301.7701-3(c)(1)(i) after the date when the claim for exempt status is withdrawn or rejected, or as of the date when the determination of exempt status is revoked.

  Thus, there was and is no change in P's corporate or tax-exempt status as a result of the administrative dissolution of its corporate charter and status in its state. P will not be treated as a newly created organization and the deemed transfer of the net assets of P to N will not terminate the status of P as a private foundation under IRC Section 507(a) and will not result in the imposition of the Section 507(c) termination tax. Finally, the IRS found that N is effectively controlled by the same persons who control P, within the meaning of Treas. Reg. Section 1.482-1(a)(3) for purposes IRC Sections 507 through 509 and Chapter 42. Accordingly, N as the transferee foundation will be treated as if it were the transferor.

• Tax Court confirms IRS' interpretation of IRC Section 2036 (a)(1) — again. In Estate of Disbrow v. Commissioner, T.C. Memo. 2006-34 (issued Feb. 28, 2006), Lorraine Disbrow had transferred her residence to a newly formed general partnership whose partners were herself, her children, and her “children-in-law” (that is to say her daughters- and sons-in-law). No other partners contributed assets to the partnership. Shortly thereafter, Disbrow gave all of her interest in the partnership to the other partners. She continued to live in the residence until she died, paying the partnership less than fair rental value (FRV).

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