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

By: Rorie M. Sherman Editor in Chief

From David A. Handler, partner in the Chicago office of Kirkland & Ellis LLP, we have this report:

• Post-death distribution from retirement plan is not IRD. In Eberly v. Commissioner, T.C. Summary Opinion 2006-45 (issued March 29), William Eberly, a week before his death, submitted a request to withdraw $600,000 from his retirement plan to be deposited into his savings account. The request was signed, dated and mailed to the retirement plan sponsor, but not received until four days after Eberly died. At that time, the funds (less $120,000 for federal income tax withholdings) were transferred to Eberly's account, and eventually distributed to his son, pursuant to Eberly's will.

  The Tax Court held that Eberly had exercised his option to receive a lump-sum distribution during his lifetime in accordance with the plan requirements, and that receipt of the withdrawal request and actual payment during Eberly's lifetime were not required by the terms of the plan. As a result, the distribution was income to Eberly and includible in his gross income, and the amounts received by his son were neither a death benefit payment nor includible in his gross income under Internal Revenue Code Section 691(a) as income in respect of a decedent (IRD).

• Distribution from a trust doesn't accelerate deferred estate tax under IRC Section 6166; the current regulation saying so is declared invalid. In Private Letter Ruling 200613020 (issued Dec. 14, 2005 and released Mar. 31, 2006), a decedent's will left the residue of his estate to a trust for the benefit of his daughter. The trust owns an interest in a partnership that engages in forest products ownership, harvesting and sale, and invests in other real estate. The executor of the estate elected under IRC Section 6166 to pay the estate tax attributable to the partnership in installments.

  The will provided that when the daughter attained a certain age, she could, upon request, withdraw up to one-half of the trust assets, and at a later age could withdraw the rest. The daughter has attained the first age and plans to exercise her right to withdraw half of the trust assets, including half of the trust's interest in the partnership. She also plans to withdraw the rest of the assets when she attains the later age.

  IRC Section 6166 allows the executor of an estate to pay all or any part of the estate tax imposed on an interest in a closely held business in two or more (but not exceeding 10) equal installments, if certain requirements are met. IRC Section 6166(g)(1)(A) provides that if (1) any portion of an interest in a closely held business that qualifies for the election is distributed, sold, exchanged or otherwise disposed of, or money and other property attributable to such an interest is withdrawn from such trade or business, and (2) the aggregate of such distributions, sales, exchanges or other dispositions and withdrawals equals or exceeds 50 percent of the value of the closely held business, then the unpaid portion of the tax payable in installments is payable upon notice and demand from the Treasury Secretary.

  IRC Section 6166(g)(1)(D) provides that Section 6166(g)(1)(A)(i) does not apply to a transfer of property of the decedent to a person entitled by reason of the decedent's death to receive the property under the decedent's will, the applicable law of descent and distribution, or a trust created by the decedent. Treasury Regulations Section 20.6166A-3(e)(1) provides that a transfer by the executor of an interest in a closely held business to a beneficiary or a trustee named in the decedent's will does not constitute a distribution thereof for purposes that rule, but that a subsequent transfer of the interest by the beneficiary, trustee or heir will constitute a distribution, sale, exchange or other disposition thereof for such purposes. However, that regulation was developed pursuant to former IRC Section 6166A(h)(1)(D), which provided that payment of the deferred estate tax was not accelerated if the transfer of property was made pursuant to the decedent's will or the law of descent and distribution, and did not refer to transfers made pursuant to a trust created by the decedent. Because current IRC Section 6166(g)(1)(D) provides that payment of the deferred estate tax is not accelerated with respect to transfers of property to a person entitled to receive the property under a trust created by the decedent, Treas. Regs. Section 20.6166A-3(e)(1) is inconsistent with current IRC Section 6166(g)(1)(D) and therefore no longer inapplicable.

  Accordingly, the distribution to the daughter of part or all of the partnership in response to her written request will not accelerate the payment of tax deferred under IRC Section 6166(a).

• Value of stock in limited partnership based on mean trading price. Estate of Temple, D.C. Texas, 2006-1 USTC, paragraph 60,523 (issued April 10), was a dispute over the gift tax value of interests in a family limited partnership (FLP) that owned publicly traded stock. The Tax Court in reaching its conclusion first determined the value of the stock itself, based on the average of the high and low price for the day of valuation. That is the method prescribed by Treas. Regs. Section 25.2512-2(b), which states: “In general, if there is a market for stocks or bonds, on a stock exchange, in an over-the-counter market or otherwise, the mean between the highest and lowest quoted selling prices on the date of the gift is the fair market value per share.” The court noted that the regulation does not differentiate between valuing an outright gift of stock and valuing an interest in a partnership that owns stock, also citing Estate of Cook v. Comm'r, 349 F.3d 850 (5th Cir. 2003), which held that the IRC and supporting regulations are used for valuation purposes, notwithstanding the presence of a partnership as the owner of the asset to be valued.

• Gifts eligible for gift-splitting. In PLR 200616022 (issued Dec. 26, 2005 and released April 21, 2006), a husband established Trust 1 for the benefit of his children. The trust provides that if the husband dies within three years after a gift to Trust 1 and all or a substantial portion of the trust assets are includible in the husband's gross estate, the trust assets are to be held in a marital trust for his wife, if she survives him, with an ascertainable standard for invasion on behalf of the wife.

  Treas. Regs. Section 25.2513-1(b)(4) provides that if one spouse transfers property in part to his spouse and in part to third parties, split-gift treatment is effective with respect to the interest transferred to third parties only insofar as the interest transferred to third parties is ascertainable and severable from the interest transferred to the spouse at the time of the gift.

  The IRS determined that the wife had an interest in Trust 1 as a contingent beneficiary if she survived the husband for three years after the gift, and that the wife's interest in Trust 1 in those years is susceptible of determination and is severable from the gifts to other beneficiaries. As a result, the transfers to Trust 1 are eligible for gift-splitting under IRC Section 2513 to the extent that the value of the transfers exceed the actuarial value of the wife's interest in Trust 1, determined under IRC Section 7520.

  In years one and two, the husband and wife did not file gift tax returns, but the IRS said that if they file belated gift tax returns for those years signifying their consent to gift-splitting, the consents will be effective for purposes of Section 2513.

  The husband filed gift tax returns for years three, four and five, and elected to treat the gifts as made one-half by the husband. The wife's consent to split gifts was signified on the gift tax return, but she didn't sign the return nor file her own gift tax returns. The IRS held that they nonetheless evidenced their intent to elect to split gifts on the husband's gift tax return, which was effective for purposes of Section 2513.

• Residence qualifies for QPRT. In PLR 200617035 (issued Dec. 22, 2005 and released April 30, 2006), the taxpayer proposed to transfer property located on a sparsely populated island, consisting of two contiguous parcels that constitute a portion of a larger tract owned by the taxpayer, to a qualified personal residence trust (QPRT). The structures on the property include a residence, a bathhouse and a pavilion. The residence and bathhouse are located on one of the parcels and the other parcel contains the road that provides the sole access to the residence, bathhouse and pavilion. The bathhouse consists of a roof over a small outdoor bathtub, and the pavilion is a one-room structure with no plumbing. Before transferring the property to the QPRT, the taxpayer would place a qualified conservation easement on the property.

  The IRS held that the property was a “personal residence” within the meaning of IRC Section 2702(a)(3). The size of the property was comparable to that of nearby properties used for residential purposes and included adjacent land not in excess of that which is reasonably appropriate for residential purposes, as permitted under Treas. Regs. Section 25.2702-5(c)(2)(ii). In addition, the residence and other structures on the property were used by the taxpayer exclusively for residential purposes.

• Transfers of residence and proceeds were not gifts. In PLR 200617002 (issued Jan. 10, and released April 30), the decedent and his spouse each conveyed a one-half interest in their principal residence to respective QPRTs. During the QPRT terms, the decedent and his spouse executed deeds conveying the interests in the residence to their revocable trusts, in contravention of the terms of the QPRTs. Their daughters became aware of these transfers several years later, when the decedent and his wife were selling the residence. The daughters demanded the sale proceeds, which the wife agreed to give to them in full settlement of all claims against the decedent's estate and his wife.

  The IRS held that, because the daughters were unaware of and did not consent to the transfers to the revocable trusts, such transfers were not taxable gifts by the daughters (as the QPRTs' remainder beneficiaries). Additionally, the payment of the sales proceeds from the subsequent sale of the residence was not a taxable gift by the wife or by the beneficiaries of the decedent's revocable trust or estate, because the remainder beneficiaries had enforceable claims with respect to the residence that had not otherwise been relinquished.

• Insured does not have incidents of ownership. In PLR 200617008 (issued Dec. 13, 2005, and released April 30, 2006), an irrevocable trust created by a deceased husband purchased an insurance policy on the life of the surviving spouse. The wife was a beneficiary of the trust but resigned as a co-trustee before the policy was acquired. The trustees are to pay the wife all of the net income and so much of the principal as the trustees determine in their discretion.

  The IRS held that, because the wife resigned as trustee before the policy was purchased, she never possessed nor had the power to exercise any incidents of ownership in the policy, and she did not transfer or relinquish any incidents of ownership in the policy by resigning as trustee before the policy was purchased. In addition, because it was represented that all the income of the trust will continue to be paid to the wife, the principal of the trust will be used to pay the premiums and that the wife will not pay any premiums with respect to the policy or otherwise contribute towards the maintenance of the policy, the life insurance policy proceeds would not be includible in her gross estate under IRC Section 2042(2). These conclusions were based on the assumption that the wife would not be reinstated as co-trustee and would not be serving as co-trustee when she died, or after being reinstated, resign as co-trustee within three years of her death.

  In reaching this conclusion, the IRS relied on Revenue Ruling 84-179, 1984-2 C.B. 195. In that ruling, the decedent transferred a policy on his life to his wife. The wife subsequently died and her will left the policy to a trust for the benefit of the couple's child; the decedent was named as trustee (and served in that position until he died). Although, the decedent as trustee had the power to distribute or accumulate income, and under the terms of the policy could elect to have the proceeds made payable according to various plans, use the loan value to pay the premiums, borrow on the policy, assign or pledge the policy, and elect to receive annual dividends, he could not exercise these powers for his own benefit. The premiums were paid out of other trust property.

  The PLR held the decedent would not be considered to possess incidents of ownership in the policy provided he didn't furnish consideration for maintaining the policy and couldn't exercise his powers for his personal benefit. The ruling also provides that the result would be the same if the decedent acting as trustee purchased a policy as a trust asset. In reaching that conclusion, the IRS held that IRC Section 2042(2) generally applies to include life insurance in situations that parallel the inclusion of property under IRC Sections 2036 to 2038. Those sections generally involve the transfer of property where rights or powers are retained incident to the transfer.

  Apparently, the IRS' position is that if the insured is a beneficiary of a trust that owns a policy on his life, if he furnishes consideration for maintaining the policy, directly or indirectly (for example by allowing the trust income otherwise distributable to him to be used to pay the premiums), he will be treated as having made a transfer to the trust and retained rights sufficient to cause him to possess incidents of ownership over the policy. See also PLRs 9748020 and 200518005.

• Qualifying retirement plans payable to trusts for marital deduction. In Rev. Rul. 2006-26, I.R.B. 2006-22 (issued May 30), the IRS describes three situations in which a trust is named as the beneficiary of an individual retirement account (IRA) or other qualified plan and the surviving spouse would be considered to have a “qualifying income interest for life” for purposes of IRC Section 2056(b)(7) to treat both the plan and the trust as qualified terminable interest property. In all the three situations, the income of the trust, excluding the IRA, and the income of the IRA would be determined separately to determine whether they constituted a qualifying income interest for life.

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