Aug 1, 2007 12:00 PM

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

• Estate tax value of lottery winnings is determined under the IRS tables

  U.S. District Court for the District of New Hampshire handed down Estate of Freeman v. United States, No. 04-cv-273-SM (June 13, 2007), finding that the decedent's annuity stream from a winning lottery ticket must be valued using the Internal Revenue Code Section 7520 tables. In doing so, the court also held that, when an asset is non-transferable, the estate tax valuation must assume that it would be transferable to a hypothetical purchaser, but that such a purchaser would take it subject to the transfer prohibition and adjust his price accordingly.

  Kenneth Freeman died with an annuity payable to his estate for several years, because he'd won the New Hampshire lottery. At issue in the case was the value of the right to those lottery payments for estate tax valuation purposes.

  The court observed that, for estate tax purposes, the general rule requires that the estate's annuity be valued by referring to the IRC annuity tables. However, it might be warranted to use an alternate valuation method if an estate could prove that: (1) the value ascribed to the annuity by the IRC tables is “unrealistic and unreasonable;” and (2) there is a more reasonable and realistic means by which to determine the annuity's fair market value (FMV).

  The appraiser for the Freeman estate attempted to calculate the amount for which the estate could sell the annuity to an informed and willing, hypothetical buyer. Because the annuity was not assignable, the appraiser's valuation envisioned a situation in which the estate would “sell” the annuity to a third party, who'd then depend on the estate to continue receiving payments from the state, then remit those payments to the purchaser. As a result, a purchaser would discount its value substantially, not simply because he'd have difficulty selling the “asset” to yet another party, but also because the income stream would be at risk: The purchaser would be unable to collect if the seller became mentally incompetent or died.

  The court held, “Those risks would be relevant here if the issue were valuation of the estate of a buyer of lottery winnings,” but that was not the issue before the court. Instead, the court said the question was how much a hypothetical buyer would pay to stand in the estate's shoes. Thus, the appraiser should have determined the price that a hypothetical bidder would pay — assuming that this buyer could gain full legal rights to the annuity but be unable to resell those rights.

  The court also was not convinced that the lack of marketability should give rise to a significant discount. “Despite the lack of an established secondary market in which holders of annuities might sell those assets, the lack of liquidity does not appear to affect the price at which insurance companies sell those annuities or the price that annuity buyers are willing to pay.” Indeed, the court concluded, “[a]t the very most, its lack of assignability would result in a five percent (5%) discount relative to comparable, but freely transferable, annuities.”

  The court didn't find (and the estate didn't cite) any cases holding such a relatively minor discrepancy sufficient to warrant a conclusion that the value those tables ascribe to the annuity is “unrealistic and unreasonable.” Even the two federal appellate courts that concluded lottery annuities shouldn't be valued under the IRC tables did so only after finding that the tables yielded a value that deviated from the annuities' FMV by more than 25 percent. See Gribauskas v. Comm'r, 116 T.C. 142 (2001), rev'd, 342 F.3d 85 (2d Cir. 2003) and Shackleford v. United States, 262 F.3d 1028 (9th Cir. 2001).

• FLP assets are included in a gross estate

  In Estate of Gore, T.C. Memo. 2007-169 (issued June 27, 2007), Sylvia Gore died in 1997. She was the surviving spouse of Sidney Gore, who'd died in 1995. They had two children, Michael and Pamela. In 1996, Sylvia, her children and trusts for their benefit formed a family limited partnership (FLP), making Michael and Pamela general partners.

  A marital trust for the Sylvia's benefit was intended to contribute most of the assets to the FLP in exchange for limited partnership (LP) interests. Sylvia executed an irrevocable assignment agreement in which she purported to withdraw all of the assets held in the marital trust and assign assets worth $100,000 to two trusts for her children's benefit and the remaining assets to the FLP.

  Under applicable state law, Oklahoma's, the assignment was enforceable and effectively withdrew the assets from the marital trust, as evidenced by Sylvia's exercise of dominion and control over the assets and her use of them after the assignment was executed. However, the assignment did not result in a completed gift in accordance with Oklahoma law. Sylvia did not relinquish dominion and control over the marital fund assets when the assignment was executed, and as of her death, either her name or her predeceased spouse's name appeared on all of the assets purportedly transferred to the FLP. In addition, she continued to collect interest and dividends on marital trust assets, retained proceeds from the sale of those assets, deposited income generated by the marital trust assets into her bank accounts and used income from the marital trust assets for her personal expenses.

  As a result, the value of the marital trust assets allegedly transferred to the FLP was includible in Sylvia's gross estate under IRC Section 2033. Even if she had effectively withdrawn the assets from the marital trust, she had a general power of appointment over the trust assets, causing the assets to be includible in her gross estate under IRC Section 2041.

  Alternatively, the court held, even if the transfer of the marital trust assets to the FLP was a completed gift, the value of those assets would be includible in Sylvia's gross estate under IRC Section 2036(a). At the time of her death, she owned and controlled the marital trust assets, and continued to receive all of the income from the assets, using the income without restriction. Accordingly, there was an implied agreement between Sylvia and her children that she would continue to possess and enjoy the property after the purported transfer.

• The IRS approves a joint purchase personal residence trust (PRT) on an existing home

  In Private Letter Ruling 200728018 (decided March 19, 2007, and issued July 16, 2007), a husband and wife jointly owned a home they wished to contribute to a trust intended to meet the requirements of a PRT as described in Treasury Regulations Section 25.2702-5(b)(1)-(3).

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