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I. Treasury Regulations & Proposals
¶ Treasury issued final regulations limiting the estate tax deduction for unpaid claims and expenses. With respect to decedents dying on or after October 20, 2009, an estate may deduct an expenditure only if the claim or debt is actually paid. Under the new regs, the amount of claim or expense may be determined by (i) court decree; (ii) consent decree; or (iii) settlement. No deduction is allowed to the extent a claim or expense is or could be reimbursed by insurance. Notice 2009-84.
Nevertheless, several exceptions exist to the rule requiring actual payment. If a potential for reimbursement exists, the claim may still be deductible if the executor provides a “reasonable explanation” of why the burden of collection would outweigh the anticipated benefits of collection. Another exception provides that a claim or expense may be deducted by the estate if the amount to be paid is ascertainable with “reasonable certainty.” No deduction may be claimed for claims that are contested or contingent.
¶ Although the IRS has been successful in challenging gift and estate valuation discounts with arguments premised on §2036, §2704(b) has rarely aided the IRS in litigation in the twenty years since its enactment. Treasury’s 2010 budget proposal includes a provision that would expand the scope of §2704(b). Section 2704(b) ignores in valuing an interest in a closely held entity any “applicable restriction” on liquidation that would lapse or could be removed after the transfer. Restrictions in governing agreements, if not ignored, increase estate and gift tax discounts. Under the proposal, a new category of “disregarded restrictions” would be ignored under §2704(b). Disregarded restrictions would include limitations on the owner’s right to liquidate the interest if the limitations are more restrictive than a standard identified in the regulations, even if they are no more restrictive than those imposed by state law. (Most states have enacted “friendly” statutes to take advantage of the “no more restrictive than state law” language in §2704(b), which has made it possible for estate planners to avoid the application of the statute.)
¶ Treasury’s 2010 budget proposal includes a requirement that all GRATs have a term of not less than 10 years. This limitation would be intended to ensure that the transaction has at least some downside risk. The 10 year requirement would make it unlikely that many taxpayers over 75 years old would utilize a GRAT. Instead, those individuals would likely use sales to grantor trusts to shift appreciation in transferred assets to donees. Note that the proposal would not affect the use of “zeroed-out” GRATS, where the initial taxable gift is negligable.
¶ Treasury has also proposed that taxpayers who receive property by gift or by bequest from a decedent must use the gift or estate tax value for future income tax purposes, even if they disagree with that value. Thus, a taxpayer who receives property from a decedent would be required to use as his basis that reported for estate tax purposes. Similarly, a taxpayer receiving property by gift would be required to use the donor’s basis as reported for gift tax purposes.
¶ Treasury announced new actuarial tables to reflect increased longevity. The new tables increase the value of lifetime interests and decrease the value of remainders or reversionary interests. T.D. 9448.
II. Private Letter Rulings
¶ In PLR 200944002, the grantor created a self-settled spendthrift trust for the benefit of himself, his spouse and his descendants. The trust provided that the trustees could not be related or subordinate to the grantor or his spouse, and that the grantor had no right to remove the trustees. Under state law, a trust instrument containing such restrictions prevents a creditor existing when the trust is created, or subsequent creditor, from satisfying a claim out of the beneficiary’s interest in the trust, unless (1) the trust is revocable by the grantor without the consent of an adverse party; (2) the grantor intends to defraud a creditor; (3) the grantor is in default of a child support obligation; or (4) the trust requires that all or part of the trust’s income or principal, or both, must be distributed to the grantor.
The IRS concluded that the transfers to the trust were completed gifts for gift tax purposes since the grantor had no power to revest beneficial title. Furthermore, the trust assets would not be includible in the grantor’s gross estate since the grantor’s retained power to substitute assets did not constitute a reserved power to alter beneficial enjoyment by reason of the trustee’s fiduciary obligations.
¶ In PLR 200919003, the decedent’s revocable trust created a marital trust intended to be a QTIP trust. However, the language creating the power made it both lifetime and testamentary. Noting that state law permitted reformation of a trust to correct a “scrivener’s error” which had occurred, the IRS stated that the reformation would be accepted for estate tax marital deduction purposes.
III. Chief Counsel Advisories & Notices
¶ In CCA 200923024, the Office of Chief Counsel analyzed a case where taxpayer transferred S corporation stock to a partnership, and then formed an irrevocable nongrantor trust. An IRC § 754 election was made, stepping up the inside basis of S corporation assets. After this election, nongrantor trust status was terminated, and the trusts were converted into grantor trusts under IRC § 674. The CCA concluded that although the transactions were “abusive,” they were not taxable since the conversion of a nongrantor trust to a grantor trust is not deemed to be a transfer for income tax purposes. The CCA has positive implications for asset sales to grantor trusts, where a “switch” in the trust instrument can be inserted to turn grantor trust status on and off.
¶ In Interim Guidance Memorandum 04-0509-009 (May 8, 2009), the IRS directed its estate tax attorneys to consider imposing preparer penalties under IRC §6694. The guidance states that during every examination, estate tax attorneys should determine if preparer penalties are appropriate, based on oral testimony and/or written evidence adduced during the examination process.
¶ CCA 200937028 confirmed that assets sold to an intentionally defective grantor trust receive no basis step up at the Grantor’s death. The IRS quoted Regs. §1014-1(a), and concluded that “it would seem that the general rule is that property transferred prior to death, even to a grantor trust, would not be subject to section 1014, unless the property is included in the gross estate for federal estate tax purposes as per section 1014.”
¶ Notice 2008-13 provided guidance concerning the imposition of return preparer penalties. Notice 2009-5 provides that tax return preparers may apply the substantial authority standard in the 2008 Tax Act, or may continue to rely on Notice 2008-13, which provides interim guidance.
IV. New York Developments
¶ New York imposes estate tax on a pro rata basis to nonresident decedents with property subject to New York estate tax. NYS-DTF Memorandum TSB-M-92 provides that “New York has long maintained a tax policy that encourages nonresidents to keep their money, securities and other intangible property in New York State.” TSB-A-85(1) further provides that shares of stock of a New York corporation held by a nonresident are not subject to New York estate tax since shares of stock are considered intangible personal property.
Still, TSB-A-08(1)M, provides that an interest of a nonresident in an S Corporation which owns a condominium in New York is an intangible asset provided the S Corporation has a legitimate business purpose. Presumably, if the S Corporation had only a single shareholder, and its only purpose was to hold real estate, New York could attempt to “pierce the veil” of the S Corporation and subject the condominium to New York estate tax in the estate of the nonresident.
¶ Assume a valid QTIP election is made on a New York estate tax return, but the surviving spouse is no longer a resident of New York at her death and the trust has no nexus to New York. Will New York seek to “recoup” the estate tax deduction claimed on the first spouse to die in a manner similar to the way in which California’s “clawback” tax recoups deferred tax in a like-kind exchange if out-of-state replacement property is later sold? Apparently not, provided the surviving spouse is a bona fide nonresident of New York at her death.
Would the state in which the surviving spouse dies have a right to tax the assets in the QTIP trust? Also, probably not. Generally, a QTIP trust is not includible under IRC §2036 in the estate of the surviving spouse if no QTIP election is made. Although a QTIP election was made in New York, no QTIP election was made in the state in which the surviving spouse dies. Therefore, that state would seem to have no basis to impose estate tax on the assets in the QTIP trust.
[Note, however, that if the state in which the surviving spouse dies imposes an inheritance tax (such as that imposed by Pennsylvania) then this tax would not be avoided, since an inheritance tax is imposed on the transferee, rather than on the estate.]