The following article originally appeared in newsletter of the Kansas Bar Association Real Estate, Probate and Trust Law Section. It is reprinted here by permission.
By Mike Cannady
Steinberg v. Commissioner, 145 T.C. No. 7 (Tax Ct. Sept. 16, 2015) — Assumption of Liability Reduces Value of Gift to Donees
In Steinberg, the taxpayer entered into a binding net gift agreement with her daughters under which she agreed to make gifts to her daughters, and they agreed to assume and pay any Section 2035(b) estate tax liability resulting from the gift, if she passed away within three years. The agreement was the result of several months of negotiations between the taxpayer and her daughters, during which they were each represented by separate counsel.
On the taxpayer’s gift tax return, the value of the property transferred to her daughters was reduced by the fair market value of an appraiser’s valuation of the daughters’ assumption of the Section 2035(b) liability. The IRS issued a notice of deficiency that disallowed the discount.
Under Section 2035(b), a decedent’s gross estate is increased by the amount of any gift tax paid by the decedent or the decedent’s estate on any gift made by the decedent during the three‑year period preceding the decedent’s death. Gift tax paid by the decedent or the decedents estate during that three‑year period includes gift tax attributable to a net gift the decedent made during that period, even though the donee is responsible for paying the gift tax in that situation.
A transfer for less than an adequate and full consideration in money or money’s worth is treated as a gift to the extent of the amount by which the value of the property transferred exceeds the value of the consideration pursuant to Section 2512(b). Thus, if a donor makes a gift subject to the condition that the donee pay the resulting gift tax, the gift amount is reduced by the gift tax amount (net gift).
The court said that the fundamental issue was the fair market value of the property rights transferred under the net gift agreement. The court determined that the daughters’ assumption of the Section 2035(b) liability was a detriment to them because it might result in reductions in the values of the gifts they received if the taxpayer died within three years of the gifts. A hypothetical willing buyer of the properties would recognize that to obtain the properties transferred, he or she would need to assume both the gift tax and Section 2035(b) liability, and would demand that the price be reduced to account for both of the liabilities.
The IRS argued that the daughters’ assumption of the Section 2035(b) liability did not create any new burden on the daughters or benefit for the taxpayer because the daughters would have had to bear the burden of the Section 2035(b) liability either under New York law or as beneficiaries of the taxpayer’s residuary estate. The court disagreed, saying that when the gifts were made the taxpayer was alive and capable of changing her domicile. Thus, there was the possibility that another state’s law would apply to her estate. Also, the taxpayer was entitled to change her will before her death, so it was not possible to determine that all four of her daughters would be beneficiaries in her will when she died.
Because the court found that the daughter’= assumption of liability should be considered in determining the gift’s fair market value, it needed to decide what effect the promise had on the gift’s fair market value. The taxpayer submitted an expert report that said the value of the daughters’ assumption of the Section 2035(b) liability was approximately $5.8 million, while the IRS did not submit an expert report. The court rejected the arguments the IRS made in relation to the taxpayer’s expert report, and said that its use of the mortality tables and the Section 7520 rates did not produce an unreasonable result.
Davis v. Commissioner, T.C. Memo 2015‑88 (Tax Ct. May 6, 2015) — Charitable Intent and a Bargain Sale to Charity
In Davis, the taxpayer engaged in a bargain sale of real estate to a Section 501(c)(3) charitable organization that builds, develops, and operates senior living centers. The purchase price by the charity for the real estate was $2.0 million, while the appraised value was $4.1 million. Because of the $2.1 million bargain‑sale element, the taxpayer claimed a charitable income tax deduction of $566,900 on his 2005 income tax return and carried over the remaining amounts to subsequent years.
The IRS issued a notice of deficiency, and advanced two arguments for disallowance of the entire charitable deduction. First, it asserted that the taxpayer lacked sufficient charitable intent when he sold the real estate to the charitable organization because he sought the tax benefits flowing from the bargain sale. The court rejected this argument and found instead that as of the time of the sale, the taxpayer believed that he was selling the real estate for less than its fair market value, and that he intended to transfer the excess value to the charitable organization as a charitable contribution. The court also rejected the argument of the IRS that the taxpayer lacked a charitable intent because he investigated the tax benefits of a bargain sale prior to the sale.
The second argument advanced by the IRS was that the value of the real estate did not exceed $2.0 million. The court found the appraisal by the taxpayer’s appraiser to be more credible that the appraisal performed by the IRS’s appraiser. However, the court did find some flaws in the appraisal of the taxpayer’s appraiser and therefore reduced the value of the real estate slightly.
Estate of DiMarco v. Commissioner, T.C. Memo 2015‑184 (Tax Ct. Sept. 21, 2015) — No Estate Charitable Set-Aside Deduction Where Contribution Was Subject of Litigation
John DiMarco’s will provided that, after the payment of expenses, his residuary estate was to go to the church that he regularly attended (he actually attended two churches regularly before his death). Pursuant to the will, the executor was to be the pastor at the church that he regularly attended, so the pastors of the two churches he attended were appointed as co‑executors. Several cousins of the decedent claimed that the will was ambiguous and asserted potential interests in the estate.
For the 2010 tax year, the estate reported $335,854 of total income and claimed a $314,942 charitable contribution deduction from gross income as an amount permanently set aside for charitable purposes. That return was untimely filed on or around April 19, 2012, and at some point in April 2012, the parties reached a settlement, under which the cousins would receive approximately one‑third of decedent’s gross probate estate, to be divided equally among them, and that the two churches would equally split the remaining portion. A second settlement was later reached that also provided for payment of attorney’s fees and co‑executors’ commissions, which was approved by the court on or around January 28, 2013. In the end, the two churches received a total of $343,890 from the estate, which included the pastors’ commissions for serving as co‑executors.
On October 25, 2013, IRS issued a notice of deficiency denying the $314,942 deduction and determining a deficiency in tax of $108,588. At issue was whether the contribution was “permanently set aside for a charitable purpose.”
The estate argued that, as of March 22, 2012, it could determine and account for all of its final administrative expenses, pointing to a settlement meeting that occurred on that date as evidence that the possibility of prolonged legal controversies was “so remote as to be negligible.”
IRS, however, argued that the “so remote as to be negligible” standard was not met, noting that the legal controversy was ongoing throughout the year at issue and through the time of filing and that made it likely that additional legal and other expenses would deplete estate assets. Furthermore, the funds were not segregated into a separate account, but rather were held in a general account that the estate used to pay all expenses.
The Tax Court concluded that, given that the estate was in the midst of an ongoing, unresolved legal controversy at the time the return was filed, the possibility that the amount set aside for the exempt beneficiaries could go to noncharitable beneficiaries was not “so remote as to be negligible.”
The Tax Court found that the various parties involved, the conflicting claims asserted, and complications with respect to the will itself, all should have alerted the estate that a potential legal controversy was likely and that the “so remote as to be negligible” standard therefore was not met. The court also agreed with the IRS that, under Estate of Belmont, 144 TC No. 6 (2015), the presence of active litigation disqualified the funds from meeting the “permanently set aside” standard.
In Re Mosby, Pension Plan Guide (CCH) ¶ 24018P (D. Kan. Oct. 30, 2015) — Inherited IRA Not Exempt Under Kansas Law
In Mosby, the Debtor had claimed that a certain inherited IRA was exempt under K.S.A. 60‑2308(b). The Trustee objected to the exemption, and the Bankruptcy Court sustained the objection, ruling that the inherited IRA did not fall within the language of Section 60‑2308(b). The Debtor appealed the ruling.
Section 60‑2308(b) provides in relevant part as follows:
Except as provided in subsection (c), any money or other assets payable to a participant or beneficiary from, or any interest of any participant or beneficiary in, a retirement plan which is qualified under sections 401(a), 403(a), 403(b), 408, 408A or 409 of the federal internal revenue code of 1986, and amendments thereto, shall be exempt from any and all claims of creditors of the beneficiary or participant.
The Court stated that under the plain language of the statute, there must be a “retirement plan” and the retirement plan be “qualified” under certain sections of the federal tax code. The Court indicated that the Kansas courts have not construed that term as used in Section 60‑2308(b), but that the United States Supreme Court, in Clark v. Rameker, 134 S. Ct. 2242 (2014), had recently determined that an inherited IRA is not a “retirement plan”, and the reasoning from that case applies here as well. In Clark, a unanimous Court held that funds in an inherited IRA do not qualify for the federal bankruptcy exemption because an inherited IRA does not contain “retirement funds.” The holder of such an account may not make contributions to it and may withdraw funds at any time without penalty.
Although the Debtor argued that Clark was not controlling because it involved a different statute, using a different term, the Court held that Clark was nevertheless persuasive and indicated how the United States Supreme Court would construe K.S.A. 60‑2308(b). The Court also disagreed with the Debtor that use of the words “any money” in the statute meant that the funds need not be in a plan held for present retirement purposes. The Court stated that the Kansas exemption covers “any money” payable from or any interest in a retirement plan, and an inherited IRA is not a retirement plan.
Green v. United States, 116 A.F.T.R.2d 2015-6668 (W.D. Okla. Nov. 4, 2015) — Charitable Deduction for Trust for Full Value of Appreciated Real Property
In Green, the United States District Court for the Western District of Oklahoma has concluded that a trust that donated appreciated real property to charities could claim a charitable contribution deduction under Code Sec. 642(c)(1) based on the fair market value of those properties.
Under Code Sec. 642(c)(1), in computing its taxable income, a trust may deduct‑in lieu of the deduction allowed by Code Sec. 170(a) (dealing with a charitable contribution deduction)‑any amount of income, without limitation, which under the terms of the governing instrument is paid during the tax year for a charitable purpose (as specified in Code Sec. 170(c)). The charitable deduction is allowed to the trust only for contributions made out of gross income. A contribution made out of income accumulated in earlier years is deductible, but only if no deduction was allowed to the trust for any previous year for the amount currently contributed.
In this case, the taxpayer was a trust, the terms of which expressly authorized the trustee to distribute to charity such amounts from the gross income of the trust as the trustee determined appropriate. The trust also provided that a distribution could be made from the trust to a charity only when both the purpose of the distribution and the charity were described in Code Sec. 170(c).
The trust (through a single‑member limited liability company that was disregarded as an entity separate from the trust for federal income tax purposes) donated various properties that it had purchased to three charities. Each of those properties had a fair market value in excess of its basis.
The trustee filed the trust’s income tax return claiming a charitable deduction in excess of $20 million, and later filed an amended income tax return increasing the trust’s reported charitable deduction to almost $30 million, and claiming a refund. The IRS sent the trustee a Notice of Disallowance of the refund claim, stating that the charitable contribution deduction for the real property was limited to the basis of the real property contributed.
The trustee contended that a charitable deduction under Code Sec. 642(c)(1) for donated real property purchased out of gross income should be calculated based on the property’s fair market value, arguing that the fair market value standard should apply to the charitable deduction because Congress did not specify a different valuation standard in Code Sec. 642(c)(1) .
On the other hand, IRS argued that: (1) Code Sec. 642(c)(1) limits a trust’s deduction to the amount of gross income it contributed to charity; (2) gross income does not include unrealized appreciation; and (3) a liberal construction of the statute allowing fair market valuation would negate the requirement that the donation be traceable to gross income.
The district court concluded that the plain language of Code Sec. 642(c)(1) supported a construction in favor of the trustee. The court found that Congress sought in Code Sec. 642(c)(1) to authorize a deduction without limitation, and that the fair market value was the appropriate valuation standard for the donated properties. The court held that there was a notable distinction between Code Sec. 642 and Code Sec. 170 ‑the absence in Code Sec. 642 of the limiting language that was present in Code Sec. 170-, and that the IRS’s strained interpretation sought to impose limitations where Congress clearly declined to do so.
Estate of Redstone v. Commissioner, 145 TC NO. 11 (Tax Ct. Oct. 26, 2015) and Redstone v. Commissioner, T.C. Memo 2015-237 (Tax Ct. Dec. 9, 2015) — Two Redstone Gift-Related Cases with Different Results
The two Redstone cases both arose from the same situation. Edward and Sumner Redstone were brothers who worked in the family business National Amusements, Inc. (NAI) with their father, Michael Redstone. Upon NAI’s incorporation, the father had contributed a disproportionate amount of capital, but the three were each listed as registered owners of one‑third of NAI’s shares. Edward was eventually forced out of the business, and upon his departure, he demanded all of his 100 shares of NAI stock. His father refused to deliver the stock to him, citing the disproportionate capital contributions he had made, and insisting that a portion of Edward’s stock had been held in an oral trust for the benefit of Edward=s children. After lengthy negotiations and the filing of two lawsuits, the parties reached a settlement, pursuant to which Edward transferred one‑third of the disputed shares into trusts for his children, and Edward was acknowledged as outright owner of the other two‑thirds of the disputed shares. NAI then redeemed Edward’s shares for $5 million.
Three weeks after the settlement agreement was signed, Sumner had one‑third of the NAI shares that were registered in his name re‑issued to two trusts he created for his two children. Sumner did not file a gift tax return.
IRS claimed that the transfers to trusts for Edward’s children, were taxable gifts made by Edward, and that the transfers to trusts for Sumner’s children, were taxable gifts made by Sumner.
In the case against Edward Redstone, the Tax Court concluded that the stock transfers were the result of a settlement of a dispute over the taxpayer’s ownership of stock. The transfer was made in the ordinary course of business and for full and adequate consideration, namely recognition by Edward’s father and brother that he was the outright owner of two‑thirds of the disputed share. The Court found that the evidence clearly showed that Edward Redstone transferred stock to his children, not because he wished to do it, but because his father demanded that he do it. At the time of the settlement, Edward had no desire to transfer stock to his children, but was forced to accept this transfer in order to placate his father, settle the family dispute, and obtain a $5 million payment for the remaining shares.
In the case against Sumner Redstone, however, the Tax Court found that Sumner’s transfer of stock to trusts for his children was “actuated by love and affection.” Sumner was not required to take this action by the settlement agreement that resolved Edward’s lawsuits, and was not made in the ordinary course of business within the meaning of Reg. ‘ 25.2512‑8. Therefore, the transfers made by Sumner were taxable gifts for Federal gift tax purposes.
Estate of Pulling v. Commissioner, T.C. Memo 2015‑134 (Tax Ct. July 23, 2015) — No Assembling of Land for Valuation Required
In Estate of Pulling, the decedent owned three parcels of real estate and also owned at the time of his death a 28% interest in a land trust that owned two adjacent parcels of real estate. All five parcels of real estate were contiguous and were zoned for agricultural purposes. Due to the size, boundaries, and locations of the parcels, residential development of the decedent’s parcels was not economically feasible unless the parcels were developed together with the property owned by the land trust. The appraisers for both the IRS and the estate agreed that if the estate’s property could be assembled with the property owned by the land trust, then residential development of all five parcels would be the highest and best use of the parcels. The appraisers also agreed that if assemblage was not possible, then residential development of the estate’s property would not be economically feasible.
The IRS argued that assemblage was reasonably likely because of the economic benefits that would be derived by the estate and the land trust from assemblage. The court stated that the fact that the greatest economic benefit for both the estate and the land trust would be derived from an assemblage of the property does not establish that such an assemblage was reasonably likely to occur. Evidence presented at trial showed that the owners of the land trust had previously rejected an offer to sell its property as part of a residential development. The court stated that this fact tends to show that the owners of the land trust were not interested in selling the property just because it would have been in their economic interest.
In addition, at trial, the appraisers for both the IRS and the estate testified that they would not recommend to a hypothetical buyer of the estate’s property that he purchase the land as a possible investment because assemblage was not certain enough. Therefore, the court rejected the first argument of the IRS.
The IRS’s second argument was that assemblage was reasonably likely because the decedent held a large minority interest in the land that when combined with the interests of the other owners of the land trust would result in a majority vote enabling the land trust to combine its property with the estate’s property. However, without any evidence regarding the intent of the other owners of the land trust or details as to their relationship with the decedent, the court believed that the IRS’s position essentially attributed ownership of the property of the land trust to the decedent solely on the basis of those relationships. The court concluded that the mere fact that the other owners are related to the decedent was not enough.
Therefore, the court having rejected both arguments of the IRS, held that it was not proper to combine the estate’s property with that of the land trust for purposes of valuation. Instead, each parcel must be valued separately for estate tax purposes.
RECENT STATUTORY AND REGULATORY
DEVELOPMENTS, AND IRS RULINGS
Memorandum No. 20152201F (May 29, 201) — Failure to Adequately Describe Gifts Leaves Limitations Period Open
In a memorandum from the Office of Chief Counsel, IRS has concluded that a taxpayer failed to disclose gifts (a transfer of interests in two partnerships) to his daughter in a manner adequate to apprise IRS of the nature and amount of the gifts. As a result, the period of limitations for the gift tax was held open indefinitely under Code Sec. 6501(c)(9).
The Donor (taxpayer) in this case filed a Form 709 on which he claimed two gifts, both of which went to his daughter. He attached a one‑paragraph supplement to the return with the heading “Valuation of gifts.” The supplement stated that partnership interests were given in two partnerships and provided their taxpayer identification numbers (although only 8 of the 9 digits were listed for one of the partnerships). The supplement stated that the assets of the partnership were primarily farm land and that the land was independently appraised by a certified appraiser. The statement indicated that percentage discounts were taken for “minority interests, lack of marketability, etc.” to obtain a fair market value of the gifts.
The IRS concluded that Donor’s Form 709 failed to adequately disclose his transfer of interests in two partnerships because it failed to sufficiently identify one of the partnerships, and it failed to adequately describe the method used to determine the fair market values of both partnership interests. Accordingly, the IRS could assess gift tax based upon those transfers at any time.
While the return accurately identified the percentages of the interests that Donor transferred, the descriptions of the interests transferred were incomplete. The return and statement provided an incomplete taxpayer identification number for one of the partnerships, used incorrect, abbreviated names for both partnerships (omitting the “LP” and “LLP” designations), wrongly implying that the partnerships were traditional partnerships under state law, and describing the transferred property as partnership interests without explaining whether the donor transferred general, limited, or limited liability interests.
The IRS also found that the valuation description did not include a detailed description of the method used to determine the fair market value of the property transferred, including any financial data utilized in determining the value of the interests. There was no explanation of the method (e.g., comparable sales) used to determine the value, nor any explanation of either how the percentage discount broke down between different discount types or the basis for the discounts taken. There was also no statement regarding the 100% value of either partnership, even though both entities appeared to be valued based upon their net assets.
PLR 201550005 and PLR 201550012 (Dec. 11, 2015) — Transfers to Directed Trust are Incomplete Gifts
In PLR 201550005 and PLR 201550012, the IRS stated that transfers to an irrevocable trust were not completed transfers for gift tax purposes, and that the trust was not a grantor trust. The trusts were directed trusts for the benefit of the grantor, her stepchildren, her children, and their issue. During the grantor’s lifetime, the trustee must distribute net income and principal to and among the beneficiaries as follows: (a) pursuant to the direction of a majority of the distribution committee, with the grantor=s written consent; (b) pursuant to the direction of the unanimous distribution committee members, other than the grantor; and (c) pursuant to the grantor’s sole decision, to beneficiaries other than the grantor, for their health, maintenance, support, and education. The IRS stated that, as long as there was a distribution committee, the trust was not a grantor trust, contributions of property to the trust were not completed gifts by the grantor, distributions of property by the distribution committee from the trust to the grantor were not completed gifts by any member of the distribution committee, and distributions of property by the distribution committee from the trust to any beneficiary, other than the grantor, were not completed gifts by any member of the distribution committee, other than the grantor.
Proposed Regulations Redefine Code’S Marriage‑Related Terms to Include Same-Sex Spouses
Following the Supreme Court’s decisions on same‑sex marriage in U.S. v. Windsor, 133 S.Ct. 2675 (2013) and Obergefell v. Hodges, 135 S. Ct. 2584 (2015), the IRS has issued proposed regs that would amend the current income, estate, gift, generation‑skipping, employment, and procedure regs under Code Sec. 7701.
Because of the holdings in Windsor and Obergefell, the IRS has determined that, for federal tax purposes, marriages of same‑sex couples should be treated the same as marriages of couples of the opposite sex and that, for reasons set out in Rev. Rul. 2013‑17, terms indicating sex, such as “husband,” “wife,” and “husband and wife,” should be interpreted in a neutral way to include same‑sex spouses as well as opposite‑sex spouses. Accordingly, the proposed regs would provide that, for federal tax purposes, the terms “spouse,” “husband,” and “wife” mean an individual lawfully married to another individual, and the term “husband and wife” means two individuals lawfully married to each other. These definitions would apply regardless of sex. (Prop. Reg. § 301.7701‑18(a))
In addition, the proposed regs would provide that a marriage of two individuals will be recognized for federal tax purposes if that marriage would be recognized by any state, possession, or territory of the U.S. Under this rule, whether a marriage conducted in a foreign jurisdiction will be recognized for federal tax purposes depends on whether that marriage would be recognized in at least one state, possession, or territory of the U.S. (Prop. Reg. § 301.7701‑18(b))
The proposed regs would not treat registered domestic partnerships, civil unions, or similar relationships that are not denominated as marriage under state law, as marriage for federal tax purposes. (Prop. Reg. § 301.7701‑18(c)).
IRS Account Transcript Take the Place of Estate Tax Closing Letters
The IRS has announced that, for estate tax returns filed on or after June 1, 2015, it would only issue estate tax closing letters upon request by the taxpayer. However, on its website, the IRS has now announced that, for all estate tax returns filed on or after June 1, 2015, account transcripts, which reflect transactions including the acceptance of Form 706 and the completion of an examination, and which are in many cases an acceptable substitute for an estate tax closing letter, are available to tax professionals. The transcripts are available online to registered tax professionals using the Transcript Delivery System (TDS) or to authorized representatives making requests using Form 4506‑T, Request for Transcript of Tax Return.
IRS provides detailed instructions on its website for how tax professionals register for transcripts and how they request and receive them. The instructions discuss the “Transaction Code” and note that Transaction Code 421, “Closed examination of tax return,” indicates that an estate tax return has been accepted as filed or that the examination is complete. If Transaction Code 421 is not present, then the tax return remains under review, and the tax professional should allow additional time before checking again.
IRS notes that, with respect to both the TDS and Form 4506‑T, its decision to audit a Form 706 is typically made four to six months after the filing date and that, therefore, tax professionals should wait four to six months after filing Form 706 before submitting a request for an account transcript.
Protecting Americans From Tax Hikes (PATH) Act — H.R. 2029, 114th Cong., 1st Sess. (Dec. 18, 2015)
On December 18, 2015, Congress passed and the President signed into law the Protecting Americans From Tax Hikes (PATH) Act of 2015 (P.L. 114‑113). That Act contains several charitable and gift tax related provisions.
The Act reinstates and makes permanent the rule that otherwise‑taxable IRA distributions are excluded from gross income to the extent they are “qualified charitable distributions.” IRA owners who have reached the age of 702 are allowed to make tax‑free charitable contributions of up to $100,000 directly out of their IRAs, and they can be counted as IRA required minimum distributions. The Act makes this tax break permanent so that it is available in tax years 2015 and beyond.
The Act reinstates and makes permanent several expiring tax incentives for charitable contributions of conservation easements. Liberalized deduction rules applied through 2014 that increased the maximum write‑off for these contributions, and the Act makes these liberalized rules permanent.
The Act establishes a new rule for valuing NICRUT and NIMCRUT remainder interests in an early termination. Effective for the termination of trusts after December 18, 2015, the remainder interest is valued using rules similar to the rules for valuing the remainder interest of a charitable remainder trust when determining the amount of the grantor’s charitable contribution deduction.
The Act exempts from gift tax gratuitous transfers to certain non‑charity exempt organizations, including social welfare organizations exempt under Code Sec. 501(c)(4), labor or similar organizations exempt under Code Sec. 501(c)(5), and trade associations and business leagues exempt under Code Sec. 501(c)(6).
The Act makes permanent and expands the income tax deduction for certain business contributions of food inventory, increasing the amount of deductible food inventory contributions that taxpayers other than C corporations may make in any taxable year from 10% to 15% of their aggregate net income, and limiting the amount for a C corporation to 15% of its taxable income.
The Act retroactively restores and makes permanent the favorable shareholder basis rule for stock in S corporations that make charitable donations of appreciated assets. For such donations, each shareholder’s tax basis in the S corporation’s stock is only reduced by the shareholder’s pro rata percentage of the company’s tax basis in the donated assets. Without this tax break, a shareholder’s basis reduction would equal the passed‑through write‑off for the donation (a larger amount). The provision is taxpayer‑friendly because it leaves shareholders with higher tax basis in their S corporation shares.