Analysis of and reflections on recent cases and rulings.

• Author: Beavers, James A.
• Position: TAX TRENDS

Estates, Trusts & Gifts

Full value of GRAT includible in estate

The Ninth Circuit affirmed a district court's holding that the full value of a grantor retained annuity trust (GRAT) was includible in a decedent's estate, not just the net present value of the unpaid annuity payments from the GRAT.

Background

Patricia Yoder was married to Donald Yoder, a 50% partner in Y&Y Company, a family-run general partnership and property development company in southern California. After Donald's death in 1990, Patricia succeeded to his 50% partnership interest.

In February 1998, she created a GRAT to transfer the partnership interest in Y&Y to her daughters, Judith Badglcy and Pamela Yoder. Patricia retained a right to an annuity to be paid from the GRAT for 15 years, equivalent to 12.5% of the date-of-gift value of the partnership interest for 15 years. Patricia died before the end of the 15-year annuity period. The estate tax return for her estate reported a total gross estate of $36,829,057, including the value of the assets held in the GRAT. Patricia's estate paid the reported taxes on the return of $11,187,475.

In 2016, Badgley, as executor of Patricia's estate, sought a refund of an overpayment of estate tax in the amount of $3,810,004. Badgley asserted that the overpayment resulted from the inclusion of the entire date-of-death value of the GRAT in the gross estate and that only the net present value of the unpaid annuity payments should have been included. The IRS did not respond to the refund request within six months, so Badgley filed a refund suit in district court.

Badgley argued in district court that the full value of the GRAT should not be included because Sec. 2036(a) did not apply to Patricia's GRAT and Regs. Sec. 20.2036-l(c)(2)(i) is overly broad and invalid to the extent that it applied to the GRAT.

The law and the district court's decision

Sec. 2036(a) provides:

The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his Ufe or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death-- (1) the possession or enjoyment of, or the right to the income from, the property ...

Thus, a decedent's gross estate includes the value of property transferred while the decedent was alive if the decedent retained possession of, enjoyment of, or the right to income from the property. These three factors are referred to as "strings" tying the transferor to the property despite the transfer.

Regs. Sec. 20.2036-l(c)(2) includes the formula the IRS uses to calculate the portion of the property includible under Sec. 2036(a). The regulation interprets Sec. 2036(a) to provide that GRATs are includible in a grantor's gross estate when the decedent retains an annuity interest and dies before the expiration of the GRAT term, because they are sufficiently tied to the grantor.

The district court ruled in favor of the IRS {Badgley, No. 4:17-cv-00877 (N.D. Cal. 5/17/18)). It held that Patricia's retained annuity interest was both a retained right to income from and continued enjoyment of the property. Both "strings" tied the GRAT to Patricia, so the entire date-of-death value of the GRAT was includible in her gross estate. The court also concluded that Regs. Sec. 20.2036-l(c)(2), the Treasury regulation applying Sec. 2036(a)(1) to GRATs, was valid.

Badgley appealed the decision to the Ninth Circuit.

The Ninth Circuit's decision

The Ninth Circuit affirmed the district court's holding that the full date-ofdeath value of the GRAT was includible in Patricia's estate. It found that Patricia had retained the enjoyment of the annuity in the GRAT, so it was subject to Sec. 2036.

Badgley argued in the Ninth...