Assets includible in a transferor's estate.

• Author: Segal, Mark A.

A common challenge encountered by practitioners working in the estate and financial planning area is how to help a taxpayer retain lifetime control or enjoyment of an asset while eliminating the asset from the taxpayer's estate. For many years a straightforward and successful approach allowed taxpayers simply to transfer a remainder interest in the asset, while retaining a life estate in it or its income. It was argued that since the transferor's interest, i.e., the life estate, terminated at his death, the transferor possessed no interest in the asset capable of estate inclusion. Court decisions and statutory enactments, however, largely eliminated this tactic. The end was signaled in the Supreme Court's landmark decision in Church.' The Court applied a substanceover-form-type analysis to find the life-estatetransfer-of-remainder gambit analogous to a testamentary transfer, and the asset involved includible in the transferor's estate.

See. 2036 constitutes the principal statutory impediment to using the life-estate-transfer-of-remainder stratagem. In recent years the provision has been increasingly identified with its provisions concerning traditional corporate and partnership estate freezes. Sec. 2036's scope extends much further, however: Sec. 2036(a)is of primary importance to most attempts at retaining enjoyment of an asset while avoiding its estate inclusion. Somewhat surprisingly, the amendment of Sec. 2036(c) during the late 1980s, and the expansive interpretation accorded it by the Service in Notice 89-99) gave the Service an additional weapon with which to seek estate inclusion for transactions typically scrutinized under Sec. 2036(a).

The repeal of Sec. 2036(c) in the Revenue Reconciliation Act of 1990 (RRA) did away with this additional threat to inclusion. The legislative actions, however, were not entirely benevolent. As part of the RRA, provisions were enacted that make many Sec. 2036 planning techniques vulnerable to gift tax, while leaving open the potential application of estate inclusion under Sec. 2036(a).

This article will examine the scope of Sec. 2036(a), the planning options available for contending with its provisions and the impact of relevant RRA provisions and recently proposed regulations on such options. Sec. 2036(a) Sec. 2036(a)requires that the gross estate of a decedent include the value of all interests in property that the decedent has transferred (for less than adequate and full consideration in money or money's worth in a bona fide sale), in which the decedent has retained:

[] The possession of, enjoyment of, or right to income from, the property, or

[] The right, either alone or in conjunction with another, to designate who will enjoy or possess the property or income therefrom, for any of the following:

1. The transferor's life.

2. A period not ascertainable without reference to the transferor's death. For example, a transfer will not avoid Sec. 2036's provisions if it involves a transfer of property in trust, with income to be paid to the transferor at the end of each year, except for the year in which he dies, with the remainder on his death to go to another person. It should be noted that Sec. 2036 or 2037 may cause an inclusion of transferred property in the transferor's gross estate when he retains a reversionary interest in the property, or income thereto, even if this does not come to fruition. 3. A period that does not in fact end before the transferor's death.

   Example 1: X transfers property in trust retaining an interest in income from the property for 10 years and providing that following the 10-year period the remainder is to go to Z. X dies in the seventh year following the transfer. Since X's interest survived his death, Sec. 2036 requires an inclusion in X's estate.

   * Transactions included in a gross estate

   The diversity of situations susceptible to inclusion in a transferor's gross estate under Sec. 90361a1 is substantial. Transfers in trust when the transferor retained the right to discharge the trustee: This treatment has been applied even though the transferor did not retain a potential direct interest in the possession or enjoyment of the transferred property? The reasoning behind this treatment is that the taxpayer's ability to remove the trustee is tantamount to actual control over the trust income or corpus.

   While retention of a power to remove or discharge is often desirable, it is clearly fatal to avoiding estate inclusion. Alternative courses of action, which may allay grantor fears of unsatisfactory conduct by a trustee, and which do not entail as severe a risk of estate inclusion, include the careful selection of a friend or trusted third party to serve as trustee, and providing a power to remove or discharge a trustee, based on express conditions, to a trusted third party.

   Transfers with regard to which the transferor (grantor) has retained the power to designate who will possess or enjoy the transferred property or the income therefrom.4 Transfers of assets made to another, e.g., a trust, to be used to discharge a legal obligation of the transferor:s Examples include the use of the transferred assets or the income there from to pay creditors of the transferor, or legal obligations of child support of the transferor. To be includible in the transferor's estate the obligation must be outstanding at the transferor's death. Example 2: Transferor T transfers assets in trust to provide income for the support of his four children until they reach the age of majority. On a child's reaching the age of majority, that child's share of income will be paid to him directly each year; on the death of a child, the child's interest will go outright to the child's estate. At the time of T's death only one of the four children is below the age of majority. As a result, only one-fourth of the income of the trust is considered to be expended to discharge a legal obligation of the transferor and, thus, is the percentage of the value of the property in trust includible in the transferor's estate under Sec. 2036(a).

   Transfers made subject to the reciprocal trust doctrine:6 The reciprocal trust constitutes an apparently crafty, but usually futile, attempt to retain enjoyment of property while keeping it out of the transferor's estate. To the extent transfers in trust are found reciprocal, a...