Recent developments in estate planning.

• Author: Ransome, Justin
• Position: Part 2

[ILLUSTRATION OMITTED]

This is the second part of a two-part article examining developments in estate, gift, and generation-skipping transfer (GST) tax, and trust income tax between June 2015 and May 2016. Part 1, in the September issue, discussed legislative and gift and estate tax developments. Part 2 discusses GST tax and trust tax developments as well as President Barack Obamas budget proposals and inflation adjustments for 2016.

Generation-Skipping Transfer Tax

Finality of Returns

In IRS Letter Ruling 201523003, a husband created the trusts shown in the exhibit below.

The husband and his wife both filed gift tax returns for year 1 and made gift-splitting elections for the transfers to Family Trust, Trust 1, and Trust 2. They also elected out of an automatic GST tax exemption allocation for Family Trust and, instead, allocated GST exemption to a portion of Family Trust, resulting in an inclusion ratio of other than zero (0) or one (1). They did not make any GST exemption allocations for Trust 1 or Trust 2 because the estate tax inclusion period (ETIP) was still open for those trusts at the time of the year 1 filings. In year 2, the husband filed a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, reporting Trust 1 pouring into Family Trust. The wife did not file a Form 709. No GST exemption allocations occurred.

In year 3, the husband and wife filed gift tax returns and made gift-splitting elections for the transfers to Trust 3 and Trust 4; they did not allocate GST exemption because the ETIP remained open. However, the couple did affirmatively allocate GST exemption to their portions of the transfers from Trust 2 to Family Trust. Additionally, they each noted that for year 2, Sec. 2632(c) operated to automatically allocate GST exemption to the transfers from Trust 1 to Family Trust (covered on the husband's year 2 gift tax return). At the time of the ruling, the couple had not filed gift tax returns for year 4 for Trust 3 and Trust 4 pouring into Family Trust, and the statute of limitation had expired for gift tax returns for year 1 and year 2, but not for year 3 or year 4.

The IRS ruled that, even though the elections to split gifts on the transfers to Family Trust, Trust 1, and Trust 2 were improperly made, the time for determining whether gift-splitting treatment is effective had expired. In reaching this conclusion, the IRS began by noting that gifts cannot be split if one spouse's interest in the gift is not severable. Relying on Rev. Rul. 56-439, the IRS reasoned that the wife's interests in the income and principal of Family Trust are not susceptible to valuation and, therefore, not severable from the interests that the other beneficiaries have in Family Trust. However, the Sec. 6501 statute of limitation had already expired, so the gift-splitting election is irrevocable for the initial transfer to Family Trust and the subsequent transfers from Trust 1 and Trust 2 to Family Trust.

Further, the IRS ruled that the couple's election out of the automatic GST exemption allocation rules for contributions to Family Trust was effective, as were their individual affirmative allocations of GST exemption to a portion of the one-half treated as made by each of them. Additionally, the automatic allocation rules for GST exemption applied to allocate the couple's GST exemptions to one-half of the transfer of property from Trust 1 to Family Trust at the close of their respective ETIPs. Finally, the couple's affirmative allocation of GST exemption to the value of Trust 2 transferred to Family Trust was proper.

Because the statute of limitation had not expired for the transfers to Trusts 3 and 4, the husband and the wife can alter their elections by filing supplemental gift tax returns to report the transfers as being made solely by the husband. Further, the husband can file a gift tax return to allocate his available GST exemption to the transfers from Trusts 3 and 4 to Family Trust at the close of the ETIPs for those trusts.

The result of strict adherence to a closed limitation period may surprise some practitioners because it operates in limited circumstances to permit legally improper elections to stand. However, the IRS's ruling is proper based on the language in the preamble to the final Sec. 2504 regulations, (1) which states that the final regulations preclude adjustment with respect to all issues once the gift tax statute of limitation expires for a particular gift, and the regulations themselves state that this rule applies to adjustments involving all issues relating to the gift, including valuation and legal issues. This letter riding was a great result for the taxpayers, but it also means there is less certainty as to the finality of erroneous elections and allocation of GST exemption.

GST Exemption Allocation

In Letter Ruling 201536012, the IRS concluded that prior allocations of GST exemptions were void because the donor did not make gifts that would otherwise be subject to GST tax.

Donors were the parents of an adult child who died and was survived by two children. Over the years after the adult child's death, the donors made transfers directly to their grandchildren and filed timely gift tax returns to report the gifts. The donors also elected to split the gifts to their grandchildren, and each donor allocated GST exemption to these gifts. After one of the donors died, the personal representative of his estate requested a ruling that the allocations of GST exemptions to gifts made outright to the grandchildren were void because there was no GST tax potential for those transfers.

In general, an allocation of GST exemption made on a timely filed return becomes irrevocable after the due date of the return. However, Regs. Sec. 26.2632-1(b)(4)(i) provides that certain allocations of GST exemption are void. For example, an allocation of GST exemption made to a trust is void if the allocation is made to a trust that has no potential to be subject to GST tax at the time of the allocation.

The IRS began its analysis by noting that Sec. 2601 imposes a tax on every GST, including a direct skip, which is a transfer of an interest in property subject to gift or estate tax made to a "skip person." A skip person is a natural person assigned to a generation two or more generations below the generation assignment of the transferor. However, under Sec. 2651(e)(1), if an individual is a descendant of a parent of the transferor, and the individual's parent (who is a lineal descendant of the parent of the transferor) is deceased at the time of the transfer, the individual is treated as if he or she were a member of the generation that is one generation below the lower of the transferor's generation or the generation assignment of the youngest living ancestor of the individual who is also a descendant of the transferor's parent (the "predeceased parent rule"). Regs. Sec. 26.2651-1(c), Example 1, illustrates the rule in Sec. 2651(e)(1). In Example 1, Grandchild (GC) is not treated as a skip person because GC's parent, C, was deceased at the time of the transfer and, as a result, GC was treated as a member of the generation who is one generation below the transferor's generation.

The IRS concluded that at the time the donors made outright transfers to their grandchildren, their parent (and the donors' child) was deceased. Therefore, the grandchildren were treated as members of the generation that was one generation below the donor (i.e., the generation of the grandchildren's parent). Due to the predeceased parent rule, the grandchildren were not skip persons at the time of the transfers, and the transfers were not direct skips. Therefore, the transfers to the grandchildren had no potential to be subject to GST tax at the time of the transfers, and, accordingly, the allocations of GST exemption were void.

Although an allocation of GST exemption is irrevocable after the due date of Form 709, the ruling confirms that an allocation of GST exemption to an outright transfer that has no GST tax potential is void. Even though the express language of Regs. Sec. 26.2632-1(b)(4)(i) does not involve outright transfers, the IRS reasonably interpreted the regulation to reach this result.

Trusts and Estates

Charitable Deduction

Dieringer: In Estate of Dieringer, (2) the Tax Court concluded that the estate was liable for a deficiency of $4,124,717 in federal estate tax because the estate's charitable contribution was less than the date-of-death value of the property. Although the date-of-death value normally dictates the value of charitable deductions, in this case, numerous events occurred between the decedent's death and the day the property was donated, which contributed to the reduction in value.

When the decedent died unexpectedly on April 14, 2009, she owned 425 out of 525 voting shares and 7,736.5 out of 9,220.5 nonvoting shares of Dieringer Properties Inc. (DPI), a closely held real property management corporation. The other shareholders were the decedent's two sons. The two sons were officers and members of the board of directors, and the decedent was an officer and chairman of the board.

Before the decedent's death, DPI's shareholders discussed buying some of her shares and she had suggested she wanted to sell, but at the time of her death there was no discussion regarding the number of shares to be redeemed or the price.

The decedent's will left her entire estate in trust with the sons as trustees. Under the terms of the trust, $600,000 of assets was to be donated to various charitable organizations. The decedent's sons received some of her personal effects (but no money). The remainder, mostly DPI stock and promissory notes, went to a family foundation.

After the decedent died, the estate hired an appraiser to appraise the value of the decedent's DPI stock on the date of her death. At the time, DPI was a C corporation with an adjusted net asset value of $17,777,626. The appraisal...