Recent developments in estate planning.

• Author: Ransome, Justin

This is the second part of a two-part article examining developments in estate, gift, and generation-skipping transfer (GST) tax and fiduciary income tax between June 2018 and June 2019. Part 1 (in the October 2019 issue) discussed trusts, GST tax, and inflation adjustments for 2019. Part 2 discusses gift and estate tax issues.

Gift tax

Valuation of S corporation

In Kress, (1) a district court generally relied on the taxpayers' expert in determining the fair market value (FMV) of shares of a family-owned S corporation for gift tax purposes. It further concluded that, while Sec. 2703 applied to the valuation, it did not affect the valuation of the stock in a meaningful way.

The taxpayers were shareholders in a family-owned S corporation that was a vertically integrated manufacturer of corrugated packaging, folding cartons, coated labels, and related products. The S corporation bylaws required family shareholders to gift, bequeath, or sell the shares only to other family members.

In 2006 through 2008, the taxpayers gifted shares to their children and grandchildren. The IRS challenged the value of the gifts reported by the taxpayers on their gift tax returns. The taxpayers paid the deficiency and accrued interest, filed amended returns, and sought a refund. The issue before the district court was the FMV of the transferred shares.

The district court considered the experts of both the taxpayers and the IRS and determined one of the taxpayers' experts to have used the soundest methodology, producing credible valuations, and, thus, accepted that expert's analysis. The court next looked to whether Sec. 2703 applied, because of the restriction on the transfer of the stock. Sec. 2703(b) allows valuation adjustments for certain restrictions that are: (1) a bona fide business arrangement; (2) not a device to transfer the property to a decedent's family members for less than full and adequate consideration; and (3) comparable to similar arrangements in arm's-length transactions.

Regarding the first requirement, the district court took notice that courts have recognized that maintaining family ownership and control of a business may be a bona fide business purpose. The court determined that the S corporation was an operating business and that the bylaws were adopted to ensure that the family retained control of the company, to minimize the risk of disruption by a dissident shareholder, to ensure confidentiality of the S corporation's affairs, and to ensure that all sales of the S corporation's minority stock were to qualified Subchapter S shareholders. The court determined that, although the family transfer restrictions might not have maximized shareholder value, they were consistent with maintaining a family business and ensuring that the business continued to allow family members to make a living, while serving the interests of its employees and the community. Therefore, the court found that the first requirement was satisfied.

Regarding the second requirement, although by referring to a "decedent" the statute specifically applies to transfers at death, the IRS argued that it also applies to gifts during life, based on regulations that state that Sec. 2703(b)(2) applies to inter vivos transfers in addition to transfers at death. (2) However, the court noted that Congress has attempted to amend Sec. 2703(b)(2) to conform to this regulation and has failed to do so. Thus, the court determined that the statute is unambiguous in its reference to a decedent and that the second requirement does not apply to inter vivos transfers.

Regarding the third requirement, Regs. Sec. 25.2703-l(b)(4)(i) provides that a right or restriction is comparable to similar arrangements in an arm's-length transaction if it could have been obtained in a fair bargain among unrelated parties in the same business dealing with each other at arm's length. Although the taxpayers argued that such restrictions are common in practice, the taxpayers provided no evidence of this. Therefore, the third requirement was not satisfied, and the court determined that it was improper for the taxpayers' appraiser to consider the restriction in valuing the stock.

Although the district court found some of the adjustments in the taxpayers' appraisal were improper under Sec. 2703(a), the court still found it was more persuasive than the IRS's appraisal. The court noted that the taxpayers' appraiser's projections were more accurate and addressed the economic recession occurring at the time the transfers were made. Additionally, the taxpayers' appraiser's analysis was made without the benefit of hindsight. Thus, the court concluded that the taxpayers' valuation should be used, with only a slight increase to remove the adjustments based on the taxpayers' not satisfying Sec. 2703(b).

Completed gift

In Letter Ruling 201825003 the IRS determined that a transfer of legal title, naked ownership, and the remainder interest in artwork was a completed gift for gift tax purposes.

The taxpayer was predeceased by her spouse. Prior to the spouse's death, the couple entered into a deed of transfer with two museums in a country outside the United States, in which they agreed to donate artwork that they owned on the death of the second to die of the spouses. The deed provided that the taxpayers (or, as was subsequently the case, a surviving spouse as taxpayer) would provide to the museums the legal tide, naked ownership, and remainder interest in and to the artwork. The deed further provided that the taxpayer reserved for her benefit a life interest and usufruct in and to the art that were to automatically expire on her death. The taxpayer was restricted from disposing of the art and was barred from changing the disposition of the art to the museums. The deed contained a provision that if the taxpayer did not receive a favorable ruling regarding the U.S. federal gift tax treatment of the transfer, the deed would not come into force. The taxpayer requested a ruling that the transfer under the deed's terms would not be treated as a completed inter vivos gift upon receipt of a favorable ruling.

The deed also contained some conditions subsequent in which the taxpayer would have the option to revoke the transfer of artwork, including: (1) the museums must comply with the requirements regarding the housing, display, and exhibition of the art, as set forth by the deed of trust (applicable to art delivered to the museums prior to the taxpayer's death pursuant to the deed); (2) certain laws in the museums' jurisdiction must not change; (3) the museums must not become privately owned; and (4) the tax laws of the foreign country in which the museums were located could not cause the taxpayer to become subject to taxation during the taxpayer's life or upon death in connection with the transfer of art.

Regs. Sec. 25.2511-2(b) provides that a gift is complete when the donor has parted with the property's dominion and control, retaining no power to change its disposition, whether for the donor's or another's benefit. Events beyond the donor's control do not amount to dominion and control over the property and will not cause the transfer to be incomplete.

The IRS determined that powers that would cause revocation of the transfer did not depend on any act by the taxpayer. Therefore, the IRS ruled that such a transfer, but for the condition precedent of receipt of a favorable ruling on the gift tax treatment, would be a completed gift for gift tax purposes because the taxpayer had abandoned sufficient dominion and control over the property under the deed.

Determining whether retained powers are considered "sufficient dominion and control" for gift tax purposes as to cause an attempted gift to be incomplete is a facts-and-circumstances determination. This case, however, highlights that a transfer of a partial interest in property should be a completed gift for gift tax purposes if a taxpayer gives up dominion and control over that partial interest. Note, however, that just because the transfer is a completed gift for gift tax purposes does not mean that it might not still be includible in a decedent's estate under Sees. 2035 through 2039 (the so-called string provisions), as the retention of such rights is not necessarily focused upon the standard of releasing dominion and control. Instead, these provisions focus on retained rights.

Estate tax

Clawback

On Nov. 23, 2018, Treasury and the IRS issued proposed regulations (3) addressing the effect of recent legislative changes on the basic exclusion amount (BEA) used in computing federal estate and gift taxes. These regulations will affect donors of gifts made after 2017 and estates of decedents who died or will die after 2017.

Before the law known as the Tax Cuts and Jobs Act (TCJA) (4) became effective on Jan. 1,2018, the BEA under Sec. 2010(c)(3) was $5 million, indexed for inflation after 2011. The TCJA doubled the BEA to $10 million (also indexed for inflation) for estates of decedents dying from Jan. 1, 2018, through Dec. 31, 2025; then the BEA reverts to $5 million, effective Jan. 1, 2026.

The proposed regulations address this temporary change in the BEA. As noted in the preamble to the proposed regulations, the TCJA also directed Treasury to prescribe regulations necessary or appropriate to carry out Sec. 2001 with respect to any difference between the BEA applicable at the time of the decedent's death and the BEA applicable with respect to any gifts made by the decedent.

The preamble to the regulations sets out four examples illustrating issues that could arise as a result of the temporary increase in the BEA and concludes that only the fourth situation could be problematic.

Situation 1. Whether for gift tax purposes, the temporarily increased BEA is reduced by pre-2018 gifts on which gift tax was paid: For donors who made both pre-2018 gifts that exceeded the $5 million BEA, incurring gift tax liability, and other gifts during the...