Recent developments in estate planning.

AuthorRansome, Justin
PositionPart 2

EXECUTIVE SUMMARY

* The Tax Court addressed whether Sec. 2036 or 2038 applied to transfers made as part of three split-dollar arrangements, and, if not, whether Sec. 2703 applied to require that a mutual termination restriction be disregarded in the valuation of the split-dollar agreement rights.

* In a tax dispute involving the estate of pop star Michael Jackson, the Tax Court ruled on the value of certain intellectual property at Jackson's death, including Jackson's image and likeness.

* In another estate tax case, the Tax Court addressed the valuation of majority and minority interests in family LLCs that held real estate and whether lack-of-control and lack-of-marketability discounts should be applied in determining the value of a charitable contribution deduction for contributions of interests in one of the LLCs to two different charities.

* The IRS issued final regulations that establish a new $67 user fee to obtain an estate tax closing letter.

* The IRS issued several inflation adjustments that may be of interest to estate planning professionals in Rev. Proc. 2020-45.

This is the second part of a two-part article examining developments in estate planning. The first part, in the October issue, covered trust and gift tax issues. The current installment updates readers on estate taxation, as well as inflation adjustments. The general period covered is from July 2020 through June 2021.

Estate tax

Bona fide transaction

In Estate of Morrissette, (1) the Tax Court ruled that the cash surrender values of three splitdollar agreements were not includible in the decedent's estate under Sec. 2036 (transfers with retained life estate) or 2038 (revocable transfers). The court further ruled that the values of the rights in the split-dollar agreements includible in the decedent's gross estate were not subject to the special valuation rules under Sec. 2703 but were significantly undervalued for estate tax purposes.

Facts: According to the Tax Court's factual findings, Arthur Morrissette and his wife, Clara, had three sons, Buddy, Don, and Ken. In 1943, Arthur started a moving company, Interstate Group Holdings Inc. (Interstate). Once the sons were teenagers, they began to work at Interstate. The relationships between Arthur and his sons and among the sons were plagued by a history of strife, fighting, and contention. Although Arthur had considered selling Interstate in the late 1980s, he eventually concluded that he wanted Interstate to stay within the family. At this time, Buddy had become Interstate's CEO and had already become instrumental in orchestrating Interstate's tremendous growth that would continue over the next three decades.

After learning that their father had planned to sell Interstate, Ken and Don told their father that they no longer wished to work for, or own interests in, Interstate. Arthur regarded Ken and Don's request as disloyal but offered to buy out their interests. Ken and Don opined that Arthur, with Buddy, "unfairly lowered" the buyout price and took steps that "caused [Ken and Don] financial hardship." In 1995, Clara persuaded Arthur to forgive Ken and Don and invite them back into the business. In response, Arthur gave both sons executive positions within Interstate and nonvoting stock in the company. Arthur and Buddy retained all voting power. Buddy resented his brothers and felt cheated by his father's decision to allow them back into the business.

In 1994, Clara formed a revocable trust (the CMM Trust) to hold her Interstate stock and, in 1995, Arthur followed suit, also creating a revocable trust (the AEM Trust) to hold his Interstate stock. Both the AEM Trust and the CMM Trust provided that the elder

Morrissettes desired Interstate to be owned equally by each of their three sons following the elder Morrissettes' deaths--except that Buddy should receive additional nonvoting shares for his previous loyalty. Additionally, the trusts further reiterated their desire that Interstate stay a family business. Following Arthur's death, the AEM Trust distributed its assets to three trusts--one for the Interstate voting stock, one for the Interstate nonvoting stock, and one for real estate and marketable securities owned by the AEM Trust. Each of the newly created trusts was for the benefit of Clara and, eventually, the three brothers.

After their father's death, the brothers' relationships with each other continued to deteriorate. During this time, Buddy's two sons began working for the business and were described as successful Interstate employees--each being groomed to run the business in the future. Buddy's sons worried about Interstate's succession and the long-term business plan. Each wanted to ensure a stable transition of the business in the future.

In addition to the family problems (and their impact on Interstate's business), it was quickly becoming apparent that there was no plan to pay the estate tax that would be due at Clara's death. The family became increasingly worried that they would have to sell Interstate stock to pay the estate tax--thereby destroying the elder Morrissettes' goal of keeping Interstate a family business. Although cautioned otherwise, the brothers believed Clara's estate would qualify for Sec. 6166 deferred estate tax payments but were worried that using Interstate's profits to pay her estate tax would dilute the business and hamper further growth.

In 2005, Clara developed Alzheimer's disease and dementia. In 2006, the family was introduced to an insurance agent who suggested, along with an estate planning attorney, estate planning strategies either to qualify Clara's estate for Sec. 6166 deferral or to purchase life insurance through split-dollar arrangements sufficient to cover Clara's estate's estate tax. Following consultation with the insurance agent and attorney, the family decided to create a new multistep estate plan designed to cure deficiencies in Clara's earlier planning. With the help of a court-appointed conservator, it was decided that Clara would create a dynasty trust for each child.

Next, Clara's CMM Trust would enter into split-dollar life insurance arrangements with each of the dynasty trusts. The split-dollar arrangements provided that each dynasty trust would purchase life insurance on each dynasty trust's beneficiary's brothers (e.g., Buddy's trust would purchase life insurance on Ken's and Don's lives). The total value of the insurance purchased, including additional riders, was $58.2 million. The premiums on the policies equaled $30 million. The arrangements stated that the CMM Trust would provide each dynasty trust an amount necessary to pay the insurance premiums and, in exchange, the CMM Trust was entitled to receive the greater of the amount of the premiums paid or the cash surrender value of the insurance policy at the insured's death.

The CMM Trust had no ownership interest in the policies and could not force the dynasty trusts to surrender the policies. The parties to the split-dollar arrangements could terminate the agreements by mutual consent (the mutual termination restriction), and the agreements would terminate on bankruptcy, receivership, or dissolution of either party. Concurrently, the dynasty trusts and each of the brothers signed a new shareholder agreement severely restricting the transfer of Interstate stock.

Following Clara's death, the CMM Trust transferred the split-dollar arrangement rights to the respective dynasty trusts equal to Clara's remaining generation-skipping transfer tax exemption and sold, subject to a note receivable, the remaining value of those rights to the dynasty trusts. On Clara's federal estate tax return, the estate reported the discounted value of the split-dollar agreement rights at $7.479 million--considerably less than the initial amount provided to the dynasty trusts ($30 million).

The IRS issued a notice of deficiency for tax and penalty based on its opinion that the value of the split-dollar agreement rights was underreported. The issues before the Tax Court were: (1) whether Sec. 2036 or 2038 applied to the transfers made as part of the splitdollar arrangements; and (2), if not, whether Sec. 2703 applied to require that the valuation of the split-dollar agreement rights disregard the mutual termination restriction.

Sec. 2036 and Sec. 2038: The IRS argued that Secs. 2036 and 2038 should apply to the transfer of the life insurance premium amounts from the CMM Trust to the dynasty trusts and that the value of the split-dollar rights should be at least the amount of transferred premiums ($30 million), if not the surrender value of the underlying policies ($32.6 million).

Generally, Secs. 2036 and 2038 require that a decedent's estate include inter vivos transfers (i.e., transfers made during the decedent's lifetime) where the decedent retained certain rights or powers over the transferred property. The Tax Court noted that Secs. 2036 and 2038 apply if each of the following three conditions is met:

  1. The decedent made an inter vivos transfer;

  2. The transfer was not a bona fide sale for adequate and full consideration (the crux of the issue here); and

  3. The decedent retained an interest in, or a right or power over, the transferred property that she did not relinquish before her death.

    After briefly considering whether Clara maintained rights to the split-dollar advance interests, the court focused on the "bona fide sale" exception (that is, whether the transfer was a bona fide sale for adequate and full...

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