Selected Federal Tax Legislation, Cases & Rulings

• Citation: Vol. 10 No. 1
• Publication year: 2004
• Author: By James M. Allen, Esq.

SELECTED FEDERAL TAX LEGISLATION, CASES & RULINGS

By James M. Allen, Esq.^*

This article will provide a summary of selected developments in federal taxation since the Winter Quarterly of particular interest to trust and estate attorneys.

I. FEDERAL LEGISLATIVE ACTIVITY

Military Family Tax Relief Act of 2003 (H.R. 3365)

On November 11, 2003, the President signed the Military Family Tax Relief Act of 2003 into law. In addition to several income tax provisions directed towards the military, the act also extends to astronauts who die on a mission and specified terrorist victims the same tax relief available to members of the armed forces, including the estate tax reduction provided in I.R.C. § 2201.

II. FEDERAL REGULATORY ACTIVITY

A. T.D. 9096, 68 FR 67595 (December 3, 2003)

The Internal Revenue Service has deleted regulations under repealed I.R.C. § 6152, which generally permitted a decedent's estate to pay income taxes in four (4) equal installments. I.R.C. § 6152 was repealed for tax years beginning after December 31, 1986.

B. T.D. 9102, 69 FR 12 (January 2, 2004)

The Internal Revenue Service has issued final regulations revising the definition of income under I.R.C. § 643(b). The regulations are a response to changes in state law that redefine the traditional concept of income and principal in order to accommodate total return investment strategies designed to treat income and remainder beneficiaries impartially. Under revised Treas. Reg. § 1.643(b) - 1, an allocation of amounts between income and principal pursuant to local (state) law will be honored if local law provides for a reasonable apportionment of the trust's total return between income and remainder beneficiaries. For example, a state law providing that income in a unitrust amount between 3% and 5% of the fair market value of the trust assets is, according to the regulations, a reasonable apportionment. A statute that permits the trustee to make adjustments between income and principal to fulfill the trustee's duty of impartiality between the income and remainder beneficiaries will generally also be regarded as a reasonable apportionment. Conforming amendments have also been made to the estate and gift tax regulations.

C. REG-1108986-98, 2003-51 I.R.B. 1226 (November 20, 2003)

Proposed amendment Treas. Reg. § 1.664-1 would revise the ordering rules for determining the character of distributions from a charitable remainder trust. The proposed regulations would revise the rules for characterizing a charitable remainder trust distribution to account for the differences in federal income tax rates applicable to items of income that are assigned to the same category under I.R.C. § 664(b). Under the proposed regulations, income would be assigned to one of three categories: ordinary income, capital gains and other income. Furthermore, within the ordinary income and capital gains categories, items would be assigned to different classes based on the federal income tax rate applicable to each. Within the ordinary income and capital gains category, income would be treated as having been distributed from the classes of income in that category starting with the class subject to the highest federal income tax rate.

D. REG-139845-02, 2004-5 I.R.B. 397 (December 24, 2003)

The Internal Revenue Service has proposed amendments to Treas. Reg. § 20.2032-1(b) and Temporary Treas. Reg. § 301.9100-6T(b) that would revise the amount of time allowed to make the alternate valuation under I.R.C. § 2032. Prior to the enactment of the Deficit Reduction Act of 1984, the alternate valuation election had to be made on a timely filed estate tax return, including extensions actually granted. The proposed amendments, however, would allow the alternate valuation election to be made on a decedent's estate tax return, whether it is filed timely or late, so long as the return is filed no more than one year after the estate tax return due date, including extensions. Furthermore, the proposed amendments would clarify the requirement that, pursuant to the Tax Reform Act of 1986, the election may be made only if it results in a reduction both in the value of the gross estate and in the sum of the estate tax and generation skipping transfer tax liability.

E. REV. PROC. 2003-85, 2003-49 I.R.B. 1184

The 2004 amounts for inflation adjusted tax items have been issued by the Internal Revenue Service. The amounts set forth apply to any of the following transactions or events occurring in calendar year 2004:

1. Annual Exclusion for Gifts. The I.R.C. § 2503(b) annual gift tax exclusion remains at $11,000. Additionally, the first $114,000 of gifts to a non-citizen's spouse are not included in the donor's annual amount of taxable gifts under I.R.C. § 2503 and 2523(i)(2) (up from $112,000 in 2003).
2. Special Use Valuation. An estate that elects to use I.R.C. § 2032A special use valuation may not cause an aggregate decrease in the property's value by more than $850,000 (up from $840,000 in 2003).
3. Interest on Estate Tax Installment Payments. For decedents dying in calendar year 2004, the dollar amount used to determine the 2% portion (for purpose of calculating interest under I.R.C. § 6601(j)) of the estate tax payable in installments is $1,140,000 (up from $1,120,000 in 2003).
4. Generation Skipping Transfer Tax Exemption. The I.R.C. § 2631 exemption is no longer adjusted for inflation for years beginning in 2004 as the exemption amount is tied to the applicable exclusion amount under I.R.C. § 2010(c) and in 2004, that amount is $1,500,000.

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III. FEDERAL CASES AND RULINGS - ESTATE TAX

A. Definition of Gross Estate (I.R.C. § 2031)

1. Estate of Frazier v. Commissioner, 83 Fed. Appx. 164 (9th Cir. 2003)

Several structures built on a decedent's land were not includable in a decedent's gross estate because the structures were removable trade fixtures under applicable California law. In an unpublished ruling, the appellate court has reversed the Tax Court's holding that most of the improvements were not removable trade fixtures under California law and were therefore includable in the decedent's estate. The Court apparently found that in cases such as the decedent's, where the entire building was the fixture, California courts had permitted the lessee to remove the entire building as a trade fixture, holding that the building had not become an integral part of the underlying land.

2. Estate of Mitchell v. Commissioner, 83 Fed. Appx. 987 (9th Cir. 2003)

A decedent's interest in a closely held corporation was property valued at $41,532,600 for estate tax purposes, the 9th Circuit Court of Appeals has held. On remand, the Tax Court had reaffirmed its original holding with regard to the value of the decedent's stock. The Court had used a $150,000,000 acquisition value as the starting point and subsequently allowed a 35% minority interest discount for a 49.04% holding and a 10% discount to account to the impact of the decedent's death on the company. The Court also reduced the value of the decedent's interest by $1.5 million to reflect the possibility of litigation with the company's other co-founder.

3. Estate of Green v. Commissioner, T.C. Memo 2003-348

In valuing unlisted stock, the Tax Court has allowed a 17% minority interest discount and a 35% lack of marketability discount for to the decedent's shares. Taking the average of the values derived under an income approach, a guideline market approach, and a transaction market approach, the Court determined that the pre-discount aggregate value of all of the outstanding stock was $26,266,667. After applying the discounts, the decedent's stock was valued at $721,297.

B. Alternative Valuation (I.R.C. § 2032)

Priv. Ltr. Rul. 200348010

A decedent's estate was granted an extension of time to elect alternate valuation under I.R.C. § 2032. The Internal Revenue Service noted that the estate tax return preparer admitted that he failed to consider the effect of the election when he prepared the return and did not discuss the election with the co-executors. The Internal Revenue Service determined that the standards for granting an extension contained in Treas. Reg. § 301.9100-3 were satisfied because: (1) the estate acted reasonably and in good faith by relying on a qualified tax professional, and (2) granting the extension did not prejudice the interests of the government.

C. Transfers With Retained Life Estate (I.R.C. § 2036)

1. Estate of Stone v. Commissioner, T.C. Memo 2003-309

None of the assets transferred to five family limited partnerships by a husband and wife were included in their respective gross estates because the transfers were bona-fide sales for adequate and full consideration under I.R.C. § 2036(a). The five family limited partnerships were created subsequent to substantial litigation among the couple's children. The Court found that the transfers were motivated primarily by investment and business concerns relative to the management of the couple's assets and that the family limited partnerships had economic substance as for-profit joint enterprises. The Court also noted that the couple retained assets outside of the family limited partnerships sufficient to maintain their accustomed standard of living.

2. Priv. Ltr. Rul. 200350009

A distribution from an irrevocable trust to a private foundation did not cause the trust corpus or the trust distributions to be included in the grantor's gross estate. The grantor funded the trust with S Corporation stock, and the trustees, a trust company and a sibling of the grantor had the power to make discretionary distributions to charitable beneficiaries. The foundation members included the grantor, the grantor's siblings and the trust company. However, in conjunction with the distribution to the foundation, the foundation created a special restricted fund, and amended its bylaws to provide that neither the grantor nor any related or subordinate party would have any control over the special restricted fund. The Internal Revenue Service has concluded...