Significant recent developments in estate planning.

• Author: Whitlock, Brian T.
• Position: Part 2

EXECUTIVE SUMMARY

* More and more cases are allowing minority interest and LOM discounts on an estate's closely held stock.

* The Service has shifted focus from valuation issues to use of a FLP as a tax-avoidance vehicle that lacks business purpose.

* The Ninth Circuit joined the Third and Fifth Circuits in upholding the exclusion of a remainder interest from an estate.

This article--the second of two parts--examines recent developments in estate and gift taxation. Specifically, this part discusses cases and rulings on, among other items, family limited partnerships, valuation, retained interests, procedural issues (standing, liens and equitable recoupment) and retirement planning.

This two-part article focuses on recent developments in estate, gift and generation-skipping transfer taxes. Part one, in the August issue, focused on current legislative and regulatory developments; this part examines recent cases and rulings on girl and estate taxation.

Overview

Family limited partnerships (FLPs) appear to be attracting more attention from the Service, as evidenced by an increased number of rulings. The Service continues to test numerous theories, to persuade practitioners to avoid use of such entities. The Service appears to have shifted focus from valuation issues to use of a FLP as a tax-avoidance vehicle that lacks business purpose.

Gift Tax

Present Interest of FLP Gifts

In Letter Ruling (TAM) 9751003,(15) the Service determined that gifts of limited partnership interests were not present interests under Sec. 2503(b) that qualified for the $10,000 per person annual gift tax exclusion; rather, the general partner's ability to withhold income created a future interest. However, Letter Ruling (TAM) 9944003(16) holds just the opposite, that such a power is a gift of a present interest. This ruling shows the precise circumstances under which a claim of a present interest will prevail.

Educational (Tuition) Exclusion Accelerated

Although taxpayers cannot pre-fund future tuition payments through trusts that would use them for non-educational purposes, Sec. 529 permits pre-funding under qualified state tuition programs. The Service recently permitted a less formal alternative to grandparents seeking to make significant excludible gifts. In Letter Ruling (TAM) 9941013,(17) the Service permitted a grandparent to prepay tuition to a private school (grades kindergarten--12) in which her grandchildren were already enrolled. Under the arrangement, additional tuition would be due if rates increased; if rates decreased or a grandchild ceased attending, the school would keep the excess.

Sale of Remainder Interest

With its decision in Est. of Magnin,(18) the Ninth Circuit joins the Third(19) and Fifth(20) Circuits in upholding the exclusion of a remainder interest from an estate.

Under a written agreement with his father, the decedent had received a life income interest in his father's stock in family corporations and lifetime voting control, in exchange for agreeing to transfer all of his stock to his children. The decedent created three trusts to hold the transferred stock. The value of the income interest and lifetime control in the father's stock was less than the stock the decedent transferred to the trusts. The Tax Court had held that the estate included the value of the trusts, less the value of the life income interest and voting control. Reversing and remanding, the Ninth Circuit held that, to determine whether the decedent received adequate and full consideration from his father, the consideration from the father had to be measured against the actuarial value of the remainder interest in the trusts, rather than the fee-simple value of the property transferred thereto.

Observation: Interfamily transfers of a remainder interest in trust made after the enactment of Sec. 2702 (Oct. 8, 1990) are permitted only for personal residences and to nonapplicable family members (i.e., nephews, nieces, etc.) under Sec. 2702(e) or 2704(c)(2).

Charitable Split-Dollar Insurance

The IRS has targeted split-dollar arrangements between irrevocable life insurance trusts (ILITs) and charities. These agreements have been structured to generate a charitable deduction for a donation to an organization that will independently invest in a life insurance policy on the donor's life. The policy would be held in an ILIT; under the agreement, the charity would ultimately receive all of its premiums back, and the insured family would receive the death benefits in excess of the premiums paid. The IRS will challenge a charitable organization's exempt status...