Significant recent developments in estate planning.

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

EXECUTIVE SUMMARY

* In Schuler, the Tax Court examined the reciprocal-transaction doctrine; in Rosano, the Second Circuit rejected application of the relation-back doctrine.

* In Notice 2001-10, the IRS reversed over 35 years of rulings and notices by announcing a new income tax treatment of split-dollar life insurance.

* In a series of significant cases, the Tax Court offered practitioners some clear guidance on whether the IRS's Chapter 14 pronouncements will bar FLP use.

This article--the second of two parts--examines recent developments in estate, gift and generation-skipping transfer tax planning. Specifically, this part highlights recent cases and rulings on grantor retained income trusts, valuation, gift disclosure, gift tax annual exclusion, family limited partnerships and split-dollar life insurance.

This two-part article focuses on recent developments in estate, gift and generation-skipping transfer taxes. Part I, in the last issue, discussed new legislation and regulations; Part II, below, examines cases and rulings on grantor retained income trusts (GRATs), valuation, gift disclosure, gift tax annual exclusion, family limited partnerships (FLPs) and split-dollar life insurance.

Cases and Rulings

Invalidated GRAT Regs.

In a landmark case, the Tax Court unanimously agreed that Example 5 of Regs. Sec. 25.2702-3(e) was invalid. Treasury had attempted, through this example, to bar practitioners from constructing GRATs with a zero gift tax value.

In Walton,(8) the taxpayer (the widow of Wal-Mart's founder) created two two-year GRATs, one for each of her daughters. Each trust was funded with over $100 million of Wal-Mart stock. Under the trust documents, if the grantor died before the end of the term, the remaining annuity payments would be made to her estate; the balance of the property would be paid to the remainder beneficiaries. The sole question before the Tax Court was whether the grantor's interest should be valued as an annuity for a straight two-year term (i.e., $6,200) or, under Example 5, for the shorter of the term or until her death (i.e., $3,822,000). The potential gift tax difference was enormous.(9) Relying on the legislative history, the Tax Court found the example, contained in an interpretive regulation, to be an "unreasonable interpretation and an invalid extension of Section 2702."

Lottery Winnings

Gribauskas(10) addressed valuing a state lottery prize. A married couple won approximately $16 million in the Connecticut state lottery, payable in 20 annual installments. The taxpayers divorced after receiving the first payment; the ex-husband died after the second payment. The divorce decree gave each party half of each installment; the decedent's share was included in his estate. The sole issue was the value at which the installments should have been reported on the estate tax return: the present value based on Sec. 7520 actuarial tables as a Sec. 2039 annuity (producing a 9.4% discount), or the present value under a willing buyer-seller arrangement, with a lack-of-marketability (LOM) discount (yielding a 15% discount). The court concluded the Sec. 7520 tables applied.

The court first noted that finding that an annuity does not exist under Sec. 2039 does not bar finding that one exists for Sec. 7520 valuation purposes. Thus, the central issue was the definition of an annuity for Sec. 7520 purposes, a question unanswered by the statute, regulations and case law. The court thus had to use the normal and customary meaning.

The court stated that the dictionary defined "annuity" as a fixed payment, made periodically, to a specified recipient. The estate argued such a narrow view ignored the nature of the underlying asset giving rise to the payment stream. It argued the winnings did not stem from an investment, but a wager; it also cited other payment streams that did not have to be valued using the Sec. 7520 tables. The court rejected all of these arguments.

It first rejected the narrow view of an annuity in favor of a broad interpretation and, in doing so, recognized the winnings as a private annuity. Next, the court stated that a fundamental difference between an annuity and other income streams not subject to Section 7520 is the interest factor. For example, notes are not the same as the lottery payments; the former involve an interest factor, while the latter do not.

The IRS argued that a departure from the Sec. 7520 tables is warranted only when the assumptions on which the tables are based depart substantially from the facts. The court rejected the estate's counter-argument that use of the Sec. 7520 tables made for an unreasonable result, because of the inability to dispose of the interest. Noting that other illiquid annuities (such as GRATs) have to be valued using Sec. 7520, the court rejected a California district court's decision in Shackleford(11) and noted that no case law supported considering marketability in the context of an annuity. Finally, the court envisioned a "policy" under Sec. 7520 to avoid unjust enrichment of the estate.

Gift Disclosure

The Service provided additional guidance on the Sec. 6501(a) final regulations' procedures for late adequate disclosure of gift valuation. Rev. Proc. 2000-34(12) allows taxpayers to file an amended Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return...