Significant recent developments in estate planning.

AuthorLipschultz, Brent S.
PositionPart 1

This article examines current developments in the area of estates, trusts and gifts. Cases, regulations and rulings on the following are discussed: use of deathbed and other family limited partnerships; qualified personal residence trust final regulations; gift tax on the sale of a qualified terminable interest property remainder interest; and gift tax ramifications of gifts of nonvested, nonstatutory compensatory stock options.

Since the last estate planning developments article,(1) the IRS has issued a series of rulings attacking perceived abuses in the estates, trusts and gifts arena. The flurry of developments demonstrates the IRS's continuing focus in this area and the need for practitioners to be aware of developments to effectively serve clients.

Part one of this two-part article, below, highlights in-depth, significant judicial and administrative developments between May 1997 and April 1998, in the areas of estates, trusts and gifts. Part two, in the September issue, will discuss additional cases, rulings and regulations involving gifts, disclaimers, valuation, marital deduction, charitable planning, generation skipping transfer (GST) tax and Chapter 14.

Highlights

The period's highlights included:

* The issuance of new technical advice memoranda (TAMs) attacking the use of family limited partnerships (FLPs) as an estate planning tool.

* Imposition of gift tax on a sale of a qualified terminable interest property (QTIP) remainder interest.

* The announcement of the long-awaited IRS position on the transfer tax implications of gifting nonvested, non-qualified compensatory stock options to family members.

FLP Gifts

Seeking a new avenue of attack against the use of FLPs for estate planning purposes, the Service ruled in Letter Ruling (TAM) 9751003(2) that the transfer of a limited partnership interest did not qualify as a present interest for gift tax purposes. As a result, the donor was denied the Sec. 2503(b) $10,000 annual gift tax exclusion on the transfer.

The annual exclusion is allowed for a gift of a present interest in property, but not for a gift of a future interest. A future interest in property is an interest that limits the use, possession or enjoyment of the property to some future date or time. Deviating from previous rulings in which it had held that a gift of a limited partnership interest was a present interest for annual exclusion purposes,(3) TAM 9751003 held that the annual exclusion was not available. Given the Service's stance on FLPs,TAM 9751003 is no surprise.

In the ruling, the Service first stated that in accordance with Supreme Court holdings,(4) the critical question in determining if a present interest exists at the time of a transfer is whether the done received the right to a substantial present economic benefit from the property gibed, not whether legal title vests in the done at that time. For this purpose, a gift may be separated into its component parts of corpus and income; an annual exclusion is available if there is a requirement for a steady and ascertainable flow of income to the donee. The Service then noted that it was not dispositive that the donees at issue had a vested interest in the partnership; rather, the pivotal fact was that the partnership agreement vested the right to determine the timing of income distributions in the absolute discretion of the general partner. Thus, the donee did not receive a present interest in the FLP's current income.

Turning to liquidation rights, the Service concluded that the donee had no more than an illusory right to benefit from the partnership through a sale or a liquidation, because the partnership agreement restricted a partner's right to unilaterally transfer or assign his partnership interest. Having decided that neither the donees' income nor their liquidation rights were present interests, the Service ruled that the donees did not receive a present interest in the FLP. Even if the Service's conclusions are correct given the facts and circumstances, its holding is easily avoided.

Flawed analysis: It is not clear that the Service's bifurcation of a partnership interest into a gift of income rights and a gift of corpus rights is supportable. The cases cited by the Service justifying this approach concern trust interests.(5) Clearly, if (1) a donee receives both an income and corpus interest in a trust, (2) trust income and corpus are distributable solely at the trustee's discretion and (3) the beneficiary is precluded from transferring either interest, it is reasonable to conclude that neither the gift of the income interest or the corpus interest is a gift of a present interest. This conclusion is supported by the fact that, in general, state law allows a trust agreement to contain an absolute restriction on alienation of a trust interest,(6) at least fox; a limited amount of time. As a result, it is impossible for a trust beneficiary to receive presently any economic value from such discretionary income and corpus rights through the sale of the interest.

In contrast, even when state law allows a restriction on a partner's ability to transfer a partnership interest, it usually does not recognize an absolute restriction on the right of a partner to alienate his interest. At the very least, the transferee or a partnership interest who receives his interest in violation of a partnership restriction receives the rights of an assignee. Thus, in most states, the holder of a partnership interest subject to liquidation and transfer restrictions may still benefit immediately from his partnership interest by selling an assignee interest.

It is easy to imagine a potential purchaser of such a partnership interest, because eventually, the partnership will make income or liquidating distributions. In arriving at a purchase price, the potential purchaser will take into account the partnership's present ability to generate income; provided the purchaser holds the interest until its liquidation, he will eventually benefit from the current income stream. Further, in the absence of a partnership agreement provision voiding an assignment of an interest, it should be possible to negate the Service's holding in TAM 9751003, because a partner may benefit immediately through the sale of an assignee interest in the partnership.(7)

Because the ability to assign a partnership interest is a present right and a potential purchaser would consider the partnership's present income stream in arriving at a purchase price, the Service's conclusion in TAM 9751003 that the gift of the partnership interest is not a present interest is subject to challenge. The Service's position more appropriately supports the argument that the receipt of a restricted partnership interest should be discounted to reflect the value at which it could presently be sold, not that only a future interest has been received.

FLP Discounts

The IRS issued...

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