Significant recent developments in estate planning.

• Author: Lipschultz, Brent S.
• Position: Part 2

Part I of this article, in the August issue, analyzed current developments in family limited partnerships, qualified personal residence trusts and gift taxes. Part II examines cases, regulations and rulings on the following: gifts, disclaimers, valuation, the marital deduction, charitable planning, the generation-skipping transfer tax and Chapter 14.

Part II of this two-part article examines a number of judicial decisions and administrative pronouncements concerning gifts, disclaimers, valuation, the marital deduction, charitable planning, the generation-skipping transfer (GST) tax and Chapter 14 that have occurred between May 1997 and April 1998.

Gift Taxes

The following significant developments occurred during the period:

* A trustee with no beneficial interest in corpus did not make a gift to a trust beneficiary.

* The Service sanctioned a private split-dollar insurance arrangement.

* Final disclaimer regulations were issued.

No Gift By Trustee

In Saltzman,(35) the Second Circuit held that the Tax Court erred in concluding that an exchange of common stock held by a trust in a recapitalization for preferred stock of lesser value constituted a gift by the trustee. Saltzman revisits a basic requirement for imposition of the gift tax--the existence of a "transfer" for Federal gift tax purposes.

In Saltzman, a majority shareholder (S) transferred his shares proportionally to two irrevocable trusts and outright to his child. S was the co-trustee of both trusts. Acting in their capacity as corporate directors, the co-trustees recapitalized the corporation, exchanging the trust common stock for preferred. The recapitalization resulted in an increase in the value of the stock held outright by the child and a decrease in the value of the stock held by the trusts. The Service assessed additional gift tax, contending that the shift in value accompanying the recapitalization was, in effect, a gift from S to his child. The Tax Court sustained the Service's determination, concluding that S did not make the transfer in his capacity as co-trustee. The Second Circuit disagreed, holding that the Tax Court had erred as a matter of law.

The Second Circuit first restated the axiom that Federal revenue law creates no property rights, but merely attaches federally defined consequences to rights created under state law. After recognizing that the recapitalization was performed by S and others in their capacity as corporate directors and reviewing New York State trust law, the court found that S was, by necessity, also acting in his capacity as a trustee. As such, S owed the trust beneficiaries the absolute duty of undiluted loyalty. Because S was acting within his fiduciary power, the court concluded that, as a matter of law, S could not have made a gift to his child as a result of the recapitalization. If S had made a gift, it was in violation of his fiduciary duties and voidable by the trust beneficiaries. Because the gift was voidable, it was not a completed gift. The Second Circuit also cited Regs. Sec. 25.2511-(g)(1) as grounds for its decision, which states in part that "a transfer by a trustee of trust property in which he has no beneficial interest does not constitute a gift by trustee...."

Saltzman highlights the courts' continuing reluctance to assume that a fiduciary is violating fiduciary duties or acting in a capacity other than as a fiduciary absent substantial proof to the contrary.

Split-Dollar Life Insurance

In Letter Ruling 9745019,(36) the Service ruled that a private split-dollar life insurance arrangement involving a husband and wife and an irrevocable trust did not trigger inclusion of the policy proceeds in the insureds' estates.

A trust acquired and owned a second-to-die life insurance policy on the lives of a husband and wife and was the named policy beneficiary. The taxpayers and the trustee entered into a collateral assignment split-dollar agreement for the policies held by the trust. Under the arrangement, the trustee paid the portion of the annual insurance premiums that equaled the insurer's current published premium rate for annually renewable term insurance. After the first death, the trustee was required to pay the portion of the annual premium equal to the lesser of (1) the applicable amount provided in the P.S. 58 tables or (2) the insurer's current premium rate for annually renewable term insurance. The taxpayers would pay the remaining portion of the annual premium.

The Service held that the taxpayers' annual premium payment under the split-dollar agreement would not be a gift to the trust, because the survivor's estate would be reimbursed for the portion of the premiums paid. This aspect of the ruling is consistent with the Service's earlier rulings on split-dollar arrangements in the employer-employee context. More interesting is the Service's conclusion that the taxpayers did not retain any incidents of ownership in the policy to force estate inclusion.(37) The Service focused on the part of the split-dollar agreement that entitled the trustee to reimburse the taxpayers the cash surrender value of the policy and to continue to maintain the policy in the trust for the beneficiaries' benefit. The Service viewed the right of the trustee to continue the policy as preventing the taxpayers from forcing a policy cancellation.

This taxpayer-favorable ruling presents planning opportunities. It provides a means of structuring a life insurance arrangement that may help minimize the value of the gifts associated with premium payments. By structuring a life insurance arrangement similar to that found in Letter Ruling 9745019, a taxpayer can reduce gift tax exposure, because the annual gift necessary to pay premiums should be limited to the lesser of the excess of the amount transferred to the trust in any year over (1) the applicable amount provided in the P.S. 58 tables or (2) the insurer's current premium rate for annually renewable term insurance.

Final Disclaimer Regs.

The Service issued final regulations under Sec. 2518 on the treatment of disclaimers for estate and gift tax purposes.(38) Regs. Sec. 25.2518-2(c) (4)(i) now permits a joint tenant to disclaim jointly held property not unilaterally severable on the same basis as joint property unilaterally severable. Previously, a surviving joint tenant could disclaim an interest in a joint tenancy with right of survivorship or a tenancy by the entirety only if the tenancy was severable under local law. This created problems, especially if a purchaser of a residence was not aware that the decision to take title to the property as either joint tenants with right of survivorship or tenants by the entirety affected the ability to disclaim the property after the first joint tenant's death.

Retained Interests and Powers of Appointment

Sale of Remainder Interest

In Wheeler,(39) the Fifth Circuit held that the sale of a remainder interest at actuarial value was for full and adequate...