Wills, Trusts & Estates Prof Blog

Estate Tax Reform May Be Underway

According to Jeff Carlson, Finance Panel Mulls Reform of Estate Tax Rules, tax.cchgroup.com, April 4, 2008:

By all indications, the Senate Finance Committee is serious about reforming estate tax rules. On April 3, Committee Chairman Max Baucus, D-Mont., held a third hearing on the subject, ostensibly to get input from experts on where change is most needed in four areas: liquidity; portability; unification of gift and estate taxes; and charitable giving.

Prior to the 2001 tax law changes, the estate and gift tax taxes were unified; they had a single graduated rate schedule and they were also combined into a single unified credit. Under current law, the amount that transferrors can transfer tax-free while alive is substantially less than the amount that they can transfer tax-free at death. Panelists and lawmakers were in agreement that unification is necessary.

Speaking on behalf of the American Institute of Certified Public Accountants (AICPA), Roby B. Sawyers, a practicing CPA and professor in the College of Management at North Carolina State University, took it one step further, suggesting that the estate, generation-skipping transfer (GST) and gift tax exemptions be reunified.***

Special thanks to Neil E. Hendershot, Esq. (Attorney at law, Goldberg Katzman, P.C., Adjunct Professor, Widener University School of Law) for bringing this article to my attention. You can read more on Neil's blog at PA Elder, Estate & Fiduciary Law Blog.

Tax Treatment of Blended Families - Change Needed

Wendy C. Gerzog (Professor of Law, University of Baltimore School of Law) has recently posted on SSRN her article entitled Families for Tax Purposes: What About the Steps?

Here is an abstract of her article:

At least 4.4 million families in the U.S. are blended ones that include step-children and step-parents. For tax purposes, these steps receive preferential treatment for their status because they are on the one hand included as family members for many income tax benefit sections, but on the other hand excluded as family members for business entity attribution purposes and for gift and estate tax anti-abuse provisions. In the interests of fairness and uniformity, steps should be treated as family members for all tax purposes where steps have in fact voluntarily acted as their biological or adoptive counterparts, both when such treatment would decrease and increase their tax burdens.

Joint Committee on Taxation Report on Possible Areas of Tax Reform

The staff of the Joint Committee on Taxation has prepared a document entitled Taxation of Wealth Transfers Within a Family: A Discussion of Selected Areas for Possible Reform. This report was scheduled for a public hearing before the Senate Committee on Finance on April 3, 2008.

Here is an excerpt from this document:

This document is divided into two parts. The first part describes a prominent feature of the current Federal estate and gift tax system, the partially unified credit against estate and gift tax, and evaluates two possible reforms to that credit. The credit against estate and gift tax is partially unified under present law because a single tax rate schedule applies to gifts made during life and transfers at death but the effective exemption amount under the gift tax ($1 million) is different from the effective exemption amount under the estate tax ($2 million in 2008).***

The second part of this document sets forth a discussion of liquidity to pay estate tax when estates consist largely of farms or other businesses. Congress at various times has passed reforms intended to mitigate the effect of the estate tax on family farms and other family-owned businesses. A particular concern has been that if the value of an estate is largely attributable to a farm or other business, heirs of the estate may be forced to sell the business to pay the estate tax. Forced sales of family businesses are seen as undesirable in part because of possible job losses and other disruptions to communities.

Special thanks to Patrick S. Sylvester (Attorney & Counselor at Law, Sylvester Law Firm, PC) for bringing this document to my attention.

Proposed Treasury and IRS Rule Making May Have Significant Tax Consequences

James V. Roberts (Attorney at Law, Glast, Phillips & Murray P.C.) has recently published his article entitled New and Revamped 529 Plan Regulations Soon to Be Proposed, RPPT eREPORT (2008).

Here is the opening paragraph to his article:

On January 17, 2008, Treasury and the Internal Revenue Service issued an Announcement of Proposed Rule Making (“ANPRM”) regarding Section 529 college tuition plans. This ANPRM should be of interest to every estate planner and return preparer because it seeks to: (I) propose an anti-abuse rule (with changes to the preparer penalty provisions, all such rules now assume larger importance); (II) determine the estate, gift and GST tax results of contributions, transfers and withdrawals; and (III) create rules for making the 5 year election, addressing some income tax issues, and creating new record keeping requirements.

Rector v. Commissioner Analyzed

Steve R. Akers (Bessemer Trust, Dallas, Texas) has recently published his article entitled Rector v. Commissioner, TC Memo 2007-367, RPPT eREPORT (Feb. 2008).

Here is a summary of his article as posted on RPPT eREPORT:

The Tax Court finds an implied agreement under §2036 and applies the section to the assets contributed to the FLP rather than to the gifts of LP interests under a “single plan” analysis.

Tax Consequences of Financing Grandchild’s Education

Richard L. Kaplan  (Peer and Sarah Pedersen Professor of Law, University of Illinois College of Law) has recently posted on SSRN his article entitled Back to School: The New Parameters of Funding a Grandchild’s College Education. This article also appears in the Jan.- Feb. 2008 issue of the Journal of Retirement Planning.

Here is the abstract of his article:

This article examines several different mechanisms for funding college expenses from the perspective of a grandparent. The mechanisms considered include direct gifts to the grandchild or the educational institution, college savings bonds (both state and federal), prepaid tuition contracts, college savings plans created under tax code section 529, and Coverdell Education Savings Accounts.

Although these college funding mechanisms are not new, legislation enacted within the past two years has radically altered many of the rules of thumb that have applied in the past. Specifically, the Tax Increase Prevention and Reconciliation Act of 2005 (actually enacted in May 2006) and the Small Business and Work Opportunity Tax Act of 2007 that accompanied that year's increase in the federal minimum wage have basically eliminated any tax advantage of custodial accounts as college funding vehicles. On the other hand, the Pension Protection Act of 2006 has enhanced the tax appeal of 529 plans at the same time that the Deficit Reduction Act of 2005 (actually enacted in February 2006) improved the financial aid status of such plans. Finally, that Deficit Reduction Act also created significant hurdles for grandparents who anticipate accessing the Medicaid program to pay their long-term care costs.

To determine the approach that best serves all family members, this article begins by considering several factors that are relevant to the financing of a grandchild's college expenses. These factors include: (1) the grandparents' and the grandchildren's income tax situation, (2) the grandparents' possible exposure to gift taxes, (3) the grandparents' desire to ensure that the funds they provide are actually used to pay for college costs, (4) the Medicaid implications for the grandparents, and (5) the impact on a grandchild's eligibility for needs-based financial aid. The article then examines the various mechanisms that are available to fund a grandchild's college costs and analyzes each mechanism in terms of these factors.

Qualifying for a Charitable Deduction

Prof. Wendy Gerzog (Professor of Law, University of Baltimore School of Law) has recently posted on SSRN her article entitled The Strict Rules of Charitable Split Interest Gifts.  Her article also appears in Tax Notes, Vol. 118, No. 5, 2008.

Here is the abstract of her article:         

When giving both to your family and to your charity, you must follow the rules carefully to qualify for a charitable deduction. The article discusses the recent Tamulis case, other split interest charitable deduction cases, and the doctrine of substantial compliance.

Estate Planning with the IRS in Mind

John W. Porter (Attorney at Law, Baker Botts LLP), Stephanie Loomis-Price (Attorney at Law, Baker Botts LLP), and Charles E. Hodges II (Attorney at Law, Chamberlain, Hrdlicka, White, Williams & Martin), have recently published their article entitled Anticipating the Audit Call, Prob. & Prop., Jan./Feb. 2008, at 20.

Here is the conclusion to their article:

In sum, there are numerous protections of communications among advisors and between advisors and their clients. To best protect those communications from discovery or, if produced, from misinterpretation, it is important to understand the differences among those protections and to ensure that the communications are documented in the context of the broader goals of the client, such that both tax and nontax reasons for the transaction are clearly indicated. Keeping these protections in mind at all times can assist the estate planner in advising his or her client and in accomplishing the client’s goals. And, although privileges generally are thought to protect communications, anticipating that at some point the client might find it advantageous to waive these privileges and deliberately documenting communications that could be helpful in the event of a tax audit or dispute could be the linchpins for the client’s case.

Patents for Tax Planning Inventions – An Update

In Proposal to Prohibit Tax Planning Patents - S. 2369, RPPT eREPORT (2007), Rana Salti (Attorney at Law, McDermott Will & Emery LLP) "keeps us up to date on the continuing saga of the patenting of tax planning devises. On November 15, 2007, legislation was introduced in the United States Senate that would prohibit the issuance of any patents for tax planning inventions."

Only a few days left to make annual exclusion gifts for 2007

The following reminder is from Bracewell & Giuliani LLP, Year-End Wealth Transfer Opportunity – Annual Exclusion Gifts (Dec. 27, 2007):

Estate planners often recommend complex and highly technical estate planning techniques to their clients for a variety of reasons not the least of which are tax minimization and creditor protection. However, clients should not overlook a very simple yet significant way in which to transfer substantial wealth to family members through direct gifts that take full advantage of the annual exclusion from gift taxes. The annual exclusion amount is currently set at $12,000.

IRS Says Topfer Owes 65 Million in Gift Taxes

The following is from Janet Novack, Short Arms?, forbes.com, Dec. 24. 2007:

The Internal Revenue Service says that Morton L. Topfer, one of FORBES ASAP's Tech's 100 Highest Rollers when he served as Dell*** vice chairman, owes $65 million in gift taxes and penalties for undervaluing asset transfers benefiting his heirs.***

The feds say that in 2002 and 2003 he put $105 million of cash and stock into trusts for his children and grandchildren but valued the largesse at a mere $3.5 million.***

Court filings for Topfer,*** defend the complicated dealings as "bona fide, arms-length transactions."

Inequalities in the Taxation System

Lester B. Snyder   (Professor of Law, University of San Diego School of Law) has recently posted on SSRN his article entitled Taxation of the New Era 'Family Unit'.

Here is an abstract of his article:

Virtually everyone in this country is directly affected by the material in this chapter. Whether you are single, married, cohabitating with someone of the opposite or same sex, a child, an elderly person, someone going through a divorce or separation, rich or poor, there are numerous tax issues and tax disparities that impact your daily lives. Over the past 90 or so years, the taxation of the family unit has undergone numerous changes, resulting in unequal treatment of significant numbers of citizens. The evolution of the tax law of the family unit provides us with an opportunity to view the constant interplay and conflict between federal and state laws. Keeping with the theme of this book, this chapter will focus on some of these major inequalities, many of which have received only sparse public attention and are generally unknown to the ordinary taxpayer.

Taxation Issues from August 2006 through September 2007 - an Update

Samuel A. Donaldson (Associate Professor, University of Washington School of Law) has recently posted on SSRN his article entitled Federal Tax Update: Important Developments in Federal Income, Estate & Gift Taxation Affecting Individuals - August, 2006 to August, 2007.

Here is the abstract of his article:

This update explains several developments in the substantive federal income, estate and gift tax laws affecting individual taxpayers and small businesses. It contains summaries of significant cases, rulings, regulations, legislation and other matters from August, 2006, through September, 2007. This update generally does not discuss developments in the areas of qualified plans or the taxation of business entities (except to a very limited extent).

Gift and Estate Taxes -- Swedish Style

Henry Ohlsson (Professor of Economics, Uppsala University) has recently posted on SSRN his article entitled The Legacy of the Swedish Gift and Inheritance Tax, 1884-2004.

Here is an abstract of his article:

This paper has two objectives. The first is to study the revenue from the gift, inheritance, and estate taxes in Sweden during more than a century. The second is to focus on a unique episode during the second half of the 1940s when gifts and gift tax revenue exploded. This episode has never before been discussed in the research literature. It gives an extremely clear illustration of behavioral response to taxes in general, and the impact of expectations of future tax increases in particular. It is also a very interesting episode in the economic history of Sweden. I have access to aggregate tax revenue data since 1884.

Moreover, I have constructed a rich micro data set of all gifts reported during the period 1942-1949 in one county. A first main result is that gift tax revenue during the 1940s started to increase long before a new estate tax and increased wealth taxation were decided and implemented. The increase even began before the legislative process started. Second, both the number and the average values of gifts increased. Promissory notes were, in value, the most common way to give. Finally, gifts, inheritances, and estates were never important sources of tax revenue. Revenue as a share of GDP reached a peak already in the 1930s. The role of these taxes has instead primarily been equity and to provide integrity for other tax bases.

IRS Proposes Modification of Tax Return Preparer Penalty Provisions

IRS has proposed new regulations that amend Circular 230 and address the tax return preparer penalty provisions under I.R.C. § 6694. In Notice 2007-54 IRS provides guidance on the proposed amendments.

Here is an excerpt from Prof. Roger A. McEowen's discussion on this issue:

The proposed regulations, when final, would amend section 10.34 of Circular 230.  Changes to the standards of practice were triggered by the Act, which became law in May and effectively extended the application of the return preparer penalties to all tax return preparers, altered the standards of conduct that must be met to avoid imposition of the penalties for preparing a return showing an understatement of liability, and increased applicable penalties.* * *

Under the proposed regulations, IRS says that the standards of practice under Circular 230 should conform to the civil penalty standards for return preparers. That means a practitioner may not sign a tax return as a preparer unless the practitioner has a reasonable belief that the tax treatment of each position on the return would more likely than not be sustained on its merits, or there is a reasonable basis for each position and each position is adequately disclosed.  The proposed regulations say that the definitions of "more likely than not" and "reasonable basis" are to be defined by the way those phrases are defined under I.R.C. § 6662.

IRS Proposes Regulations on Patented Tax Methods

Proposed regulations would require taxpayers to report to the IRS when they use patented tax methods.  Reg-129916-07.

On-line EINs now available from IRS

Beginning Tuesday, October 9, 2007, taxpayers can apply for a federal Employer Identification Number (EIN) online and get it before disconnecting from the Internal Revenue Service website.

The IRS calls this innovation an "interview-style" application.

This new process, explained by the IRS here, supplants the former process of online completion of an IRS Form SS-4.

For more information, see Neil Hendershot, PA EE&F Law Blog, IRS "Interviews" for EINs, Oct. 8, 2007.

Loopholes in the Estate and Gift Tax System and Possible Solutions

Eric G. Reis (Attorney at Law, Thompson & Knight LLP) has recently published his article entitled Mr. Soros Goes to Washington: The Case for Reform of the Estate and Gift Tax Treatment of Political Contributions, 42 Real Prop. Prob. & Tr. J. 299 (2007).

Here is the editor's synopsis of his article:

This Article recognizes a growing interest in long-term political giving and considers how this trend will expose weaknesses in the current estate and gift tax regime for political contributions. Through an exploration of planning techniques used to exploit gift tax charitable deductions and other gift tax exclusions under prior law, the Article considers how the unlimited gift tax exclusion for political contributions might also be used to circumvent the current estate and gift tax system by facilitating tax-free transfers to members of a donor’s family. The Article then proposes several significant reforms to the system, including the adoption of rules limiting the gift tax exclusion for political contributions and the enactment of an estate tax deduction for bequests to political organizations.

Patents on Tax Planning Methods May Be Denied

James V. Roberts (Attorney at Law, Glast, Phillips & Murray P.C.) has recently published his article entitled Update on Patenting Tax Advice, RPPT eREPORT (2007).

Here is an abstract of his article:

The idea of issuing patents in the area of tax planning has stirred significant controversy and has been reported on before in eReport. As previously noted, the expansion of patents in this area has worried many practitioners for a variety of reasons, most notably the possibility that a strategy conceived for a private client later exposed (typically through a dispute process with the IRS) may be the same as or substantially similar to an existing patent, triggering an infringement claim. And from that claim, discovery could reach into the practitioner’s other files, and, if part of a firm, into the files of other practitioners in the firm.

In January of this year, the State Bar of Texas Board of Directors approved a request by that bar’s Tax Section to submit to the Internal Revenue Service a response to its request for comment on this area, and, in that response, offering specific legislation to prohibit enforcement of tax strategy patents. The model for the proposed legislation is the language added in 1997 to prevent patents on surgical procedures from being enforced against doctors and hospitals.

Appraiser Penalties for All? The New and Troubling IRS Code Provision

William S. Forsberg (Attorney at Law at Leonard, Street & Deinard) and Hugh F. Drake (Attorney at Law at Brown, Hay & Stephens, LLP) have recently published an article entitled The New IRS Appraiser Penalties Under Code § 6695A, Prob. & Prop., Sept./Oct. 2007, at 46.

Here is an excerpt from the introduction to their article:

The Pension Protection Act of 2006 (PPA) imposes new penalties under Internal Revenue Code (“Code”) §6695A for substantial or gross valuation misstatements.

Without question, the need for property to be valued properly is critical under our current transfer tax and income tax system. Estate and trust attorneys often must obtain appraisals of property or property interests when making strategic lifetime gifts for clients as well as on a client’s death. Common lifetime gifting strategies that require an appraisal include transfers to grantor retained annuity trusts and transfers to qualified personal residence trusts. Sales of property to grantor trusts, or gifts of family limited partnership interests, also require an appraisal. Asset transfers to certain types of charitable trusts require appraisals for both income and transfer tax purposes.

The American Bar Association Section of Real Property, Probate and Trust Law has submitted comments to the Internal Revenue Service on the issues surrounding new Code § 6695A. The uncertainties surrounding the new Code section are troubling not only for professional appraisers but for any person involved in the appraisal process, including attorneys and CPAs. This article will discuss the questions raised by the task force about new Code § 6695A and provide some insight into the concerns the task force raised regarding the ability of the IRS to implement its provisions fairly and equitably.

CLAT Solution to Passing on a Family Business and Getting a Charitable Deduction

Douglas W. Stein (Attorney at Law, Barris, Sott, Denn & Driker, P.L.L.C.) has recently published his article entitled The Leveraged Family Business CLAT, Prob. & Prop., Sept./Oct. 2007, at 62.

Here is an introduction to his article:

Although charitable lead trusts have been with us for decades, their use was thrust into the limelight after the death of Jacqueline Kennedy Onassis in 1994. Mrs. Onassis’s will contained a long-term charitable lead annuity trust (CLAT) that was funded by her residuary estate. On the termination of the lead interest, the trust assets were to be distributed to the descendants of her children. Based on the applicable Code § 7520 rate in effect on the date of her death, her estate was entitled to a charitable deduction of approximately 97% of the assets passing to the CLAT. * * * Since Mrs. Onassis’s death, several published articles have discussed the benefits of testamentary charitable lead trusts.

            This article discusses a technique that allows decedents to pass their closely held businesses to their beneficiaries through a testamentary CLAT while simultaneously allowing the beneficiaries to reap some of the benefits of outright ownership. Most important, this technique allows decedents to pass S corporation stock, limited liability company interests, or partnership interests to their children without violating the self-dealing and other private foundation rules applicable to CLATs and simultaneously generate a significant charitable deduction.

The Price of Charitable Deductions

In Big Gifts, Tax Breaks and a Debate on Charity, NY Times, Sept. 6, 2007, Stephanie Storm points out the nagging problem about granting income, gift, and estate tax preferences and deductions for charitable gifts.

For every three dollars they give away, the federal government typically gives up a dollar or more in tax revenue, because of the charitable tax deduction and by not collecting estate taxes.

The debate rages regarding whether it is appropriate to impose greater taxes on the general population to reduce the taxes of individuals who contribute to charity.

Mr. Broad * * * says his gifts provide a greater public benefit than if the money goes to taxes for the government to spend. “I believe the public benefit is significantly greater than the tax benefit an individual receives,” Mr. Broad said. “I think there’s a multiplier effect. What smart, entrepreneurial philanthropists and their foundations do is get greater value for how they invest their money than if the government were doing it.”

It is an argument made by many of the nation’s richest people. But not all of them. Take the investor William H. Gross, also a billionaire. Mr. Gross vigorously dismisses the notion that the wealthy are helping society more effectively and efficiently than government.

“When millions of people are dying of AIDS and malaria in Africa, it is hard to justify the umpteenth society gala held for the benefit of a performing arts center or an art museum,” he wrote in his investment commentary this month. “A $30 million gift to a concert hall is not philanthropy, it is a Napoleonic coronation.”

Elaborating in an interview, Mr. Gross said he did not think the public benefits from philanthropy were commensurate with the tax breaks that givers receive. “I don’t think we’re getting the bang for the buck for gifts to build football stadiums and concert halls * * *,” he said. “I don’t think the public would vote for spending tax dollars on those things.” * * *

What qualifies for that tax deduction has broadened over the 90 years since its creation to include everything from university golf teams to puppet theaters — even an organization established after Hurricane Katrina to help practitioners of sadomasochism obtain gear they had lost in the storm.

Inheritance Advice

In Death's certain. Taxes? Avoidable, USA Today, Aug. 24, 2007, at 4B, Mindy Fetterman provides advice on:

• How to make inter vivos gifts to reduce taxes (e.g., annual exclusion gifts, marital deduction, exemption equivalent gifts and estates, etc.), and
• How to manage an inheritance since "70% of all inheritances are frittered away in the first three years."

Proposed Grantor Retained Interest Trusts Regulations Analyzed

David A. Berek (Credit Suisse Family Wealth Management) has recently published his article entitled What's Great about GRATs?, 95 Ill. B.J. 438 (2007).  The article discusses the recently promulgated proposed regulations dealing with GRATs discussed earlier on this blog.

Here is an excerpt from the article:

The proposed regulations provide that only the portion of the GRAT necessary to satisfy the remaining annuity payment (after death) will be included in the decedent's estate. Thus, if the annuity payment is $10,000 and the stated rate of return is 6 percent, property necessary to satisfy the remaining annuity payment would be $166,666.

While this rule may have a positive impact on some GRATs by consuming less than all of the property included in the decedent's estate, this development is probably not helpful for a zeroed out GRAT. The reason: to zero out the GRAT, the grantor must increase the annuity payment. The greater the annuity amount, the less value left in the trust and the lesser the value of the gift.

Applying the proposed regulations to a zeroed-out GRAT, it becomes apparent that it will take a significant portion of the GRAT property to produce a high annuity based on the stated rate of return. Expressed another way, the amount includable in the decedent's estate to produce the annuity payment will likely be the balance (if not more) of the GRAT. Thus, the proposed regulations do not offer much relief from the old rule that the entire GRAT is includible if the grantor dies during the term.

Note, however, that while the proposed regulations may not help with zeroed out GRATs, they certainly do not diminish the value of previous GRAT planning.

Trusts and Estate Taxation -- Aussie Style

Bernard Marks has recently authored a book entitled Trusts & Estates: Taxation & Practice.

Here is the publisher's description of this book:

Trusts & Estates: Taxation and Practice guides practitioners and tax administrators beyond the mechanics of tax practice to provide a practical  understanding of even the most complex tax matters. Further, it identifies the  potential dangers and opportunities in any transaction affecting trusts, estates, trust creators and beneficiaries.

• The only comprehensive guide to the taxation of trusts published in Australia
• Written by Australia's leading authority
• In-depth commentary - organised on a tax transactional basis
• Current as at 30 June 2007

The Power of Attorney-Transfer Tax Interface

Bridget J. Crawford (Associate Professor of Law, Pace University - School of Law) has recently posted her article on SSRN entitled The Tax Regulation of Contractual Intimacy: Transfer Tax Aspects of Powers of Attorney.

Here is the abstract of her article:

Powers of attorney are both the most common and the most abused of all estate planning documents. Newspapers and court cases are full of stories of alleged wrongdoing by agents who, whether due to misunderstanding or overt abuse, exceed the authorities given to them by the principal. Part I of this article provides an overview of the creation, scope and limitations powers of attorney. A power of attorney is, at its core, a contract for legal intimacy. It is an instrument that permits one person (called the attorney-in-fact or the agent) to act as the legal alter ego of another (the principal). Part II examines the estate and gift tax consequences of creating a power of attorney. Most lawyers assume (correctly) that the execution of a power of attorney does not give rise to a taxable gift by the principal and should not cause any estate tax inclusion in the estate of the agent. Part III explores how a fiduciary analysis of an agent's authorities is consistent with the Uniform Durable Power of Attorney Act. Part IV considers the implications of the Act's efforts to regularize powers of attorney. By making the principal/agent relationship more standard, some tax and estate planning professionals may shift their business practices in unexpected ways. Part V interprets the projected commodification of the principal/agent relationship in light of the way people live in the United States.

This article seeks to make two principal contributions to critical tax scholarship. The first is methodological. Instead of critiquing the existing law, this article explores a positive aspect of the existing wealth transfer tax rules. Critical tax scholarship to date tends to explore how existing law is biased, discriminatory or has a disparate impact on certain segments of the population. The article's second intended contribution is a normative one. In examining the tax treatment of intimacy that arises by contract, such as that between a principal and agent, this article opens the door for further exploration of ways in which the tax law can and should recognize choice-based human relationships. Scholars with an anti-subordination agenda should focus on ways to use existing tax laws to their advantage, given the political obstacles to left-oriented reform of the tax system.

Gift Tax Consequences of Trusts Employing Distribution Committee

The following is from IR-2007-127, July 9, 2007:

The Internal Revenue Service * * * is reconsidering a series of private letter rulings (PLRs) * * *.

The PLRs address, in part, the gift tax consequences under sections 2511 and 2514 of the Internal Revenue Code of trusts that utilize a distribution committee consisting of trust beneficiaries who direct distributions of trust income and corpus. It has come to the Office of Chief Counsel's attention that the conclusions in the PLRs regarding the application of section 2514 may not be consistent with Rev. Rul. 76-503, 1976-2 C.B. 275, and Rev. Rul. 77-158, 1977-1 C.B. 285. Accordingly, the Office of Chief Counsel is requesting comments as to whether the conclusions in these PLRs regarding section 2514 can be reconciled with the revenue rulings.

These PLRs involve a situation where trust distributions are made at the unanimous consent of a distribution committee that consists of trust beneficiaries, or at the discretion of an individual committee member with the consent of the grantor. If a distribution committee member resigns or dies, the committee member is replaced with another person. The PLRs conclude that the distribution committee members have substantial adverse interests to each other for purposes of section 2514. Therefore, they do not possess general powers of appointment over the trust. Accordingly, distributions from the trust will not be subject to gift tax with respect to the distribution committee members.

However, the holdings in Rev. Rul. 76-503 and Rev. Rul. 77-158 indicate that because the committee members are replaced if they resign or die, they would be treated as possessing general powers of appointment over the trust corpus. It has been suggested that the facts presented in the PLRs are distinguishable from the revenue rulings because in the PLRs, the grantor's gift to the trust is incomplete since the grantor retains a testamentary special power of appointment. See, however, section 25.2514-1(e), Example (1) of the Gift Tax Regulations, and Rev. Rul. 67-370, 1967-2 C.B. 324.

Before the Office of Chief Counsel takes any action with respect to the PLRs, the Office of the Associate Chief Counsel, Passthroughs & Special Industries is requesting comments regarding the question of whether the distribution committee members possess general powers of appointment under section 2514. The comments could also include suggestions for a substantially similar trust structures that would achieve the intended income, gift, and estate tax objectives of the transactions described in the PLRs.

Comments should be provided within ninety (90) days of the date of this news release. Send written comments to: Internal Revenue Service, Attn: CC:PA:LPD:PR (CC:PSI:4), room 5203, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (CC:PSI:4), Courier's Desk, Internal Revenue Service, 1111 Constitution Ave, N.W., Washington, DC, or sent electronically, via Notice.comments@irscounsel.treas.gov (indicate CC:PSI:4)

Transfer Tax CLE

The American Bar Association Section of Real Property, Probate and Trust Law, Young Lawyers Division and the ABA Center for Continuing Legal Education is sponsoring a Teleconference and Live Audio Webcast on August 14, 2007 entitled Review of Estate Tax, Gift Tax and GST Tax -- Part 1.

Here is a description of the program:

The Essential Issues in Trust and Estate Law Series provides attorneys with the opportunity to learn more about the key basics of trust and estate law. Whether you are a new attorney wanting to know more about trust and estate law, or a seasoned attorney looking for a refresher, this series has the information you need.  Click here for more information on the series and series registration options.

This first program in our comprehensive series consists of an overview of the estate tax, gift tax, and generation-skipping transfer tax systems.  In particular, this program focuses on fundamental estate planning concepts such as: planning with your client’s applicable exclusion amount, computing gross and taxable estates, utilizing marital and charitable deductions, implementing annual exclusion gifts, and understanding generation-skipping transfer tax transfers.  In addition, the program will briefly address recent proposals for estate tax reform.  The program will provide both a solid framework for junior practitioners and an excellent review for senior practitioners.

Charitable Giving in 2006

The following are the key points reported in Stephanie Strom, Absence of Major Disaster in ’06 Affected Giving, NY Times, June 25, 2007:

• Charitable giving was up an inflation-adjusted 1% over 2005.
• Disasters in 2005 such as Hurricane Katrina triggered an increase in giving, especially when coupled with the accompanying tax incentives.
• "When donations for disaster relief are excluded * * *, giving rose 5.7 percent on an inflation-adjusted basis" in 2006.
• Religious-based gifts made up 32.8% of charitable giving in 2006.
• The biggest gains in 2006 was in the category of universities, private schools, and other educational institutions.
• Arts organizations saw a 6.5% inflation-adjusted increase in 2006.
• Organizations focusing on international affairs such as disaster relief saw a 12% inflation-adjusted decrease in 2006.

Davenport Analyzed

Prof. Wendy Gerzog (Professor of Law, University of Baltimore School of Law) has recently posted her article entitled Davenport: Res Judicata Applied on SSRN.

Here is the abstract of her article:

The Fifth Circuit applied res judicata in Davenport and the gift tax on 1980 gifts may finally be paid. The article details a long history of litigation culminating in this case.

Prof. Gerzog's article also appears in 115 Tax Notes 1199 (June 18, 2007).

Study Reveals that Paying Taxes May Make People Happy

John Tierney, Taxes a Pleasure? Check the Brain Scan, NY Times, June 19, 2007, reports that

The University of Oregon announced a new piece of research last week with a startling headline: “Paying taxes, according to the brain, can bring satisfaction.”

Note, however, that "this study did not exactly involve a nationally representative sample of taxpayers. The sample consisted of 19 female students at the University of Oregon. And they were not exactly paying taxes * * *."
   

“The most surprising result is that these basic pleasure centers in the brain don’t respond only to what’s good for yourself,” said Dr. Mayr, the psychologist. “They also seem to be tracking what’s good for other people, and this occurs even when the subjects don’t have a say in what happens.”

Recommendations to Prevent Gift Tax Avoidance

Mitchell Gans (Steven A. Horowitz Distinguished Professor of Tax Law, Hofstra University - School of Law) and Jay A. Soled (Professor, Accounting, Business Ethics & Information Systems and Director, Master of Accounting in Taxation Program, Rutgers University) have recently posted on SSRN their article entitled Reforming the Gift Tax and Making it Enforceable.

Here is the abstract of their article:

Historically, the gift tax has performed the admirable role of safeguarding the integrities of both the estate and income taxes. Due to taxpayers' abilities to narrow the gift tax base and ignore their filing obligations, however, fulfillment of its historical role is now in jeopardy. This analysis details how taxpayers circumvent their gift tax obligations and then sets forth reforms that Congress can readily institute to curb taxpayers' transgressions. Institution of these recommendations would enable the gift tax to continue to fulfill its historic functions.

Plan Ahead When Cashing Out

The following excerpts are from Lauren Foster, Preparing for life after cash out, Financial Times, April 2, 2007:

When that private equity firm or strategic buyer comes knocking, it pays to have a plan: cashing out raises complex issues ranging from family wealth preservation and philanthropy to how best to invest the windfall, be it tens of millions or hundreds of millions of dollars. * * *

There are several pre-liquidity strategies that can help lower federal transfer taxes, which include the gift tax, the estate tax and the generation-skipping transfer (or GST) tax. They range from basic steps such as taking advantage of the annual gift tax exclusion-- you can make annual gifts of up to $12,000 tax-free to any number of people, with a lifetime exclusion of $1m per donor is to setting up a Grantor Retained Annuity Trust (GRAT) and making an instalment sale to a Grantor Trust. * * *

This is how a GRAT works: the business owner makes a gift of stock to an irrevocable trust and in exchange receives an annuity for the term of the trust, usually two or three years. The value of the gift for tax purposes is the difference between the amount contributed to the trust and the present value of the annuity payments the grantor will receive.

With a bit of financial engineering, an adviser can select a combination of annuity payments and trust term that will result in the present value of all future payments being equal to the amount contributed to the trust. By IRS calculations, the GRAT will have zero assets by the time the trust expires, so no gift tax is owed. * * *

Another popular tax-efficient strategy is a sale to an Intentionally Defective Grantor Trust.

With an IDGT, a grantor sells assets – say, stock in a closely held or family business, marketable securities, limited partnership interests or property – to an irrevocable trust in exchange for an instalment note with interest. This trust works best if the assets are subject to discounts in determining their fair market value and are expected to appreciate in value at a rate greater than the interest payable on the note.

When the grantor dies, only the fair market value of the note is included in the estate. This technique "freezes" the value of the assets in the estate.

Another benefit of the IDGT is that the grantor pays the income tax on any income generated by the trust. "That effectively allows the trust assets to compound tax free and the payment of the trust’s tax by the grantor is not treated as a taxable gift," says Mr Raaf, of Harris myCFO. Also, an IDGT can be used for very effective "GST" planning as the grantor can allocate his/her "GST" exemption to the trust.

Special thanks to Prof. Joel C. Dobris of the University of California-Davis for bringing this article to my attention.