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Selected Issues in Transferring Assets
ne person transfers assets to another. It is a simple transaction that might be expected to have a predictable tax consequence. Yet it does not. The human experience is such a diversified tableau of possibilities that it is often hard to find any two transfer transactions that are comparable.
It is hard to imagine the majority, if not all, of the current transfer-tax issues being eliminated in the future by proposed legislation. For the present, and the foreseeable future, transfer-tax issues continue to have vital planning significance.
A flurry of recent cases involving transfers demonstrates just how diversified an array of issues may arise. There are transfers during life or at death. Transfers of commercial interests. Transfers carried out by agents after death. Transfers within three years of death. Transfers that create transferee liability.
Transfer With Retained Power
G transferred assets to a land trust within three years of her death. She retained the power to direct the trustee's actions. This retention of power caused the trust to be included in G's gross estate. After G's death, the state law involved (Illinois) was amended to indicate that a retained power of direction does not entitle the holder to reclaim or modify the beneficial interest of a trust. However, the Seventh Circuit Court of Appeals decision was not set aside pursuant to Federal Rules of Civil Procedure 60(b)(1) or 60(b)(6). The change in state law was not sufficient to warrant the extraordinary remedy of reopening the case. Swain v. U.S., DC-Ill. (Jan., 2000).
Transferees Liable Re Taxable Transfers Within Three Years of Death
F transferred securities to his children within three years of death. The gift tax paid on the transfer was includable in F's estate pursuant to §2035. Since the estate was left insolvent by the transfer of securities, the children, as transferees, were liable under §6324(a)(2) for the estate tax attributable to the inclusion of such gift taxes in the estate under §2035. Armstrong v. Comm'r, 114 T.C. __, (Feb., 2000).
Transfers Were Gifts
D made payments to his companion, C, for several years and then left C a bequest in his will. In concluding that both the lifetime payments and the bequest were taxable gifts as opposed to compensation for services rendered, the Tax Court noted that the relationship between D and C was comparable to marriage rather than employment, so services resulted from love and affection and were not a quid pro quo.
Although an "Agreement to Make Will" was offered as evidence, that document merely reflected a desire to help C avoid a will contest. No proof was offered of the value of the services rendered nor of other adequate consideration. Cavett Est., TC Memo. 2000-91.
Excessive Fees Were Taxable Gifts
A surviving spouse paid fees to her children, who were serving as the trustees of a qualified terminable interest property (QTIP) trust for her benefit. There was no evidence of any arm's-length bargaining or any effort to determine standard fees. The IRS concluded that, as opposed to being fees paid as consideration in the ordinary course of business, the trustees' fees were excessive payments that were being transferred to facilitate the spouse's estate plan by removing assets from her gross estate. As a result, the transfers constituted taxable gifts to the extent that they were excessive. TAM 200014004.
Incomplete Transfers Were Not Gifts
Faced with a class-action lawsuit, Husband transferred mineral rights for land in 10 states to Wife. Since mineral rights are treated as realty, the laws of each situs applied, yet under the law in each of the 10 states, the transfers to Wife were fraudulent. Having prevailed against Husband, the plaintiffs successfully had their judgment applied to Wife, nunc pro tunc (retroactively).
From the government's perspective, Husband appeared to have made taxable gifts to Wife--note that the transfers took place prior to the enactment of the unlimited marital deduction. However, in the Court's analysis, it was concluded that since Husband's creditors were able to seek compensation directly from Wife, Husband was still benefiting from the assets.
Moreover, Husband's retention of blank assignment forms that had been signed by Wife to enable him to transfer the mineral interests from Wife back to his care, meant that any transfer to Wife was incomplete; he had not parted with dominion and control over the assets. As a result, no taxable gift under §2511 took place. Grynberg v. Comm'r, T.C. Memo. 2000-15 (Jan., 2000).
Charitable Payment Accelerated
A charitable remainder annuity trust (CRAT) was reformed to provide for accelerated payments to the charity without triggering additional gift tax, provided that the §7520 rate was the same as, or greater than, the annuity percentage initially stated in the trust. The settlers retained their interests in their lifetime annuities and the present value of those interests was not affected by the reformation. Letter Ruling 200010035.
Gifts of Business Assets
Gifts of Partnership Interests Qualify for Annual Exclusion
Parents holding general and limited partnership interests in a newly created partnership transferred their limited partnership interests to their children. The limited partnership interests entitled the children to receive distributions before dissolution of the partnership, assign or sell the interest, and bring a cause of action against the general partners.
The IRS concluded that these rights, collectively, entitled the donees to the current economic benefits of the partnership. As a present interest, the transferred rights qualified for the gift tax annual exclusion under §2503(b). TAM 199944003.
Family Partnership Transaction Valid Despite Timing of Death
D's transfer of securities and ranch property in exchange for an interest in a limited partnership were part of a bona fide transaction. The partnership was formed to centralize management and preserve a family ranching operation. Fractional interests had previously disrupted the ranch.
D could not have anticipated that she would die of a heart attack two days after entering the deal and her prior treatment for cancer was found to be irrelevant. As an indication of her frame of mind, she was living a normal life and had recently purchased new clothing at the time of the transaction. Since D entered a bona fide transaction in good faith, her partnership interests were taxed under §2033.
Although the value of properties D contributed to the partnership exceeded the value of her partnership interests, D received a pro rata share of the partnership based on the assets she invested. Hence, no taxable gift took place. Nor were the assets transferred to the partnership taxable in D's estate; her estate included the value of the partnership interests which she received. Church v. U.S., DC-Tex. (Jan., 2000).
Gift Triggered by Stock Redemption
Prior to D's death, Company redeemed D's stock in the family bottling operation for $3 million under a plan devised by her son and Company's legal advisors. Yet, Company was actually worth $4.9 million at the time. Years later, when D learned of this discrepancy, she disinherited her son and sought a rescission of the transaction. However, it was found that the redemption was intended as an estate-freezing device and the price had been chosen as the lowest amount that could be defended for gift-tax purposes.
Arguments of fraud, bad business bargain, and unilateral mistake were therefore rejected. But, since the transaction lacked adequate consideration, it was considered a taxable gift of $1.9 million to D's son, who was the remaining Company shareholder, under §2512. Maggos v. Comm'r, TC Memo. 2000-129.
Gifts Implemented by Agents
Gifts Authorized Prior to Death
A state (Nebraska) court authorized S to make various cash gifts in S's capacity as D's guardian-conservator. The court also authorized S to make a gift of real estate. S conveyed the real estate to himself and his wife but had not made the cash gifts at the time of D's death.
As of the date of death, D's estate lacked sufficient liquid assets to make the cash gifts. However, the estate did make the gifts several weeks later and excluded their value from D's gross estate. An estate-tax deficiency was assessed.
The estate argued that S had breached his fiduciary duty to the other beneficiaries covered by the court order when the real estate was conveyed. This breach, argued the estate, caused the formation of a constructive trust on D's property to the extent of the authorized gifts that had not yet been made. The cash gifts made after death should therefore relate back to the time of the real estate conveyance. The court rejected this theory since a constructive trust pertains to property conveyed, not to property a transferee has not yet received. The cash transfers were not completed prior to death because there was no delivery. Estate of Devlin v. Comm'r, TC Memo. 1999-406.
Authorization of Gifts Implied by Durable Power of Attorney
Decedent's daughter, acting in her capacity as an attorney-in-fact pursuant to a durable power of attorney, transferred Decedent's house to a qualified personal residence trust (QPRT) of which the daughter was the beneficiary. Decedent's daughter also transferred cash from Decedent to another trust for the benefit of Decedent's grandchildren.
Although the durable power of attorney document did not specifically authorize the attorney to make gifts, the language was sufficiently broad to create a general power of attorney, the value of gifts was small compared to the overall size of the estate, Decedent was not disadvantaged by the gifts, and the gifts were consistent with Decedent's intent as well as her history of gift giving. Therefore, the gifts were validly completed and the transferred assets were not included in Decedent's gross estate. TAM 199944005.
Special Use Valuation For Timberland
An estate's four tracts of timberland were entitled to special use valuation under §2032A(e)(7). Using a formula method of valuation, the value of two of the tracts was adjusted for the value of improvements on two of the tracts. Other tracts presented as comparable in value were subject to long-term leases, but the Tax Court noted that long-term timber leases were not uncommon and that the leases in question contained rent escalation clauses and therefore reflected current prevailing rates during the statutory five-year period preceding the decedent's death.
The estate's land, as well as the comparable leased properties, had nine of the timberland features identified in Reg. §20.2032A-4(d). These factors include soil, depletion of soil by crops, soil conservation techniques, flooding, slopes, carrying capacity of the land with respect to livestock, comparable timber quality, property's segmentation and accessibility, improvements, and location. Estate of Rogers v. Comm'r, TC Memo. 2000-133.
Partnership Agreement Was Not Substantially Modified
A partnership agreement required the repurchase of a deceased partner's interest over a maximum of 10 years with an interest rate of five percent. The agreement was created prior to the effective date of §2703. Although the agreement was modified so that the interest rate would be the greater of five percent or the current applicable federal rate, the amendment was not substantial enough to subject the agreement to §2703. Letter Ruling 200015012.
Valuing Claim at Death
In Estate of Smith v. Comm'r, CA-5, 2000-1, 198 F3d 515, an oil company sued a group of royalty owners, including the decedent, for an overpayment of royalties. After the decedent's death, but before the filing of his estate tax return, a U.S. district court granted summary judgment in favor of the oil company. The decedent's estate tax return included a deduction for the $2.48 million the oil company claimed the decedent owed, as a claim against the estate.
Fifteen months after the decedent's death and nine months after filing the return, the estate paid the oil company $681,840 in settlement of the claim. Although the Tax Court had ruled that the claim was not certain and the deduction had to be limited to the post-death settlement, the Court of Appeals reversed and found that the appropriate deduction was the fair market value of the claim on the date of death. The IRS has announced its nonacquiescence in the result. Nonacquiescence Announcement I.R.B. 2000-19 (May, 2000).
Transfer Tax Reform
It's back...and there it goes again. The repeal of federal estate, gift, and generation-skipping transfer taxes has once again been proposed in H.R. 8, the Death Tax Elimination Act of 2000. And just as last year, the proposal has been vetoed by the President.
Under the proposal, transfer taxes would be gradually reduced each year starting in 2000 until 2010. State death-tax credit rates would also be reduced gradually each year. Transfers after December 31, 2009, would no longer be taxed.
An important aspect of the proposal that is somewhat overshadowed is the impact of the law on capital gains. Under our current stepped-up basis, capital gains tax does not apply to capital assets that are transferred at death. Notwithstanding the fact that the last attempt to convert to a carryover basis failed and had to be retroactively removed from the tax code.
Certain safe harbors in the carryover basis would cushion the new law. Assets of up to $1.3 million could still pass to individuals with a stepped-up basis. Assets of $3 million could pass with a stepped-up basis to a spouse.
As we go to press, attempts to override the veto are being explored. Meanwhile, alternative estate-tax relief provisions are moving forward. That makes the climate ripe for some form of legislative reform following the election.
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