Report No. 2 (Mon. 1/14)
As we have done in January for the last eleven years, and again with the
permission of the University of Miami School of Law Center for Continuing
Legal Education, we will be posting daily Reports to this list containing
highlights of the proceedings of the 42nd Annual Philip E. Heckerling
Institute on Estate Planning that is being held January 14-18, 2008 at the
Orlando World Center Marriott Resort and Convention Center in Orlando,
Florida, a new venue for the Institute starting in 2007. A complete listing
of the proceedings will be published here and is also available on the
Institute's Web site at http://www.law.miami.edu/heckerling.
We also will be posting the full text of each of these Reports on the ABA
RPPT Section's Web site, as we have since the 2000 Institute. Those Reports
can be found at URL http://www.abanet.org/rppt/meetings_cle/heckerling. In
addition, each Report can also be accessed at any time from the ABA-PTL
Discussion List's Web-based Archive at URL
http://mail.abanet.org/archives/aba-ptl.html.
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This Report covers the Recent Developments session that was presented on
Monday afternoon. The next Report will cover some of the Tuesday sessions
and a few of Jason Havens' reports from the Exhibit Hall.
When Institute director Tina Portuondo welcomed the attendees Monday she
noted that this year's program is dedicated to Professor John Gaubatz, who
died last year. John was the long-time director of the Institute prior to
Tina, and a professor at the University of Miami School of Law.
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A News Item: Orlando World Center Marriott, Jan. 15, 2008 – WealthCounsel,
LLC announced today from the exhibit hall of the 42nd Annual Heckerling
Institute on Estate Planning the results of its 2007 WealthCounsel®
Industry Trends Survey in a report entitled “A Look Inside the Estate
Planning Industry.” The survey was designed to identify the challenges
confronting today’s estate planning professionals and to obtain a sense for
the estate planning needs of American consumers. Approximately 5,000 estate
planning attorneys were invited to participate in the survey during
November 2007. An electronic copy of the 16-page report may be downloaded
as a PDF at the following link:
www.wealthcounsel.com/WealthCounsel_2007_Industry_Trends_Survey.pdf.
Copies will also be available at the WealthCounsel exhibit booth at
Heckerling (Booth 214), or by sending an email to
marlene.frith@wealthcounsel.com">marlene.frith@wealthcounsel.com
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Recent Developments in Estate, Gift and Income Tax 2007
Monday, January 14, 2007
Presenters: Dennis Belcher, Carol Harrington and Prof. Jeff Pennell
Reporter: Bruce Stone
Dennis first thanked Dick Covey and Dan Hastings for the extensive written
materials (a separate volume of 378 pages).
Dennis then characterized 2007 as an interesting year for estate
planners. Some practitioners would say that there aren't a lot of
significant matters or concrete real matters that we need to worry about in
January 2008. Instead we find lots of proposed regulations, and things
that will happen sometime in the future. Dennis stated that it was his
view that 2007 was significant as a year of change, changes that will
dramatically affect our profession. He cited as one example the new tax
preparer rules and penalties which make it critical for us to keep up with
current developments in the law, as we practitioners may become the
enforcers of the tax law.
Dennis then discussed repeal/reform of the federal estate and gift tax
laws. Congress didn't do much of anything in this area in 2007. Everybody
blames someone else for nothing happening: the parties blame each other;
the branches of government blame each other. Estate tax reform in the year
2008 will be very unlikely due to the campaign and the fall elections, so
reform will spill over in 2009. Dennis believes that the chances for
repeal of the estate tax are slim and none. He finds that clients are now
starting once again to make taxable gifts and to pay gift tax after a
hiatus of several years. This is particularly true in states which have an
estate tax but no gift tax. One may question why pay gift tax now at a 45%
tax rate, when the tax rate may drop. One answer is that as clients age
and become elderly, and in face of the increasing likelihood that the
estate tax will not be repealed, it is important to get the advantages of
paying gift tax as opposed to paying estate tax, and to make transfers and
pay tax to avoid the three-year rule that otherwise would pull the gift tax
back into the base for estate tax liability.
Dennis noted that Senator Baucus (Senate Finance Committee) said last
November that he will hold aggressive hearings on the federal estate tax in
the spring of 2008. Senators Baucus and Grassley are looking primarily for
relief for owners of small businesses and ranchers. There will be much
talk in 2008, and there will be an election in 2008, and we will likely
have action in 2009. Repeal or reform of the estate tax has not been a
focus of the presidential campaign. There likely will be a fresh look at
the overall topic after the election. We must remember that 60 votes will
still be needed in the Senate for action. One source has reported that of
the 35 Senate seats up for election, 23 are held by Republicans, and the
other 12 are held by Democrats. Only 5 of the 23 Republican seats are
regarded as safe by this source. Six of the 12 Democratic seats are
regarded as safe. If the Democrats increase their seats to the mid-50’s
range, there still be no clear block that can carry 60 votes, and so a
smaller group of moderate Senators will be key to whatever decisions are
made. The general talk is increasing the exemption equivalent to $3.5
million or $5 million, and phasing the increase in over a period of time,
perhaps in increments of $250,000 or $500,000, so that a full increase to
$5 million could take a long time to become effective. The general talk is
of decreasing the estate tax rate maybe to 35%, possibly with a second and
higher rate for larger estates, but that too could be phased in over 5
years or even a longer period.
One major issue is whether the gift tax will once again be unified with the
estate tax. If this does happen, it will unleash a lot of estate planning.
Dennis also discussed proposals for portability of the unified credit
between spouses. This could lead to an exemption equivalent of $5 million
or $7 million for married couples. If this happens, it too will change
estate planning and make it much simpler for a vast majority of
Americans. But Congress has looked at portability in the past. Which is
more acceptable or desirable politically: to decrease the tax rates, or to
allow portability?
Prof. Jeff Pennell then discussed the IRS priority guidance plan for 2008,
and he ran down a list of the 13 items on the 2007-08 plan. He noted the
inflation adjustments to various statutory amounts: the section 6166
adjustment, the special use valuation limit under section 2032A, and the
gift tax annual exclusion for transfers to a noncitizen spouse.
Jeff next drew attention to the IRS sample forms for charitable lead
annuity trusts that were released in 2007. He noted that there will be
charitable lead unitrust forms sometime in 2008, both for testamentary and
inter vivos trusts. According to the priority guidance plan, the ordering
rules for distributions from charitable lead trusts will be dealt
with. Generally, for charitable remainder trusts, the government applies a
WIFO rule: worst in, first out. Will this apply to charitable lead
trusts? Jeff indicated that mostly like the government will say instead
that distributions from charitable lead trusts will be deemed to come out
on a pro rata basis.
The guidance plan states that authority will be issued that governs the
division of charitable remainder trusts under section 664, which happens
frequently when times turn bad economically and charitable remainder trusts
are terminated prematurely. What are the consequences? To date, the
Service has ruled that the lead private beneficiary is selling her or his
interest, with basis of zero. Everything that the lead beneficiary gets
upon termination is long term capital gain for income tax purposes. Will
the Service reach the same conclusion in a revenue ruling?
Jeff then discussed the alternate valuation date regulations project on the
guidance plan. He referred to the Kohler case in the Tax Court. In the
case of a tax free corporate reorganization that occurs within the
alternate valuation period, how is the newly issued stock to be
valued? One rationale is that a tax free reorganization is a mere change
in form for tax purposes, not a disposition, so that the new stock is the
asset that should be valued on the alternate valuation date. But the
concern of the IRS is that this will lead to abusive post mortem planning,
such as the formation of a family limited partnership with a transfer of
assets owned directly by the decedent on the date of death, and the estate
will argue for value of the partnership interest rather than the
securities. This is what this project is about.
Jeff called attention to the project on defective grantor trust planning:
what are the estate tax consequences of holding a section 674(4)(c) power
to swap assets. The government thinks there might be a transfer with a
retained interest, but in any event, guidance will be issued. Jeff doesn't
think that holding a power to reacquire trust assets by paying adequate and
full consideration creates a true section 2036 retention issue. This will
be a very important item to watch in 2008.
The government intends to issue regulations dealing with restricted
management accounts, and likely will use section 2703 to say this technique
does not work to create valuation discounts.
Finally, Jeff noted that the 2704 regulations project may add another arrow
in the quiver for the government's fight against family limited partnerships.
Carol Harrington first examined a line of four cases on trusts that are
grandfathered for GST tax purposes (a topic dealt with on pages 1 – 42 in
the materials!). Carol reviewed the Peterson Marital Trust case, and the
Simpson and Bachler cases where the exercise of a power of appointment took
the assets out of the grandfathered trust. The rationale seems to be that
if assets are taken out of trust, the constructive addition regulations are
not applicable, and that the statute governs. But these questions were
litigated again in the Gerson case, where Tax Court reaffirmed its same
position: the trust assets still remained subject to the GST tax. The
existing regulations date back to 1995 and deal with assets remaining in
trust. The Gerson case also deals with the important doctrine of how much
deference must be given to agency regulations. The Gerson case was
decided by a 10 to 5 vote in favor of the government, but still 5 judges
said that the plain meaning of the statute governed the issue. So does the
IRS have the authority to issue regulations to change the result that would
follow under the statute? The Gerson appeal just came down from the 6th
Circuit in November 2007, which affirmed Tax Court: the regulation was
reasonable.
Carol observed that the fight isn't over, however. You might want to have
an executor or trustee located in the 8th or 9th Circuits, and this is
sufficient at the time the tax case comes up, not when the tax is
supposedly due.
Jeff then reviewed three tax apportionment cases, one of which was the Lee
case (p. 47 of the materials) which involved a QTIP trust with 2 pecuniary
gifts passing to individuals and the balance passing to charity upon the
death of the surviving spouse. Who pays the tax due on the QTIP trust in
that event? The drafter said that intent was for the two pecuniary gifts
to pass free and clear of tax to the two individuals, and to diminish the
interest passing to the charity, knowing that this would involve an
interrelated calculation. Section 2207A governs the tax due with respect
to the surviving spouse's estate: whether there is a right of recovery or
not, and the surviving spouse controls that particular decision. But the
issue in Lee is one that must be addressed by the drafting attorney for the
first spouse to die, the spouse who created the QTIP trust. Section 2207A
says to override its workings, you must comply with the statutory
requirements by specific reference. The Eisenbach case from Washington
dealt with that issue, where the state courts held that 2207A did not
override the testator's clear intent.
Dennis then discussed state death taxes, and noted that many of us practice
across state lines. A majority of states have no estate tax. Some states
have an estate tax with the old brackets and a maximum rate of
8.8%. Fourteen states have an estate tax with decoupled exemptions (e.g.,
a $1 million state exemption, whereas there is a $2 million federal
exemption equivalent). Five of the decoupled states have a separate QTIP
election. With the $3.5 million exemption equivalent in 2009, these state
law differences will become even more significant.
Clients should avoid owning real estate interests in states which don't
match up with the federal exemption equivalent. A common technique is
using LLCs to turn realty into an intangible property interest, but some
states look through single member LLCs. You need to associate a good
lawyer in those jurisdictions, and make sure that the conversion works.
Jeff next discussed the seven prior credit states which apply the current
Internal Revenue Code provisions other than the repeal of the state death
tax credit. Three of these states are scheduled to end their decoupling
and thus end their estate tax. For some states the better planning may be
to provide for payment of death taxes from an otherwise deductible
residuary estate. But for others, the general rule would be to increase
the nonmarital trust to the largest amount that can pass free of tax due to
the unified credit plus the section 2058 deduction. (These complicated
topics are discussed in the materials beginning on page 61 and going
through page 80.)
One good technique for states with only a $1 million credit is to use $1
million of the federal exemption equivalent during lifetime so that there
is a match on death.
Jeff then discussed inter vivos QTIP trusts and the operation of section
2523(b)(2), which Jeff said that basically he doesn't understand why it
even exists. You don't want to fight the statutory provision,
however. The issue involves the creation of an inter vivos QTIP trust,
where if the donor spouse survives the beneficiary spouse, beneficial
enjoyment comes back to the donor spouse. This is clearly safe under the
regulations. But what kind of beneficial enjoyment can the donor spouse
have? Section 2523(b)(2) appears to say the donor spouse may not have a
power to appoint after the donee spouse dies. Is this interpretation
correct? Jeff seems to disagree with Covey's and Hastings' spin on trying
to interpret the statute. A cautious drafter will not retain powers to
appoint in the donor spouse in an inter vivos QTIP. A third party trustee
having the power to invade for the benefit of the donor spouse should be
ok. Perhaps it is ok if the donor spouse acting as trustee has the power
to invade for health, education, support and maintenance, but Jeff isn't
certain about this.
Carol then spoke on the proposed regulations under section 2053. Isn't the
transfer tax supposed to be based on a snapshot taken at death? Or do we
wait and see what actually gets paid out in order to measure the transfer
tax? But now we can deduct claims only in the amounts actually paid by
time of filing the return. If you pay more amounts later, you must file a
claim for refund. But beware of the statute of limitations for claims for
refunds. The answer to that concern is to file a protective claim for
refund. To understand the biggest flaw in this overall reasoning, per
Carol: assume an estate passing entirely to spouse or charity (fully
deductible), and the existence of a significant claim against the
estate. Either item is deductible. Under the snapshot rules you couldn't
take a full marital or charitable deduction, because of the existence of
the claim, knowing that there are amounts which will not pass to the spouse
or charity. But if you think the claim is worth $5 million, and that
amount hasn't been paid by the time the return is filed, you would owe
estate tax because you cannot deduct the full amount of the claim until it
is actually paid. The answer of the regulations is to get a refund
later. This is unfair: the federal estate tax is a tax on net
transfers. The regulations result in great administrative inconvenience
and expense, particularly where there are periodic payments and thus
periodic claims for refunds. There is a large potential for
malpractice. In addition there is a rebuttable presumption that claims by
family member (with a broad definition of family) are not bona fide and not
deductible.
Dennis asked Carol whether we should change our practice by filing
protective claims for refunds whenever a 706 is filed, and Carol answered
yes. File the protective claim for refund at the same time you file the
706. Hopefully the IRS will hold off and wait on dealing with these
protective claims. Dennis noted that the Kimberly Hicks case (page 276 of
the materials) would have been decided differently had the section 2053
regulations applied then. That case involved a personal injury, where
damage proceeds went into a special needs trust for a minor child, and some
portion went to the father, who loaned his share of the proceeds to the
child's trust. The child died. Was the loan valid, and was there a
deduction for the loan? In this case, which predated the regulations, the
loan was held to be valid and deductible. Dennis urged the audience to be
careful for notes, loans, and other receivables that are intra-family.
Carol reminded us that these are proposed regulations. She is hopeful that
the government will fix the otherwise 100% deductible situation where all
goes to the spouse or charity.
Dennis then discussed the section 6166 installment payment of estate
taxes. Suppose that one third of the estate passes to charity or to the
spouse, and the balance passes to children. This would result roughly in
one third to the deductible interest, one third to the children, and one
third for estate taxes, with the children paying the estate taxes. What is
most effective way to structure the gifts? Pecuniary amount to the spouse
or charity, or pecuniary amount to the children? The interest paid on the
deferred tax is nondeductible for any tax purposes (estate or
income). Significant income can be building up while the estate is
open. Where should the interest payments be allocated? A lot of this
turns on the Hubert regulations: are items management expenses or are they
transmission expenses? You would want nondeductible interests classified
as management expenses. Covey and Hastings conclude that the interest
charges are management expenses, but Dennis said that he leaves that
determination up to the audience.
Carol next discussed the Rudkin (Knight) case, and gave a general
background on the O'Neill, Mellon and Scott cases that preceded it (all
involving the section 67(e) 2% floor issue). Carol highly recommends
reading the transcript of the oral argument before the Supreme
Court. "Don't all trusts have a grantor?" one justice asked.
Dennis asked Carol about bundling and unbundling. Carol noted that all
four cases say that trustee fees are fully deductible, but the proposed
regulations say they are not. Attorney's fees will have to be
unbundled. Jeff commented that a Treasury official has said the government
issued the regulations when they did so that when the government wins the
Rudkin case in the Supreme Court, the regulations will be ready to go right
away. Will these new rules be effective for 2008 returns? Dennis said
that we have to think about this being a possibility for tax years that
have already begun, but that hopefully the regulations will have a deferred
effective date.
Jeff discussed the fact that the IRS is revisiting prior private letter
rulings that dealt with trusts which have distribution committees designed
to achieve nongrantor trust status. These have been designed to avoid
state income taxes. A lot of inconsistent comments have been received by
the IRS.
Jeff commented on PLR 200748008 came out since the materials were printed
for the conference. It deals with section 2041 and rules that the
reciprocal trust doctrine cannot apply outside the realm of section 2038
where it was created. Jeff thinks this is the direction the government is
going even though the PLR doesn't say the reciprocal trust doctrine cannot
apply – all it said was that it did not apply in that case.
Jeff next commented on Rev. Rul. 2007-13, which said that a transfer of an
insurance policy to a grantor trust is not a transfer for value. The
ruling basically affirms the principles of Rev. Rul. 85-13. Dennis
questioned the integrity of the ruling but was delighted it was
issued. Dennis cautioned the audience to be careful, however: be sure the
transfer of an insurance policy is truly for its fair value, which as we
should now know is not always cash surrender value. Also we should
remember in representing trustees, that the trustee has fiduciary duties,
and a transfer of an existing policy might be a breach of fiduciary duty.
Dennis next commented on the passive activity rules under section 469, and
the material participation requirement. TAM 200733023 deals with the level
of activity at the trustee level. If the trustee actually does the work,
the trust is actively participating. The TAM refuses to concede the
holding of the Mattie K. Carter Trust case, which allowed the activity of
the employees of the trust be counted as material participation.
Dennis then discussed ordering provisions for allocation of the sources of
payments of the lead interest in charitable lead annuity trusts. PLR
200648025 refused to follow an ordering provision in a CLAT.
Jeff next discussed the Jelke case, in which the 11th Circuit reversed the
Tax Court. The case involved whether built in capital gain tax liability
in a C corporation is to be considered in valuing the entity. The 11th
Circuit said yes. The Tax Court had said that it would take 16 years to
sell off the assets and to incur the tax liability, so the liability was
discounted back to present value (the impact of the built in gain). The
11th Circuit reversed on this issue. Jeff stated that in his opinion, the
dissent in the 11th Circuit decision was absolutely right: the decision is
absolutely arbitrary. The court is saying all the appreciated assets will
be deemed to be sold on the moment of death, and the full tax cost taken
into account in determining the value, and that is an unreasonable and
arbitrary assumption.
In a partnership you would make a 754 election and wipe out the inside
gain. Here, you get an estate tax savings for an income tax liability
doesn't go away. Which is better? Getting the immediate federal estate
tax reduction is probably better in most cases.
Dennis is not sure all courts will follow the holding of Jelke. In
addition, he observed that the courts have not given much traction to the
same reasoning in S corporation cases. Jeff noted that the shareholder
only owned about 6% of the stock and could not have compelled a sale of the
stock by the corporation. Dennis said that planners should not rely on
Jelke in planning. He observed that in the real world of business, tax
discounts are negotiated in actual buyouts where there is built in gain,
and so the discount was overstated in Jelke.
Carol then discussed TAM 200648028, which involved an estate where a
decedent owned a minority interest in a closely held company and which
passed to charity upon his death. A separate irrevocable trust created by
the decedent with a retained right to income and a limited power of
appointment also owned stock in the same company, and thus was includible
in the decedent’s gross estate at death. The combined holdings
represented control of the company. The Service ruled that the stock
holdings were considered as one and valued based on control, but the
minority interest held in the estate and passing to charity had to be
discounted. This resulted in estate tax on phantom value. Carol said that
this should be contrasted to the proposed section 2053 regulations. We
have a snapshot at date of death for valuation of assets, but not for
valuing debts or claims.
Dennis next discussed the Estate of Georgina Gimbel case, a 2006 TCM
decision. The decedent owned 13% of the stock of a company. There were
Rule 144 securities law restrictions on the ability to sell or transfer the
stock, and there was a valuation dispute over the shares. Dennis observed
that time is the death of value. Any delay in sale is a death of
value. Dennis said that the moral of the Gimbel case is always to get a
securities lawyer to work with you when there are insider or affiliate
restrictions on transfer or sale of shares.
Jeff then discussed cases involving the right to lottery payments (Negron
and Davis). Jeff said that the analysis should be how much a hypothetical
willing buyer would pay to stand in the shoes of the estate – which would
be to have the right to receive the same stream of payments. That was the
real question and that is what the court in Davis was saying. This could
be a blockbuster decision if other courts pick up on it, according to Jeff.
Carol then discussed the Stone case decided in federal district court in
California, which involved the estate tax valuation of a 50% interest in 19
paintings. The estate's expert opined for a 44% fractional interest
discount. The IRS would only allow a 5% discount, which the court
accepted. Carol noted that the technical corrections to the Pension
Protection Act have a very helpful change to the estate and gift tax
mismatch that occurs when you have to use the original appraised value for
gifts made in installments over time. The legislation repeals the
provision retroactively with respect to gift and estate taxes, so that
there is no more mismatch. But one piece is still left: the gifting must
be completed within 10 years or before the taxpayer dies.
Dennis pointed out the revisions made to form 706 in September 2007, in
particular the questions asked in items 10a and 10b, which trigger
disclosure of total accumulated valuation discounts.
Jeff then went through a quick thumbnail review of family limited
partnership cases, and noted that John Porter would be covering these cases
in more detail in John's presentation on Tuesday. One case, the Rector
case, TC Memo 2007-367, was too new to be included in the program materials.
Jeff reviewed five cases where the government won. These cases involved
common themes: partnerships created without any negotiations among the
partners, with one person pulling all the strings. Sometimes a child
creates the FLP by using a durable power of attorney. There are de minimis
contributions by persons other than the decedent. Sometimes there are
backdated documents transferring assets into the FLP. Taxpayers get greedy
and transfer virtually all of their assets into the FLP: did they retain
enough liquid wealth outside the FLP to live on? If not, it looks like a
transfer with an implied retained interest. Another factor: in the balance
of the decedent's lifetime remaining after partnership formation,
distributions are made back to the decedent that are disproportionate to
what the other partners got – sometimes these payments back are alleged as
loans, or asserted to be management fees that obviously were trumped
up. And usually the cases are planned too close to death.
The Rector case is interesting in that only a 19% discount was sought by
the taxpayer: but what got the government's attention was that inter vivos
gifts of partnership interests were reported on gift tax returns, but were
not reported on the 706. This got the taxpayer spotlighted.
The test that the courts are applying: the Tax Court decision in Bongard
sets the base for all of these cases. To have full and adequate
consideration for the exception to section 2036, two factors are most
important: is there a bona fide sale? Bigelow says that there must be a
significant and legitimate nontax reason for the sale. Judge Laro in
Rector said there must be legitimate and significant nontax business
purposes. In the Rosen case, Judge Laro said there must be an important
reason that was motivated from a business point of view. The 9th Circuit
in the Bigelow case recrafted the standard: there must be legitimate
significant nontax business related purposes that would have affected
partners operating at arms length.
Jeff conclude by saying: "I don't have any freaking idea what any of these
tests mean." That drew a large and sustained laughter with applause from
the audience. He said if any other commentators tell you otherwise, take
what they say with a grain of salt.
He questioned some of the reasons advanced for formation of partnerships.
Creditor protection? There was no conceivable justification for that in
some of these cases: in Rosen the decedent was bedridden and
incompetent. Jeff asked, but does she drive, again drawing a big laugh
from the audience.
What about for formation of partnerships for gifting reasons? Jeff says
that gifting is not a nontax purpose.
What about for more efficient asset management? The courts say no. If
there was active management or if management had changed in any meaningful
way, maybe, but there was none of that either in the cases won by the
government.
Dennis said that he does not recommend entities for clients unless they do
serve a purpose other than for valuation discount purposes. Carol
immediately asked Dennis if that means that all of his partnerships do
qualify? Dennis said yes, to great laughter form the audience. Dennis
then analogized the overall situation involving planning with partnerships
by saying that we are all going across the Serengeti, and you do not want
to be the wildebeest that lags behind and gets caught, once again drawing
laughter. He cautioned that these are high audit items. Your client had
better not have unrealistic expectations. Your client and the client's
family had better be willing and able to deal with risk.
Carol asked about the rationale about pooling assets to allow better
investment strategies as a reason for partnership formation. Dennis
replied that this might be valid, but why the long term lock in provisions
in the FLP?
Jeff next discussed the proposed regulations on inclusion of unexpired GRAT
interests under sections 2036 and 2039. The government used to say that
section 2039 applied because the section title says annuities, but now the
government will limit application of section 2039 to commercial annuities
or employee annuities in retirement contexts. For GRATs the government
will now look to section 2036. But by going to section 2036, some results
are not so good. One result that is good: if section 2036 applies, so
should the right of reimbursement under section 2207B. If the right of
reimbursement is not altered, the GRAT should pay the tax. We might want
to address this in tax apportionment provisions.
Jeff then spoke of what remains of the 3 year rule in section
2035(a). Suppose that there is a 5 year GRAT now in year two, and the
client learns that he or she has a terminal illness and will die in 6
months. What can be done to avoid inclusion under section 2036? If you
get rid of the GRAT interest within 3 years, section 2035(a)
triggered. Full and adequate consideration will get you out of that
trap. But the Allen case says that full and adequate doesn’t mean an
amount equal only to the 3 remaining payments.
Jeff concluded by questioning the reasoning that underlies the theory of
the proposed regulations. Do any of us believe that if we buy a commercial
annuity worth $1 million, that section 2036 is applicable? No. So suppose
that Carol or Dennis creates a trust, and Jeff buys that same $1 million
annuity from the trust. Does section 2036 apply? No. Now suppose that
Jeff himself creates the trust and buys the same exact $1 million annuity
from the trust he has created. Why does section 2036 apply in this
instance? The regulations don't talk about section 2043 consideration
offsets, and they should. Jeff believes there are a number of errors in
these regulations, and so we must be careful.
Jeff then commented on the charitable lead trust forms that were issued by
the Service in 2007. The hot issue is the ordering provisions for source
of payments for the lead payment. Jeff said that even with the IRS forms,
we should include provisions that state the intention to qualify for
charitable lead trust treatment.
Carol then turned to a discussion of current developments in the GST
tax. She said that the IRS will no longer rule on grandfathering
provisions if the factual situations are the same as those in the examples
in the regulations. She said that the IRS personnel are very friendly and
helpful, so you should call the IRS and ask if they will give a ruling
before going to the expense of preparing for a ruling request on whether a
trust will remain grandfathered.
Carol briefly discussed the rules for retroactive allocation of GST
exemption under section 2632(d), and noted that there were no new
developments in this area. She said that if you have an irrevocable life
insurance trust, for example, and someone dies out of order, you need to do
the analysis to see whether a late allocation will work as opposed to a
retroactive allocation. Depending on policy values, a late allocation may
work just as well.
Carol cited the audience to an article that she and several other persons
wrote on the final regulations governing qualified severances in the
November and December 2007 issues of the Journal of Taxation. There are a
number of requirements for a severance to be effective for GST
purposes. The severance must be effective and authorized under the terms
of the governing instrument or under local law. It cannot be
retroactive. The effective date can be set by court order or by the
trustee. If funding of the severed trusts is not done on a pro rata basis,
there are rules on how fast funding must occur. The IRS is worried about
delays in funding being used to manipulate changes in values of
assets. Funding must begin immediately on the effective date. Carol said
that she would recommending beginning funding on the very date of the
severance although it is not clearly whether this is literally
required. Funding must be completed in a reasonable time. Delays maybe
required in order to obtain valuations of assets, but 90 days is the
maximum deadline. Trusts must be severed on a fractional and not a
pecuniary basis. For you can achieve a pecuniary result by using a
pecuniary amount as the numerator of the fraction. There is an appropriate
interest requirement, and there must be the same succession of interests in
the two trusts. The beneficiary terms are not required to be identical
terms, but the same succession of interests is required. However, if the
trust document itself or state law requires identical trusts (and some
state laws do require this), the beneficial interests in the trusts must be
identical or the severance will not be effective and therefore will not be
valid.
Carol gave an example of a single trust fund being split up along family
lines in order to separate branches of the family. It is not clear to her
whether cross remainder interests are necessary or not.
If the inclusion ratio of a trust being severed is zero or one, the new
trusts must also have an inclusion ratio of zero or one. If the trust has
an inclusion between zero and one, the severed trusts must have ratios of
zero and one after the severance.
Reporting a severance to the IRS is no longer required, but is now
optional. If you elect to file a report, it is to be done on form 706 GST,
and is due by April 15. Finally, it is not longer required to write
“qualified severance” in red on top of the return.
The regulations contain a safe harbor for income tax purposes: certain
qualified severances are not taxable events for income tax purposes. But
if the terms of the severed trusts aren’t identical, you have to be
careful. It is possible to have a severance that is ok for GST purposes
but for which the income tax safe harbor won’t apply.
A provision attempts to eliminate valuation discount techniques in some
funding situations, which is covered in some detail in the Journal of
Taxation article.
Finally, nonqualified severances will be recognized in some circumstances.
Carol concluded by stating that overall, the qualified severance
regulations are very good.
Jeff then briefly discussed the appraiser penalty provisions, and noted
that a prior glitch has been fixed to apply the penalties to appraisals
prepare for estate and gift tax returns as well.
Carol then discussed the new tax preparer penalty provisions. Reasonable
basis used to be the usual level of compliance for estate and gift tax
purposes, but advisers on income tax matters have long lived with higher
standards. There is now a real mismatch between the standards for
preparers and the standards applicable to taxpayers. Preparers now have a
higher standard of conduct: we will tell our clients they have to disclose
but the client doesn’t have to disclose. The use of disclosure forms by
tax preparers is going to increase dramatically. The tax preparer will be
ok if the tax form is furnished to the taxpayer with the disclosure
statement, and the preparer will not be required to follow up with the
taxpayer to make sure the form was filed as furnished. Preparers will also
be safe if we actually advise our clients on the proper standards and
disclosures and document contemporaneously that we gave the advice.
There is a significant gap between whether something has a reasonable basis
versus whether it is more likely than not correct. You cannot take into
account the “audit lottery,” and you have to decide matters and issues
on the merits.
However, even if our clients do not follow our advice, we can still be
penalized. The panel agreed that these developments have enormously
complicated our practice. If you give advice that forms a substantial part
of the return preparation, you are liable as a tax preparer even though you
don't sign the return.
Finally, Dennis reported on a Florida appellate decision in which a
prominent law firm was found liable in a jury trial for failing to disclose
to one of its estate planning clients that the law firm had a significant
business relationship with the corporate fiduciary that was named to serve
in the client's estate planning documents. The law firm was found to have
a conflict of interest and to have breached its fiduciary duty, and it was
required to disgorge all of its fees and in addition to pay damages to the
client's estate after death for the fiduciary fees paid to the corporate
fiduciary. (Although Dennis deliberately did not cite the case or name any
of the parties, the opinion can be found at 965 So.2d 182.) Dennis
concluded the panel presentation by citing this case and developments such
as the changes in the rules governing liability of tax preparers as
examples of the changes that are coming to our area of practice that we
must beware of.
===========================================================
THE REPORTERS
Our on-site local reporters who are present in Orlando this year are Gene
Zuspann Esq. of Zuspann & Zuspann in Denver, Colorado; Joanne Hindel Esq.
of Fifth Third Bank in Cleveland, Ohio; Jason Havens Esq. of Howard, Mobley
& Havens PLLC in Florida and Tennessee; Kimon Karas Esq. of McCarthy,
Lebit, Crystal and Liffman Co., LPA in Cleveland, Ohio; Bruce Stone Esq. of
Goldman, Felcoski & Stone, PA in Coral Gables, Florida; Craig Dreyer Esq.
of McDonald Hopkins LLC in Cleveland, Ohio; Carol Sobczak Esq. of The Law
Offices of Carol A. Sobczak in St. Helena, California; Ronda Martinez Esq.
of Fifth Third Bank in Southfield, Michigan; and Mike Stiff Esq. of
Hutchins & Stiff LLC in Denver, Colorado. The editor again this year will
be Joseph G. Hodges Jr. Esq, a solo practitioner in Denver, Colorado, who
also is the Chief Moderator of the ABA-PTL List.
_________________________________________
GENERAL INFORMATION ABOUT INSTITUTE:
Inquiries/Registration:
Philip E. Heckerling Institute on Estate Planning
University of Miami School of Law
Center for Continuing Legal Education
P.O. Box 248087
Coral Gables, FL 33124-8087
Telephone: 305-284-4762 / FAX: 305-284-6752
Web site: www.law.miami.edu/heckerling
E-mail: heckerling@law.miami.edu
===========================================
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