Current Events In Trusts & Estates

• Applicable Restriction Under IRC '2704(b)

• GST Grandfather Regulations

• Gift Tax Disclosure Final Regulations

• Disclaimer Does Not Defeat Tax Lien

• Estate Planning Update: December 1999

• Qualified Personal Residence Trusts: Questions and Answers

• Defective Grantor Trusts

Applicable Restriction Under IRC '2704(b)

In Baine P. Kerr, et ux. v. Commissioner, 113 T.C. No. 30 (12/31/99), the IRS challenged a transfer to a family limited partnership designed by Stacey Eastland. The IRS argued that under IRC '2704(b) it could disregard the restrictions on liquidation contained in the agreement of limited partnership and thereby ignore the valuation discount. The taxpayer argued that '2704(b) did not apply because:

• the transferred interests were "assignee interests" rather than limited partnership interests and
• the restriction under the agreement were no more restrictive than provided under Texas law and therefore it met the exception in Reg. '25.2704-2(b).

The court agreed with the IRS that the these were limited partnership units and not assignee interests, but agreed with the taxpayer that under the gift tax regulations (which expand the exception higher than would have been the case under the statute) the ability to liquidate the entity was no more restrictive than Texas law would have provided in the absence of the restriction. Significantly, the court ignored the provision under state law that a limited partner could withdraw and receive the value of his or her interest in six months (as is the case under Pa. law). According to the court, state law is to be reviewed in terms of its effect on liquidation, not withdrawal.

GST Grandfather Regulations

In order to clarify the effective date rules of the GST Tax, the IRS has issued proposed amendments to Reg. '26.2601-1. The proposed amendments take a more liberal stance regarding the modifications which may be made to a trust without losing the GST exempt status. Under the proposed amendments, a GST exempt trust would remain exempt if modified under any of the following circumstances:

1. pursuant to a court order resolving an ambiguity in the trust instrument
2. pursuant to a court-approved settlement relating to the administration or construction of the trust provided the settlement is the result of a bona fide controversy
3. pursuant to the trustee’s discretionary power to distribute trust assets to a new trust, as long as the vesting under the new trust does not exceed the perpetuities period of the original trust
4. as long as the modification does not shift a beneficial interest to a beneficiary of a lower generation than the person holding the beneficial interest prior to the modification, and the vesting date is not extended beyond the original trust’s perpetuities period.

Gift Tax Disclosure Final Regulations

Section 6501(c)(9) provides that for the applicable statute of limitations to have run on a gift, the value of such gift must have been "adequately disclosed." On December 3, 1999 the IRS issued final regulations adopting with few minor exceptions the proposed regulations issued on December 22, 1998. The final regulations provide a list of information that, if applicable to a transaction, must be reported on a gift tax return. The required information must completely and accurately describe the transaction and include:

• the nature of the transferred property
• any consideration involved
• the parties involved and their relationship
• the value of the transferred property
• how the value was determined, including any relevant financial data and any discount or adjustments used in valuing the transferred property.

There are specific rules for entities that are not publicly traded. The proposed regulations required that a taxpayer submit in a statement the fair market value of an inactively traded entity without discounts, even though less than 100 percent of the entity was transferred. The final regulations do not require this as long as the value in the interest in the entity is determined using only a portion of the net asset value, rather than the net assets value of the entire entity. Also, the final regulations no longer require that the taxpayer file a statement alerting the IRS to any potential gift tax controversies.

The new regulations also clarified the standard for adequate disclosure regarding split-gifts under section 2513. The gifts attributed to the non-donor spouse are considered adequately disclosed as long as the donor spouse includes them in his or her gift tax return. There is a special rule for incomplete gifts. Adequate disclosure of a transfer reported as a completed gift will start the statute running for assessment of gift tax, even if the transfer is ultimately determined to be an incomplete gift. However, if a transfer is reported as an incomplete gift with adequate disclosure, the statute will not begin to run, even if the transfer is ultimately determined to be a completed gift. Instead, the statute will not begin to run until a return is filed reporting the transfer as a complete gift. Regarding transfers made to family members which are not gifts, as long as the parties satisfy the reporting requirements for income tax purposes, the transfers will be treated as adequately disclosed. Other changes from the proposed regulations include:

1. a copy of the trust document may now be submitted instead of a description of the trust terms
2. any financial information used in computing values must be submitted, including information from subsidiary entities if relevant to the valuation of the parent entity
3. appraisals may now be submitted in lieu of the description of the method previously used to compute FMV.

Disclaimer Does Not Defeat Tax Lien

In Drye v. U.S. ., 84 AFTR 2d 99-7160 (120 S.Ct. 474, the opinion of the Court, authored by Justice Ginsburg, rules unanimously that a disclaimer of an interest in a decedent's estate did not defeat a federal tax lien. The decedent's son owed approximately $325,000 in taxes, and stood to inherit $233,000. His disclaimer met the requirements of state law, however, the Court held that federal law determines whether inheritance rights constitute property rights susceptible to a federal tax lien.

Current Events in Trusts & Estates is a publication of the Trusts & Estates Practice Group of Pepper Hamilton LLP. The material in this newsletter is based on laws, court decisions, administrative rulings and congressional material, and should not be construed as legal advice or legal opinions on specific facts.