No Gain or Loss Recognized on Sale to Spouse’s Grantor Trust

In PLR 201927003, released on July 5, 2019, the IRS ruled that neither Spouse 1, nor Spouse 1’s grantor trust would recognize gain or loss on the sale of partnership interests to Spouse 2’s grantor trust.

Both Spouse 1 and Spouse 2 created and funded respective grantor trusts.  As to each spouse’s grantor trust, the applicable spouse is treated as the owner of the trust’s assets.  The grantor trust is disregarded as a separate tax entity, and all income is taxed to the grantor spouse. Rev. Rul. 85-13.

Spouse 1 proposed to sell certain limited partnership interests to Spouse 2’s grantor trust.  Further, the trustees of Spouse 1’s grantor trust proposed to sell certain limited partnership interests to Spouse 2’s grantor trust.

Code § 1041(a)(1) provides that no gain or loss shall be recognized on a transfer of property from an individual to such individual’s spouse.  Code § 1041(b) provides that the property transferred will be treated as acquired by the recipient spouse by gift, and the basis of the recipient spouse in the property is the adjusted basis of the transferor spouse.

This private letter ruling provides that transfers by Spouse 1 or Spouse 1’s grantor trust to Spouse 2’s grantor trust will be treated for federal tax purposes as sold by Spouse 1 and received by Spouse 2.

Therefore, pursuant to Code § 1041(a), Spouse 1 will recognize no gain or loss with respect to the proposed transfers, and the basis of the property held by Spouse 2’s grantor trust will be the same as the adjusted basis of the the property in the hands of Spouse 1 and Spouse 1’s grantor trust, as applicable.

ACTEC Seeks Revision of Proposed Qualified Opportunity Fund Regulations

An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.  These investments are Qualified Opportunity Funds (“QOF”s).  ACTEC suggests that the proposed regulations be revised to provide relief for successors-in-interest to a QOF investment after a taypayer’s death.

ACTEC provides the following example:

Suppose that D has a $2,000,000 capital gain on April 1, 2019 and timely reinvests it in a QOF on July 1, 2019. D then dies four years later — on July 1, 2023. At the time of D’s death, D’s interest in the QOF is worth only $100,000. D’s Will gives his interest in the QOF to his child, C, as part of the residue of the estate. On December 31, 2026, the interest in the QOF is worth $1,000,000.

Here, the gain is income in respect of a decedent under Code § 691 (“IRD”).  Section 1014(c) denies a step-up in basis at death to items of IRD.

It appears that on December 31, 2026, C will be required to recognize all that deferred gain, reduced by basic adjustments applicable to the 5 and 7-year holding periods.  C, however, might not have the liquidity to pay the tax, which will be particularly problematic for C if the QOF does not have redemption provisions, or if there is not a secondary market for the QOF interest.

ACTEC suggests that the proper remedy for C’s potential illiquidity is to allow C to defer the IRD until C disposes of his interest in the QOF, thereby protecting C from inheriting a potentially significant tax liability without having the liquidity to pay for it.

ACTEC letter to the IRS re: Treasury Notice 84 Fed. Reg. 18652 (5/1/19): Comments on Proposed Regulations on Qualified Opportunity Funds Under Code Section 1400Z-S. June 27, 2019.

Use Date of Death Value if Result is Lower Combined Estate and GST Tax Despite Code Section 2032 Election

In CCA 201926013, the IRS informally advised that despite a valid 2032 election, the alternate valuation values can only be used if the result would be a lower gross estate and a lower combined estate and GST tax.  Here, the 2032 election was a protective election that would have allowed for the alternate valuation date to be used if it had been subsequently determined that the combined taxes would have been lower based on the alternate valuation date rather than based on the date of death values.

Code Section 2032(c) is controlling and provides that “No election may be made under this section with respect to an estate unless such election will decrease (1) the value of the gross estate, and (2) the sum of tax imposed by this chapter and the tax imposed by chapter 13 with respect to property includible in the decedent’s gross estate (reduced by credits allowable against such taxes).”

IRS CCA: Using Date of Death Value When Results in Lower Combined Estate and GST Tax (IRC §2032). Bloomberg Law.

Trust in Tennessee: Kaestner Decision Could Create New Opportunities for Tennessee Planning

Yesterday, the United States Supreme Court unanimously ruled in favor of the trust in North Carolina Department of Revenue v. Kimberley Rice Kaestner  1992 Family Trust .  Although limited to the facts presented in the case, the Court held that accumulated income of a trust held for the benefit of a North Carolina beneficiary who had “no right to demand that income and [was] uncertain to ever receive it,” was not subject to North Carolina state income tax.  Note, however, that the Court described three trust tax regimes that do pass Due Process Clause muster: taxation of trust distributions to a state resident, taxation based on the residence of the trustee, and taxation based on the trust’s place of administration.

Out-of-state residents, with advice of their home-state tax counsel as to their home state income tax treatment of trusts, should consider establishing trusts to be located and administered in Tennessee to avoid state income tax on accumulated trust income.  Additionally,  a new Tennessee law, Tenn. Code Ann. § 35-15-1301, allowing for the creation of special purpose entities to serve as Trust Advisors, may help avoid state income tax in states that tax trusts based on the residence of the trust’s fiduciaries or the trust’s place of administration.

How to Opt Out of the Automatic Allocation Rules

In PLR 201921001, the IRS granted an extension of time to opt out of the GST automatic allocation rules under Code Section 2632(c).  The Automatic Allocation rules applies to transfers beginning January 1, 2001.  To avoid the need for a PLR granting an extension to elect out, here’s what you need to do, as described in PLR 201921001.

As background, Code Section 2632(c) provides that “If any individual makes an indirect skip during such individual’s lifetime, any unused portion of such individual’s GST exemption shall be allocated to the property transferred to the extent necessary to make the inclusion ratio for such property zero.  If the amount of the indirect skip exceeds such unused portion, the entire unused portion shall be allocated to the property transferred.”

A transferor may prevent the automatic allocation of GST exemption (elect out of the automatic allocation rules) with respect to any transfer or transfers constituting an indirect skip made to a trust. A transferor may elect out with respect to one or more (or all) current-year transfers made by the transferor to a specified trust or trusts.

In order to elect out, the transferor must attach an election out statement to a Form 709 filed on or before the due date for timely filing the Form 709. In general, the election out statement must identify the trust, and specifically must provide that the transferor is electing out of the automatic allocation of GST exemption with respect to the described transfer or transfers. To elect out, the Form 709 with the attached election out statement must be filed on or before the due date for timely filing the Form 709 for the calendar year in which the transfer to be covered by the election out was made.

Automatic Allocation Rules Applied to Trust Transfers Despite Incorrect Reporting on Form 709

Parents made irrevocable gifts to separate trusts for each of their two children.  The terms of each trust provided for distributions of income and principal to the child, as determined necessary by the Trustee for each child’s health, education, maintenance and support.  When the child attained age 30, the Trustee was directed to pay to or apply for the benefit of the child the entire net income of the child’s trust.  The child had a limited testamentary power of appointment, which could be exercised after the child attained 34 years of age.  Further, if distribution of principal from the child’s trust would result in the imposition of GST taxes, the child had a testamentary general power of appointment as to the balance of the child’s trust.  Absent the exercise of a power of appointment, the child’s trust would be divided into separate shares, by representation, among the child’s living issue, and each share would be held as a separate trust.

Although the Form 709s were timely filed, the transfers were incorrectly reported on Schedule A Part 1, instead of on Schedule A, Part 3, Indirect Skips.  Nevertheless, the IRS ruled in Letter 201924016 that the each of the parents’ respective GST exemptions was automatically allocated to the transfers under the automatic allocation rules of § 2632(c).  Code § 2632(c) provides that if an individual makes an indirect skip during that individual’s lifetime, any unused portion of such individual’s GST exemption will be allocated to the property transferred to the extent necessary to make the inclusion ratio for the property zero.

In some circumstances, however, you may prefer not to rely on the automatic allocations rules, but, rather, affirmatively elect, pursuant to Code § 2632(c)(5)(A)(ii), to treat a trust as a GST Trust with respect to all transfers deemed made by the taxpayer to such trust during the year for which the Form 709 is filed, as well as all future transfers to the Trust. Accordingly, the inclusion ratio of the Trust immediately after the automatic GST allocation will be zero.

Special Purpose Entities May Now Serve as Trust Advisors in Tennessee

Public Chapter 340, recently signed into law by Governor Bill Lee, represents a significant evolution of Tennessee trust law by permitting the creation of special purpose entities, as defined in Tenn. Code Ann. § 35-15-1301(a)(6), to serve as Trust Advisors for trusts for which a Tennessee corporate fiduciary is serving as Trustee.

To read more about these new entities, check out Aaron Flinn’s recent article.

State Court Reformation to Remove Potential General Power of Appointment Not an Exercise or Release of a General Power

In PLRs 201920001, -20002, and -20003, the IRS determined that the reformation of three trusts for the benefit of the grantor’s grandchildren to remove language that could be construed as granting a general power of appointment to each grandchild would not result in adverse tax consequences to the grantor or his grandchildren.

The petition to reform the trusts was supported by three affidavits, one each from the grantor’s accountant, law firm, and trustee of the trusts, providing that the grantor intended for the trusts to be GST exempt, and that the grantor did not realize that the powers of appointment granted to each grandchild under the trust instrument would result in inclusion of the trust’s assets in the grandchild’s gross estate. 

Specifically, the IRS determined that the reformation would not cause corpus of the trust to be included in the grantor’s gross estate; the reformation revising the power of appointment so that it was limited to the grantor’s lineal descendants and excluded the grandchild, the grandchild’s creditors, the grandchild’s estate and the creditors of the grandchild’s estate, wasn’t a release or an exercise of a general power of appointment; and the assets of a deceased grandchild’s trust would not be included in the grandchild’s gross estate under Code § 2041.

The IRS respected this state law reformation respected because there was clear and convincing evidence of a scrivener’s error. 

LISI 60-Second Planner: PLR 201920001 — Trust Reformed to Correct Scrivener’s Error. Leimberg Information Services, Inc. (LISI).

SECURE Act Stalled in Senate

Senate Finance Committee Chair Chuck Grassley said that “as many as six” Senators oppose certain parts of the Setting Every Community Up for Retirement Enhancement (SECURE) Act (H.R. 194).

The SECURE Act passed the House on May 23rd with a vote of 417-3, and was expected to pass in the Senate through unanimous consent.  Grassley indicated that Senate Majority Leader Mitch McConnell is unlikely to take up the SECURE Act unless it is through unanimous consent.

Senator Ted Cruz is one of the opponents to the bill because of the elimination of a provision allowing certain distributions for home-schooling and elementary and secondary education expenses.

Chamseddine, Jad. Retirement Bill with ‘Kiddie’ Tax Fix Faces Further Opposition. Tax Notes Today. June 4, 2019.

Lost Will Admitted to Probate

On April 25, 2012, Mr. Gayle Franklin Cook (the “Decedent”) executed a valid will at his attorney’s office.  The Decedent’s brother, Mr. Cook, who had accompanied the Decedent to the office, but was not present during the will signing, took the Decedent’s original will home and placed it in his drawer with other items of importance.  The Decedent died in February 2017, but Mr. Cook could not find the original will.

The Decedent’s niece, Ms. Jenkins, filed a petition in December 2017, alleging that the Decedent’s original will had been lost.  She attached a copy of the will to her petition and asked that it be admitted to probate.  Although the Decedent had two heirs at law, there were three beneficiaries under the Decedent’s will, including Ms. Jenkins.

The following elements must be established by the proponents of a lost will (1) that the testator made and executed a valid will in accordance with the forms of law; (2) that the will had not been revoked and is lost or destroyed or cannot be found after due and proper search; and (3) the substance and contents of the will.  The only question remaining for the court was whether the Decedent revoked his will prior to his death.

Despite the heavy burden faced by the proponents of a lost will, a proponent is not required to prove absolutely that the Decedent did not revoke the will; rather, the proof must establish that it is “highly probable” that the April 25, 2012 will was not revoked by the Decedent.

The Decedent’s brother, Mr. Cook, received possession of the will immediately following its execution.  Mr. Cook testified that the Decedent never had possession of the will.  Although there was evidence that the Decedent visited Mr. Cook’s home, there is no evidence that the Decedent knew of the will’s location.  Ms. Jenkins testified that her mother, Mr. Cook’s wife, suffered from dementia and “had a tendency to move things around, misplace things.”

Based on the uncontradicted testimony presented at trial, the court found that it was “highly probable” that the April 25, 2012 will was not revoked by the Decedent.

In re Estate of Gayle Franklin Cook, No. W2018-01766-COA-R3-CV. (Tenn. Ct. App. Apr. 10, 2019).