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By Lawrence M, Lipoff, CEBS, CPA, Rogoff & Company, P.C.

A transaction that has been of recent interest to the trust and estate professional community has been a surviving spouse's purchase of a remainder interest in a qualified terminal interest property (QTIP) trust. Such a transaction appears to allow some assets to pass to heirs without being subject to gift and estate taxation. In January 1998, the IRS issued revenue ruling 98-8 to attempt to stop such a transaction.

The IRS presents two scenarios. The surviving spouse purchases the remainder interest in the QTIP trust in return for a promissory note. Since the surviving spouse now owns both the income and remainder interest of the trust, state law causes the trust to cease to exist and the assets to be distributed to the spouse. After the assets are distributed to the spouse, the note to the remaindermen is repaid. The revenue ruling also addresses the scenario where the surviving spouse would use separate assets to purchase the remainder interest. In either case, the IRS believes the surviving spouse has made a gift to the remaindermen.

Until recently, it appeared that the IRS would look to argue based upon either IRC section 2519 or 2702. This revenue ruling is interesting both in terms of what the IRS argued and what it did not address. Specifically, the IRS stated that section 2519 should be viewed to "apply broadly to circumstances in which the surviving spouse's right to receive the income is relinquished or otherwise terminated, by whatever means." The IRS goes on to define a commutation transaction by saying "a proportionate division of trust property between the life beneficiary and remainderman based on the respective values of their interests is, in the context of a QTIP trust, a taxable disposition by the spouse of the qualifying income interest, resulting in a gift under section 2519 of the value of the remainder interest." Treasury regulation section 25.2519-1(g), Example 2 and then section 25.2510- l(f) says "the sale of qualified terminal interest property, followed by the payment to the donee-spouse of a portion of the proceeds equal to the value of the donee-spouse's income interest, is considered a disposition of the qualifying income interest." The IRS, therefore, has apparently taken the position that section 2702 is either a weaker or incorrect position. Finally, the IRS has not taken the worst position for the taxpayer, i.e., to retrospectively disregard the marital deduction. Since the gift tax is tax-exclusive and the estate tax is tax-inclusive, it is relatively cheaper to make an inter vivos rather than a testamentary transfer.

While the analysis indicated above appears correct, the revenue ruling then proceeds to make a highly questionable statement that is the basis of its position. "There is little distinction between the sale and commutation transactions treated as dispositions in the regulations and the transactions presented here, where S [the surviving spouse] acquired the remainder interest." Unfortunately for the IRS, their analysis appears flawed. In a sale of an income interest, the surviving spouse liquidates her property interest in the QTIP trust. Commutation transactions forcibly liquidate a trust based upon proportionate ownership. In either case, in full or on a percentage basis, a surviving spouse's relationship to the decedent's property has come to an end. The purchase of a remainder interest does not do this. Rather, it strengthens the relationship of the surviving spouse with the decedent's property. Now the ownership is outright. The unlimited marital deduction, albeit a tax-deferral device, appears more logical.

Alternatively, the IRS argues under section 2044 that the courts have recognized "as gifts, transfers that are not made for 'adequate and full (money) consideration'" and "aims to reach those transfers which are withdrawn from the donor's estate." Using a case from the 1940s, they state that the lack of a payment of "adequate and full consideration" regarding marital rights leads to the logical conclusion that a gift was given. Although courts in the 1990s [most specifically Wheeler v. United States (80 AFTR2d 97-5075, 97-2 USTC P 60278), and Estate of Rose D'Ambrosio (78 AFTR2d 96-7347, 101 F3d 309, 1996)] have started to uphold purchases of property for actuarial value as meeting the "adequate and full (money) consideration" test, they are pre-section 2702 cases. The courts have said that on an average life basis with market rates of return, neither party is placed into a financially weaker position. Furthermore, such transactions are often made by totally independent parties. Therefore, the IRS's causal-link analysis fails.

After establishing that the IRS's position appears incorrect, what should taxpayers do? Should one take a contrary position? If so, does one need to disclose such a position? More basically, does the requirement of disclosure apply to taxes other than income taxes? While answers to these questions are outside the scope of this article, mention of LRC Sec-2702 is required. While case history is silent because relevant cases relate to issues prior to the enactment of section 2702, the key issue is whether the purchase of a remainder interest is considered a transfer of an interest in trust. If the answer is that a transfer of an interest has been made, then the purchase of a remainder interest transaction will only work to the extent that the QTIP is funded with a primary or secondary house, like if a house grantor retained interest trust (GRIT) otherwise known as a qualified personal residence trust (QPRT) was established under section 2702(a)(3)(A)(ii).

It is hoped that this discussion will gently direct discussion of this important tax planning technique and lead to further development in the dialogue among professionals. *


By Richard B. Covey, Esq.

Reviewed by Nicole S. Splitter, United States Trust Company of New York

United States Trust Company of New York has published an updated version of Marital Deduction and Credit Shelter Dispositions and the Use of Formula Provisions, the definitive work on these important estate planning concepts by Richard Covey, Esq., nationally known estate planner and author of Practical Drafting. This first comprehensive revision of the book reflects all estate tax law changes and developments impacting marital deduction and credit shelter dispositions in the last 13 years, including those made by the Taxpayer Relief Act of 1997.

The book not only explains the interaction of credit shelter and marital deduction bequests, as well as the application of basic types of formula provisions, but also outlines the principals behind pecuniary and fractional credit shelter and marital deduction dispositions, comparing their respective benefits and drawbacks. In addition, a full chapter is devoted to the use of hybrid formulas, with other chapters of the book covering analyses of the effect on the marital deduction and credit shelter dispositions of state death taxes and the exercise of various tax elections.

The book also includes a separate chapter on estate planning, covering, among other concepts, the prior transfer tax credit, lifetime planning and transfers between spouses, qualified plan benefits planning, chapter 13 transfers, planning for state death taxes, and planning for smaller estates where outright dispositions to the spouse are desired.

Lastly, Appendix A provides several easy-to-use forms with sample causes for drafting credit shelter and marital deduction pecuniary amount bequests, preresiduary QTIP trusts, and division of the residuary estate into credit shelter and marital deduction shares. Appendix B provides a state-by-state analysis of the proper allocation of income between credit shelter and marital deduction dispositions.

Marital Deduction and Credit Shelter Dispositions and the Use of Formula Provisions can be purchased through United States Trust Company of New York for $125.00. *


By Lawrence M. Lipoff

Between the time "Reapplying The Estate of Lucille P. Shelfer v. Commissioner" was authored and published in the April 1998 issue of The CPA Journal in this column, the Treasury Department amended a proposed regulation. While the change will not affect the main point of the article--creative planning opportunities with QTIP trusts as a pension beneficiary--the first paragraph requires updating.

Specifically, proposed regulation 1.401 (a)(9)-1, Q&A D-5 now allows an irrevocable trust or one that would become irrevocable upon the death of the participant to be a pension beneficiary. Formerly, as stated in my article, a trust must have been irrevocable at the earlier of the participant's required beginning date or the participant's death. *

Eric M. Kramer, JD, CPA
Farrell, Fritz, Caemmerer, Cleary, Barnosky & Armentano, P.C.

Alan D. Kahn, CPA
The AJK Financial Group

Contributing Editors:
Richard H. Sonet, JD, CPA
Marks Shron & Company LLP

Frank G. Colella, LLM, CPA
Own Account

Jerome Landau, JD, CPA

James B. McEvoy, CPA
The Chase Manhattan Bank

Nathan H. Szerlip, CPA
Edward Isaacs & Company LLP

Lenore J. Jones, CPA
Jacobs Evall & Blumenfeld LLP

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

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