Prop. Regs. Address Application of Secs. 2036 and 2039 to Certain Annuities

By Alistair M. Nevius, J.D.

Sec. 2036 provides for the inclusion in a decedent’s estate of certain transfers the decedent made during his or her lifetime in which the decedent retained certain rights in the property. Sec. 2039 provides for the inclusion in a decedent’s estate of the value of any annuity receivable by a beneficiary by reason of surviving the decedent if such annuity was payable to the decedent. These provisions may overlap in the case of certain tax planning techniques a decedent executed during his or her lifetime that were still in place at the time of the decedent’s death. The determination of value for estate tax purposes can vary significantly depending on whether a decedent’s estate applies Sec. 2036 or Sec. 2039 in these cases. The IRS has issued proposed regulations under Secs. 2036 and 2039 to provide for the uniform application of Sec. 2036 in these cases (REG-119097-05 (6/6/07)).

The proposed regulations provide that, if a decedent transfers property during life to a trust and retains the right to an annuity, unitrust, or other income payment from, or retains the use of an asset in, the trust for the decedent’s life, the decedent has retained the right to income from all or a specific portion of the property under Sec. 2036. These transfers involve transfers to a charitable remainder trust (CRT) or a grantor retained (annuity/unitrust/income) trust (GRT). The portion of the trust corpus includible in the decedent’s gross estate is that portion of the trust corpus, valued as of the decedent’s death, necessary to yield that annual payment using the appropriate Sec. 7520 interest rate. The proposed regulations provide both rules and ex-amples for calculating the amount of the trust to be included in a decedent’s gross estate under Sec. 2036 in such a case.

The IRS acknowledges that while both Sec. 2036 and Sec. 2039 may be applicable to a CRT or GRT, it believes it is appropriate to provide a regulatory rule under which only one of these sections is to be applied in the future, in the interest of ensuring similar tax treatment for similarly situated taxpayers. The IRS gives two reasons for the choice of Sec. 2036. First, Sec. 2039 appears to have been intended to address annuities purchased by or on behalf of the decedent and annuities provided by the decedent’s employer. Second, the interests retained by grantors in a CRT or GRT are more similar to the interests addressed under Sec. 2036 than to those most clearly addressed under Sec. 2039.

The position taken by the IRS in these proposed regulations is taxpayer-favorable in that the application of Sec. 2036, in some cases, may result in a smaller amount of the trust’s assets being included in the estate of a decedent than would otherwise be includible under Sec. 2039. While the application of Sec. 2039 will generally result in the inclusion of the entire value of the trust in the decedent’s estate, the application of Sec. 2036 may result in an amount that is less than the entire value of the trust being included in the decedent’s estate. This position is contrary to the position the IRS had taken previously in prior rulings on the issue. See Letter Ruling (TAM) 200210009 (11/19/2001) and Letter Ruling 9345035 (8/13/1993).
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