Significant Recent Developments in Estate Planning (Part II)

By Justin Ransome, J.D., MBA, CPA, and Frances Schafer, J.D.




  • In Linton, the Ninth Circuit reversed the Tax Court and held that the step-transaction doctrine did not apply to a case involving a gift of LLC interests made by parents to their children’s trusts.
  • A district court ruled on the effect of a failure to make a qualified disclaimer of a remainder interest in a qualified personal residence trust. The Fifth Circuit determined the effect of a failure to disclaim all of a person’s interest in property.
  • In Notice 2011-37, the IRS provided that trusts and estates are not required to unbundle fiduciary fees (to determine whether they are deductible under Sec. 67(a) or Sec. 67(e)(1)) until final regulations on the subject are published.

This article examines developments in estate, gift, and generation-skipping tax planning and compliance between June 2010 and May 2011. Part I, in the September issue, discussed estate tax reform and other estate tax developments. Part II covers gift tax, generation-skipping transfer (GST) tax, trust developments, and the annual inflation adjustments for 2011 relevant to estate and gift tax.

Gift Tax

Step-Transaction Doctrine

In recent years, the IRS has attempted to use the step-transaction doctrine to collapse the formation and funding of family limited partnerships (FLPs) or limited liability companies (LLCs) and the transfer of an interest in such entity when these transactions have taken place close together in time. The Tax Court in Holman 1 indicated for the first time (in a footnote) that it might entertain such an argument in certain cases. In a recent case, the Ninth Circuit overruled a district court’s decision to apply the step-transaction doctrine. 2

The step-transaction doctrine treats a series of formally separate steps as a single transaction if the steps are in substance integrated, interdependent, and aimed toward a particular result. The courts have generally followed one of three alternative tests in determining whether a series of transactions should be stepped together. Those tests are (1) the binding commitment test, (2) the end result test, and (3) the interdependence test.

The binding commitment test collapses a series of steps if at the time the first step is entered into there was a binding commitment to undertake a later step. The end result test looks to whether a series of formally separate steps are prearranged parts of a single transaction intended from the outset to reach the ultimate result. The interdependence test considers whether, based on a reasonable interpretation of the objective facts, the steps are so interdependent that the legal relations created by one transaction will be fruitless without a completion of the series of transactions.

In Linton , the Ninth Circuit reversed the district court’s decision granting the IRS’s motion for summary judgment on one issue and remanded the case back to the district court for further development on another issue. The taxpayers in Linton thought they were creating an LLC and then transferring interests in the LLC to their children’s trusts. In valuing the gifted LLC interests on their gift tax returns, they claimed a 47% discount for lack of control and lack of marketability. The IRS contended that the taxpayers had made gifts of the LLC interests prior to funding the LLC. Therefore, the transfer of assets to the LLC increased the value of the LLC interests previously transferred to the trusts, and the transfers of the assets to the LLC were indirect gifts of the assets themselves to the children’s trusts for which no discount was appropriate. The district court, in granting the IRS’s motions for summary judgment, concluded that the taxpayers made indirect gifts to the children’s trusts of the assets transferred to the LLC because they could not establish that the transactions took place in the order they claimed and, in the alternative, because the step-transaction doctrine applied.

On appeal, the Ninth Circuit addressed the requirements for a gift to become effective under the laws of the state of Washington. The court concluded that the date when the gift of the LLC interests occurred was the first date at which objective circumstances existed that would suggest the gift documents were meant to be operative. Because there was insufficient information in the record to make a conclusion about the timing of the gifts, the court remanded the case to the district court for further development of the facts related to this issue.

The district court also granted the government’s motion for summary judgment on grounds that the taxpayers had made indirect gifts under the step-transaction doctrine, even if the taxpayers could establish the proper sequence of events. The court, after examining the three tests of the step-transaction doctrine, determined that all the tests were met. The Ninth Circuit disagreed and concluded that none of the tests was met.

Regarding the binding commitment test, the Ninth Circuit determined that it applies only to transactions spanning several years, and the transactions in this case took place over no more than a few months. Regarding the end result test, the district court had focused on the taxpayers’ efforts to minimize their gift tax liability by structuring the transaction to use available discounts. The Ninth Circuit focused on the taxpayers’ desire to transfer LLC interests to their children without giving them management control over the LLC or ownership of the underlying assets.

Regarding the interdependence test, the district court had contended that the taxpayers would not have contributed assets to the LLC without the ability to claim the discounts for gift tax purposes. The Ninth Circuit concluded that transferring assets to an LLC is an ordinary and objectively reasonable business activity that makes sense with or without a subsequent gift of LLC interests. Because the Ninth Circuit concluded that none of the three tests was met, it reversed the district court’s holding that the taxpayers had made indirect gifts under the step-transaction doctrine.

Sec. 2703

In Fisher, 3 over a period of three years the taxpayers transferred to their children minority interests in an LLC that held undeveloped real estate on Lake Michigan. The issue before the district court was whether the value of the LLC interests should be determined without regard to any restriction on the right to sell or use the property under Sec. 2703(a).

Congress enacted Sec. 2703 to prevent the valuation of property for transfer tax purposes under agreements that artificially determine the value of property at less than its fair market value (FMV). Sec. 2703(a) provides that the value of property for transfer tax purposes is determined without regard to (1) any option, agreement, or other right to acquire or use property for a price less than its FMV or (2) any restrictions on the sale or use of the property.

Under Sec. 2703(b), Sec. 2703(a) does not apply to such an option, agreement, right, or restriction if:

  • The restriction is a bona fide business arrangement;
  • The restriction is not a device to transfer property to family members for less than full and adequate consideration; and
  • The restriction is comparable to similar arrangements entered into by persons in an arm’s-length transaction.

In determining whether a restriction constitutes a bona fide business arrangement, the district court looked to the standard applied by the Eighth Circuit in Holman. 4 The Eighth Circuit stated that maintenance of family ownership and control of a business may be a bona fide business purpose, but the restriction must foster active involvement in the business. A “mere asset container” is not sufficient to establish a business.

The district court determined that there was no evidence of any business activity with regard to an investment strategy concerning the active sale or development of the current property or, alternatively, the acquisition of additional property. It noted that the LLC sold a portion of the property but that the purchaser initiated the transaction and the sales proceeds were distributed to the LLC members. The court ruled that the taxpayers failed to establish that the LLC was a bona fide business, so the exception in Sec. 2703(b) was not applicable. As a result, the transfer restrictions applicable to the LLC interests were disregarded in valuing the gifts under Sec. 2703(a).


In a very unusual but interesting case, a district court allowed a taxpayer to rescind his disclaimer because it was not a qualified disclaimer under Sec. 2518. In Breakiron, 5 the taxpayer’s parents created two qualified personal residence trusts (QPRTs) for a period of 10 years by placing their undivided one-half interests in their personal residence in the trusts and naming themselves as the income recipients (i.e., the right to live in the home for 10 years) and their two children as the remaindermen. Upon the expiration of 10 years, the taxpayer and his sister would own the residence.

Approximately six months before the expiration of the 10-year term, the taxpayer decided that he wanted to transfer his interest in the residence to his sister. He consulted an attorney to determine the tax implications of the gift and was advised that if he executed qualified disclaimers (as that term is defined in Sec. 2518) within nine months of the expiration of the parents’ interests in the QPRTs, there would be no gift tax consequences of the transfers. The only problem was that the attorney was wrong. One of the requirements of executing a qualified disclaimer is that the disclaimer must be executed within nine months of “the date on which the transfer creating the interest in such person is made.” 6 The date creating the taxpayer’s interest (i.e., the remainder interests in the QPRTs) was the date on which the QPRT was funded—almost 10 years prior to the date the taxpayer executed the disclaimer.

The failure to execute a qualified disclaimer resulted in a $2.3 million gift tax liability, leading to the IRS placing a gift tax lien in that amount on the property. The taxpayer filed an action in a Massachusetts court to rescind the transfer of his interest in the residence to his sister, which was later removed to the district court.

The district court noted that it sat as a Massachusetts court applying Massachusetts law. Under Massachusetts law, a written instrument may be reformed or rescinded in equity on the grounds of mistake when there is full, clear, and decisive proof of mistake. The court also noted that the highest court of Massachusetts has recognized that a disclaimer may be reformed or rescinded if it was based on a mistake that frustrated the purpose for which the disclaimer was executed. After analysis of the taxpayer’s intent regarding the disclaimer, the court held that under Massachusetts law the taxpayer was entitled to rescind the disclaimers.

The district court next addressed the effect of the rescission on the taxpayer’s obligation to pay federal gift tax that attached to the transfer at the time the disclaimer was executed. The court noted that the various cases on the issue are divided. One line of cases holds that state law reformation of the original transfer does not abrogate federal tax liability, the rationale being that because neither party to the state law reformation proceeding has an interest in paying a federal tax liability on the transfer, reformation under state law may not be the product of a bona fide adversarial proceeding. This is especially true when the IRS is not a party to the state reformation proceeding to represent the federal government’s interest in collecting federal taxes.

The other line of cases holds that where the underlying transfer has been reformed by a state court due to mistake, such reformation does abrogate a party’s duty to pay federal taxes, the rationale being that the original transfer was defective ab initio because the original instrument contained a mistake. As a result, there was no completed gift because as long as the transferor has an equitable right of reformation under state law, the transferor has not “so departed with dominion and control as to leave him with no power to change its disposition.” 7

The district court determined that it was unnecessary to resolve this conflict because there was no issue regarding collusion, thus making the line of cases regarding the prejudice of the federal government’s tax rights inapposite. The court noted that it was a federal court, not a state court, that granted rescission of the disclaimers and that the IRS was a party to the proceeding. The court also noted that the IRS did not dispute that the taxpayer made a mistake when he executed the disclaimers. Finally, it noted that the IRS had an opportunity during the case to adduce evidence that the plaintiff’s execution of the disclaimers was something other than a mistake, and it did not do so. Accordingly, the court held that the rescission of the disclaimers was conclusive of the federal gift tax liability.

Observation: It is questionable whether the district court’s decision would be upheld on appeal given the gift tax ramifications of the court’s ruling. If the court’s ruling were the law of the land, when would there ever be a completed gift for gift tax purposes where laws of other states were similar to Massachusetts law on the subject? Not at death, because that would then make it an estate tax issue (which is more costly than if it were a gift tax issue since the gift tax is tax exclusive and the estate tax is tax inclusive). What about when the statute of limitation runs out? The value of a transfer is subject to gift tax when the gift is complete. If the IRS ever took the position of this court, it would wreak havoc on taxpayers and their advisers because there would be no certainty as to the gift tax consequences of a transfer until the gift was considered complete.

The Estate of Tatum 8 case highlights another gift tax consequence of the failure to disclaim all of one’s interest in property. The decedent was entitled to a 60% interest in the residue of the property in his father’s estate. The father’s will provided that if the decedent should predecease the father, his descendants would take the share of the deceased ancestor. The decedent disclaimed his interest in certain stock held in the father’s estate. The probate court determined that the disclaimed property would pass to the decedent’s children as if the decedent had predeceased his father. After the decedent’s death, the IRS issued a notice of deficiency claiming that the disclaimer was not a qualified disclaimer and that the decedent had made gifts to his children of the property that he purported to disclaim.

The district court examined whether the applicable local law would provide that the alternate disposition set forth in the will would apply regardless of whether the decedent actually died before his father or merely disclaimed his interest. Subsequent to the time the disclaimer was executed, the state enacted legislation to specifically provide that a disclaimed interest passes as if the disclaimant had predeceased the decedent. However, based on the state of the law at the time the disclaimer was executed, the court determined that the alternative disposition applied only if the decedent actually died before his father. The disclaimed property therefore passed to the decedent by intestacy. Since the decedent did not disclaim any intestate interest he may have had in the stock, he was treated as having made a gift of the stock to his children.

The taxpayer, however, was saved by the Fifth Circuit on appeal. 9 The Fifth Circuit took note of the state law anti-lapse statute providing that when the deceased beneficiary is a child of the testator, the bequest does not lapse but passes as if the legatee had survived the testator and then died intestate. Thus, if the disclaimer resulted in a lapsed bequest, the interest would pass to the taxpayer’s children under the anti-lapse statute without any direction on the taxpayer’s part. In addition, the court concluded that the clear intent of the father’s will was that the property would go to the taxpayer’s children if it did not go to the taxpayer. Because it ruled that the property disclaimed by the taxpayer passed without direction on the taxpayer’s part and that the property did not fall into intestacy, the court determined that the taxpayer’s disclaimer was a qualified disclaimer. The court therefore ordered a refund of the gift taxes and penalties paid to the IRS.

Observation: While it eventually worked out for this taxpayer, it took a trip to the Fifth Circuit to achieve a favorable answer. It would have been much better for the original disclaimer to include all possible interests that an individual may have in property to ensure the disclaimer was a qualified disclaimer and avoid any IRS challenges.

QTIP Election

For a qualified terminable interest property (QTIP) transfer made during life, a QTIP election must be made on the gift tax return for the calendar year in which the interest is transferred. Sec. 2523(f)(4)(A) provides that the QTIP election shall be made on or before the date prescribed by Sec. 6075(b) for filing a gift tax return for the transfer. The IRS has the authority to provide taxpayers relief by granting extensions of time to make certain elections under Regs. Sec. 301.9100-3(a) (9100 relief), provided the due date for making the election is prescribed by regulations rather than by statute.

The IRS has always taken the position that the deadline for making the gift tax QTIP election is statutory, and therefore 9100 relief is not available for such an election. In Letter Ruling 201025021, 10 the IRS granted an extension of time to make a QTIP election for an inter vivos transfer to the trust. The letter ruling, however, was subsequently revoked in Letter Ruling 201109012 11 retroactively to the date of its issuance.

QTIP Termination

In Letter Ruling 201024008, 12 the IRS addressed the tax consequences of the termination of a QTIP trust during the life of the surviving spouse. Because a QTIP election was made on the wife’s estate tax return, an estate tax marital deduction was allowed for the property passing to the trust, and the value of the trust assets was includible in the surviving spouse’s gross estate under Sec. 2044. Inclusion in the transfer tax base of the surviving spouse is the quid pro quo for allowing the marital deduction to the estate of the first spouse to die.

Sometimes the surviving spouse wants to terminate the QTIP trust during his or her lifetime by giving away the income interest. In that situation, the value of the income interest is subject to gift tax under Sec. 2511. In addition, Sec. 2519 provides that the surviving spouse is considered to make a gift of the remainder interest in the property. Sec. 2207A authorizes the surviving spouse to recover from the person who receives the remainder interest in the trust the amount of gift tax attributable to the deemed transfer of the remainder interest.

In some situations, the surviving spouse may want to give away only part of his or her income interest in the trust. In order to avoid having the full value of the remainder interest subject to gift tax even though only part of the income interest is given away, the trust is usually divided first. One trust is then collapsed with the surviving spouse treated as making gifts of the income interest and the remainder interest in that trust, while the other trust continues on with the surviving spouse receiving the income interest for life.

In Letter Ruling 201024008, the husband had a different way of approaching the split. From what can be gathered by reading the ruling, apparently he wanted to monetize his income interest by taking some assets out of the trust. The husband and the decedent’s children, who were the remainder beneficiaries of the trust, petitioned the court to authorize splitting the trust into two, with trust 1 to be funded with the actuarial present value of the husband’s income interest and trust 2 to be funded with the rest of the property. The husband and the children agreed that the husband’s gift of his qualifying income interest will be net of federal gift tax and that he will exercise his right of recovery under Sec. 2207A(b) to recover the gift tax attributable to the gift of the remainder interest under Sec. 2519. A set amount will be distributed from trust 1 to the husband, and the remainder, net of gift tax, will be distributed to the children’s trusts. The assets in trust 2 will be distributed, net of gift tax, to the children’s trusts.

The IRS concluded that under Sec. 2511 the husband is making a net gift of his qualifying income interest less the value of the assets he retained, and under Sec. 2519 he is treated as making a net gift of the remainder interest in the trust.

Observation: It is unclear why the trust needed to split into two since both of the new trusts were going to terminate. Nevertheless, this ruling presents the option of allowing the surviving spouse to receive assets currently equal to the present value of his or her income interest, rather than having to wait to receive the income over time.

Gifts from Foreign Persons

The United States imposes a gift tax on the donor for the lifetime transfer of property by gift. U.S. citizens and non-U.S. citizens domiciled in the United States (U.S. persons) are subject to U.S. gift tax on gifts of real property and tangible and intangible personal property made anywhere in the world. Non-U.S. citizens not domiciled in the United States (non-domiciliaries) are subject to gift tax on gifts of real property and tangible personal property situated (i.e., physically located) in the United States at the time of the gift. Examples of tangible property situated in the United States include cars and cash located in the United States. U.S. stocks and bonds are intangible assets and are therefore not subject to the gift tax for a non-domiciliary.

Letter Ruling 201032021 13 highlights the application of U.S. gift tax to transfers of foreign stock by a non-domiciliary. In the letter ruling, the non-domiciliary transferred a remainder interest in stock in a foreign holding company to her descendants, some of whom were U.S. citizens and some of whom were U.S. domiciliaries. The non-domiciliary retained the income interest in the foreign stock. Upon the death of the non-domiciliary, the income interest in the foreign stock will expire, and the descendants will obtain full ownership of the stock. The descendants who were U.S. persons requested rulings regarding (1) the income interest held by the non-domiciliary, (2) the U.S. gift and GST tax consequences of the transfer, and (3) the informational returns that the U.S. persons would be required to file.

The IRS analyzed whether the arrangement creating an income interest and a remainder interest in the foreign stock was a trust for U.S. tax purposes and whether the non-domiciliary was, in effect, a trustee of the trust. The IRS ruled that because the non-domiciliary was neither a guardian nor a trustee for the benefit of the remainder beneficiaries but rather held the income interest for her own benefit, a trust was not established for U.S. tax purposes. It further ruled that the non-domiciliary’s income interest in the foreign stock should be treated as that of a life tenant in a common law state.

As to the U.S. gift tax consequences of the transfer of the remainder interest in the foreign stock, the IRS noted that the non-domiciliary was not a U.S. citizen or domiciled in the United States. It further noted that the foreign stock was intangible property issued by a foreign corporation. Therefore, the transfer of the remainder interest in the foreign stock was not subject to U.S. gift tax. The IRS explained that a transfer is subject to GST tax only to the extent it is subject to gift or estate tax. Since the IRS ruled that the transfer of the income interest in the foreign stock was not a transfer subject to U.S. gift tax, it also ruled that the transfer was not subject to GST tax.

Regarding the reporting requirements for U.S. persons who receive property by gift from a non-domiciliary, the IRS noted that under Sec. 6039F, as interpreted by Notice 97-34, 14 if the value of the aggregated foreign gifts received by a U.S. person during any tax year exceeds $100,000, that person must report the receipt of the foreign gifts on Part IV of Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. Given the value of the remainder interests in the foreign stock transferred to the U.S. persons, the IRS ruled that such persons would be required to file Form 3520 to report the gifts of these interests.


In Letter Ruling 201118003, 15 the IRS addressed the GST tax consequences arising with respect to two trusts. The trusts provided that upon the settlor’s death, all the net income will be distributed annually in equal shares to the settlor’s five children. Upon the death of any child, that child’s share of the income will be distributed to that child’s children per stirpes. No principal may be distributed from either trust until the trust terminates. Upon termination of each trust, the remaining assets will be distributed per stirpes to the settlor’s grandchildren. No GST exemption was allocated to the transfers to either trust at the time of the settlor’s death. At the time the ruling request was submitted, two of the settlor’s children were deceased.

Sec. 2654(b) provides that substantially separate and independent shares of different beneficiaries in a trust are treated as separate trusts for purposes of the GST tax. Regs. Sec. 26.2654-1(a)(1) provides that the phrase “substantially separate and independent shares” generally has the same meaning as provided under the Sec. 663(c) regulations. However, a portion of a trust is not a separate share unless that share exists from and at all times after the creation of the trust.

Under the facts of ruling request submission, all the income must be distributed currently to the appropriate beneficiaries, and no distributions of principal are permitted during the term of the trust. Upon the death of a child, that child’s share passes to the child’s children. The IRS concluded that each trust consists of five separate shares, one for the benefit of each of the settlor’s children and their children. As a result, at the death of a child there is a taxable termination with respect to that child’s share, and GST tax is due to be paid from the trust share.


Deduction for Fiduciary Fees

The IRS has issued new guidance 16 that again extends the interim guidance on fiduciary fees originally provided in Notice 2008-32 and extended in Notice 2008-116 and Notice 2010-32. 17 The IRS initially issued Notice 2008-32 in anticipation of issuing final regulations to settle questions raised in Knight 18 regarding the unbundling of fiduciary fees by trusts and estates. Notice 2008-32 provided that trusts and estates would not be required to determine the portion of unbundled fiduciary fees for any tax year beginning before January 1, 2008. Notice 2011-37 extends the guidance for any tax year beginning before the date the IRS publishes final regulations, thus alleviating the need for the IRS to continually release additional notices extending this guidance.

Sec. 212 allows individuals to take a deduction for expenses incurred in connection with property held for investment. Sec. 67(a) limits this deduction (along with other miscellaneous deductions) to 2% of adjusted gross income (AGI). Sec. 67(e)(1) provides that the AGI of a trust or an estate is to be computed in the same manner as an individual except that deductions that are paid or incurred in connection with the administration of the trust or estate, and that would not have been incurred if the property were not held in the trust or estate, shall be treated as allowable in arriving at AGI (i.e., deductible above the line).

In Knight , the Supreme Court settled a split among the circuit courts of appeals and put to rest the issue of whether investment advisory fees are fully deductible under Sec. 67(e) or are instead deductible under Sec. 67(a), making them subject to the 2% AGI floor. The Court ruled that investment advisory fees were not “uncommon (or unusual, or unlikely)” for a hypothetical individual to incur. Therefore, it ruled that the second requirement of Sec. 67(e)(1) (requiring that the expense “would not have been incurred if the property were not held in the trust”) had not been met.

The IRS issued proposed regulations in September 2011 (REG-128224-06) (replacing proposed regulations it had issued in 2007) intended to reflect the Knight decision regarding the determination of whether a “cost” paid or incurred in connection with the administration of an estate or nongrantor trust is deductible as a cost that would not have been incurred if the property were not held in such estate or trust. If a cost is commonly or customarily incurred by a hypothetical individual holding the same property, it will not meet the requirement in Sec. 67(e)(1). Therefore, such cost will be subject to the 2%-of-AGI floor.

The regulations state that in order to analyze whether a cost would “commonly” or “customarily” be incurred by a hypothetical individual, the focus is on the type of product or service, not the description. In addition to this general analysis, the regulations specifically address ownership costs, tax preparation fees, and investment advisory fees.

In addition, the proposed regulations provide guidance on bundled fees. If an estate or a grantor trust pays a single fee, commission, or other expense for both costs that are subject to the 2%-of-AGI floor and those that are not, the fee must be allocated between such costs. Any reasonable method may be used to make such an allocation. An exception is made for a bundled fee that is not computed on an hourly basis. Only the fee that that is attributable to investment advice is subject to the 2%-of-AGI floor. The exception does not apply to (1) payments made to a third party out of the bundled fee that would have been subject to the 2% floor if paid directly by the trust or estate and (2) separately assessed expenses (in addition to usual or basic fees or commissions) that are commonly or customarily incurred by an individual.

The new proposed regulations will be effective for tax years beginning on or after their publication as final regulations. Because Notice 2011-37 applies until regulations on bundled fees are finalized, trusts and estates are not currently required to unbundle fiduciary fees under the rules set out in the proposed regulations.

Unused Loss Carryovers

Chief Counsel Advice (CCA) 201047021 19 concluded that the remainder beneficiaries of an estate were not entitled to the estate’s capital loss carryover under Sec. 642(h)(1) because the estate had assigned all its assets to the United States as part of a settlement of the decedent’s federal income tax liability.

Sec. 642(h)(1) provides that the beneficiaries succeeding to the property of an estate upon its termination are allowed to deduct the estate’s net operating loss carryover under Sec. 172 and the estate’s capital loss carryover under Sec. 1212. In this situation, the estate had a capital loss carryover on its final return that it planned to distribute to the named beneficiaries of the estate. The estate had no assets to distribute to these beneficiaries because it was forced to assign all its assets (less outstanding administrative expenses) to the United States to satisfy the decedent’s liability for unpaid income taxes that had accumulated for several years prior to the decedent’s death.

The IRS concluded that the residual beneficiaries of the estate were not entitled to the estate’s capital loss carryover because they were no longer entitled to receive anything from the estate after the assignment, and it cited Regs. Sec. 1.642(h)-3(a) as support for this conclusion. That section provides that the phrase “beneficiaries succeeding to the property of the estate” means those beneficiaries who upon termination of the estate bear the burden of any loss for which a carryover is allowed under Sec. 642(h). The IRS claimed that because of the assignment, the beneficiaries could no longer receive anything from the estate and were no longer beneficiaries of the estate.

In the example in Regs. Sec. 1.642(h)-4, the decedent’s will leaves $100,000 to A and the residue of his estate equally to B and C . His estate is sufficient to pay only $90,000 to A and nothing to B and C . There is a $5,000 excess of deductions over gross income for the last tax year of the estate and a capital loss carryover of $15,000, both of which are covered by Sec. 642(h). A is a beneficiary succeeding to the property of the estate to the extent of $10,000, and since the total of the excess of deductions and the loss carryover is $20,000, A is entitled to the benefit of one-half of each item, and the remaining half is divided equally between B and C .

The IRS claimed that the case it was ruling on was different from the one in the example in which beneficiaries receive a loss carryover despite not receiving any property, because those beneficiaries had the potential to receive property if the estate had sufficient funds. In the present case, the IRS determined that, as a legal matter, the individual beneficiaries could no longer receive anything.

Observation: The IRS’s decision here seems hard to square with the example in Regs. Sec. 1.642(h)-4. If the estate’s property had been worth more, the estate could potentially have satisfied the decedent’s income tax problem and made distributions to the estate beneficiaries. Therefore, it seems that the beneficiaries should be entitled to the capital loss carryover, just as the ones in the example were so entitled.

Ascertainable Standard

In Letter Ruling 201039003, 20 the IRS addressed whether a distribution standard in a trust agreement was an ascertainable standard. The trust agreement provided the trustees with authority to distribute principal to income beneficiaries in order to provide for their “reasonable care, maintenance, or proper education, or on account of any illnesses, infirmity or other like emergency” affecting them. Two income beneficiaries were co-trustees of the trust along with a bank. The co-trustees petitioned the local court to modify the trust and to divide it into separate trusts, one for each beneficiary. One of the requested modifications was to change the standard for principal distributions to eliminate “other like emergency.” The new standard would permit the distribution of principal for “education, including college and professional education, and medical, dental, hospital and nursing expenses and expenses of invalidism.” The question was whether the “other like emergency” language created a general power of appointment in the beneficiaries, who were also the trustees, so upon the elimination of that language as part of the court’s modification of the trust agreement, the beneficiaries released a general power of appointment that would be subject to gift tax under Sec. 2514(b).

Sec. 2514(b) provides that the exercise or release of a general power of appointment created after October 21, 1942, is treated as a transfer of property by the individual possessing the power. Under Sec. 2514(c), a general power of appointment is a power that is exercisable in favor of the individual possessing the power, his or her estate, his or her creditors, or the creditors of his or her estate. However, a power to consume, invade, or appropriate property for the benefit of the possessor that is limited by an ascertainable standard relating to the possessor’s health, education, support, or maintenance is not deemed to be a general power of appointment.

The IRS attempted to determine whether under applicable local law the standard of “other like emergency” would be an ascertainable standard relating to health, education, support, or maintenance. Eventually the ruling applies case law to conclude that the use of the words “other like” limits the meaning of “emergency” to the type of emergency itemized before the word “other,” and therefore the entire standard for principal distribution is an ascertainable standard. As a result, the beneficiaries who were co-trustees did not have a general power of appointment that was released upon the court-approved modification of the standard.

Observation: The ultimate answer the beneficiaries received was favorable, but why invite uncertainty? Regs. Sec. 20.2041-1(c)(2) provides examples of standards that meet the requirement of being an ascertainable standard, such as “support in reasonable comfort,” “maintenance in health and reasonable comfort,” “support in his accustomed manner of living,” “education, including college and professional education,” and “medical, dental, hospital and nursing expenses and expenses of invalidism.” When drafting trust agreements, practitioners should limit the powers of the trustee to the standards that have been approved and not try to include extraneous provisions that could cause uncertainty as to whether the standard is ascertainable.

Charitable Deduction

A trust is allowed a deduction under Sec. 642(c) for any amount of gross income, without limitation, that under the terms of the governing instrument is, during the tax year, paid for a charitable purpose. In CCA 201042023, 21 the IRS concluded that a trust’s charitable deduction for property contributed to charity is limited to the trust’s adjusted basis in the property that had been purchased from the trust’s gross income.

In this case, the trust had used its gross income to purchase three properties, which it subsequently gave to charity. The properties had appreciated in value since their purchase. The trust wanted a deduction equal to the current FMVs of the properties. Previous court decisions have held that it is not necessary for a charitable contribution to be made from the current year’s gross income as long as the contribution can be traced to gross income earned in the past. The amount of gross income imbedded in the properties contributed to charity equaled the trust’s adjusted basis in the properties purchased with gross income, so this was the amount of the trust’s charitable deduction.

Annual Inflation Adjustments

Rev. Proc. 2010-40 22 sets forth inflation adjustments for various tax items for 2011. The following is a list of items that may be of interest to individual taxpayers:

  • The gift tax annual exclusion for gifts of a present interest is $13,000 (same as 2010).
  • The gift tax annual exclusion for gifts of a present interest to a spouse who is not a U.S. citizen is $136,000 (up from $134,000 in 2010).
  • The ceiling on special-use valuation in Sec. 2032A is $1,020,000 (up from $1 million in 2010).
  • For an estate of a decedent dying in 2010, the dollar amount used to determine the 2% portion (for purposes of calculating interest under Sec. 6601(j)) of the estate tax extended as provided in Sec. 6166 is $1,360,000 (up from $1,340,000 in 2010).



1 Holman, 130 T.C. 170 (2008).

2 Linton, 630 F.3d 1211 (9th Cir. 2011).

3 Fisher, No. 1:08-cv-00908 (S.D. Ind. 2010). In an earlier decision dated March 11, 2010, the district court ruled that gifts of the LLC interests were not gifts of a present interest and therefore were not excluded by the gift tax annual exclusion.

4 Holman, 601 F.3d 763 (8th Cir. 2010), aff’g 130 T.C. 170 (2008).

5 Breakiron v. Gudonis, No. 1:09-cv-10427 (D. Mass. 8/10/10).

6 See Sec. 2518(b)(2)(A).

7 See Regs. Sec. 25.2511-2(b).

8 Estate of Tatum, No. 2:09-cv-00048-KS-MTP (S.D. Miss. 10/6/10).

9 Tatum, No. 10-60852 (5th Cir. 8/8/11).

10 IRS Letter Ruling 201025021 (6/25/10).

11 IRS Letter Ruling 201109012 (3/4/11).

12 IRS Letter Ruling 201024008 (6/18/10).

13 IRS Letter Ruling 201032021 (8/13/10).

14 Notice 97-34, 1997-1 C.B. 422.

15 IRS Letter Ruling 201118003 (5/6/11).

16 Notice 2011-37, 2011-20 I.R.B. 785.

17 Notice 2008-32, 2008-1 C.B. 593; Notice 2008-116, 2008-2 C.B. 1372; and Notice 2010-32, 2010-1 C.B. 594.

18 Knight, 552 U.S. 181 (2008).

19 CCA 201047021 (11/26/10).

20 IRS Letter Ruling 201039003 (10/1/10).

21 CCA 201042023 (10/22/10).

22 Rev. Proc. 2010-40, 2010-46 I.R.B. 663.


Editor Notes

Justin Ransome is a partner and Frances Schafer is execu­tive director in the National Tax Office of Grant Thornton LLP in Washington, DC. For more information about this article, contact Mr. Ransome at or Ms. Schafer at

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