Only with an understanding of the foregoing issues can one properly proceed to analyze the estate and gift tax consequences of transfers of property interests under plans of deferred compensation.
IRC §2039(a) is the operative statute taxing annuities or other payments (other than life insurance) under a plan or contract which are receivable by a beneficiary “by reason of surviving the decedent” if the amounts were payable to the decedent during life or the decedent possessed the right to receive the payment either for his life or for any period not ascertainable without reference to death. IRC §2039 deserves a careful reading. It was designed to apply where other estate tax sections of the IRC (particularly §§2036, 2037, 2038, and 2041) would not apply.
§2039(b) limits inclusion under §2039(a) to the decedent’s proportionate contribution toward the purchase of the benefit. For this purpose a contribution by the “decedent’s employer” is considered as being made by the decedent, “if made by reason of his employment.”
IRC §2039(c)-(e), as variously designated and redesignated, formerly exempted from federal estate taxation in the participant’s estate benefits payable under a qualified plan or IRA, and also exempted from taxation in the nonparticipant spouse's estate, the spouse’s interest in the participant's qualified plan or IRA arising solely by virtue of the community property laws. Each of these exemptions were repealed over the course of the even number years from 1982-1986, subject, however to some important transition rules.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, generally repealed the unlimited exclusion applicable to participants in plans and IRAs, but retained an unwieldy estate tax exclusion for up to $100,000 in benefits. This awkward exception went the way of the old orphan’s deduction (which some of you will remember), and was repealed by The Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369.[1] Finally, the exception for the community property interest of the nonparticipant spouse was repealed by TRA ’86, Pub. L. No. 99-514 on the erroneous assumption (clearly stated in various Committee Reports and even in the Blue Book) that it was no longer necessary.
Sec. 245(a) of TEFRA, Pub. L. No. 97-248, added §2039(g), which limited the application of 2039(c) and (e) to $100,000. 2039(c) previously provided an unlimited estate tax exclusion for a participant’s interest in a qualified plan: 2039(e) had a similar exclusion for IRAs. This change was made effective “for estates of decedents dying after 12/31/82, except that such amendments shall not apply to the estate of any decedent who was a participant in any plan, who was in pay status on 12/31/82, and irrevocably elected before 1/1/83.”
Sec. 525(a) of DEFRA, Pub. L. No. 98-369, repealed §2039(c),(e) and (g) and redesignated (d) as (c), effectively revoking the estate tax exclusion for IRAs and qualified plans altogether, except for the community property interest of the nonparticipant spouse, which was retained as redesignated 2039(c) (it was formerly 2039(d)).
Sec. 1852(e)(1)(A) of the 1986 Tax Reform Act, Pub. L. No. 99-514, repealed §2039(c), which used to be 2039(d), and which, at the time of its repeal read, in part:
(c) Exception of certain annuity interests created by community
property laws.
“(1) In general. In the case of an employee on whose behalf contributions or payments were made by his employer or former employer under a trust, plan, or contract to which this subsection applies, if the spouse of such employee predeceases such employee, then notwithstanding any provision of law, there shall be excluded from the gross estate of such spouse the value of any interest of such spouse in such trust, plan, or contract, to the extent such interest –
“(A) is attributable to such contributions or payments, and
“(B) arises solely by reason of such spouse's interest in community income under the community property laws of a State. . . .”
This section was thought to no longer be necessary, but alas, its demise was premature. An extended discussion of this issue is found later in this treatise, where we explore the question of whether 2039 causes the nonparticipant’s community property interest in the participant’s qualified plan or IRA to be subject to estate tax in the first place, and if so, whether a marital deduction for it is allowable.
The bottom line, the path to which is explained below, is that if (1) the decedent was both a participant in the plan and in pay status on December 31, 1984, and the decedent irrevocably elected the form of the benefit before July 18, 1984, or (2) if the decedent separated from service before January 1, 1985, and did not change the form of benefit before death, then up to $100,000 of plan benefits may be excluded from the estate tax.
Further, if (3) the decedent was both a participant in the plan and in pay status on December 31, 1982, and the decedent irrevocably elected the form of the benefit before January 1, 1983, or (4) the decedent separated from service before January 1, 1983, and did not change the form of benefit before death, there is an unlimited exclusion from estate tax.[2]
The instructions to the Form 706 clearly imply that either test (1) or (2) must be met before moving on to test (3) or (4). This is an interesting way of putting it, and may be true as a matter of logic. If test (4) is met, then test (2) would automatically be met. So the only implication is that if test (3) is relied upon, then either test (1) or test (2) must also be met. The decedent will pass test (1) if still a participant on December 31, 1984. If the decedent was not still a participant on December 31, 1984, then presumably the decedent would have separated from service before January 1, 1985, thereby passing test (2), provided the form of benefit was not changed before death, which would be the case if test (3) was relied upon since the form of benefit had to be irrevocable. All this leads me to conclude, somewhat tentatively, that passing test (3) or (4) is sufficient without further analysis.
This is not an exercise I would have gone through if the instructions to the Form 706 did not make it seem that there could be a circumstance under which one could pass test (3) or (4) and yet fail (1) or (2), thus losing the exclusion. There may be, but I haven’t found it yet.
What is the source of these four tests? See the following.
TEFRA[3] §245 repealed the former unlimited estate tax exclusion and replaced it with a $100,000 exclusion. §245(c) provided that the change would apply to estates of decedents dying after December 31, 1982. DEFRA[4] §525 amended IRC §2039 once again, this time by striking out subsections (c),(d), (e),(f), and (g) and replacing them with new subsections (b) and (c), effective for estates of decedents dying after December 31, 1984. Among other things, the change eliminated the $100,000 estate tax exclusion. More specifically, DEFRA §525(b)(3) amended TEFRA 245(c) to provide that the TEFRA change to IRC §2039 would “not apply to the estate of any decedent who was a participant in any plan who was in pay status on December 31, 1982, and irrevocably elected before January 1, 1983, the form of benefit.” (Emphasis added.)
Employing rather convoluted verbiage, TRA ‘86[5] §1852(e)(3) amended DEFRA §525(b) to do away with both the “irrevocable election” and the “in pay status” requirements if the individual separated from service before January 1, 1983 and does not change the form of benefit before death. In summary, the present rule (after the three effective date amendments) is that if the individual separated from service prior to January 1, 1983, the individual can take advantage of the pre-TEFRA estate tax exclusion rules, as long as the individual does not change the form of benefit before death.
The pre-TRA ’86 DEFRA rule still applies, if the individual was in pay status on December 31, 1982, and irrevocably elected the form of benefit before January 1, 1983. There could be instances in which although the individual was in pay status the individual had not separated from service, in which case, the old rule might apply.
The DEFRA committee reports make it clear that the beneficiary designation need not be irrevocable.[6]
The TRA ‘86 committee reports state that the new law provides that the estate tax exclusion grandfather rule “is also available for individuals who separated from service . . . [before the applicable date], elected a form of benefits to be paid in the future, and who was [sic] not in pay status as of the applicable dates.”[7] It is a shame that words like “pay status” are used without benefit of definition.[8] In any event, the statute requires that, pay status or not, the form of benefit cannot be changed. This is not necessarily the same as “electing a form of benefits to be paid in the future.” What if the participant separated from service, but made no election? See Treas. Reg. §20.2039-1T (T.D. 8073, 1/29/86).
DEFRA §525(b) provided that the former $100,000 estate tax exclusion would continue to apply to plan participants who were in pay status on December 31, 1984 and who had made an irrevocable election by July 17, 1984 as to the form of such benefits. TRA ‘86[9] §1852(e)(3) amended DEFRA §525(b) to do away with both the “irrevocable election” and the “in pay status” requirements if the individual separated from service before January 1, 1985 and does not change the form of benefit before death.
Does a “plan” include an IRA? The DEFRA Committee Reports imply that the exception from estate tax can apply to an IRA.[10] Although an IRA is not generally thought of as a “plan,” Treas. Reg. §20.2039-1T (T.D. 8073, 1/29/86) makes it clear that an IRA can qualify for the exclusion under certain circumstances.
All four of the exceptions require either (1) that an irrevocable election have been in place or (2) that there be a separation from service. Applied to an IRA, that poses problems: Regarding the first condition, it would be a very unusual for an IRA election to have been irrevocable. As to the requirement of a separation from service, this simply has no context in which to operate, unless, perhaps the IRA is a SEP.
On the face of it, the TRA ‘86 changes ought to be applicable to IRAs, if the DEFRA changes were applicable to IRAs, and by publishing Treas. Reg. §20.2039-1T (T.D. 8073, 1/29/86) it would appear that the Service has admitted the latter. However, the TRA ‘86 Blue Book states that the TRA ‘86 change does not apply to IRAs.[11] The only thing in the amendment that could justify this distinction between the original DEFRA rule and the TRA ‘86 amendment to it, is the TRA ‘86 separation from service requirement, which requirement does seem somewhat out of place in the case of an IRA.
The pre-TEFRA IRC 2039 rules are applicable in any event. IRC §2039(e) required that in order for an IRA to be exempt from estate tax the IRA beneficiary must receive the benefit as an “annuity.” For this purpose, an annuity is defined as “an annuity contract or other arrangement providing for a series of substantially equal periodic payments to be made to a beneficiary (other than an executor) for his life or over a period extending for at least 36 months after the date of the decedent’s death.[12]
Under the old rules, if a lump sum distribution[13] was paid or payable with respect to a decedent under a plan described in Treas. Reg. §20.2039-2(b)(1) or (2), the unlimited estate tax exclusion was not available unless the recipient of the distribution made the §402(a)/403(a) taxation election described in Treas. Reg. §20.2039-3(d).[14] The election to forego special averaging in favor of the exclusion is made on the Form 709 or in a request for refund.[15]
The Treasury has published regulations (mentioned above) in the form of three questions and answers concerning the effective date exceptions to the TEFRA limitation of the estate tax exclusion to $100,000 and the DEFRA elimination of the exclusion.[16] The temporary regulations predate the TRA ‘86 changes. Since they are just about the only authority we have interpreting the DEFRA exclusions, the regulations are worth setting forth in detail.
Section 20.2039-1T. Limitations and repeal of estate tax
exclusion for qualified plans and individual retirement plans (IRAs)
(Temporary).
Q-1: Are there any exceptions to the general effective dates of the $100,000 limitation and the repeal of the estate tax exclusion for the value of interests under qualified plans and IRAs described in section 2039(c) and (e)?
A-1: (a) Yes. Section 245 of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) limited the estate tax exclusion to $100,000 for estates of decedents dying after December 31, 1982. Section 525 of the Tax Reform Act of 1984 (TRA of 1984) repealed the exclusion for estates of decedents dying after December 31, 1984.
(b) Section 525(b)(3) of the TRA of 1984 amended section 245 of TEFRA to provide that the $100,000 limitation on the exclusion for the value of a decedent’s interest in a plan or IRA will not apply to the estate of any decedent dying after December 31, 1982, to the extent that the decedent-participant was in pay status on December 31, 1982, with respect to such interest and irrevocably elected the form of benefit payable under the plan or IRA (including the form of any survivor benefits) with respect to such interest before January 1, 1983.
(c) Similarly, the TRA of 1984 provides that the repeal of the estate tax exclusion for the value of a decedent’s interest in a plan or IRA will not apply to the estate of a decedent dying after December 31, 1984, to the extent that the decedent-participant was in pay status on December 31, 1984, with respect to such interest and irrevocably elected the form of benefit payable under the plan or IRA (including the form of any survivor benefits) with respect to such interest before July 18, 1984.
Q-2: What is the meaning of “in pay status” on the applicable date?
A-2: A participant was in pay status on the applicable date with respect to a portion of his or her interest in a plan or IRA if such portion is to be paid in a benefit form that has been elected on or before such date and the participant has received, on or before such date, at least one payment under such benefit form.
Q-3: What is required for an election of the form of benefit payable under the plan to have been irrevocable as of any applicable date?
A-3: As of any applicable date, an election of the form of benefit payable under a plan is irrevocable if, as of such date, it was a written irrevocable election that, with respect to all payments to be received after such date, specified the form of distribution (e.g., lump sum, level dollar annuity, formula annuity) and the period over which the distribution would be made (e.g., single life, joint and survivor, term certain). An election is not irrevocable as of any applicable date if, on or after such date, the form or period of the distribution could be determined or altered by any person or persons. An election does not fail to be irrevocable as of an applicable date merely because the beneficiaries were not designated as of such date or could be changed after such date. If any interest in any IRA may not, by law or contract, be subject to an irrevocable election described in this section, any election of the form of benefit payable under the IRA does not satisfy the requirement that an irrevocable election have been made. [Reg. Section 20.2039-1T.] [Emphasis added.]
[T.D. 8073, 1-29-86]
§2039(a), by explicit provision, does not apply to insurance under policies on the life of the decedent. If a plan provides a life insurance death benefit, the provisions of §2042 should be consulted to determine if the proceeds are includable in the decedent's estate, which will be the case if the decedent possessed an incident of ownership in the policy.
Treas. Reg. §20.2039-1(a) states: "Section 2039(a) and (b), however, has no application to an amount which constitutes the proceeds of insurance under a policy on the decedent's life." Treas. Reg. §20.2039-1(d) also states: "If an annuity or other payment receivable by a beneficiary under a contract or agreement is in substance the proceeds of insurance under a policy on the life of a decedent, §2039(a) and (b) does not apply. For the extent to which such an annuity or other payment is includable in a decedent's gross estate, see §2042 and §20.2042-l." (Emphasis added.)
Treas. Reg. §20.2039-1(d) is explicit that if an annuity or other payment is life insurance, then subsections 2039(a) and (b) do not apply, and the estate taxation of the proceeds is to be determined under IRC §2042. However, in the case of a combination annuity contract and life insurance policy (e.g. "a retirement income policy with death benefits") the benefit may or may not be life insurance, depending on the relation between the reserve value of the policy to the value of the death benefit at death. If the combination annuity contract/life insurance policy matures during the decedent's lifetime, so that there is no longer an insurance element at death, IRC §2039 will apply. The regulation, however, provides, in part:
“On the other hand, the treatment of a combination annuity contract and life insurance policy on the decedent's life which did not mature during the decedent's lifetime depends upon the nature of the contract at the time of the decedent's death. The nature of the contract is generally determined by the relation of the reserve value of the policy to the value of the death benefit at the time of the decedent's death. If the decedent dies before the reserve value equals the death benefit, there is an insurance element under the contract. The contract is, therefore, considered, for estate tax purposes, to be an insurance policy subject to the provisions of section 2042. However, if the decedent dies after the reserve value equals the death benefit, there is no longer an insurance element under the contract.[17]“
The question of whether or not life insurance can escape estate taxation under IRC §2039 has assumed new significance since the estate tax exclusions formerly contained in IRC §2039 were repealed. An article on the subject, appearing in the July, 1983 issue of Estate Planning, has received a great deal of attention. See "I.R.S. Opens The Way Toward Favorable Estate And Income Tax Treatment of Planned Distributions," by Kenneth C. Eliasberg, Vol. 10, No. 4, Estate Planning. The theory advanced in the article is that the taxation of plan life insurance is governed by IRC §2042 and not IRC §2039. This point should be beyond cavil. However, in most cases the participant will have a §2042 incident of ownership, particularly if the participant is a principal owner of the employer.
If the benefit is in fact "insurance," as that term is used in IRC §2039(a), then the Service ought not to be able to use IRC §2039 as a basis for estate tax includability. Indeed, all indications are that the Service has never clearly taken a contrary position. However, Treas. Reg. §20.2039-1(d) suggests that the I.R.S. may have left itself some latitude in the determination of what insurance is and what it is not. If a benefit is "insurance" then, Treas. Reg. §1.2039-2(d), example (3); Rev. Rul. 67-371 and Rev. Rul. 82-199, are clear that the I.R.S. will look to IRC §2042 as the basis for estate tax includability.
The IRS takes the position that in applying §2039, separate contracts with the employer can be combined and treated as one. This is one way of taxing a death benefit only plan that, standing alone, might escape §2039.
The term “contract or agreement” includes any arrangement, understanding or plan, or any combination of arrangements, understandings or plans arising by reason of the decedent's employment.[18]
* * * *
Example (6). The employer made contributions to two different funds set up under two different plans. One plan was to provide the employee, upon his retirement at age 60, with an annuity for life, and the other plan was to provide the employee's designated beneficiary, upon the employee's death, with a similar annuity for life. Each plan was established at a different time and each plan was administered separately in every respect. Neither plan at any time met the requirements of section 401(a) (relating to qualified plans). The value of the designated beneficiary's annuity is includible in the employee's gross estate. All rights and benefits accruing to an employee and to others by reason of the employment (except rights and benefits accruing under certain plans meeting the requirements of section 401(a) (see §20.2039-2)) are considered together in determining whether or not section 2039(a) and (b) applies. The scope of section 2039(a) and (b) cannot be limited by indirection.[19]
The government has not always been successful in this technique. See below. Further, qualified and nonqualified plans are not to be combined.[20] Finally, not all nonqualified plans are combinable.[21]
A source of continuing controversy exists with respect to whether certain employer provided death benefits, particularly non-qualified death benefits, are described in IRC §2039(a), and if not, whether such benefits will thereby escape estate taxation altogether. (For instance, voluntary payments of employers are not included under IRC §2039(a).)[22] If IRC §2039(a) does not apply to an employer provided benefit, then the Service will have to rely on some other code section for taxability. IRC §2038 or IRC §2037 is the most likely basis for attack, in a non-insurance case; in the case of life insurance, IRC §2042 will usually apply.[23]
The Service's primary attack under §2039 is to consider the death benefit as being part of the interest that the decedent had in a plan or contract which contained other benefits in which the decedent had a lifetime interest. The problem for the Service is where the death benefit stands alone and the decedent didn't have a lifetime interest subject to transfer or gift. The courts tend to reject the notion of the decedent having made a gift at the moment of death, and the estate tax statutes, in order to apply where the decedent doesn't have an interest at death, generally require a prior transfer with a retention of an interest. Death benefit only plans just do not neatly fit any of the applicable transfer tax statutes.
The Service’s alternative argument that a DBO arrangement is a gift in the calendar quarter of death is set forth in Rev. Rul. 81-31.[24]
For two important cases on the subject see:
i. Estate of DiMarco, 87 T.C. No. 39 (1986), acq., 1990-2 C.B.1 (a gift tax case); and
ii. Estate of Schelberg, 612 F.2d 25 (2nd Cir. 1979) (an estate tax case).[25]
Both of these cases involved an IBM plan in which the decedent had no enforceable rights during lifetime, under which IBM gratuitously undertook to pay a survivor's benefit to the deceased employee's surviving spouse. In DiMarco it was held that the decedent did not make a gift, and in Schelberg it was held that the value of the survivor's benefits were not includable in the decedents estate.
DiMarco and Schelberg were obviously distinguishable because the decedents in those cases did not have a controlling interest in IBM. The IRS has acquiesced in the DiMarco case, and has revoked a Revenue Ruling that supported its pre-acquiescence position.[26]
In Estate Of Levin,[27] the Tax Court distinguished DiMarco[28] on the ground that the corporation offering the death benefit in DiMarco was not closely held. Since the corporation in Levin was closely held, the court held that there was a transfer, which was includible in the decedent’s estate under IRC §2038(a)(1), since the decedent had the power at his death to alter, amend, revoke, or terminate, by virtue of his control over the corporation.
Interestingly, the IRS has ruled in a Technical Advice Memorandum, PLR 8701003, that §2038 does not apply to a DBO Plan where the decedent had control of the company.[29]
The Service apparently thinks that the value of a spouse’s community property interest in a plan is includable in the spouse’s gross estate under §2039(a) if the spouse cannot dispose of the interest by testamentary disposition, but had a beneficial interest in the plan prior to death.[30]
However, even if §2039(a) would on its face cause inclusion, there is §2039(b) to consider:
“(b) Amount INCLUDABLE-Subsection (a) shall apply to only such part of the value of the annuity or other payment receivable under such contract or agreement as is proportionate to that part of the purchase price therefor contributed by the decedent. For purposes of this section, any contribution by the decedent’s employer or former employer to the purchase price of such contract or agreement (whether or not to an employee’s trust for fund forming part of a pension, annuity, retirement, bonus or profit-sharing plan) shall be considered to be contributed by the decedent if made by reason of his employment.”
The problem with treating the predeceased nonemployee’s community property interest as includable under §2039 is that although it might be said under §2039(a) the employee is a beneficiary who will receive an interest under the plan by reason of surviving the nonparticipant (assuming the interest cannot be disposed of by the nonparticipant), the amount includable under §2039(b) is limited to the proportionate value of the interest contributed by the decedent (in this case the decedent is the “nonemployee spouse”) or by the decedent’s employer. The employer is not the employer of the nonemployee spouse.
If §2039 does not apply, what section does? §2041? Not if the nonemployee has no power of disposition. Under the Boggs[31] case, the nonemployee has no such power if the interest is under a plan subject to ERISA!
§2033? If §2033 were good enough to cause inclusion in the case of a nonemployee, it would presumably never have been necessary to enact §2039 to cover the employee’s interest, now would it?
If the spouse can dispose of the interest by testamentary disposition, then the Service has held that the interest is includable under §2033.[32] (Alternatively, §2041 ought to suffice to bar any argument.)
If the spouse lacks the power to transfer the interest, it is arguable that the interest is not includable in the estate, as a matter of Constitutional law, since the estate tax is an excise tax on the power to transfer property. If it were a direct tax, other than an income tax, it would be prohibited by the Constitution unless apportioned in accordance with the census:
“No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”[33]
The example I have heard used is that if an individual owns the formula to make Coca ColaTM, and, instead of transferring the formula to someone at death, instead instructs the executor to burn it, the value of the formula is not includible in the gross estate for estate tax purposes because it is not being transferred. This is also the reason that a burial plot is not taxed.
On the other hand, in all candor, there is arguably a transfer of
the qualified plan interest; it is just that it is not a transfer by the
spouse. This is unlike the Coca ColaTM or burial
plot example, in this perhaps important respect.
(This portion of the outline may safely be skipped by those who already possess a general understanding of the operation of the marital deduction.)
A deduction is allowed under IRC §2056 from the gross estate of a decedent who was a citizen or resident of the United States at the time of his death for the value of any property interest which passed from the decedent to his surviving spouse, if the interest is a "deductible interest" as defined in Treas. Reg. §20.2056(a)-2. Under present law, as enacted by the Economic Recovery Tax Act of 1982 (ERTA), Pub. L. No. 97-34, the marital deduction is now unlimited, and it applies irrespective of whether the property passing is community or separate property.
In order to be entitled to a marital deduction, an interest in property must pass or have passed from the decedent to his or her surviving spouse. The passing requirement is defined in Treas. Reg. §§20.2056(e)-1 through 20.2056(e)-3. Of particular importance to the subject at hand, is Treas. Reg. §20.2056(e)-1(a)(6).
Treas. Reg. §20.2056(a)-2(a) provides:
“Property interests which pass from a decedent to his surviving spouse fall within two general categories: (1) those with respect to which the marital deduction is authorized and (2) those with respect to which the marital deduction is not authorized. These categories are referred to in this section and other sections of the regulations under section 2056 as 'deductible interests' and 'non-deductible interests,' respectively.”
A "terminable interest" in property is:
“An interest which will terminate or fail on the lapse of time or on the occurrence or the failure to occur of some contingency. Life estates, terms for years, annuities, patents, and copyrights are, therefore, terminable interest.”[34]
A property interest which constitutes a terminable interest is non-deductible if:
“(i) another interest in the same property passed from the decedent to some other person for less than an adequate and full consideration in money or money's worth, and
(ii) by reason of its passing, the other person or his heirs or assigns may possess or enjoy any part of the property after the termination or failure of the spouse's interest.”[35]
An outright bequest to a surviving spouse will generally qualify for the marital deduction. However, an outright bequest of a nondeductible terminable interest will not qualify. Therefore, if the surviving spouse is to be made the beneficiary under a deferred compensation plan, and if the plan benefit is going to be paid out over a number of years, and if the interest in the plan proceeds, on the death of the surviving spouse, may pass to someone other than the spouse, or his estate, the spouse's interest in the plan proceeds will be nondeductible under IRC §2056.
There are at least three forms of gifts in trust which will qualify for the marital deduction:
An estate trust is a trust with respect to which trust income is to be accumulated for a term of years or for the surviving spouse's life and the augmented fund paid to the spouse or her estate.[36]
A marital deduction power of appointment trust is a trust as to which the surviving spouse is entitled to all of the income at least annually for life, and in which the surviving spouse also is given a lifetime or testamentary general power of appointment over the remainder of the trust.[37]
A qualified terminable interest property trust (QTIP trust) is similar to a marital deduction power of appointment trust in that the surviving spouse is entitled to all of the income at least annually for life; however, the spouse need not be given a general power of appointment over the remainder. The decedent can direct who will receive the remainder of the trust upon the surviving spouse's death. IRC §2056(6)(7). It is this feature of the QTIP trust which makes it so desirable.
A true life only annuity will be a terminable interest because it “will terminate or fail on the lapse of time.”[38] Nevertheless, it is a deductible terminable interest. Recall that in order to be a nondeductible terminable interest, it must be the case that “another interest in the same property passed [or could pass] from the decedent to some other person, and by reason of its passing, the other person or his heirs or assigns may possess or enjoy any part of the property after the termination or failure of the spouse's interest.”[39] If an annuity lapses upon the death of the surviving spouse and no interest in it passes to another person, the first part of the definition is not met. If, however, the annuity is for a term certain, and will not necessarily lapse at death, then the interest will be a nondeductible interest unless some other exception applies.
Notwithstanding the fact that an annuity may be deductible if the spouse has a general power of appointment over it and notwithstanding that a true life only annuity passes to no one at the death of the annuitant, if the testator directs her executor to purchase such an annuity, the annuity so purchased will fail to qualify.
IRC §2056(b)(1)(C) denies marital deduction treatment to an annuity or other terminable interest, even though no portion of the interest will pass to anyone other than the spouse, “if such interest is to be acquired for the surviving spouse, pursuant to direction of the decedent, by his executor or by the trustee of a trust.” (Emphasis added.)
The regulations describe the rule this way:
“(2) Even though a property interest which constitutes a terminable interest is not nondeductible by reason of the rules stated in subparagraph (1) of this paragraph, such an interest is nondeductible if --
“(i) The decedent has directed his executor or a trustee to acquire such an interest for the decedent's surviving spouse (see further paragraph (f) of this section), or
“(ii) “Such an interest passing to the decedent's surviving spouse may be satisfied out of a group of assets which includes a nondeductible interest (see further 20.2056(b)-2). In this case, however, full nondeductibility may not result.”[40]
The Proposed QTIP regulations ameliorated the problem in the case of a QTIP trust; however, the final QTIP regulations eliminated this favorable treatment and reverted to the rule found in the statute.[41]
IRC §2056(b)(6) provides that a marital deduction is available for payments under a life insurance, endowment or annuity contract, payable to a surviving spouse, if the spouse has a general power of appointment over the proceeds.
In the case of a periodic distribution scheme under a qualified plan or IRA, there will be no guaranty that the annual payments will equal or exceed the income on the account balance. Further, most qualified plans are going to be under no obligation to invest in income producing property, and this might be sufficient to lose the marital deduction if it indicates an intent to deprive the spouse of the beneficial enjoyment of the income stream.[42] For these reasons, qualified plans are not readily amenable to QTIP treatment. However, to the extent that payments may be characterized as an “annuity” (whatever that means), there may be hope.
The Technical Corrections Act of 1982, Pub. L. 97-448, added the following as the last sentence to §2056(b)(7)(B)(ii), the section defining qualified terminable interest property:
“To the extent provided in regulations, an annuity shall be treated in a manner similar to an income interest in property (regardless of whether the property from which the annuity is payable can be separately identified).” (Emphasis added.)
Unfortunately, the
regulations we have so far are generally limited to decedents dying before
October 25, 1992! See below.
Do the final regulations provide that “an annuity shall be treated in a manner similar to an income interest in property”?
The only provisions found in the final QTIP regulations for treating annuities as a qualified income interest are in a section entitled “[a]nnuities payable from trusts in the case of estates of decedents dying on or before October 24, 1992, and certain decedents dying after October 24, 1992, with wills or revocable trusts executed on or prior to that date.”[43]
Other than in the case just noted, the regulations do not contain rules treating an annuity as an income interest under §2056(b)(7)(B)(ii). §2056(b)(7)(C), which carves out an exception for annuities under §2039, discussed below, is not dependent on regulations being issued for its effectiveness. This is fortunate, since the treatment of joint and survivor annuities is expressly “reserved” from the final QTIP regulations.[44]
§6152(a) of The Technical and Miscellaneous Revenue Act of 1988 (TAMRA), Pub. L. No. 100-647 added §2056(b)(7)(C) to the IRC.[45] This section, prior to its amendment by the 1997 Taxpayer Relief Act, read as follows:
“Treatment of Survivor Annuities.- In the case of an annuity included in the gross estate of the decedent under section 2039[46] where only the surviving spouse has the right to receive payments before the death of such surviving spouse-
(i) the interest of such surviving spouse shall be treated as a qualifying income interest for life, and
(ii) the executor shall be treated as having made an election under this subsection with respect to such annuity unless the executor otherwise elects on the return of tax imposed by section 2001.” [Emphasis added.]
An election under clause (ii), once made, shall be irrevocable.
The effective dates for this new section are specified in TAMRA §6152(a). Temp. Reg. §5h.6 sets forth the procedure for making the election.
For the reasons set forth below, it is hard to understand why the statute is even necessary if the surviving spouse is not the employee, unless there is an event or contingency under which some portion of the annuity might pass to someone other than the spouse or the spouse’s estate, and that can’t happen if the annuity is a true life only annuity not having any minimum term.
Indeed, unless §2056(b)(7)(C) applies to annuities other than life only annuities (or unless it is meant to apply where the surviving spouse is the employee in a community property state), it will be of no benefit in the only place where it is really needed. If the annuity is not payable to anyone other than the surviving spouse it is not a nondeductible terminable interest. If however, as is common, the annuity has a term certain feature, then help is in order. An annuity with a term certain feature may continue to provide benefits after the death of both spouses, an event or contingency that can cause the annuity to be classed as a nondeductible terminable interest. It is for this reason that we desperately need regulations telling us what an annuity is for §2056(b)(7)(C) purposes.
The Service has suggested in a private letter ruling, issued prior to the change to the statute wrought by the 1997 Taxpayer Relief Act, that where the nonemployee dies in a community property state in which the nonemployee has no power of testamentary disposition over the nonemployee’s community property interest in the employee’s plan, the interest has “passed” from the nonemployee to the employee and further, a marital deduction was allowable. (The plan was subject to the joint and survivor annuity rules, but, significantly, the interest was not in pay status.) The interest was includable in the decedent’s estate under §2039, but §2056(b)(7)(C) was held to apply. Whether or not §2056(b)(7)(C) was the exclusive means for qualifying for the marital deduction was not stated.[47]
[The Service did not discuss what would happen if the employee remarried. If the employee remarried, it could not be said in truth that “only the surviving spouse has the right to receive payments before the death of such surviving spouse,” and so one of the requirements of the first clause of §2056(b)(7)(C) would not seem to have been met. (Far be it from me to be nit picky.)]
Section 7816(q) of The Omnibus Budget Reconciliation Act of 1989 (OBRA ‘89), Pub. L. 101-239 amended the just passed §2056(b)(7)(C) by changing “an annuity” and inserting “an annuity included in the gross estate of the decedent under section 2039.” So, if the annuity is not included in the gross estate under §2039 the marital deduction is not available under §2056(b)(7)(C). The change is effective as if included in TAMRA in the first place. Although §2039 applies to a decedent's interest in an employer sponsored plan, it is not so limited on its face.
The gift tax corollary to §2056 is §2523. IRC §2523(f)(6) was added by TAMRA to give a gift tax marital deduction and automatic QTIP treatment for joint and survivor annuities. But for some reason the OBRA change to §2056(b)(7)(C), changing “an annuity” and inserting “an annuity included in the gross estate of the decedent under section 2039” was not made to §2523, and no reference to §2039 will be found there. Of course, there is no real gift tax corollary to §2039.
The 1997 Taxpayer Relief Act amended 2056(b)(7)(C) by adding the language in italics quoted below, so that the statute now reads
“Treatment of Survivor Annuities.- In the case of an annuity included in the gross estate of the decedent under section 2039 (or, in the case of an interest in an annuity arising under the community property laws of a State, included in the gross estate of the decedent under section 2033) where only the surviving spouse has the right to receive payments before the death of such surviving spouse-
(i) the interest of such surviving spouse shall be treated as a qualifying income interest for life, and
(ii) the executor shall be treated as having made an election under this subsection with respect to such annuity unless the executor otherwise elects on the return of tax imposed by section 2001.”
The reason for the change was that under Boggs [48] a predeceased spouse of a participant in a qualified plan has no power of disposition over the spouse’s community property interest in the participant’s plan, and thus, a marital deduction might not be available when the nonparticipant died first, because the interest either would not be considered to have “passed” to the participant, or because of the terminable interest rule (if the participant remarried there is an event or contingency under which the interest would pass to someone other than the participant). A premise of the change is the assumption that the interest is includable under §2033 which is questionable, for reasons discussed elsewhere in this paper. The essence of the question is whether an interest which a person never transferred and over which the person never had any power of transfer can be taxed without violating the U. S. Constitutional prohibition against direct or capitation taxes not in proportion to the census.[49] Incidentally, the drafters were correct in referring to §2033 rather than §2039, since the nonparticipant is not the “employee,” as also discussed elsewhere in this paper.
If the participant has an interest under a profit sharing plan that provides a single sum distribution at retirement as the only option, does the predeceasing nonparticipant spouse’s estate receive a marital deduction under amended §2056(b)(7)(C)? What is an annuity?
Under the final regulations, the applicable interest rate for valuing annuities is determined under IRC §2031 and §7520. These sections provide that the annual annuity payments are compared to the yield on property using 120% of the federal mid-term rate to determine value.[50] Under the final regulations, these rules only apply to decedents dying before October 25, 1992, with limited exceptions.[51]
An IRA and complementary trust established for the benefit of a spouse who is not a citizen of the United States, can be made to qualify for both QTIP (IRC §2056(b)(7)) and QDOT (IRC §2056A(a) marital deduction treatment under certain circumstances. See PLR 9321032 and its word for word counterpart PLR 932005.
If the payments are to a QTIP trust, rather than to the spouse directly, there are other issues to consider, particularly state law principal and income characterization questions, since payments to the trust may not necessarily be considered as income currently distributable. Until the Treasury issues more specific regulations on this subject, funding a QTIP trust with an annuity or periodic payment from a qualified plan will be hazardous.
It may be that both the QTIP trust and the IRA or qualified plan could be structured so that distributions from the latter to the former will qualify.
If the payments would qualify for QTIP treatment if made directly to a spouse, then such payments should likewise qualify if made to a QTIP trust, provided that the trust characterized such payments as income when received, so that such payments do not become corpus to the trust, or otherwise provides that such income will be distributable annually to the spouse.
Before discussing Rev. Rul. 89-89,[52] it is worth reminding ourselves that though we may to a certain extent rely upon a revenue ruling, as a shield, the IRS may generally not use it as a sword.
It has been said many time that “proposed regulations carry no more weight than a position advanced on brief by respondent [IRS],”[53] but what about a published Revenue Ruling?
Clearly, a taxpayer may rely upon a published Revenue Ruling under certain circumstances:
Taxpayers generally may rely upon revenue rulings and revenue procedures published in the Bulletin in determining the tax treatment of their own transactions and need not request specific rulings applying the principles of a published revenue ruling or revenue procedure to the facts of their particular cases.[54]
So the taxpayer, in appropriate circumstances can use a published Revenue Ruling as a shield. But can the IRS use it as Revenue Ruling as a sword? In the Estate of Grace Lang the court said:
Revenue rulings, unilaterally issued by respondent [IRS], do not rise to the dignity of those ‘rules and regulations’ which under the authority of sec. 7805(a) are prescribed by respondent ‘with the approval of the Secretary.’ Sec. 301.7805-1(a), Proced. & Admin. Regs. A long-continued administrative interpretation, whether reflected by revenue ruling or otherwise, may of course achieve the force of law when it interprets a statute which has been reenacted unchanged after such interpretation was expressly called to congressional attention. See United States v. Correll, 389 U.S. 299 (1967). Needless to say, this is not the case here.[55]
A more definitive statement is found in Beneficial Foundation v. U.S.:
Revenue rulings are not binding on the court when invoked by the Service, since they are considered ‘simply the contention of one of the parties to the litigation.’ Estate of Lang, 64 T.C. 404, 407-08 (1975); accord Minnis v. Commissioner, 71 T.C. 1049, 1057 (1979). The matter is quite different when a ruling that has not been revoked or modified is invoked by a taxpayer. The taxpayer to whom the ruling is issued is normally entitled to rely on it fully. See Lesavoy Foundation v. Commissioner, 238 F.2d 589, 591-92 [ 50 AFTR 756] (3d Cir. 1956); J. Mertens, Law of Federal Income Taxation §49.95 (1984). But cf. Exxon Corp. v. United States. 7 Cl. Ct. 347, 352 [ 55 AFTR2d 85-755] (1985), appeal filed, No. 85-2160 (Fed. Cir. Mar. 29, 1985) (taxpayer cannot rely on issues not presented to or considered by the Service in issuing its ruling). When a ruling is invoked by another taxpayer, its precedential effect turns on whether the ruling is published. The Service issues numerous private rulings each year; such rulings affect only the rights of the taxpayer in question. See Hanover Bank v. Commissioner, 369 U.S. 672, 686 & n.19 [ 9 AFTR2d 1492] (1962); International Business Machines Corp. v. United States, 170 Ct.Cl. 357, 373 n.15 [ 15 AFTR2d 1526] (1965); J. Mertens, §60.16, at 62. On the other hand, some rulings are published for the specific purpose of giving guidance to all taxpayers. fn So long as a [pg. 85-5720] published ruling is not revoked or modified, fn it may be invoked by any taxpayer as if it were issued to him personally and, to be extent that it addresses issues in his case, the ruling will normally be dispositive. fn In this case, the published rulings on which plaintiff relies clearly establish that the purpose of its grant program is sufficiently narrow to meet the requirements of subsection (g)(3). This interpretation is binding on the Service here. fn [56]
In Rev. Rul. 89-89[57], an IRA was required to make equal annual installments over the life expectancy of the spouse to a QTIP trust. Further, the income earned on the undistributed portion of the IRA was required to be distributed to the trust annually.
Under the terms of the trust and the state law, the installment payments were characterized by the trust as corpus. However, the income earned on the portion of the IRA not distributed as an equal installment payment was treated as income and was distributed, along with any income on the corpus of the trust.
Not surprisingly, the trust and the IRA both qualified for QTIP treatment, under this unusual fact pattern.
IRC §2056(b)(5) requires that the surviving spouse must be entitled to all of the income, at least annually, from a marital deduction power of appointment trust, in order for the trust to qualify. The same requirement is found in IRC §2056(b)(7) with respect to a Qualified Terminable Interest Property (QTIP) trust.
If a QTIP trust or a marital deduction power of appointment trust is funded with the proceeds from a qualified plan, what portion will constitute income? For income tax purposes, all of the proceeds will be income (other than the portion attributable to nondeductible employee contributions). But for fiduciary accounting purposes, such a distribution ought to constitute principal, or at least a portion should be principal, resulting, perhaps, in a trapping distribution, taxed at the trust level, for good or ill, and not subject to the throwback rule. All of these issues are extremely important.
The issue should be addressed in the Trust Code or Principal and Income Act of the appropriate state, and each state differs in this regard. Florida has a comprehensive statute, specifically designed to address this problem. The Texas Trust Code used to be unclear on this point, but fortunately has been amended and is now very precise.
Tex. Trust Code §113.109 treats the right to income in much the same way as if the right were represented by a 5% interest bearing note in the principal amount of the original inventory value assigned to the right.
Tex. Trust Code §113.109 provides:
“(a) If the principal of a trust includes a deferred payment right, the proceeds of the right, on receipt, are income up to five percent of the inventory value of the right, determined separately for each year following the year in which the right first becomes subject to the trust. The remainder of the proceeds is principal. The allocation to income is computed in the same manner in which interest under a loan of the initial inventory amount would be computed, at five percent interest compounded annually, if periodic payments are made by the borrower to the lender.”[58]
* * * *
“(e)(1) A deferred payment right is a depletable asset, other than natural resources or timber, consisting of the right to property payable in the future under a contract, account or other arrangement. . . . ”[59] [Emphasis added.]
“Death benefits,” “income in respect of a decedent,” and benefits under an “employee benefit plan” are all specifically identified under the statute as forms of a “deferred payment right.”[60] Clearly, a right of a trust to receive a payment from an IRA or qualified plan is a deferred payment right under the statute.
Tex. Trust Code §113.109 treats the right to income in much the same way as if the right were represented by a 5% interest bearing note in the principal amount of the original inventory value assigned to the right. Roughly speaking, payments received by the trust are allocated to income up to 5% of the inventory value times the number of years for which income payments were not made. The inventory value is reduced, for purposes of making the allocation in future years, to the extent the receipts exceed the 5% compounded allocation to income.
Given the problems of determining the income from a qualified plan interest and then guarantying that it will be distributed timely, can a QTIP trust safely hold such an asset, without a lot of elaborate work? Perhaps.
One solution is that found in Rev. Rul. 89-89 discussed above. However, this solution requires restrictive language to be added to the IRA beneficiary designation form itself, and is rather inflexible. The issue considered below is whether the IRA can be an asset of the QTIP trust, like any other asset.
Consider the following will provision:
Provisions Respecting the Marital Deduction. Notwithstanding the following or anything else in this instrument to the contrary, a trust in which the Surviving Spouse has a qualifying income interest for life may not be funded with property that does not constitute Eligible Marital Deduction Property[61] if there is any other alternative available to the fiduciary. Subject to this rule, Maker recognizes that there may be situations in which a Surviving Spouse has a “qualifying income interest for life in a retirement plan,” or in which The Marital Deduction Trust estate has an interest in a retirement plan. For example, the trust may own the right to receive distributions from a retirement plan that constitutes Eligible Marital Deduction Property. In such event, the interest shall be held, invested, reinvested and maintained, and income attributable to the interest shall be determined, in a manner that guarantees that the Surviving Spouse has a qualifying income interest for life with respect to such interest. [But see TAM 9220007.]
The rule that the Surviving Spouse is guaranteed a qualifying income interest for life in such cases is overriding and shall govern in case of conflict with the following rules, which Maker nevertheless believes to be consistent with it.
(1) Determination of Fiduciary Accounting Income. Subject to the overriding rule that the Surviving Spouse is guaranteed a qualifying income interest for life in any retirement plan in which the trust has an interest, income from an interest in a retirement plan shall be determined by reference to state statutory law, if any, or if none, by applying general equitable principles, having due regard for the interest of the income beneficiary and the remaindermen.
Further, in the case of any retirement plan in which the trust has an interest, fiduciary accounting income, if greater, shall be determined and distributed in the same manner as if the retirement plan in which the trust has an interest was itself “qualified terminable interest property” within the meaning of IRC 2056.
Income is an accounting notion representing a value, and not representing particular assets. Therefore, whether or not all of the income from a retirement plan (in which The Marital Deduction Trust has an interest) is distributed by the plan in a given year, an amount representing the income shall nevertheless be credited to the income account and shall be distributable by the trust, in the manner otherwise provided under the terms of the trust. If the other assets available for distribution in The Marital Deduction Trust are insufficient for that purpose, then the trustee shall compel a distribution from the retirement plan of such an amount as is necessary to satisfy the obligation to the spouse.
(2) Additional Demand Rights Granted to Surviving Spouse. In addition to the above, and notwithstanding anything else herein to the contrary, the Surviving Spouse, at any and all times, shall have the unfettered right to demand an immediate distribution, from each retirement plan in which the trustee of The Marital Deduction Trust has an interest, of all (or any part of) the income from such plan (determined as if the plan were itself a trust in which the Spouse had a qualifying income interest for life), and the trustee shall comply with such request. (Any distribution under this Paragraph shall be credited against any rights the spouse would otherwise have had to such income, of course.) [N.B. This paragraph should not really be necessary. It is included as a matter of caution, or perhaps overkill. In fact, if this clause is used, the preceding paragraph is probably not necessary.]
(3) Explicit Provisions Regarding Distributions and Acceleration of Installment Distributions. For so long as The Marital Deduction Trust has any interest in a retirement plan, the trustee shall take whatever steps are required to assure that such interest, to the extent not previously distributed, is (and will at all times remain) immediately distributable on demand to the trust. Accordingly, the trustee shall retain the unrestricted power to accelerate any installment distributions elected under the minimum distribution rules or otherwise; otherwise, the trustee shall not make an installment distribution election.
If The Marital Deduction Trust has an interest in a retirement plan, no distribution of all or any part of such interest shall be made to anyone other than the Surviving Spouse (or to the trustee, as such) during the Surviving Spouse’s lifetime, and no distribution of all or any part of such interest shall be made directly out of the retirement plan to anyone else (other than the trustee, as such), following the Surviving Spouse’s lifetime.
(4) Unproductive Property In Retirement Plan. If the
assets of a retirement plan in which the Surviving Spouse has (or is treated as
having) a qualifying income interest for life, or in which The Marital
Deduction Trust has an interest, ever include unproductive or under productive property, then the Surviving
Spouse (or the Surviving Spouse’s guardian or other legal representative) is
specifically permitted to require the trustee of The Marital Deduction Trust
and the trustee or custodian of the retirement plan to either make the property
productive or convert it within a reasonable time. This right shall include the
power, to the extent necessary, to cause the retirement plan interest to be
distributed directly to the trustee, or rolled over or transferred to another
eligible retirement plan, where, in either case, the property can be made
productive.
The language suggested above may still be inadequate to qualify an IRA or qualified plan interest as a permissible asset to be held by a QTIP trust. It may be that a qualified plan interest will hardly ever qualify, given the limited options available to a beneficiary, but an interest in an IRA ought to qualify since the beneficiary will ordinarily have total control over the IRA. Nevertheless, TAM 9220007 casts doubt on this.
This TAM is extremely unfortunate because it is going to make even more difficult an area that is already difficult enough. Under the facts of the case a marital deduction trust was named as the beneficiary of an IRA. The Service made two rulings with respect to the facts. The first was that the IRA itself did not qualify as QTIP. I have no problem with that. It probably didn’t.
However, I have a great deal of difficulty with the second ruling which was that the right to receive the proceeds from the IRA was not a permissible QTIP trust asset. I think that this is clearly wrong, unless there were some unique facts. Barring some form of unusual election, the trustee of the QTIP trust would have the absolute right to draw down the entire IRA or any portion of it at a moment’s notice, no matter what interim IRA distribution elections might have been in place.
The beneficiary of a qualified plan interest may be limited in the choice of available distribution options, but the IRA beneficiary seldom is. In this respect, owning the right to receive distributions from an IRA is not a whole lot different from owning the underlying assets in the IRA. I fail to see how this situation is all that different from a trustee who has the theoretical power to invest in raw land, or in growth stocks, subject to the spouse’s power to compel the trustee to make the assets productive. I assume that the spouse would have the same power with respect to the IRA.
It may be that the facts in this TAM were unique and the holding turned on these facts:
“In addition, if a nonqualifying pay out option was selected by the trustee of the marital trust, neither the trustee nor the surviving spouse would have had the requisite power or the right to make this asset productive (by changing the pay out option) for purposes of § 2056(b)(7) of the Code, since the trustee of the IRA is in a position to hold the trustee of the marital trust to its initial election.”
It appears from this statement that the QTIP trustee may have lacked the power to draw down the assets. If so, the case is highly unusual. The election options discussed in the TAM would appear to be the §401(a)(9) minimum distribution options required by law. This makes me suspect that there may have been a misunderstanding here. On more than a few occasions I have had to explain to banks and to participants that the §401(a)(9) options are minimums. The elections irrevocably set the minimum, but don’t ordinarily preclude the exercise of normal withdrawal rights. Both the beneficiary and the participant have the right to draw down more than the statutory minimum at any time, in all but the most extraordinary of cases. If this TAM merely represented a peculiar fact pattern, it could be dismissed.
Unfortunately, the TAM expressed concerns that went beyond the distribution option issue. The author expressed concern that the right to receive payments could not be treated as a QTIP trust asset under any circumstances, meaning that in order to constitute eligible marital deduction property, the IRA itself must be the QTIP.
“Initially, we question whether the IRA is properly characterized as a trust asset. The nature of the IRA account (a significant amount of liquid assets held by a fiduciary) is such that the account is itself a trust that may qualify for QTIP treatment based on its own terms, as in Rev. Rul. 89-89. The QTIP rules should not be avoidable by classifying what is inherently a separate trust corpus as an “asset” of a QTIP trust, thus vitiating the requirement that the spouse receive all the income from the separate trust property.”
I think this letter ruling is wrong, unless the trustee really was powerless to accelerate distributions under the IRA, which I doubt. And I agree that the elections that are actually made by the trustee ought to be irrelevant. The important thing is that if the trustee had total control over the property in the IRA, the IRA itself ought not to have to qualify for QTIP treatment independently, any more than a bank or brokerage account that is an asset of a QTIP trust ought to have to separately qualify. As long as the spouse has the right to demand that unproductive property be made productive, an IRA is no different from any other asset, including raw land and growth stocks. I fail to see any policy reasons against this position.
This letter ruling is either unique to its special facts, or so far off the mark, that in either event one ought to be able to ignore it, provided that extra care is taken in authorizing unrestricted distributions to the trustee, crediting the income beneficiary with income earned by the plan/IRA, etc., in the manner indicated by the suggested language quoted above.
In PLR 9229017, a testamentary trust provided for a fractional share of the residue to go to a formula marital deduction trust. The will stated that only property that qualified for the marital deduction could be used to fund the marital deduction trust and that the Wife had the right to require unproductive property in the trust to be made productive. If the marital trust was the beneficiary of a qualified plan or IRA (“benefit arrangement”), the trustee was to direct that the benefit be distributed to the trust over the life expectancy of the Wife. (This last condition ought not to have been relevant.) More importantly, whether or not the payments were to be allocated to principal for ordinary fiduciary accounting purposes, the trustee was to allocate to marital trust income that portion of the total amounts payable from the benefit arrangement each year which was equal to the income earned by the benefit arrangement for that year. For any year in which the distribution was less than the income earned by the benefit arrangement for that year, the trustee was to demand additional distributions from the benefit arrangement so that the total distributions for any period would at least equal the income earned by the benefit arrangement for the period. In addition, the Wife had the power to compel the trustee to demand such distributions. Other distributions from the benefit arrangement were to be allocated to principal.
So far, so good, and the facts as recited ought to be sufficient to qualify the marital trust for the deduction. Unfortunately, in addition to these facts, the IRA election that named the trust as beneficiary provided that all of the income would be distributed to the trust at least annually. The ruling was favorable (why wouldn’t it be?) assuming that a QTIP election was made both for the trust and for the IRA. So, we are still hung with an awkward and unnecessary set of facts. Why separately qualify the IRA itself?
If the IRA is an asset of the QTIP trust, and if the trustee has the right to demand distributions in whatever amount the trustee feels like, and if the trust gives the spouse the right to make unproductive property productive, and if the income of the IRA is to be treated as income of the trust, and if all of the income from the trust must be distributed, why look any farther; why be concerned about the IRA distribution terms, and for heaven’s sake why make a separate QTIP election for the IRA?
Regarding the question of whether a QTIP election must be made for the IRA as well as or instead of for the QTIP trust, does it (or should it) make a difference whether the IRA is a custodial IRA or a trusteed IRA? Compare the differences between IRS Form 5305 Individual Retirement Trust Account Form IRA, and IRS Form 5305-A Individual Retirement Custodial Account Form IRA. The only noticeable difference between the two forms is that one uses the term “Custodian” where the other uses the term “Trustee.”
For purposes of IRC §408, it makes no difference whether the IRA is trusteed or not:
For purposes of this section, a custodial account shall be treated as a trust if the assets of such account are held by a bank (as defined in subsection (n)) or another person who demonstrates, to the satisfaction of the Secretary or his delegate, that the manner in which he will administer the account will be consistent with the requirements of this section, and if the custodial account would, except for the fact that it is not a trust, constitute an individual retirement account described in subsection (a). For purposes of this title, in the case of a custodial account treated as a trust by reason of the preceding sentence, the custodian of such account shall be treated as the trustee thereof.[62] [Emphasis added.]
The section referred to above is 408, but the Title is Title 26, which is the IRC.
In a typical two trust estate plan, the trustee or executor is directed to divide the estate into a martial deduction trust and a bypass trust in accordance with a formula designed to utilize the advantages of the unified credit and the federal estate tax marital deduction. A typical approach for coordinating nonprobate assets with this plan would be to name the trustee of a testamentary or revocable living trust as the designated beneficiary.
The trustee is then directed to collect the proceeds as to which it is a beneficiary, and to allocate these proceeds between trust A (the marital deduction trust) and trust B (the bypass trust) in accordance with the formula. This achieves the desired flexibility necessary to fine tune the estate plan, but it engenders other problems.
One problem is whether the trust can be treated as a designated beneficiary under the minimum distribution rules of IRC §401(a)(9). This issue is discussed in depth later on in this outline. In the context at hand, however, the problem is that if, prior to death, the participant must have made a distribution election that would enable the IRA to qualify as QTIP at death, e.g., that all the income must be paid out annually, then the participant would have to periodically fine tune the IRA terms to keep from overqualifying for the marital deduction. The decision in that case must be made pre-mortem whether to qualify the IRA for QTIP treatment or bypass trust treatment, i.e., whether the accumulation of income is to be permitted. It is not at all desirable to be placed in this position, since between the time the beneficiary designation is completed and the date of death a lot of changes could take place in the size of the IRA, the size of the estate, and, for that matter, the size of the available unified credit. Reacting to these changes could be inconvenient and expensive.
It is for these reasons that the constraints suggested by a narrow reading of TAM 9220007 are of concern.
Whether or not the participant's estate is entitled to a marital deduction with respect to the participant's interest in a qualified plan passing to the participant's spouse may depend upon whether or not the interest passing is a nondeductible terminable interest, and this will be a function of the terms of the plan and of the beneficiary designation.
If the participant's spouse is the primary beneficiary of the participant's undistributed interest in the plan upon the participant's death, then whether or not the participant's estate will get a marital deduction for the interest passing to the spouse may depend upon what could happen if the spouse fails to survive the complete distribution of the participant's benefits. If the interest could or will pass to someone other than the spouse then the interest passing to the spouse is probably a nondeductible terminable interest, (1) unless the interest is in the form of an annuity qualifying under IRC §2056(b)(6), or IRC §2056(b)(7)(B)(ii), last sentence, flush language, regulations permitting, or (2) unless the spouse is guaranteed all of the income from the participant's interest (which would be highly unusual), in which case the interest passing might qualify for QTIP treatment under the general rule of IRC §2056(b)(7), or (3) unless the interest qualifies for automatic QTIP treatment under IRC §2056(b)(7)(C) as “an annuity included in the gross estate of the decedent under section 2039 where only the surviving spouse has the right to receive payments before the death of such surviving spouse,” or (4) unless the remaining interest will be paid to the spouse's estate, in which case the interest would not technically be a nondeductible terminable interest at all.[63]
To the extent that a participant's interest passes to the surviving spouse in the form of a life annuity under a qualified plan, as would be the case if the surviving spouse receives a Qualified Preretirement Survivor Annuity (QPSA) or a Qualified Joint and Survivor Annuity (QJSA) on the decedent’s death,[64] the estate tax marital deduction ought to be available since no part of the interest will pass to anyone other than the surviving spouse following the spouse's death.[65] (The rule may be different in the case of the gift tax marital deduction for a gift of a QJSA since the participant will have retained an interest at the time of the "transfer."[66] )
As noted above under the discussion of annuities, TAMRA added §2056(b)(7)(C) to the IRC. This new section (as amended by OBRA ‘89) treats a survivor’s interest in an “annuity included in the gross estate of the decedent under section 2039” as a QTIP unless the executor elects otherwise (reversing the usual order of things).
In essence, IRC §2056(b)(7)(C) gives automatic QTIP treatment to spousal annuities under employer sponsored plans. Since a true annuity having only life contingency features will not pass to anyone on the death of the annuitant, a true annuity having only life contingency features is not a terminable interest and doesn’t need QTIP treatment. This fact poses interesting suggestions. Did Congress pass §2056(b)(7)(C) because it didn’t know what it was doing—always a distinct possibility— or did Congress intend to afford some of the benefits of QTIP treatment to term certain annuities?
Other than obtaining an estate tax marital deduction, what are the benefits of QTIP treatment? One benefit is the ability to elect out of QTIP treatment so that there will be no marital deduction. Sometimes this is beneficial, but since in a true annuity there will be no value to be taxed in the survivor’s estate in any event, this can hardly be considered an advantage. QTIP trusts are uniquely given the right to make a reverse election under the generation skipping tax (GST) rules, but this will not be of any benefit here, and for the same reason: there won’t be any remainder passing to a third person on the death of the spouse.
Interestingly, the term “annuity” is not defined in §2056(b)(7)(C). An annuity includable under IRC §2039 may include installment payments based on life expectancy, rather than life, in which case there might be a remainder. If §2056(b)(7)(C) accomplishes anything at all, and there must be a presumption that Congress would not pass a meaningless act (at least not on purpose), then it must apply to annuities other than true life contingency only annuities. On the other hand, if §2056(b)(7)(C) does not apply to §2039 annuities with term certain features or to installment payouts (which is the only place it is needed), then it is quite possible that the interest under the plan will fail to qualify for the marital deduction since it is likely to constitute a nondeductible terminable interest.
Perhaps, §2056(b)(7)(C), if nothing else, can be read as addressing the “passing” problem which is sometimes raised as a possible bar to the marital deduction in the case of an interest passing under a plan. Ordinarily, in order to be entitled to the marital deduction the interest must “pass” “from the decedent.”
If the spouse is the named beneficiary and the plan provides that the choice of benefit payment is in the sole discretion of the spouse, the participant's estate certainly ought as a matter of policy to be entitled to a marital deduction? However, whether the estate is entitled to the deduction, as a technical matter, is somewhat problematic.
There are two lines of reasoning that might be applicable to either support or deny the marital deduction in a case where a spouse beneficiary has a range of alternative benefits from which to choose: (1) the power of appointment line and (2) the elective bequest cases. There are undoubtedly some troubling theoretical aspects to the application of these lines.
One line, found in the regulations[67] and cases[68] tells us that if the spouse has an absolute power of withdrawal (appointment?) during life, the interest qualifies as a deductible terminable interest, even though the spouse does not have a testamentary power of appointment and even though there is no requirement that all of the income be distributed—unless the spouse asks for it. (McGehee involved a gift of property to the spouse with an unlimited power to consume or dispose for life, but there was a gift over to the children on the death of the spouse of whatever, if anything, remained.)
In order to be entitled to a deduction under IRC §2056(b)(5), (a) the spouse must be entitled to all of the income, and (b) there be “power in the surviving spouse to appoint the entire interest . . .”
In order to satisfy the income requirement — whether the marital deduction trust is a life estate power of appointment trust or a QTIP— the spouse must be given "substantially that degree of beneficial enjoyment . . . which the principles of the law of trusts accord to a person who is qualifiedly designated as the life beneficiary of a trust."[69] This requirement will be satisfied if income is to be distributed only at the request of the spouse.[70]
Note that the final QTIP regulations provide that “the principles of §20.2056(b)-5(f), relating to whether the spouse is entitled for life to all of the income from the entire interest, or a specific portion of the entire interest, apply in determining whether the surviving spouse is entitled for life to all of the income from the property regardless of whether the interest passing to the spouse is in trust.”[71]
Treas. Reg. §20.2056(b)-5(f)(8) reads in its entirety as follows:
“(8) In the case of an interest passing in trust, the terms 'entitled for life' and 'payable annually or at more frequent intervals,' as used in the conditions set forth in paragraph (a)(1) and (2) of this section, require that under the terms of the trust the income referred to must be currently (at least annually; see paragraph (e) of this section) distributable to the spouse or that she must have such command over the income that it is virtually hers. Thus, the conditions in paragraph (a)(1) and (2) of this section are satisfied in this respect if, under the terms of the trust instrument, the spouse has the right exercisable annually (or more frequently) to require distribution to herself of the trust income, and otherwise the trust income is to be accumulated and added to corpus. Similarly, as respects the income for the period between the last distribution date and the date of the spouse's death, it is sufficient if that income is subject to the spouse's power to appoint. Thus, if the trust instrument provides that income accrued or undistributed on the date of the spouse's death is to be disposed of as if it had been received after her death, and if the spouse has a power of appointment over the trust corpus, the power necessarily extends to the undistributed income.”
Therefore, unless an unrestricted right to receive distributions of income at least annually either (a) does not exist or (b) will lapse during life, the income requirement of §2056(b)(5) will be satisfied.
The income requirement or §2056(b)(5) is also satisfied if the spouse “has the right, exercisable in all events, to have the corpus distributed to her at any time during her life.”[72] (Emphasis added.)
“(6) . . . . If a trust may be terminated during the life of the surviving spouse, under her exercise of a power of appointment or by distribution of the corpus to her, the interest passing in trust satisfies the condition set forth in paragraph (a)(1) of this section (that the spouse be entitled to all the income) if she (i) is entitled to the income until the trust terminates, or (ii) has the right, exercisable in all events, to have the corpus distributed to her at any time during her life.” [Emphasis added.]
Case law has also established the principle that the marital deduction is also available where the surviving spouse has the unlimited power to appoint to anyone or to invade or withdraw corpus at will.[73]
The power of appointment requirement of §2056(b)(5) is also satisfied by a power of invasion, even though the power lapses at death.
The power must be “exercisable in favor of such surviving spouse, or the estate of such surviving spouse, or in favor of either, whether or not in each case the power is exercisable in favor of others.”[74] IRC §2056(b)(5) concludes with the following sentence:
“This paragraph shall apply only if such power in the surviving spouse to appoint the entire interest, or such specific portion thereof, whether exercisable by will or during life, is exercisable by such spouse alone and in all events.” [Emphasis added.]
Treas. Reg. §20.2056(b)-5(g) sets forth the requirements for satisfying the power of appointment condition. The power of appointment qualifies if it falls within one of three enumerated categories, the first of which is
“A power so to appoint fully exercisable in her own favor at any time following the decedent’s death (as, for example, an unlimited power to invade).”[75]
Treas. Reg. §20.2056(b)-5(g)(3), last sentence, provides:
“In order for a power of invasion to be exercisable in all events, the surviving spouse must have the unrestricted power exercisable at any time during her life to use all or any part of the property subject to the power, and to dispose of it in any manner, including the power to dispose of it by gift (whether or not she has power to dispose of it by will).” [Emphasis added.]
Finally, Treas. Reg. §20.2056(b)-5(g)(5), last sentence, reads:
“Similarly, if she has an unlimited power of withdrawal, she may have a limited testamentary power.”[76]
These three regulations make it clear that a testamentary power is not required if a lifetime power of invasion exists. All this is relevant, of course, to the issue of whether a decedent’s estate is entitled to a marital deduction where the beneficiary of the decedent’s interest in an IRA or qualified plan interest is the decedent’s spouse. And the point is that the answer is clearly “yes,” if the beneficiary has a lifetime power of withdrawal, even if the spouse does not have a testamentary power (i.e., there is a gift over to third parties if the spouse fails to consume or dispose of the property during life).
The other line is that an elective bequest is not a terminable interest at all, provided that the election is made. This line is represented by Estate of Mackie v. Commissioner, 545 F.2d 883 (4th Cir. 1976), Estate of Tompkins v. Commissioner, 68 T.C. 912 (1977), acq., 1982-1 C.B. 1; Estate of Neugass v. Commissioner, 555 F.2d 322 (2d Cir. 1977), rev’g, 65 T.C. 188 (1975); and to some extent by Rev. Rul. 82-184, 1982 C.B. 215.
Unlike the lifetime general power of appointment cases, in the elective bequest cases, the spouse had an option exercisable for a limited period of time (i.e., not for life). These are the “widower’s election” cases. These cases hold that an elective bequest is not a power of appointment, and is therefore not a terminable interest (so long as the election is actually made!).[77]
In Tompkins the spouse had 60 days to elect to take a $40,000 cash legacy, otherwise the gift passed to a trust that did not qualify for the marital deduction because the spouse’s interest terminated upon remarriage. The election to take the cash was made, and the Tax Court found that a marital deduction was allowable. The Commissioner has acquiesced in this decision.
At the heart of the elective bequest cases is the age old distinction between a lapse and a transfer. (Life would have been easier for all of us if this distinction under the tax rules had never been made in the first place. It complicates the analysis of all sorts of transfer tax and income tax issues, as anyone that has thoroughly analyzed the tax implications in the use of Crummey withdrawal powers is well aware.) The election cases do not treat a lapse of the right to property as a transfer. This means that whether or not a marital deduction is available depends on whether or not an election to take the property is actually made. This notion is not easily reconciled with the terminable interest rule, but it is nevertheless a well established principle by now.
In one case, a spouse who was the beneficiary of a trust. The trust was a beneficiary of an IRA. The spouse had a right to withdraw all of the trust principal of the trust at will. She exercised that right by withdrawing the assets in the IRA. The Service privately ruled that the spouse could rollover the proceeds within 60 days.[78]
If the right of a spouse to choose among various distribution options (including lump sum) is a power of appointment, then presumably it will have to comply with §20.2056(b)-5(f)(6), last clause, and the power will have to last for life. If, instead, the spouse has the unrestricted right to the property that will lapse if not made within a limited period of time (an “elective bequest”), then the marital deduction will only be available if the election is in fact made.
The election cases are hard to reconcile with a technical reading of the terminable interest rule. This may be the source of the problem. In the case of an election will, there is an “event or contingency” under which the bequest will pass to someone other than the spouse or the spouse’s estate, viz., the failure of the spouse to make the election to take the benefits. Nevertheless, there is, as indicated, ample precedent that an “elective bequest” will not violate the terminable interest rule if the election to take the bequest is in fact made.
The power of appointment cases make better theoretical sense. Although it is quite clear that a gift of a testamentary general power of appointment over property does not qualify (absent a gift of the income interest as well), a gift of a nonlapsing lifetime general power of appointment (over income and corpus) will qualify under §20.2056(b)-5(f)(6), and well it should.
Now, what if after having been granted a GPA over an interest the spouse exercises that power to make a gift. Is the marital deduction lost retroactively? No. If the matter were analyzed as an elective bequest the answer would be yes, but obviously, the elective bequest line is inappropriate in this case. What we have here is no different than a case where property has been given to a spouse unconditionally, and the spouse in turn makes a taxable gift of the property to a third party.
So how are bequests to spouses of a participant’s interest in a qualified plan or IRA to be analyzed: (1) as a gift of an unlimited lifetime power of appointment or (2) as an elective bequest? If the latter, then a spouse who fails to take a lump sum distribution within a reasonable period of time after the death of a decedent may be considered (in effect) to have elected out of entitlement to the marital deduction, which will probably come as a surprise to several million Americans and their lawyers. If the former, then the spouse’s election as to the actual form of the distribution should be irrelevant, so long as a lump sum distribution was available, and the decedent’s estate will get a marital deduction for it (phew!).
If the IRA or plan fiduciary has the power to determine whether or not the spouse can receive a total withdrawal of the spouse’s interest, then there is definitely a terminable interest problem. Under §411(d)(6) the fiduciary of a qualified plan cannot have this power. Does an IRA custodian have this latent power where the document is silent? Perhaps, but the notion seems unlikely, if not far fetched.
It is an interesting question whether (or to what extent) a beneficiary has the right to give up (assign, alienate?) an otherwise unrestricted right to a death benefit under a qualified plan or IRA, without disqualifying the plan or IRA. Perhaps this right exists if the form chosen is an irrevocable annuity with a term certain feature and no right to accelerate. If so, §401(a)(9) defines the outer limits.
Let us assume, for the sake of argument, that the beneficiary has this right. Does it make a difference to our analysis whether the alternative form of benefit is elected by the beneficiary or is the result of a failure to make an election? Perhaps.
The marital deduction is more likely to be available if the general power of appointment cases apply than if the election cases apply. The reason is that the election cases require some kind of affirmative act within a limited period of time, failing which the marital deduction is lost, whereas under the general power of appointment cases the marital deduction is not dependent upon future events.
If the termination of the interest requires the affirmative act of the beneficiary, then the power of appointment line of cases should be applicable, not the election cases, meaning that there should be no problem. It should be beyond cavil that so long as the beneficiary has the right to draw down the interest at any time, the power of appointment cases should apply and the marital deduction will automatically be available. If, on the other hand, the interest will terminate in the absence of an affirmative election, then the elective bequest cases may apply.
If there is a problem here, it should be confined to two narrow situations only: (1) where the IRA fiduciary really has the latent power to veto an acceleration election by a beneficiary, or (2) where the default under §401(a)(9) is installments with no power of acceleration. If these are the facts then it is arguable that the marital deduction is lost because of the terminable interest rule. If these are the facts, but the beneficiary has the right for a limited period of time to take a lump sum distribution, then if the right is treated as an elective bequest, entitlement to the marital deduction will depend on whether or not a timely lump sum election is made.
My position is that before an IRA fiduciary can have a veto power, and before a default provision can preclude a right of withdrawal or acceleration, the document would have to be very specific and that such broad power to affect the beneficial enjoyment of a beneficiary’s interest can never be implied. Further, if the beneficiary fails to survive the complete distribution of his interest, the undistributed benefit should be payable to the beneficiary’s estate, unless the document specifically provides otherwise, or unless state law on the subject is bizarre. (Consider whether the beneficiary of an insurance policy is ever thought to be faced with these sorts of problems when the policy is silent.)
In conclusion, if one of the alternative forms of benefit available to a surviving spouse is a lump sum distribution, then even if this form is not chosen, the spouse's beneficial interest in the plan proceeds ought to qualify for the marital deduction absent very unusual facts. Clearly such a result is called for under existing authorities if the spouse has, in effect, a nonlapsing presently exercisable general power of appointment over the benefits, so complete as to be the equivalent of outright ownership.
This whole analysis is admittedly problematic.[79]
If it is clear that under all contingencies only the spouse will receive distributions so long as living, and that any benefits remaining undistributed at the spouse’s death will pass to the spouse’s estate, then the marital deduction ought to be available no matter what elections are available to the spouse and no matter what powers the trustee has or does not have to affect the timing of distributions during the spouse’s lifetime.[80] In such a case, there is no terminable interest.
The participant clearly ought to be able to assure payment to
the spouse’s estate on the spouse’s death by so indicating on the beneficiary
designation form.
If the Trustee or other plan fiduciary has the discretion to determine the time and manner in which a beneficiary is to receive the participant's death benefit, the participant's interest ought not to qualify for the marital deduction unless the benefit will ultimately be payable to the spouse's estate. It is easy to understand why. For instance, if the participant's account balance is payable to the surviving spouse in equal installments over a thirty year period and if the spouse survives the participant for six months and the undistributed benefit remaining passes to the children without being taxed in the spouse’s estate,[81] the Service would understandably view with displeasure any attempt to benefit from the marital deduction. This is the type of situation that the nondeductible terminable interest rule was designed to prevent.
If, on the other hand, the remaining undistributed benefit on the spouse's death were payable to the spouse's estate, the potential for abuse would be gone, and the marital deduction ought to be available under the estate trust rules.[82]
The examples just illustrated serve to demonstrate why it is necessary for the estate planner to be familiar with the terms of the plan and the terms of any outstanding beneficiary designations. It may be that the planner would prefer that the estate not be the ultimate beneficiary, in order to bypass the spouse's estate to the extent of the unified credit exemption equivalent; however, as indicated, the price is the loss of the marital deduction, and the point to be made is that the choice of which way to go should be made consciously.
Final Treas. Reg. §1.411(d)-4 holds that lodging discretion in the trustee or other fiduciary to limit the available forms of alternative benefits under a qualified plan may be a per se violation of IRC §411(d)(6). If one of the alternative forms of benefit available to a surviving spouse is a lump sum distribution, the rule may have the salutary side effect of assuring the availability of the marital deduction in instances where discretion as to the form of payment would otherwise have made the deduction unavailable.
Although the consent requirements of §411(a)(11) do not apply to a death beneficiary,[83] optional forms of death benefits are nevertheless protected benefits under §411(d)(6).[84]
As ever and always, one must be mindful of the impact of the community property laws on these rules. It is only the decedent’s community and separate property interest that is taxable for estate tax purposes. The spouse, however, may have made a taxable gift of his or her community property interest if the property passes to a third person, as discussed in more detail elsewhere herein.[85]
If the nonparticipant spouse in a non-community property state waives the QPSA or the QJSA and then dies, there should be no estate tax consequence to that spouse’s estate so long as no interest in the plan was retained in connection with the waiver.
If the participant’s spouse in a non-community property state does not waive the QPSA or the QJSA, the spouse, on death, should not have any interest in the participant's plan subject to estate tax, since the spouse did not make a transfer and since whatever the interest the spouse had by virtue of federal law no longer exists on the spouse's death. Furthermore, a §2056(b)(7)(C) deduction (discussed above) might also be applicable.
In a community property state the transfer tax questions are more involved.
The Congressional intent on this issue is clear. The 1986 Tax Reform Act repealed IRC §2039(c)/(d) which previously allowed an exclusion from estate taxes for qualified plan interests which were includable in the decedent's gross estate solely by reason of the decedent's interest in community income under the community property laws of the state. In explaining the intended effect of TRA §1852(e) (repealing §2039(c)), the Technical Corrections Blue Book states:
“Under the Act, the special community property rules applicable to qualified plans for purposes of the estate and gift tax provisions are repealed. However, the Act clarifies that, if a transfer is made to an employee spouse by a nonemployee spouse in a community property state, the amount transferred is eligible for the unlimited marital deduction (secs. 2056 and 2523).
“The Act also repeals the general exemption from the gift tax provisions of transfers pursuant to the exercise or nonexercise by an employee of an election or option under a qualified plan, etc.” (Emphasis added.)
A virtually identical statement is reputed to be in the Conference Committee Reports and in the Report of the House Ways and Means Committee to H.R. 3838. The Senate Finance Committee Report at page 1019 has the same statement.[86] Nevertheless, it is believed that this statement is in error, as there does not, in fact, appear to be anything in the Act that might be supposed to clarify that if a transfer is made to an employee spouse by a nonemployee spouse in a community property state the amount transferred is eligible for the unlimited marital deduction. Clearly, however, §1852(e) of the Act did repeal §§2517 and 2039(c), thereby doing away with the special community property rules applicable to qualified plans for purposes of the estate and gift tax provisions.
The 1997 Taxpayer Relief Act amendments to 2056(b)(7)(C) are yet another attempt to finally cure the problem, but the cure requires that the interest be an annuity interest.
“Treatment of Survivor Annuities.- In the case of an annuity included in the gross estate of the decedent under section 2039 (or, in the case of an interest in an annuity arising under the community property laws of a State, included in the gross estate of the decedent under section 2033) where only the surviving spouse has the right to receive payments before the death of such surviving spouse-
(i) the interest of such surviving spouse shall be treated as a qualifying income interest for life, and
(ii) the executor shall be treated as having made an election under this subsection with respect to such annuity unless the executor otherwise elects on the return of tax imposed by section 2001.”[87]
If the participant has an interest under a profit sharing plan that provides a single sum distribution at retirement at the only option, does the predeceasing nonparticipant spouse’s estate receive a marital deduction under amended §2056(b)(7)(C)? What is an annuity?
Why might a transfer by a nonparticipant spouse to the employee spouse not qualify for the marital deduction? It probably would qualify, but then again, the interest "passing" does not pass in all events. The interest could be cut off in favor of a new spouse. Also, the interest passing to the participant is not subject to rights the equivalent of ownership. For instance, the plan might restrict the participant's ability to designate his estate as the beneficiary of the undistributed benefits at death.
In a community property state, the non participant spouse will have a one-half interest in the participant's plan which will presumably be subject to estate tax either under §2033, §2039 or §2041, unless the marital deduction applies.
If the interest is in pay status and is being received in true annuity form, there should be a marital deduction available both because the interest will never pass to anyone other than the spouse, and if for some reason that is not good enough, §2056(b)(7)(C) should suffice to solve the problem, assuming that the non participant spouse at death does not, or is unable to, divest the survivor of the survivor annuity interest.[88] Otherwise, the question of whether the nonparticipant spouse gets a marital deduction will be crucial.
If the benefit is in pay status, but is not payable in the form of a true life only annuity, then whether or not a marital deduction is available may depend on whether the benefit qualifies as an annuity under either §2056(b)(7) flush language, last sentence, or §2056(b)(7)(C) as previously discussed.
If the nonparticipant spouse dies first in a community property state and the benefit is not in pay status, it is not at all clear, even after the 1997 TPRA amendments to §2056(b)(7)(C), that a marital deduction will automatically be available to the participant’s spouse's estate.
Why might a transfer by a nonparticipant spouse to the employee spouse not qualify for the marital deduction? The interest "passing" does not pass in all events. Whatever the nature of the interest, if any, which passes to the participant from the nonparticipant in such a case, it is doubtful that the interest literally qualifies under either 2056(b)(5) or (6) or, possibly, (7). But is the beneficial ownership in the participant so great as to be the equivalent of outright ownership, and if so, is this sufficient to obtain a marital deduction? The participant's rights under the plan following the nonparticipant spouse's death are not unlimited. For one thing, if the participant remarries, the new spouse will be able to cut off or limit that portion of the participant's interest which is subject to the survivorship rules. If the interest is an “annuity,” then the 1997 TPRA amendments to §2056(b)(7)(C) may allow the interest to qualify for QTIP treatment, but if the interest is not in pay status, is it nevertheless an “annuity.”
Despite the foregoing, it is expected that the IRS in most cases will treat the interest as qualifying. Why? For reasons of politics, policy and Congressional intent, or, perhaps, because the interest which passes to the spouse is the “equivalent of outright ownership.” Recall that the Service appears to believe that §2056(b)(7)(C) (discussed above) applies to both sides of the community property fence, even where the benefit is not in pay status, and that this may suffice to obtain a marital deduction.[89] In PLR 8943006 the Service held that the wife’s community property interest in her husband’s Louisiana qualified plan was includable in her estate under IRC §2039 but that her estate was entitled to a marital deduction.
A related question is whether under State law the nonparticipant spouse has any rights of testamentary disposition over his or her community property interest in the participant's plan. See below.
A final argument in favor of the marital deduction is that the only real event or contingency under which the nonparticipant’s community property interest passing to the participant might later pass to someone other than the participant or the participant’s estate is the event of remarriage, in which case federal law may require that the interest in question ultimately pass to the new spouse. The application of federal or state law, it is submitted, should not be an “event or contingency” within the purview of the terminable interest rule. If it were, then any disposition in favor of a spouse could arguably be said to be a terminable interest because of the event or contingency of the spouse’s remarriage followed by prior death or divorce, in which case state divorce or probate laws might mandate that the interest passes to the new spouse.
Under normal circumstances, the decedent's undistributed interest in a qualified plan is going to be a nonprobate asset. If a large portion of a decedent's estate consists of qualified plan proceeds which do not qualify for the marital deduction, the probate estate may be entirely depleted in paying the estate taxes attributable to the plan benefits. Avoiding such a situation may require advance planning on the part of the attorney or other advisor.
In the case of life insurance proceeds payable under a plan and included in the decedent's estate, IRC §2206 might be of help. §2206 is an estate tax IRC provision which purports to grant a decedent's executor the right to recover from an insurance policy beneficiary an amount equal to the estate taxes attributable to the policy; however, there is no corresponding IRC provision specifically designed to reach a decedent's community property interest in qualified plan proceeds.
§2207 imposes liability on the recipient of property over which the decedent had a power of appointment under §2041. Does the decedent have a power of appointment over plan benefits under IRC §2041, such that, in the absence of contrary directions under the will, the executor can avail himself of IRC §2207 to seek reimbursement for estate taxes from the beneficiaries of the benefits? Probably not, in the case of the participant, because §2041 does not apply to powers reserved by the decedent to himself:
“(2) Relation to other sections.
“For purposes of §§20.2041-1 to 20.2041-3, the term 'power of appointment' does not include powers reserved by the decedent to himself within the concept of sections 2036 to 2038. . . “[90]
However, IRC §2207B(a) provides for a right of recovery in the case of any property includable in the estate by reason of a retained power under §2036. This provision was enacted in conjunction with the passage of §2036(c). But §2036 requires a lifetime transfer. Presumably, estate tax includability will be under §2039 in the case of the participant, not §2036 (or §2041).
Probate Code §322A provides a comprehensive estate tax apportionment statute affecting Texas decedent's estates.
In the absence of a contrary direction in the decedent's will, the personal representative is directed to charge each person interested in the estate a portion of the estate tax assessed against the estate. The portion of the total estate tax that is charged to each person interested in the estate must represent the same ratio as the taxable value of that person's interest in the estate bears to the total taxable value of the interests of all persons interested in the estate.
Expenses incurred in connection with the determination or collection of estate taxes are likewise apportionable. The executor is charged with the duty to make recovery unless the cost would be economically impractical.
No estate tax is charged to a gift qualifying for the marital or charitable deduction, nor is a charge made against a temporary interest such as a life estate or a term for years.
Probate Code §322A is not confined to probate assets, but allows recovery against any person interested in the decedent's estate, including anyone who is entitled to receive property included in the decedent's taxable estate.
The new statute is effective for estates of persons who die after September 1, 1987. An estate of a person who dies prior to that date is governed by prior law.
The law in Texas, prior to the enactment of Code §322A was somewhat uncertain. It is thought that the residuary estate would ordinarily be the primary source for payment of debts and expenses, including estate taxes, absent a contrary direction in the will, although inheritance taxes may have been apportionable.[91]
The anti-alienation rule of ERISA may operate to prohibit the executor from imposing a charge on a qualified trust.[92] If the plan is subject to Title I of ERISA, then the anti-alienation rule will presumably preempt any state apportionment law. Even if IRC §2207 or §2207B(a) would otherwise apply (a problematic assumption), are these sections overridden or preempted by IRC §401(a)(13) (the anti-alienation rule of the IRC) or by ERISA §206(d) (the anti-alienation rule of ERISA)? Federal law is usually not preempted by federal law (at least not under the Supremacy clause).
A particularly thorny problem concerns the tax on the community property interest of the nonparticipant spouse. The 1986 Tax Reform Act repealed IRC §2039(c) which previously allowed an exclusion from estate taxes for qualified plan interests which are includable in the decedent's gross estate solely by reason of the decedent's interest in community income under the community property laws of the state. This means that the nonparticipant decedent spouse's interest in the surviving participant spouse's qualified plan might now be includable in the nonparticipant decedent spouse's estate, whether or not the decedent had any lifetime or testamentary power of disposition over the property! This gets us back to the question of whether §2039 applies to the spouse in the first place. For a long time §2039(c)/(d) obviated the need to make this determination. Of course, if the spouse has a testamentary power of disposition, §2041 (if not §2033[93]) would suffice for inclusion. (§2039(c)/(d) was a “notwithstanding any other provision of law” type statute.)
§2041 ought to apply in the case of a nonparticipant’s community property interest in an IRA, since clearly the principles of Allard v. Frech[94] would be applicable. If Allard is not preempted by ERISA then §2041 will apply to the nonparticipant’s interest in a qualified plan as well. §2207 imposes liability on the recipient of property over which the decedent had a power of appointment under §2041. In addition, Texas Probate IRC §322A would technically allow recovery against the recipient.
However, in both cases, it may be difficult to recover against a qualified plan because of the anti-alienation rule and Federal preemption. As I have long pointed out, under the principles of Free v. Bland [95] and Meek v. Tullis[96] there was a question of whether the effects of preemption can be avoided by recovery against the participant herself. That question has been laid to rest by the U.S. Supreme Court in the Boggs[97] decision.
In Boggs v. Boggs,[98], five of the nine justices squarely held that Dorothy Boggs had no power to transfer at death her interest in her husband’s undistributed benefits under a pension plan subject to ERISA. To the extent state law would have provided a contrary result, it is preempted. Further, citing Free v. Bland,[99] the state of Louisiana could not make an end run around the federal rule by seeking an accounting from Isaac Boggs’ beneficiary, his new wife Sandra.
Even if recovery can eventually be made when the benefits are paid, the executor might have to wait many years before reimbursement could be obtained, and the statutes do not contemplate an interest charge for the wait. (Be reminded, in the case of an IRA, however, there is no anti-alienation or preemption rule to impede the executor.)
It may be that the nonparticipant has no power of testamentary disposition over his community property interest in the survivor's plan because of preemption. If so, query which (if any) IRC section explicitly requires includability in the gross estate.
On the face of it, §2039 could not apply since it only applies to amounts receivable by a beneficiary “by reason of surviving the decedent” Further, §2039(b) limits inclusion under §2039(a) to the decedent’s proportionate contribution toward the purchase of the of the benefit. For this purpose a contribution by the “decedent’s employer” is considered as being made by the decedent, “if made by reason of his employment.” The Service does not interpret §2039 literally, however.[100]
If, as would clearly be the case in an IRA, the nonparticipant has a testamentary power, then §2041 would cause inclusion. If, however, as might be the case with a qualified plan, the preemption applies to cut off the spouse’s testamentary power, then perhaps the spouse does not have a power of transfer covered by the estate tax (which is, after all, an excise tax on the right to transfer). Alternatively, if the asset is simply includable under §2001 (which makes one wonder why §2039 was ever thought necessary), then perhaps the spouse’s interest (over which the spouse has no control) will “pass” to the participant, and if there is no event or contingency under which that interest will fail and pass to someone other than the spouse (such as a new spouse as defined by REA), then the predeceased spouse would perhaps be entitled to a marital deduction. In either case there will be no estate tax to apportion and the issue may be moot.
Under the present state of the law, it appears that the nonparticipant's interest is a probate asset for the nonparticipant and a nonprobate asset for the participant. In either case, if the benefit is not in pay status, it is going to be difficult to collect the tax.
Whether it is wise to direct apportionment against plan assets depends. Not to do so risks bankrupting the residuary estate. If the beneficiaries are the same, this may be of little consequence.
To direct apportionment may mean that the plan assets will have to be taken out of tax free solution, meaning that income, and perhaps excise, taxes will have to be paid on the assets so that the net amount available will be sufficient to pay the apportioned estate taxes.
What happens if the residuary beneficiaries, who are also the beneficiaries of a trust that is the beneficiary of the decedent’s interest under an IRA, pay the trustee’s portion of the estate taxes on the trust? Is the debt forgiven, or do the beneficiaries simply have a subrogated claim against the trust. If the latter, what happens when the statute of limitations runs against the subrogated claim?
If the beneficiaries are the same, or if a trust is both the residuary beneficiary and the beneficiary of the retirement benefits, it should make no difference who is charged. Under Texas apportionment law, the estate tax is charged against the “person interested in the estate,”[101] not the fund.
If the beneficiaries are not the same, and formula clauses are used, apportionment may only be an issue with respect to the excess accumulations estate tax (IRC §4980A(d)), in which case the formula may self adjust whoever is charged. If the beneficiaries are not the same, and there will be estate taxes in any event, such as might be the case if the decedent leaves half of his net taxable estate to his children, and the other half to his new spouse, it may be appropriate to charge the spouse with a share of estate taxes, even if this reduces the size of the marital deduction, if the intent is that after all taxes, debts and expenses are paid, the children and the spouse will receive equal shares.
These are hard questions, in light of which, the attorney should not be faulted for recommending that the will simply direct everyone to pay her fair share, in whatever manner is called for under state apportionment. On the other hand, if the client can swallow the additional complicated drafting necessary to accommodate the questions raised above, such a adjustment to the tax apportionment provisions of the will might be beneficial.
The estate of the decedent is liable for the excess accumulations estate tax imposed under §4980(d).[102] State estate tax apportionment law may automatically give the estate a right of reimbursement against the recipient (unless there is a “deduction allowed” with respect to the property “because of the relationship of the person interested in the estate to the decedent”[103]), and in many cases it would seem more appropriate for the recipient to pay the tax. But if the recipient is forced to take a distribution to pay the excise tax, he will have to pay an income tax first. Therefore, the testator may wish to vary the statutory scheme, particularly if a portion of the account balance is passing to the beneficiaries of a nonparticipant predeceased spouse. Can state apportionment laws[104] be utilized here without running into our old friend the anti-alienation rule?[105]
For decedents dying after December 19, 1989, there is no longer any estate tax deduction for qualified sales of employer stock to an ESOP. We all knew it was to good to be true and we dearly miss Senator Long.
For decedent’s dying before December 20, 1989, the old law is still applicable. Under prior law, brief though its existence may have been, IRC §2057 (the old "Orphan's Deduction section, orphaned yet again) allowed an estate to deduct an amount equal to 50% of the proceeds from a qualified sale occurring after October 22, 1986 and before January 1, 1992 of employer securities to an employee stock ownership plan (an ESOP) described in IRC §4975(e)(7) or to an eligible worker-owned cooperative (an EWOC) within the meaning of IRC §1042(c). The statute as originally enacted apparently did not require that the decedent owned the qualifying securities during lifetime! This was an oversight[106] and was the subject of a technical correction under the Omnibus Budget Reconciliation Act of 1987 (OBRA ‘87), a.k.a. the Revenue Act of 1987, Pub. L. P.L. 100-203.
§2517(a) used to exempt from gift taxation the election or nonelection of an employee of a right or option under a qualified plan whereby an employee's interest derived from employer contributions passed to a third party at or after the employee's death. §2517(c) formerly contained a similar provision exempting from gift tax the transfer of a nonparticipant spouse's community property interest in the participant's qualified plan derived from employer contributions. Now that §2517 is no longer a part of the IRC, it is particularly appropriate to analyze elections with respect to qualified plan death benefits to determine whether or not a transfer subject to the gift tax statutes has occurred.
It is relatively difficult for the Participant to make a gift of his interest prior to the time his interest becomes payable, because the ERISA anti-alienation rule prohibits most transfers by the Participant.[107] However, the participant’s spouse is practically invited by the IRC to waive his interest under his spouse’s plan.[108] IRC §2503(f) operates to protect the spouse from transfer tax as a result of such waiver in a noncommunity property state, but affords no protection against transfer tax applicable to a transfer (as a result of such waiver) of a spouse’s community property interest.
In the case of separate (noncommunity) property, the only interest that a nonparticipant spouse will have in the plan will be the federally created interest under REACT. Although it is questionable whether the nonparticipant's interest under REACT is a property interest subject to the transfer tax statutes, the question has been mooted by new IRC §2503(f).
The Explanation of the Technical Corrections Provisions of the 1986 Tax Reform Act (the Technical Corrections Blue Book) prepared by the Joint Committee Staff, states:
“The Act provides that the waiver of the qualified joint and survivor annuity or a qualified preretirement survivor annuity by a nonparticipant spouse prior to the death of a participant does not result in a taxable transfer for purposes of the gift tax provisions.”
The provision referred to was added by §1897(b) of The Technical Corrections portion of the 1986 Tax Reform Act which in its turn added a new subsection (f) to §2503 of the IRC which now reads as follows:
“(f) Waiver of Certain Pension Rights.--If any individual waives, before the death of a participant, any survivor benefit, or right to such benefit, under section 401(a)(11) or 417, such waiver shall not be treated as a transfer of property by gift for purposes of this chapter.”[109]
Query whether there is a survivor benefit that the participant can waive. The protection of §2503(f) extends to "any individual." Also note that the waiver must take place during the lifetime of the participant for the gift tax exclusion to apply.
In the case of community property, however, IRC §2503(f) does not foreclose the gift tax issue since the participant’s spouse will have rights that do not arise under either §§401(a)(11) or 417, but which arise under state law. Now that §2517(c) is no longer part of the IRC there is no blanket exemption for transfers of a community property interest in a plan, and the issue is liable to turn upon whether the gift is complete, and if so, whether it qualifies for a marital deduction.
§2517(c) used to exempt from gift tax the transfer of a nonparticipant spouse's community property interest in the participant's qualified plan derived from employer contributions, but §2517(c) was repealed by the 1986 Tax Reform Act. The estate tax corollary to §2517(c) was found in §2039(c), which was also repealed by the 1986 TRA. It was thought by some that through the careful use of §2039(c) and §2517(c) a transfer in a community property state of the nonparticipant spouse's community property interest in the participant's plan could be made to children, for example, without incurring any transfer tax whatsoever! It is doubtful that planners will be able to use §2503(f) as a means of avoiding transfer tax altogether in the case of a nonparticipant's community property interest (by waiving the right to the survivor annuity in favor of a third party), as was formerly the case under §§2039(c) and 2517(c), but this remains to be seen.
In treating the gift tax issues associated in particular with spousal waivers of a community property interest under a qualified plan, a good starting place is Treas. Reg. §25.2511-2, which deals with the question of when a gift is complete, which is in large measure a function of the cessation of the donor's dominion and control.
Treas. Reg. §25.2511-2 provides in part as follows:
Ҥ25.2511-2. Cessation of donor's dominion and control.
“(a) The gift tax
is not imposed upon the receipt of the property by the donee, nor is it
necessarily determined by the measure of enrichment resulting to the donee from
the transfer, nor is it conditioned upon ability to identify the donee at the
time of the transfer. On the contrary, the tax is a primary and personal
liability of the donor, is an excise upon his act of making the transfer, is
measured by the value of the property passing from the donor, and attaches regardless
of the fact that the identity of the donee may not then be known or
ascertainable.
“(b) As to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another, the gift is complete. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined. For example, if a donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among his descendants, no portion of the transfer is a completed gift. On the other hand, if the donor had not retained the testamentary power of appointment, but instead provided that the remainder should go to X or his heirs, the entire transfer would be a completed gift. . . . .
“(c) A gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title to the property in himself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard. . . .
* * * * * *
“(e) A donor is considered as himself having a power if it is exercisable by him in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property or the income therefrom. A trustee, as such, is not a person having an adverse interest in the disposition of the trust property or its income.”
Under REACT spousal consent is required before a participant may elect to waive the QPSA. Under IRC §417(2)(A)(ii) as amended by TRA '86 the election must designate "a beneficiary (or a form of benefits) which may not be changed without spousal consent (or the consent of the spouse expressly permits designations by the participant without any requirement of further consent by the spouse)."
Where a participant’s spouse executes an irrevocable consent to a beneficiary designation in a community property state, has the spouse made an adjusted taxable gift of the death benefit portion of his interest in the plan? There may be a threshold question as to whether or not a transfer of a property interest has taken place, because if it has not, it may be that we need look no farther. On the other hand, if this amounts to a transfer, then the question may boil down to whether or not the gift is complete. If this were viewed as the release of a power of appointment, the issue might be easier to understand, but, as was alluded to earlier, IRC §§2514 and 2041 ought not to be applicable in a case where the power holder has an interest in the property that is the subject of the power.
The fact that the beneficiary will not receive the benefit unless the beneficiary survives the participant, and will not receive the benefit if the participant retires and draws down the entire benefit, does not alone make the gift incomplete.[110]
There are two questions that are particularly relevant in this context: (i) has the nonparticipant spouse retained a unilateral power to change the beneficiary or (ii) has the nonparticipant spouse retained a power, in conjunction with any person not having a substantial adverse interest, to change the beneficiary. If either is the case the gift will be incomplete.
In a common fact pattern the consent of the nonparticipant to a beneficiary designation will be irrevocable unless the participant revokes the designation, in which case the consent of the nonparticipant will again need to be obtained before a new designation will be wholly effective. Recall the provisions of §25.2511-2(e) which would treat a gift as being incomplete if the donor retains the power to change the beneficiaries either alone “or in conjunction with any person not having a substantial adverse interest in the disposition or the transferred property.” Is the interest of the participant adverse?
For examples of what constitutes a substantial adverse interest for purposes of IRC §2041, see Treas. Reg. §20.2041-3(c)(2):
“A coholder of the power has no adverse interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power. However, a coholder of a power is considered as having an adverse interest where he may possess the power after the decedent's death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate. Thus, for example, if X, Y, and Z held a power jointly to appoint among a group of persons which includes themselves and if on the death of X the power will pass to Y and Z jointly, then Y and Z are considered to have interests adverse to the exercise of the power in favor of X. Similarly, if on Y's death the power will pass to Z, Z is considered to have an interest adverse to the exercise of the power in favor of Y.” (Emphasis added.)
If the beneficiary were not the participant’s estate, one would think that the participant’s interest would not be adverse to a beneficiary designation change, and that therefore, the gift would be incomplete. However, if the nonparticipant does not have a testamentary power of disposition over his community property interest in the plan, then the participant will presumably possess the power after the decedent’s death to revoke the designation and name his estate as the beneficiary. For §2041 purposes that would seem to constitute an adverse interest.
At this point we should consider whether the adverse interest test of §2041 ought to be the same under §2511, since the underlying issues are very different. For example, for IRC §2041 purposes adversity helps, whereas for completed gift purposes it hurts.
It would seem that in the gift tax context the issue ought to turn on the identity of the death beneficiary. If a third party is the designated beneficiary, the participant's interest in the death benefits would not be adverse to a change of beneficiary and the gift ought to be incomplete; but if the beneficiary were the participant's estate, the participant would be adverse to the revocation of the designation and the gift should be complete; however in that case a gift tax marital deduction might be available.
TRA '86 now expressly sanctions blanket consents as long as a
nonblanket consent is another available option.[111]
If the consent is a blanket consent, the non-participant has not retained a
power to revoke at all, and the preceding discussion becomes moot.
If the nonparticipant spouse has a testamentary power of disposition over his community 1/2 interest under the Plan, then it seems clear that the gift cannot be complete. Recall the following sentence from Treas. Reg. §25.2511-2(b):
“For example, if a donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among his descendants, no portion of the transfer is a completed gift.”
The case of Allard v. Frech[112] was discussed above. In that case the Texas Supreme Court held that a nonparticipant spouse has a testamentary power to dispose of the spouse’s community one-half interest in the participant’s retirement plan. Assuming the case is correct, the nonparticipant is free to dispose of his interest by will.
This would presumably be true notwithstanding any consent (revocable or otherwise) to a beneficiary designation intended to take effect on the death of the participant. After all, it is unlikely that the beneficiary designation will be at all concerned with the nonparticipant’s death. Further, it is not clear that the nonparticipant has the right to make a nontestamentary transfer which is effective only at death.
In any event, we can safely say that at least one salutary side effect of the Allard case is that so long as it is the law it guarantees that any consent to a beneficiary designation by a nonparticipant spouse will be subject to a retained general testamentary power of appointment to the extent the spouse had a community property interest in the plan that might have been subject to the gift tax, and that the retention of such a power makes the gift incomplete and ineffective under the principles of Treas. Reg. §§25.2511-2(b).
If the community property interest of the Participant’s spouse passes to a third party upon the participant's death pursuant to the participant's beneficiary designation or the terms of the plan, there will certainly be a gift by the surviving spouse at that time, whether or not the spouse consented to the gift.[113] The situation is analogous to a community property life insurance contract on the life of a deceased spouse where the beneficiary is not the survivor. This has long been held to be a gift by the surviving spouse.[114] Of course, if the situation amounts to fraud on the spouse, the spouse may have equitable remedies to call upon.
If a participant’s spouse waives the QPSA or the QJSA in such a manner that the participant has the power to designate anyone as the death beneficiary, and if such waiver constitutes a completed gift, then will it qualify for the marital deduction? An argument the marital deduction is available is that the participant has such a degree of beneficial control as to be the equivalent of an outright ownership and could designate his estate. Nonetheless, the question is not free from doubt. Of course, this question is also affected by the issue of whether or not the transferor has retained anything.
If there is a gift, what is its value? Presumably, the value of the gift would have to be determined in light of the contingencies attendant to it, including the contingency that the beneficiary would receive nothing if the participant survives to take the benefit. However, if Chapter 14 applies, it is altogether another matter.
Since REA, it is no longer necessary to elect a joint and survivor annuity to have the benefit paid in that form. Under present law, one must elect not to receive the benefit in joint and survivor form; and, moreover, the nonparticipant spouse must affirmatively consent to the waiver. So it can no longer be said that the participant has a choice in the matter. Despite this, private letter rulings have held that a participant makes a taxable gift to his spouse where the benefit is paid in joint and survivor annuity form, notwithstanding that the "gift" was made by Congress and not the participant, who may hate his spouse for all we know. This problem may have been partially cured by post TRA '86 legislation,[115] but it is still instructive to view how, in the absence of legislation, a gift could arise as a result of not waiving the QJSA.
As indicated clearly by the regulations, so long as the donor/participant retains the power to revoke or change a beneficiary designation, there will be no completed gift. It would be highly unusual for a participant not to retain this power, at least prior to such time as the benefits begin to be paid. In view of the anti-alienation rules applicable to qualified plans under IRC §401(a)(13) and ERISA §206(d), it is difficult for a participant to complete a gift except in very special circumstances.
Once the participant is entitled to benefits under the plan, it is possible for a gift to arise if the form of benefit chosen provides benefits to the spouse following the participant’s death, and the form of benefit is not revocable by the participant. This is understandable where the participant makes the election voluntarily.[116] However, in PLR 8708008[117] the participant was required by law to accept a reduced lifetime benefit so that his wife would continue to receive benefits after his death. The Service ruled that the gift to the spouse was complete upon the participant's retirement. It did not qualify for the gift tax marital deduction because the participant retained a reversionary interest in the event his wife predeceased him (making it a nondeductible terminable interest) and it did not qualify for the annual exclusion because it was a gift of a future interest. The case arose under the Civil Service Retirement Spouse Equity Act of 1984 which apparently provides for an automatic QJSA in the absence of a joint waiver. Benefits under the Civil Service Retirement Spouse Equity Act were not governed by IRC §401, and thus, were never exempt from estate tax under IRC §2517.
Prior to TRA '86, if a participant exercised or failed to exercise an election whereby an annuity or other payment would become payable to a beneficiary at or after the employee's death, IRC §2517 exempted the transaction from gift tax, if the plan was a qualified plan under §401(a).
There are two potential gifts in a situation involving joint and survivor annuity rights. If the spouse waived the right to the survivor annuity in favor of the participant, it might be argued that a gift from the spouse to the participant was made. (But see new §2503(f), supra.) Or it could be argued, as was the case in PLR 8708008, that the failure to waive the survivor feature amounts to a gift by the participant to the spouse. However, it would be theoretically inconsistent to argue both cases since at a particular instant in time one cannot be both a potential transferee and transferor of the same interest in property; one cannot transfer property in which one does not have any interest, and a transfer to one's self is a nonsequitur. The question to be answered then, is who has the interest that is subject to transfer, the participant, or the participant's spouse.
In PLR 8708008 the wife had a vested interest under the husband's plan created by Federal law. Since, in the absence of a waiver, the husband had no enforceable interest in the wife's survivor benefits, one might have thought that if a potential for a gift existed, it would arise, if at all, upon a waiver by the wife, and not the other way around. Presumably the silver lining in this cloudy ruling is that if the spouse had relinquished her right to the annuity she would not have made a gift.
TAMRA[118] added §2523(f)(6)[119] to the IRC, and this section specifically provides:
“Treatment of Joint and Survivor Annuities.-In the case of a joint and survivor annuity where only the donor spouse and donee spouse have the right to receive payments before the death of the last spouse to die-
“(A) the donee spouse’s interest shall be treated as a qualifying income interest for life,
“(B) the donor spouse shall be treated as having made an election under this subsection with respect to such annuity unless the donor spouse otherwise elects on the date specified in paragraph (4)(A),
“(C) paragraph (5) and section 2519 shall not apply to the donor spouse’s interest in the annuity, and
“(D) if the donee spouse dies before the donor spouse, no amount shall be includable in the gross estate of the donee spouse under section 2044 with respect to such annuity. An election under subparagraph (B), once made, shall be irrevocable.” (Emphasis added.)
In essence, IRC §2523(f)(6) gives automatic gift tax QTIP treatment to spousal annuities. This section raises similar concerns to those raised in the discussion of §2056(b)(7)(C) above. However, here we really did need some relief, because of the possible reversion retained by the donor spouse clearly otherwise results in a nondeductible terminable interest for gift tax purposes. True, the interest will never pass to a third party in the case of a true life contingency only annuity, but the retention by the donor of an interest is enough to defeat the marital deduction without special treatment. §2523(f)(6) appears to supply that special treatment.
Further, we can speculate, as we did in the discussion regarding the interpretation of §2056(b)(7)(C), as to whether or not §2523(f)(6) is confined to pure life contingency annuities or may also apply to installment payouts based upon life expectancy. It would appear here as well that Congress must have had this in mind because the first sentence of §2523(f)(6) requires only that the donor spouse and the donee spouse have the right to receive payments before the death of the last spouse to die. This clearly leaves open the question of whether or not, and even suggests that, payment to a third party at the death of the survivor will be permissible. (In fact, payment to a third party at the death of the survivor is the essence of QTIP.) Again, we were not favored by Congress with a definition of what an annuity is, but we do know that if the annuity is a true annuity with life contingency features only, there will be no payment to a third party at the death of the survivor, and this makes automatic QTIP treatment an odd vehicle for granting a marital deduction.
The estate tax corollary to §2523 is §2056. IRC §2523(f) was added by TAMRA to give a gift tax marital deduction and automatic QTIP treatment for joint and survivor annuities. OBRA[120] changed §2056(b)(7)(C) so that it only applies to “an annuity included in the gross estate of the decedent under section 2039.” A similar change was not made to §2523, and no reference to §2039 will be found there, probably because there is no gift tax counterpart to §2039.
In a community property state the analysis is likely to be different. In a community property state the nonparticipant spouse would have a community property interest in the plan all along, and if there is a transfer, the value of the interest received by the spouse would have been reduced by the recipient’s preexisting community property interest.[121] However, this may be irrelevant under §2523(f)(6). Note that if the annuity is community property, both spouses will be both donees and donors!
We desperately need regulations telling us what an annuity is for §2523(f) purposes. It is very common for spouses to elect annuities with term certain payment periods. Such annuities are probably not qualified annuities under IRC §417! and §2523(f) might not apply.
If a participant with a benefit under a plan marries, the participant's new spouse automatically become vested under REACT with certain indefeasible rights to survivor benefits, which reduce what would otherwise have been the interest of the participant. Does this result in a gift? If so, does it qualify for the unlimited gift tax marital deduction? The answer to the second question is probably no, because of the participant's retention of an interest in the property "transferred."[122]
Congress keeps shooting at the problem, but has so far been wide of the mark.
As indicated above §2503(f) doesn’t cover the community property interest of the nonparticipant in the event of a waiver of REACT spousal rights, and doesn’t keep the participant from having made a gift if the nonparticipant doesn’t make a waiver.
§2523(f)(6) does not define annuities, and thus may be of benefit solely in the case of a gift (voluntary or otherwise) of a life contingency only annuity, and there, only where the benefit is not community property. If the benefit is payable as a term certain payout or in fixed installments, where the contingency exists that the payments may continue to the transferor on death of the spouse or may be made to a third party following the death of the last survivor of the marriage, then unless the term certain payment is an “annuity” §2523(f)(6) will be of no avail. (The problem may be illustrated by the following question. Is a contract to pay $200 per month for life, with a 200 year term certain, an “annuity”?)
As was the case with §2523(f)(6), §2056(b)(7)(C) does not define annuities, and thus may not be of any benefit at all in the only place that it could be relevant, i.e., in cases where the benefit is payable as a term certain payout or in fixed installments, where the contingency exists that the payments may be made to a third party following the death of the last survivor of the marriage.
Same objections as above, plus the additional fact that regulations are required.
There are a number of issues associated with the disclaimer of qualified plan and IRA benefits. First of all, one must consult state law to determine whether the disclaimer of nonprobate assets is even contemplated by the applicable disclaimer statute. Other issues that come immediately to mind are whether, in the case of a qualified plan, the antialienation rule applies, and whether, in the case of an IRA, a disclaimer will be treated as an assignment. Finally, we have a concern as to how the minimum distribution rules are to interact with a disclaimer that takes place after the required beginning date.
Fortunately, the Service has informally taken a liberal position on the application of the antialienation rule (i.e., IRC 401(a)(13) or ERISA §206(d)) to the exercise of a disclaimer. In General Counsel Memorandum 39858 the position taken was that a spouse was entitled to make a §2518 qualified disclaimer of death benefits that were otherwise subject to the joint and survivor annuity rules.[123]
Another issue that might possibly be of concern is whether a disclaimer for estate or gift tax purposes could generate an income tax under the assignment of income rule. This is particularly important in the case of a disclaimer of an interest in a qualified plan or IRA because such interest is income in respect of a decedent (IRD) and has a zero basis. GCM 39858 addressed this issue as well, and held that the disclaimer did not result in an assignment of income. The income on the distribution was to be taxed to the recipient (and not to the disclaimant) when received.[124]
The income taxation of the disclaimed interest was also specifically addressed in PLR 9037048. In that ruling, the Service held that the beneficiary of a disclaimed IRA interest was the payee or distributee for purposes of IRC §408(d)(1), and therefore, the beneficiary of the disclaimed interest —not the disclaimant— would be taxed in the year the interest was distributed.[125]
The problem here is that IRC §2518 provides that a disclaimer is not treated as a transfer for gift tax purposes. The statute does not address income tax issues. However, state law disclaimer statutes affect directly the question of whether or not the disclaimant ever has a state law property interest in the first place. The effect of a disclaimer statute is generally to provide that if the disclaimer is made timely and in the manner provided by statute, the disclaimant is treated as never having had a property interest to assign. A close reading of IRC §691(a)(1)(B) and 691(a)(2), together with GCM 39858 and PLR 9037048, support the idea that a disclaimer is not an assignment because as a matter of state law (read technically, but precisely) the disclaimant never “acquired the right” to receive the amount.[126]
This important issue is discussed in the portion of the outline dealing with §401(a)(9).
See PLR 9450041 for a very interesting fact pattern that permitted a rollover following a nonqualified disclaimer. In the ruling the spouse made a nonqualified disclaimer of her interest in a qualified plan that otherwise passed to a marital deduction trust. As a result of the disclaimer, the interest passed to a credit shelter trust, as a gift. The beneficiaries of the credit shelter trust then disclaimed. Their disclaimer was timely because it was made within 9 months of the untimely disclaimer. As a result of the subsequent disclaimer, the interest passed back to the spouse under the intestate distribution rules. The Service ruled that the spouse could then rollover the proceeds.[127]
At first blush, this ruling is surprising because one would think that the gift from the spouse would violate the anti-alienation rule. However, if the whole picture is viewed at once, the disclaimer of the credit shelter beneficiaries may have cured the problem, since the effect of the gift and the subsequent disclaimer was merely to return the property to the donor.
The Service approved a disclaimer by a spouse in favor of a bypass trust in PLR 9630034. The ruling is interesting on a number of fronts.
Under the terms of Decedent's will, the Decedent devised and bequeathed his entire residuary estate to Spouse, but further provided that if Spouse disclaimed any part of this bequest, the disclaimed portion will not be liable for any debts, funeral and administration expenses and taxes, and will be distributed to [Bypass Trust] Spouse, as trustee, to be held, administered and distributed in accordance with the terms of the trust created under Article FIFTH of the will.
* * * *
At the time of his death, Decedent had reached his required beginning date. Decedent elected to take his minimum required distribution over the joint life expectancy of Decedent and Spouse, with both lives being recalculated. Section 401(a)(9) required distributions from IRA D had begun prior to Decedent's death.
* * * *
Section 25.2518-3(c) of the Gift Tax Regulations relates to the disclaimer of a pecuniary amount. Under that section, the disclaimer of a specific pecuniary amount out of a pecuniary or nonpecuniary bequest or gift which satisfies the other requirements of a qualified disclaimer under section 2518(b) and the corresponding regulations is a qualified disclaimer provided that no income or other benefit of the disclaimed amount inures to the disclaimant either prior to or subsequent to the disclaimer. Thus, following the disclaimer of a specific pecuniary amount from a bequest or gift, the amount disclaimed and any income attributable to such amount must be segregated from the portion of the gift or bequest that was not disclaimed.
The segregation of assets making up the disclaimer of a pecuniary amount must be made on the basis of the fair market value of the assets on the date of the disclaimer or on a basis that is fairly representative of value changes that have occurred between the date of transfer and the date of the disclaimer.
In the present case, Spouse proposes to make a pecuniary disclaimer of a specific portion of Decedent's community one-half interest in IRA D. This disclaimer will be described in terms of a formula that is expressed as a fraction, the numerator of which is the largest amount which, if allocated to the Article FIFTH trust, would not increase above zero the total federal estate tax and those state death taxes computed by reference to the credit allowable under section 2011 payable from all sources by reason of Decedent's death, after consideration of several enumerated items. The disclaimed property (and any income attributable to the disclaimed amount) will be segregated from the portion of IRA D that is not disclaimed and will continue to be held in IRA D while the nondisclaimed portions of IRA D will be transferred to another separate IRA. The payments from IRA D consisting of the disclaimed portion will be paid and will pass without direction on the part of Spouse to the trust created under Article FIFTH of decedent's will.
Additionally, under the Article FIFTH trust, Spouse has a power that is limited by an ascertainable standard to distribute income to herself “for her proper health, education, maintenance and support.” Because the power is so limited, Spouse will not be treated as having the power to direct the beneficial enjoyment of the disclaimed property. See, section 25.2518-2(e)(5), Example 6.
We conclude, therefore, that if the other requirements of section 2518(b) are satisfied, the formula disclaimer by Spouse of a pecuniary portion of Decedent's community one-half interest in IRA D will be a qualified disclaimer for purposes of section 2518.
Additionally, Spouse does not possess a general power of
appointment, within the meaning of section 2041(b)(1), over the Article FIFTH
trust or the separate IRA, or a power or interest that would require inclusion
of the trust or the IRA in the gross estate under sections 2036, 2037, or 2038. Therefore, upon
Spouse's death, the property contained in the Article FIFTH trust, including
the disclaimed portion of IRA D, will not be includible in the gross estate of
Spouse.[128]
This forum does not lend itself to a comprehensive discussion of Generation Skipping Transfer (GST) Tax[129] issues, but a few comments are needful.
The Generation Skipping Transfer (GST) Tax[130] can apply to IRAs or qualified plans. Any time that a grandchild or more remote descendant is a beneficiary or potential beneficiary of a death distribution from a qualified plan or IRA, one must consider whether (a) the death of the participant,[131] (b) a distribution to the grandchild[132] or (c) even the death of a beneficiary who is a child of the participant, if the beneficiary is a parent of the new beneficiary,[133] will attract a GST tax. The tax could either be a result of a direct skip, a taxable distribution, or a taxable termination, depending on the context.
For example, if there were multiple beneficiaries of (a) a trust that was a beneficiary, or (b) of the IRA or qualified plan itself, there could be a taxable termination when the last nonskip person ceased to be a beneficiary —by death or otherwise. If all of the beneficiaries were skip persons at the death of the participant, a direct skip will probably occur at that time. If there are multiple beneficiaries at least one of whom is not a skip person and at least one of whom is, any distribution to a skip person will be a taxable distribution. The tax on taxable terminations, taxable distributions, and direct skips differs, both as to who is responsible for the tax, and in the amount of the tax. Generally, direct skips are favored, because the tax is on the amount passing to the skip person, net of the tax itself, whereas in the case of a taxable distribution or taxable termination, the tax is computed on the amount involved, out of which the tax itself is paid.
The following is a summery of rules that are described in more detail in the remaining provisions of this Subsection.
An IRA, even a custodial IRA, is probably considered a trust for GST tax purposes. If a tax is owed, whether on account of a taxable distribution, taxable termination or direct skip, the tax will be charged against the IRA “unless otherwise directed pursuant to the governing instrument by specific reference to the tax imposed by this chapter.” [134] [Emphasis added.]
This “unless” provision might apply in the case of a direct skip at death, if a will is considered to be the governing instrument referred to, and if the will specifically states that the GST tax (mentioned by name) attributable to the IRA is to be paid by the probate estate. If the only beneficiaries of the IRA were skip persons at the date of death of the participant, the death of the participant should be a direct skip.
The IRA trustee/custodian is responsible for paying the GST tax on (a) a taxable termination, or (b) a direct skip from the IRA[135] or with respect to property that continues to be held in the IRA.[136] However, in the case of a direct skip occurring at the death of a decedent dying after June 23, 1996, a special rule introduced under the final regulations, provides that the executor is responsible for paying the tax initially, if the transfer is less than $250,000. Nevertheless, “the executor is entitled to recover from the trustee (if the property continues to be held in trust) or from the recipient of the property (in the case of a transfer from a trust), the generation-skipping transfer tax attributable to the transfer.”[137]
The transferee (beneficiary) is responsible for the payment of the GST tax in the case of a taxable distribution.[138]
Examples of a GST tax owed with respect to an IRA would include the following:
Direct Skip. The death of the participant, naming a grandchild (whose parent is alive) as the beneficiary, will probably result in a direct skip. (It is arguably a taxable termination too, but here the final regulations give precedence to the direct skip.) Any future distributions to the grandchild would not be GST transfers, because of the multiple skip generation move-up rule of IRC §2653(a).[139] This situation may be fairly common. Although the IRC provides that the tax on a direct skip is to be paid by the trust,[140] a special rule found in the final regulations provides that the executor is to pay this tax, if the transfer is less than $250,000, subject to a right to be reimbursed by the trust. If the governing instrument provides otherwise, it may be that the trustee can recover against the estate for a tax paid on a direct skip.[141]
Taxable Termination. It will be uncommon for a taxable termination of an IRA to occur, but it could happen. A taxable termination could conceivably occur on the death of a child, where the child was the primary beneficiary, if, on the death of the child, the remaining interest was to be paid to a grandchild, but only if the IRA were structured so that the child was not the transferor for estate and gift tax purposes. If the child had a power of appointment over the IRA (e.g., a power of withdrawal), as would usually be the case,[142] the child would be the transferor for estate tax purposes,[143] and thus, the child would be the transferor for GST purposes;[144] in which case, a subsequent transfer to a grandchild of the participant would not attract a GST tax, because the grandchild would not be a skip person in relation to the child.[145] The tax, if any, on a taxable termination, is to be paid by the trust.[146]
Taxable Distribution. If it is in fact possible to have one IRA with multiple beneficiaries, after the death of the participant, and if one or more, but not all, of the beneficiaries were skip persons, then a distribution to a skip person would be a taxable distribution, to be paid by the distributee.[147]
* * * *
Note that no matter who pays the tax, the decision as to whether or not, or the extent to which, to allocate the $1 million GST exemption lies with the executor. So, as a practical matter, the executor may determine whether or not the tax is owed, even though the tax is to be paid by the IRA.
Further, if no executor has been appointed, the IRA trustee/custodian may be treated as the executor,[148] in which case the IRA trustee/custodian will not only owe the tax, but will be responsible for reporting an allocation of the exemption.[149]
A GST tax may only be triggered by one of three events: (a) a taxable termination, (b) a taxable distribution, or (c) a direct skip. The IRC defines these three terms as follows—
Sec. 2612. Taxable termination; taxable distribution; direct skip
(a) Taxable termination.
(1) General rule. For purposes of this chapter, the term "taxable termination" means the termination (by death, lapse of time, release of power, or otherwise) of an interest in property held in a trust unless --
(A) immediately after such termination, a non-skip person has an interest in such property, or
(B) at no time after such termination may a distribution (including distributions on termination) be made from such trust to a skip person.
(2) Certain partial terminations treated as taxable. If, upon the termination of an interest in property held in trust by reason of the death of a lineal descendant of the transferor, a specified portion of the trust's assets are distributed to 1 or more skip persons (or 1 or more trusts for the exclusive benefit of such persons), such termination shall constitute a taxable termination with respect to such portion of the trust property.
(b) Taxable distribution. For purposes of this chapter, the term "taxable distribution" means any distribution from a trust to a skip person (other than taxable termination or a direct skip).
(c) Direct skip. For purposes of this chapter --
(1) In general. The term "direct skip" means a transfer subject to a tax imposed by chapter 11 or 12 of an interest in property to a skip person.
(2) Special rule for transfers to grandchildren. For purposes of determining whether any transfer is a direct skip, if --
(A) an individual is a grandchild of the transferor (or the transferor's spouse or former spouse), and
(B) as of the time of the transfer, the parent of such individual who is a lineal descendent of the transferor (or the transferor's spouse or former spouse) is dead,
such individual shall be treated as if such individual were a child of the transferor and all of that grandchild's children shall be treated as if they were grandchildren of the transferor. In the case of lineal descendants below a grandchild, the preceding sentence may be reapplied. If any transfer of property to a trust would be a direct skip but for this paragraph, any generation assignment under this paragraph shall apply also for purposes of applying this chapter to transfers from the portion of the trust attributable to such property.
(3) Look-thru rules not to apply. Solely for purposes of
determining whether any transfer to a trust is a direct skip, the rules of
section 2651(e)(2) shall not apply.
IRC §2603 provides:
Sec. 2603. Liability for tax
a. Personal
liability.
(1) Taxable distributions. In the case of a taxable distribution, the tax imposed by section 2601 shall be paid by the transferee.
(2) Taxable termination. In the case of a taxable termination or a direct skip from a trust, the tax shall be paid by the trustee.
(3) Direct skip. In the case of a direct skip (other than a direct skip from a trust), the tax shall be paid by the transferor.
b. Source of tax.[150] Unless otherwise directed pursuant to the governing instrument by specific reference to the tax imposed by this chapter, the tax imposed by this chapter on a generation-skipping transfer shall be charged to the property constituting such transfer.
(c) Cross reference. For provisions making estate and gift tax provisions with respect to transferee liability, liens, and related matters applicable to the tax imposed by section 2601, see section 2661. [Emphasis added.]
The regulations under IRC §2603 are found in Treas. Reg. §26.2662-1(c). These regulations provide—
(1) In general. Except as otherwise provided in this section, the following person is liable for the tax imposed by §2601 and must make the required tax return --
(i) The transferee in a taxable distribution (as defined in 2612(b));
(ii) The trustee in the case of a taxable termination (as defined in 2612(a));
(iii) The transferor (as defined in 2652(a)(1)(B)) in the case of an inter vivos direct skip (as defined in 2612(c));
(iv) The trustee in the case of a direct skip from a trust or with respect to property that continues to be held in trust; or
(v) The executor in the case of a direct skip (other than a direct skip described in paragraph (c)(1)(iv) of this section) if the transfer is subject to chapter 11. See paragraph (c)(2) of this section for special rules relating to direct skips to or from certain trust arrangements (as defined in paragraph (c)(2)(ii) of this section).[151]
Note, however, that Treas. Reg. §26.2662-1(c)(2)(iii) contains a special rule for direct skips occurring at death with respect to property held in trust arrangements, including a special, special rule imposing an “Executor's liability in the case of transfers with respect to decedents dying on or after June 24, 1996, if the transfer is less than $250,000.”[152]
The tax on a direct skip from an estate is to be paid by the executor, whether or not it was charged against the property transferred. “In the case of a direct skip (other than a direct skip from a trust), the tax shall be paid by the transferor.”[153]
Part 2 of Schedule R of the Form 706 (U.S. Estate and GST Tax Return) is used to report any direct skips “Where the Property Interests Transferred Bear the GST Tax on the Direct Skips.” Ordinarily, Part 2 or Part 3 would be completed only in those cases where the executor was to pay the tax. As between Part 2 and Part 3, Part 2 is appropriate if the tax paid by the executor is to be charged against the transferred property, and Part 3 would be used if the tax paid by the executor is not to be charged against the transferred property.
The tax on a taxable termination or a direct skip from a trust is ordinarily “to be paid by the Trustee and not by the estate.”[154] The regulations make clear that the trustee is also liable for a direct skip “with respect to property that continues to be held in trust.”[155]
It is important to distinguish between (i) who is responsible for paying the tax, and (ii) whether or not the tax paid is to be charged against the interest transferred. These are different concepts.
Although the executor may or may not be responsible for paying the tax, the source of the tax is another matter:
Unless otherwise directed pursuant to the governing instrument by specific reference to the tax imposed by this chapter, the tax imposed by this chapter on a generation-skipping transfer shall be charged to the property constituting such transfer.[156] [Emphasis added.]
The instructions to the Form 706 provide:
Section 2603(b) requires that unless the governing instrument provides otherwise, the GST tax is to be charged to the property constituting the transfer. Therefore, you will usually enter all of the direct skips on Part 2.
You may enter a transfer on Part 3 only if the will or trust instrument directs, by specific reference, that the GST tax is not to be paid from the transferred property interests.[157]
Part 3 of Schedule R is used to report any direct skips “Where the Property Interests Transferred Do Not Bear the GST Tax on the Direct Skips.”
Schedule R-1 Is Used as a Payment Voucher To Report Direct Skips Of Nonprobate Assets Held in Trust Where the Trustee Owes the Tax. The executor is to complete Schedule R-1 “as notification from the executor to the Trustee that a GST tax is due.”[158] Schedule R-1 serves as a payment voucher to give to the Trustee of a trust to report a direct skip from the Trust occurring by reason of the death of the decedent, where the property in the Trust is includable in the decedent’s estate (e.g., under IRC §§2035-2042). The trustee pays the tax.
Schedule R-1 can also be used to allocate the GST exemption to the direct skip being reported. Note that the trustee can be treated as if the trustee were the executor in some circumstances.
The instructions to the Form 706 provide:
If any of the executors of the decedent’s estate are trustees of the Trust, then all direct skips with respect to that trust must be shown on Schedule R and not on Schedule R-1 even if they would otherwise have been required to be shown on Schedule R-1.
This rule applies even if the Trust has other trustees who are not executors of the decedent’s estate.[159] Although the return requirements are addressed in temporary regulations, this issue is not.[160]
The Form 706 is to be filed by the executor. However, note that—
The term ‘executor’ means the executor, personal representative, or administrator of the decedent’s estate. If none of these is appointed, qualified, and acting in the United States, every person in actual or constructive possession of any property of the decedent is considered an executor and must file a return.[161]
Notwithstanding the foregoing discussion, the final regulations contain a special rule applicable in the case of decedents dying after June 23, 1996 if the transfer is less than $250,000.
Perhaps the simplest approach at this point would be to simply quote the regulations:
(2) Special rule for direct skips occurring at death with
respect to property held in trust arrangements.
(i) In general. In the case of certain property held in a trust arrangement (as defined in paragraph (c)(2)(ii) of this section) at the date of death of the transferor, the person who is required to make the return and who is liable for the tax imposed by chapter 13 is determined under paragraphs (c)(2)(iii) and (iv) of this section.
(ii) Trust arrangement defined. For purposes of this section, the term trust arrangement includes any arrangement (other than an estate) which, although not an explicit trust, has the same effect as an explicit trust. For purposes of this section, the term "explicit trust" means a trust described in 301.7701-4(a).
(iii) Executor's liability in the case of transfers with respect to decedents dying on or after June 24, 1996, if the transfer is less than $250,000. In the case of a direct skip occurring at death, the executor of the decedent's estate is liable for the tax imposed on that direct skip by chapter 13 and is required to file Form 706 or Form 706NA (and not Schedule R-1 of Form 706) if, at the date of the decedent's death --
(A) The property involved in the direct skip is held in a trust arrangement; and
(B) The total value of the property involved in direct skips with respect to the trustee of that trust arrangement is less than $250,000.
(iv) Executor's liability in the case of transfers with respect to decedents dying prior to JUNE 24, 1996, if the transfer is less than $100,000. In the case of a direct skip occurring at death with respect to a decedent dying prior to June 24, 1996, the rule in paragraph (c)(2)(iii) of this section that imposes liability upon the executor applies only if the property involved in the direct skip with respect to the trustee of the trust arrangement, in the aggregate, is less than $100,000.
(v) Executor's right of recovery. In cases where the rules of paragraphs (c)(2)(iii) and (iv) of this section impose liability for the generation-skipping transfer tax on the executor, the executor is entitled to recover from the trustee (if the property continues to be held in trust) or from the recipient of the property (in the case of a transfer from a trust), the generation-skipping transfer tax attributable to the transfer.[162]
Note that “[a]n allocation of GST exemption to a trust is void to the extent the amount allocated exceeds the amount necessary to obtain an inclusion ratio of zero with respect to the Trust.”[163] Although this rule is found under the section of the regulations dealing with lifetime allocations, the rule is not literally limited to this context. A fortiori the same principal would apply in the case of an attempted allocation in excess of the transfer tax value of an asset subject to estate or gift tax, or, an attempt to allocate the exemption to a direct skip that did not exist.
In order to compute the GST tax it is necessary to know the meaning of the following terms.
Taxable Amount
Applicable Rate
Inclusion Ratio
Applicable Fraction
The GST tax is the product of the “taxable amount” times the “applicable rate.”[164] The “taxable amount” is the net value of the property received from the transferee.[165] The “applicable rate” is 55% times the inclusion ratio.[166]
The “inclusion ratio” in the case of non direct skips is the excess of 1 over the “applicable fraction.”[167] The “applicable fraction” in such case is a fraction, the numerator of which is the amount of the GST exemption allocated to the Trust and the denominator of which is the net value of the property transferred to the Trust.
An IRA would almost certainly be considered a trust for GST purposes, even if it was only a custodial IRA. IRC §2652(b) provides-
Sec. 2652. Other definitions. . . .
(b) Trust and trustee.
(1) Trust. The term "trust" includes any arrangement (other than an estate) which, although not a trust, has substantially the same effect as a trust.
(2) Trustee. In the case of an arrangement which is not a trust but which is treated as a trust under this subsection, the term "trustee" shall mean the person in actual or constructive possession of the property subject to such arrangement.
(3) Examples. Arrangements to which this subsection applies include arrangements involving life estates and remainders, estates for years, and insurance and annuity contracts.
While not mentioning IRAs specifically, the regulations tend to
support the notion that a custodial IRA is to be treated as a trust for GST
purposes.
(b) Trust defined. (1) In general. A trust includes any arrangement (other than an estate) that has substantially the same effect as a trust. Thus, for example, arrangements involving life estates and remainders, estates for years, and insurance and annuity contracts are trusts. Generally, a transfer as to which the identity of the transferee is contingent upon the occurrence of an event is a transfer in trust; however, a transfer of property included in the transferor's gross estate, as to which the identity of the transferee is contingent upon an event that must occur within 6 months of the transferor's death, is not considered a transfer in trust solely by reason of the existence of the contingency.[168]
We have discussed above the specific question of whether an IRA is a trust for generation skipping tax purposes, and concluded that it was. We also discussed the question of whether a QTIP election must be made for the IRA as well as or instead of for the QTIP trust, and whether or not it should make a difference whether the IRA is a custodial IRA or a trusteed IRA? And we likewise determined that it made no difference.
At this point we should restate some of the reasons for the conclusions previously reached, and should consider the reasoning abstractly, because there are many cases in which this analysis could be important.
Federal law is fairly clear that there is virtually no difference between trusteed and custodial IRAs. A comparison between IRS Form 5305 Individual Retirement Trust Account Form IRA, and IRS Form 5305-A Individual Retirement Custodial Account Form IRA will disclose that virtually the only difference between the two forms is that one uses the term “Custodian” where the other uses the term “Trustee.”
IRC §408 makes the equation official:
For purposes of this section, a custodial account shall be treated as a trust if the assets of such account are held by a bank (as defined in subsection (n)) or another person who demonstrates, to the satisfaction of the Secretary or his delegate, that the manner in which he will administer the account will be consistent with the requirements of this section, and if the custodial account would, except for the fact that it is not a trust, constitute an individual retirement account described in subsection (a). For purposes of this title, in the case of a custodial account treated as a trust by reason of the preceding sentence, the custodian of such account shall be treated as the trustee thereof.[169] [Emphasis added.]
The section referred to above in italics is 408, but the title is Title 26, which is the IRC.
The question of state law is more problematic. Over time I have been more inclined to view a trusteed IRA as a true trust, though I resisted the inclination for quite a while. I still think that there are some important differences, and that state trust law, if it operates at all, must operate in some modified form here, but I am no longer so sure about how and why exactly.
In the case of a custodial IRA, I think that there is a difference, notwithstanding what the IRC says. There is a long and well established difference between a custodian and a trustee. It may be that both are fiduciaries, but their duties and powers are certainly not the same.
I expect that this an area of developing law in which we will see new cases arise in the not too distant future.
[1] Sec. 525(a) of DEFRA accomplished this by deleting §2039(g). §2039(g) was added to the Code by TEFRA 245(f).
[2]See Instructions for Form 706 (Revised October 1991), page 13. It is interesting to note that the 706 instructions spend about as much time in explaining these mundane rules as in discussing any other matter necessary to the proper completion of the estate tax return.
[3]P.L. 97-248. See 1982-2 C.B. pp. 462 et. seq.
[4]P.L. 98-369. 1984-3 C.B. Vol. 1.
[5]TRA §1852(e)(3). All references to TRA are to the Tax Reform Act of 1986, including the technical amendments to REA, P.L. 99-514.
[6]House Report No. 98-861 at page 1142, 1984-3 C.B. Vol. 2 p. 396.
[7]House Committee Report p. II-851.
[8]The meaning of “pay status” has finally been given to us in Q&A (4) to Temp. Treas. Reg. §20.2039-1T.
[9]TRA §1852(e)(3). All references to TRA are to the Tax Reform Act of 1986, including the technical amendments to REA, P.L. 99-514.
[10]House Report No. 98-861 at page 1142, 1984-3 C.B. Vol. 2 p. 396.
[11]Staff, Joint Committee on Taxation, Explanation of Technical Corrections to the Tax Reform Act of 1984 and Other Recent Tax Legislation at p. 140 (1987).
[12]IRC §2039(e), last sentence, prior to its repeal by DEFRA.
[13]As defined in Treas. Reg. §20.2039-4(b).
[14]Treas. Reg. §20.2039-4(a).
[15]Treas. Reg. §20.2039-4(d).
[16]Treas. Reg. §20.2039-1T (T.D. 8073, 1/29/86).
[17]Treas. Reg. §20.2039-1(d). (Emphasis added.)
[18] Treas. Reg. §20.2039-1(b)(1)(ii).
[19] Treas. Reg. §20.2039-1(b)(1)(ii), Ex. 6.
[20] Rev. Rul. 76-380, 1976-2 CB 270 declared obsolete on other issues; Rev. Rul. 88-85, 1988-2 CB 333.
[21] Rev. Rul. 77-183, 1977-1 CB 274; Estate Of Firmin D. Fusz, 46 TC 214, 05/11/1966. But see James Gray, Executor v. U.S., (1969, CA3) 23 AFTR 2d 69-1916 , 410 F2d 1094 , 69-1 USTC ¶12604; and Ruth Eichstedt (f/k/a Sawyer), Executrix v. U.S., (1972, DC CA) 30 AFTR 2d 72-5912 , 354 F Supp 484 , 72-2 USTC ¶12891.
[22]See Treas. Reg. §20.2039-1(b)(2), Example (4); Estate of William E. Barr, 40 T.C. 227 (1963), acq. in result, 1978-1 C.B. 1; Carrie Kramer, 406 F.2d 1363 (Ct. Cl. 1969); Estate of Firmin D. Fusz, 46 T.C. 214 (1966), acq. 1967-2 C.B. 2; Estate of H.C. Beal, 47 T.C. 269, acq.; Margaret A. Neely, 613 F.2d 802, (Ct. Cl. 1980); Estate of T.C. McCobb, 321 F.2d 633; Est. of L.L. Silberman, 333 F.Supp 1120 and Rev. Rul. 77-183, 1977-1 C.B. 274.
[23]See, for example, Est. of M. Siegle, 74 T.C. 613.
[24] Rev. Rul. 81-31, 1981-1 CB 475.
[25]Other cases include Estate of Van Wye v. United States, 686 F.2d 426 (6th Cir. 1982); Estate of Porter v. Commissioner, 442 F.2d 915 (1st Cir. 1971); Kramerv. United States, 406 F.2d 1363 (Ct. Cl. 1969); Estate of VFuszv. Commissioner, 46 T.C. 214 (1966), acq. 1967-2 C.B. 2. Cf. Rev. Rul. 76-380, 1976-2 C.B. 270.
[26]Rev. Rul. 92-68, 1992-36 I.R.B. 15, revoking Rev. Rul. 81-31.
[27]Estate Of Levin, 90 TC 723, Code Sec(s) 2038; 2511, 04/19/1988.
[28] Estate of DiMarco, 87 T.C. No. 39 (1986), acq., 1990-2 C.B.1.
[29]The following authorities were cited in support of the ruling in PLR 8701003: Hinze v. U.S., 72-1, U.S.T.C., ¶12,842 (D.C. Calf. 1972); Harris v. U.S., 72-1 U.S.T.C. ¶12,845; Kramer v. U.S., 406 F.2d 1363 (Ct. Cl. 1969); Est. of Tully, Sr., v. U.S., 528 F. 2d 1401 (Ct. Cl. 1976); Rev. Rul. 77-139, 1977-1 C.B. 278, and U.S. v. Byrum, 408 U.S. 125 (1972), Ct. D. 1954, 1972-2 C.B. 518.
[30]PLR 8943006.
[31]Boggs v. Boggs, 117 S.Ct. 1754, 138 L.Ed.2d 45, 65 U.S. L.W. 4418 (1997).
[32]Rev. Rul. 67-278, 1967-2 C.B. 323. Made obsolete by 88-85. Cf. PLR 8943006.
[33]U.S. Constitution, Article I, Sec. 9.
[34]Treas. Reg. §20.2056(b)-1(b).
[35]Treas. Reg. §20.2056(b)-1(c).
[36]IRC §2056(b)(1)(A) second parenthetical clause. Treas. Reg. §20.2056(e)-2(b) example (1)(iii); Rev. Rul. 79-240, 1979-2 C.B. 335.
[37]IRC §2056(b)(5).
[38]Treas. Reg. §20.2056(b)-1(b).
[39]Treas. Reg. §2056(b)-1(c)(1)(i).
[40]Treas. Reg. §2056(b)-1(c)(2).
[41]Treas. Reg. §20.2056(b)-7(b)(1)(i), reversing the position formerly articulated in Prop. Treas. Reg. §20.2056(b)-7, Example 14.
[42]Treas. Reg. §20.2056(b)-5(f)(5).
[43]Treas. Reg. §20.2056(b)-7(e).
[44]Treas. Reg. §20.2056(b)-7(j).
[45]The gift tax corollary is §2523(f).
[46]The boldfaced language was added by OBRA ‘89. See below.
[47]PLR 8943006. My thanks to Terry Oneal of Arlington for sending me a copy of this private letter ruling.
[48]Boggs v. Boggs, 117 S.Ct. 1754, 138 L.Ed.2d 45, 65 U.S. L.W. 4418 (1997).
[49]U.S. Constitution, Article I, Sec. 9. The problem is that a transfer here will take place. It is just that the decedent had no say-so over where it was going to go. This is unlike the example where an individual owns the formula to make Coca ColaTM, and, instead of transferring the formula to someone at death, instead instructs the executor to burn it. This is also unlike a burial plot, which is not taxed, presumably because it is not transferred to anyone at death.
[50]Treas. Reg. §20.2056(b)-7(e)(4). IRC §7520 as added by TAMRA §5031(a).
[51]Treas. Reg. §20.2056(b)-7(e).
[52]Rev. Rul. 89-89, 1989-2 C.B. 231. See also PLRs 9320015, 9317025, 9038015 and 8728011.
[53]Laglia v. Comm, 88 TC 894 (1987).
[54]Rev. Proc. 89-14, 1989-1 C.B. 814.
[55]Estate of Grace Lang, 64 T.C. 404 (1975).
[56]Beneficial Foundation, Inc. v. U.S., 56 AFTR 2d 85-5715, 8 Cl Ct 639, 85-2 USTC P 9601, 56 AFTR 2d 85-5715, 08/09/1985.
[57]Rev. Rul. 89-89, 1989-2 C.B. 231. See also PLRs 9320015, 9317025, 9038015 and 8728011.
[58]Tex. Trust Code §113.109(a).
[59]Tex. Trust Code §113.109(e)(1).
[60]Tex. Trust Code §113.109(e)(1)(B)-(E).
[61]“Eligible Marital Deduction Property” means property that is included in a deceased Maker's gross estate for federal estate tax purposes and which it is possible, by election or otherwise, to obtain a federal estate tax marital deduction if used to fund the Marital Deduction Gift.
[62]IRC §408(h).
[63]See Treas. Reg. §20.2056(e)-2(b)(1)(ii).
[64]See IRC §§401(a)(11) and 417 and discussion infra for the meaning of these terms.
[65]Consider the estate freezing potential available through the use of annuities. There will be no remainder left to include in the estate of the survivor. Of course, the proceeds will be taxable to the extent not expended or given away during lifetime.
[66]Treas. Reg. §25.2523(b)-1(c)(2).
[67]Treas. Regs. §20.2056(b)-5(f)(8); §20.2056(b)-5(f)(6), last clause; §20.2056(b)-5(g)(1)(i); §20.2056(b)-5(g)(3) last sentence; §20.2056(b)-5(g)(5), last sentence; and §20.2056(b)-5(3).
[68]McGehee v. Commissioner, 260 F.2d 818 (5th Cir. 1958), Estate of McCabe v. United States, 475 F.2d 1142 (Ct. Cl. 1973), Hoffman v. McGinnes, 277 F.2d 598 (3rd Cir. 1960), and Estate of Benjamin v. Commissioner, 44 T.C. 598 (1965).
[69]Treas. Reg. §20.2056(b)-5(f)(1).
[70]Treas. Reg. §20.2056(b)-5(f)(8).
[71]Treas. Reg. §20.2056(b)-7(d)(2).
[72]Treas. Reg. §20.2056(b)-5(f)(6), last clause.
[73]McGehee v. Commissioner, 260 F.2d 818 (5th Cir. 1958); Estate of McCabe v. United States, 475 F.2d 1142 (Ct. Cl. 1973); Hoffman v. McGinnes, 277 F.2d 598 (3rd Cir. 1960); Estate of Benjamin v. Commissioner, 44 T.C. 598 (1965); Estate of Tompkins v. Commissioner, 68 T.C. 912 (1977), acq., 1982-1 C.B. 1; Estate of Neugass v. Commissioner, 555 F.2d 322 (2d Cir. 1977), rev’g, 65 T.C. 188 (1975); Estate of Mackie, 64 T.C. 308 (1975), affirmed, 545 F.2d 883 (4th Cir. 1976); Rev. Rul. 82-184, 1982 C.B. 215 and Cf., Treas. Reg. §20.2056(e)-2(c).
[74]IRC §2056(b)(5), first sentence, first parenthetical clause.
[75]Treas. Reg. §20.2056(b)-5(g)(1)(i).
[76]Cf., Treas. Reg. §20.2056(b)-5(3). The third of the five requirements for a §2056(b)(5) marital deduction that are listed here is that “the surviving spouse must have the power to appoint the entire interest or the specific portion to either herself or her estate.” [Emphasis added.]
[77]Estate of Tompkins v. Commissioner, 68 T.C. 912 (1977), acq., 1982-1 C.B. 1; Estate of Neugass v. Commissioner, 555 F.2d 322 (2d Cir. 1977), rev’g, 65 T.C. 188 (1975); Rev. Rul. 82-184, 1982 C.B. 215.
[78]PLR 9416039. Contrast 9416045.
[79]The reader may wish to note in passing that this discussion has signal implications in the case of Crummey powers of withdrawal exercisable by spouses.
[80]IRC §2056(b)(1)(A) second parenthetical clause. Treas. Reg. §20.2056(e)-2(b) example (1)(iii); Rev. Rul. 79-240, 1979-2 C.B. 335.
[81]After all, unless the spouse has a general power of appointment, or the QTIP election has been made, the undistributed plan interest won’t be taxable in the spouse’s estate because the spouse has made no transfer.
[82]Treas. Reg. §20.2056(e)-2(b) example (1)(iii); Rev. Rul. 79-240, 1979-2 C.B. 335. IRC §2056(b)(1)(A) second parenthetical clause.
[83]Treas. Reg. §1.411(a)-11(c)(5).
[84]Treas. Reg. §1.411(d)-4, Q&A(2)(a)(4).
[85]Rev. Rul. 75-240. Treas. Reg. §25.2511-1(h)(9).
[86]S. Rep. No. 313, 99th Cong., 2d Sess. 1019 (1986), 1986-3 C.B. (Vol. 3) 1019.
[87]IRC §2056(b)(7)(C). Italicized language was added by 1997 Taxpayer Relief Act.
[88]See the discussion of Allard v Frech, 754 S.W.2d (Tex. 1988), infra.
[89]PLR 8943006.
[90]Treas. Reg. §20.2041-1(b)(2).
[91]See Sinnott v. Gidney, 322 S.W.2d 507 (1959).
[92]ERISA §206(d); IRC §401(a)(13).
[93]Rev. Rul. 67-278, 1967-2 C.B. 323. Cf. PLR 8943006.
[94]Allard v Frech, 754 S.W.2d (Tex. 1988).
[95]Free v. Bland, 369 U.S. 663, 668-670, 82 S.Ct. 1089, 8 L.Ed.2d 180 (1962).
[96]Meek v. Tullis, et. al., 791 F.Supp. 154 (W.D. Louisiana 1992).
[97]Boggs v. Boggs, 117 S.Ct. 1754, 138 L.Ed.2d 45, 65 U.S. L.W. 4418 (1997).
[98]Boggs v. Boggs, 117 S.Ct. 1754, 138 L.Ed.2d 45, 65 U.S. L.W. 4418 (1997).
[99]Free v. Bland, 369 U.S. 663, 669.
[100]PLR 8943006.
[101]Tex. Prob. Code §322A.
[102]Temp. Treas. Reg. §54.4981A-1T d-8.
[103]E.g., Tex. Prob. Code §322A(d), What this means in this context is somewhat problematic.
[104]E.g., Tex. Prob. Code §322A.
[105]ERISA §206(d). IRC §401(a)(13).
[106]I.R.S. Notice 87-13, 1987-1 C.B. 432..
[107]IRC §401(a)(13) and ERISA §206(d).
[108]IRC §417(a).
[109] This addition to the IRC will not affect the result of PLR 8708008, discussed below, for two reasons: (1) the gift in PLR 8708008 was from the participant to the nonparticipant as a result of the failure to waive, and (2) the joint and survivor annuity in that case did not arise under §401(a)(11) or §417. See discussion infra.
[110]Cf., Treas. Reg. §25.2511-1(h)(6).
[111]IRC §417(a)(2)(A)(i).
[112]Allard v Frech, 754 S.W.2d (Tex. 1988).
[113]Rev. Rul. 75-240.
[114]Treas. Reg. §25.2511-1(h)(9).
[115]See discussion of IRC §2523(f)(6), below.
[116]Treas. Reg. §25.2511-(h)(10).
[117]See also PLR 8639075 and Rev. Rul. 70-514. Note Rev. Rul. 70-514 & Rev. Rul. 72-62 were declared to be obsolete by the IRS in Rev. Rul. 93-29.
[118]The Technical and Miscellaneous Revenue Act of 1988 P.L. 100-647.
[119]The estate tax corollary is §2056(b)(7)(C).
[120]Section 7816(q) of The Omnibus Budget Reconciliation Act of 1989 (OBRA ‘89), Pub. L. 101-239.
[121]Treas. Reg. §25.2325(f)-1.
[122]Treas. Reg. §25.2523(b)-1(c).
[123]GCM 39858. PLR 9016026. Stobnicki v. Textron, Inc., 868 F.2d 1460 (5th Cir. 1989). Treas. Reg. 1.401(a)-13.
[124]GCM 39858.
[125]PLR 9037048. See also PLR 9226058 & 9319029.
[126]See PLRs 9319029, 7851131 and 7830022.
[127]PLR 9450041.
[128] PLR 9630034.
[129]See IRC §§2601-2663.
[130]See IRC §§2601-2663.
[131]Possibly a direct skip.
[132]Possibly a taxable distribution.
[133]Possibly a taxable termination.
[134]IRC 2603(b).
[135]IRC §2603(a)(2).
[136]Treas. Reg. §26.2662-1(c)(1)(iv).
[137]Treas. Reg. §26.2662-1(c)(2).
[138]IRC §2603(a)(1).
[139]See Treas. Reg. §26.2653-1.
[140]IRC §2603(a)(2).
[141]IRC §2603(b).
[142]In the model IRA beneficiary designation, the beneficiary will have a general power of appointment in the form of a withdrawal right, unless the IRA owner provided otherwise in the beneficiary designation.
[143]I.e., the IRA will be taxable in the child’s estate at the death of the child.
[144]IRC §2652(a).
[145]IRC §2613(a)(1).
[146]IRC §2603(a)(2).
[147]IRC §2603(a)(1).
[148]IRC §2203.
[149]Form 706 (Rev. Aug. 1993) Instructions, beginning in the middle of Col. 1, p. 2.
[150]Distinguish between the person who is liable for the tax and the source of the tax.
[151]Treas. Reg. §26.2662-1(c)(1).
[152]Treas. Reg. §26.2662-1(c)(2)(iii).
[153]IRC §2603(a)(3).
[154]IRC §2603(a)(2) and Form 706 (Rev. Aug. 1993) Instructions, bottom of Col. 1, p. 19.
[155]Treas. Reg. §26.2662-1(c)(1)(iv).
[156]IRC §2603(b).
[157]Form 706 (Rev. Aug. 1993) Instructions, top of Col. 3, p. 20.
[158]Form 706 (Rev. Aug. 1993) Instructions, bottom of Col. 1, p. 19.
[159]Form 706 (Rev. Aug. 1993) Instructions, beginning at the bottom of Col. 2, p. 19.
[160]Temp. Reg. §26.2662-1.
[161]Form 706 (Rev. Aug. 1993) Instructions, beginning in the middle of Col. 1, p. 2. Or, going to the source, IRC §2203.
[162]Treas. Reg. §26.2662-1(c)(2).
[163]Prop. Treas. Reg. 26.2632-1(b)(2) (Proposed 12/24/92).
[164]IRC §2602.
[165]IRC §2621.
[166]IRC §2641.
[167]IRC §2642.
[168]Treas. Reg. §26.2652-1(b).
[169]IRC §408(h).