Wills and Trusts

Wyatt, Tarrant & Combs, LLP


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Values included in Gross Estate: Estate of Trombetta

The Estate of Helen A. Trombetta et al. v. Commissioner, T.C. Memo 2013-234, involved two unusual transactions. The first was the decedent’s transfer of certain pieces of real property to a trust in exchange for an annuity. The decedent could, with her children, give herself any trust income in excess of the annuity. The decedent could reduce the term of the annuity and did so, effective about six weeks before she died. The Tax Court agreed with the IRS that the properties would be included in the decedent’s estate by sections 2036 and 2035. The court rejected the estate’s argument that the transfer to the annuity trust was a sale for full and adequate consideration, stating:

First, decedent did not receive full and adequate consideration for the transfers of the rental properties. Decedent received an interest reducible to money value, i.e., the present value of the periodic payments. However, decedent and Eigner [her attorney] structured the annuity trust as a grantor trust, and decedent reported the difference between the then present value of the periodic payments and the FMV of the Tierra Plaza and Black Walnut Square properties as a gift on her Form 709 for 1993. Decedent’s structuring of the annuity trust and subsequent tax reporting supports a finding that she did not transfer the properties to the trust in exchange for full and adequate consideration.

Second, no bona fide sale, in the sense of an arm’s-length transaction, occurred in connection with decedent’s transfers of the properties to the annuity trust. Eigner prepared the annuity trust agreement in the absence of any meaningful negotiation or bargaining with the other anticipated cotrustees or future beneficiaries. Eigner and decedent determined how the entire estate plan would be structured and operated and what property would be contributed to which vehicle. Decedent, as the sole beneficiary and the sole transferor, formed the transaction, fully funded the annuity trust, and essentially stood on both sides of the transaction.

Petitioner nonetheless contends that decedent’s transfers of the properties to the annuity trust satisfy the bona fide sale exception because, according to petitioner, decedent had clear nontax purposes for the transfers. In particular petitioner contends that decedent’s purpose in transferring the properties was to relieve herself of the burden of managing the properties and to receive an assured income. Petitioner urges us to adopt the standard set forth in Estate of Bigelow v. Commissioner, 503 F.3d 955, 969 (9th Cir. 2007), aff’g T.C. Memo. 2005-65, for evaluating whether a decedent transferred an asset to a family member as part of a bona fide sale.

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Although a number of other cases have applied the “legitimate and significant nontax reasons” standard to determine whether a bona fide sale exception was satisfied, all of the cases applied the standard in the context of a transfer to a family limited partnership. See, e.g., Estate of Black v. Commissioner, 133 T.C. 340, 362 (2009); Estate of Bongard v. Commissioner, 124 T.C. at 118-119; Estate of Stone v. Commissioner, T.C. Memo. 2012-48; Estate of Turner v. Commissioner, T.C. Memo. 2011-209. Decedent transferred the Tierra Plaza and Black Walnut Square properties to a grantor trust, not a family limited partnership. Decedent’s transfers are not comparable to a transfer [*24] to a family limited partnership, particularly given that no other individual received a present interest in the annuity trust. We are not persuaded and are unable to find that decedent’s transfers to the annuity trust are sufficiently similar to a transfer to a family limited partnership to apply the “legitimate and significant nontax reasons” standard.

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Decedent undisputedly transferred the rental properties to the annuity trust as part of her overall estate plan. Decedent transferred her assets to the annuity trust at age 72, and at the same time she executed her will. See, e.g., Estate of Rosen v. Commissioner, T.C. Memo. 2006-115, slip op. at 44. Decedent had significant stated tax reasons for creating the annuity trust. While decedent’s creation of the annuity trust accomplished some nontax objectives, we are unable to find that, when viewed in totality, those nontax objectives were significant. Accordingly, the transfers do not qualify under the bona fide sale exception.

The decedent retained sufficient rights to implicate section 2036:

In addition, the annuity trust agreement provided that any additional income could be distributed to decedent at the direction of the trustees. Decedent retained 50% of the voting rights, and the remaining voting rights were divided among her children. Because decedent and her children could make distributions of additional income to decedent when and in the amount they pleased, decedent maintained the same enjoyment of the properties and their income stream as she had before she transferred the properties to the annuity trust. See, e.g., Estate of Thompson v. Commissioner, 382 F.3d 367; Estate of Rosen v. Commissioner, slip op. at 50-51; see also sec. 20.2036-1(b)(3), Estate Tax Regs. Decedent also received an additional economic benefit in that the annuity trust, on behalf of decedent, applied the income from the transferred properties to the discharge of her loan obligations with respect to those properties. See Estate of Bigelow v. Commissioner, 503 F.3d at 965; Strangi v. Commissioner, 417 F.3d 468, 477 (5th Cir. 2005), aff’g T.C. Memo. 2003-145; Estate of Malkin v. Commissioner, T.C. Memo. 2009-212.

The decedent also transferred her residence to a trust described as follows:

Decedent was grantor, trustee, and the sole beneficiary of the residence trust. The residence trust agreement provided that decedent had the right to use any trust property as a personal residence and the right to receive the net income from the trust. The only limitation on decedent’s right to use the trust property was the residence trust term. The term of the trust was 180 months, subject to decedent’s power to reduce the term. The residence trust agreement further provided that decedent intended the residence trust to qualify as a qualified personal residence trust under section 2702.

Upon termination of the residence trust term decedent or her estate would receive the trust property and any accrued income. If decedent was living at termination, the trust property would be distributed equally to her children or their children. If decedent was deceased at termination, the trustee would distribute the balance of the trust property as directed by decedent’s will or, if not so directed, equally to decedent’s children or their children.

The Tax Court held that the estate included the full value of the residence.

Turney P. Berry
Louisville, Kentucky


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Graduated GRATs

TD 9555 sets forth the rules for valuing annuity interests that increase over the term of a GRAT. Under the regulations, the amount includible is the greater of: (1) the amount of corpus required to generate sufficient income to pay the annual amount due to the decedent at death, or (2) the amount of corpus required to generate sufficient income to pay the annuity, unitrust, or other payment that the decedent would have been entitled to receive if the decedent had survived the other beneficiary, reduced by the present value of the other beneficiary’s interest. Long-term GRATs with flat annuities may be more efficient than those with increasing annuities. In addition, the final Treas. Reg. §20.2036-1(c)(1)(i) is revised to provide that retained interest payments paid to a decedent’s estate after the decedent’s death are not includible under §2033 if a portion of the trust corpus is includible in the decedent’s gross estate under §2036.

When the §7520 rate is very low, a long term (99 year) GRAT may produce favorable results because an increase in the rate between creation and death will reduce the amount includible in the grantor’s estate. For example, if the section 7520 rate is 2.4%, a 99 year GRAT will zero out with an annuity of $26,536 paid annually. If the section 7520 rate were 5% when the annuitant died, then 53.072% of the GRAT would be included in the grantor’s estate. The 2012 Administration proposals would limit the maximum GRAT term to life expectancy plus 10 years.

Turney P. Berry
Louisville, Kentucky


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Application of Section 2036 to Family Limited Partnerships

The Tax Court did not apply §2036 to a family limited partnership in Estate of Beatrice Kelly et al. v. Commissioner, T.C. Memo. 2012-73, on unusual facts. After Mrs. Kelly’s health had declined, without knowing the contents of her Will, her children entered into a settlement agreement among themselves that would ensure each received an equal amount. Sometime later, the children discovered mom’s Will which did not treat them equally:

In the summer of 2002 the children received decedent’s will and discovered that, primarily because of uneven asset appreciation and acquisition, decedent’s will did not divide her estate equally among the children. For example, decedent’s will bequeathed all stock to Bill and Claudia equally, with none going to Betty. Between the signing of decedent’s will in 1991 and 2002, decedent converted nonstock assets into over $1,500,000 in stock. To address this matter, on August 8, 2002, the children signed a second settlement agreement in which they agreed to honor all specific bequests to nonsignatories of the agreement and to distribute the remainder among the children in equal shares.

In order to implement the settlement agreement, the family was advised by Mr. Stewart, an estate planner, to create family partnerships and make gifts. Because mom lacked capacity, the children as co-guardians received court approval for the plan:

Mr. Stewart prepared a plan that called for the creation of four limited partnerships and a corporation which would serve as general partner of the limited partnerships (collectively, the plan). Decedent would create three limited partnerships (i.e., one for the benefit of each of the children), transfer equally valued assets to each of these partnerships, transfer the quarries to a fourth partnership, and retain, in her own name, over $1,100,000 in liquid assets, including certificates of deposit and investment accounts. The real property listed as specific bequests to the children in decedent’s will would be contributed to the partnerships. By contributing property that would otherwise be the subject of unequal specific bequests to the partnerships, the specific bequests would be converted to equal devises of partnership interests, passing pursuant to the residuary clause in decedent’s will.

The children, as coguardians, on May 5, 2003, petitioned the Superior Court of Rabun County, State of Georgia, (superior court) for approval of the plan (superior court petition). See Ga. Code Ann. sec. 29-5-5.1 (2007). The superior court petition provided in part:

The Will of Mrs. Kelly does not divide the estate equally among the children. The children of Mrs. Kelly have entered into a written agreement whereby the children have agreed to divide the estate equally among themselves after the death of Mrs. Kelly. * * * Under the estate plan proposed herein, equalizing the allocation of inherited assets can be achieved in a simple way without the necessity of a complex series of disclaimers and would reduce the risk of potential conflict and disagreement among the heirs.

* * * * * * *

Pursuant to an executed partnership agreement of each of the limited partnerships, the general partner is entitled to a special allocation of the net income of the limited partnerships each year in order to pay the operating expenses of the limited partnerships and a reasonable management charge for the general partner’s management duties and responsibilities. Because the ward will own all the outstanding stock in the corporation that will serve as the general partner, the special allocation of net income for the reasonable management charge will insure that the ward will be provided with adequate income to cover the ward’s probable expenses for support, care and maintenance for the remainder of the ward’s lifetime in the standard of living to which the ward has become accustomed. Specifically, the corporation that will serve as the general partner will receive from each limited partnership a percentage of the net asset value of each limited partnership as determined on December 31 of each year. * * *

The superior court petition included a statement that the proposed plan would result in estate tax savings of $2,985,177.

On June 3, 2003, the superior court held a hearing and entered an order approving the plan. A guardian ad litem represented decedent at the hearing. The superior court found: decedent was incompetent; decedent’s incompetency was expected to continue for her lifetime; implementation of the plan allowed for continued support of decedent during her lifetime; a competent, reasonable person in decedent’s circumstances would likely implement the plan to avoid undesirable tax consequences; and there was no evidence that decedent, if able, would not make the transfers set forth in the plan.

Thereafter the plan was implemented – partnerships for each child’s family and a corporate general partner (KWC). The Court held that the bona fide sale exception was met for the creation of the partnerships:

As evidenced by the three settlement agreements, two of which were signed long before the superior court petition was drafted, decedent’s primary concern was to ensure the equal distribution of decedent’s estate thereby avoiding litigation. In addition, decedent was legitimately concerned about the effective management and potential liability relating to decedent’s assets. Probate court approval was required for basic day-to-day management decisions. By contributing the quarries and other properties to partnerships, decedent limited her liability and reduced her management responsibilities. Through KWC, the children were able to manage the properties as individuals rather than as coguardians. Decedent’s ownership of two quarries, the waterfall property, the post office, and multiple rental homes required active management and would lead any prudent person to manage these assets in the form of an entity.

Further, ownership of KWC was not a retained interest:

The creation of KWC changed decedent’s rights to, and relationships with, the contributed assets. Decedent retained 100% ownership of KWC which, pursuant to the partnership agreements, received a management fee for serving as general partner of the family limited partnerships. In return, KWC provided management and paid expenses including taxes, insurance, salaries, professional fees, repairs, and maintenance. The general partner provided a service (i.e. management) to the partnerships for which the partnerships paid a reasonable management fee. The children, in their role as officers and directors, performed an analysis to determine the appropriate fee and held regular officer/director meetings to address the significant, active management the partnerships required. Cf. Estate of Korby v. Commissioner, 471 F.3d 848, 853 (8th Cir. 2006) (stating that the lack of a management contract, the failure to document management hours, the manner in which payments were made, and the failure of decedent to retain adequate assets in her own name supported rejection of petitioner’s contention that payments to decedent’s living trust were a management fee), aff’g T.C. Memo. 2005-102 and T.C. Memo. 2005-103. Furthermore, not only did decedent have a bona fide purpose for creating the partnerships, decedent had a bona fide purpose for creating KWC to manage the partnerships. Decedent’s health prevented her from managing the partnership property, and thus an entity to act as general partner was a natural choice. The children served as officers and directors of KWC, successfully managed the family business, and avoided potentially divisive intrafamily litigation upon decedent’s passing.

Decedent owned 100% of KWC, the value of which was appropriately included in her gross estate. The payment of the management fee by each of the family limited partnerships to KWC, however, is not, pursuant to section 2036(a)(1), a retention of income which would cause inclusion in decedent’s gross estate of the value of the family limited partnership interests. Decedent did not retain an income stream from the partnership interests. To the contrary, decedent’s implementation of the plan changed decedent’s rights to, and relationship with, the transferred property. In the resulting entity, decedent indeed had an income interest, but this interest does not trigger the applicability of section 2036. The partnership agreements, which were respected by the parties, called for a payment of income to KWC, not to decedent. In essence, respondent is requesting that the Court disregard KWC’s existence, the general partner’s fiduciary duty, and the partnership agreements. We will not do so. Decedent did not retain an interest in the transferred family limited partnership interests. Accordingly, the value of these family limited partnership interests will not be included in decedent’s gross estate.

Turney P. Berry
Louisville, Kentucky