Wills and Trusts

Wyatt, Tarrant & Combs, LLP


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You Are Under Attack!

By Turney P. Berry

Blue ribbon pears at the Kentucky State Fair

Blue ribbon pears at the Kentucky State Fair

Yes, You. If you have an interest in a family business or benefit from a family business – and that is almost all of us  – then you should know that on August 2 the IRS unveiled a proposal specifically designed to increase the taxes paid by family business owners versus the unrelated owners of identical businesses. Family farms, investment companies, real estate investors and developers, every sort of business and business entity are included within the scope of the IRS proposal. Thus you need to take immediate action.

What does this new proposal do? Let’s consider a business with four equal owners that’s worth $10,000,000. The economic reality is that none of those co-owners could sell a one-quarter interest for $2,500,000. Appraisers tell us that minority interests – less than 50% of the vote – in privately held businesses should be discounted by 30% – 40% in a typical situation, although sometimes more or less depending on the facts in the real world.

Now let’s move from the real world to the world of the IRS. If the four owners are unrelated, then real world rules will apply. But if they are family members the Continue reading


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Late Disclaimer OK: Disclaimer within Nine Months of Awareness

In PLR 201334001 the IRS determined disclaimers were timely on the following facts:

Grantor created Trusts several years before his death on Date 1, a date before January 1, 1977, for the benefit of the lawful lineal descendants of his daughter (Daughter), per stirpes. Daughter’s son, Grandson is the current beneficiary of Trusts. Upon the death of Grandson, Grandson’s son (Taxpayer) will be entitled to income distributions from Taxpayer’s per stirpital share of Trusts. The income distributions will continue until the earlier of Taxpayer’s death or the perpetuities date. Upon termination of each of the Trusts, any remaining trust property will be distributed to Taxpayer and Taxpayer’s brother, per stirpes.

Taxpayer, who is over 18 years of age, represents that Taxpayer learned of the transfers creating his interests in Trusts on Date 2. Taxpayer further represents that he had no knowledge that he possessed any interest in Trusts, prior to Date 2. Taxpayer proposes to execute and timely file and deliver a written disclaimer to the trustees for each of Trust 1, Trust 2, Trust 3, and Trust 4, on or before Date 3, stating that he irrevocably, unconditionally and without qualification, disclaims and refuses to accept any interest that would otherwise pass to Taxpayer under the relevant provisions of Trusts. The disclaimers will be valid under Statute 1 and Statute 2. Date 3 is a date occurring not more than nine months after Date 2.

The ruling states:

Section 25.2511-1(c)(2) of the Gift Tax Regulations provides, in relevant part, that, in the case of taxable transfers creating an interest in the person disclaiming made before January 1, 1977, where the law governing the administration of the decedent’s estate gives a beneficiary, heir, or next-of-kin a right completely and unqualifiedly to refuse to accept ownership of property transferred from a decedent (whether the transfer is effected by the decedent’s will or by the law of descent and distribution), a refusal to accept ownership does not constitute the making of a gift if the refusal is made within a reasonable time after knowledge of the existence of the transfer. The refusal must be unequivocal and effective under the local law. There can be no refusal of ownership of property after its acceptance. In the absence of the facts to the contrary, if a person fails to refuse to accept a transfer to him of ownership of a decedent’s property within a reasonable time after learning of the existence of the transfer, he will be presumed to have accepted the property.

The U.S. Supreme Court has recognized that, under the predecessor to this regulation, an interest must be disclaimed within a reasonable time after obtaining knowledge of the transfer creating the interest to be disclaimed, rather than within a reasonable time after the distribution or vesting of the interest. Jewett v. Comm’r, 455 U.S. 305 (1982). The requirement in the regulations that the disclaimer must be made within a “reasonable time” is a matter of federal, rather than local law. Id. at 316. Whether a period of time is reasonable under the regulations is dependent on the facts and circumstances presented.

In this case, Taxpayer will execute each disclaimer within nine months of learning of the transfers creating his interests in each of Trust 1, Trust 2, Trust 3, and Trust 4. Accordingly, based upon the information submitted and the representations made, we conclude that Taxpayer’s proposed disclaimers of his interests in Trusts, if made on or before Date 3, will be made within a reasonable time after Taxpayer learned of the existence of the transfers under § 25.2511-1(c)(2). Furthermore, provided that Taxpayer’s disclaimers are valid under State law and assuming the other requirements of § 25.2511-1(c)(2) are met, Taxpayer’s disclaimer of his interests in Trusts will not be taxable gifts under § 2501.

Turney P. Berry
Louisville, Kentucky


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Estate of Kite: Sale of Business to Children for a Deferred Private Annuity

In Estate of Virginia V. Kite et al. v. Commissioner, T.C. Memo. 2013-43, the court confronted the sale of a partnership (“KIC”) in 2001 by Mrs. Kite to her children, in exchange for a private annuity that would begin in 10 years. Mrs. Kite was then 74 and had a greater than 50% chance of living for more than 18 months and in fact she had a 12.5 year life expectancy. However, Mrs. Kite died in 2004. The Court upheld the transaction as being bona fide for full and adequate consideration, stating as follows:

Before participating in the annuity transaction, Baldwin [another limited partnership], which was wholly owned by the Kite children or their trusts, contributed approximately $13.6 million of assets to KIC. As a result, the Kite children did not need to rely on the assets already held by KIC to make the annuity payments. In addition, the Kite children did not transfer the assets underlying the KIC interests back to Mrs. Kite after the annuity transaction was completed. In fact, they did not make any distributions from KIC, but allowed the KIC assets to accumulate in order to have income available when the annuity payments became due. The Kite children therefore expected to make payments under the annuity agreements and were prepared to do so.

Mrs. Kite also demonstrated an expectation that she would receive payments. Mrs. Kite actively participated in her finances and over the course of her life demonstrated an immense business acumen. Accordingly, it is unlikely that Mrs. Kite would have entered into the annuity agreements unless they were enforceable and, more importantly, she could profit from them. In addition, Mrs. Kite, unlike the surviving spouse in Estate of Hurford, was not diagnosed with cancer or other terminal or incurable illness. In fact, the record, which includes a letter from Mrs. Kite’s physician, establishes to the contrary — that Mrs. Kite was not terminally ill and she did not have an incurable illness or other deteriorating physical condition. Mrs. Kite and her children reasonably expected that she would live through the life expectancy determined by IRS actuarial tables, which was 12.5 years after the annuity transaction. Indeed, if Mrs. Kite lived to her life expectancy as determined by IRS actuarial tables, she would have received approximately $800,000 more in annuity payments than the value of her KIC interests. At a minimum, Mrs. Kite would have made a profit with the potential of a greater return if she lived longer. Continue reading


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SECTION 1014 AND UNDERSTANDING THE TAX NATURE OF CERTAIN ASSETS – Part III

SECTION 1014 AND UNDERSTANDING THE TAX NATURE OF CERTAIN ASSETS – Part III D

Traditional IRA and Qualified Retirement Assets

In 2013, Investment Company Institute estimated that total retirement assets were over $20 trillion (including government plans, private defined benefit plans, defined contribution plans and individual retirement accounts).[1]  Assets in IRAs and defined contribution plans totaled more than ½ of the total at approximately $11.1 trillion.  Although IRA and qualified retirement assets make up one of the largest asset types of assets owned by individuals, they are one of the most problematic from an estate planning perspective.

IRA and qualified retirement assets are not transferable during the lifetime of the owner,[2] so the assets are never candidates for lifetime gifts unless the owner is willing to incur a taxable distribution of the assets.  As such, to the extent not drawn-down prior to death, the assets are includible in the estate for transfer tax purposes,[3] and by definition, the assets will use some or all of the decedent’s Applicable Exclusion Amount, unless the assets to surviving spouse under the marital deduction under section 2056 of the Code or to a charitable organization under section 2055 of the Code.[4]  To make things worse, IRA and qualified retirement assets are considered income in respect (IRD) under section 691 of the Code.[5]   IRD assets are not entitled to a “step-up” in basis,[6] and all distributions (whether paid over time or not) to a beneficiary are taxable as ordinary income.[7]  Even though the beneficiary is entitled to an income tax deduction[8] (“IRD deduction”) for estate taxes payable by virtue of the inclusion of the assets, there is no Federal income tax deduction for state death taxes that might be payable, and given the reduced Federal transfer tax rate of 40% and the cost-of-living increase on the Applicable Exclusion Amount, many taxpayers will have very little or no IRD deduction to shelter the on-going ordinary income tax problem.

A distribution from a decedent’s IRA to a surviving spouse may be “rolled over” to another qualified retirement plan or IRA, thereby deferring the recognition of income.[9]  In addition, if the surviving spouse is the beneficiary of all or a portion of the decedent’s IRA, the surviving spouse may also elect to treat the decedent’s IRA as his or her own IRA.[10]  In both of the foregoing cases, the IRD problem discussed above continues after the death of the surviving spouse (unless the surviving spouse remarries).

Contrast the foregoing treatment with Roth individual retirement plans (“Roth IRAs”).[11]  Roth IRA assets are treated similarly to assets in a traditional IRA in that: (i) the account itself is not subject to income tax;[12] (ii) distributions to designated beneficiaries are subject to essentially the same required minimum distribution rules after the death of the original Roth IRA owner;[13] and (iii) surviving spouses may treat a Roth IRA as his or her own and from that date forward the Roth IRA will be treated as if it were established for the benefit of the surviving spouse.[14]  In contrast to a traditional IRA, distributions to a qualified beneficiary are not taxable to the beneficiary,[15] and as discussed above, are not subject to the Medicare tax.[16]  The overall result for decedents with Roth IRA assets, the qualified beneficiaries of the Roth IRA effectively receive the benefit of a “step-up” in basis.  Since 2010,[17] all taxpayers regardless of adjusted gross income[18] could convert traditional IRA assets into a Roth IRA.  The conversion is considered a taxable event causing the converted amount to be includible in gross income and taxable at ordinary income tax rates.[19]  Direct taxable rollovers from qualified company-based retirement accounts (section 401(k), profit sharing, 403(b), and section 457 plans) into a Roth IRA.[20]  Individuals who have excess qualified retirement assets, have sufficient funds to pay the resulting tax liability from outside of the retirement account, and who are not planning to donate the asset to a charitable organization are great candidates to do a Roth IRA conversion.  Notwithstanding the clear benefits of passing the Roth IRA assets to children and grandchildren outside of the scope of the IRD provisions, not many individuals are willing to pay the income tax cost of the conversion.

Turney P. Berry

Louisville, Kentucky


[1] Investment Company Institute, Release: Quarterly Retirement Data, First Quarter 2013, http://www.ici.org/research/stats/retirement/ret_13_q1,  (03/31/201).

[2] See the anti-alienation provision in § 401(a)(13)(A).

[3] § 2039(a).

[4] The IRS has taken the position that qualified retirement assets used to fund a pecuniary bequest to a charitable organization will be considered an income recognition event, triggering ordinary income.  CCA 200644020.

[5] See e.g., Ballard v. Commissioner, T.C. Memo 1992-217, Hess v. Commissioner, 271 F.2d 104 (3d Cir. 1959), Rev. Rul. 92-47, 1992-1 C.B. 198, Rev. Rul. 69-297, 1969-1 C.B. 131, PLR 9132021, and GCM 39858 (9/9/91).

[6] § 1014(c).

[7] §§ 72, 402(a) and 408(d)(1), assuming the decedent owner had no nondeductible contributions.  See § 72(b)(1) and (e)(8).

[8] § 691(c)(1).

[9] § 402(c)(9).

[10] Treas. Reg. § 1.408-8, Q&A-5(a).

[11] § 408A.

[12] Treas. Reg. § 1.408A-1, Q&A-1(b).

[13] Treas. Reg. § 1.408A-6, Q&A-14.  One specific exception is the “at-least-as-rapidly” rule under § 401(a)(9)(B)(i).

[14] Treas. Reg. § 1.408A-2, Q&A-4.

[15] § 408A(d)(1).

[16] § 1411(c)(5).

[17] Tax Increase Prevention and Reconciliation Act of 2005, P.L. 109-222, effective for tax years beginning after December 31, 2009.

[18] Prior to this change, only taxpayers having less than $100,000 in modified adjusted gross income could convert a Traditional IRA to a Roth IRA.  Former § 408A(c)(3)(B).

[19] § 408A(d)(3)(A)(i).

[20] See Notice 2008-30, 2008-12 I.R.B. 638 (3/24/2008) and Notice 2009-75, 2009-39 I.R.B. 436 (9/28/2009). § 408A(d)(3)(A).


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Charitable Lead Annuity Trust Funded With Illiquid Assets Payable to Family Foundation

PLR 201323007 involved a CLAT carefully drafted to avoid problems arising from funding with non-marketable assets where the annuity would pass to a family foundation.  The ruling recites these provisions of the CLAT agreement:

Trust further provides that Taxpayer shall never exercise the power of the trustee described in the immediately preceding sentence. The trustee shall pay Foundation the Annuity Amount each year for the X-year term on the last day of Trust’s taxable year. Notwithstanding any existing or later enacted state law, except on termination of the Annuity Period, no amount may be paid from Trust to or for the use of any person other than an organization describe in each of §§ 170(b)(1)(A), 170(c), 2055(a) and 2522(a).

* * *

Section III(p) provides that on or immediately prior to any valuation of trust assets, the trustee shall report to the valuation trustee the identity of all assets of Trust that do not have a readily ascertainable fair market value. The valuation trustee shall then have any of those assets valued as of the appropriate valuation date and report the value to the trustee. The valuation shall be made independent of the trustee and of any related or subordinate party or disqualified person with respect to Trust. In all events, the valuation trustee and any successor must be an independent trustee. An independent trustee is any party other than a related or subordinate party with respect to Trust within the meaning of § 672(c) or a disqualified person with respect to Trust within the meaning of § 4946 (other than a party who is a disqualified person with respect to Trust solely by reason of service as the trustee of Trust).

* * *

On Date 3, the Board of Directors of Foundation amended Foundation’s bylaws, as follows. Article III, Section 3.2 provides that if at any time Foundation is a beneficiary of a charitable lead trust, a charitable remainder trust or other similar trust, and the charitable trust was established by a director or officer of, or substantial contributor to, Foundation, the director, officer or substantial contributor establishing the charitable trust shall be prohibited from acting on or involvement in matters concerning the receipt, investment, grant or distribution of, or any other decisions involving funds received by Foundation from such charitable trust. In addition, any funds received from a charitable trust shall be segregated into a separately established and dedicated account and separately accounted for on the books and records of Foundation in a manner that clearly allows the tracing of the funds into and out of such separate account.

Article III, Section 3.9 provides that a director who establishes a charitable trust for the benefit of Foundation may not be counted when establishing a quorum to vote on matters relating to the receipt, investment, grant or distribution of, or any other decisions involving funds received by Foundation.

Article VI, Section 5.1 provides that no committee established by the Board of Directors, including a standing committee established under Section 5.5 of the bylaws, shall include as a member a director or officer of, or a substantial contributor to, Foundation who has established a charitable trust of which Foundation is a beneficiary.

On Date 4, a quorum of the Board of Directors, excepting Taxpayer, established a standing committee (Committee) under Section 5.5. of the bylaws, with the sole authority to receive, separately invest and make all investment decisions and administrative, grant and distribution decisions on behalf of Foundation with respect to and regarding all funds received by Foundation from Trust. The bylaws provide that Committee consists of at least three members, at least one of whom is not a director of Foundation and at least one of whom is not related or subordinate to any director of Foundation as defined by § 672(c). All actions by Committee shall require unanimous consent.

Turney P. Berry
Louisville, Kentucky


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TRANSFER TAX COST VS INCOME TAX SAVINGS FROM “STEP-UP” IN BASIS – Part III

Community Property Considerations

Given the central role the “step-up” in basis has in estate planning now, community property states have a significant advantage over separate property states because both the decedent’s and the surviving spouse’s on1-half interest in community property will receive a basis adjustment to fair market value under § 1014(b)(6) of the Code.  Because the unlimited marital deduction under § 2056 of the Code essentially gives couples the ability to have no transfer taxes on the first spouse’s death, this “step-up” in basis provides an immediate income tax savings for the benefit of the surviving spouse (rather than the subsequent beneficiaries).

This theoretically provides a bifurcated approach to estate planning for spouses in community property:

  1. During the lifetimes of both spouses, limit inter-vivos transfers and maximize value of the assets in order to benefit the most from the basis adjustment under section 1014(b)(6) of the Code.
  2. During the lifetime of the surviving spouse, with assets in excess of the Available Exclusion Amount (taking into account any amounts that might have been “ported” to the surviving spouse) transfer as much wealth out of the estate through inter-vivos transfers and other estate planning techniques.  Further, through the use of family limited partnerships (“FLPs”) and other techniques, attempt to minimize the transfer tax value of the assets that would be includible in the estate of the surviving spouse.

Notably, with the U.S. Supreme Court’s declaration that § 3 of the Defense of Marriage Act[1] (“DOMA”) is unconstitutional, pursuant to its decision in U.S. v. Windsor,[2] the tax planning ramifications are far reaching for clients in states like California where community property and same-sex marriage laws exist.[3]

The basis adjustment at death for community property and other planning considerations, including the electing into community property status, are discussed in more detail later in this outline.

Turney P. Berry

Louisville, Kentucky

[1] 1 U.S.C. § 7.  § 3 of DOMA defined marriage and spouse as excluding same-sex partners.

[2] 570 U.S. ____ (2013).

[3] Hollingsworth v. Perry, 790 F.Supp.2d 1149 (N.D. Cal. 2010), aff’d, 591 F.3d 114 (9th Cir. 2010 & 2012), aff’d, No. 12-144 (U.S. 6/26/13)