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Key Developments at Heckerling 2018

Heckerling again illustrates the variety and complexity of issues facing planners, particularly in the wake of tax reform.

Here are some key takeaways from the Recent Developments panel at the 52nd Heckerling Institute on Estate Planning. However, we all know the most major of all developments is tax reform, which is a topic unto itself.

Purchase of GRAT Remainder Interest

Where a GRAT remainder interest may still be includable in a donor’s estate, the purchase of that interest by the Grantor will not constitute adequate and full consideration for gift tax purposes. In CCA 201745012, the IRS determined that a donor’s purchase of GRAT remainder interests in exchange for promissory notes constituted gifts to the selling trust, and did not create estate tax deduction for the debt, because the donor retained an interest in the trusts under section 2036. Here, taxpayer, was quite bold to attempt to solve for GRAT estate inclusion via a purchase close in time to death.  The IRS reasoned that adequate and full consideration for gift and estate tax purposes is that which replenishes the donor’s taxable estate. The IRS determined that adequate and full consideration was not provided because the donor’s estate was not increased by the purchase of the remainder interests, since the GRAT’s assets would already be included in the gross estate under section 2036. Further, since section 2053(c)(1)(A) only allows a deceased’s estate a deduction for any indebtedness to the extent that the indebtedness is contracted for adequate and full consideration, no deduction would be allowed for estate tax purposes.  It is conceivable that this reasoning may extend beyond GRATs to QPRTs, QTIPs or even sales of life insurance.

Lack of Liquid Assets Key to Valid Graegin Loan

The deductibility of Graegin loan interest is limited when the estate has access to sufficient liquidity to pay estate tax liability. In Koons v. Commissioner, 686 Fed. Appx. 779 (11th Cir. Apr. 27, 2017), decedent’s revocable trust borrowed approximately $10.75 million from a LLC structured as a Graegin loan in order to claim an administrative expenses deduction under section 2053(a)(2) of $71M, as a result of a high interest rate—a very significant deduction relative to the amount loaned.  The court agreed with the Tax Court that it was not necessary for the trust to borrow from the LLC because the LLC had over $200 million of liquid assets and the trust had a 70.42 percent interest to could compel a pro-rata distribution to members. Koons is a good example regarding what is not acceptable regarding Graegin loans.

Valuation of Self-Cancelling Installment Notes

Though the IRS continues to question the value of SCINs, taxpayers may still see success concerning valuation of the notes. In Estate of Johnson v. Commissioner, T.C. Docket No. 11708-16 (filed May 16, 2016) the IRS questioned the value of a SCIN granted in exchange for shares in closely-held entity. The face value of the SCIN was $5,532,589, of which $2,941,356 represented a principal premium to compensate for the actuarial risk of the decedent’s premature death and subsequent cancellation of the note. The estate challenged the IRS’ position that SCIN was not bona fide consideration equal to the value of the shares plus fair market value of the risk of the decedent not surviving SCIN term. The parties ultimately settled for a $969,761 deficiency.

Inclusion of Family Limited Partnership Assets in an Estate

For the first time, the Tax Court has applied section 2036(a)(2) to the retention of limited partnership interests in a FLP, subjecting value of the FLP’s assets in a decedent’s estate under sections 2036 and 2033. In Estate of Powell v. Commissioner, 148 T.C. No. 18 (May 18, 2017), the court held that the decedent’s transfer of cash and securities into a FLP in exchange for a 99 percent limited interest was subject to a retained right to designate persons who would possess or enjoy the transferred assets or income therefrom, because decedent had ability to dissolve the FLP in conjunction with her son, who individually held the general partner interest. This allowed her to direct disposition of FLP’s assets, likely resulting in reversion of a majority of transferred property to decedent. Accordingly, the value of the transferred assets were includible in decedent’s gross estate under section 2036(a)(2). Historically, the concern with respect to section 2036(a)(2) related to the retention of a general partnership interest, and this case serves as an important reminder that this issue is one that needs to be considered even in situations in which the parent retains only limited partnership interests.

Reformation of GRATs

Reformation can be an effective way to solve problematic trusts. In PLR 201652002, the IRS permitted the reformation of GRATs to correct a scrivener’s error were permitted under the trust instrument and state law. The attorney hired to draft several GRATs over a two year period failed to include language prohibiting the trustees from issuing a note, other debt instrument, option, or other financial arrangement in satisfaction of an annuity obligation as required by Reg. §25.27023(d)(6). After obtaining court approval for the reformation to correct the error, the grantor requested an IRS ruling that, as a result of the reformation, the retained annuity interest in each GRAT was a qualified interest effective as of the date of creation. The IRS granted the request, noting that each GRAT provided that the retained interest was intended to be a qualified interest under section 2702.

Gift Tax Statute of Limitations

In the wake of so much change, it is important to remember the essentials of estate planning. Make certain to file gift tax returns, and also make certain that the gift tax returns contain adequate disclosures. The IRS, via LAFA 20172801F, discusses adequate disclosures. Keep in mind, where gifts are inadequately disclosed the statute of limitations does not commence.  Here, the issue was that the taxpayer failed to adequately explain the valuation methodology.  It is a good practice for attorneys and accountants to review gift tax returns against the adequate disclosure rules so as to ensure the starting of the statute of limitations. 

Marianne R. Kayan contributed to this report. 

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