• Revenue ruling clarifies new rules regarding gain on sale of insurance contracts—Internal Revenue Code Section 1016(a) provides rules regarding basis adjustments for expenditures, receipts, losses or other items properly chargeable to a capital account. Two revenue rulings from 2009 (Revenue Ruling 2009-13 and Rev. Rul. 2009-14) applied that rule to hold that if a taxpayer holds a life insurance contract for purposes of insurance protection, the taxpayer must reduce his basis in the contract by that portion of the premium paid for the contract that was expended for the provision of insurance before a sale of the contract to a third party, to measure the taxpayer’s gains on the sale of the contract. However, if an individual sells a policy on the life of the unrelated individual solely for profit and enjoyed no insurance protection from the contract, the cost basis isn’t adjusted for the cost of insurance.
The 2017 Tax Cuts and Jobs Act (TCJA) amended IRC Section 1016(a) to provide that no basis adjustment is made for mortality, expense or other reasonable contract charges for insurance contracts. Based on the TCJA amendment, Rev. Rul. 2020-05 modifies the 2009 revenue rulings so that in each case, there’s no adjustment to basis for the costs of insurance.
• Internal Revenue Service determines that community property retains status in incomplete non-grantor trust—In Private Letter Ruling 202006002 (released Feb. 7, 2020), the IRS determined the tax status of community property transferred to an incomplete gift, non-grantor trust. The married couple lived in a community property state. They funded a trust for asset protection purposes under state law with a corporate trustee. The trust stated that the property transferred to the trust was community property (funded equally from each grantor’s share of community property) and that it would retain its character as community property, even when distributed to either grantor prior to the death of either grantor. The first grantor to die would have a general power of appointment (POA) over his one-half interest in the trust.
The trust was for the benefit of the grantors, their issue, a sibling and a friend. The trust had various distribution restrictions and terms allowing distributions to be made by an Appointment Committee, as directed by or subject to certain consent rights of the grantors, which resulted in it being a non-grantor trust, and the IRS confirmed various gift and estate tax treatment of the trust:
• The grantors’ contributions of property to the trust wouldn’t be completed gifts, and the trust would be treated as a non-grantor trust for income tax purposes
• Distributions made by the Appointment Committee to beneficiaries wouldn’t be completed gifts by the Appointment Committee members
• No trust property will be included in the estate of any member of the Appointment Committee
The PLR held that the basis of all the trust’s community property would be adjusted on the death of the first spouse to die to the fair market value as of such date. This ruling seems to be based on the validity of the trust provisions maintaining community property status. It doesn’t mention whether applicable state law would treat the trust property as community property, and generally property transferred to an irrevocable trust ceases to be community property. For example, California Family Code (CFC) Section 761(a) provides:
Unless the trust instrument or the instrument of transfer expressly provides otherwise, community property that is transferred in trust remains community property during the marriage, regardless of the identity of the trustee, if the trust, originally or as amended before or after the transfer, provides that the trust is revocable as to that property during the marriage and the power, if any, to modify the trust as to the rights and interests in that property during the marriage may be exercised only with the joinder or consent of both spouses.
CFC Section 761(e) goes on to say that “Nothing in this section affects the community character of property that is transferred before, on, or after July 1, 1987, in any manner or to a trust other than described in this section.” Therefore, CFC Section 761(a) creates a presumption that community property transferred to a revocable trust will remain community property unless the trust says otherwise, but CFC Section 761(e) appears to allow transfers of community property to a trust not described in CFC Section 761(a) (that is, an irrevocable trust) and possibly retaining its community property character.
• IRS confirms that tax benefits are protected by state court reformation to correct scrivener’s errors—In PLR 202009012 (released Feb. 28, 2020), a taxpayer died survived by his wife. A revocable trust established two shares of his own property (the couple lived in a community property state): a Family Trust and Marital Trust. The Family Trust was intended to be excluded from the surviving spouse’s estate, and the Marital Trust was intended to be a qualified terminal interest property (QTIP) trust. The proper tax elections (QTIP, reverse QTIP and generation-skipping transfer (GST) tax and estate tax exemption allocations) were made on a timely filed Form 706.
After the decedent’s death, the trust terms governing his property (that is, the Family Trust and Marital Trust) became irrevocable. The surviving spouse still had a power to amend and revoke the portions of the trust governing her own property.
The surviving spouse ultimately retained an attorney to restate the trust (the Restatement) and update her estate plan. In the Restatement and her new will, several errors were made, which included:
• The provision in the trust providing that the Family Trust and Marital Trust became irrevocable was omitted, and so the surviving spouse appeared to have a broad power of amendment and revocation over the entire trust.
• The surviving spouse purported to exercise POAs over the Family Trust and Marital Trust to her own Survivor’s Trust, but she was granted no such power over the Family Trust, and only a limited (special) POA over the Marital Trust.
• The surviving spouse’s will failed to waive the right to reimbursement from the GST tax-exempt Marital Trust.
The surviving spouse later died, and when her child was appointed as trustee, he noticed the errors. He was concerned about the language regarding the POA to her own revocable trust, which might be interpreted as a general POA appointing in favor of her own creditors. As trustee, her child petitioned a local court for instruction and to reform the trust.
The attorneys’ affidavits were convincing to the local court and the IRS. The local court held that the scrivener’s errors in the Restatement could be reformed under state law. The IRS concluded that the reformation was proper under state law and that the attempted exercise of a POA over the Family Trust was invalid because the Family Trust granted her no such power. It noted that the exercise of the POA over the Marital Fund couldn’t exceed its original scope, and the language of the Restatement didn’t alter or expand the power granted.
The PLR confirmed that the court reformation was effective to preserve the QTIP and reverse QTIP elections and estate and GST tax exemption allocations reported on the estate tax return, so that the Marital Trust continued to be GST tax exempt, and the Family Trust wasn’t includible in her estate under IRC Sections 2041, 2033 or 2038.
Lastly, the IRS noted that while the spouse’s will didn’t waive the right to reimbursement from the decedent’s estate for estate taxes attributable to the GST tax-exempt Marital Trust, her trust did so, and the PLR concluded that the waiver under the trust was sufficient (the result of which was that the surviving spouse’s estate wasn’t treated as making any constructive additions to the GST tax-exempt Marital Trust).