• Ruling on valuation of gifts of remainder interests in real estate—In Private Letter Ruling 201808001 (Nov. 16, 2017), the Internal Revenue Service ruled on the valuation and gift tax consequences of certain transfers of interests in real estate. The taxpayers previously purchased land together with their six children: The parents purchased life estates, and the children each purchased a 1/6th common undivided interest in the remainder. This joint purchase was made before Internal Revenue Code Section 2702 was enacted.
The parents wanted to give their life estates with respect to a certain portion of the real estate to their children so that their children would own that portion entirely. The remaining real estate would continue to be owned by the parents (successive life estates) and children (sharing the remainder interests).
The IRS ruled that the remaining property would still be treated under the pre-IRC Section 2702 rules, unaffected by the proposed gift. The gifts of the life estates in the property would be valued using the actuarial value of the individual life estates under the IRC Section 7520 rate applicable in the month of the gift. The ruling also held that because the parents wouldn’t be retaining any right or interest in the portion of property being given to the children now, no portion of it would be includible in their estate.
This PLR is interesting because it held that since the initial purchase was made before the enactment of Section 2702, this later gift to the children was outside of the rules of Section 2702 as well. If the taxpayers had wanted to enter into a similar purchase today, the valuation rules of Section 2702 would apply. Under Section 2702, if family members make a joint purchase of a life estate and a remainder interest in the same property (and the interests aren’t qualified, by using a joint qualified personal resident trust, for example), the holder of the life estate will be treated as having purchased the entire property and then making a gift (reduced by any consideration paid by the remainderman and limited to the consideration paid by the life tenant) of the remainder interest, with the retained term interest being valued at zero.
• Ruling on GST/gift tax splitting—In PLR 201811002 (March 16, 2018), a taxpayer filed gift tax returns reporting gifts made to four irrevocable trusts, one for each of his four children. On the initial gift tax returns, he and his wife elected to split gifts under IRC Section 2513. However, due to a CPA error, the dollar value for each of the husband and his wife wasn’t properly reflected on their returns. The husband showed a gift of 75 percent of the value of the transfers; the wife’s gift tax return showed a gift of 25 percent of the value of the transfers. The husband and wife each should have shown a gift of 50 percent of the total transfer as required under Section 2513. They didn’t allocate generation-skipping transfer (GST) tax exemption.
The husband subsequently decided to make a late allocation of GST tax exemption. He filed a gift tax return to make a late allocation of GST tax exemption to the trusts. In another error by the CPA, the return showed a GST tax exemption allocation by the husband equal to 100 percent of the value of the trusts’ property as of the allocation date, even though both the husband and wife were transferors.
The statute of limitations expired on both the gift tax returns reporting the gifts and the late GST tax allocation. The PLR held that because the statute of limitations expired, the gift amounts on the returns as filed were final. Therefore, the husband was treated as making a gift of 75 percent of the initial transfer, despite the rules under IRC Section 2513 mandating an equal split. The gifts as finally determined for gift tax purposes were the amounts shown on the gift tax returns. However, Treasury Regulations Section 26.2652-1(a)(4) provides that the husband is only treated as transferring 50 percent of the property for GST tax purposes, “regardless of the interest the electing spouse is actually deemed to have transferred under section 2513.” So, despite the statute of limitations having expired on the GST tax allocation, the husband was treated as allocating GST tax exemption to only 50 percent of the trust property.
A similar issue was presented in PLR 201724007 (March 2, 2017). In that ruling, the taxpayers had elected to split gifts that weren’t eligible for gift splitting. Nonetheless, the split gift treatment became final after the gift tax statute of limitations ran. Both of these rulings show that once the statute of limitations runs on a gift tax return, the reported treatment of the gift splitting is final, even if incorrect because it couldn’t typically be split (PLR 201724007) or was split improperly (PLR 201811002). But, once the election is made to split the gifts, the spouses must equally (50/50) make the allocation of GST tax exemption.
• Tax Court holds taxpayers liable for taxes on excess contributions to Roth IRAs resulting from investment scheme using FSCs—In Mazzei v. Commissioner (150 T.C. No. 7, March 5, 2018), the taxpayers established a company that produced injector components that mixed chemicals with water for agricultural purposes. The business grew, and it began selling its products overseas through foreign distributors. Angelo Mazzei joined a trade association for farmers. The trade association sold interests in foreign sales corporations (FSCs) in Bermuda to its members. In 1998, the company applied to and joined the FSC/individual retirement account program. As part of the program, Angelo and his wife Mary each opened self-directed Roth IRAs and contributed $2,000 to each one. Each IRA then purchased stock in the FSC. The company and the FSC signed an agreement under which the FSC was to perform export-related activities for the company, and the company was to pay the FSC a commission. However, the company retained complete control regarding whether to pay a commission—the commissions weren’t mandatory.
The company made regular payments to the FSC, and the FSC then paid the IRAs. Between 1998 and March 2002, the FSC paid $533,057 to the Mazzeis’ IRAs. The Mazzeis filed protective disclosures on their Forms 1040 noting the transactions, and the IRS issued notices of deficiency to them for excise taxes for excess contributions to their Roth IRAs.
The taxpayers argued that the payments to the Roth IRAs were dividends paid from the FSC. However, the Tax Court held for the IRS. The court found that the FSCs were, in fact, owned and controlled by the taxpayers because the Roth IRAs paid nothing for the FSC stock, and the Roth IRAs had no economic risk or entitlement to an upside benefit from their ownership in the FSC. Further, the Mazzeis retained control of all the transactions (including whether to pay such commissions to the FSC and even the power to take previous payments back). Therefore, the court held that the Mazzeis were the owners of the FSC stock for federal tax purposes, and the dividends were properly characterized as dividends paid to the Mazzeis and then contributed to the IRAs. The $533,057 routed through the FSC exceeded the contribution limits to the Roth IRAs and were subject to excise taxes under IRC Section 4973.
The majority distinguished this case from a recent U.S. Court of Appeals for the Sixth Circuit case, Summa Holdings, Inc. v. Commissioner (848 F.3d 779), in which the dissent’s argument was identical to the Mazzeis’ case, other than it involved a different type of foreign entity (a domestic international sales corporation).