• Treasury proposes regulations regarding charitable remainder annuity trust (CRAT) transactions—The Treasury recently proposed regulations (the proposed regs) (26 CFR Part 1[REG-108761-22] RIN 1545-BQ58) that will characterize certain CRAT investments as listed transactions, which have mandatory disclosure requirements for both the participants and their advisors. The Treasury issued the proposed regs in response to CRATs investing in a single premium immediate annuity (SPIA). In these situations, the recipient taxpayers report the annuity payment received from the CRAT as if the beneficiary of the CRAT is the owner of the SPIA directly. As an annuity payment under Internal Revenue Code Section 72, the beneficiary reports some portion of it as ordinary income and the rest (a majority) as a return of principal.
The Internal Revenue Service has found that some of the CRATs involved may deviate from the sample-approved CRAT forms it publishes, which could violate certain requirements of IRC Section 664, meaning that the trust doesn’t qualify as a CRAT. Assuming the trust involved in the transaction qualifies as a CRAT, the proposed regs list the transaction because the Internal Revenue Service asserts that the usual tiered income rules of IRC Section 662 apply to the reinvestment of sale proceeds by CRATs in an SPIA. These rules tax the annuity payment to the recipient in tiers: first as ordinary income, then accumulated capital gain, then other income, then non-taxable corpus.
The proposed regs require the participants and advisors to report the transaction if:
- The grantor creates a CRAT under Section 664 and funds it with appreciated property;
- The trustee sells the CRAT’s property;
- Some or all of the proceeds are used to purchase an annuity; and
- On a federal income tax return, the beneficiary reports the amount payable from the trust as if it were, in whole or in part, an annuity payment subject to Section 72, so it doesn’t carry out income to the recipient under the tiers of ordinary income and capital gain tiers under Section 664(b).
The proposed regs impose various penalties if the disclosures aren’t made.
• IRS issues its 2025 revenue proposals—The IRS has published its revenue proposals, noting its policy priorities in the estate and gift arena, many of which continue from prior years:
- Changing generation-skipping transfer (GST) tax rules applicable to trusts that are defined as non-skip persons because they include a charitable beneficiary.
- Implementing rules to restrict the structure of payments to charitable lead annuity trusts (CLATs) to avoid deferring charitable payments at the expense of the charities.
- Treating loans to beneficiaries from GST trusts as distributions for GST and income tax purposes.
- Requiring a minimum remainder value of 25% and a term of 10 years for grantor-retained annuity trusts (GRATs), among other types of trusts.
- Prohibiting discounting the estate tax value of promissory notes issued at the minimum applicable federal rate for income tax purposes.
- Treating carried interests as ordinary income.
- Prohibiting the deferral of gain on the exchange of real property used in a trade or business under the like-kind exchange rules and instead treating the gains from the exchange that exceed a certain threshold as a sale.
• U.S. Supreme Court declines to hear United States v. Paulson estate case—In the well-publicized case of U.S. v. Paulson (May 17, 2023), reported in prior issues, the IRS sued the estate and trust for over $10 million in unpaid estate tax and imposed liability on the individual beneficiaries under IRC Section 6324(a)(2).
The IRC imposes a lien on the gross estate and personal liability on six listed categories of persons “who receive or have estate property.” The six categories are: (1) spouses, (2) transferees (not including bona fide purchasers), (3) trustees, (4) surviving tenants, (5) persons in possession by way of exercise of a power of appointment, and (6) beneficiaries. The district court granted motions to dismiss under federal law to trustees and those defendants not in possession of estate property on the date of death. In May 2023, the U.S. Court of Appeals for the Ninth Circuit Court reversed the district court ruling, holding the statute imposes personal liability on persons who have estate property on the date of death and who receive estate property on or after the date of death for the amount of unpaid estate tax on such property. The estate filed a petition for writ of certiorari at the Supreme Court. Simultaneously, the beneficiaries asked the district court to certify on remand the amount of estate tax due, arguing that the assets had depreciated, and the estate tax now exceeded the value of the estate’s property. The Supreme Court declined to hear the case, likely because of the remand to the district court for the determination of estate tax due.
• Private Letter Ruling determines gift tax consequences of corporate transaction—In PLR 202406001 (Feb. 9, 2024), the taxpayer sought a determination of the gift tax consequences of a capital reorganization. An executive had previously formed several trusts and GRATs that owned shares of Stock A and Stock B in Company. A limited liability company (LLC) was formed for a certain business purpose (not described in the PLR). Company and a disregarded entity wholly owned the LLC. Company and its Board approved a share repurchase program whereby executives and the trusts would contribute shares of Stock A and B to Company, which would then retire those shares and issue new shares of
Stock C to the LLC. As part of the plan, the executive and the trusts planned to sign a contribution agreement under which they would contribute a proportionate number of shares back to Company. Then, the LLC would use cash derived from Stock C for a business purpose.
A transfer of property by one shareholder of a company to a corporation is a gift to the other shareholders unless it’s made in the ordinary course of business, meaning it’s bona fide, at arm’s length and free from donative intent. In that case, the transfer is considered to be made for adequate and full consideration in money or money’s worth.
The IRS held that the agreement implemented transfers that met these requirements. First, the whole structure of the agreement was for a business purpose. Second, the executive and trusts acted in their own self-interests, and the non-contributing shareholders weren’t related to the executive or the trusts. So, the indirect transfers resulting from the share contributions increased the value of the non-contributing shareholders but weren’t gifts because they were made in the ordinary course of business.
As between the executive and the trusts, the transfers the executive made increased the value of the shares held by trusts, but the same was true for the transfers made by the trusts to the executive. Because they contributed an equal proportion of their shares, the value contributed by each will equal the value each received. Therefore, those indirect transfers weren’t gifts either.
Separately, the IRS held that the exchange of shares didn’t interfere with a GRAT qualifying under IRC Section 2702. The question was whether the contribution of shares to Company would be characterized as a transfer to the executive annuitant, which would violate the GRAT. The GRAT correctly prohibits any distributions to the annuitant other than the qualified annuity interest. The contribution of the shares to Company resulted in an indirect transfer from the GRAT to the executive (as the annuitant) and an indirect transfer to the non-contributing shareholders (as the remaindermen). The IRS held that those transfers were really a reinvestment of GRAT assets, not an addition to the GRAT or a specific distribution to the annuitant executive.