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Tax Law Update: November 2023

David A. Handler and Alison E. Lothes highlight the most important tax developments of the past month.

• Internal Revenue Service rules on tax consequences of surviving spouse’s renunciations and transfers to children—In Private Letter Ruling 202339008 (Sept. 28, 2023), a surviving spouse accelerated distributions to her children by renouncing certain interests in her late spouse’s trust. The surviving spouse sought confirmation of the gift, estate and income tax consequences of the transactions under Internal Revenue Code Sections 2503, 2518 and 2519.

The decedent established a revocable trust that used a formula to fund a non-marital trust and a marital trust. The marital trust would be funded with the smallest amount necessary to eliminate federal estate tax. The decedent had none of his unified credit remaining at death, so all of his trust property was initially transferred to the marital trust. The estate filed an estate tax return and made a timely qualified terminable interest property (QTIP) election.

The widow wished to renounce her interest in the marital trust, which would cause the assets to pass to the non-marital trust, and to renounce her interest in the non-marital trust, resulting in the assets to be distributed to her children. The IRS ruled that the renunciation of her interest in the marital trust wasn’t a qualified disclaimer because it didn’t occur within nine months of the date of the decedent’s death (when his trust became irrevocable). Therefore, the widow was treated as making a gift to the non-marital trust. The gift was the income interest renounced under IRC Section 2511 and then the remaining interest in the marital trust under Section 2519. Section 2519(a) provides that any disposition of all or part of a qualifying income interest for life in any property to which Section 2519 applies is treated as a transfer of all interests in the property other than the qualifying income interest.

However, the IRS ruled that the renunciation of the interest in the non-marital trust was a qualified disclaimer because it occurred within nine months of the date of the taxable gift (that is, the renunciation of the marital trust) that created the non-marital trust. Treasury Regulations Section 25.2518-2(c)(3) provides that the 9-month period for making a disclaimer generally is to be determined with reference to the transfer creating the interest in the disclaimant, and with respect to inter vivos transfers, a transfer creating an interest occurs when there’s a completed gift for federal gift tax purposes. Here, the widow’s interest in the non-marital trust was created when she made a taxable gift by renouncing the marital trust, so the 9-month period began at the time of her gift. (If the non-marital trust had received assets on the decedent’s death, or if the renunciation of the marital trust was a qualified disclaimer, then the 9-month period to disclaim the non-marital trust would have begun at the decedent’s death.)

As a condition to the widow’s renunciation, the children agreed to pay gift tax imposed by Section 2511 in a net gift agreement (and the widow had the right to recover the gift tax triggered by Section 2519 under IRC Section 2207A). The gift tax liability assumed by the children reduced the value of the widow’s gift.

The widow also requested confirmation of how the transactions might affect her own estate tax. The PLR confirmed that none of the property in the marital trust or non-marital trust would be includible in her estate. However, gift tax paid on the transfers would be includible in her estate if she died within three years of the gift, although the children would pay the gift tax. 

Lastly, because the children agreed to pay the gift tax on the gift of the income interest, the transfer of her income interest is treated as a sale, and the gift tax paid by the children is the consideration. Revenue Ruling 72-243 holds that the proceeds received by the life tenant of a testamentary trust, in consideration for the transfer of their entire interest in the trust to the remaindermen, are to be treated as an amount realized from the sale or exchange of a capital asset under IRC Section 1222 and that the life tenant’s basis attributable to their life interest at the time of the sale is considered to be zero, pursuant to IRC Section 1001(e). So, the entire gift tax paid by the children is treated as capital gains for the widow.

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