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Tax Law Update: September 2023

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

Internal Revenue Service waives requirement of actual conveyance of property assigned to qualified domestic trust (QDOT) so spouse can qualify for marital deduction—In Private Letter Ruling 202332013 (Aug. 11, 2023), the decedent’s surviving spouse wasn’t a U.S. citizen at his death. Prior to the due date of the estate tax return, the spouse irrevocably assigned assets to the QDOT that would have otherwise passed outright to the spouse, but the assets weren’t actually conveyed to the trust. The spouse became a U.S. citizen before the date that was one year after the due date (including extensions) for filing the estate tax return, currently resides in the United States and has resided continually in the United States since the decedent’s death. The estate intends to timely file a final Form 706-QDT on or before “Date 5” to notify the IRS and certify that the spouse has become a U.S. citizen.

In this PLR, the estate requested a waiver to the requirement of an actual conveyance of property irrevocably assigned to a QDOT for purposes of qualifying for a marital deduction under Internal Revenue Code Section 2056.

IRC Section 2056(d)(2)(B) provides that property passing from the decedent to the surviving spouse will be treated as passing to the surviving spouse in a QDOT if the property is irrevocably transferred or assigned to the QDOT by the spouse before the date on which the estate tax return is filed.

Under Section 2056A(b)(12)(A) and Treasury Regulations Section 20.2056A-10(a)(1) and (2), a QDOT is no longer subject to the estate tax imposed under Section 2056A(b) if the surviving spouse of the decedent becomes a citizen of the United States, the spouse was a U.S. resident at all times after the date of the death of the decedent and before becoming a U.S. citizen and the U.S. trustee of the QDOT notifies the IRS and certifies in writing that the surviving spouse has become a U.S. citizen. Notice is to be made by filing a final Form 706-QDT on or before April 15 of the calendar year following the year that the surviving spouse becomes a citizen, unless an extension of time for filing is granted. Treas. Regs. Section 20.2056A-4(b)(6) provides that, for purposes of Section 2056(d)(2), property irrevocably assigned but not actually transferred to the QDOT before the estate tax return is filed must be conveyed and transferred to the QDOT under applicable local law before the administration of the decedent’s estate is completed. If there’s no administration of the decedent’s estate (because for example, none of the decedent’s assets are subject to probate), the conveyance must be made on or before the date that’s one year after the due date (including extensions) for filing the decedent’s estate tax return.

Treas. Regs. Section 20.2056A-4(b)(6) further provides that the decedent’s estate may request an extension of time for completing the conveyance, or a waiver of the actual conveyance, under Treas. Regs. Section 301.9100-1(a). The IRS granted a waiver of the requirement of actual conveyance of the assets to the trust.

• Taxpayer challenges IRS’ aggregation of two minority interests into one controlling interest for valuation purposes—In Estate of Epstein v. Commissioner, No. 11534-23 (T.C. 2023), the estate filed a petition challenging a $2.6 million tax deficiency, arguing that the IRS improperly combined limited partner (LP) and general partner (GP) interests when valuing an interest in an apartment complex for estate tax valuation purposes. On Jerry Epstein’s death, a marital trust created by his late wife held an 8.746% LP interest and a 1.2% GP interest, and a survivor’s trust held a 10.4% LP interest. The IRS valued the marital trust’s interests at a total of $15.59 million versus the estate’s value of $12.6 million, and the IRS valued the survivor’s trust interest at $16.4 million versus the estate’s $13.1 million, for a total difference of $6.29 million. Among other arguments, the estate claimed the IRS improperly aggregated the LP and GP interests in the two trusts to arrive at its valuation.

The IRS has lost on several attempts to aggregate two minority interests held in different capacities into one controlling interest and has now conceded the issue in the case of qualified terminable interest property (QTIP) marital trusts; that is, property passing to an individual’s estate isn’t aggregated, for estate tax valuation purposes, with property in a QTIP marital trust that’s included in such individual’s gross estate under IRC Section 2044. See Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981); Estate of Bonner v. U.S., 84 F.3d 196 (5th Cir. 1996); Estate of Mellinger v. Comm’r, 112 T.C. 26 (1999); Estate of Nowell v. Comm’r, 77 T.C.M. 1239 (1999); Estate of Lopes v. Comm’r, 78 T.C.M. 46 (1999); and AOD-1999-006 (Aug. 30, 1999). The IRS has acquiesced to this line of cases.

The above courts noted that the surviving spouse doesn’t possess, control or have any power of disposition over the assets in the QTIP trust; that is, the surviving spouse’s estate didn’t have control over the trust assets “such that it could act as a hypothetical seller negotiating with buyers free of the handicaps associated with fractional undivided interests. The valuation of the assets should reflect that reality.” Estate of Bonner v. U.S., 84 F.3d 196, at p. 199. So it seems likely the Tax Court in Epstein will rule in favor of the estate on this claim.

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