LEGISLATIVE UPDATE

A ruling on whether an individual's transfer of securities to a family limited partnership constituted indirect gifts of a portion of those securities to the other members of the partnership, who were the individual's daughters, was issued late last month by the U.S. Tax Court in Gross v. Commissioner (T.C., No. 9693-06, T.C. Memo. 2008-221, 9/29/08). The court held that the gifts were properly treated as gifts of interests in limited partnership and not as indirect gifts of portions of the securities contributed to the partnership.

Bianca Gross, donor and the petitioner, had accumulated a sizeable portfolio of publicly-traded securities over the years, which would ultimately be left to her two daughters. Due to spendthrift concerns about one of the daughters, in 1998 she opted to form a family limited partnership with her daughters in which Bianca would contribute $100 and each daughter would contribute $10. Bianca would also contribute her securities, and as general partner and majority owner, retain control over the partnership. Distributions from the partnership were also at her discretion. The daughters, as limited partners, could not transfer their partnership interests without their mother's approval, withdraw from the partnership, receive a return of their capital contributions, or force dissolution of the partnership. Also, the daughters could not take part in the management of the business and affairs of the partnership, except as specifically provided in the partnership agreement or as required by law.

On her 1998 Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, Bianca reported gifts of a 22.25-percent limited partnership interest valued at $312,500 to each daughter. On the schedule attached to the return, she listed the securities contributed to the partnership with a market value of $2,158,646. The schedule also included a computation of each partner's capital accounts of $100, $10, and $10 for Bianca and her daughters, respectively, and a credit to Bianca's account for the securities in the amount of $2,158,646 followed by a debit for $960,598 due to her gifts of $480,299 (22.25% x $2,158,646) each to her daughters, whose capital accounts were then credited for the same amount. The schedule then applied an approximate 35 percent discount to the value of the gifts due to "minority interest", "lack of control", and "lack of marketability" resulting in the reported $312,500 value.

In 2006, following an examination of the return, the Internal Revenue Service issued a notice of deficiency of $120,583.22 for the 1998 gift tax, claiming Bianca had made indirect gifts in the amount of $480,299 to each of her daughters of securities when she contributed the securities to the limited partnership rather than direct gifts of 22.25-percent interests in the partnership.

The court disagreed, and found that Bianca's gifts made to her daughters were in fact gifts of interests in the limited partnership and not indirect gifts of portions of the securities contributed to the partnership. The court further held that Bianca was correct in reporting the discounted value of each of those gifts as $312,500 on the Form 709.

Source:
Westlaw: Gross v. C.I.R., T.C. Memo. 2008-221, T.C.M. (RIA) P 2008-221, 96 T.C.M. (CCH) 187 (2008); United States Tax Court: Gross v. Commissioner, T.C. Memo. 2008-221, September 29, 2008.

On October 1, in Nelson v. First Nat. Bank and Trust Co. of Williston, (2008 WL 4414601 (8th Cir. 2008)), the U.S. Court of Appeals for the Eighth Circuit affirmed a district court's grant of summary judgment in favor of the former trustee of decedent's trust that was being sued for breach of fiduciary duty by the trust's beneficiaries and new trustee.

In 1998, Leonard Nelson established the Leonard Nelson Trust, naming First National Bank and Trust Co. as trustee. Among other things, the purpose of the trust was to pay taxes due on Leonard's estate, and to provide income to his children, Jane and Bruce Nelson. The trust held 597,164 shares of Medtronic stock, which constituted 90 percent of the trust's marketable assets available for paying any estate tax, and most of the interest in two limited partnerships, which in turn held 700,000 more shares of Medtronic stock. The trust contained a provision that "any investment made or retained by the trustee in good faith shall be proper despite any resulting risk or lack of diversification or marketability and although not of a kind considered by law suitable for trust investments." An investment authorization was also signed by Leonard stating that Medtronic was a proper investment and directing the trust to retain it.

After Leonard's death on June 5, 2006, First National estimated that the estate taxes that would be due in nine months would total $20 to $30 million. Four months later the Nelsons removed First National as trustee, and directed them to transfer the trust assets promptly to the successor trustee, US Bank. After failing to dissuade the Nelsons from changing trustee, First National offered to sell the stock itself, but the Nelsons refused, so the bank transferred the stock to US Bank. The next day, US Bank sold all of the stock at one time, for a net price of $48.1375 per share. The closing price that day was $48.71 per share. The Nelsons and US Bank brought action against First National alleging that the bank breached its fiduciary duties of care and prudence, which they argued dictated that First National liquidate the Medtronic stock within two weeks of the date of death in order to reduce exposure to market risk, and preserve the trust assets to pay the estate tax that would be due in nine months. They claimed that they were damaged by this breach of duty, because in this two week period, the closing price of Medtronic stock fluctuated between $49.66 and $51.83 per share, which was higher than the $48.71 per share closing price on the date US Bank sold the stock.

The district court found that First National had acted "in reasonable reliance on the express and implied terms of the trust, which provided for retention of the Medtronic stock despite any lack of diversification." The plaintiffs appealed, but the court of appeals affirmed the district courts finding, noting that the above-referenced provision regarding marketability "was an integral part of the trust, as it allowed First National to follow Leonard Nelson's explicit directive despite potential risks," and that the "loss of value due to market risk and lack of diversification were the sort of claims from which First National was protected..."

Sources:
Westlaw: Nelson v. First Nat. Bank and Trust Co. of Williston, 2008 WL 4414601 (8th Cir. 2008); United States United States Court of Appeals for the Eighth Circuit, Nelson v. First National Bank and Trust Co. of Williston, No. 07-3543, October 1, 2008.

Last month the U.S. Department of the Treasury and the Internal Revenue Service jointly announced the release of their 2008 - 2009 Priority Guidance Plan. To assist officials in drafting the plan, the Department and Service issued Notice 2008-62 soliciting suggestions from taxpayers, tax practitioners, and industry groups in an attempt to identify guidance items that are most important to taxpayers and the tax administration. The current plan contains 314 projects to be completed over a twelve-month period, from July 2008 through June 2009, as well as an Appendix listing routine guidance that is published each year.

This year's plan will address a variety of issues, including guidance concerning self-employment taxes and grantor trusts under I.R.C. §§ 1402 and 671, a variety of projects covering employee benefits including recent law changes for pre-approved IRAs and special issues relating to rollovers from qualified retirement plans (other than from Roth IRAs or designated Roth accounts) to Roth IRAs, guidance under I.R.C. § 7430 regarding attorney fees to reflect miscellaneous changes made by the Tax Reform Act of 1997 and the Internal Revenue Service Restructuring and Reform Act of 1998, and projects concerning the housing market and the current economic environment.

Among the projects listed in the plan are several items of interest related to gifts, estates and trusts, as follows:

• Regulations under I.R.C. § 67 regarding miscellaneous itemized deductions of a trust or estate.
• Guidance under I.R.C. § 529 regarding qualified tuition programs.
• Final regulations under I.R.C. § 642(c) concerning the ordering rules for charitable payments made by a charitable lead trust.
• Guidance under I.R.C. § 643 regarding uniform basis rules for trusts.
• Adjustments to sample charitable trust forms under I.R.C. § 664.
• Revenue ruling regarding the consequences under various income, estate, gift, and generation-skipping transfer tax provisions of using a family owned company as a trustee of a trust.
• Final regulations under I.R.C. § 2032(a) regarding imposition of restrictions on estate assets during the six month alternate valuation period.
• Guidance under I.R.C. § 2036 regarding graduated grantor retained annuity trusts (GRATs).
• Guidance providing procedures for filing and perfecting protective claims for refunds for amounts deductible under I.R.C. § 2053.
• Guidance under I.R.C. § 2053 regarding personal guarantees and the application of present value concepts in determining the deductible amount of administration expenses and claims against the estate.
• Final regulations under I.R.C. § 2053 regarding the extent to which post-death events may be considered in determining the deductible amount of a claim against the estate.
• Final regulations under I.R.C. § 2642(g) regarding extensions of time to make allocations of the generation-skipping transfer tax exemption.
• Guidance under I.R.C. § 2704 regarding restrictions on the liquidation of an interest in a corporation or partnership.
• Final regulations under I.R.C. § 7477 regarding declaratory judgment procedures relating to gift tax valuation issues.
• Guidance under I.R.C. § 7520 updating the mortality based actuarial tables to reflect data compiled from the 2000 census.

Source:
Westlaw: Department of the Treasury 2008-2009 Priority Guidance Plan, 2008 WL 4287828 (statement); 2008 WL 4287827 (plan contents); Internal Revenue Service: 2008-2009 Priority Guidance Plan (both statement and plan contents), published September 13, 2008.

Last month the IRS posted a corrected version of Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return to its web site. The form was revised in August to incorporate two minor corrections involving inserting mathematical symbols in formulas given on page 20 and page 32 of the form. Taxpayers who downloaded the form prior to September 11, 2008 should download this new form for future filings. The new form is available at http://www.irs.gov/pub/irs-pdf/f706.pdf.

Source:
Westlaw: IRS Corrects Estate Tax Return, Form 706, 184 DTR G-6, 2008; Internal Revenue Service, Caution — Change to Form 706, U.S. Estate Tax Return (Rev. August 2008), Changes to Current Tax Forms, Instructions, and Publications, September 18, 2008.

In SBSE-04-0808-046, the Internal Revenue Service re-issued and amended temporary guidance for the timely release of Form 668-J, Notice of Federal Estate Tax Lien Under Internal Revenue Laws, which is recorded to secure estate tax deferred under I.R.C. § 6166.

According to the memorandum, upon receipt of the full amount of tax deferred under IRC § 6166, the Cincinnati Campus Estate & Gift Tax Operation must notify the Advisory, Estate Tax Group within ten working days of receiving notice of the payment, and provide instructions to release any lien that was recorded.

Source:
Westlaw: IRS Updates Guidance on Estate Tax Lien Release, SBSE-04-0808-046, 174 DTR G-11, 2008; Internal Revenue Service: Interim Guidance on Estate Tax Lien Releases, Electronic Reading Room, SBSE-04-0808-046, published August 29, 2008.

The IRS is soliciting public comments concerning the following items of interest to estate planning professionals:

• Proposed rules (FI-165-84) on below-market loans. I.R.C. § 7872 recharacterizes a below-market loan as a market rate loan and an additional transfer by the lender to the borrower equal to the amount of imputed interest. The regulation requires both the lender and the borrower to attach a statement to their respective income tax returns for years in which they have imputed income or claim imputed deductions under section 7872.
• Form 56, Notice Concerning Fiduciary Relationship. Form 56 is used to inform the IRS that a person is acting for another person in a fiduciary capacity so that the IRS may mail tax notices to the fiduciary concerning the person for whom he or she is acting. The data is used to ensure that the fiduciary relationship is established or terminated and to mail or discontinue mailing designated tax notices to the fiduciary.

Comments should be sent to Glenn Kirkland, IRS, Room 6516, 1111 Constitution Ave. N.W., Washington, D.C. 20224 by November 28, 2008.

Source:
Westlaw: Proposed Collection; Comment Request for Regulation Project, 73 FR 56630-01, 2008 WL 4376157, Proposed Collection; Comment Request for Form 56, 73 FR 56631-01, 2008 WL 4376158; Department of the Treasury: Internal Revenue Service, Proposed Collection; Comment Request for Regulation Project, 73 Federal Register 56630-56631, No. 189, Notices – September 29, 2008; Internal Revenue Service, Proposed Collection; Comment Request for Form 56, 73 Federal Register 56631, No. 189, Notices – September 29, 2008.

Source:
Westlaw: Federal Rates; Adjusted Federal Rates; Adjusted Federal Long-term Rate and the Long-term Exempt Rate, Rev. Rul. 2008-49, 2008 WL 4225448; Internal Revenue Service: Rev. Rul. 2008-49, Index of Applicable Federal Rates (AFR) Rulings, published September 18, 2008.