LEGISLATIVE UPDATE

Supreme Court Affirms Benefits Properly Distributed to Ex-Spouse Beneficiary Despite Her Waiver of Rights in Divorce Decree

Last month, the U.S. Supreme Court unanimously affirmed a Fifth Circuit Court's decision that the deceased participant's benefits under an ERISA pension plan were properly distributed by the plan administrator to decedent's designated ex-spouse beneficiary despite her waiver of rights to the plan's benefits in the couple's divorce decree. (Kennedy v. Plan Adm'r for DuPont Sav. and Inv. Plan, 129 S.Ct. 865, No. 07-636 (01/26/2009))

The decedent, William Kennedy, was an employee of E. I. DuPont de Nemours & Company and a participant in its savings and investment plan (SIP), which was an ERISA-defined employee pension benefit plan. 29 U.S.C. § 1002(2). In 1971, while employed by DuPont, Kennedy married Liv Kennedy, and in 1974 he executed a beneficiary designation form in accordance with plan requirements naming Liv the sole primary beneficiary of his SIP. No contingent beneficiaries were named. When the couple divorced in 1994, Liv agreed in the decree to divest "all right, title, interest, and claim in and to ... the proceeds therefrom, and any other rights related to any ... retirement plan, pension plan, or like benefit program existing by reason of [decedent's] employment". An ERISA Qualified Domestic Relations Order (QDRO), pursuant to 29 U.S.C. § 1056(d)(3)(B)(i), providing instructions for disbursement of some of William Kennedy's non-SIP employee benefits was approved in 1997, but a QDRO for the SIP was never submitted. Kennedy retired from DuPont in 1998 and died in 2001 without ever replacing or removing his ex-spouse as sole beneficiary of his SIP.

After Kennedy's death, Kari Kennedy, daughter of the couple and executrix of her father's estate, demanded in a letter to DuPont that the SIP funds be distributed to the estate. She claimed that her mother's beneficiary designation was invalid pursuant to Texas Family Code § 9.302, which provides that a spouse's designation as a retirement-plan beneficiary is invalidated (with certain exceptions) by a subsequent divorce. However, DuPont relied on the decedent's SIP beneficiary designation form and distributed the SIP balance of approximately $400,000 to Liv, who refused a request by the estate to relinquish her SIP interest. The estate filed suit seeking recovery of the SIP benefits, claiming that the SIP beneficiary designation was invalid since Liv had waived her rights to the SIP benefits through the divorce decree and thus DuPont had incorrectly distributed the balance to her.

The district court granted summary judgment for the estate holding that the divorce decree constituted a valid waiver and therefore the estate was entitled to the SIP benefits. The Fifth Circuit reversed the ruling, holding that Liv's waiver constituted an assignment or alienation of her interest in the benefits to the estate. This was in violation of 29 U.S.C. § 1056(d)(1), which requires plans to provide that benefits may not be assigned or alienated unless the elimination of a spouse's interest in plan benefits is specifically provided for in a QDRO pursuant to 29 U.S.C. § 1056(d)(3).

The Supreme Court affirmed the Fifth Circuit's ruling, basing its decision, however, on the plan designation. The Court noted that "[b]ecause Liv did not attempt to direct her interest in the SIP benefits to the Estate or any other potential beneficiary, her waiver did not constitute an assignment or alienation rendered void under §1056(d)(1)." Although ruling against the nullity of the waiver, the Court determined that "the plan administrator did its ERISA duty by paying the SIP benefits to Liv in conformity with the plan documents. ERISA provides no exception to the plan administrator's duty to act in accordance with plan documents...By giving a plan participant a clear set of instructions for making his own instructions clear, ERISA forecloses any justification for enquiries into expressions of intent, in favor of the virtues of adhering to an uncomplicated rule." Although the Court did acknowledge that "[t]he guarantee of simplicity is not absolute, since a QDRO's enforceability may require an administrator to look for beneficiaries outside plan documents notwithstanding §1104(a)(1)(D)", it went on to say that in enforcing a QDRO, an administrator must enforce plan documents, not ignore them. In closing, the Court said, "Under the SIP, Liv was William's designated beneficiary. The plan provided a way to disclaim an interest in the SIP account, which Liv did not purport to follow. The plan administrator therefore did exactly what §1104(a)(1)(D) required and paid Liv the benefits."

Source:
Westlaw: Kennedy v. Plan Adm'r for DuPont Sav. and Inv. Plan, 129 S.Ct. 865, No. 07-636 (01/26/2009), 2009 WL 160440; U.S. Supreme Court: Kennedy, Executrix of the Estate of Kennedy, Deceased v. Plan Administrator for DuPont Savings and Investment Plan et al, No. 07-636 (01/26/2009)

Tax Court Calculates Value of Decedent's Minority Interests in Family Corporations

Last month, in the Estate of Marjorie deGreeff Litchfield et al. v. Commissioner (T.C. Memo. 2009-21; No. 15882-05 (29 Jan 2009)), the U.S. Tax Court calculated the percentage discounts to be used for built-in capital gains taxes, for lack of control, and for lack of marketability relating to the estate's minority interests in two closely held family corporations. In determining the discounts, the court upheld the estate's discounts on built-in capital gains and lack of control, but reduced the claimed discounts for lack of marketability.

Decedent's husband, Edward S. Litchfield, had died in 1984. At the time of his death, Mr. Litchfield owned minority stock interests in two closely held family-owned corporations, Litchfield Realty Co. (LRC) and Litchfield Securities Co. (LSC). In his will, the shares were transferred to a qualified terminable interest property trust with Marjorie Litchfield the lifetime income beneficiary. Under I.R.C. § 2044, Mrs. Litchfield's estate was required to include the fair market value of the LRC and LSC stock that was owned by the trust at the time of her death in April 2001. The estate elected to use the alternate valuation date of October 17, 2001 under I.R.C. § 2032(a)(2).

When LRC was formed in 1921, members of the Litchfield family contributed their farmland in Iowa to the corporation in return for shares of LRC stock. As of the October 17th valuation date, all outstanding shares of LRC stock were owned by Litchfield family members and by the trust, with the trust owning 43.1 percent of the 500,000 shares outstanding. The corporation had a total net asset value of $33,174,196, consisting of $23,422,439 in farmland, equipment, and a subsidiary corporation that owned and operated a grain elevator and sold crop insurance and services such as pesticide and fertilizer applications and $9,751,757 in marketable securities. Of the $33,174,196 net asset value. $28,762,306 represented built-in capital gains.

When LSC was formed in 1924 to invest in marketable securities, members of the Litchfield family contributed marketable securities they owned in return for shares of stock. As of the October 17th valuation date, all outstanding shares of LSC stock were owned by members of the Litchfield extended family or the trust, with the trust owning 22.96 percent of the 168,990 shares outstanding. The corporation had a total net asset value of $52,824,413, consisting blue-chip marketable securities, a partnership and other equity investments. Of the $52,824,413 net asset value, $38,984,799 represented built-in capital gains.

In valuing the estate's assets, the appraisal expert determined the fair market value of the estate's 43.1-percent stock interest in LRC to be $6,475,000, applying discounts of 17.4 percent for built-in capital gains taxes, 14.8 percent for lack of control, and 36 percent for lack of marketability. The appraiser also discounted the estate's 22.96-percent stock interest in LSC by 23.56 percent for built-in capital gains taxes, by 11.9 percent for lack of control, and by 29.7 percent for lack of marketability, and determined the fair market value of the estate's interest in LSC to be $5,748,000. In June 2002, the executors for Mrs. Litchfield's estate filed the federal estate tax return reporting these values in a total taxable gross estate of $56,057,800, total federal estate tax liability of $22,396,609, and overpayment of $3,391 as a result of $22.4 million in estimated federal estate taxes previously paid by the estate.

Audit of the return commenced in March 2003, with the Internal Revenue Service's valuation expert determining the discounted values of the estate's interests in LRC at $10,300,207 and in LSC at $8,762,783. At the conclusion of the audit in June 2005, the IRS accessed a deficiency of $6,223,176.

After reviewing the methodology used by both experts to determine the discounts, the court concluded that the built-in capital gains tax discounts of 17.4 and 23.6 percent and the lack of control discounts of 14.8 percent and 11.9 percent for the estate's minority stock interest in LRC and LSC, respectively, were appropriate. However, the court determined the estate's 36 percent and 29.7 percent lack of marketability discounts, when combined with the lack of control discounts, to be high, and concluded that discounts of 25 percent and 20 percent should apply instead to the estate's respective LRC and LSC minority stock interests.

Source:
Westlaw: Estate of Litchfield v. C.I.R., T.C. Memo. 2009-21, No. 15882-05 (01/29/2009), 2009 WL 211421; U.S. Tax Court: Estate of Marjorie deGreeff Litchfield, Deceased, George B. Snell and Peter deGreeff Jacobi, Co-Executors v. C.I.R., T.C. Memo. 2009-21, No. 15882-05 (01/29/2009)

Annuity Tables Reflect Fair Market Value of Lottery Annuities According to Sixth Circuit

The U.S. Court of Appeals for the Sixth Circuit concluded last month that the tables for valuing an annuity prescribed in I.R.C. § 7520 are appropriate for use in determining the fair market value of a stream of state lottery payments owed the estates of two lottery winners. (Negron v. United States, 6th Cir., No. 07-4460, 1/28/08, 553 F.3d 1013).

In 1991, Mildred Lopatkovich and Mary Susteric each won one-third of the Ohio Super Lotto jackpot of $20 million. Each winner was to receive 26 annual payments of $256,410.26 for a total payment of $6,666,666.67. After receiving eleven payments each, both Lopatkovich and Susteric died in 2001. The remaining fifteen lottery payments could not be used as collateral and were unassignable. Carol Negron, the executrix of both estates, elected for each estate to receive a lump sum cash settlement of the remaining winnings pursuant to Ohio Rev. Code § 3770.07.

As required by I.R.C. §§ 2001, 2031, 2039, and 2051, each estate included the value of the remaining lottery payments on its estate tax return. The reported value on each return was $2,275,867, the amount that each estate received from the Ohio Lottery Commission as determined by the Commission using a discount rate of 9.0% from the state valuation tables in effect on January 19, 1991, the date the lottery prize was won. The Internal Revenue Service, however, determined that the proper values of the remaining lottery payments were $2,775,209 for Lopatkovich and $2,668,118 for Susteric by using discount rates of 5.0% for Lopatkovich and 5.6% for Susteric from the annuity tables in effect on the dates of death pursuant to I.R.C. § 7520 and Treas. Reg. §§ 20.2031-7(d), 20.7520-1. The additional tax of $330,302 for Lopatkovich and $141,175 for Susteric was paid by the respective estates, and refund claims were subsequently filed with the IRS.

Both claims were denied, and the executrix filed suit in the district court for refund arguing that an exception from use of the Section 7520 valuation tables was warranted because the tables created unreasonable and unrealistic results. The district court granted partial summary judgment to Negron when it found that "transferability of an annuity would affect its fair market value" and that "the value ascribed by the annuity tables for both estate taxes [was] unrealistic and unreasonable" in determining the fair market value of each estate's lottery annuity payments.

In reviewing the case, the Sixth Circuit analyzed the purpose of the tables and observed that it was each estates choice to take lump sum payments rather than to continue the annuities payments. While acknowledging that the circuit courts have been split on whether the IRS annuity tables produce an unrealistic and unreasonable result when valuing lottery payments with marketability restrictions, the court agreed with the Fifth Circuit in Cook v. Commissioner (349 F.3d 850, 856 (5th Cir. 2003)) that "the non-marketability of annuities is an assumption underlying the IRS annuity tables" and thus "a marketability factor is not necessary to determine the value of a guaranteed income stream; the value of the decedent's interest at the time of death is readily ascertainable and fairly reflected by the present value of the remaining payments using the IRS annuity tables in effect on the date of death." Thus the court determined that the IRS had properly used the tables to value the remaining lottery payments for estate tax purposes despite the fact that the lump sum paid by the Ohio Lottery Commission was different.

Source:
Westlaw: Negron v. U.S. 553 F.3d 1013, 6th Cir., No. 07-4460 (1/28/08), 2009 WL 186195; U.S. Court of Appeals for the Sixth Circuit: Carol Negron v. USA, No. 07-4460 (1/28/08)

Private Letter Rulings Conclude Splitting Trust into Four Separate Trusts Non-Taxable

Recently, the Internal Revenue Service concluded in two private letter rulings that splitting a trust into separate trusts does not result in taxable gain or loss for any beneficiary, trust or severed trust.

Treatment of division of a testamentary trust established for the benefit of decedent's daughter and her issue is the subject of PLR 200904014 while in PLR 200904016 the trust is an irrevocable inter vivos trust established for the benefit of settlor's daughter and her issue. Facts in the rulings are nearly identical. Trust income is payable to daughter for life. Upon daughter's death, the corpus is divided into equal shares with one share for each of the daughter's surviving children, and one share for each of her deceased children leaving surviving issue. The trustee has discretion to pay income to each beneficiary for support, maintenance and education. Daughter has one deceased child with surviving issue. In the testamentary trust in PLR 200904014, each respective share is distributed outright to the beneficiary when he/she attains a specified age. In the irrevocable inter vivos trust in PLR 200904016, one-half of each respective share is to be distributed outright to the beneficiary when he/she attains a specified age and the remainder distributed outright to the beneficiary at a later specified age.

In each request, taxpayer proposes to divide the trust into four separate trusts, one for each of daughter's surviving children, and one for the issue of daughter's deceased child with trust assets distributed in kind on a pro rata basis among the four trusts. Daughter will remain lifetime beneficiary of each trust and the terms of each trust will remain the same as those of the common trust, except each trust will be modified to name as its trustee the child or grandchild who will take upon daughter's death.

In the analysis for each ruling, the Service noted that I.R.C. § 61(a)(3) provides that gross income includes gains derived from dealings in property. Further, under I.R.C. § 1001(a) gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis, and loss is the excess of the adjusted basis over the amount realized with the entire gain or loss required be recognized by I.R.C. § 1001(c). However, the Service compared these situations to that in Rev. Rul. 56-437, noting that divisions of trusts are "not sales or exchanges of trust interests where each asset is divided pro rata among the new trusts. Here, Trust's assets will be distributed in kind on a pro rata basis among the four separate trusts." Therefore, the beneficiaries, trusts or severed trust need not realize a gain or loss due to the modification and severance of trust under I.R.C.§§ 61 and 1001.

Source:
Westlaw: PLR 200904014, 2009 WL 155817; PLR 200904016, 2009 WL 155819; Internal Revenue Service: PLR 200904014, published January 23, 2009; PLR 200904016, published January

Period for Compounding

Note: Under Section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service after July 30, 2008, and before December 31, 2013, shall not be less than 9%.

Source:
Westlaw: Federal Rates; Adjusted Federal Rates; Adjusted Federal Long-term Rate and the Long-term Exempt Rate, Rev. Rul. 2009-5, 2009 WL 104646; Internal Revenue Service: Rev. Rul. 2009- 5, Index of Applicable Federal Rates (AFR) Rulings, published January 16, 2009.

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