RECENT DEVELOPMENTS 2015:

SELECTED FEDERAL CASES, RULINGS AND STATUTES

ILLINOIS CPA SOCIETY

MAY 10, 2016

Robert E. Hamilton Ryan A. Walsh Hamilton Thies & Lorch LLP 200 South Wacker Drive, Suite 3800 Chicago, Illinois 60606

© 2016 Robert E. Hamilton All Rights Reserved

RECENT FEDERAL DEVELOPMENTS

FEDERAL REGULATIONS AND ADMINISTRATIVE MATTERS

A. Rev. Proc. 2015-53, 2015-44 I.R.B. at 615 (November 2, 2015) sets forth the inflation- adjusted figures for exclusions, deductions and credits for 2016. In the estate and gift tax area these figures are the following:

 Applicable Exclusion Amount Increases to 5,450,000  Annual Exclusion: Remains at $14,000  Foreign Spouse Annual Exclusion: Increases to $148,000  §2032A Aggregate Decrease: Increases to $1,110,000  §6601(j) 2% Amount: Increases to $1,480,000  §6039F Gifts From Foreign Persons Increases to $15,671  39.6% Bracket for Trusts and Estates Income over $12,400

B. 2014-15 Priority Guidance Plan.

On July 31, 2015, Treasury and the Internal Revenue Service released their joint priority guidance plan for 2015-2016. The plan includes the following initiatives:

GIFTS AND ESTATES AND TRUSTS:

1. Guidance on qualified contingencies of charitable remainder annuity trusts under §664. COMMENT: This initiative is new, and relates to Section 664(f), which permits certain contingencies to accelerate the termination of a charitable remainder trust. 2. Final regulations under §1014 regarding uniform basis of charitable remainder trusts. Proposed regulations were published on January 17, 2014 and final regulations published in August, 2015. See part E, infra. 3. Guidance on basis of grantor trust assets at death under §1014. COMMENT: This initiative is also new and relates to the position of some practitioners that a grantor’s death, which causes the obligation to report income to shift from the grantor to the trust, is an event under Code section 1014(b)(1) that allows for a step-up in basis on the trust assets even though they are not included in the grantor’s estate. See also Revenue Procedure 2015-37, which provides that until the Service resolves the issue through publication of a revenue ruling, revenue procedure, regulations, or otherwise, it will not issue rulings to taxpayers concerning whether the assets in a grantor trust receive a § 1014 basis step-up at the death of the deemed owner of the trust for income tax purposes when those assets are not 2

includible in the gross estate. The Revenue Procedure is effective for ruling requests received after June 15, 2015. Rev. Proc. 2015-37, 2015-26 I.R.B. 1196. This issue involves, among others, assets that have been sold to a grantor trust and which are not includible in the estate of the grantor-decedent at his or her death. Because the assets are not includible in the decedent’s estate, there is no step-up under Section 1014(b)(9). However, there is precedent under Section 1014(b)(1) that assets not includible in the decedent’s estate can receive a basis step up. See, for example, Rev. Rul. 84-139, 1984-2 C.B. 168 dealing with foreign real property owned by a foreign person and passing to a U.S. Person at death. See also PLR 201544002, also dealing with foreign grantors, in which the Service granted the ruling request because it was received before the June 15, 2015 effective date of the Rev. Proc. Rev. Rul. 84-139 concluded that the property was inherited from a decedent and eligible for basis step up under 1014(b)(1). The argument for a Section 1014(b)(1) basis step up for grantor trust assets is that when a grantor dies the ownership of the trust assets changes, for income tax purposes, from the now-deceased grantor to the trustee, and this transfer of ownership comes within the language of (b)(1) allowing a step up for “property acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent.” 4. Revenue procedure under §2010(c) regarding the validity of a QTIP election on an estate tax return filed only to elect portability. COMMENT: This provision was first proposed in 2013 and arises from a concern that if a QTIP election is made but is not necessary to reduce federal estate tax, it may not be effectively recognized. See, e.g. Rev. Proc. 2001-38, 2001-2 C.B. 24, and PLRs 201345006 and 201338003. See also part G, infra, discussing the final portability regulations. Note also that a recent private letter ruling – PLR 201615004 – granted taxpayer relief under Rev. Proc. 2001-38 in an unusual situation. Under the facts of the ruling, the estate made a QTIP election on Schedule M of the decedent’s estate tax return for a trust that qualified for the marital deduction under Section 2056(b)(5) (a general power of appointment trust). QTIP was unnecessary to qualify for the marital deduction. In a later year the martial trust wanted to engage in a commutation of interests, but appeared to be concerned that Section 2519, which treats any disposition of an income interest as a deemed distribution of the remainder of the trust, would be implicated in the commutation. The Service granted the relief. The situation is a little odd because Rev. Proc. 2001-38 discusses situations where the QTIP election is made over a credit shelter trust – i.e,. a trust that would not have generated any tax absent a marital deduction – or over a trust where the taxable estate was not sufficient to cause tax. In either case the QTIP election is not necessary to reduce estate tax. Here it is also true that had the QTIP election not been made, there would be no reduction in estate tax, but for a completely different reason – that the trust already qualified for the marital deduction. 5. Guidance on the valuation of promissory notes for transfer tax purposes under §§2031, 2033, 2512, and 7872. COMMENT: This proposal is new and arises, perhaps, from the disconnect between valuing notes for gift tax purposes by reference to adequate interest as a so-called “safe harbor” and then valuing the same notes for estate tax purposes at fair market value, subject to substantial discounts. There was an interesting discussion in the Recent Developments portion of the 2016 Miami Institute regarding this issue, which has application in some inter-generational life insurance planning. For federal gift tax 3

purposes the taxpayer will maintain that a note with interest at the applicable federal rate at the time of issuance should be valued at face. Absent some other consideration (lack of collectability, for example), taxpayers who have used the AFR have been on pretty safe ground. Under Section 7872 a loan of money at AFR is valued for gift tax purposes at face. Two Tax Court cases have extended the application of gift tax valuation at AFR to notes issued for a sale of property (Frazee v. Commissioner, 95 T.C. 554 (1992)) and to notes issued in connection with a buy/sell transaction (True v. Commissioner, T.C. Memo 2001-167). Current proposed regulations under Section 2512 refer to Section 1012 for note valuation, and proposed regulations under Section 1012 in turn refer to Section 1274, which uses AFR. Several private letter rulings have “blessed” the use of AFR in intra-family transaction when considering possible gift issues. See PLR 9408018 and PLR 9535026. The material accompanying the Recent Developments discussion at this year’s Miami Institute point out that if the AFR exceeds 6%, additional care will have to be taken in the planning stage. The Seventh Circuit has adopted the position that the “safe harbor” 6% rate in installment contracts governed by Section 483 applies for all purposes of title 26 (which includes chapters 11 and 12), so that notes meeting the Section 483 safe harbor of 6% may be valued at face notwithstanding that actual interest rates may be greater. See, e.g., Ballard v. United States, 854 F 2d 185 (7th Cir. 1988). The Eight and Tenth Circuits have taken the position that although Section 483 applies for all purposes of title 26, it only deals with how to allocate payments between principal and interest, and that valuation for gift tax purposes will not be governed by the 6% safe harbor. See, e.g., Krabbenhoft v. Commissioner, 939 F.2d 529 (8th Cir. 1991); Schusterman v. United States, 63 F. 3d 986 (10th Cir. 1995). When a person dies is the note valued pursuant to AFR principles or does the estate apply fair market value principles? The difference can be significant, especially where a note may not be due for a considerable period of time – for example where a note issued in connection with life insurance premium financing is not due until the death of a child of the note holder. Section 7872(i)(2) authorized Treasury to issue regulations regarding the chapter 11 valuation of notes and since 1985 there has been a proposed regulation that, if enacted, would apply to term loans made “with donative intent.” If the loan was issued at the appropriate AFR to begin with, it’s hard to see how the loan could be characterized as one made with donative intent for the reasons stated above. Obviously the Service believes it is being whipsawed by the variance in valuation principles, and thinks the practice is abusive. At the Recent Developments session of the 2016 Miami Institute the comment was to expect a fight over this at the audit level. In this connection, note Morrissette v. Commissioner, 146 T.C. No. 11, a 2016 case that considers intergenerational split dollar loans. In Morrissette, the decedent’s revocable trust advanced $29.9 million in equal amounts to each of three trusts, one for each of the decedent’s three children. This was done at a time when the decedent was 93 years old, had been declared an incompetent by the local probate court, and had been succeeded as trustee of her revocable trust by her three sons. The advance to each of the trusts for the sons was to enable the trusts to purchase life insurance policies to fund a cross purchase buy/sell agreement for an S company owned by the decedent’s revocable trust and by the trusts maintained for the sons. The split dollar agreement was structured under the endorsement regime. The Service challenged the characterization of the 4

arrangement under the endorsement regime, claiming instead that the arrangement should be governed by the loan regime. The split dollar agreement for each of the three trusts provided that the decedent’s revocable trust would be entitled to receive the greater of the cash surrender value of the policies that were purchased with the contributed funds, or the cumulative premiums paid. The policies were all purchased with a single premium. When the decedent died, the estate retained a valuation expert to value the receivables due with respect to the split dollar agreements. The expert found these values to be $7,479,000, presumably because the receivables would not be paid for many years, until the sons died and the trusts received the insurance. The Service asserted both a gift tax and an estate tax deficiency notice. The case considered the narrow issue of whether the arrangement was governed by the economic benefit regime. The Tax Court believed it was, and granted summary judgement to the taxpayer. However, the summary judgment ruling does not dispose of the case, as the issue of valuing the receivables under the split dollar arrangement has not yet been decided – something to watch in the future. 6. Final regulations under §2032(a) regarding imposition of restrictions on estate assets during the six month alternate valuation period. Proposed regulations were published on November 18, 2011. 7. Guidance under §2053 regarding personal guarantees and the application of present value concepts in determining the deductible amount of expenses and claims against the estate. COMMENT: This issue probably relates to Graegin loans, which are structured to prohibit prepayment over the life of the loan. If the interest is considered an ordinary and necessary administration expense (e.g., estate has a closely held business, or substantial partnership assets that cannot be easily liquidated), the entire amount of interest that is required to be paid is deducted under Section 2053 without regard to present value issues. 8. Guidance on the gift tax effect of defined value formula clauses under §§2512 and 2511. COMMENT: This is the fourth new guidance initiative in the estate and gift tax area for 2015-2016. At the 2016 Miami Institute Recent Developments it was reported that the IRS continues to look for an appropriate case to challenge a formula allocation clause, especially a Wandry-type clause that defines the amount of the transfer in terms of a value as finally determined for federal gift tax purposes. Wandry clauses may be a “safer” bet for relatively small transfers. When the transfers are more significant, an allocation formula that transfers an entire interest but allocates it between transferees arguably will be safer. An allocation that splits the transfer between the target trust and a charity seems safest, especially if the charity is a donor advised fund, which will assure that there is independent fiduciary oversight. Other possibilities are transfers split between the target trust and an entity that will generate a low or no taxable gift, such as a GRAT or a QTIP trust. If a QTIP trust is used, it may be advisable to have a trustee different from that of the target trust, and beneficial interests that are varied (if not completely different) from the target trust. And of course if the formula price is determined by reference to values as finally determined for federal gift tax purposes, a gift tax return must be filed. 9. Regulations under §2642 regarding available GST exemption and the allocation of GST exemption to a pour-over trust at the end of an ETIP. 5

10. Final regulations under §2642(g) regarding extensions of time to make allocations of the generation-skipping transfer tax exemption. Proposed regulations were published on April 17, 2008. 11. Regulations under §2704 regarding restrictions on the liquidation of an interest in certain corporations and partnerships. COMMENT: There is little news with respect to the long-anticipated issues of guidance under Section 2704. Section 2704(a) treats the lapse of voting or liquidation rights in a corporation or partnership, which has the effect of lessening value, as a transfer by gift or a transfer includible in the estate of the decedent, if the family controls the entity before and after the lapse. Section 2704(b) provides that an “applicable restriction” will be disregarded when valuing certain family controlled entities. An applicable restriction includes any restriction which limits the ability of a corporation or partnership to liquidate and which either lapses, in whole or in part, after the transfer, or if the transferor and any member of the transferor’s family, either alone or collectively, have the right after such transfer, to remove, in whole or in part, the restriction. However, under Section 2704(b)(3) an applicable restriction does not include any restriction imposed, or required to be imposed, by a federal or state law. The limited partnership and limited liability acts of many states prohibit a partner/member from withdrawing from the entity unless the right is specifically conferred by the agreement. The problem for the Service under Section 2704(b) is that if certain restrictions that are imposed by the organizational documents are disregarded, the state law restrictions would nevertheless allow for significant discounts. At the 2016 Miami Institute nobody could predict when these long- awaited regulations would be issued and when they are issued what they would say. Speculation is that comments on the legality of the scope of what the IRS may have been ready to propose has caused the Service to rethink its approach. 12. Guidance under §2801 regarding the tax imposed on U.S. citizens and residents who receive gifts or bequests from certain expatriates.

EXEMPT ORGANIZATIONS

1. Revenue procedures updating grantor and contributor reliance criteria under §§170 and 509. 2. Revenue procedure to update Revenue Procedure 2011-33 for EO Select Check. 3. Proposed regulations under §501(c) relating to political campaign intervention. 4. Final regulations and additional guidance on §509(a)(3) supporting organizations. 5. Guidance under §512 regarding methods of allocating expenses relating to dual use facilities. 6. Final regulations under §529A on Qualified ABLE Programs as added by §102 of the ABLE Act of 2014. Proposed regulations were published on June 22, 2015. COMMENT: An ABLE account is an account arising under Code section 529A, which was added by Public Law 113-295 on December 19, 2014 and is effective for taxable years beginning after December 31, 2014. “ABLE” stands for “Achieving a Better Life Experience.” Section 529A permits states to establish programs whereby

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aggregate annual contributions of up to the Code section 2503(e) annual exclusion per year may be made to a single account for a disabled person, without the gift being considered the gift of a future interest or incomplete. A disabled person is one who meets the definition of a blind or disabled person under the Social Security Act and such condition has occurred before the individual attained age 26. Income earned on the account is not subject to federal income tax and distributions to the extent they meet the definition of “qualified disability expense” under the statute are not includible in the disabled person’s income. The term "qualified disability expenses" means any expenses related to the eligible individual's blindness or disability which are made for the benefit of the person, including expenses for education, housing, transportation, employment training and support, assistive technology and personal support services, health, prevention and wellness, financial management and administrative services, legal fees, expenses for oversight and monitoring, funeral and burial expenses, and other expenses, which are approved by the Secretary under regulations and consistent with the purposes of Section 529A. Distributions that do not meet the statutory definition are taxable under Section 72 and subject to a 10% penalty. Assets inside the ABLE account will not count as resources for federal assistance programs but will be subject to Medicaid payback rules on the disabled person’s death. The state establishing an ABLE program is required to impose rules regarding the limits on aggregate contributions to an ABLE account. On July 27, 2015 Governor Rauner signed Senate Bill SB 1383 (Public Act 099-0145) into law. SB 1383 is effective January 1, 2016 and enables Illinois to establish ABLE accounts. The Illinois legislation says that the Illinois Treasurer may not accept ABLE contributions until the IRS issues final regulations under IRC 529A. Illinois ABLE accounts are exempt from the account owner’s creditors and are also exempt from the claims of Illinois or its creditors. 7. Guidance under §4941 regarding a private foundation's investment in a partnership in which disqualified persons are also partners. 8. Final regulations under §§4942 and 4945 on reliance standards for making good faith determinations. Proposed regulations were published on September 24, 2012. 9. Final regulations under §4944 on program-related investments and other related guidance. Proposed regulations were published on April 19, 2012. 10. Guidance regarding the excise taxes on donor advised funds and fund management. 11. Guidance under §6033 relating to the reporting of contributions. 12. Final regulations under §6104(c). Proposed regulations were published on March 15, 2011. 13. Final regulations under §7611 relating to church tax inquiries and examinations. Proposed regulations were published on August 5, 2009.

C. Basis Consistency. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Public Law 114-41, 129 Stat. 443 (Act).added a new Section 1014(f) to the Internal Revenue Code regarding consistency between federal estate tax value and basis. This issue has been in the President’s Greenbook Proposals for several years and in that sense the new enactment was not surprising, although the legislation arose quickly and without legislative history. In addition to adding Section 1014(f), the Act added a new Section

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6035, requiring basis information to be provided to certain persons. The full text of 1014(f) and 6035 are attached to this outline as Exhibit A. Section 6035, dealing with the requirement of providing certain statements, is applicable to property with respect to which an estate tax return is filed after July 31, 2015. Thus, it applies somewhat retroactively, in the sense that it captures filing requirements for decedents who died as early as May 1, 2014 if the estate tax return was extended and filed on the extended date of August 1, 2015. The statute provides that the required basis information is to be furnished within 30 days of filing the return, if the return is timely filed, or 30 days after the due date, if the return is not timely filed. Due to the absence of regulations and proposed forms, the Service postponed the date for filing the required information under section 2035 to February 29, 2016. See Notice 2015-57, 2015 I.R.B. 36 at 294 (September 7, 2015). On December 18, 2015, the Service issued a preliminary form 8971 and related Schedule A. On January 6, 2016 the Service issued proposed instructions. The final version of the instructions for the form was published on January 29, 2016. On February 11, 2016, in Notice 2016-19, the Service announced that statements required under sections 6035(a)(1) and (a)(2) to be filed with the IRS or furnished to a beneficiary before March 31, 2016, need not be filed with the IRS and furnished to a beneficiary until March 31, 2016. On March 2, 2016 Treasury published proposed regulations under both 6035 and 1014(f). The proposed regulations answer many of the questions raised by the inartful language of the statutes but still impose an additional and sometimes confusing burden on executors and in some cases beneficiaries who transfer interests received from executors. The Service then announced that the statements required under sections 6035(a)(1) and (a)(2) to be filed with the IRS or furnished to a beneficiary before June 30, 2016 need not do so until June 30, 2016. Notice 2016-27, 2016-15 I.R.B. at 576 (April 11, 2016). As a preliminary matter, it is important to understand that the reporting requirements of Section 6035 exist regardless of whether the recipient of property is bound by the basis consistency obligation of Section 1014(f). In short, the executor in many cases will be providing initial basis information to persons who will not necessarily be obligated to use it. In cases where the recipient is not bound by Section 1014(f), the Service will follow Rev. Rul. 54-97, 1954-1 C.B. 113, which provides that for purposes of determining basis of property acquired from a decedent under Section 113(a)(5) (a predecessor of 1014(a)(1)), the value reported on an estate tax return establishes a presumption as to such value, but when the taxpayer is not estopped by previous actions or statements, the presumption is not conclusive and may be rebutted by clear and convincing evidence. See, e.g., TAM 199933001. The following summarizes some of the major issues: 1. The general basis consistency rule of section 1014(f)(1) provides that the basis of property acquired from a decedent cannot exceed, in the case of property the final value of which has been determined under chapter 11, such value, and in the case of other property the value of which is required to be furnished on a statement pursuant to section 6035, that value. However, section 1014(f)(2) provides that the basis consistency obligation shall only apply to any property whose inclusion in the decedent’s estate increased the liability for the tax imposed by chapter 11 (reduced by credits allowable against such tax) on such estate. Prop. Reg. §1.1014-10(b)(1) states that the consistency requirement applies to any property includible in the decedent’s estate under section 2031, any property subject to tax under section 2106, and any other property the basis of which is determined in whole or in part by reference to the basis of 8

such property (for example as the result of a like-kind exchange or involuntary conversion) that generates a tax liability under chapter 11 on the decedent’s estate in excess of allowable credits, except for the credit for prepayment of tax under chapter 11. The proposed regulations then clarify this general rule: A. Property that qualifies for an estate tax marital or charitable deduction under sections 2055, 2056 or 2056A does not generate a tax liability under chapter 11 and therefore is excluded from the property subject to the consistency requirement. Prop. Reg. §1.1014-10(b)(2). B. Tangible personal property for which an appraisal is not required under Treas. Reg. §20.2031-6(b) is deemed not to generate a tax liability under chapter 11 and therefore is also excluded from the consistency obligation. Prop. Reg. §1.1014-10(b)(2). C. If an estate tax liability is payable after the application of credits (except the credit for prepayment of tax), the consistency requirement applies to the entire gross estate (except for the property described at A and B above). Prop. Reg. §1.1014-10(b)(3). D. If no estate tax liability is payable after the application of available credits, the entire gross estate is excluded from the application of the consistency requirement. Prop. Reg. §1.1014-10(b)(3). 2. Separate from what property is subject to the consistency requirement are the issues of whether and to what extent the executor is required to furnish information on estate tax values to the beneficiaries. Section 6035(a)(1) provides that the basis statement is to be furnished whenever a return is required to be filed under 6018(a), but gives the Service authority to deal by regulations with situations when no return is required to be filed. Portability returns are not required to be filed under 6018; however, the portability regulations at Treas. Reg. § 20.2010-2(a)(1) state that when a return that is less than the filing requirement is nevertheless filed to elect portability, the return shall be “considered” for purposes of subtitle F (which includes Section 6035) as if it is one required to be filed under 6018. Does this then implicate Section 6035? The proposed regulations answer this in the negative: an executor who is not required under section 6018 to file an estate tax return but does so for other purposes, such as to elect portability, to make a GST allocation or to make a protective filing to avoid any penalty if an asset value is later determined to cause a return to be required or otherwise does not have to file or furnish the form 8971 or Schedule A. Prop. Reg. §1.6035-1(a)(2). The proposed regulations at §1.6035-1(b)(1) exclude from the reporting requirement four types of property that are includible in the decedent’s estate: A. Cash (other than a coin collection or other coins or bills with numismatic value); B. Income in respect of a decedent (as defined in section 691); C. Tangible personal property for which an appraisal is not required under Treas. Reg. §20.2031-6(b); and D. Property sold, exchanged, or otherwise disposed of (and therefore not distributed to a beneficiary) by the estate in a transaction in which capital gain or loss is recognized.

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The proposed regulations provide two examples, one for tangible personal property and another for shares of a publicly traded company that are exchanged prior to the filing of an estate tax return for shares in another publicly held company in a fully taxable transaction. In the tangible personal property example, the gross estate includes a rug, a clock and a painting, each having a value exceeding $3,000, and a miscellany of other personal and household effects. The example states that in each room a number of the miscellaneous articles are grouped, none of which has a value exceeding $100. The executor obtains an appraisal of the rug, clock and painting for a “disinterested, competent appraiser(s) of recognized standing and ability, or a disinterested dealer(s) in the class of personalty involved” and attaches these to the estate tax return. The example states that the reporting requirements apply only to the painting, rug and clock. 3. The general basis consistency obligation is imposed with respect to final values as determined for purposes of the estate tax and in other cases the values reported in the statement furnished under section 6035. A. The proposed regulations clarify a glitch in the statute concerning property whose basis changes during the course of administration, such as property subject to depreciation or depletion, or interests, such as S corporation shares or partnership/LLC interests where income, loss and distributions affect basis. Prop. Reg. §1014-10(a)(1) states that the taxpayer’s initial basis cannot exceed the final value of the property as determined for estate tax purposes. Prop. Reg. 1.1014-10(a)(2) then states that the final value of property required to be reported on an estate tax return is its initial value. This permits the taxpayer to adjust basis due to the operation of other provisions of the Internal Revenue Code without violating the requirement that the taxpayer’s basis be consistent with the final estate tax value. The proposed regulations note that the existence of recourse or non-recourse debt secured by property at the time of the decedent’s death does not affect the property’s basis, whether the gross value of the property and the outstanding debt are reported separately on the estate tax return or the net value is reported on the return. Therefore, post-death payments on such debt will not result in an adjustment to the property’s basis. B. The final value of property reported on a return required under Section 6018 is: (1) The value reported on the return once the period for assessment has expired without the value having been challenged; or (2) If (1) above does not apply, the value determined or specified by the IRS once the period of limitations for assessment and for claim for refund or credit of the estate tax have expired without that value having been timely constested; or (3) If (1) and (2) don’t apply, the value determined in an agreement, once the agreement is binding on all parties; or (4) In other cases, the value determined by a court, once the court’s determination is final. C. Prior to the determination of a final value under B above (which will include situations where an estate tax return is required to be filed, and situations 10

where a statement has been furnished to the taxpayer under Code section 6035 on account of a subsequent transfer as described below), the recipient of property may not claim an initial basis in excess of the value reported on the statement that is furnished. In cases where the final value changes from the initial value furnished in a statement, the taxpayer may not rely on the value initially furnished under section 6035 and may have a deficiency and underpayment resulting from the difference. See discussion below for the duty to file supplemental statements under Section 6035. D. The proposed regulations deal explicitly with omitted or after-discovered assets which are subject to the consistency requirement of section 1014(f). The treatment of the omitted or after-discovered asset depends in part on whether the executor has filed the required estate tax return. 1. If the statute of limitations on the estate tax return that was required to be filed has not run, the value of the asset will be determined under the rules described at B and C above if the executor files an initial or supplemental return to report the asset. If the limitations period runs without the executor having reported the asset on a supplemental return, the value of the unreported asset will be zero. Prop. Reg. §1.1014-10(c)(3)(i). Note that the zero basis rule applies only to property subject to the consistency requirement of section 1014(f). 2. In situations where the executor did not file a return, but the existence of the unreported asset would have generated or increased a federal estate tax liability, the final value of all property subject to the basis consistency rule of section 1014(f) is zero until a final value is determined under the rules described at B and C above. 4. Form 8971 must be filed by the earlier of 30 days after the date that Form 706, Form 706-NA or Form 706-A is required to be filed (including extensions) or 30 days after the date such form is actually filed. It seems anomalous to require an early filer to submit basis information 30 days after actually filing rather than 30 days after the filing due date (including extensions). Late filers must provide the statement under Section 6035 within 30 days after the due date no matter when they file. 5. The executor has a duty to supplement the Form 8971 and Schedule A. Section 6035(a)(3)(B). A. The proposed regulations explain that the duty to supplement arises with respect to any change to information required to be reported on the Information Return [Form 8971] or the Statement [Schedule A] that causes the information as reported to be incorrect or incomplete. This may include the discovery of property that should have been, but was not, reported on an estate tax return, a change in value pursuant to examination or litigation, a change in the identity of the beneficiary (such as by reason of death, disclaimer, bankruptcy or otherwise), or the executor’s disposition of property in a transaction in which the basis of the new property received by the estate is determined in whole or in part by reference to the property acquired form the decedent or as a result of the death of the decedent. Prop. Reg. §1.6035-1(c)(2). The proposed regulations make exceptions for inconsequential errors or omissions within the meaning of Treas. Reg. §301.6722-1(b) or situations where the supplemental filing would only 11

specifically identify the actual distribution of property previously reported as being available to satisfy the interests of multiple beneficiaries as described in Prop. Reg. 1.6035-(1)(c)(3). See Prop. Reg. §1.6035-1(e)(3). B. The supplemental filing must be done no later than 30 days after (1) the final value is determined within the meaning of the 1014 proposed regulations, (2) the executor discovers that the information reported on Form 8971 or Schedule A is incorrect or incomplete (there are exceptions for inconsequential errors or reports that would only include property values previously reported), or (3) a supplemental estate tax return is filed under section 6018 reporting property which was not reported on a previously filed estate tax return. 6. One issue raised at the 2016 Miami Institute was whether a fiduciary who settles a tax audit by “horse trading” some issues for others would be susceptible to liability if the settlement is required to be expressed by value adjustments to includible assets. 7. Penalties accrue for failure to file a correct form by a due date. The penalties apply for the failure to timely file the form, or the failure to file a form, even if timely, that contains correct or complete information. The penalties are those that apply to information returns and statements under Code Sections 6721 and 6722. They are inflation adjusted. Currently there is a $50 penalty for each Form 8971 (including Schedule A forms attached) that is filed late, but within 30 days after its due date. If the return is filed late, but more than 30 days after its due date, the penalty is $260 for each Form 8971 (and its attached Schedule A forms) filed late. There are limitations on the maximum annual penalties that can accrue for the failure to file either within or after the 30 day period following the due date, but since the penalties are geared to each 8971 and associated Schedule A filed late, the limitations would really only apply to an institutional filer. There are also penalties for failing to provide Schedule A to the persons entitled thereto. The penalty is $50 for each Schedule A form provided late but within 30 days of the due date, and increases to $250 for each Schedule A form provided late but after 30 days of the due date. Again these penalties are subject to maximum amounts which are designed to apply to institutional filers. If the filer is found to have intentionally disregarded the filing requirements, the penalties under both Section 6721 and 6722 increase to the greater of $530 per Form 8971 and $530 for each Schedule A, or 10% of the aggregate amount of the items required to be reported correctly. Inconsequential errors or omissions are not considered a failure to provide correct information, but errors related to a beneficiary’s tax ID, a beneficiary’s surname, the value of the asset the beneficiary is receiving from the estate or a significant item in a beneficiary’s address is never considered inconsequential. 8. The statute does not define the term “executor.” The proposed regulations fill in this gap by stating that the term “executor” has the same meaning as in section 2203, and includes any other person required under section 6018(b) to file a return. See Prop. Reg. §§1.1014-10(d) and 1.6035-1(e). The executor must use reasonable due diligence to identify and locate all beneficiaries. If the executor is unable to locate a beneficiary by the due date of the Form 8971, the executor must so report on the Form and explain its efforts in order to satisfy the due diligence obligation. Prop Reg. §1.6035(c)(4). Presumably a diligent but unsuccessful effort will qualify for the “reasonable cause” exception to the penalties, but few fiduciaries will want to rely on reasonable cause as an excuse for late or incomplete filing.

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9. An unrealistic provision of the statute is the assumption that the fiduciary will know, 30 days after filing an estate tax return, how the assets will be apportioned among the beneficiaries of the estate. This is true especially in situations where there is a formula allocation of assets. Funding rarely even begins before a return is filed, and in many cases may not begin until a closing letter is received. The proposed regulations state that if the executor has not determined which beneficiary is to receive an item of property as of the due date of the Form 8971 and Schedule(s) A, the executor must list all items of property that could be used to fund the beneficiary’s distribution on that beneficiary’s Schedule A. Prop. Reg. §1.6035-1(c)(3). The instructions to Form 8971 point out that this could mean that the same property could be listed on more than one Schedule A. Of course this will confuse many beneficiaries, as the information they are receiving will be largely useless to them until actual funding takes place. The proposed regulations state that once the exact distribution has been determined, the executor may, but is not required to, file and furnish a supplemental Form 8971 and Schedule A. Prop. Reg. §1.6035-1(c)(3). 10. The requirements of the statute militate strongly in favor of early funding. Imagine the situation where an estate leaves a bequest of $1,000 to a caretaker, distant relative or friend. If the bequest is not funded by the date that Form 8971 is required to be filed, the beneficiary’s Schedule A must list every asset which could be used in whole or in part to fund the bequest. When a bequest may be satisfied in kind, this might include every asset in the estate. Does the executor really want the $1,000 legatee to know this information? Paying early should allow the executor to report that the bequest was satisfied with cash. 11. Section 6035(a)(2) provides that the basis statement must be furnished to the Secretary and “each other person who holds a legal or beneficial interest in the property to which such return relates . . . .” The proposed regulations clarify this requirement by stating that if the beneficiary is a trust or another estate, the executor must furnish the Schedule A to the fiduciary rather than to the beneficiaries of the estate or trust. If the beneficiary is a business entity, the Schedule A is to be furnished to the entity. Prop. Reg. §1.6035- 1(c)(2).

12. The proposed regulations also impose a “subsequent transfer” filing requirement. This new provision states that if the recipient of property that previously was reported or was required to be reported on a Form 8971 (and thus on the beneficiary’s Schedule A) subsequently distributes, by gift or otherwise, such property in whole or in part in a transaction in which a related transferee determines its basis in whole or in part by reference to the recipient’s basis, the recipient/transferor must, no later than 30 days after the date of the distribution or other transfer, file with the IRS a supplemental statement and furnish a copy of the same to the transferee. The requirement to furnish information regarding the subsequent transfer also applies to property that the recipient/transferor acquired in transactions (such as like-kind exchanges or involuntary conversions) where the basis of the acquired property was determined in whole or in part by reference to the property initially obtained from the estate. For example, the subsequent transfer requirements could apply to real estate the recipient/transferor acquires from the estate, or real estate that the recipient/transferor acquires in a 1031 exchange involving real estate acquired from an estate. It the recipient/transferor disposes of the property before he receives the Schedule A from the executor, the supplemental statement need only disclose the change of ownership but does not have to provide value information that otherwise would be required. However, if the transfer 13

occurs before the final value of the estate property is determined, the recipient/transferor must provide the executor with a copy of the supplemental statement. When the executor subsequently files any return or statement that is required to be filed, the new transferee is substituted tor the recipient/transferor with respect to the transferred property. A “related transferee” means any member of the transferor’s family as defined in §2704(c)(2), any controlled entity (a corporation or any other entity in which the transferor and members of the transferor’s family (as defined in section 2704(c)(2)), whether directly or indirectly, have control within the meaning of section 2701(b)(2)(A) or (B), and any trust of which the transferor is a deemed owner for income tax purposes. In situations where the transferor/recipient’s basis has changed from the final value as determined under section 6035 (e.g., depreciable property, interests in passthroughs, etc) the recipient/transferor may, but is not required to, report those changes to the transferee on the supplemental statement. However, the changes must be shown separately from the final value of the property that is required to be reported on the statement. See Prop. Reg. §1.6035-1(f). The preamble to the proposed regulations explain that this “subsequent transfer” obligation has arisen out or Treasury’s concern “ . . .that opportunities may exist in some circumstances for the recipient of such reporting [i.e., recipient of a Schedule A] to circumvent the purposes of the statute (for example, by making a gift of the property to a complex trust for the benefit of the transferor’s family).”

COMMENT: The subsequent transfer rule was unanticipated, raises many difficult issues, and undoubtedly impose difficult burdens on recipients of property. First, it is not clear how one determines family relationships in the context of transfers by and between fiduciaries. Second, there is no temporal limit on how long the subsequent transfer rules apply. Think of situations where 10 or 15 years after inheriting property, a recipient transfers it by gift to a family member. Third, in defining a related transferee as a grantor trust as to the transferor, the proposed regulations do not make an exception for transfers to revocable trusts. Must a person who inherits property and then funds his or her own revocable trust report the subsequent transfer. Also, requiring a gift to an irrevocable grantor trust to be reported, but not requiring a gift to an irrevocable non- grantor trust to be reported, does not seem to make much sense.

D. Greenbook Proposals. The revenue proposals for FY 2017 were released on February 9, 2016. In the estate and gift tax area, the topics listed from the prior year were retained, with several minor refinements, except that the proposal for basis consistency was replaced with a proposal to expand the application of Section 1014(f) to gift tax returns and portability returns. In addition, the administration retained its 2015 capital gains tax proposal which, while not technically within the estate and gift tax provisions, would apply to transfers at death or during life. The topics are as follows. See http://www.treasury.gov/resource-center/tax-policy/Documents/General-Explanations- FY2017.pdf

1. Reform the Taxation of Capital Income. This proposal is unchanged from last year, when it was first introduced. It is contained in the section entitled "Reforms to Capital Gains Taxation, Upper Income Tax Benefits, and the Taxation of Financial Institutions" within the general topic of "Reform the Taxation of Capital Income." The proposal would increase the capital gains tax rate to 24.2% and treat death as a realization event. Any capital gains tax incurred as a result of death would be deductible on an estate tax return, if one was required to be filed. The proposal states as follows: 14

Proposal The proposal would increase the highest long-term capital gains and qualified dividend tax rate from 20 percent to 24.2 percent. The 3.8 percent net investment income tax would continue to apply as under current law. The maximum total capital gains and dividend tax rate including net investment income tax would thus rise to 28 percent. Under the proposal, transfers of appreciated property generally would be treated as a sale of the property. The donor or deceased owner of an appreciated asset would realize a capital gain at the time the asset is given or bequeathed to another. The amount of the gain realized would be the excess of the asset’s fair market value on the date of the transfer over the donor’s basis in that asset. That gain would be taxable income to the donor in the year the transfer was made, and to the decedent either on the final individual return or on a separate capital gains return. The unlimited use of capital losses and carry-forwards would be allowed against ordinary income on the decedent’s final income tax return, and the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate (if any). Gifts or bequests to a spouse or to charity would carry the basis of the donor or decedent. Capital gain would not be realized until the spouse disposes of the asset or dies, and appreciated property donated or bequeathed to charity would be exempt from capital gains tax. The proposal would exempt any gain on all tangible personal property such as household furnishings and personal effects (excluding collectibles). The proposal also would allow a $100,000 per-person exclusion of other capital gains recognized by reason of death that would be indexed for inflation after 2016, and would be portable to the decedent’s surviving spouse under the same rules that apply to portability for estate and gift tax purposes (making the exclusion effectively $200,000 per couple). The $250,000 per person exclusion under current law for capital gain on a principal residence would apply to all residences, and would also be portable to the decedent’s surviving spouse (making the exclusion effectively $500,000 per couple). The exclusion under current law for capital gain on certain small business stock would also apply. In addition, payment of tax on the appreciation of certain small family-owned and family operated businesses would not be due until the business is sold or ceases to be family-owned and operated. The proposal would further allow a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets such as publicly traded financial assets and other than businesses for which the deferral election is made. The proposal also would include other legislative changes designed to facilitate and implement this proposal, including without limitation: the allowance of a deduction for the full cost of appraisals of appreciated assets; the imposition of liens; the waiver of penalty for underpayment of estimated tax if the underpayment is attributable to unrealized gains at death; the grant of a right of recovery of the tax on unrealized gains; rules to determine who has the right to select the return filed; the achievement of consistency in valuation for

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transfer and income tax purposes; and a broad grant of regulatory authority to provide implementing rules. To facilitate the transition to taxing gains at death and gift, the Secretary would be granted authority to issue any regulations necessary or appropriate to implement the proposal, including rules and safe harbors for determining the basis of assets in cases where complete records are unavailable. This proposal would be effective for capital gains realized and qualified dividends received in taxable years beginning after December 31, 2016, and for gains on gifts made and of decedents dying after December 31, 2016. 2. Expand the Definition of Executor. The proposal was new in 2014 and remains unchanged. Section 2203 of the Internal Revenue Code, which defines “executor”, would be expanded to apply for all tax purposes. Currently the definition refers, in connection with the estate tax, to the executor or administrator of the decedent, or if there is no executor or administrator appointed, qualified or acting within the United States, then any person in actual or constructive possession of any property of the decedent. This could include, for example, the trustee of the decedent’s revocable trust, an IRA or life insurance beneficiary, or a surviving joint tenant of jointly owned property. The Greenbook proposal identifies the following problems associated with the narrow definition, and the suggested solution: Because the tax code’s definition of executor currently applies only for purposes of the estate tax, no one (including the decedent’s surviving spouse who filed a joint income tax return) has the authority to act on behalf of the decedent with regard to a tax liability that arose prior to the decedent’s death. Thus, there is no one with authority to extend the statute of limitations, claim a refund, agree to a compromise or assessment, or pursue judicial relief in connection with the decedent’s share of a tax liability. The problem has started to arise with more frequency as reporting obligations, particularly with regard to an interest in a foreign asset or account, have increased, and survivors have attempted to resolve a decedent’s failure to comply. In addition, in the absence of an appointed executor, multiple persons may meet the definition of “executor” and, on occasion, more than one of them has each filed a separate estate tax return for the decedent’s estate or made conflicting tax elections. [New language in this year's proposal is in italics.]

The proposal would apply upon enactment, regardless of a decedent’s date of death.

3. Simplify Gift Tax Exclusion for Annual Gifts. This proposal was new in 2014 and remains essentially unchanged, except that the limit of $50,000 on the new category of gifts would be indexed for inflation after 2017. The proposal explains that it is aimed at the perceived abuse of granting so-called "naked" Crummey powers -- rights of withdrawals to persons who are not otherwise included as current or remainder beneficiaries of a trust, called "accommodation parties" in the proposal. However, the proposal would also affect gifts of illiquid interests, such as gifts of partnership

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interests and limited liability companies. The proposal also cites cost savings to taxpayers and the government as another reason for change. The proposal states as follows:

Proposal

The proposal would eliminate the present interest requirement for gifts that qualify for the gift tax annual exclusion. Instead, the proposal would define a new category of transfers (without regard to the existence of any withdrawal or put rights), and would impose an annual limit of $50,000 (indexed for inflation after 2017) per donor on the donor’s transfers of property within this new category that will qualify for the gift tax annual exclusion. This new $50,000 per-donor limit would not provide an exclusion in addition to the annual per-donee exclusion; rather, it would be a further limit on those amounts that otherwise would qualify for the annual per-donee exclusion. Thus, a donor’s transfers in the new category in a single year in excess of a total amount of $50,000 would be taxable, even if the total gifts to each individual donee did not exceed $14,000. The new category would include transfers in trust (other than to a trust described in section 2642(c)(2)), transfers of interests in passthrough entities, transfers of interests subject to a prohibition on sale, and other transfers of property that, without regard to withdrawal, put, or other such rights in the donee, cannot immediately be liquidated by the donee. [New language in this year's proposal is in italics.]

The proposal would be effective for gifts made after the year of enactment.

4. Restore the Estate, Gift and Generation-Skipping Transfer Tax Parameters in Effect in 2009. The administration has continued its proposal to return the transfer tax regimes to the 2009 rates and exemption levels. Portability would remain, and there would be no "clawback," but if the gift tax limit returns to $1,000,000 there would be a limitation on a spouse's use of a ported exemption for gift tax purposes. Proposal The proposal would make permanent the estate, GST, and gift tax parameters as they applied during 2009. The top tax rate would be 45 percent and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift taxes. There would be no indexing for inflation. The proposal would confirm that, in computing gift and estate tax liabilities, no estate or gift tax would be incurred by reason of decreases in the applicable exclusion amount with respect to a prior gift that was excluded from tax at the time of the transfer. Finally, the unused estate and gift tax exclusion of a decedent electing portability and dying on or after the effective date of the proposal would be available to the decedent's surviving spouse in full on the surviving spouse's death, but would be limited during the surviving spouse's life to the amount of remaining exemption the decedent could have applied to his or her gifts made in the year of his or her death.

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The proposal would be effective for the estates of decedents dying, and for transfers made, after December 31, 2016.

5. Modify Transfer Tax Rules for Grantor Retained Annuity Trusts (GRATs) and Other Grantor Trusts. This proposal combines a modified GRAT proposal with the proposal that the administration has put forward since 2013 retarding the taxation of grantor trusts.

The GRAT proposal continues the proposal from prior years of requiring a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years. The proposal is significantly modified, however, by adding two new requirements. First, the remainder interest would have to have a minimum value equal to the greater of 25% of the value of the property contributed to the GRAT or $500,000 (but not more than the value of the property transferred). Second, the grantor would be prohibited from engaging in the tax free exchange of any asset held in the trust (similar in concept to the prohibition of purchasing the residence in a QPRT). The proposal continues to prohibit any decrease in the annuity during the GRAT term. The proposal would apply to trusts created after the date of enactment.

The proposal regarding other grantor trusts remains the same as last year's proposal. Essentially, the proposal takes aim at installment sales to defective trusts by treating the termination of grantor trust status (by death or otherwise) as a taxable event. The proposal states: Proposal The proposal would require that a GRAT have a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years to impose some downside risk in the use of a GRAT. The proposal also would include a requirement that the remainder interest in the GRAT at the time the interest is created must have a minimum value equal to the greater of 25 percent of the value of the assets contributed to the GRAT or $500,000 (but not more than the value of the assets contributed). In addition, the proposal would prohibit any decrease in the annuity during the GRAT term, and would prohibit the grantor from engaging in a tax-free exchange of any asset held in the trust. If a person who is a deemed owner under the grantor trust rules of all or a portion of a trust engages in a transaction with that trust that constitutes a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person’s treatment as a deemed owner of the trust, then the portion of the trust attributable to the property received by the trust in that transaction (including all retained income therefrom, appreciation thereon, and reinvestments thereof, net of the amount of the consideration received by the person in that transaction) would be subject to estate tax as part of the gross estate of the deemed owner, would be subject to gift tax at any time during the deemed owner’s life when his or her treatment as a deemed owner of the trust is terminated, and would be treated as a gift by the deemed owner to the extent any distribution is made to another person (except in discharge of the deemed owner’s obligation to the distributee) during the life of the 18

deemed owner. The transfer tax imposed by this proposal would be payable from the trust. The proposal would not change the treatment of any trust that is already includable in the grantor’s gross estate under existing provisions of the Internal Revenue Code, including without limitation the following: grantor retained income trusts; grantor retained annuity trusts; personal residence trusts; and qualified personal residence trusts. Similarly, it would not apply to any trust having the exclusive purpose of paying deferred compensation under a nonqualified deferred compensation plan if the assets of such trust are available to satisfy claims of general creditors of the grantor. It also would not apply to any irrevocable trust whose only assets typically consist of one or more life insurance policies on the life of the grantor and/or the grantor's spouse. The proposal as applicable to GRATs would apply to GRATs after the date of enactment. The proposal as applicable to other grantor trusts would be effective with regard to trusts that engage in a described transaction on or after the date of enactment. Regulatory authority would be granted, including the ability to create exceptions to this provision. 6. Limit Duration of Generation-Skipping Transfer (GST) Tax Exemption. The proposal is the same from those of the last several years. The proposal is that, on the 90th anniversary of the creation of a trust, the GST exclusion allocated to the trust would terminate. This would be achieved by increasing the inclusion ratio of the trust (as defined in section 2642) to one, thereby rendering no part of the trust exempt from GST tax. The proposal states that because contributions to a trust from different grantors are deemed to be held in separate trusts under section 2654(b), each such separate trust would be subject to the same 90-year rule, measured from the date of the first contribution by the grantor of that separate trust. The special rule for pour-over trusts under section 2653(b)(2) would continue to apply to pour-over trusts and to trusts created under a decanting authority, and for purposes of this rule, such trusts would be deemed to have the same date of creation as the initial trust, with one exception. The exception is that if, prior to the 90th anniversary of the trust, trust property is distributed to a trust for a beneficiary of the initial trust, and the distributee trust is as described in section 2642(c)(2),1 the inclusion ratio of the distributee trust will not be changed to one (with regard to the distribution from the initial trust) by reason of this rule. This exception is intended to permit an incapacitated beneficiary’s distribution to continue to be held in trust without incurring GST tax on distributions to the beneficiary as long as that trust is to be used for the sole benefit of that beneficiary and any trust balance remaining on the beneficiary’s death will be included in the beneficiary’s gross estate for Federal estate tax purposes. The other rules of section 2653 also would continue to apply, and would be relevant in determining when a taxable distribution or taxable termination occurs after the 90th anniversary of the trust. An express grant of regulatory authority would be included to facilitate the implementation and administration of this provision. This proposal would apply to trusts created after enactment, and to the portion of a pre-existing trust attributable to additions to such a trust made after that date (subject to rules substantially similar to

1 A trust that does not allow distributions except to a single individual and that is includible in the individual's estate if the trust has not terminated before the individual's death. 19

the grandfather rules currently in effect for additions to trusts created prior to the effective date of the GST tax).

7. Extend the Lien on Estate Tax Deferrals Provided Under Section 6166 of the Internal Revenue Code. This proposal was first introduced in 2012 and is unchanged. Under current law the Section 6324(a)(1) lien generally applies for 10 years following the decedent's death. The maximum deferral period of 14 years is longer than the lien. The proposal would extend the estate tax lien under Section 6324(a)(1) throughout the Section 6166 deferral period. The proposal would be effective for the estates of all decedents dying on or after the effective date, as well as for all estates of decedents dying before the date of enactment as to which the Section 6324(a)(1) lien has not expired as of the effective date.

8. Clarify Generation-Skipping Transfer (GST) Tax Treatment of Health and Education Exclusions Trusts (HEETS). This proposal was new in 2013 and remains unchanged. It would eliminate the benefits of funding a trust designed to take advantage of Code Section 2611(b)(1), which permits distributions from the trust to avoid the generation-skipping tax if the trust pays directly to the provider of medical care for another person or directly to a school for another person’s tuition in a manner that if made by an individual would be exempt from gift tax under section 2503(e). The Service believes that the intent of section 2611(b)(1) is to exempt from GST tax only those payments that are not subject to gift tax, that is, payments made by a living donor directly to the provider of medical care for another person or directly to a school for another person’s tuition. The proposal would clarify that the exclusion from the definition of a GST under section 2611(b)(1) applies only to a payment by a donor directly to the provider of medical care or to the school in payment of tuition and not to trust distributions, even if for those same purposes. The proposal would apply to trusts created after the introduction of the bill proposing this change, and to transfers after that date made to pre-existing trusts.

9. Expand Requirement of Consistency in Value for Transfer and Income Tax Purposes. This proposal is new and seeks to expand the reach of Code Section 1014(f) regarding basis consistency.

Current Law

Section 1014 provides that the basis of property acquired from a decedent generally is the fair market value of the property on the decedent’s date of death. Similarly, property included in the decedent’s gross estate for estate tax purposes generally must be valued at its fair market value on the date of death. Although the same valuation standard applies to both provisions, until the enactment on July 31, 2015, of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the Act), there was no requirement that the recipient’s basis in that property be the same as the value reported for estate tax purposes. This Act amended section 1014 to provide generally that the recipient’s initial basis in property as determined under section 1014 cannot exceed the final value of that property for estate tax purposes. This consistency requirement applies to property whose

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inclusion in the decedent’s gross estate increases the estate’s liability for federal estate tax.

Reasons for Change

Because the consistency requirement enacted in 2015 applies only to the particular items of property that generate a federal estate tax, the requirement does not apply to property transferred by gift, or to property that qualifies for the estate tax marital or charitable deduction, or to any property of an estate with a total value that does not exceed the applicable exclusion amount ($5,450,000 for 2016). Although the exclusion of property given on death to charities (tax exempt organizations) has only a minimal impact for income tax purposes, there is a possible effect on the annual excise tax imposed on certain such organizations. However, the exclusion from the application of the consistency requirement of property qualifying for the estate tax marital deduction is significant because an unlimited amount of property may qualify for the estate tax marital deduction in a decedent’s estate tax proceeding. Although it is true that the value of such property passing to the decedent’s surviving spouse may be increased without incurring any federal estate tax, and a high estate tax value provides a high cap on the recipient’s permissible basis, current law contains provisions to prevent an inaccurately high estate tax valuation. Specifically, the executor certifies to the accuracy of the information on the estate tax return under penalties of perjury, and significant underpayment penalties are imposed on the understatement of capital gains and thus income tax that would result from an overstatement of basis.

Proposal

The proposal would expand the property subject to the consistency requirement imposed under section 1014(f) to also include (1) property qualifying for the estate tax marital deduction, provided a return is required to be filed under section 6018, even though that property does not increase the estate’s federal estate tax liability, and (2) property transferred by gift, provided that the gift is required to be reported on a federal gift tax return.

The proposal would be effective for transfers after the year of enactment. 10. Retirement Proposals. Although not listed under the proposed changes to the estate and gift tax regime, the Greenbook proposals continue recommendations from the last three years regarding retirement accounts. One proposal is that the so-called "stretch- out" rules for retirement accounts be curtailed except for spouses and certain other "eligible" individuals (disabled or chronically ill persons, minors and beneficiaries not more than 10 years younger than the plan participant or IRA owner). Another proposal is to limit the amount that can be accrued in retirement plans. A. The proposal regarding "stretch out" is as follows: Proposal Under the proposal, non-spouse beneficiaries of retirement plans and IRAs would generally be required to take distributions over no more than five years. Exceptions would be provided for eligible beneficiaries. 21

Eligible beneficiaries include any beneficiary who, as of the date of death, is disabled, a chronically ill individual, an individual who is not more than 10 years younger than the participant or IRA owner, or a child who has not reached the age of majority. For these beneficiaries, distributions would be allowed over the life or life expectancy of the beneficiary beginning in the year following the year of the death of the participant or owner. However, in the case of a child, the account would need to be fully distributed no later than five years after the child reaches the age of majority. Any balance remaining after the death of a beneficiary (including an eligible beneficiary excepted from the five-year rule or a spouse beneficiary) would be required to be distributed by the end of the calendar year that includes the fifth anniversary of the beneficiary’s death. The proposal would be effective for distributions with respect to plan participants or IRA owners who die after December 31, 2016. The requirement that any balance remaining after the death of a beneficiary be distributed by the end of the calendar year that includes the fifth anniversary of the beneficiary’s death would apply to participants or IRA owners who die before January 1, 2016, but only if the beneficiary dies after December 31, 2016. The proposal would not apply in the case of a participant whose benefits are determined under a binding annuity contract in effect on the date of enactment. B. The proposal to limit accrual of benefits reads as follows: Proposal A taxpayer who has accumulated amounts within the tax-favored retirement system (i.e., IRAs, section 401(a) plans, section 403(b) plans, and funded section 457(b) arrangements maintained by governmental entities) in excess of the amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan under current law (currently an annual benefit of $210,000) payable in the form of a joint and 100-percent survivor benefit commencing at age 62 and continuing each year for the life of the participant and, if longer, the life of a spouse, assumed to be of the same age would be prohibited from making additional contributions or receiving additional accruals under any of those arrangements. Currently, the maximum permitted accumulation for an individual age 62 is approximately $3.4 million. The limitation would be determined as of the end of a calendar year and would apply to contributions or accruals for the following calendar year. Plan sponsors and IRA trustees would report each participant’s account balance as of the end of the year as well as the amount of any contribution to that account for the plan year. For a taxpayer who is under age 62, the accumulated account balance would be converted to an annuity payable at age 62, in the form of a 100-percent joint and survivor benefit using the actuarial assumptions that apply to converting between annuities and lump sums under defined benefit plans. For a taxpayer who is older than age 62, the accumulated account balance would be converted to an annuity payable in the same form, where actuarial 22

equivalence is determined by treating the individual as if he or she was still age 62. In either case, the maximum permitted accumulation would continue to be adjusted for cost of living increases. Plan sponsors of defined benefit plans would generally report the amount of the accrued benefit and the accrual for the year, payable in the same form. Regulations would provide for simplified reporting for defined benefit plans. As one example, a sponsor of a cash balance plan would be permitted to treat a participant’s hypothetical account balance under the plan as an accumulated account balance under a defined contribution plan for purposes of reporting under this provision. It is anticipated that other simplifications would be considered in order to ease administration. If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings and gains. If a taxpayer’s investment return for a year was less than the rate of return built into the actuarial equivalence calculation (so that the updated calculation of the equivalent annuity is less than the maximum annuity for a tax-qualified defined benefit plan), there would be room to make additional contributions. In addition, when the maximum defined benefit level increases as a result of the cost-of-living adjustment, the maximum permitted accumulation will automatically increase as well. This also could allow a resumption of contributions for a taxpayer who previously was subject to a suspension of contributions by reason of the overall limitation. If a taxpayer received a contribution or an accrual that would result in an accumulation in excess of the maximum permitted amount, the excess would be treated in a manner similar to the treatment of an excess deferral under current law. Thus, the taxpayer would have to include the amount of the resulting excess accumulation in current income and would be allowed a grace period during which the taxpayer could withdraw the excess from the account or plan in order to comply with the limit. If the taxpayer did not withdraw the excess contribution (or excess accrual), then the excess amounts and attributable earnings would be subject to income tax when distributed, without any adjustment for basis (and without regard to whether the distribution is made from a Roth IRA or a designated Roth account within a plan). The proposal would be effective with respect to contributions and accruals for taxable years beginning after December 31, 2016. E. Charitable Remainder Trust Sales. The proposed regulations regarding the sale of entire interests in charitable remainder trusts have been finalized without change. T.D. 9729, 2015-35 I.R.B. (August 31, 2015). The regulations change the tax consequences of such a sale and foreclose a tax strategy to avoid the imposition of capital gains taxes on appreciated property.

The strategy involved a person donating highly appreciated property to a charitable remainder trust. The CRT would eventually sell the property and reinvest the proceeds, thereby acquiring a new basis in the underlying assets. Then the charity and the beneficiary would join

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in terminating the trust by selling their respective interests to a third party. The taxable beneficiary invoked Code Section 1001(e) to take the position that the uniform basis rules were not disregarded, and that gain or loss of the taxable beneficiary's portion of the transaction was measured by the beneficiary's actuarial portion of the basis that the trust held in the assets.

The new regulations will require that in such a sale the taxable beneficiary's basis must be reduced (but not below zero) by the amount of ordinary income and capital gain of the trust that would be taxable to the beneficiary on a distribution. The Regulations under Section 1014 now read as follows:

(c) Sale or other disposition of a term interest in a tax-exempt trust—(1) In general. In the case of any sale or other disposition by a taxable beneficiary of a term interest (as defined in § 1.1001–1(f)(2)) in a tax-exempt trust (as described in paragraph (c)(2) of this section) to which section 1001(e)(3) applies, the taxable beneficiary’s share of adjusted uniform basis, determined as of (and immediately before) the sale or disposition of that interest, is—

(i) That part of the adjusted uniform basis assignable to the term interest of the taxable beneficiary under the rules of paragraph (a) of this section reduced, but not below zero, by

(ii) An amount determined by applying the same actuarial share applied in paragraph (c)(1)(i) of this section to the sum of—

(A) The trust’s undistributed net ordinary income within the meaning of section 664(b)(1) and § 1.664–1(d)(1)(ii)(a)(1) for the current and prior taxable years of the trust, if any; and

(B) The trust’s undistributed net capital gains within the meaning of section 664(b)(2) and § 1.664–1(d)(1)(ii)(a)(2) for the current and prior taxable years of the trust, if any.

The regulations contain two new examples of how the rules will operate. The final regulations apply to sales and other dispositions of interests in charitable remainder trusts occurring on or after January 16, 2014, except for sales or dispositions occurring pursuant to a binding commitment entered into before January 16, 2014. However, the fact that a sale or disposition occurred, or a binding commitment to complete a sale or disposition was entered into, before January 16, 2014, does not preclude the Service from applying legal arguments available to it before the issuance of the final regulations in order to contest the claimed tax treatment of such a transaction.

F. Closing Letters. In early June, 2015 the Service announced on its website (irs.gov) that for all estate tax returns filed on or after June 1, 2015, estate tax closing letters will be issued only upon request by the taxpayer. Taxpayers are asked to wait at least four months after filing the estate tax return to make the closing letter request to allow time for processing. To request a closing letter taxpayers should call (866) 699-4083 and provide the name of the decedent, the decedent’s social security number and the date of death.

G. Final Portability Regulations.

Final regulations on portability were issued in June, 2015, to be effective as of June 12, 2015. T.D. 9725, 2015-26 I.R.B. at 1094 (June 29, 2015). The explanation to the final 24

regulations noted a number of revisions and clarified some issues that various commentators had raised:

1. Application of 9100 relief to late elections. In order for a decedent’s surviving spouse to take advantage of the deceased spouse's unused exclusion amount, the executor of the decedent’s estate must elect portability on a timely-filed estate tax return. The final regulations clarify the point that if an estate does not meet the statutory filing threshold of Section 6018, then the filing requirement is fixed by regulation, rather than by statute, so that relief for a late-filed return may be granted under Reg. §301.9100-3. Reg. §20.2010-2(a)(1). However, where the filing requirement is fixed by statute (section 6018 for estate tax returns), the discretionary relief for late filing will not be available.

2. Unknown DSUE Amount. One of the requirements of a portability election is that the return must be timely filed and complete. The inclusion of a computation of the DSUE amount is an essential requirement of a complete and properly prepared estate tax return intended to make the portability election. See section 2010(c)(5)(A). One commentator proposed that the Service should permit a protective election in the situation where the executor files an otherwise complete return but the DSUE amount cannot be accurately computed, for example, when there is a large claim that is pending which cannot be deducted under Section 2053. The claim, if allowed, would create unused exclusion. The Service did not believe a protective election would be necessary because unless the executor has opted out of portability, a complete and timely return would have elected it even if the exact amount of DSUE could be determined at a later time. The final regulations clarify this intended result by providing in § 20.2010-2(b) that the computation requirement in section 2010(c)(5)(A) will be satisfied if the estate tax return is prepared in accordance with the requirements of § 20.2010-2(a)(7).

3. Executor To Make Election. The final regulations confirmed that under the statute the “executor” must make the election. Some commentators proposed allowing the surviving spouse to make the election where, for example, a premarital agreement attempted to confer such a right, or where a non-spouse executor refused to make the election. The preamble recognizes that there will be situations where the executor will refuse to elect DSUE.

4. Valuation Issues. Under the proposed regulations if the estate did not meet the statutory filing requirement of section 6018, a return filed to elect portability did not need to report the values of certain property qualifying for the charitable and marital deductions. The final regulations retain this rule, but provide that it could be modified by future regulatory action if the circumstances arise. The issue of possible future modification arose in response to comments that the exception for reporting values should be expanded to meet other situations. The preamble gave the following examples: (a) the marital deduction property or charitable deduction property is a stated number of shares of stock and a stated number of shares of the same stock are includible in the gross estate but are not marital deduction property or charitable deduction property; (b) the property represents the balance of the value of shares remaining after a non-marital or non- charitable bequest of shares based on a specific value; and (c) the property represents the marital or charitable portion of a fractional division of property, whether by bequest, spousal election, or disclaimer. The preamble observed that in the first two instances, the value of the marital deduction property or charitable deduction property may be relevant to assessing the accuracy of the valuation of the nondeductible interest and

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whether any valuation premium or discount is warranted. In the example at (c), because any beneficiary's share of the estate usually can be satisfied in a manner other than with that beneficiary's proportional share of each individual asset, it will be necessary to know the total value in order to verify the non-deductible portion of the estate.

5. Foreign Spouse and QDOT Issues. The election for portability is not permitted if the decedent was a non-resident who was not a citizen of the United States at the time of death. Treas. Reg. §20.2010-2(a)(5). A non-resident surviving spouse who is not a citizen of the United States is not allowed to take into account the deceased spouse’s unused exclusion amount, except as allowed under any treaty obligation of the United States. Treas. Reg. §25.2505-2(f). However, the final regulations allow a surviving spouse who becomes a U.S. citizen after the death of the deceased spouse to take into account the DSUE amount of such deceased spouse, because the surviving spouse who becomes a U.S. citizen is then subject to the estate and gift tax rules of chapter 11 and 12 that apply to U.S. citizens and residents. The surviving spouse is permitted to take into account the DSUE amount available from any deceased spouse as of the date such surviving spouse becomes a U.S. citizen, provided the deceased spouse's executor has made the portability election. See §§ 20.2010-3 and 25.2505-2.

Also, in the case of a surviving spouse who is not a citizen, there are special rules for property passing to a qualified domestic trust, and the final regulations modify the rule from the temporary regulations. In the case of a surviving spouse the DSUE amount is computed as would be the case with a citizen spouse but under the temporary regulations the DSUE amount was subject to redetermination upon the occurrence of the final distribution of the QDOT or other final event (generally, the death of the surviving spouse) on which estate tax is imposed under Code Section 2056A (“final QDOT event”). In addition, when a QDOT is involved, the DSUE amount could not be applied to lifetime gifts of the surviving spouse until the year in which the final QTOD event occurs. Treas. Reg. § 25.2505-2T(d)(2).

In the final regulations, if the surviving spouse becomes a U.S. citizen and the other requirements of section 2056A(b)(12) and the regulations are satisfied so that the tax imposed by section 2056A(b)(1) ceases to apply, the decedent’s DSUE amount is no longer subject to adjustment and can be used by the surviving spouse as of the date the surviving spouse becomes a U.S. citizen. Reg. §§20.2010-2(c)(4), 20.2010-3(c)(3), and 25.2505-2(d)(3).

The requirements for causing Section 2056A(b)(1) not to apply can be complicated. Under section 2056A(b)(12), the estate tax imposed under section 2056A(b)(1) will cease to apply to property held in a QDOT if the surviving spouse becomes a United States citizen (a fact to be certified to the IRS under § 20.2056A-10(a)(2)) and either of the following requirements are met: (A) the spouse was a resident of the United States at all times after the death of the decedent and before the spouse becomes a citizen of the United States, or (B) no tax was imposed by section 2056A(b)(1)(A) with respect to any distribution before the spouse becomes a citizen. If the spouse becomes a U.S. citizen, but does not satisfy either of these two requirements, section 2056A(b)(12)(C) provides that the section 2056A(b)(1) estate tax will cease to apply to the QDOT if the spouse elects (i) to treat any distribution on which tax was imposed by section 2056A(b)(1)(A) as a taxable gift made by the spouse during the year in which the spouse becomes a U.S. citizen or in any subsequent year, and thereby including each such

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distribution in the spouse's own adjusted taxable gifts for both estate and gift tax purposes, and (ii) to treat any reduction in the tax imposed by section 2056A(b)(1)(A) by reason of the credit allowable under section 2010 with respect to the decedent as a credit allowable to such surviving spouse under section 2505 for purposes of determining the amount of the credit allowable under section 2505 with respect to taxable gifts made by the surviving spouse during the year in which the spouse becomes a U.S. citizen or any subsequent year.

6. Open-Ended Limitations Period. The IRS may examine returns of a decedent in determining the decedent’s DSUE amount, regardless of whether the period of limitations on assessment has expired for that return. Treas. Reg. §20.2010-2(d). In addition, for the purpose of determining the DSUE amount to be included in the applicable exclusion amount of the surviving spouse, the IRS may examine returns of each of the surviving spouse’s deceased spouses whose DSUE amount is claimed to be included in the surviving spouse’s applicable exclusion amount, regardless of whether the period of limitations on assessment has expired for any such return. The IRS’s authority to examine returns of a deceased spouse applies with respect to each transfer by the surviving spouse to which a DSUE amount is or has been applied. Upon examination, the IRS may adjust or eliminate the DSUE amount reported on such a return; however, the IRS may assess additional tax on that return only if that tax is assessed within the period of limitations on assessment under section 6501 applicable to the tax shown on that return. Several commentators proposed changes to these rules, all of which the Service rejected, so the final regulations are essentially the same as the proposed regulations on these points. In the preamble the Service discussed the situation where a change to the date-of-death value of an asset included in the estate of a decedent survived by a spouse is made pursuant to an examination of a return of that decedent after the expiration of the period of limitations on the assessment of tax on that return. It stated that the change in value does not necessarily result in a change to the basis of that asset under section 1014. Rather, the basis of property acquired from a decedent is determined in accordance with the existing principles of section 1014.

7. Portability and Rev. Proc. 2001-38. Treas. Reg. §20.2010-2T(a)(7)(ii)(A), example 2 of the temporary regulations suggested a situation where the Service would recognize an unnecessary QTIP election. Cf. Rev. Proc. 2001-38. In the final regulations the Service changed the facts of the example so that the marital deduction is outright, instead of in a QTIP trust. The preamble refers to the Rev. Proc. 2001-38 issues as follows:

Rev. Proc. 2001-38 provides a procedure by which the IRS will disregard and treat as a nullity for Federal estate, gift, and generation-skipping transfer tax purposes a QTIP election made under section 2056(b)(7) in cases where the election was not necessary to reduce the estate tax liability to zero. The commenter notes that, with the introduction of portability of a deceased spouse's unused exclusion amount, an executor may purposefully elect both portability and QTIP treatment and the rationale for the rule voiding the election in Rev. Proc. 2001-38 (that the election was of no benefit to the taxpayer) is no longer applicable. The Treasury Department and the IRS intend to provide guidance, by publication in the Internal Revenue Bulletin, to clarify whether a QTIP election made under section 2056(b)(7) may be disregarded and treated as null and void when an executor has elected portability of the DSUE amount under section 2010(c)(5)(A).

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8. Estate Tax Credits. Section 20.2010-2(c)(3) of the final regulations clarifies that eligibility for credits in Code sections 2012 through 2015 against the tax imposed by section 2001 does not factor into the computation of the DSUE amount.

9. Correction to Example. Finally, §§ 20.2010-3T and 25.2505-2T included an incorrect basic exclusion amount for the applicable year in the examples. The final regulations correct this mistake.

CASES AND PRIVATE LETTER RULINGS

A. Estate of Pulling v. Commissioner, 110 T.C.M. (CCH) 93 (T.C. 2015). Pulling considered whether for valuation purposes three land parcels owned individually by the decedent’s estate could be combined with two contiguous parcels that were owned by an entity in which the decedent held a 28% interest. Other family members of the decedent owned 32% of the entity. Also, the decedent’s separately owned parcels lacked access to a public right of way. The concept of aggregating the properties for valuation purposes was referred to as “assemblage” by the Court. The Tax Court commented that it could value the land on the basis of assemblage if at the time of the decedent’s death it was reasonably likely that the land would be assembled in the reasonably near future. Absent proof to the contrary, the current use of the land would be presumed to be its highest and best use. The burden of proof for assemblage was on the Service. In this case there was no evidence that assemblage was reasonably likely. Instead, the Service argued that assemblage was appropriate because of (1) the economic benefits of assemblage and (2) the ties between decedent and the various stakeholders in the entity (TCLT) that owned the contiguous parcels. Although the experts for both parties agreed that assemblage would yield the greatest economic benefits, the economic benefits of assemblage can only come into consideration once the court decides that assemblage is otherwise reasonably likely. The court found no basis for valuing on the basis of assemblage. The Service’s arguments in this case were reminiscent of arguments it has made in other cases where interests held by spouses or other family members should be valued on the basis of the likelihood that the owner will combine with another to effect control. See, for example, Estate of Lee v. Commissioner, 69 T.C. 860 (1978); Estate of Bright v. United States, 658 F 2d 999 (5th Cir. 1981); Propstra v. United States, 680 F2d 1242 (9th Cir. 1982). The Courts have generally rejected this approach and also did so here: Respondent's second argument is based on the premise that assemblage was reasonably likely because decedent held a large minority interest in TCLT that, when combined with either the interests of (1) STGP or (2) the other TCLT stakeholders, would result in a majority vote enabling TCLT to combine its property with the estate's property. However, without any evidence regarding the intent of the other TCLT stakeholders or details as to their relationship with decedent, respondent's position is left essentially attributing ownership of TCLT's property to decedent solely on the basis of those relationships. This position lacks merit The Tax Court also rejected an “aggregation of interest” argument that the Service has sometimes raised in the family context.

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There is also no evidence to support the proposition that other members of the Pulling family would be reasonably likely to agree to combine the properties. The mere fact that they are related to decedent is not enough. See Estate of Bright, 658 F.2d at 1006 (rejecting application of family attribution for purposes of valuing property for estate tax purposes); see also Minahan v. Commissioner, 88 T.C. 492, 499, 1987 WL 49279 (1987) (“It has been noted that the Congress has explicitly directed that family attribution or unity of ownership principles be applied in certain aspects of Federal taxation, and in the absence of legislative directives, judicial forums should not extend such principles beyond those areas specifically designated by Congress.”).4 4 Estate of Bright v. United States, 658 F.2d 999 (Former 5th Cir.1981), is binding on the Court of Appeals for the 11th Circuit, to which this case is appealable. Allen v. Autauga Cnty. Bd. of Educ., 685 F.2d 1302, 1304 n. 4 (11th Cir.1982) (“[D]ecisions of the former fifth circuit in which active judges of this circuit participated are binding precedent, regardless of the date of decision.”); Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir.1981).

B. Estate of Purdue v. Commissioner, T.C. Memo. 2015-249 (December 28, 2015) Purdue considered several issues relating to the estate tax consequences of forming a family limited liability company. In Purdue the decedent and her husband formed a family LLC agreement. The LLC agreement was formed for a number of reasons, including the desire to consolidate investment accounts and to educate the children as to investment matters. Prior to the formation of the LLC, the decedent and her husband maintained five separate investment accounts, under which each account was separately managed with little or no communication from one manager to another. Following the formation of the family LLC, the decedent and her husband transferred all five accounts to the LLC; thereafter they were consolidated into one account under a single investment management firm. During decedent’s life she made gifts of LLC interests to a family trust which conferred Crummey powers on her five children. Following the decedent’s death there was a dispute among the children over distributions from the family LLC to the estate and a QTIP trust that had been established by the decedent’s husband, who had predeceased her. As a result of the dispute the LLC was deadlocked, and the decedent’s estate needed to borrow money to pay its estate tax liabilities. It deducted the interest on the loan on its estate tax return. On audit the service raised the following arguments: 1. The assets transferred by the decedent to the LLC were includible in her estate under Section 2036. 2. The lifetime gifts of LLC interests did not qualify as present interest annual exclusions. 3. The interest payment on the loan was not necessarily incurred and therefore not deductible as a Section 2053 administration expense. In a memorandum decision, the Tax Court held for the taxpayer on all issues. On the issue of bona fide sale, the court found that there was a legitimate non-tax reason for the transfer. It rested its decision primarily on the purpose of consolidating the five investment management accounts (along with the management of a building in Hawaii called the “Hocking Building”), although the taxpayer’s case was helped by the presence of several other factors. The Court stated:

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The estate argues that decedent had seven nontax motives for transferring the property to the PFLLC: (1) to relieve decedent and Mr. Purdue from the burdens of managing their investments; (2) to consolidate investments with a single adviser to reduce volatility according to a written investment plan; (3) to educate the five Purdue children to jointly manage a family investment company; (4) to avoid repetitive asset transfers among multiple generations; (5) to create a common ownership of assets for efficient management and meeting minimum investment requirements; (6) to provide voting and dispute resolution rules and transfer restrictions appropriate for joint ownership and management by a large number of family members; and (7) to provide the Purdue children with a minimum annual cashflow. Respondent argues that the PFLLC was a testamentary substitute and that transfer tax savings were the primary motivation for the formation and funding of the PFLLC. a. Testamentary Objective Decedent transferred property to the PFLLC to simplify the gift giving process and to assure transfer tax savings. Respondent claims that the PFLLC was created only for tax savings and the other nontax reasons were purely hypothetical. While we agree with respondent that gift giving alone is not an acceptable nontax motive, we disagree that gift giving was decedent's only motive in transferring property to the PFLLC. b. Creation of Family Asset Testimony at trial, coupled with the memorandum from MPBA and the PFLLC operating agreement, establishes that a significant purpose of decedent's transfer of property to the PFLLC was to consolidate investments into a family asset managed by a single adviser. Before the transfer, the marketable securities were maintained across five different brokerage accounts at three management firms, subject to individual advice from the three different management firms. Following the formation of the PFLLC and formulation of an investment plan with the Rainier Group, the parents' assets were consolidated into PFLLC accounts with the Rainier Group subject to an overall, well-coordinated professional investment strategy applied to all of the investments. Before the formation of the PFLLC, Mr. Purdue handled all of the financial decisions regarding the marketable securities. After the formation of the PFLLC, the Purdue children made the PFLLC investment decisions jointly. Although this transfer to the PFLLC was also made with testamentary purposes in mind, we have previously noted that “[l]egitimate nontax purposes are often inextricably interwoven with testamentary objectives.” Estate of Bongard v. Commissioner, 124 T.C. at 121. We find that decedent's desire to have the marketable securities and the Hocking Building interest held and managed as a family asset constituted a legitimate nontax motive for her transfer of property to the PFLLC. See Estate of Schutt v. Commissioner, T.C. Memo. 2005–126 (consolidation of assets was allowed as a legitimate and significant nontax motive to further a buy and hold investment strategy); cf. Estate of Hurford v. Commissioner, T.C. Memo. 2008–278 (no advantage found to consolidating asset management where the partner's relationship to the assets did not change after formation of a family limited partnership).

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c. Other Factors The estate concedes that decedent was advised of the transfer tax savings. Therefore, decedent discounted the value of the partnership interest relative to the value of property contributed, and this factor weighs against the estate. Respondent argues that other facts show a nontax purpose did not actually exist. Respondent first argues that decedent stood on both sides of the transaction, as Mr. Purdue and decedent transferred all of the assets and there were no negotiations over the terms of the PFLLC operating agreement between the parents and the Purdue children. Respondent contends that the Purdue children did not retain an independent adviser or attorney to represent them in the formation of the PFLLC. Where a taxpayer stands on both sides of a transaction, we have concluded that there is no arm's-length bargaining and thus the bona fide transfer exception does not apply. Estate of Liljestrand v. Commissioner, T.C. Memo. 2011–259; Estate of Strangi v. Commissioner, T.C. Memo. 2003–145, aff'd, 417 F.3d 468 (5th Cir.2005). However, we have also stated that an arm's-length transaction occurs when mutual legitimate and significant nontax reasons exist for the transaction and the transaction is carried out in a way in which unrelated parties to a business transaction would deal with each other. Estate of Bongard v. Commissioner, 124 T.C. at 123. We have already found the existence of a legitimate nontax motive for the transaction between decedent and the PFLLC. We also believe decedent received interests in the PFLLC proportional to the property she contributed. See id. Accordingly, this factor does not weigh against the estate. Other factors, however, support the estate's argument that a bona fide sale occurred. First, decedent and Mr. Purdue were not financially dependent on distributions from the PFLLC. Decedent retained substantial assets outside of the PFLLC to pay her living expenses. Second, aside from a minimal dollar amount across three deposits to the PFLLC account, there was no commingling of decedent's funds with the PFLLC's funds. Further, the formalities of the PFLLC were respected. The PFLLC maintained its own bank accounts and held meetings at least annually with written agendas, minutes, and summaries. Third, Mr. Purdue and decedent transferred the property to the PFLLC. Lastly, the evidence shows that decedent and Mr. Purdue were in good health at the time the transfer was made to the PFLLC. Although decedent was 88 at the time of transfer in 2000, she lived until 2007. Aside from the accident in 1984 and the incident in 2000, decedent never experienced any mental illness or life- threatening illnesses. Mr. Purdue was 83 at the time of the transfer and experienced symptoms of Alzheimer's disease. Otherwise, Mr. Purdue lived an active lifestyle until his death in 2001. On the issue of present interest the Court focused on the income production, and distribution history, of the partnership: When determining whether a gift is of a present interest, we examine all facts and circumstances as they existed on the date of the gift. See, e.g., Fondren v. Commissioner, 324 U.S. at 21–22. Thus, on each date of gift, the estate must show from all the facts and circumstances that, in receiving the PFLLC interests,

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the donees thereby obtained use, possession, or enjoyment (1) of the limited partnership interests or (2) of income from those interests within the meaning of section 2503(b). With respect to the PFLLC interests themselves, the primary source of the donees' rights and restrictions to the use, possession, or enjoyment of the property is the PFLLC operating agreement. The donees' rights, however, are limited. The members of the PFLLC could not transfer their interests without unanimous consent by the other members. Therefore, the donees did not receive unrestricted and noncontingent rights to immediate use, possession, or enjoyment of the PFLLC interests themselves. Instead, we will consider whether the donees received such rights in the income. To ascertain whether rights to income satisfy the criteria for a present interest under section 2503(b), the estate must prove, on the basis of the surrounding circumstances, that: (1) the PFLLC would generate income, (2) some portion of that income would flow steadily to the donees, and (3) that portion of income could be readily ascertained. See Calder v. Commissioner, 85 T.C. 713, 727–728 (1985); see also Hackl v. Commissioner, 118 T.C. at 298; Price v. Commissioner, T.C. Memo. 2010–2. First, the PFLLC held an interest in the Hocking Building, subject to a 55– year lease, expected to generate rent income, as well as dividend paying marketable securities. Second, the PFT made annual distributions from 2000 through 2008, totaling $1,997,304. Further, the PFLLC operating agreement and applicable State law impose a fiduciary duty on the PFLLC to make proportionate cash distributions sufficient for the QTIP Trust and the Bypass Trust to pay their income tax liabilities. See Wash. Rev.Code sec. 25.05.165 (West 2005) (specifying that partners are subject to the duty of loyalty, the duty of care, and the duty of good faith and dealing); Estate of Wimmer, T.C. Memo. 2012–157; Estate of Petter v. Commissioner, T.C. Memo. 2009–280, aff'd, 653 F.3d 1012 (9th Cir.2011). Lastly, as previously stated, the property of the PFLLC consisted of marketable securities and the interest in the Hocking Building. The rent amount for the Hocking Building was readily ascertainable from the lease and the marketable securities were publicly traded. Therefore, the partners could estimate the expected dividends. See, e.g., Estate of Wimmer v. Commissioner, T.C. Memo. 2012–157. Accordingly, the gifts qualify for the annual gift tax exclusion under section 2503(b). Finally, on the issue of the deductibility of the interest, the Court observed that the LLC operating agreement did not permit distributions except by unanimous consent. One of the children had refused to give consent. The Court found that the deduction was properly taken.

C. Mikel v. Commissioner, 109 T.C.M. (CCH) 1355 (T.C. 2015-64). This case appears to be the matter discussed in Chief Counsel's Advice Memorandum 201208026 (Release Date 2/24/2012), which generated a lot of comment when issued several years ago. In Mikel the grantors created an irrevocable trust, the beneficiaries of which were the grantors’ children, the children’s lineal descendants, and all their respective spouses. Many of the descendants were minors. This was a very large family, numbering some 60 people. The trustee had discretionary authority to pay amounts from the trust to the beneficiaries; in 32

addition, each beneficiary had a Crummey withdrawal right exercisable in the amount of $12,000 from each grantor, or $24,000 in total. The grantors contributed their residence in Brooklyn, New York, two other properties in Brooklyn held directly or through a limited liability company, and a condominium in Florida. The reported values totaled $3,262,000. The gifts were made in 2007 but neither grantor filed a gift tax return until they were contacted by the IRS in 2011. At that time they filed, consented to treat each person’s transfers as made half by the other, and claimed annual exclusions of $24,000 x 60, or $1,440,000 on the returns. The Service disallowed the annual exclusions on the basis that they were illusory. In this case the trustee had given notice to the beneficiaries of the contributions to the trust. There was no evidence of a pre-arranged plan or understanding that the beneficiaries would not exercise their rights of withdrawal. In other words, there did not appear to be any impediment to the exercise by the beneficiaries of their legal rights to withdraw additions. The Service’s argument was based on two provisions of the trust that in the Service’s opinion made the Crummey rights “practically” (but not legally) unenforceable. First, the trust provided that any dispute arising over the proper interpretation of the trust must be submitted to arbitration before a panel consisting of three persons of the Orthodox Jewish faith – in Hebrew, according to the opinion, a beth din. This panel was directed, in the event of any dispute, to enforce the provisions of the trust and give any party the rights he or she was entitled to under New York law. The trust as a whole was to be construed “. . . to effectuate the intent of the parties . . . that they have performed all the necessary requirements for this Declaration to be valid under Jewish law.” The other provision was an in terrorem clause which read as follows: In the event a beneficiary of the Trust shall directly or indirectly institute, conduct or in any manner whatever take part in or aid in any proceeding to oppose the distribution of the Trust Estate, or files any action in a court of law, or challenges any distribution set forth in this Trust in any court, arbitration panel or any other manner, then in such event the provision herein made for such beneficiary shall thereupon be revoked and such beneficiary shall be excluded from any participation in the Trust Estate . . . . The Service argued that a beneficiary would only have a legally enforceable right if the beneficiary could enforce the right in state court. Here, the Service hypothesized, a trustee could without justification refuse to honor a withdrawal right. The beneficiary would be reluctant to go to state court to compel the trustee to honor the right, for fear of forfeiture under the in terrorem clause. Thus the beneficiary’s rights were illusory. In the Tax Court each party filed a summary judgment motion. The Tax Court granted the taxpayer’s motion and denied that of the Service. In agreeing that the Crummey rights were not illusory, the Tax Court discussed the Service’s position as follows: We discern two flaws in respondent's argument. First, if we adopt his premise that a withdrawal right must not only be “legally irresistible” under the trust instrument, but also be “legally enforceable” in an extrinsic sense, it is not obvious why the beneficiary must be able to “go before a state court to enforce that right.” Here, if the trustees were to breach their fiduciary duties by refusing a timely withdrawal demand, the beneficiary could seek justice from a beth din, which is directed to “enforce the provisions of this Declaration . . . and give any party the rights he is entitled to under New York law.” A beneficiary would suffer no adverse consequences from submitting his claim to a beth din, and respondent has not explained why this is not enforcement enough. 33

Second, if we assume arguendo that our hypothetically-frustrated beneficiary must have an enforcement remedy in State court, respondent concedes that the beneficiaries of the trust have such a remedy. Respondent's argument is not that judicial enforcement is unavailable, but that this remedy is “illusory” because the in terrorem provision would deter beneficiaries from pursuing it. We think respondent has misapprehended this provision's meaning. Article XXVI of the declaration provides that a beneficiary shall forfeit his rights under the trust if he “directly or indirectly institute[s] . . . any proceeding to oppose the distribution of the Trust Estate, or files any action in a court of law, or challenges any distribution set forth in this Trust in any court, arbitration panel or any other manner.” While not a paragon of draftsmanship, this provision is evidently designed to discourage legal challenges to decisions by the trustees to make discretionary distributions of trust property, e.g., to help beneficiary A finish college, help beneficiary B enter a business, or enable beneficiary C to have a nice wedding. Article VI(b)(3) gives the trustees “absolute and unreviewable discretion” in such matters and states that their judgment “as to the amounts of such payments and the advisability thereof shall be final and conclusive.” The evident purpose of the in terrorem provision is to backstop article VI by discouraging legal actions seeking to challenge the trustees' “absolute and un- reviewable discretion” concerning discretionary distributions from the trust. The first and third clauses of the in terrorem provision explicitly track this purpose, providing that a beneficiary will forfeit his rights if he institutes a proceeding “to oppose the distribution of the Trust Estate” or “challenges any distribution . . . in any court.” A beneficiary who filed suit to compel the trustees to honor a timely withdrawal demand would not be “opposing or challenging” any distribution (discretionary or otherwise) from the trust. Because the beneficiary's action would not be covered by the in terrorem provision, that provision logically would not dissuade him from seeking judicial enforcement of his rights. In urging a broader construction of the in terrorem provision, respondent focuses on its second clause, “or files any action in a court of law.” But this clause cannot be read literally; otherwise, it would bar beneficiaries from participating in the trust if they filed suit to recover for mischievous behavior by their neighbor's dog. The second clause must be given a limiting construction.6 We think the most sensible limiting construction is to interpret this clause in pari materia with the two clauses that surround it. The second clause thus bars a beneficiary from enjoying benefits under the trust if he files suit in any court to oppose or challenge a decision by the trustees to distribute trust property to another beneficiary. This interpretation gives the in terrorem provision a coherent meaning that is consistent with the provisions of article VI affording the trustees “absolute and unreviewable discretion” concerning such matters.7 In sum, we conclude that the beneficiaries of the trust possessed a “present interest in property” because they had, during 2007, an unconditional right to withdraw property from the trust and their withdrawal demands could not be “legally resisted” by the trustees. Crummey, 397 F.2d at 88; Estate of Cristofani, 97 T.C. at 84. Assuming arguendo that the beneficiaries' withdrawal rights must be enforceable in State court, we conclude that this remedy, which respondent concedes was literally available, was also practically available because the in terrorem provision, properly construed, would not deter beneficiaries from 34

pursuing judicial relief. We will accordingly grant petitioners' motion for summary judgment to the extent consistent with this opinion and deny respondent's motion for partial summary judgment. 6. See In re Estate of Walsh (Tipping), 975 N.Y.S.2d 370, 2013 WL 3388644, at *2 (N.Y.Sur.2013) (“While in terrorem clauses are enforceable, they are not favored and must be strictly construed.” (quoting Matter of Singer, 13 N.Y.3d 447, 451, 892 N.Y.S.2d 836, 920 N.E.2d 943 (2009))). 7. The canon of construction “noscitur a sociis”—a Latin phrase meaning “it is known by its associates”—supports the construction set forth in the text. This canon of construction “hold[s] that the meaning of an unclear word or phrase should be determined by the words immediately surrounding it.” Black's Law Dictionary 1160–1161 (9th ed.2009). While this canon does not set forth an inescapable rule, it is often wisely applied to avoid giving unintended breadth to a terms that are susceptible to multiple meanings. See James v. United States, 550 U.S. 192, 222, 127 S.Ct. 1586, 167 L.Ed.2d 532 (2007) (A word should be interpreted “in a manner that makes it ‘fit’ with the words with which it is closely associated.”); Wallace v. Commissioner, 128 T.C. 132, 141, 2007 WL 1120249 (2007) ( “[T]he meaning of an unclear word or phrase should be determined by the words immediately surrounding it.”). For example, in Jarecki v. G.D. Searle & Co., 367 U.S. 303, 307, 81 S.Ct. 1579, 6 L.Ed.2d 859 (1961), the Supreme Court interpreted the word “discovery” as used in section 456(a)(2)(B) of the Internal Revenue Code of 1939, which imposed tax on “income resulting from exploration, discovery, or prospecting.” Whereas “discovery” is a broad term that in other contexts can include geographical and scientific discoveries, the Court held that its association with “exploration” and “prospecting” suggested that the term, as used in this statute, had the narrower meaning of “discovery of mineral resources.” Id. at 307. Here, the clause “files any action in a court of law” is susceptible to a broad range of meanings. Applying the “noscitur a sociis” canon, we can surmise that the drafters of the declaration intended to give it scope comparable to that of the clauses surrounding it. Although this interpretation renders the second clause surplusage to some degree, there is a great deal of surplusage in article XXVI anyway, and we do not regard this as a strong counterweight here. COMMENT: Note that the case does not hold that a binding arbitration provision does not prevent a beneficiary’s trust from being legally enforceable, because the Court found that the beneficiary could go to state court to enforce the Crummey right. Insofar as an in terrorem clause is designed to prevent challenges to the validity of the trust, and not to the exercise of a right of withdrawal, it would seem that in terrorem clauses in Crummey trusts would not impair a beneficiary’s right of withdrawal. At the 2016 Miami Institute Recent Developments session, and also in the Question and Answer session, it was emphasized that there is no reported case holding that actual notice is required in order to legitimize a Crummey right of withdrawal. Nor is there any requirement that notice be in writing. Nevertheless, notice is a good idea in order to avoid disputes at the audit level. One should avoid drafting a trust that conditions the lapse of the Crummey right of withdrawal on a time period after notice is received. If no notice is given, arguably the right never lapses.

D. “Net Net” Gifts and Steinberg Cases. When a donor makes a gift subject to the donees assuming the responsibility of paying the gift tax, the amount of the gift is reduced by the amount of the tax payable. As a simple example, if a taxpayer who is already in a 40% gift tax rate makes a $1,000,000 gift subject to the donees paying the tax, the gift is $714,286. The tax on this amount, at 40%, is $285,714. The initial transfer of $1,000,000 is reduced by the amount of the liability that the donees assumed, and the tax is computed on the net amount of the transfer. For valuation purposes, a further issue can arise when the donor dies within 3 years of making the gift. Under Section 2035(b) the amount of gift tax paid within three years of making a gift is brought back into the estate. The Tax Court, in Estate of Sachs v. Commissioner, 88 T.C. 769, 777–778, 1987 WL 49299 (1987), affd. in part and revd. in part on another ground, 856

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F.2d 1158 (8th Cir.1988), has held that the tax is brought back into the donor’s estate notwithstanding the fact that the donees may have been contractually bound to pay the tax. See also Estate of Morgans v. Commissioner, 133 T.C. 402 (2009), holding to the same effect when the gift arose by virtue of a deemed gift under Section 2519 (lifetime disposition of QTIP interest). But what if the donees also agree to pay the additional estate tax on the Section 2035 inclusion? May this amount be valued and deducted from the gift also? 1. Steinberg I. In Steinberg v. Commissioner, 141 T.C. 258 (2013), Mrs. Steinberg, a New York resident, made a net gift to her four daughters. By written contractual agreement, the daughters promised to pay the gift tax on the gift, and any estate tax that would be payable with respect to the gift tax includible in Mrs. Steinberg's estate under Code Section 2035(b) should she die within 3 years of the gift. The contractual agreement was the result of several months of negotiation between Mrs. Steinberg and her daughters. Mrs. Steinberg and the daughters were represented by separate counsel. An appraiser determined that the actuarial value of the consideration for the assumption of the potential Section 2035(b) liability was $5,838,540. The donor reported taxable gifts of $71,598,056 and total gift tax of $32,034,311. The Service audited the gift tax return and issued a notice of deficiency for a gift tax increase of $1,804,908. At issue was whether the value of the gift should be reduced by the actuarial value of the donees' assumption of the potential Section 2035(b) liability. The Service filed a motion for summary judgment, arguing that under the Tax Court decision in McCord v. Commissioner, 120 T.C. 358 (2003), rev'd and remanded sub. nom. Succession of McCord v. Commissioner, 461 F. 3d 614 (5th Cir. 2006), the agreement to pay the potential Section 2035(b) liability did not result in any benefit to the donor and therefore must be disregarded. Steinberg was appealed to the Second Circuit while McCord was appealed to the Fifth; for that reason the Service in Steinberg argued that the Tax Court could stick with its reasoning in McCord even though its decision in that case was overturned. In McCord the Tax Court had held that in advance of the death of a person, no recognized method exists for the approximating the burden of the estate tax with a sufficient degree of certitude to be effective for Federal gift tax purposes. This was referred to as the "too speculative" theory. The Court also held that any benefit from the donees' assumption of the potential Section 2035(b) tax would accrue to the benefit of the donor's estate rather than the donor, which might provide peace of mind but would not yield the type of tangible benefit required to invoke net gift principles. This was referred to as the "estate depletion" theory. In Steinberg the Service reserved argument on the "too speculative" theory and concentrated on the "estate depletion" theory. The Tax Court denied the Service's motion for summary judgment. The majority opinion was written by Judge Kerrigan, who was joined by Judges Colvin, Foley, Vasquez, Wherry, Homes, Paris and Buch. Judges Gale, Goeke, Kroupa, Gustafson, Morrison and Lauber concurred in the result only. Judge Halpern dissented. The majority reviewed its reasoning in McCord, in light of the Fifth Circuit's reversal, and concluded that a willing buyer and a willing seller in appropriate circumstances may take into account a donee's assumption of the potential Section 2035(b) estate tax liability in arriving at a sale price. In reaching its conclusion, the 36

majority observed that the contingency of a three-year survival is a relatively simple matter that does not depend on multiple occurrences. Whether it is too speculative or highly remote is a factual issue and therefore not proper for summary judgment. The majority also reasoned that even if estate tax exemptions and rates are subject to change, the Court could not foreclose the possibility that an appropriate method may exist to fix the potential Section 2035 estate tax liability assumed by the donees. Regarding the "estate depletion" theory, the majority admitted that its distinction between a benefit to the donor's estate and a benefit to the donor was incorrect. For purposes of the estate depletion theory, ". . . the donor and the donor's estate are inextricably bound. According to the estate depletion theory, whether a donor receives consideration is measured by the extent to which the donor's estate is replenished by the consideration." Note that in denying the government's motion, the Tax Court did not find that there was a benefit to the donor or her estate; it simply found that the assumption of the potential estate tax liability could be consideration in money or money's worth within the meaning of Code Section 2512(b). Finally, the majority also rejected the Service's argument that the contractual agreement to pay the estate tax was a gift because it was not in the "ordinary course of business." Whether a transfer that is or is not in the ordinary course of business is irrelevant if there is full and adequate consideration in money or money's worth for the transfer. 2. Includible Asset. Judge Goeke wrote a concurring opinion to point out a potential valuation issue, with which Judge Lauber agreed. Judge Goeke stated: The Code is clear that "[t]he value of the gross estate of the decedent shall be determined by including . . . the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated." Sec. 2031(a). Petitioner recognized that the donor's legal right to have the donees pay any section 2035(b) estate tax liability is a new asset of the donor that must be included in her gross estate like any other contract right, indemnity right, or similar claim she owned at death. Petitioner's position presumes the value of this obligation at death is the same as the calculated value at the time the asset is created. This presumption is illogical. The estate tax liability, and therefore the indemnity right, is going to depend on the facts and circumstances. If the donor dies after three years have passed since the date of the gift transaction, then the value of that "new asset" will be zero (i.e., no estate tax liability arises by virtue of section 2035(b)). If, however, the donor dies within that three-year period, then the indemnity right will be equal to whatever the estate tax liability actually is. This is in contrast to the value petitioner estimates with mortality table calculations. Consequently, the donees either could get a windfall (i.e., getting a gift tax discount and not paying any estate tax) or may end up suffering some serious repercussions necessitated by finding consideration (i.e., potentially paying a lot more in estate tax than is in accord with the discount they received). This issue is not before us now, but we should recognize the issue we create in finding the present promise to pay contingent estate tax may be consideration to the donor.

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If the donees’ assumption of the additional estate tax under Section 2035(b) can be ascertained and deducted, the amount could be significant for an elderly client, since the probability of death within three years of the gift increases with age. However, such an assumption is not without its risks, given the point that if death in fact occurs within three years the decedent’s estate may well have an additional includible asset – the benefit to the estate of the donees paying the additional tax – that is much greater than the discount for the net net gift. 3. Steinberg II. On September 16, 2015, the Tax Court issued its opinion on the issue of whether the donees’ promise to pay the potential 2035(b) tax was an appropriate factor in determining the value of the gift under the willing seller/willing buyer standard and, and, if so, whether the taxpayer correctly calculated the amount of the additional potential liability. Steinberg v. Commissioner, 145 T.C. No. 7. The Court found that the promise to pay the potential tax was an appropriate consideration when the donee’s assumption of the potential 2035(b) liability is a detriment to the donee and a benefit to the donor. The Court found that a willing buyer would have to assume both the gift tax liability and the 2035(b) liability in a net gift situation and would insist on a reduction of the purchase price to reflect his or her assumption of these liabilities. The Court believed that reduction for this liability was similar in nature to the reduction in the built-in gain cases, discussed at IV C above. The court also found benefit to the donor, because when the donor’s children assumed the tax liabilities, the donor’s assets were relieved of the liability and in this sense her assets were replenished. The Service argued that under the terms of the donor’s will, as well as under New York statutes, the 2035(b) liability would have been apportioned to the daughters in any event, so that the agreement of the daughters did not provide any benefit to the donor that she did not already enjoy. The facts of the case indicated that the decedent’s will, at the time of the net gift agreement, provided that any 2035(b) tax would be apportioned to her four daughters. The Tax Court disagreed with the Service’s position, pointing out that the donor could change her will at any time, or could move from New York, or that New York law could change, so as to relieve the daughters of their liabilities. Thus, the agreement in effect ensured that the liabilities would remain with the daughters regardless of domicile or future changes in the estate plan or New York law. Also, the Court observed, New York law is silent on how the 2035(b) tax would be recouped, while the agreement that the daughters signed contained an escrow arrangement for taxes. On the issue of the value of the gift, the Service did not submit an expert report. The calculation of the “net” gift was straightforward and followed the methodology of Code Section 2512, Treas. Reg. §25.2511-1 and Rev. Rul. 75-72, 1975-1 C.B. 310. For the 2035(b) liability the donor’s expert (Mr. Frazier) used Life Table 90CM to calculate the probability of the donor’s death within each of the three years following the gift, using the Section 7520 interest rate applicable on the date of the transfer to determine the present value factors for each of those years. The report took the effective state and federal estate tax rates for each of those years and multiplied them by the gift tax included in the estate under Section 2035(b). The Tax Court found this methodology to be persuasive. Although it offered no expert opinion, the Service attacked the calculations on its mortality assumptions and interest rate assumptions. First, the Service argued that the analysis was flawed because it did not consider contingencies such as the petitioner’s health and general medical prognosis. The Tax Court observed: The most common way to measure the value of a property interest that is dependent on the life expectancy of an individual is to use the 38

Commissioner's actuarial tables. See, e.g., Estate of Van Horne v. Commissioner, 720 F.2d 1114, 1116-1117 (9th Cir. 1983) (obligation based upon the life of an individual), 78 T.C. 728 (1982); see also Estate of Green v. Commissioner, 22 T.C. 728 (1954) (remainder interests in trusts). The actuarial tables are favored in part because they "'provide a needed degree of certainty and administrative convenience in ascertaining property values.'" Estate of Van Horne v. Commissioner, 720 F.2d at 1116 (quoting Bank of Cal. v. United States, 672 F.2d 758, 760 (9th Cir. 1982)). Respondent contends that Mr. Frazier should have also considered petitioner's health and general medical prognosis. The Commissioner's mortality tables necessarily take some account of a person's health and general medical prognosis when arriving at a probability of death. Respondent has not pointed to any specific facts or circumstances that would justify special consideration of petitioner's health or general medical prognosis beyond use of the mortality tables, and the evidence does not suggest that the tables produce an unreasonable result. Cf. Huntington Nat'l Bank v. Commissioner, 13 T.C. 760, 772 (1949) (stating that we deviated from use of the mortality table because the elderly widow's health was poor). The Service also argued that the Section 7520 rates were not applicable because they apply only to annuities, life interests, terms of years, remainders and reversionary interests. The Tax Court rejected this argument also: Mr. Frazier calculated the present value (the value on the day that the parties signed the net gift agreement) of the daughters' potential liability to make a payment to petitioner's estate in one of the subsequent three years. The fact that the payment is contingent rather than certain does not preclude use of the section 7520 rates. It simply requires adjusting the value of the payment to take into account the likelihood of the contingency. Mr. Frazier did account for the contingency by using the Commissioner's actuarial tables. Respondent has not persuaded us that there was a more appropriate method that should have been used. We conclude that the valuation was proper.

E. Estate of Redstone v. Commissioner, 145 T.C. No. 11 (October 26, 2015). Redstone is a gift tax case that considered the ordinary business exception to the gift tax regulations. Treas. Reg. §25.2511-1(g)(1) provides that the gift tax is not applicable to a transfer for a full and adequate consideration in money or money's worth, or to ordinary business transactions, described in § 25.2512-8. Treas. Reg. §25.2512-8 in turn provides in relevant part as follows: Transfers reached by the gift tax are not confined to those only which, being without a valuable consideration, accord with the common law concept of gifts, but embrace as well sales, exchanges, and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money’s worth of the consideration given therefor. However, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm’s length, and free

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from any donative intent), will be considered as made for an adequate and full consideration in money or money’s worth. In Redstone a father (Mickey) and two sons (Sumner and Edward) were shareholders in a family business that Mickey had founded. The family business was operated through a holding company in which each of the three family members owned 100 shares of stock. However, when the holding company was formed in 1959, the contributions to capital had not been equal. Mickey had contributed approximately 48% of the assets, Sumner about 26.5% and Edward about 25.5%. Mickey later contributed half of his shares to a trust for his grandchildren and then exchanged his remaining common shares for preferred shares. In the early 1970s tension arose in the family over how Edward and his wife were dealing with their son Michael, who had psychiatric issues. Also, Edward became dissatisfied with his role in the business and decided to separate. He demanded his 100 shares of stock and threatened to sell them to a third party. Mickey refused to deliver the shares, arguing that the company had a right of first refusal and that a portion of the shares were subject to an oral trust. The basis of the oral trust theory was that in the 1959 formation of the holding company Mickey had gratuitously accorded Edward more stock than he was entitled to, and that, to effectuate Mickey's intent in 1959, the “extra” shares should be regarded as being held in trust for Edward's children. Mickey initially insisted that at least half of Edward's shares were covered by this alleged oral trust. Edward was represented by counsel, who eventually filed two lawsuits to obtain possession of the stock. After negotiations, the lawsuits were settled on the basis of the parties agreeing that one third of the stock registered in Edward’s name was always subject to the oral trust, and the parties recognizing that Edward owned the remaining two thirds. The agreement further provided that Edward would execute declarations of trust for the benefit of each of his two children, to which the one third “oral trust” stock would be conveyed. Edward would receive his two thirds, but he would resign from the business and agree to a redemption of his stock for $5 million. The parties released each other. The settlement was effectuated in 1972 and the transfers were made. Edward executed the trusts and assigned the shares. He did not file a gift tax return. In 2006 litigation erupted again within the family. In this litigation Michael, Edward’s son, sued Edward, Sumner, certain family trusts and the holding company over whether in 1972 additional stock should have been transferred to his trust pursuant to the “oral trust” arrangement that supposedly existed. The issue of whether there was, in fact, an oral trust for any of Edward’s shares was extensively examined in this litigation, and at the close of evidence the court concluded that the plaintiff had failed to prove that there was ever an oral trust to begin with. Edward testified at the trial, stating that he never thought there was an oral trust, but that he agreed to the settlement in 1972 on the advice of counsel as an acceptable compromise of the litigation. He also testified that he never filed a gift tax return for transferring one third of his interest to trusts for his children because he did not believe he made a gift. Someone at the Internal Revenue Service must have been paying attention to the trial, because after the conclusion of the case Edward was presented with a notice of deficiency (which included additions to tax for fraud, negligence and failure to file) for failing to pay gift tax for the 1972 settlement. Edward’s defense, of course, centered on Treas. Reg. §25.2512-8. The Tax Court concluded, and the Service did not seriously challenge, that the 1972 settlement was at arm’s length, bona fide, and free from any donative intent. Rather, the Service argued that the business exception could not apply because there was no consideration that flowed to Edward from his two children, Ruth Ann and Michael, when Edward created the trusts and 40

transferred stock to them. Absent consideration, the Service argued, there had to be a gift. The Tax Court found the issue of whether the alleged donees provided consideration to be irrelevant to the business exception: Respondent's argument derives no support from the text of the governing regulations. Section 25.2511–1(g)(1), Gift Tax Regs., provides unequivocally that “[t]he gift tax is not applicable to a transfer for a full and adequate consideration in money or money's worth.” Section 25.2512–8, Gift Tax Regs., provides that a “transfer of property made in the ordinary course of business . . . will be considered as made for an adequate and full consideration in money or money's worth.” Section 25.2512–8, Gift Tax Regs., specifies three elements that an ordinary business transaction must meet, and we have found that Edward's transfer met all three elements. The consequence of that determination is that “[t]he gift tax is not applicable to . . . [the] transfer.” Sec. 25.2511–1(g)(1), Gift Tax Regs. Respondent's argument focuses on whether the transferees provided consideration. But that is not the question the regulation asks. It asks whether the transferor received consideration, that is, whether he made the transfer “for a full and adequate consideration” in money or money's worth. Sec. 25.2511–1(g)(1), Gift Tax Regs. (emphasis added). We have determined that Edward received “a full and adequate consideration” for his transfer-namely, the recognition by Mickey and Sumner that Edward was the outright owner of 66 2/3 NAI shares and NAI's agreement to pay Edward $5 million in exchange for those shares. Section 2512(b) and its implementing regulations require that the donor receive “an adequate and full consideration”; they make no reference to the source of that consideration. The parties have not brought to our attention, and our research has not discovered, any Tax Court precedent addressing the “source of consideration” question that respondent presents for decision. However, the result we reach accords with that reached by the U.S. District Court in Shelton v. Lockhart, 154 F.Supp. 244 (W.D.Mo.1957). The taxpayer there, an Osage Indian, applied for a certificate of competency from the Bureau of Indian Affairs (BIA). This certificate would have afforded her (among other things) the unrestricted right to own and dispose of $600,000 in property that the BIA held on her behalf. In her application she stated that she would make a portion of this property available to her children when they reached the age of 18. Fearing that the property might be dissipated before then, the BIA replied that it would issue her a certificate of competency only if she first placed in trust irrevocably for her children $300,000 of the property that the BIA held. She rejected that demand, and counsel for the parties commenced negotiations. Ultimately, the taxpayer agreed to place $200,000 of the disputed property into a trust for her children. The BIA then issued her a certificate of competency affording her unrestricted rights to the rest of the property, then worth $412,857. The IRS contended that the taxpayer's transfer in trust for her children was a taxable gift. The District Court disagreed, ruling that the transfer qualified as a transaction in the “ordinary course of business” under section 25.2512–8, Gift Tax Regs. The Court found it irrelevant that the taxpayer's children were not parties to the dispute or its settlement: 41

In essence, this transaction simply represents a business venture between Mrs. Shelton and the . . . [BIA]. It was the result of negotiations extending over a period of many months. The fact that in her original application she indicated that one of the purposes of the application was to be in position to make adequate trust provisions for her children after they reached majority does not in any way negative the unalterable conclusion that the result here-a trust she did not want, made at a time she did not want to make it, and for an amount she was unwilling to pay at the time-was the completion of a cold business bargain, as bona fide as any business bargain could be, negotiated at arm's length, and obviously free from any donative intent. . . . . Shelton, 154 F.Supp. at 248. Concluding that the transfer satisfied all three elements requisite to the “ordinary course of business” exception, the Court held that the transfer was not subject to the Federal gift tax. Ibid. The facts of Shelton are remarkably similar to those here. In both cases the assets in dispute were held by a third party. Edward, like Mrs. Shelton, initially demanded 100% of the disputed assets; when the party in actual possession of those assets demurred, lengthy negotiations ensued in which both sides were represented by counsel. Eventually a compromise was reached whereby the taxpayer obtained unrestricted ownership rights over 2/3 of the assets in exchange for transferring 1/3 of the assets in trust for the children. In both cases the consideration received by the taxpayer flowed, not from the transferee children, but from the third party who had possession of the disputed assets. The District Court in Shelton found the source of the consideration irrelevant and concluded that the taxpayer's transfer resulted from a “cold business bargain.” We reach the same conclusion here.6 6 Respondent contends that the children in Shelton provided “consideration” because they assertedly gave up claims to a greater percentage of the disputed assets. But Mrs. Shelton's children did not and could not relinquish anything because they were not parties to the dispute or its settlement. The BIA was negotiating on their behalf, just as Mickey was negotiating on behalf of Michael and Ruth Ann. In both cases, the party negotiating on the children's behalf was in possession of the disputed property; the dispute was settled by the taxpayer's transferring a portion of the disputed property to the children in consideration of receiving the balance of the disputed property in his or her own right. In Shelton, the BIA was the sole source of the “consideration” received by Mrs. Shelton, just as Mickey and Sumner were the source of the consideration received by Edward. In neither case is it material that no consideration was furnished directly by the transferees. F. Green v. United States, 2015 WL 6739089 __ F3d __ (Western Dist. Okla., 2015). Suppose an irrevocable trust is established that allows the trustees to distribute to Section 170(c) organizations such amounts from the gross income of the trust as the trustees determine appropriate. Suppose further that the trustees then use trust income to purchase properties which are held by the trust for a period of time, and then, in a tax year subsequent to the year of purchase, are donated to Section 170(c) organizations. Can the trust claim a charitable deduction under Section 642(c) and, if so, in what amount? The questions implicated are:

42

 Does property, purchased from income in one year, but held in the trust, become principal and ineligible for a Section 642(c) deduction for amounts paid from “gross income”?  Does Section 642(c) require the deduction to be paid from income of the current year?  If the property has appreciated in value, can the trustee deduct the fair market value, or is the deduction limited to basis? In Green the taxpayer had initially claimed a 642(c) deduction for the adjusted basis of the property transferred to charity. The trust applied for a refund, having concluded that it should have deducted the fair market value of the property rather than its basis. The Service resisted the refund claim. On cross summary judgment motions, the District Court held for the taxpayer and allowed a deduction for fair market value for properties initially purchased with income but held in the trust for subsequent distribution. The Court noted that the Service’s argument that the purchased properties had become “principal” and thus could not qualify for the section 642(c) deduction conflated the federal tax concept of “gross income,” with state law fiduciary accounting concepts of “income” and “principal. The properties, having been purchased with gross income, retained their federal tax law characteristics as gross income. Further, in Old Colony Trust Company v. Commissioner, 301 U.S. 37957 S.Ct. 81381 L.Ed. 1169 (1937), the Supreme Court had held with respect to a predecessor statute of 642(c) that the statute contained no words limiting donations to something actually paid from that year's gross income. The Court found that fair market value was the appropriate amount for the deduction: Under the facts of this case, using adjusted basis as the valuation standard would allow no consideration for the appreciation of real property donated in kind, regardless of whether such property was donated in the year of acquisition or in subsequent tax years. Defendant asks the Court to read a limitation into the statute where none expressly exists. Conversely, “the fair market value standard is as close to a generalized valuation standard as there is in the tax code.” Schwab v. Comm'r, 715 F.3d 1169 (9th Cir.2013).18 Notably, Congress did not specify a different standard of valuation in § 642. Further, considering the context of the statutory language in question and in light of § 170's general rule of fair market valuation regarding donations of property other than cash, a fair market valuation standard is consistent with the observation of the court in Schwab, and does not do violence to the plain language of § 642(c)(1). 18 The Ninth Circuit furthered its explanation by quoting an earlier decision by the Tax Court—“the concept of fair market value has always been part of the warp and woof of our income, estate, and gift tax laws, and ... [thus] the necessity of determining ... fair market values ... for ... numerous purposes has always been a vital and unavoidable function of the tax administrative and judicial process.” Id. (quoting Nestle Holdings, Inc. v. Comm'r, 94 T.C. 803, 815 (1990) (internal quotations omitted)).

G. Batchelor-Robjohns v. United States, 788 F.3d 1280 (11th Cir. 2015) This case dealt in part with whether an estate which claimed a large estate tax deduction for a settlement could also claim an income tax deduction (or credit) under the “claim of right” provisions of Code Section 1341. Code Section 1341 comes into play when a taxpayer receives and reports income in one tax year under a claim of right, and then, in a 43

subsequent tax year, is compelled to return the income. Code Section 1341 grants the taxpayer relief if (1) a deduction is allowable for the taxable year because it was established after the close of such prior taxable year that the taxpayer did not have an unrestricted right to item or a portion of such item and (2) the amount of the deduction exceeds $3,000. The relief is the lesser tax savings that results from allowing the taxpayer a deduction in the current year, or allowing a credit for the decrease in tax that would have been realized had the item been excluded from income in the prior year. In Batchelor-Robjohns the taxpayer reported a large capital gain in the year that he sold his company stock. Subsequently litigation arose over whether the taxpayer should be obligated to return a portion of the consideration he received, and on which gain was reported. After the taxpayer’s death, his estate settled the litigation by returning $41 million of consideration received, and on which tax was paid. The taxpayer’s estate claimed the $41 million payment as an estate tax deduction under Section 2053, and was not challenged. Later the taxpayer’s estate claimed that the return of the $41 million should also entitle it to an income tax deduction under Section 1341, notwithstanding the prohibition against double deductions under Section 642(g). The District Court did not allow the deduction; the estate appealed and the 11th Circuit affirmed, rejecting several arguments raised by the estate. The estate first argued that Section 1341 itself permitted a deduction because it was designed to afford relief where a taxpayer reports income that it is later required to repay. In this case the estate claimed that it was not seeking a tax windfall but simply a refund for the income tax attributable to the $41 million it was required to repay. The court disagreed, finding the language of the statute and its corresponding regulations did not by itself create an independent tax deduction; instead, Section 1341 would apply only if another code section would provide the basis for a deduction in the current year. Having found that taxpayer must claim the deduction under another Code Section, the 11th Circuit then observed that having claimed a Section 2053 deduction for the $41 million repayment, the estate was then precluded under Section 642(g) from claiming a deduction for this amount under any other Code section unless an exception to the statute was met. The exception to the statute is a deduction in respect of a decedent under Section 691(b), which, if present, allows double deductions. Section 691(b) enumerates six statutes where deductions accrued at the death of a decedent will result in double deductions: sections 27, 162, 163, 164, 212 or 611. The estate argued that because the payment of the $41 million arose out of the taxpayer’s sale of his business, the repayment was an ordinary and necessary business expenses or expenses incurred for the production of income that would be deductible under Code sections 162 or 212. The Court disagreed: . . . The $41 million at issue derives from income Batchelor originally reported as capital gain through the sale of his IAL stock. Batchelor's treatment of this income as capital gain determines the character of a subsequent repayment of that income pursuant to Kimbell v. United States, 490 F.2d 203 (5th Cir.1974), in which this Court determined that “a payment made by a taxpayer in satisfaction of a liability arising from an earlier transaction, on which that taxpayer reported capital gain [as here], must be treated as a capital loss at least to the amount of the capital gain,” rather than as a § 162 business expense. Id. at 205. It is undisputed that Batchelor obtained the $41 million of income as a result of his sale of IAL stock. It is also undisputed that the settlement payments were made to resolve claims that Batchelor had received excess consideration in selling his interest in IAL, such that the Estate's repayments are sufficiently linked to 44

Batchelor's original receipt of income.26 Accordingly, Kimbell does not permit the Estate to claim a deduction under § 162, and the Estate thus fails to satisfy § 691(b) by way of § 162. The Estate also attempts to satisfy § 691(b) by invoking § 212, which, in pertinent part, permits a deduction to “an individual” for “ordinary and necessary expenses paid or incurred during the taxable year ... for the production or collection of income.” 26 U.S.C. § 212(1). In this Circuit, however, “. . . § 162(a) and 212 are ... considered in pari materia; ” thus, “the restrictions and qualifications applicable to the deductibility of trade or business expenses [under § 162] are also applicable to expenses covered by section 212.” Sorrell v. Comm'r, 882 F.2d 484, 487 (11th Cir.1989) (quoting Fishman v. Comm'r, 837 F.2d 309, 311 (7th Cir.1988), cert. denied, 487 U.S. 1235, 108 S.Ct. 2902, 101 L.Ed.2d 935 (1988)); Estate of Meade v. Comm'r, 489 F.2d 161, 164 n. 6 (5th Cir.1974) (“For purposes of this distinction between capital expenses and ordinary expenses, sections 162 and 212 are construed in the same manner....”). Moreover, the rationale of Kimbell—that a taxpayer who initially reported income as capital gain may not receive the tax windfall that would result by recharacterizing a related expense as an ordinary business expense—applies with equal force to § 212.27 See Estate of Meade, 489 F.2d at 163–66 (taxpayers who received settlement payments in a lawsuit and reported those proceeds as capital gain were not permitted to deduct their legal fees associated with the suit as payments for the production of income under § 212). Thus, the Estate's attempt to invoke § 212 also fails. In an attempt to circumvent the statutes, the Estate insists it should be allowed a double deduction because otherwise the government will receive a windfall from the income taxes Batchelor paid on the $41 million at issue. In effect, the Estate urges us to fashion an equitable result; however, doing so would require us to either disregard § 642(g), or to construe § 691(b) as though it also included § 1341 as an exception, neither of which we can do. The double deduction the Estate seeks is plainly prohibited by 26 U.S.C. § 642(g), see Estate of Luehrmann v. Comm'r, 287 F.2d 10, 12–13 (8th Cir.1961) (recognizing that the purpose of § 642(g)'s predecessor statute “was to prevent taxpayers claiming the same items of administration expenses as deductions for both estate income tax and estate tax purposes”), and § 1341 is not one of the enumerated exceptions in § 691(b). Accordingly, we do not believe Congress intended to allow a double deduction based solely upon the potential application of § 1341. See Andrus v. Glover Constr. Co., 446 U.S. 608, 616–17, 100 S.Ct. 1905, 64 L.Ed.2d 548 (1980) (“Where Congress explicitly enumerates certain exceptions to a general prohibition, additional exceptions are not to be implied, in the absence of evidence of a contrary legislative intent.”). See also CBS Inc. v. PrimeTime 24 Joint Venture, 245 F.3d 1217, 1226 (11th Cir.2001) (“ ‘[W]here Congress knows how to say something but chooses not to, its silence is controlling.’ ”) (quoting In re Griffith, 206 F.3d 1389, 1394 (11th Cir.2000) (en banc)); Harris v. Garner, 216 F.3d 970, 976 (11th Cir.2000) (“[T]he role of the judicial branch is to apply statutory language, not to rewrite it.”). Thus, even assuming the equities actually favor the Estate, such concerns cannot trump the applicable statutes. See Long v. Comm'r, 772 F.3d 670, 678 (11th Cir.2014) ( “[D]eductions under the Internal Revenue Code are a matter of legislative grace and the taxpayer who claims the benefit must ... ‘clearly establish’ his entitlement 45

to a particular deduction.”) (internal marks and citations omitted); Estate of Luehrmann, 287 F.2d at 15 (“Tax exemptions and deductions do not turn upon general equitable considerations but depend upon legislative grace. Statutes authorizing tax exemptions and deductions are to be strictly and narrowly construed.”); Culley v. United States, 222 F.3d 1331, 1334 (Fed.Cir.2000) (“It is basic tax law that deductions from taxable income, for purposes of computing tax due the United States, are matters of statutory grant”). Finally, the Estate points to three authorities as grounds for invoking § 1341 without reference to either 642(g) or 691(b): Revenue Ruling 77–322, which permits “[a]n estate [to] utilize ... section 1341 ... in computing its tax when it restores an item that was previously included in income by the decedent under a claim of right;” Estate of Good v. United States, 208 F.Supp. 521 (E.D.Mich.1962), in which the court determined that an estate was entitled to use § 1341 to obtain a refund of the income taxes a decedent had paid on income that the decedent's employer later determined had been erroneously paid even though the estate also took an estate tax deduction for the repayment; and Nalty v. United States, No. 73–1574–B, 1975 WL 577 (E.D.La. Apr. 16, 1975), which followed Estate of Good. Aside from the fact that these authorities are not binding, see Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652, 657 (5th Cir.1968) (noting that Revenue Rulings are merely persuasive), we disagree with their rationale. First, Estate of Good, Nalty, and Revenue Ruling 77–322 do not account for this Circuit's requirement that a deduction must be allowable under another provision of the Tax Code for § 1341 to apply. See Fla. Progress, 348 F.3d at 958–59. Thus, it is not enough to merely conclude that the requirements of § 1341(a)(1)- (3) are met when the facts of the case implicate § 642(g). Second, although the Estate's authorities purport to distinguish between the “credit” offered by subsection (a)(5) and the “deduction” offered by subsection (a)(4), see Estate of Good, 208 F.Supp. at 523; Nalty, 1975 WL 577, at *5 (relying on the same distinction); Rev. Rul. 77–322 (adopting Estate of Good without supporting explanation), we do not believe § 642(g)'s prohibition on double deductions would give way to § 1341 regardless of whether the Estate claimed a credit or a deduction. The deduction/credit distinction merely determines how to account for a § 1341 repayment on one's return, nothing more. What matters is not whether a taxpayer may use § 1341 to reduce his present year taxes through a tax credit or a deduction, but rather whether a reduction in his income taxes is permitted at all (along with a corresponding estate tax deduction). In addition, whether a particular application of § 1341 would result in more favorable treatment to a taxpayer under subsection (a)(4) or (a)(5) depends on the fortuities of a given case, including changing tax rates and tax brackets between the year of receipt and the year of repayment. See Missouri Pac. R.R. Co. v. United States, 423 F.2d 727, 729–35 (Ct.Cl.1970) (discussing the legislative history of § 1341 and its alternative methods of calculation in a case where the taxpayer's tax rates varied widely over the tax years in question); cf. Skelly Oil Co., 394 U.S. at 681, 89 S.Ct. 1379 (noting that, under the claim of right doctrine, “the tax benefit from the deduction *1298 in the year of repayment might differ from the increase in taxes attributable to the receipt; for example, tax rates might have changed, or the taxpayer might be in a different tax ‘bracket.’ ”). We do not believe Congress intended the availability of a double deduction under § 642(g) to turn on such 46

fortuities. Regardless of whether a taxpayer would be entitled to a “deduction” under subsection (a)(4) or a “credit” under subsection (a)(5), section 642(g) and its accompanying regulations make clear that § 1341 alone does not determine whether a taxpayer may reduce both his income and estate tax liabilities for the same outlay without consideration of § 691(b). Thus, we reject the underlying rationale of the Estate's authorities. Since the Estate has failed to identify an applicable deduction identified in § 691(b), we find no error in the district court's determination that the Estate cannot avoid § 642(g)'s bar on double deductions, and therefore affirm on Count III.

H. Smoot v. Smoot, 2015 WL 2340822 (Southern Dist. Ga., 2015). Smoot considered the state law effect of a divorce on the terms the decedent’s tax clause. The decedent was divorced from his ex-spouse, Diane. However, Diane receive substantial benefits from the decedent’s estate, some in the form of life insurance proceeds on policies includible in the decedent’s estate, and some from other assets. The decedent’s will provided for apportionment of taxes: All transfer, estate, inheritance, succession and other death taxes which shall become payable by reason of my death, other than any tax on any generation- skipping transfer and any additional estate tax imposed pursuant to Section 2032A(c) of the Internal Revenue Code of 1986, as amended, shall be charged against and paid by the recipient of such property or from the property to be received . . . . The amount of tax to be charged against the recipient shall be determined by multiplying a fraction, the numerator being the federal estate tax value of the property to be distributed to the recipient, and the numerator2 [sic] being the total value of my taxable estate, all values being those that are as finally determined for federal estate taxes purposes; times the federal estate tax payable by my estate . . . . 2 Naturally, a fraction cannot have two numerators. Plaintiff argues that this is simply a scrivener's error, and that the numerator (the top portion of a fraction indicating the number of parts of the whole) is intended to be “the federal estate tax value of the property to be distributed to the recipient,” and the denominator (the bottom portion of a fraction indicating the sum of the whole) is intended to be “the total value of my taxable estate.” Defendant does not challenge Plaintiff's scrivener's error argument, and the Court finds that Decedent intended Item X to operate as Plaintiff explains. The decedent’s son was the executor of the estate. He filed suit to collect what he believed should be (1) Diane’s share of estate taxes, interest and penalties on the life insurance she received; (2) Diane’s share of estate taxes, interest and penalties on the assets other than life insurance that she received, and (3) attorneys’ fees and costs. The District Court granted the son summary judgment on (1), but denied (2) and (3). Code section 2206 permits an executor to claim contribution for estate taxes attributable to life insurance payable to a third party and on which the decedent held incidents of ownership at death, unless the decedent directs otherwise in his will. The District Court found that Section 2206 was in sync with the decedent’s will – they directed the same thing – and therefore granted summary judgment on the request for contribution for estate taxes. The Court also noted that under Code section 6601(e)(1) interest is assessed, collected, and paid in the same manner as taxes, and that “any reference in this title (except subchapter B of chapter 63, relating to deficiency procedures) to any tax imposed by this title shall be deemed also to refer 47

to interest imposed by this section on such tax.” The Court concluded that Diane’s contribution included interest and penalties attributable to her share of the estate tax. There was a different consideration with respect to the non-insurance assets. Under state (Georgia) law, a statute provided that upon a divorce “[a]ll provisions of a will made prior to a testator's final divorce or the annulment of the testator's marriage in which no provision is made in contemplation of such event shall take effect as if the former spouse had predeceased the testator . . . . “ The District Court believed that this was an unambiguous provision, and that “all” provisions of a will included the tax clause. Therefore, the tax clause contribution provisions were effectively revoked for the spouse on divorce, and the executor had no other means to enforce contribution. Summary judgment was denied on claims (2) and (3).

I. Winford v. United States, 587 Fed.Appx. 207 (Mem) (5th Cir. 2014). Winford considered whether the taxpayer’s remittance of funds to the United States should be considered as a “deposit” or a “payment” of taxes. If the remittance was classified as a payment, the taxpayer’s claim for refund would be denied, as it came after the statute of limitations had run on a refund claim. In this case, a co-executor of an estate could determine the value of the gross estate, but could not properly determine the liabilities of the estate because of pending litigation. On advice of counsel, the co-executor filed a Form 4768 extension request and attached a check for $230,884.00. In addition, the co-executor attached a partially completed Form 706 on which she provided an “estimated tax” based on the assets and liabilities known at the time of submission. Neither the form nor the check specified whether the remittance was a “payment” or a “deposit,” but the co-executor did characterize the remittance as “[a]n estimated payment” in the explanation submitted with the extension request. The IRS posted the remittance as a payment on July 29, 2003. Five years later the estate's litigation was resolved, and in 2009 the co-executor filed a tax return which claimed entitlement to an overpayment of $136,268.00. The IRS disallowed the claim, finding that it was submitted outside of the statutory three-year time limitation. The co- executor filed an internal appeal, which the IRS denied, and then filed suit. The District Court granted the government’s cross motion for summary judgment. The determination of whether a remittance is a payment or deposit was examined in Winford under a facts and circumstances test set forth by the Supreme Court in Rosenman v. United States, 323 U.S. 658, 65 S.Ct. 536, 89 L.Ed. 535 (1945). The District Court found that the estate's good faith approximation of its tax liability, failure to contest the tax liability, failure to indicate that the remittance was a deposit, and submission of its remittance with a request for an extension weighed in favor of concluding that the remittance was a payment rather than a deposit. The Fifth Circuit affirmed in an unpublished opinion.

COMMENT: Although Winford cannot be cited as precedent except in limited circumstances, see Syring v. United States, 2013 U.S. Dist. LEXIS 111712 (W. Dist. Wis.) (August 8, 2013), another case where a court ruled that a remittance by an estate was properly classified as a payment rather than a deposit. Code section 6603 provides that a taxpayer may make a cash deposit with the Secretary which may be used by the Secretary to pay any tax imposed under subtitle A or B or chapter 41, 42, 43, or 44 which has not been assessed at the time of the deposit. To the extent that the deposit is used by the Secretary to pay tax, for purposes of section 6601 (relating to interest on underpayments), the tax shall be treated as paid when the deposit is made. The taxpayer is entitled to a return on any portion of the deposit not used to pay taxes on a request in writing. See Rev. Proc. 2005-18, 2005-1 C.B. 798, which sets forth 48

procedures for making, withdrawing, or otherwise identifying deposits under section 6603 to suspend the running of interest under section 6601 on potential underpayments of tax.

J. Belk v. Commissioner, 774 F. 3d 221 (4th Cir. 2014). In Belk a partnership granted a conservation easement to a land conservation group over golf course property located in North Carolina. The easement was granted in perpetuity, but allowed the grantor the right to substitute other property of equal or greater value provided it was of the same or better ecological stability. Any swap would require the consent of the land conservation group, but the consent could not be unreasonably withheld. The grant of the easement also contained a savings clause which provided that the land conservation group would have no right or power to agree to any amendment to the grant of easement that would result in the easement failing to qualify under Section 170(h) and its regulations as a qualified conservation easement. The $10,524,000 deduction for the easement flowed through to the married couple who owned the partnership interests; the Service audited their returns and challenged the deduction. Code Section 170(h)(2) defines the term “qualified real property interest” to include, as subsection (C), “a restriction (granted in perpetuity) on the use which may be made of the real property.” The Service claimed that the swap power retained by the partnership meant that the restriction placed on the real property was not in perpetuity. The taxpayer claimed that subsection (C) only required that there be a restriction on some property in perpetuity, but the restriction did not have to be perpetual on the donated property. The taxpayers lost at the Tax Court and appealed to the Fourth Circuit. The Fourth Circuit affirmed, coming to the same conclusion of the Tax Court: the statute, as well as the regulations, refers to a perpetual easement on “the real property,” which the Court believed meant the property donated. The Court observed that permitting conservation property to be swapped would allow the substituted property to bypass several requirements critical to the statutory and regulatory schemes of Section 170(h), including attaching a qualified appraisal to the taxpayer’s tax return, and providing the done with documentation sufficient to establish the condition of the property, which would be undermined if the borders of the conservation area could shift. One interesting aspect of the decision was the Fourth Circuit’s discussion of the savings clause, which it held to be a condition subsequent that under Procter must be disregarded. The Fourth Circuit observed: The Belks properly acknowledge that “the IRS and the courts have rejected ‘condition subsequent’ savings clauses, which revoke or alter a gift following an adverse determination by the IRS or a court.” Appellants' Br. 39 (citing Commissioner v. Procter, 142 F.2d 824, 827–28 (4th Cir.1944)). They maintain, however, that the savings clause here is not a “condition subsequent” savings clause, but simply “an interpretive clause meant to insure that [the Trust] makes no amendment to the Conservation Easement . . . that would be inconsistent with the overriding intention of the parties.” Id. The Belks are wrong. A condition subsequent rests on a future event, “the occurrence of which terminates or discharges an otherwise absolute contractual duty.” 30 Williston on Contracts § 77:5 (4th ed.). When a savings clause provides that a future event alters the tax consequences of a conveyance, the savings clause imposes a condition subsequent and will not be enforced. See Procter, 142 F.2d at 827; Estate of Christiansen v. Commissioner, 130 T.C. 1, 13, 2008 WL 199719 49

(2008), aff'd, 586 F.3d 1061 (8th Cir.2009). As the IRS has explained, clauses that seek to “recharacterize the nature of the transaction in the event of a future” occurrence “will be disregarded for federal tax purposes.” I.R.S. Tech. Adv. Mem.2002–45–053 (Nov. 8, 2002). In Procter, which the Belks do not suggest was incorrectly decided, the taxpayer sought to avoid the federal gift tax by including a savings clause within the trust conveying the gift. That clause provided that “[t]he settlor is ... satisfied that the present transfer is not subject to Federal gift tax,” but added that if “a competent federal court of last resort” determined “that any part of the transfer ... is subject to gift tax,” that part “shall automatically be deemed not to be included in the conveyance” and so not subject to gift tax. Procter, 142 F.2d at 827. We rejected the taxpayer's argument out of hand, holding that tax consequences could not “be avoided by any such device as this.” Id. We explained that the taxpayer's attempt to avoid tax, by providing the gift “shall be void” as to property later held “subject to the tax,” was “clearly a condition subsequent,” and involved the “sort of trifling with the judicial process [that] cannot be sustained.” Id. So it is here. The Belks' Easement, by its terms, conveys an interest in real property to the Trust. The savings clause attempts to alter that interest in the future if the Easement should “fail[ ] to qualify as a . . . qualified conservation contribution under Section 170(h).” In seeking to invoke the savings clause, the Belks, like the taxpayer in Procter, ask us to “void” the offending substitution provision to rescue their tax benefit. The Belks' attempt to distinguish Procter fails. They find significant the fact that the savings clause there altered the conveyance “following an adverse IRS determination or court judgment,” while the savings clause here does not expressly invoke the IRS or a court. Appellants' Br. 39. This is a distinction without a difference. Though not couched in terms of an “adverse determination” by the IRS or a court, the Belks' savings clause operates in precisely the same manner as that in Procter. The Easement plainly permits substitutions unless and until those substitutions “would result” in the Easement's “failing to qualify . . . under Section 170(h) of the Internal Revenue Code,” a determination that can only be made by either the IRS or a court. Indeed, relying on Procter, the IRS has found a clause void as a condition subsequent notwithstanding its failure to reference determination by a court. See Rev. Rul. 65–144, 1965–1 C.B. 442, 1965 WL 12880. The Belks do not suggest that the IRS erred in so concluding, nor do they attempt to distinguish that clause from their own. They do contend, however, that their savings clause is simply “an interpretive clause” meant to ensure the “overriding intention” of the parties that the Easement qualify as a charitable deduction. Appellants' Br. 39. We are not persuaded. When a clause has been recognized as an “interpretive” tool, it is because it simply “help[ed] illustrate the decedent's intent” and was not “dependent for [its] operation upon some subsequent adverse action by the Internal Revenue Service.” I.R.S. Tech. Adv. Mem. 79–16–006 (1979) (distinguishing Procter); see also Estate of Cline v. Commissioner, 43 T.C.M. (CCH) 607 (T.C.1982) (clause valid to interpret “ambiguous ... language in a poorly drafted ... agreement,” but not to “change the property interests otherwise created”); Rev. Rul. 75–440, 1975–2 C.B. 372, 1975 WL 34994 at *2 (clause

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“relevant ... only because it helps indicate the testator's intent not to give ... a disqualifying power” (emphasis added)). In contrast to those situations, the Belks' intent to retain “a disqualifying power” is clear from the face of the Easement. There is no open interpretive question for the savings clause to “help” clarify. If the Belks' “overriding intent[ ]” had been, as they suggest, merely for the Easement to qualify for a tax deduction under § 170(h), they would not have included a provision so clearly at odds with the language of § 170(h)(2)(C). In fact, the Easement reflects the Belks' “overriding intent[ ]” to create an easement that permitted substitution of the parcel—in violation of § 170(h)(2)(C)—and to jettison the substitution provision only if it subsequently caused the donation to “fail [ ] to qualify ... as a qualified conservation contribution under Section 170(h).” Thus, the Belks ask us to employ their savings clause not to “aid in determining [their] intent,” Rev. Rul. 75–440, but to rewrite their Easement in response to our holding. This we will not do.3 Indeed, we note that were we to apply the savings clause as the Belks suggest, we would be providing an opinion sanctioning the very same “trifling with the judicial process” we condemned in Procter. 142 F.2d at 827. Moreover, providing such an opinion would dramatically hamper the Commissioner's enforcement power. If every taxpayer could rely on a savings clause to void, after the fact, a disqualifying deduction (or credit), enforcement of the Internal Revenue Code would grind to a halt. 3 In a last-ditch effort, the Belks further argue that the savings clause is designed “to accommodate evolving ... interpretation of Section 170(h)” so that the Easement “continue[s] to be consistent” with their intent to comply with that provision. Reply Br. 20. But the statutory language of § 170(h)(2)(C) has not “evolved” since the provision was enacted in 1980. See Pub.L. 96–541, 94 Stat. 3204 (Dec. 17, 1980). The simple truth is this: the Easement was never consistent with § 170(h), a fact that brings with it adverse tax consequences. The Belks cannot now simply reform the Easement because they do not wish to suffer those consequences.

K. Specht v. United States, 2015 WL 74539 (S.D. Ohio, W.D., 2015). Specht considered whether an executor’s failure to timely file an estate tax return and pay the tax was due to reasonable cause and not to willful neglect. The executor was 73 years old, had never served as a fiduciary, and had never owned a share of stock. She retained the decedent’s attorney to handle the estate tax return. The attorney had been practicing for 50 years, but unbeknownst to the executor was battling brain cancer. The return was filed late and the tax paid on filing. The Service imposed failure to file and failure to pay penalties. The executor believed that she was misled (it was not clear whether intentionally or unintentionally) regarding whether an extension request had been filed. The basis for abatement of the penalties was reliance on the attorney. In granting the government’s summary judgment motion, the District Court observed that even if the executor was an unsophisticated person who was relying on an attorney, as a fiduciary she is still held to the knowledge of knowing the filing date for the estate’s tax obligations: The Tax Code provides for mandatory additions-to-tax (commonly referred to as penalties) for the: (1) failure to timely file a return, 26 U.S.C. § 6651(a)(1), and (2) failure to timely pay a tax, 26 U.S.C. § 6651(a)(2). With respect to Section 51

6651, the Supreme Court has stated that “Congress' purpose in the prescribed civil penalty was to ensure timely filing of tax returns to the end that tax liability will be ascertained and paid promptly.” United States v. Boyle, 469 U.S. 241, 245, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985). However, these penalties are not owed if the taxpayer can establish that the failure is “due to reasonable cause and not due to willful neglect.” 26 U.S.C. § 6651(a)(1) (failure to file); (a)(2) (failure to pay). Under this exception, “the taxpayer bears the heavy burden of proving both”: (1) that the failure was due to reasonable cause; and (2) that the failure did not result from willful neglect. Boyle, 469 U.S. at 245. The Estate does not contest that it failed to timely file or pay the estate tax. The only issue is whether these failures were due to “reasonable cause and not due to willful neglect.” A. Reasonable Cause Reasonable cause is not defined in the Internal Revenue Code. However, Treasury Regulations require the estate to demonstrate that it “exercised ‘ordinary business care and prudence’ but nevertheless was ‘unable to file the return within the prescribed time.’ “ Boyle, 469 U.S. at 246 (quoting 26 C.F.R. § 301.6651(c)(1)). In Boyle, the Supreme Court held that “[t]he failure to make a timely filing of a tax return is not excused by the taxpayer's reliance on an agent, and such reliance is not ‘reasonable cause’ for a late filing under Section 6651(a)(1).” 469 U.S. at 248. In Boyle, the Supreme Court recognized a distinction between a taxpayer who “has relied on the erroneous advice of counsel concerning a question of law,” and a taxpayer who has retained an attorney to attend to “an unambiguous, precisely defined duty to file” a return by a certain time. Id. at 250. Although a taxpayer may reasonably rely on advice received from an attorney “on a matter of tax law . . . one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due.” Id. at 251.3 For example, in Valen Mfg. Co. v. United States, 90 F.3d 1190 (6th Cir.1996), a corporation sought to avoid both failure-to-file and failure-to-pay penalties imposed when its hired bookkeeper not only failed to file the appropriate tax returns and make the required tax deposits, but actively concealed the delinquencies from her employer. Id. at 1191. The Sixth Circuit affirmed the district court's granting of summary judgment quoting Boyle: “the relevant Treasury Regulation calls on the taxpayer to demonstrate that [it] exercised ‘ordinary business care and prudence’ but nevertheless was unable to file the return within the prescribed time.” Id. at 1192 (citing 26 C.F.R. § 301–66511(c) (1)). The court rejected the taxpayer's argument that it had exercised ordinary business care and prudence by hiring several “outside” companies that would review its employees' work. “ ‘Ordinary care and prudence’ requires more than mere delegation.” In re Carlson, 126 F.3d 915, 922 (7th Cir.1997).4 Plaintiff cites Brown v. United States, 630 F.Supp. 57 (M.D.Tenn.1985), a case decided the same year as Boyle and before the controlling precedent of Valen and its progeny. Aside from the fact that Brown is an outlier,5 the facts are distinguishable. In Brown, the court found that the taxpayer was not capable of complying with the deadline for timely filing the estate tax return, because he was unaware of the deadline. 630 F.Supp. at 59–60. Here, there is no question that 52

Mrs. Specht knew the estate tax deadline. Although the Plaintiffs argue that Backsman's statements that extensions were granted is equivalent to Mrs. Specht not knowing the deadline, such misrepresentations cannot constitute reasonable cause. Whether a request for extension of time was filed and granted is an issue of fact not a question of law. Further, in Brown, the court made an affirmative finding that the plaintiff was “not physically and mentally capable” of complying with the filing deadline. 630 F.Supp. at 60. Here, Mrs. Specht argues that she lacked the sophistication to single- handedly complete and file the estate's federal tax return. However, there is no evidence to suggest that she lacks the sophistication to understand the importance of the estate tax deadline or to ensure that deadline was met. Mrs. Specht relied on an agent to file tax returns and the agent failed to do so. However, as the Sixth Circuit states, “[f]orgiveness of penalty assessments levied against taxpayers who could exert greater controls and exercise greater levels of personal responsibility would only encourage late filings and payments to the IRS.” Valen, 90 F.3d at 1194. The bright line rule articulated by the Supreme Court in Boyle and by the Sixth Circuit in Valen Manufacturing makes clear that the reasonable cause analysis looks at the party with ultimate responsibility for satisfying the tax liabilities, not the actions or medical conditions of their agent. While Plaintiff argues that the failure to meet the tax deadline resulted from circumstances largely beyond her control, there is no evidence to support a finding that she was an executor without the ability to control whether the deadline was met. Accordingly, even though Plaintiff hired counsel to handle the estate, reliance on counsel cannot constitute reasonable cause for the late filing and payment of taxes. Even if Backsman's medical condition led her to malpractice in the course of representing the Estate, this did not render Mrs. Specht “disabled.” B. Willful Neglect In addition to the reasonable cause requirement, to escape penalties under Section 6651, the Estate must also meet the heavy burden of proving that the late filing and payment did not result from willful neglect. Boyle, 469 U.S. at 245. Willful neglect is “a conscious, intentional failure or reckless indifference.” Id. However, mere carelessness is enough for a taxpayer to be denied a refund based on the exceptions in Section 6651. Id. at 245 n. 4 (“[a] taxpayer seeking a refund must therefore prove that his failure to file on time was the result neither of carelessness, reckless indifference, nor intentional failure.”). For example, in Vaughn v. United States, No. 1:12cv3135, 2014 U.S. Dist. LEXIS 105766, 2014 WL 3734492 (N.D. Ohio June 27, 2014), a former Major League Baseball player filed a lawsuit alleging that tax penalties levied against him violated Section 6651. Specifically, his financial advisor failed to timely file his taxes and embezzled millions of dollars from him. However, the court found that despite the fact that Plaintiff tried to be proactive in seeking professionals to manage his finances and taxes, the ability to pay his taxes was not beyond his control and therefore he could not prove that the late filing did not result from willful neglect. Mrs. Specht was aware that the Estate's federal tax return needed to be filed and paid nine months after Ms. Escher's death on September 30, 2009; that the 53

tax liability was approximately $6,000,000; and that the Estate would need to sell its UPS stock to cover the tax liability. Mrs. Specht further understood that the September 30, 2009 deadline was important, and that missing the deadline would result in consequences. In the months prior to the estate tax deadline, Mrs. Specht received at least four notices from the probate court informing her that the estate was missing probate deadlines. After the deadline, Mrs. Specht received at least two additional notices from the probate court warning that Backsman had failed to file a first accounting of the Estate's assets; numerous calls from the Rotterman family informing Specht that Backsman was incompetent; two letters from the Ohio Department of Taxation informing Specht that the state tax return was delinquent; and a warning from another attorney—whom she eventually hired to replace Backsman—informing her that she needed to hire another attorney. Serving as the executor of a probate estate is clearly not an easy task, which is why Mrs. Specht trusted an attorney to guide her through the process. While this Court finds it difficult to hold that Plaintiffs are ultimately responsible for Ms. Backsman's malpractice, that is what binding precedent requires. Notably, in light of Ms. Backman's malpractice, the State of Ohio refunded the late filing and payment penalties for Ohio estate taxes without the Estate filing a refund suit. (Doc. 16, Ex. 2 at ¶ 14). It is truly unfortunate that the United States did not follow the State of Ohio's lead. 4. In Estate of Ridenour v. United States, 468 F.Supp.2d 941 (S.D.Ohio 2006), the court addressed cross-motions for summary judgment in a suit where an estate plaintiff sought a refund of failure-to-file and failure-to-pay penalties. Plaintiff argued that reasonable cause existed for late filings and late payment because the estate hired an experienced probate attorney. However, the Court granted summary judgment in favor of the United States, holding that neither reliance on counsel nor the complexity of the estate could constitute reasonable cause for late filing and late payment of tax. Id. 5 The Court cannot find any case that has followed Brown to excuse a taxpayer from penalties under Section 6651. COMMENT: Reasonable cause is a facts and circumstances test. For another case where the executors could not meet the standard of reasonable cause for late filing and payment, see West v. Koskinen, 2015 SL 6159954 (E.D. Va., 2015), where the executors argued that an attorney’s e-mail stating that the administration of the estate might involve the filing of an estate tax return and fiduciary income tax returns, and might take as little as four months or as long as 2 years if an estate tax return was required, created the understanding that an estate tax return was not due until 2 years from death. The District Court, in another summary judgement holding for the government, rejected this argument: Simply put, Rodgers' January 4 email -- the basis of plaintiffs' “reasonable cause” claim -- is not legal advice as to the estate tax filing or payment deadlines. No reasonable person exercising ordinary business care and prudence would rely on the email for that purpose. To the contrary, a reasonable person exercising ordinary business care and prudence would seek clarification, as plaintiffs might have done during a later face-to-face meeting, which plaintiffs had with Rodgers in February. Indeed, the Supreme Court has made clear that the foundation of the “reasonable cause” exception is that “a taxpayer should not be penalized for circumstances beyond his control.” Boyle, 469 U.S. at 248 n. 6, 105 54

S.Ct. 687. This case presents no such facts. Here, plaintiffs had ample opportunity to seek clarity as to the deadlines but chose instead to construe vague language as specifying a two-year filing and payment deadline. In sum, plaintiffs' claim of “reasonable cause” based on plaintiffs' reliance on the erroneous advice of counsel fails because plaintiffs never received advice of counsel as to an estate tax filing or payment deadline.11 Information that an estate tax process might take “as long as [two] years” is not advice about deadlines for filing a return or paying any tax due. 11 It is important to note that Rodgers' January 4 email was sent in response to Peter West's January 3 email in which Peter West indicated that Renner, an accountant, would be handling the estate taxes. See Gov't Ex. A. In light of this information, there would be no reason for Rodgers to offer any advice about the estate tax deadlines in the January 4 email.

L. United States v. Stiles, 2014 WL 6775263 (W.D. Pa. 2015). Stiles concerned the foreclosure of the United States’ tax lien on real property for the non- payment of estate and income tax, and the personal liability of the executor for making distributions to himself and his sisters, which rendered the estate insolvent, at a time when he knew there were unpaid tax liabilities. The case is not remarkable, except perhaps as a reminder that there is no “attorney reliance” exception to the personal liability of a fiduciary under the federal priority statute (31 U.S.C. § 3713). The executor, David Stiles, claimed that he made distributions from the estate to himself and his siblings on advice of Delaware counsel. In granting the government’s motion for summary judgment, the District Court stated: The Stiles argue that they detrimentally relied on advice of their Delaware counsel when they made the distributions that led to the estate's insolvency. (ECF No. 43 at 3.) In United States v. Renda, 709 F.3d 472, 484–85 (5th Cir.2013), cert. denied, ––– U.S. ––––, 134 S.Ct. 618, 187 L.Ed.2d 400, (2013), the court of appeals discussed this argument and stated: First, the statute does not provide for an attorney-reliance exception. Over the years, courts have read into the Priority Statute the “knowledge” and “insolvency” requirements to protect innocent representatives. We decline to announce a further exception. Second, a contrary interpretation would create an exception to the Priority Statute that might swallow the rule. As long as a debtor's representative were to receive advice from counsel that the debtor had some basis to contest the government's claim, the representative could distribute the debtor's assets to nonfederal creditors. Such an interpretation would defeat the purpose of § 3713(b) to ensure that debts of the United States are repaid first. See Moore, 423 U.S. at 81, 96 S.Ct. 310, 46 L.Ed.2d 219 (explaining that the personal liability provision is what “g[ives] the priority teeth”); King, 379 U.S. at 337, 85 S.Ct. 427, 13 L.Ed.2d 315 (noting that the purpose of the personal liability provision “is to make those into whose hands control and possession of the debtor's assets are placed, responsible for seeing that the Government's priority is paid”).

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Renda, 709 F.3d at 484. As the executor, David Stiles was responsible for managing the assets of the estate. see United States v. Boyle, 469 U.S. 241, 251, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985) (“When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice . . . . By contrast, one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is of course common; but that reliance cannot function as a substitute for compliance with an unambiguous statute.”). Here, David Stiles was aware that the estate's tax returns had not been filed and he failed to take action to remedy the situation or inquire into it as “a prudent person of ordinary intelligence in his position would have so inquired.” Estate of Stiles, 2011 WL 5299295, at *5. Relying on the poor advice from an attorney is not a defense. It is unfortunate that the Stiles received poor legal advice; however, poor advice does nothing to mitigate their liability for the decisions David Stiles made in managing the estate.

M. Woelbing, Williams and Davidson. Several cases that were pending in Tax Court over the last several years were the topic of discussion at the Miami Institute this year. One set of cases involves the estates of David and Marion Woelbing (Tax Court Docket Nos. 30261-13 and 30260-13, respectively), who died within a short time of each other. Mr. Woelbing sold non-voting stock to (presumably) a grantor trust in exchange for a promissory note. It appears that the trust may have satisfied the unofficial but widely observed "10% seed asset" requirement through cash value of life insurance policies and personal guaranties. At any rate, the Service has challenged the valuation for gift tax purposes under alternate arguments. The first, and potentially most damaging, argument is that the taxpayer's sale involved the receipt of equity rather than debt. This arguably would be the case, for example, if there are inadequate assets in the trust to assure repayment of the note, so that the purchaser's repayment is essentially the equity interest of the transferred assets. If the note is considered equity rather than debt, the note would not be a qualified interest under Section 2702 and would be valued at zero, in which case there would have been a gift of the entire value of the non-voting stock transferred to the trust (some $59 million). The alternate argument is that if the note is considered debt the underlying stock was worth approximately $116.8 million so that there was part gift, part sale. The Service has raised the "note as equity" issue before, most notably in the Karmazin case, which was settled. In Woelbing the Service is also arguing that for estate tax purposes the non-voting stock must be included in the estate under Code Sections 2036 and 2038 at its date of death value, which value was purportedly significantly higher than the value at the date of the gift. On January 29, 2016 the Tax Court entered an order in each case that the parties must either submit to the court a stipulated decision document or file a joint report as to the then present status of the case. COMMENT: If there is a real concern with the IRS 2702 argument, one could attempt to structure the payments from the trust as a qualified annuity interest under Section 2702, or perhaps simply turn to a GRAT strategy instead of an installment note sale. Neither one of these alternatives is very satisfactory, so there probably is not much to say except (1) be careful to ensure there is proper coverage in the trust (the "seeding" issue); and (2) ensure that the client is well aware that the Service continues to question these transactions.

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A second case is the Estate of Jack Williams (Tax Court Docket No. 29735-13), which involved the transfer of property to an LLC. The Service had attacked the transaction on a number of fronts, including arguments that the LLC had no legitimate non-tax purpose, that the LLC property was includible in the estate under Section 2036, that Section 2703 applied to disregard the partnership entity, and that Sections 2704(a) and 2704(b) apply. The case was resolved by the entry of a stipulated decision in March, 2015. The estate agreed to pay additional estate tax of approximately $488,000 with no undervaluation penalty. The Service was initially seeking an increase in the value of the estate of about $3.2 million. The Davidson case (Estate of Davidson v. Commissioner, Tax Court Docket 13748-13), which received much attention over the past two years, also settled in 2015. The case involved a sale for a self-cancelling installment note ("SCIN") that was back-end loaded. It appears that Chief Counsel's Advice 201330033 was issued in connection with the case. In the CCA the taxpayer engaged in a series of transactions that involved the sale of assets to grantor trusts in return for notes. In some transactions, the notes represented face value of the appraised value of the stock transferred to the trusts, with interest at AFR. Interest only was payable annually, with a balloon payment of all principal at the end of the term. In other transactions, the notes were self cancelling if the taxpayer died before the maturity date. One transaction involved a SCIN where the face value of the note was equal to the appraised value of the property sold, but the risk premium was built into the interest rate. Another transaction involved a SCIN where the interest rate was AFR but the risk premium was built into the face value of the note, which the CCA noted was almost twice the value of the property sold. Both versions of the SCINs provided for interest-only payments, with a balloon payment of all principal at the end of the term. The taxpayer valued the SCINs under Section 7520. Mr. Davidson was 86 when he entered into the SCIN transaction, and the notes had a term of 5 years, slightly less than his normal life expectancy. Shortly after the SCIN transactions (December 2008 and January 2009) he was diagnosed with a terminal illness and he died on March 13, 2009 before any interest or principal was received under the notes. The CCA posed the following questions: 1. Does all or any portion of the transfers of stock from the decedent to the grantor trusts in exchange for the notes with the self-cancelling feature constitute a gift? 2. How should the fair market value of the notes with the self-cancelling feature be determined? 3. If the Date 1 transfers do not constitute a gift, what are the estate tax consequences of the cancellation of the notes with the self-cancelling feature upon the decedent’s death? In Estate of Constanza v. Commissioner, 320 F. 3d 595 (6th Cir., 2003), the Sixth Circuit stated that a SCIN transaction entered into by family members is presumed to be a gift and not a bona fide transaction. In Constanza the Court held that the taxpayer had rebutted the presumption of gift based on the taxpayer's need for a steady stream of retirement income, the expectation of repayment, and the intent to enforce repayment. The Chief Counsel contrasted this holding with a Court of Claims holding in Estate of Musgrove v. United States, 33 Fed. Cl. 657 (1995), involving a loan from a seriously ill father to his son in return for a note to be cancelled at death. In Musgrove the loan was for $251,540 in return for a note of $300,000. In granting summary judgment to the government, the Court of Claims observed that there was no repayment schedule to follow, no interest was established on the note, there were no payments to the decedent before his death, and the son was uncertain as to whether he could repay the loan. 57

The CCA reasoned that the notes were structured as interest only solely for estate planning purposes because of the back-end loading and the fact that the decedent had sufficient other assets for his daily living expenses. It characterized them as a device to transfer stock to other family members at less than fair market value. The CCA also reasoned that the grantor trusts may not have had the ability to repay, given the principal risk premium built into the one set of notes (close to 2X value), although it conceded that there may have been sufficient seed money to support the higher payments needed at the back end. The answer to the first question posed, then, was that there was a deemed gift to the extent that the value of the notes was less than the fair market value of the property transferred. This seems obvious enough and leads to the second issue -- how to value the notes. The taxpayer valued the notes using Section 7520, since the essence of a SCIN is that it has a mortality feature (payments will stop when the person dies - hence life expectancy is a factor). Here the Service disagreed with the use of the Section 7520 Tables: We do not believe that the § 7520 tables apply to value the notes in this situation. By its terms, § 7520 applies only to value an annuity, any interest for life or term of years, or any remainder. In the case at hand, the items that must be valued are the notes that decedent received in exchange for the stock that he sold to the grantor trusts. These notes should be valued based on a method that takes into account the willing-buyer willing-seller standard in § 25.2512-8. In this regard, the decedent’s life expectancy, taking into consideration decedent’s medical history on the date of the gift, should be taken into account. I.R.S. Gen. Couns. Mem. 39503 (May 7, 1986). If a SCIN cannot be valued under Section 7520, then the taxpayer who suffers from an illness or deteriorating physical condition would be unable to rely on Treas. Reg. §20.7520- 3(b)(3)(i), which presumes that a person who survives for 18 months was not terminally ill. The Regulations state that a person with a terminal illness or deteriorating physical condition is considered terminally ill if there is at least a 50% probability that the person will die within 1 year. This implies that if there is a greater than 50% probability that the person will survive for at least one year, the person is not terminally ill. The CCA would discard these standards, and the taxpayer would be left with a high degree of uncertainty in how to properly value notes where repayment is tied to mortality. Rather than using a standard set of tables, the appraiser would need to examine the medical history and possibly the family genetics of each individual taxpayer. Finally, on the third question, the Chief Counsel concluded that there was no estate tax consequence associated with the cancellation of the notes (i.e., the notes were part of the gross estate). After reciting the facts of Musgrove, the Chief Counsel concluded: There are similarities between the decedent in the subject case and the decedent in Estate of Musgrove. In each case, the decedent who received a promissory note with a self cancelling feature was in very poor health and died shortly after the note was issued. In addition, there is a legitimate question as to whether the note would be repaid in each case. COMMENT: A SCIN transaction works best when the person has significant health issues which will probably shorten life expectancy, but the health issues are not so great that the mortality tables under Section 7520 cannot be used. If the 7520 Tables simply can never be used in a SCIN transaction, the valuation issues become much more problematic. At the Miami Institute there was clearly a "chilling" effect to the CCA and Davidson, with commentators cautioning that until the issue of whether the 7520 Tables can be relied on in SCIN transactions, 58

one should proceed cautiously, perhaps looking to private annuity sales rather than SCIN transactions. Because Davidson settled without clear direction on the use of the tables in SCIN transactions, what results is a state of uncertainty as to whether the mortality tables and 7520 rates can be used for SCIN transactions. Note also that following the settlement, members of the decedent’s family sued the advisors for $500,000,000 in damages, claiming, among other charges, that they failed to design and implement bona fide economic transactions (as opposed to purely tax-driven strategies), they failed to use the decedent’s actual life expectancy, and they employed circular, illusory arrangements. According to the complaint, on the same day that Mr. Davidson sold assets to a trust for his children, with the risk premium being built into a high interest rate, he contributed the notes to a GRAT. The strategy was described in the complaint as “heads I win, tails I win.” N. Billhartz v. Commissioner, 794 F. 3d 794 (7th Cir. 2015). This case concerned the attempt by an estate to vacate a settlement the estate had reached with the Service with regard to an estate tax deficiency. The case arose from facts related to the decedent’s divorce from his first wife. The divorce decree obliged the decedent to leave 50% of his “estate” equally to his four children. When he died his estate plan did not so provide, but the estate reached a settlement with the four children that resulted in each of three daughters receiving $3.5 million and the son receiving $9.5 million, or a total of approximately $20 million, which comprised about 34% of the decedent’s estate. The estate deducted $14 million of the settlement; the Service challenged the deduction; and in the Tax Court litigation the estate and the Service agreed to a settlement whereby the estate would be allowed to deduct 52.5% of the amount it claimed on the return. Subsequently the children sued the estate to set aside their settlement, arguing that they were entitled to a greater share of their father’s estate. The estate in turn attempted to set aside the Tax Court settlement, so as to preserve the estate’s ability to claim a higher deduction for payments to the children if the state court litigation obligated higher payments. The Tax Court refused to set aside the settlement and the Seventh Circuit affirmed. The estate raised two arguments to support setting aside the settlement. The first argument was that there was a mutual mistake of fact in the settlement. The mutual mistake was, supposedly, that the estate would only be obligated to pay the children $14 million, when in fact the subsequent action in state court could result in a much greater payment. The Seventh Circuit did not find this to be a mistake at all – it was only the estate’s failure to foresee what might occur in the future. The estate’s second argument was that the Service became aware, during settlement negotiations, that one of the daughters was contemplating a lawsuit against the estate in order to recover a greater amount. The failure to convey this information to the estate was supposedly fraudulent concealment. However, the Court observed, the fact that someone “might” sue is a fact that is always present and in that sense known to all parties. There was no concealment. O. Holliday v. Commissioner, T.C. Memo 2016-51. In Holliday the Tax Court ruled, in a memorandum decision, that the assets of a family limited partnership were includible in the decedent’s estate under Section 2036(a) because of an implied agreement that the decedent had retained the enjoyment of the transferred assets. The partnership was initially created with assets from the decedent’s investment account. On creation of the partnership in November, 2006, the decedent held a 99.9% limited partnership interest, and owned all of the membership interest in the LLC general partner which owned the other .1% interest. On the same day that the partnership and LLC were funded, the decedent assigned her LLC interest to her two sons in exchange for $2,959.84, the net asset value of a 59

.1% interest in the partnership (no discount was claimed for the value of the GP interest). According to the Tax Court opinion, the sons’ purchase of the decedent’s GP interest “created the appearance that the decedent had no control over the assets she transferred to [the partnership].” On the same day the decedent transferred a 10% limited partnership interest to an irrevocable trust. The decedent was left with an 89.9% limited partnership interest, which she held until she died in January 2009. On the estate tax return the estate claimed a discount of about 33.55% for the value of the decedent’s 89.9% limited partnership interest. The partnership assets always consisted of cash and marketable securities. The decedent held substantial assets that she did not transfer to the partnership, but the opinion noted that the decedent “was not involved in deciding how her assets would be held.” She left this up to her two sons, and was not advised that the assets transferred to the partnership were selected because there was concern that someone might take advantage of her. There was only one distribution from the partnership during decedent’s lifetime. The partnership agreement contained a provision which stated that to the extent the General Partner determines that the partnership has sufficient funds in excess of its current operating needs to make distributions to the partners, “. . . periodic distributions of Distributable Cash shall be made to the Partners on a regular basis according to their respective Partnership Interests.” The Tax Court characterized this provision as “unconditionally” providing that the decedent was entitled to receive distributions from the partnership in certain circumstances, and noted that the testimony of one of the sons made it clear that had the decedent required a distribution, one would have been made. On the basis of the facts and circumstances of the case, the Tax Court found the existence of an implied agreement that the decedent had retained the right to the possession or enjoyment of, or the right to the income from, the property under Section 2036(a). Having found a retention under Section 2036, the Court then determined whether the decedent’s transfer to the partnership was a bona fide sale for full and adequate consideration. The Court found that the transfer flunked the bona fide sale requirement, as there was no legitimate and significant nontax reason for the transfer. The main problem that the estate had in supporting a bona fide sale was that the court believed the reasons the taxpayer articulated to meet the test were theoretical rather than real. There were three reasons given: 1. Protection From Trial Attorney Extortion. The decedent had never been sued, lived in a nursing home, and maintained significant assets outside of the partnership which would have been equally enticing for a tort claim. 2. Undue Influence From Caregivers. There was testimony about in laws and ancestors of the decedent having been exploited by caregivers; however, one of the sons testified that he never discussed the issue of possible undue influence with the decedent. Moreover, the Tax Court found the experiences of the relatives to be distinguishable from the situation of the decedent, whose two sons were both involved in managing her affairs. 3. Preservation of Assets. The decedent was not involved in selecting the structure to preserve her assets, and there were other vehicles, such as trusts, that could accomplish the same objective as preservation of assets. Therefor the Court found this reason to be unconvincing also. The Court cited a number of additional reasons for finding that the transfer was not a bona fide sale. The Tax Court noted that the decedent stood on both sides of the transaction, and there was no meaningful negotiation or bargaining associated with the formation of the partnership. The formation of the partnership was not an arm’s length transaction. Also, the

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partnership failed to maintain books and records other than brokerage statements and ledgers maintained by one of the sons, there were no formal meetings, and no minutes were kept. The Court also believed that by making only one distribution, and not providing for reasonable compensation to management as contemplated by the partnership agreement, the partnership agreement was being ignored.

O. Selected Rulings. PLR 201544005 allowed a reformation to cure a badly botched irrevocable trust. The grantors established an irrevocable trust for their children, naming themselves as trustees, retaining a power to amend the trust, providing for distributions to the children under a non- ascertainable standard, and providing that if both children died the grantors enjoyed a reversion. After the trust was established the grantors reformed the trust in state court based on scrivener’s error, which resulted in imposing ascertainable standards, removing the power to amend, eliminating the reversions and then resigning as trustees. They sought a ruling that their transfer was a completed gift. The Service permitted the reformation: In this case, Article 5 provides that Trust is irrevocable. However, Article 9 gives Grantors the power to amend Trust. These provisions are inconsistent and create an ambiguity. Under State law, a state court would allow extrinsic evidence to determine the Grantors' intent. In this case, it is represented that Grantors intent was to leverage the grantors' unified credit and transfer the maximum amount to their children. Retaining a reversionary interest or a distribution power not limited by an ascertainable standard was contrary to this intention. Further, the attorney who drafted Trust has sworn in an affidavit that Grantors intended the transfers to Trust to be completed gifts and that the trust provisions, prior to reformation, were scrivener's errors and were not in line with the Grantors' intent. In addition, Grantors filed Forms 709 reporting the transfers to Trust and treating the transfers as completed gifts. Grantors submitted declarations to Court of their intent to make completed gifts to Trust. Therefore, we conclude that State Court's orders on Date 2 and Date 4 reforming Trust based upon scrivener's errors are consistent with State law as applied by the highest court of State. The reformations of Trust are effective as of Date 1. PLR 201536009 considered whether a stock split, whereby shares of non-voting common would be issued for voting common, would cause an otherwise grandfathered stock purchase agreement to become subject to Section 2703. The Service ruled that it would not: Section 25.2703-1(c)(2) provides that a substantial modification does not include: (i) a modification required by the terms of a right or restriction; (ii) a discretionary modification of an agreement conferring a right or restriction if the modification does not change the right or restriction; (iii) a modification of a capitalization rate used with respect to a right or restriction if the rate is modified in a manner that bears a fixed relationship to a specified market interest rate; and (iv) a modification that results in an option price that more closely approximates fair market value. In this case, the stock split and amendment to the Articles will apply to all of the common shares (whether voting or nonvoting). Because each shareholder will receive c shares for every common share he or she currently holds, the

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beneficial interests in Company will not be affected by the stock split, amendment, and share dividend. Likewise, because the number of authorized voting shares will continue to be x, the shareholders' voting rights will remain unchanged. Consequently, the stock split, amendment to the Articles, and share dividend will not affect the quality, value or timing of any rights under the Articles, and the changes will not be a substantial modification of the Articles for purposes of § 25.2703-1(c). Accordingly, the Articles will remain exempt from the application of chapter 14. PLR 201503003 considered the effect of the statute of limitations having run on a gift tax return in which gift splitting was improperly elected. A taxpayer cannot split gifts to a spouse. A common situation is when the taxpayer establishes an irrevocable gift trust in which the spouse and the taxpayer’s descendants are discretionary income and principal beneficiaries. If the only annual gifts to the trust are Crummey rights of the spouse and descendants, the gift covered by the Crummey rights can be split as long as the rights are severable and ascertainable. In this ruling the taxpayer established an irrevocable gift trust under which his spouse and descendants were discretionary income and principal beneficiaries. The taxpayer transferred property to this trust, and also created two GRATs which provided that at the end on the annuity terms if the husband were living the GRAT property would pass to the irrevocable gift trust. The taxpayer filed a gift tax return, to which the taxpayer’s spouse consented for gift tax purposes as having transferred one half. The statute of limitations then ran with respect to the gift tax return. The Service ruled that because the statute had run, the taxpayer and spouse each would be treated as the transferor of one half of the property for gift tax purposes. In a later year the taxpayer created two more GRATs, again naming the irrevocable trust as the beneficiary at the end of the GRAT terms. The taxpayer and spouse reported these at split gifts, but unlike the earlier transfers, the statute had not run on the gift tax returns reporting these transfers. The Service ruled that the section 2513 consent was ineffective, and that the taxpayer was not precluded from filing a supplemental gift tax return to report the transfers as being made solely by him. The ruling also considered the GST issues involved. Section 26.2652-1(a)(4) provides that in the case of a transfer with respect to which the donor's spouse makes an election under § 2513 to treat the gift as made one-half by the spouse, the electing spouse is treated as the transferor of one-half of the entire value of the property transferred by the donor, regardless of the interest the electing spouse is actually deemed to have transferred under § 2513. The Service ruled in this case that after the statute of limitations had run, the electing spouse would be considered as the transferor under section 2652 as to one half of the property as to the transfers to the irrevocable trust, which was considered a GST Trust for purposes of Code section 2632(c). This was also the case with respect to the transfer of property from the first two GRATs to the irrevocable trust when the ETIP periods for both ended In this case the taxpayer and spouse had opted out of the automatic allocation rules for the initial transfer of property to the irrevocable trust, and then allocated exemption for less than the entire amount of the transfer. Further, the taxpayers had not made a timely allocation of GST exemption on a later filed gift tax return when the ETIP period for the first GRAT ended, but had allocated GST exemption for the second GRAT on a timely filed gift tax return when its ETIP ended. The Service ruled that the actual allocation for the initial transfer would be respected, that the automatic allocation rules applied to the transfer from the first GRAT at the end of its ETIP, and

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that the timely allocation by the spouses of GST exemption from the second GRAT to the irrevocable trust at the end of the GRAT’s ETIP would be respected. Field Attorney Advice 20152201F. This field attorney advice considered the issue of whether a gift tax return provided “adequate disclosure” to begin the running of the statute of limitations under Code section 6501(c)(9). The gift tax return in question reported gifts of partnership interests and included the following statement which was redacted for purposes of the advice: Partnership interests were given in (Taxpayer ID: ------) and in (Taxpayer ID: [ )]. The assets ------of the partnership were primarily farm land. The land was independently appraised by a certified appraiser. Discounts of % were taken for minority --- interests, lack of marketability, etc[.], to obtain a fair market value of the gift. The taxpayer ID was missing a digit and the attachments to the return included appraisals of the farm land but not an appraisal of the partnership interest. The Service found numerous shortcomings with the information attached to the return, which anyone filing a return and wishing to start the statute running should take note of: As filed, Donor’s Form 709 satisfies at least paragraph (ii) of the adequate disclosure standard.2 The return clearly identifies the donee by name and address, in addition to providing her relationship to Donor. Treas. Reg. § 301.6501(c)-1(f)(2)(ii). The return probably satisfies paragraph (v) and the “consideration” part of paragraph (i), as well. The return does not specify any consideration received by Donor or any positions taken contrary to regulation or revenue rulings. Treas. Reg. § 301.6501(c)-1(f)(2)(i), (v). At this time, we cannot identify any consideration received by Donor or any positions contrary to regulations. Paragraph (i) requires a sufficient “description of the transferred property.” Treas. Reg. § 301.6501(c)-1(f)(2)(i). Here, the descriptions are incomplete. The return accurately identifies the percentages of the interests that Donor transferred. The return and statement provide the nine-digit EIN for ______, but both include only eight digits for ------EIN. Moreover, the return uses incorrect, abbreviated names for both and . ------. It refers to “” and “” without explaining ------that the “ ” is an abbreviation for “ ”. Those labels also omit the “LP” and ------“LLP” designations, wrongly implying that and are traditional partnerships under ------state law. Likewise, the return describes the transferred property as “[p]artnership interests” without explaining whether the donor transferred general, limited, or limited liability interests. The complete EIN for permits the Service to determine the full name of that ---- partnership, but the partial EIN for does not. Once the partnership is identified ------by querying its EIN, it is possible to extrapolate that the partnership may also have ---- been abbreviated and from there to discover that the EIN provided matches that unabbreviated partnership’s EIN once the missing “ ” is inserted after the dash.3 --Donor’s gift tax return and the statement attached to that return may have ------described the partnership, but he failed to adequately describe the partnership. ------. The Code requires a disclosure adequate to apprise the Secretary of the nature of the gift, I.R.C. § 6501(c)(9), but the abbreviated name and botched EIN failed to do so for the partnership interests. ----

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Paragraph (iv) requires a “detailed description of the method used to determine the fair market value of property transferred,” including any “financial data” used to determine the value of that interest. Treas. Reg. § 301.6501(c)-1(f)(2)(iv). Where the gift consists of an interest in an entity that is not actively traded, the description must include “any discount claimed in valuing the interests in the entity or any assets owned by such entity.” Id. Additionally, if the value of the entity is properly determined based on the net value of its assets, the return must include a statement regarding the value of 100 percent of the entity. Id. The description in the return of the method used to determine the fair market value of Donor’s gifts appears in the “Valuation of gifts” statement, which states:

Partnership interests were given in (Taxpayer ID: ------) and in (Taxpayer ID: [ )]. The ------assets of the partnership were primarily farm land. The land was independently appraised by a certified appraiser. Discounts of % were taken for minority --- interests, lack of marketability, etc[.], to obtain a fair market value of the gift.

This valuation description does not include “a detailed description of the method used to determine the fair market value of the property transferred, including any financial data … utilized in determining the value of the interests.” § 301.6501- 1(f)(2)(iv). This description recites that Donor had the land appraised, not that he had the partnership or the donated partnership interest appraised. The description does not identify “any restrictions on the transferred property that were considered in determining the fair market value”. Id.

This description further suggests (by asserting that the assets are primarily farm land and that the land was appraised) that and are properly valued based upon ------the net value of their assets. Id. If that is the case, the return’s valuation description is not “detailed” as required by the regulation. There is no financial data (e.g., actual land values) used in determining the value of the gifts. Id. There is no explanation of the method (e.g., comparable sales) used to determine the value nor any explanation of either how the % discount breaks down between different discount types or the basis ---for the discounts taken. The “etc” in the return’s description suggests that unlisted discounts were applied to the gifts. Id. There is also no statement regarding the 100 percent value of either or, even though both entities appear to be valued based ------upon their net assets.

Donor’s return arguably identifies the partnership (because the complete EIN ---- will lead to the unabbreviated partnership name), but it does not adequately identify the partnership, and it fails to describe adequately the method used to determine the ---- interests’ fair market values. Thus, the statute of limitations exception in I.R.C. § 6501(c)(9) applies to assessing gift tax based upon the Form 709. The Service ------may assess such tax at any time.

2 Paragraph (iii) applies to transfers in trust and is inapplicable here. Treas. Reg. § 301.6501(c)-1(f)(2)(iii). 3 Excluding any check digits in an EIN, the missing digit could be any integer between 0 and 9 and in any of the seven positions after the dash. That results in seventy possible EINs that the partial EIN could match. It is not reasonable to expect 64

the Service to look up seventy EINs to find the one that matches the partnership, particularly because even when the correct EIN is identified, it matches the ---- unabbreviated partnership, rather than the partnership actually described by Donor.

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EXHIBIT A

Text of New Subsection 2014(f) and New Section 6035.

New Subsection 2014(f): (f) Basis must be consistent with estate tax return. For purposes of this section— (1) In general. The basis of any property to which subsection (a) applies shall not exceed— (A) in the case of property the final value of which has been determined for purposes of the tax imposed by chapter 11 on the estate of such decedent, such value, and (B) in the case of property not described in subparagraph (A) and with respect to which a statement has been furnished under section 6035(a) identifying the value of such property, such value. (2) Exception. Paragraph (1) shall only apply to any property whose inclusion in the decedent’s estate increased the liability for the tax imposed by chapter 11 (reduced by credits allowable against such tax) on such estate. (3) Determination. For purposes of paragraph (1), the basis of property has been determined for purposes of the tax imposed by chapter 11 if— (A) the value of such property is shown on a return under section 6018 and such value is not contested by the Secretary before the expiration of the time for assessing a tax under chapter 11, (B) in a case not described in subparagraph (A), the value is specified by the Secretary and such value is not timely contested by the executor of the estate, or (C) the value is determined by a court or pursuant to a settlement agreement with the Secretary. (4) Regulations. The Secretary may by regulations provide exceptions to the application of this subsection.

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New Section 6035:

6035. Basis information to persons acquiring property from decedent.

(a) Information with respect to property acquired from decedents

(1) In general - The executor of any estate required to file a return under section 6018(a) shall furnish to the Secretary and to each person acquiring any interest in property included in the decedent's gross estate for Federal estate tax purposes a statement identifying the value of each interest in such property as reported on such return and such other information with respect to such interest as the Secretary may prescribe. 66

(2) Statements by beneficiaries - Each person required to file a return under section 6018(b) shall furnish to the Secretary and to each other person who holds a legal or beneficial interest in the property to which such return relates a statement identifying the information described in paragraph (1).

(3) Time for furnishing statement

(A) In general - Each statement required to be furnished under paragraph (1) or (2) shall be furnished at such time as the Secretary may prescribe, but in no case at a time later than the earlier of-

(i) the date which is 30 days after the date on which the return under section 6018 was required to be filed (including extensions, if any), or

(ii) the date which is 30 days after the date such return is filed.

(B) Adjustments – In any case in which there is an adjustment to the information required to be included on a statement filed under paragraph (1) or (2) after such statement has been filed, a supplemental statement under such paragraph shall be filed not later than the date which is 30 days after such adjustment is made.

(b) Regulations - The Secretary shall prescribe such regulations as necessary to carry out this section, including regulations relating to-

(1) the application of this section to property with regard to which no estate tax return is required to be filed, and

(2) situations in which the surviving joint tenant or other recipient may have better information than the executor regarding the basis or fair market value of the property.

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