In Lewis v. Commissioner, the U.S. Tax Court had to determine the value of the deemed gift made by two siblings to their father. The court had previously held that the siblings, who were remainder beneficiaries of a qualified terminable interest property marital trust created under their mother’s will, of which their father Bruce was the current beneficiary, made a gift to their father by agreeing to an early termination of the trust in his favor, allowing him to receive all the assets.
The marital trust was a valid QTIP trust under Internal Revenue Code Section 2056(b)(7), requiring annual distributions of all income to Bruce and permitting principal distributions in the trustee’s discretion to Bruce for his health, maintenance and support in his accustomed manner of living. Bruce held a testamentary limited power of appointment, enabling him to appoint a principal among the children and further descendants at his death. Subject to the exercise of that power, the trust was to be divided into equal shares among the children who were living or deceased with surviving descendants. Importantly, an additional provision of the will required that on termination of the trust, the trustee was to distribute the trust assets among the beneficiaries not necessarily pro rata “so long as the distributees receive assets of a value equal to the value of their respective interest in the trust at the time of distribution.”
In October 2016, the children and Bruce entered into a nonjudicial agreement to terminate the trust in favor of the father. The assets had a value of $117,604,143 on the date of termination. The court reaffirmed that “the value of the gifts Linda and Peter made to Bruce equaled the value of the distribution to which they would have been entitled … upon the termination of the … Trust” if the trust had terminated according to its terms on that date, rather than pursuant to the settlement agreement.
Testamentary POA
In determining the value of the children’s gift, the court disagreed with the children’s argument that Bruce’s testamentary limited POA must be taken into account in valuing the gift because it could have affected what they would have eventually been entitled to at Bruce’s death (or deprived either of them entirely of any remainder interest). Instead, the court emphasized that if the settlement agreement hadn’t stipulated that all assets were to go to Bruce, the will would have required each distributee to receive their respective beneficial interests’ present value on the date of termination of the trust. The court reasoned that a Washington state court would have agreed with this result because it would hold the testator’s intent paramount, which in this case was to leave the children with a remainder interest of substantial value, and that intent was reflected by the provision of the will stipulating distribution of amounts equivalent to beneficial interests on termination of the trust, along with the fact that the testator had left the assets to a marital trust (rather than outright to Bruce).
IRC Section 2207A
Under IRC Section 2519, if the children had received amounts commensurate with their beneficial interests on termination of the trust, a “disposition” of Bruce’s income interest within the meaning of Section 2519 would have occurred, resulting in Bruce being treated as having transferred all of the trust property less his income interest for gift tax purposes. In this event, Bruce would have owed gift tax and, under Section 2207A, would have been entitled to recover the portion of the gift tax resulting from the deemed transfer from the children. Because of that right of recovery, the children would have received less than the “gross” amount of their beneficial interest. The court held that this lesser amount (net of gift tax recoverable) is what the children gave up in the nonjudicial settlement agreement.
IRC Section 7520 Tables and Bruce’s Life Expectancy
The court held that the Section 7520 tables don’t apply to determine the value of the children’s gifts because the question of valuation rests on the value of what the children would have received from the trust at termination (their remainder beneficial interest present value) based on the trust terms (that is, had they not separately agreed that Bruce receive all of the assets). In making this determination, the trustee would have looked to Washington state trust law for guidance as to the appropriate value, which doesn’t necessarily rest on the Section 7520 tables.
The court further held that Bruce’s actual age must be used in estimating his life expectancy for purposes of determining the remainder interest values, disagreeing with the children’s valuation expert, who asserted that Bruce should be treated as five years younger than his actual age because of his higher income. The court noted that the valuation expert wasn’t an actuary and that his methodology didn’t use all information regarding Bruce’s actual health; instead, it prejudicially focused on some but not all factors affecting Bruce’s life expectancy.