Submitted by: Richard Julien
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Bright addressed aggregation at the death of the first spouse (“DS”) in the game of family attribution. Bonner addresses aggregation at the death of the Surviving Spouse (“SS”).
Estate of Bonner v US (5th Cir. June 4 1996, No 95-20895) 84 F. 3d 196 (per Curiam) rejected IRS hot issue assertion that fractionalized interest holdings in the QTIP created by the deceased spouse (“DS”) should be aggregated with the holdings in the taxable estate of the surviving spouse (“SS”) to determine the valuation under 2031 of SS’s interest and the QTIP under 2044 and, in particular, 2044(c). See TAM 9608001, 9550002, 9140002 (and Rev Rul. 79-7 cited by the IRS ); but cf TAM 9403002 (which dealt with 2038 not 2044).
The QTIP established by DS (Mrs. Bonner, who died 12/07/86) held 37.5% fee simple undivided interest in a Texas ranch, 50% in New Mexico property and 50% in a 56 ft. pleasure boat. SS (Mr. Bonner, who died 01/11/89) owned the balance.
45% Discounts were claimed by SS’s estate but the district court granted summary judgement to the IRS. The government contended, in the district court found, that “... the interest held by the QTIP trust and the interest held by [SS] merged ...pursuant to the plain language of 2044, extinguishing the fractional undivided interest and resulting in 100% fee ownership of the assets by [SS’s] estate”. At page 198.
The 5th Circuit reversed, holding :
“The question before us is controlled by the holding in Bright [Our old friend The Estate of Bright, the US, 658 F. 2d 999 (5th Cir 1981) (en banc)] Although 2044 contemplates that the QTIP property will be treated as having passed from [SS] for estate tax purposes, the statute does not require, nor logically contemplate that in so passing, the QTIP assets would merge with other assets. The assets in the QTIP trust could have been left to any recipient of [DS’s] choosing, and neither [SS] nor the estate had any control over their ultimate disposition. We are precluded from considering evidence submitted by the government regarding who actually received the assets. An estate tax is an excise tax on the transfer of property at death and accordingly the valuation is made as of the moment of death and must be measured by the interest that passes, as contrasted with the interest held by the decedent or the interest held by the legates after death. Bright, 658 F.2nd at 1006” (at page 198) .
... [P]ublic policy mitigates in favor of the estate's position .... The estate of each decedent should be required to pay the taxes on those assets whose disposition that decedent directs and controls, in spite of the labyrinth of federal tax fictions. In this case, [DS] controlled the disposition of her assets, first into a trust with a life interest for [SS] and later to the object of her largesse. The assets, although taxed as if they passed through [SS’s] estate, in fact were controlled at every step by [DS], which a tax valuation with a fractional interest discount would reflect. At the time of [DS’s] death, his estate did not have control over [DS’s] interests in the assets such that it could act as a hypothetical seller negotiating with a willing buyer free of the handicapsassociated with fractional undivided interests. The valuation of the assets should reflect that reality.” (at page 199.)
The case was remanded to the district court to address the valuation issue.
The IRS is not going to roll over and play dead, (“If all you have is a hammer, everything looks like a nail”).
The law professors consider this case and its set of issues to be most significant. Even Professor Pennell thinks the IRS is wrong.
Absent legislation, there will not be a final resolution of this issue for several years and we must live with uncertainty. Planning may solve some of the problems. Read the handwriting on the wall - plan.
Planning Considerations.
I. What steps should be taken at the death of the first spouse to minimize the impact of possible IRS future success?
II. Does aggregation matter if neither the QTIP nor the surviving spouse was a general partner? For example, it appears that the fractionalized interest discount still applies if a single 99% limited partner has no right to cause liquidation and can only make a transferee an "assignee". The major difficulty should be if the QTIP or the surviving spouse (rather than the ByPass trust or another person or entity) were the general partner.
III.How does one resolve the administrative nightmare in the surviving spouse's estate?
Thoughts.
Question I.
There is no indication of who was the trustee of Mrs. Bonner’s QTIP. It would seem that with the “death” of Rev. Rul. 79-353 and with Byrum, the fiduciary duties of trustee would make who was the trustee immaterial. (If the QTIP trust was defective because of too much trustee power, it would be included in the SS’s estate because of 2036 and 2038, not 2044).
Did SS have a power of “disappointment” over the QTIP? The court does not indicate one way or the other, but inference could be drawn from the discussion at page 199 that SS did not have such a power. The court did indicate that destination of the assets could not be considered. “We are precluded from considering evidence submitted by the government regarding who actually received the assets.” Bonner at page 198.
Given the advisability of powers of appointment in most estate plans, this factor must be considered. The focus should be on the fractional interest, not on who gets the residue of theQTIP. The SS’s “...estate did not have control over [DS’s] interest in the assets such that it could act as a hypothetical seller negotiating with a willing buyer free of the handicaps associated with fractional undivided interest.” Bonner at page 199.
2044 (c) says “passing from”. If the QTIP owned a fraction interest in another property, valuation adjustment would be appropriate. 2044 (c) was added in the 1982 Technical Corrections Act to make clear 1014 (b) (9) applied to adjust basis at SS’s death.
Make a 2519 “death bed” disposition by the SS governed by 2044 (b) (2). 2035 is not applicable. The loss of the 1014 basis adjustment often will be worth the price of the valuation adjustment.
Allocate fractional interest to the bypass trust. Be careful that this does not lower the value of the asset allocated to the marital deduction to the point that the marital deduction gift cannot be fully funded.
Sell or exchange assets by either the SS or the QTIP.
Lifetime gift by SS of SS’s own assets.
Question II.
Who cares if the QTIP and SS interest are “assignee” interests in a FLP or FLLC? Bonner was of an undivided interest (e.g. tenancy-in-common). Great reason for post-death (of DS) formed FLPs and FLLCs.
Question III.
The IRS attack appears to raise an interesting question under IRC 2207A and its provisions that property which had been the subject of the QTIP marital deduction in the deceased spouse's estate is not only added (2044) to the surviving spouse's taxable estate (and bears the incremental increase) but also that the surviving spouse's estate is entitled to recover"from the person receiving the property" that additional tax. If there is likelihood of dispute (e.g. the QTIP residue goes to children of DS by a previous marriage) addressing the issue in the instrument appears advisable.
What would happen under 2207A and the IRS approach in the following scenario (4 blocks of assets):
Block 1. QTIP with $4,000,000 limited partnership interest in a FLP. To further complicate the question, alternatively, the FLP could be involved in a "trade or business" otherwise qualifying for Section 6166 deferral or a securities partnership possibly only entitled to Section 6161 treatment. Assume the son (who is also the QTIP trustee and the surviving spouse's executor) is the general partner of the FLP, but the QTIP has no right to liquidate.
Block 2. QTIP also owns a $1,000,000 residence. Assume the residence is in Hawaii where such property would take over a year to sell and appraisals are SWAGs (“Scientific Wild Assed Guesses”).
Block 3. Surviving spouse's estate has a similar $1,000,000 real estate holding.
Block 4. Surviving spouse's estate also owns, as its remaining asset, a $4,000,000 limited partnership interest in another FLP.
Questions:
A.Are 6161 and 6166 privileges only available to the estate of the surviving spouse or should each of the four asset blocks proportionately have such deferral available through the estate os the SS (which is the primary obligor)?
B.What interest deduction for FET purposes is available on the extension of payment and how is it allocated among the asset blocks?
C.What if the QTIP merely owns stocks and bonds outright (without FLP)? Must the QTIP come up with all the taxes without 6161, or does it merely come up with its 40% share of the taxes (ignoring for simplicity the tax bracket creep)?
D.Would the answer be different if it's a $2,000,000 residence owned 50/50, or if it's the same FLP in which the QTIP and the survivor's estate own limited partnership interests?
Given that 6161 and 6166 are hardship provisions, shouldn't each of the four holdings
above be entitled to borrow their proportionate shares of the estate tax from the IRS? Obviously, there is the distinct benefit of the deductibility of the interest for FET purposes.
Given the 2053 distinction between "property subject to claims", is 2207A such a claim?
It would appear that the QTIP and the estate should be treated as a common pot. But
then, when it comes to revenue loss, the IRS mentally quotes Emerson's "foolish consistency is the hobgoblin of little minds". Aggregation only works when it enhances the fisc.
Scary Thoughts
A.What if the QTIP was a GRAT, QPRT, or NIMCRUT? My mind short circuits.
B.Will Bonner be the straw that breaks the camel’s back, getting Congress to help the hapless IRS?