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IRS Proposes Gift Tax Valuation Guideline Revision

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The Internal Revenue Service has proposed regulations that could change the way the IRS interprets gift tax special valuation rules.[@@]

The IRS is proposing the regulations as a result of one tax court ruling involving Audrey Walton, the widow of Wal-Mart founder Sam Walton, and a second tax court ruling involving relatives of Marge Schott, the late owner of the Cincinnati Reds.

One change would provide that a unitrust amount or annuity payable for a specified number of years to the grantor is a qualified interest for the term, according to a discussion of the proposed rule that appears today in the Federal Register.

The change also would provide that the amount would count as a qualified interest for the term if the grantor died before the expiration of the term and the amount were paid to the grantor’s estate.

Another section of the proposed regulations would make it clear that the exception for a spouse’s revocable successor interest to be treated as a retained qualified interest applies only if that interest, by itself, constitutes a qualified interest, but for the grantor’s revocation power.

Section 2702 of the Internal Revenue Code provides special rules for determining the value of gifts in trust when the donor retains an interest in the trust. According to those rules, if the retained interest is not a qualified interest, then the value is 0. If the interest is qualified, then the value of the gift is the value of the assets given minus an actuarially determined value of the interest.

The IRS is proposing the new rules because of issues raised in the Walton and Schott tax court cases.

In the Walton case, the tax court declared that Example 5 in Section 2702-3(e) of the Internal Revenue Code was invalid. In Example 5, a grantor transfers property to an irrevocable trust while retaining the right to receive a unitrust amount for 10 years, with the grantor’s estate receiving the amount if the grantor dies during that term. In Example 5, the grantor’s interest is a qualified interest to the extent of the grantor’s right to the payment for 10 years or until the grantor’s death, but the amount payable to the grantor’s estate should the grantor die during that term is not a qualified interest.

“After considering the legislative history and purpose of Section 2702, the court held that Example 5 is an unreasonable interpretation and invalid extension of Section 2702,” Juli Ro Kim, an IRS official, writes in the discussion of the proposed rules. “The court concluded that a retained annuity payable for a specified term of years to the grantor, or to the grantor’s estate if the grantor dies prior to the expiration of the term, is a qualified interest under Section 2702 for the specified term of years.”

In a notice released in October 2003, the IRS said it would conform to the Walton decision and revise Example 5, as well as Example 6 in the same section.

“Under the examples as revised,” Kim writes, “a unitrust amount payable for a specified term of years to the grantor, or to the grantor’s estate if the grantor dies prior to the expiration of the term, is a qualified interest for the specified term.”

The Schott case raised the issue of a revocable spousal interest. The court also looked at questions about when such interests are considered qualified interests. Provisions in Section 2702 state that the valuation rules for a gift do not apply if that gift is incomplete, but Section 2702 also contains an exception for spousal interests.

“The proposed regulations clarify that the revocable spousal interest exception applies only if the spouse’s interest, standing alone, would constitute a qualified interest [meeting the requirements of the relevant tax provision] but for the grantor’s revocation power,” Kim writes.

The IRS has scheduled a public hearing on the proposed regulation for Oct. 28.

A copy of the proposed regulation is on the Web at