IRS Proposes Gift Tax Valuation Guideline Revision

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The Internal Revenue Service recently proposed new regulations aimed at clarifying the special valuation rules of the gift tax to establish what constitutes a qualified interest in a trust set up under the gift tax system in cases where the donor retains some rights under the trust.

Under the proposed regulations, the right of the individual giving the gift in trust to receive an annuity payment from that trust for a set period of time would continue to be considered a “qualified interest” for tax purposes, meaning that the amount of their payments must be deducted from the overall tax value of the gift. However, if the giver should die before receiving all of the payments promised them, their estates right to those remaining payments would now also constitute a qualified interest.

The proposed rules also would clarify that the exception to the tax rules for a spouses revocable successor interest to be treated as a qualified interest only applies if that interest, without the spouses revocation power, would still be considered a qualified interest.

Special rules for determining the value of gifts in trust when the donor retains an interest in the trust were established under Section 2702 of the Internal Revenue Code. According to those rules, if the retained interest is not a qualified interest, then the tax value of the gift is zero, but 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 impetus for the new rules, according to the discussion of the rules, were the decisions in two tax court cases, Walton v. Commissioner and Schott v. Commissioner.

In the Walton case, the tax court declared that Example 5 in the relevant section of the tax code, section 25.2702-3(e), was invalid. Under Example 5, a grantor transfers property to an irrevocable trust while retaining the right to receive a unitrust amount for 10 years, with the grantors estate receiving the amount if the grantor dies during that term. In this example, the Tax Code established that the grantors interest is a qualified interest to the extent of their right to the payment for 10 years or until their death, but that the amount payable to their estate should they 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,” said Juli Ro Kim of the Office of the Associate Chief Counsel and author of the regulations, in the discussion. “The court concluded that a retained annuity payable for a specified term of years to the grantor, or to the grantors 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 of 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,” said Kim, “a unitrust amount payable for a specified term of years to the grantor, or to the grantors 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, and 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 also contains an exception for spousal interests.

“The proposed regulations clarify that the revocable spousal interest exception applies only if the spouses interest, standing alone, would constitute a qualified interest,” meeting the requirements of the relevant tax provision, but for the grantors revocation power, Kim said.

The IRS will be holding a public hearing on the proposed regulation scheduled for Oct. 28, 2004.

The proposed regulation is on the Web at: http://www.regulations.gov/freddocs/04-6593.htm .


Reproduced from National Underwriter Edition, July 29, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.