In an ever eagerly anticipated annual tradition, Ronald Aucutt, a McGuireWoods partner and co-chair of the firm’s private wealth services group, has identified the following as the top ten estate planning and estate tax developments of 2015. Ron is a past president of The American College of Trust and Estate Counsel, an observer and frequent participant in the formation of tax policy and regulatory and interpretive guidance in Washington, D.C., and the editor of the Recent Developments materials that are presented each year at the Heckerling Institute on Estate Planning.
Number Ten: The Meaning of “Of,” Another “Investor Control” Case: Webber v. Commissioner, 144 T.C. No. 17 (June 30, 2015)
In this case, Jeffrey T. Webber, venture capital investor and private equity fund manager, created a grantor trust that bought “Flexible Premium Restricted Lifetime Benefit Variable Life Insurance Policies” on the lives of his aunt and step-grandmother-in-law. The trust was held for the benefit of Webber and his descendants, with a corporate trustee with “uncontrolled discretion” to distribute trust assets to the beneficiaries, and with Webber’s attorney (in the U.S.) as trust protector.
The policies stated that Webber had no power to direct investments. But the investment manager always followed Webber’s investment directions. Nearly all of the investments were non-publicly traded securities, and Webber admitted that the investment manager could not have had access to these investments except through him. In many cases, Webber negotiated a deal directly with a third party, then “recommended” that the investment manager implement the deal that he had already negotiated. “In reality,” as the Tax Court (Judge Lauber) bluntly put it, “the Investment Manager selected no investments but acted merely as a rubber stamp for petitioner’s ‘recommendations,’ which we find to have been equivalent to directives.” Webber was taxed on the income from the policies’ investments, under the “investor control” doctrine.
In the most basic of income tax analysis, the court pointed out that section 1 of the Internal Revenue Code imposes a tax on the taxable income “of” every individual and quoted the Supreme Court’s elaboration that “[t]he use of the word ‘of’ denotes ownership.” Poe v. Seaborn, 282 U.S. 101, 109 (1930). As to “ownership,” again quoting the Supreme Court, “taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed – the actual benefit for which the tax is paid.” Corliss v. Bowers, 281 U.S. 376, 378 (1930). The “investor control doctrine” is derived from Revenue Rulings 77-85 (1977-1 C.B. 12), 80-274 (1980-2 C.B. 27), 81-225 (1981-2 C.B. 12), 82-54 (1982-1 C.B. 11), and 2003-91 (2003-2 C.B. 347). Making an important jurisprudential point that might apply in other contexts, the court noted that it was not bound by these revenue rulings, but that under Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944), they may be given weight on the basis of “their persuasiveness and … consistency” over 38 years.
The outcome in Webber, based on de facto control despite the governing trust documents, is reminiscent of SEC v. Wyly, Number Nine in the 2014 Top Ten.
As wealth becomes more concentrated – or at least as increases in the federal estate tax exemption focus estate planning more on the very wealthy – the hazard of talented and strong-willed individuals’ seeking to maintain control even after making gifts may be encountered more frequently.
Number Nine: Developments with Crummey Powers: Mikel v. Commissioner, T.C. Memo 2015-64 (April 6, 2015); Administration’s Budget Proposals (Feb. 2, 2015)
In Chief Counsel Memorandum 201208026 (dated Sept. 28, 2011, and made public Feb. 24, 2012), the IRS Chief Counsel’s office stated that the gift tax annual exclusion would not be available for contributions to “Crummey trusts” by reason of the beneficiaries’ right to withdraw contributed amounts, because the trust document provided that questions and disputes concerning the trust had to be submitted to an “Other Forum,” widely assumed to be some form of arbitration, and because a beneficiary who filed or participated in a civil proceeding to enforce the trust would be excluded from any further participation in the trust (a “no contest” or “in terrorem” clause). Under those circumstances, the Chief Counsel’s office viewed the withdrawal rights as “unenforceable and illusory.” It turns out that this memorandum apparently was issued with respect to the facts of the Mikel case, which rejected the position taken by the memorandum.
The Mikel opinion reveals that in 2007 a husband and wife jointly gave property they claimed to have a value of $3,262,000 to a trust in which 60 beneficiaries had “Crummey” withdrawal rights. If those transfers thereby qualified for 120 $12,000 gift tax annual exclusions, the taxable gifts would have been reduced to $911,000 for each spouse, less than the $1 million gift tax exemption. The trust agreement provided that any dispute regarding the interpretation of the agreement “shall be submitted to arbitration before a panel consisting of three persons of the Orthodox Jewish faith.” Such a panel in Hebrew is sometimes called a “beth din” (pronounced “bet deen”).
The Tax Court (Judge Lauber) held that the transfers created present interests that qualified for the annual gift tax exclusion. The court stated that “it is not obvious why the beneficiary must be able to ‘go before a state court to enforce that right.’ … 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.” Moreover, the court held that the specific in terrorem provision in this case would not apply to a beneficiary’s withdrawal right because it applied only to actions to oppose or challenge discretionary trust distributions.
There may be at least three more developments relating to the issues in Mikel. In the first development, Judge Lauber denied the taxpayers’ request for payment of attorney’s fees under section 7430, finding that the position of the IRS, although unsuccessful, was substantially justified, in that it had a reasonable basis in fact and law and was justified to a degree that could satisfy a reasonable person. Mikel v. Commissioner, T.C. Memo 2015-173 (Sept. 8, 2015).
In the second development, apparently still to come, it must be determined, either by a decision of the court or by a settlement between the Mikels and the IRS, whether the withdrawal rights of all 60 beneficiaries justify annual exclusions and whether the $3,262,000 value of the contributions to the trust is accurate.
And as a third possible development, although it wouldn’t affect the Mikels’ 2007 gifts, the Obama administration’s budget-related revenue proposals would significantly limit the effectiveness of Crummey withdrawal powers. The “General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals” (March 4, 2014), at pages 170-71, and the “General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals” (Feb. 2, 2015), at pages 204-05, include a proposal to “Simplify Gift Tax Treatment for Annual Gifts.” The General Explanations (popularly called the “Greenbooks”) note the compliance costs of Crummey powers, including the costs of giving notices, keeping records, and making retroactive changes to the donor’s gift tax profile if an annual exclusion is disallowed, as well as the enforcement costs to the IRS. They also lament the IRS’s lack of success in combating the proliferation of Crummey powers, especially in the hands of persons not likely to ever receive a distribution from the trust, in Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991), and Kohlsaat v. Commissioner, T.C. Memo 1997-212. If its 60 Crummey powers are ultimately upheld, Mikel is likely to be added to this list.
Although the proposal states that it “would eliminate the present interest requirement for gifts that qualify for the gift tax annual exclusion,” what it actually proposes is to limit the annual exclusion (currently $14,000 per donee) to outright gifts, gifts to “tax-vested” trusts exempt from GST tax under section 2642(c)(2), and “a new category of transfers” that some interpreted in 2014 to be allowed, up to $50,000 per donor per year, without tapping into the donor’s $14,000-per-donee annual exclusions. That interpretation was repudiated by a new sentence in the 2015 Greenbook: “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, the compliance burdens of identifying donees would not be eliminated after all, and drafting to take advantage of the $50,000 (indexed) category could be more complex, not less. (The 2015 Greenbook also added that the proposed limit of $50,000 would be indexed for inflation.)
Although there is little reason to expect this Greenbook proposal to be enacted, the proposal, along with the Mikel decision, does illustrate the frustration of Treasury and the IRS with at least some uses of Crummey powers.
Number Eight: Continued Erosion of the Power of States to Tax Trust Income:Kimberly Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue, 12 CVS 8740 (N.C. Sup’r Ct. April 23, 2015), and Residuary Trust A u/w/o Kassner v. Director, Division of Taxation, 2015 N.J. Tax LEXIS 11, 2015 WL 2458024 (N.J. Sup’r Ct. App. Div. May 28, 2015), aff’g 27 N.J. Tax 68 (N.J. Tax Ct. Jan. 3, 2013)
In Kaestner, discussed in more detail in our Legal Alert of May 1, 2015, the Superior Court of Wake County, North Carolina, held North Carolina’s income tax on the taxable income of a trust for the benefit of a North Carolina resident unconstitutional as applied to a...
