ESTATE PLANNING PROBLEMS
TERRY ONEAL
1.
Assume the Louise D. Rhodes Family Trust was crea.ted in
1970.
Also assume that Louise Rhodes retained a reversionary
interest in the principal.
(This provision is in lieu of
Article Second of the Trust.)
In 1971 Louise transferred
m<'lrketll.ble securities worth $200',000 to the trust.
the trustee sold the securities for $250,000.
In 1973
In 1974 Louise
transferred a.nother $200,000 worth of securities to the trust.
The principal was to revert to Louise in 1982.
What are the
income, estate, and gift tax consequences of these tra.nsactions?
Ans.
Gift Tax
Louise would have to pa.y gi1't tax on the completed
gift of the income interest, but not on the incomplete
gift of the rema.inder. (25.2511-2(b) ).
The $200,000
transferred in 1971 has a.n income interest for 11 years.
This interest is actuarially determined under 25.2512-9,
Table B.
The value would be ;.47321 x $200,000
= $94,642.
The trAnsfer in 1974 of another $200,000 has an ~ income
.
interest for 8 yea.rs which makes a completed gift of
.37259 x $200,000 = $74,518.
Estate Ta.x
Under 2038
Il.
decedent·s gross estate must include the
value of all property to the extent of any interest therein
of which the decedent has ' made a trans.fer subject to a power
affecting the .c, snjoyment thereof.
A power falls within
2038(a) if it is a power to alter, amend, or revoke the
trust.
Only the value o.f the interest subject to the
power to which 2038 a.pplies is included in the gross estate
( 20. 2038-1(a) . ).
Thus, only the remainder interest in the
securities postponed for a term certain must be included.
Under 20.2031-10, Table B the 1971 transfer has a remainder
interest valued at .52679 x $200,000 = $105,358.
The 1974
transfer ha.s a remainder interest valued at .62741 x$200 ,000
= $125,482.
Income Tax
Under 673(a) the grantor is treated as the owner and
thus ta.xable on the income under 671 of any portion of a
trust in which he has a reversionary interest that takes
effect before the expiration of a ten year period.
Since
the 1971 transfer will not revert to Louise for 11 years,
she will not be taxed on that portion of the trus t .
1974 transfer, however, reverts in 8 years.
The
Therefore, she
must be trea ted as the owner of that portion of the trust
and will be taxed on the income from the $200,000 of securities.
In addition Louise must be taxed on the capital gains
derived from the sale of the securities in 1973.
1.671-3(b) ).
(677(8)(2) &
Since the corpus does not constitute 8 com-
pleted gift the basis in the securities is not the fair
market value of the securities at the time of the transfer,
but it remains the cost basis which Louise
or~ginally
had.
2.
Louise Rhodes transfers securities worth $400,000 to an
irrevocable trust naming
hers~lf
as trustee.
The income
may be accumulated or distributed to her children, Robert and
Mary, during Louise's lifetime at the trustee's di scretion.
Louise retains the power to appoint by will the rema.lnder
of the trust to a.ny of her grandchildren.
estate, gift, or income will she incur?
What tax consequences,
Would there by any
difference if Robert were named as a co-trustee with Louise?
.&1!!. •
Gift Tax
Under 25.2511-2 there is no completed gift until the
donor has ceased dominion and control over the transferred
property.
Since Louise has discretion to accumulate income
and appoint by will she has sufficient control to prevent a
completed gift.
On the other hand, if Robert were a
co~
trustee the transfer may be considered a completed gift
because he has an adverse interest in the property.
By
negative implication 25.2511-2(e) seems to say that a donor
is ,not considered as having a power if it is exercisable
in conjunction with a person having an adverse interest.
Estate Tax
Under 2038(a)(1) Louise will be considered as having
the power to alter or amend the trust since she has the power
to accumulate and then appoint the remainder to her grandchildren • . The trust also falls within 2036(a)(2) since
Louise has the right either alone or in co.junction with
any person, to designate who shall possess or enjoy the
(
property.
ThuB the entire amount will be included in
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her estate.
Under 20.2038-1(a) it is immaterial whether
the power wa.s exercisable alone or in conjunction with
another person, whether or not they have an adverse interest.
This would mean that making Robert a co-trustee would not ·
prevent inclusion in Louise's gross estate.
Income Tax
Louise has retained certain powers which may require her to be trea.ted as owner of the trust for income
tax purposes under 674.
If she wishes to be sole trustee
then she will fall within 674(a) as owner of the trust.
If Robert is appointed as co-trustee he meets the definition of an a.dverse party in 672(a) since he has a substantial beneficial interest in the trust.
Therefore, Louise
would not have the power to accumulate income without the
,
consent of s.n adverse party, and she would not be considered
owner under 674(a).
However, Louise does have a power to
appoint the property by will which does not require the
consent of an a.dverse party.
674(b)(3) provides an excep-
tion for a power exercisable only by will, other than a
power in the grantor to appoint by will
~he
income of the
trust where the income is s.ccumulated for such disposition
by the grantor without the approval of an adverse party.
Since the accumulation of such income does require the approval of Robert as co-trustee the appointment by will is a
power within the exception of 674(b)(3), and Louise should
not be considered as owner , of the trust.
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3,
Assume in the Louise D, Rhodes Family
Article Second,
Paragraph~,
Trust (Pol 621)
that in the event Louise
survived Mary the trust was to terminate with remainder to
Louise,
If Louise did not survive Mary then the remainder
would go to Mary's heirs (paragraph 3),
affect Louise taxwise?
How would this
Suppose paragraph 3 instead said
upon Louise's death, remainder to Louise's estate?
Ans,
Gift Tax
Gift tax must be imposed upon the completed gift,
which in this case is the entire amount less the value
of the reversionary interest (25,2511-(1){h){7) ).
The
value of the reversionary interest is found in TableA(2),
25,2512-9 and is based on Mary's life expectancy at age J9,
The reversion will be 15% of the value of the corpus,
Thus, 85% of the trust corpus is taxable as a gift,
If paragraph 3 required the corpus to return to
Louise's estate at her death then the income interest to
Mary is a completed gift, but is now based on Louise's life
expectancy,
of . ,388J3,
A life estate based on age 75 has a value
Thus 38,8% of the corpus is a gift,
Estate Tax
Assuming that Louise dies before Mary the estate
is determined under 2037(a){2),
If immediately before
Louise's death the value of the reversionary interest
exceeded
5%.
Louise will be taxed on the amount of the
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reversionary inter<
e st.
Since Louise's reversionary
interest
is 15% at the time of the transfer it will always be greater
than 5% since it will increase as Mary gets older.
As the
value of the reversionary interest increases it will mean
eventually that Louise when she dies will be paying estate
and gift tax on the same property.
off for any
~ift
2012(a) allows a set-
tax paid on propertlf subject to estate tax.
If Mary's income interest were measured by Louise's
life (which would be the case if Paragraph 3 were revised to
pay the remainder to Louise's estate) then the entire transfer would be subject to estate tax,
This would be true even
if the remainder did not return to Louise's estate.
See
Westfall, p.131.
Income Tax
Under 673(c) Louise will not be treated as the ewner
of the trust since her reversionary interest is not to take
effect in possession or enjoyment until the death of Mary.
However, Louise may be taxed on capital gains because they
will be accumulated and may be distributed to her in the
"-
event Mary predeceases her.
677(a)(2) • .
If paragraph 3 provided that the remainder at Louise's
death were to go to her estate then 673(a) may apply if
Louise's life expectancy is less than 10 years.
1.673(a)(c),
Since she is 75 her life expectancy is about 6t years.
<T herefore, she would be treated as owner,
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4.
Assume Robert Rhodes set up a funded irrevocable life
insurance trust.
The Gotham City National Bank is trustee,
and Rhodes transfers his $60,000 term life insurance policy
B.nd $40,000 ordinary life policy.
Rhodes also transfers
$20,000 of securities to the trust.
The trustee is to pay
the premiums from the income on the securities and accumulate any excess.
At Robert's death the trustee is to
begin paying the income annually to Robert's wife.
Whet
are the tax consequences of the transfer?
.An§. •
Estate and Gift Tax
Robert has made a completed gift of the insurance
policies and the securities.
The life insurance policies
B.re evaluated for gift tax purposes under 25.2512-6.
The
va lue of insurance. is determined by its terminal reserve
value which is slightly higher than its cash surrender
value.
The $60,000 term policy would hs.ve no cash value.
There will .b e no estate tax if Robert has retained
no incidents of ownership in the policies .
Income Tax
Robert will be treated s.s owner of that portion of
the trus t which is used to pay the premiums on the policies under 677(a) (3), becaus e the income may be a.pplied
wi thout the consent of s.n s.dverse party to the payment .
of premiums on policies on the life of the grantor . Any
income which is accumulated will be taxed to the trust.
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5.
Robert Rhodes transfers Stone Mounta.in Skiing stock to
8n irrevocRble trust, Gotham National Bank as trustee, so
much of the income to Robert's children Jonathan and Ellen
as is necessary for their maintenance and support until
they reach age 21.
Income not so distributed is to be
accumu18ted and added to principal.
When Ellen reaches age
21 the trust terminates with remainder to Jonathan and
Ellen equally.
What are the tax consequences to Robert?
A!:l!! •
Gift Tax
The transfer is a completed gift under 25.2511-2(b).
A support trust for the benefit of one's children will be
considered a. gift unless it is in release of a legal obligation such as might be found in child support settlements.
Estate Tax
If Robert dies before the trust terminates then 2036(a)(1)
will bring the entire amount of corpus and accumulated earnings
into Robert's estate.
20.20)6-(1)(b)(2) provides that the use,
possession, right to the income, or other enjoyment of the
transferred property includes cases where the income is to
be applied toward the discharge of a legal obligation.
The
term "legal obligation" includes a legal obligation to
support a dependent during the
decedent's lifetime.
This
also includes not only where the transfer is to be applied
toward the discharge of a legal obligation but also where
I
•
an enforceable right exists to cause it to be applied.
Thus
since the "possession or enjoyment" does not .in faot end
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before his death the entire amount is includable in
Robert·s gross estate.
Income Tax
Under 677(b) income of a. trust shall not be considered taxable to the grantor merely because in the discretion of the trustee such income may be applied or distributed for the support or maintenance of a beneficiary
whom the grantor is legally obligated to support, except
to the extent that such income is so applied or distributed.
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6.
Louise Rhodes transfers $50,000 of securities to an
irrevocable trust with Robert Rhodes and Louise Rhodes
co-trustees, income to be accumulated until Louise's
death. ' At such time the trustee will begin paying all
the income to Mary Rhodes stevens or her heirs :
The
trustees have the power to make loans for adequate interest
and security.
Louise borrowed the income for the first
year, but did not pay it back for 2 years.
lems arise in the creation of this trust?
What tax probWhat if Louise
retained the right as grantor to substitute other property of equal value for the securities?
.!D.§. •
Estate and Gift Taxes
25.2511-2(b) of the gift tax regulations state when
a donor reserves a power over the disposition of property
transferred by him, the terms of the power and the facts
of es.ch case determine whether a completed gift has been
made.
In the case of the power to make loans including
to herself, the loans must be made ',for adequate consideration and security.
This power alone would not be enough
to make the gift incomplete.
The same-result is reached
as to the estate tax consequences, i.e., the property will
not be included in Louise'S estate.
As for Louise\s retained power to substitute other
property of equal value the cases have generally held that
the gift is complete and that this is not a power to alter
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or amend or to a.ffect the beneficial enjoyment.
mere ~y
a power to direct investment policy.
It is
However,
if there is no restriction that the property substituted must be of equal value, then the estate and gift
ta.x consequences are the exact opposite.
See, e.g.,
Commonwealth Trust Co. of Pittsburgh v. Driscoll,
137 F.2d 653.
Income Tax
Louise will be treated as the owner of the trust
for the years in which she has an outstanding debt to
the trust.
675(3) provides for this result even though
the loan is for adequate consideration and security if
the trustee is the grantor or a related or subordinate
party.
Robert is a related or subordinate party under
672(c) (2), 'so even if he were trustee alone, Louise
would be treated as owner for income tax purposes,
In addition, if Louise retains the power to
substitute other property for the trust corpus, she
will have a general power of administration under 675(4).
Th ts will result in her being taxed on the income
every year until she relinquishes such right.
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7.
If Louise gave the trustee of the Louise D. Rhodes
Family Trust the power to revoke would it cause her to
be treated as the owner for income tax purposes?
it be includable in her gross estate?
Would
Suppose the Gotham
National Bank were named trustee instead of Robert?
if Mary were named as trustee?
What
What if Robert were given
the power to reVOke after Mary'S chidren reached age 18?
In!!.
Estate and Gift Tax
The transfer is a completed gift regardless of
who ha.s the power to revoke as long as it isn't the grantor.
The presence of a related or subordinate party as trustee
does not cause the property to be included in the grantor's
gross estate.
For estate and gift tax purposes the code
seems to presume that the grantor could not exercise
sufficient control of a trustee even if related. 20.2038-1(a)(3).
Income Tax
For income .t ax purposes, . however, the code will
treat the grantor as owner of the trust if a power :·to revoke is vested in anyone other tha.n a non-adverse party. 676(a).
,
Thus, since Robert is a ' related or subordinate party under
, 672(c)(2), he would not be an adverse party.
Even if the
Bank were trustee their power to revoke would cause Louise
to be taxec;l on the income, If Mary were trustee, however,
Louise would not be taxed as owner of the trust,
Since
Mary is an income beneficiary she has a "SUbstantial bene-
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ficial interest in the trust which would be advers ely
affected by the exercise of the power which she possesses."
672(a).
Thus as an adverse party, 676(a) will not apply.
If Robert, as trustee, hBd a power to revoke after
Mary's children reached 18, Louise would not be treated
as the owner under 676(b) since Mary's children ( the
youngest
of which is two ) will not reach 18 for a period
of at least 10 years.
However,
~ouise
may be treated as
owner forthe purpose of tax on any capital gains realized
by the trust because they will be accumulated as corpus
and in the exercise of the discretion of a nonadverse
party (Robert) they may be distributed to the grantor.
677(8)(2).
8.
Robert Rhodes created an irrevocable trust, naming
himself
BS
trustee.
All the income was to be distri-
buted to his children until the youngest reached the age
of )0.
At such time the trust would terminate, end the
reme.inder would be divided between his children equally.
Robert reserved the right as trustee to withhold from
either child any part of his share of income and add it
to the corpus.
that ~.Robert
If both his children were over 21 so
no longer had a legal obligation to support
them, what would be the tax consequences of the transfer?
Ans.
Estate and Gift Tax
The transfer is a completed gift because Robert
cannot affect the ultimate disposition of the corpus .
Robert can, : however, control the ultimate disposition
. of the income because of his discretionary power to
accumulate.
Thus 20)6(a)(2) will bring the entire value
of the trust into Robert ' s estate because, he has
th~
power to designate the persons who shall possess or enjoy
the property.
20)8(a)(1) would also apply as this would
be considered as a power to alter or amend the trust.
Income Tax
A· contrary result will be reached as far as income
tax is concerned,
674(b) (6) (B).
Robert falls within the exception
o~
This excepts a power to distribute income
to any current income beneficiary or to accumulate for
'.
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him provided that any accumulated income must ultimately
be payable upon termination of the trust in conjunction
with a distribution of corpus which is augmented by such
accumulated income to the current income beneficiaries
in shares which have been irrevocably specified in the
trust instrument. Thus by accumulating income of just
one of the beneficiaries to his detriment, Robert is
able to alter the ultimate disposition of the income by
adding it to the corpus which will be divided equally.
Yet Robert is not treated as owner of the trust in spite
of what seems to be a
~ry
broad power.
1.674(b)-(1)(b)(6)ii.
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See example (1),
9.
If Louise Rhodes appointed herself' as trustee of
the Family Trust (p.621) would she incur estate, gift,
or income tax liability?
~.
Estate and Gift Tax
In Article Second of the Family Trust the trustee
is authorized in his discretion to invade the corpus if
necessary for Mary's comfortable support and maintenance
in her accustomed standard of living.
Such a power held
by a grantor does not make a gift incomplete as long as
it is fixed by a reasonably a,scertainable standard.
25.2511-2(g).
The same rationale has been applied under
section 2036(a)(2) so that as long as there is a fixed or
ascertainable standard, the grantor has not retained the
right to designa te the , person who will enjoy the property.
United States v. Powell, 307 F.2d 821, & Westfall, p.228.
The definition of an ascertainable standard has
been set by the courts as one that is "fixed in fact and
capable of being stated in terms of money."
p.138.
See Westfall,
The standard set forth in Atri£le Second, Paragraph 1,
should fit this definition.
Income Tax
Sec.tion 674(a) provides that the grantor will be
treated as the owner 'of a trust if the grantor or a nonadverse party has a power ,of disposition of the beneficial
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enjoyment of the corpus or income.
An exception to this
rule is ma.de if the power is a power to distribute corpus
to or for
:it
beneficiary if limited to a. reasonably defi-
nite standard set forth in the trust instrument. 674(b)(5)(AJ.
The standa.rd set forth in the Family Trust will meet this
exception.
Therefore, Louise should not have any differ-
ent tax results
~egardless
of whether she or Robert is
the trustee.
Note, however, that if the discretionary power attached also to the income of the trust even if limited by
an ascertainable standa.rd, would cause Louise to be treated
as owner if she were trustee, whereas if Robert were
trustee it would not. 674(d).
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10.
Robert Rhodes tra.n sfers Stone MountA.in Skiing stock
to an irrevocable trust appointing himself as trustee,
with income to Louise for life, remainder to whoever
~ouise
appoints by will.
The administrative powers given
to the trustee include I (1) the power to allocate ca.p i tal
ga.ins to either income or principal, (2) the power to vote
the stock. (The stock tra.nsferred gives the trust control
of the corporation.)
What are the estate and income tax
consequences of the transfer to Robert?
Estate Tax
The fact that Louise has a testa.mentery power of
appointment mea.ns tha.t she may re-vest the property in
Robert.
This might reasonably be interpreted to mean
tha.t 2037(a) (2) could bring the property within Robert's
gross estate.
However, the regulations at 20.2037-2
. sp'ecifica11y state that the term reversionary interest
does not include the possibility that the decedent might
receive ba.ck the property by inheritance through the
estate of another person.
Inclusion of the pr'o perty can not be found in 2037,
but it may be included under 2036(a)(2).
The power to
allocate between principal and income is probably not in
itself enough to cause inclusion in Robert's gross estate.
This power has ,been held to be within 2036(a)(2) in
state Street Trust Co. v. U.S., 263 F.2d 635 (1959), but
in that case there were other broad powers besides the
power to allocate between income and principal. Generally,
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cases since then have held the power will not cause inclusion under 2036(R)(2) so long as it is reasonably
See, e.g., Estate of
exercised and in good faith.
Marvin L. Pardee, 49 T.e. 140 (1967) • . Thus to prevent
estate problems because of retention of this power, it
should be made clear that the power is not absolute,
but should be subject to a standard of reB,sonableness
and good faith.
The second power, i.e., to vote controlling stock
in a company has been held to cause inclusion of the property subject to the power under 2036(a)(2). United
states v. Byrum, 408 U.S. 125 (1972). See Westfall, p.198.
The court held that by retaining voting control the
grantor can select the corporate directors, which in
turn gives him
con~rol
over dividend policy.
Thus, by
increasing, decreBsing, or stopping dividends completely
the grantor can "regulate the flow of income and thereby
defer beneficial enjoyment of trust income between present beneficiaries and remaindermen."
Thus the retained
power amounts to a power 'to accumulate , income which has
been recognized B,S a power taxable under 2036(a) (2).
Although this theory seems novel to say the least, it
appears that such retained powers will be taxed in the
grantors estate from now on,
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Income Tax
While, apparently the power to vote controlling
stock is now taxable in the grantor's estate, it will
not cause the grantor to be considered the owner for
income tax purposes provided the power is held in a
fiduciary capacity, 675(4)(A).
Thus since Robert app-
ointed himself trustee he may exercise the power to vote
the stock, whereas, if he had retained the power as grantor
and appointed someone else as trustee, he would continue
to be taxed on the income from the stock.
The power to allocate between income and principal
will not cause income tax problems for Robert.
This
power is specifically excepted from 674(a) under 674(b)(B)
,
even though the power is expressed in broad language.
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