[this is a placeholder for a blog post referenced in Jack Straw five comma eight]
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[this is a placeholder for a blog post referenced in Jack Straw five comma eight]
I received an e-mail inquiry today from Lorman asking whether the materials for a program I did for them three years ago on income splitting might require updating. I pulled up the slide deck and the supporting text -- the latter appended below --, and responded in effect that apart from the fact that the Supreme Court did ultimately rule in Kaestner Trust, nothing had significantly changed in the interim, but that my approach to the subject was perhaps idiosyncratic. And that another presenter might start in somewhere around page 3. 
The Greystocke Project submitted comments urging the Treasury and IRS to reinstate the guidance project on "basis of grantor trust assets at death" under section 1014, added to the priority guidance plan for fiscal 2015-16 but dropped from the current plan.
[copy also posted to LinkedIn]
Following up on an item I posted here last August. This is the second in what may turn out to be an intermittent series. The other day I was engaged to write up a "qualified appraisal" on the assignment of a gift annuity to the issuing charity. A not at all uncommon transaction that should maybe be more common than it is. This is a gift of a noncash capital asset,[a] subject to the 30 pct. limitation per section 170(b)(1)(B). If the taxpayer acquired the annuity in exchange for appreciated property, her basis in that property would have been pro rated between the "gift" and "sale" components of the transaction. Over a term of years called the "expected return multiple," i.e., her table life expectancy at the time the annuity was set up, a portion of each payment represents a recovery of basis and a portion represents realization of gain, somewhat in the manner of an installment sale. Yet another portion of each annuity payment is ordinary income. If the annuitant survives the "expected return multiple," she will have fully recovered her "investment" in the contract,[b] the basis and capital gain components, and the entire annuity payout going forward will be ordinary income. Are you with me so far. The present value of the unexpired annuity itself trends down as the annuitant ages, but it also fluctuates as the section 7520 rate moves up or down. In the particular case, just as the taxpayer was making the decision to assign the annuity to the issuing charity, the 7520 rate was rising rapidly. The rate for April was already up to 2.2 pct., and we were looking at a solid 3.0 pct. coming up in May, the highest rate in three years. But if the gift were completed in April, the two-month lookback would allow us to use the 1.6 pct. rate from February. Which is a spread of sixty basis points from the April rate and a hundred forty from the May rate in a number that is used as a multiplier in valuing the annuity. The leverage we could get by using the February rate was tens of thousands of dollars.[c] the catch However. And the taxpayer already knew this and accepted it. It is widely believed among tax professionals, including your correspondent, that the income tax deduction would be limited, regardless of the current value of the unexpired annuity, to the taxpayer's "unrecovered investment" in the annuity contract at the time of the assignment. That amount goes down every year, so the incentive to do this transaction is early. In the particular case, since this was a deferred annuity that had not yet commenced, the taxpayer had recovered no basis at all, but she had of course aged several years. So a portion of the projected annuity payout over the expected return multiple[d] would be allocated to the recovery of the taxpayer's basis, and a portion would be allocated to long term gain. And those amounts, at least, would be deductible in full. But everything above those amounts would eventually have been paid to the taxpayer as ordinary income. Does Code section 170(e)(1)(A) require a reduction here? Seems likely.[e] But this is a matter for the taxpayer's legal and tax advisors. My role as appraiser (reference the blog post title) does not include opining on the amount of the deduction itself. In some other case I might be brought in by one of the advisors, and I could help them frame an opinion. But that was not this case. But if I say anything about this in the text of the appraisal, the taxpayer will in effect be pre-empted from taking a different reporting position. Not my role, as I openly explained to the taxpayer. So the appraisal recites the present value of the unexpired annuity, measured over a slightly longer life expectancy than had been projected at the time the annuity contract had been signed, and reflecting the leverage obtained by electing the February 7520 rate. And it says nothing about the likely limitation due to the reduction rule, because my opinion relates only to the value the issuing charity is actually receiving, not to whether some portion of that value might not be deductible. notes [a] See, e.g., Rev. Rul. 2009-13, 2009-1 C.B. 1029. Also, Estate of Katz, 309 F.2d 587 (1st Cir. 1962), aff'g T.C.Memo. 1961-270. The idea that an existing gift annuity contract should be seen by folks in development as a capital asset that might itself be the subject of a gift is the premise of what has become my signature talk for roundtable breakfasts and regional conferences. I gave an early version of this talk at the national conference in Las Vegas in 2018, linked here. [b] If she does not survive the term of years, any unrecovered investment will be an itemized deduction on her final 1040. Technically "miscellaneous" itemized, but not subject to the two pct. floor nor to the temporary suspension of miscellaneous itemized deductions through 2025. [c] The 7520 rate had held at 1.6 pct. for three months after making a mostly steady climb over a full year from an historic low 0.4 pct., which had itself held for four months, from August through November 2020. Those days appear to be gone. [d] As determined at the inception of the contract. [e] The arguments I have seen against are unconvincing. We can get into that elsewhere if you like. Tl;dr, the differences in the value of a gift annuity over time are entirely a function of the annuitant aging into slightly longer table life expectancies and to fluctuations in the 7520 rate. Or in the extreme case, the insolvency of the issuing charity. There is no underlying investment whose performance we are measuring, analogous to the "inside buildup" in an insurance policy, cf. the revenue ruling cited in footnote [a]. In effect, the gift annuity is an unsecured promissory note arising from an installment sale. Your correspondent had an article published today in the quarterly Journal of the Bar Association of Metropolitan St. Louis, of which he is a member. The subject is a Missouri statute enacted back in 2014, drafted by a committee of the state bar, to enable a trust beneficiary to test the water before committing to a petition or motion that might trigger an in terrorem clause, forfeiting her interest in the trust. And how that statute has fared in five different cases reviewed by various state appellate courts. We talked about one of these cases, Knopik, in Jack Straw volume three number four. The link below is to a .pdf of the article as published. Also posted to SSRN.
addendum I am finding that the article as printed was edited for a couple of style niceties that are inconsistent with my preferences, so I am also posting the typescript as submitted. In particular, it is my practice to note motions for rehearing or transfer to the state supreme court, even where they were not granted, because I believe this information is actually of use to the practitioner in citing an appellate decision as authority. Also, as regular readers of Jack Straw will have observed, I uniformly use the feminine form of the third person singular pronoun for generic references, and I am finding that the editor here prefers the plural to avoid the gendered pronoun altogether, with the result that there are plurals here where the singular would have been clearer. 
Attached is a piece I wrote last year for the quarterly newsletter of the planned giving office at the University of Chicago, linked here.
Posted this thread to Twitter today
https://twitter.com/rawillis3/status/1444003210826432512 challenging the sector's position on the push for legislation to require minimum payouts from donor advised funds. I will be posting the appended text to LinkedIn on Wednesday. The article describes a brainstorming process that is typical in my consulting practice -- in the particular case, salvaging an income tax deduction for the distribution of a nonqualified trust remainder to charity.
[copy also posted to LinkedIn]
Word seems to be getting around that alongside his consulting practice, helping other lawyers sort through various tax and nontax issues arising in connection with private wealth transfers, particularly those involving split-interest trusts funded with appreciated property, interests in closely held business entities, etc., your correspondent also performs the calculations required to substantiate a claimed income and/or transfer tax charitable deduction for funding one of these, or for accelerating the remainder. An eight- or ten-page narrative, showing the math step by step, and his signature on an 8283. Often in these engagements, your correspondent is brought in after the transaction has already been completed. And some of the details on which he might have advised had he been involved earlier as a consultant have already been locked in. Sometimes some t's did not get crossed or some i's dotted. And sometimes this can require delicate handling. Specifically. For example. Where you have a remainder trust created by one spouse for her own life, with a successive "income" interest in her surviving spouse, subject to revocation, and they both renounce in favor of the remainder org, or they surrender or assign their respective interests, however you want to phrase it,[fn. 1] but the settlor does not take the preliminary step of releasing her power to revoke the spouse's successive interest, do you say anything about this in the appraisal report? Obviously you would rather not, but if you do not, have you misstated the value of the deductible gift, exposing yourself to a penalty under section 6695A? and to possibly being barred from doing similar appraisal work going forward? The stakes are not negligible. difficulty level two The result everyone is looking for here is a deductible gift in the amount of the present value of the consecutive life interests combined. But there is a question whether the successive interest in the spouse had any value on the date of the assignment. Not only was it contingent on the spouse surviving the settlor, but it was also subject to defeasance by the settlor exercising her reserved power to revoke. You can calculate the actuarial likelihood the spouse will survive the settlor, and by how many years, but you cannot calculate the likelihood the settlor will or will not arbitrarily exercise her power. Yes, the settlor had to take the successive interest into account in calculating her deduction at the inception of the trust for the then present value of the remainder, and if we cannot claim a deduction now for the present value of the successive interest, we would have some rather substantial slippage. But that is a problem that could have been addressed by going through the formality of releasing the power to revoke before making the assignments. This would have completed a gift to the spouse, which would be eligible for a gift tax marital deduction per section 2523(g). We might then have to calculate separately the present values of the settlor's life interest and the spouse's deferred, contingent life interest, but in the end these would add to the present value of the two lives combined. is this trip necessary You raise the issue with the taxpayer's advisors, and after some hesitation they respond quite sensibly that it is obvious what the parties intended. Fair enough. However. In a letter ruling issued back in the late 80s, IRS did determine this question adversely to the taxpayer. So we have to pay attention. The ruling was PLR 8805024.[fn 2] The settlor had created a five pct. straight unitrust payable to himself for his life, then to his spouse if she survived, but he reserved a testamentary power to revoke her successive interest. They each proposed to transfer a portion of their respective unitrust interests to the remainder org. Our facts on almost all fours. IRS ruled the spouse could not claim a deduction for the acceleration of her contingent, defeasible interest, because there was no "ascertainable assurance" her interest "will ever pass to charity." It is not entirely clear what that means. Obviously the spouse did hold a transferable interest, albeit contingent and defeasible and therefore of negligible to zero value. Absent her assigning this interest to the remainder org, there would be no merger. The trust would continue to pay out over the settlor's life, but directly to the remainder org. And then if the spouse survived the settlor and he had not exercised his power to revoke, she would step into the income stream. So it is necessary for her to participate in the transaction to effect a merger of the income and remainder interests, and her assignment does "assure" that her interest will pass to the remainder org, not at some future date, but immediately. In any event. Twenty years later, IRS issued another letter ruling approving the workaround described above -- the settlor first releases her power to revoke, completing the gift to the spouse, and only then do they each assign their separate interests to the remainderman. PLR 200802024 does not get into the weeds on valuing the spouses' respective interests separately, but in any event they should add to the value of the combined life interests.[fn. 3] And that might be all we need. push comes to shove Your correspondent struggled with the question whether to include any of this in the appraisal report for maybe five minutes before concluding it was not technically his problem. The decision to characterize the transferred property as the consecutive life interests combined, rather than as two separate interests, one of which might have negligible or zero value, is to be made by the taxpayers' tax advisors. The appraiser simply attributes a value to the property as thus characterized by others. In other words, the appraiser, in that role at least, is not a "practitioner" subject to section 10.34 and/or section 10.37 of Circular 230. The appraisal report indicates a value, but does not in itself express a view with respect to deductibility. That is a matter for the lawyers, the accountants, and the return preparers. It is sufficient that the appraiser communicate her concerns to the "practitioners," so that they can exercise the necessary diligence to determine whether the reporting position is supported by "substantial authority," and to instruct the appraiser to place a value on x rather than y. _______________________________________ [fn. 1] In any event, the unexpired life interest passes to the remainderman, in whose hands the interests merge. [fn. 2] The online resource at irs.gov does not go back this far. Your correspondent gratefully acknowledges the Planned Giving Design Center for making the text available online without having to go behind a paywall. Incidentally, as some readers may have heard, pgdc.com is doing some kind of relaunch on September 01. Your correspondent has done some writing for them in the past, and is looking forward to seeing what this "PGDC2 eCampus" is all about. [fn. 3] In other words, while the present value of the deferred single life interest for the spouse might be calculated with reference to the probability of her surviving the settlor by x years, the result should be the same as simply subtracting the present value of the settlor's life interest from the combined two-life interest. |
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