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«Aggregated Summary of Reports Provided by ABA-PTL and ACTEC-Prac List serves 2015 Heckerling Estate Planning INSTITUTE Edited, Aggregation of On-Site ...»

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In closing, Mr. Eastland briefly mentioned income tax planning with IRAs. You could convert to a Roth avoid income taxes, but must pay the taxes up front, so the issue becomes, who should pay this tax ? Create a dynasty grantor trust and either borrow the amount of taxes due or sell a call option to simulate derivatives. Trust can call in 12 years or so depending on grow of the IRA and terms of the call and the results are income and estate tax benefits of making the conversion.

11;45 - 12-35 The 30,000 Foot View from the Trenches: A Potpourri of Issues on the IRS’s Radar Screen (Litigation Series) This presentation will address a number of current audit and litigation issues from the perspective of a seasoned litigator who deals with the IRS on a daily basis. The discussion will include hard to value assets, formula clauses, 6166 issues, GRATs, tax return preparation issues, and avoidance of penalties.

Reporter: Carol A. Sobczak Esq.

This presentation addressed a number of current audit and litigation issues from John Porter’s perspective, who is a seasoned litigator who deals with the IRS on a daily basis.

The issues on the IRS’s radar are:

–  –  –

Mr. Porter first paraphrased President Nixon and said that it’s not paranoia; the IRS is really out to get you in these areas! He noted that the IRS is bringing up more arguments in their 30-day and 90-day audit letters, that examiners are requesting more pre-appeals conferences, and Appeals is not considering any new issues. These need to be brought up at the examination level.


The area of installment sales to intentionally defective grantor trusts is still a hot area on the IRS’s radar screen. In the gift tax area, the issues include the fair market value of the interest sold and the consideration received. See the Woelbing cases (Tax Court Docket Nos. 30261-13 and 30260 13). Also be aware that the IRS is looking at the step transaction doctrine also. See Pierre v Comm’r, 133 T.C. 24 (2009).

The estate tax issues include estate tax inclusion under § 2036 and § 2038 regarding the interest sold, whether the sale was a bona fide sale for full and adequate consideration. Watch the timing of payments and put some time between the seed gift and the sale to the trust.

SECTION 2036 Section 2036 is still the most litigated issue. The “bona fide sale” is “where the rubber meets the road.” If the bona fide sale requirement is satisfied, the taxpayer generally wins. Make sure you have adequate consideration, the interests are proportionate, and value is credited to capital accounts. Make sure there are significant and legitimate non-tax reasons for the transaction, which can include centralized asset management (see Stone and Kimball), protecting assets from creditors and possible divorces, preservation of family assets such as ranches and other large real estate holdings, and avoiding imprudent expenditures by the next generation.

Most § 2036 cases involved the retained right to control of §2036(a)(1). You should avoid using trust income to pay personal expenditures, using trust assets for the benefit of the grantor, and paying transfer taxes and expenses when the assets are transferred close to the death of the grantor. Keep accurate books and make sure there are sufficient assets outside of the entity for the grantor to live on comfortably. Some of the cases in this area include Harper, Strangi, and Miller.

To avoid inclusion under § 2036(a)(2), don’t allow the senior family member to have sole discretion to make distribution decisions, but put limits on that discretion. Mr. Porter includes in his agreements a definition of a “business judgment ascertainable standard” for distributions and defines what cash should be available for distribution. Also, bring on younger generation family members to be involved in the entity. Remember that if you satisfy the bona fide sale requirement of § 2036(a)(1), you won’t ever get to an (a)(2) issue.

The best advice is to prepare at the planning stage. The IRS will require all documents relating to the creation of the entity including e-mails. Drafters and CPAs may be required to testify, especially in estate tax cases where the decedent can’t. You should help your client’s case by corresponding about non-tax reasons for the transaction, but you don’t need to ignore the tax reasons.


Discounts are still a hot area. The discounts allowed by the IRS since 2000 range from 7.5% (Koons, T.C. Memo 2013-94 (April 8, 2013)) to 63% (Church 2002). The speaker’s best advice is to obtain a qualified appraisal from a qualified appraiser, and make sure it is finalized and signed.


Types of approved formula clauses include defined value clauses based on values “as finally determined for federal estate and gift tax purposes,” defined value as in the McCord case (120 T.C. 358 (2003)), and price adjustment clauses as in the King case. Whatever you do, do not ever use a reversion clause as in the Procter case (142 F.2d 824 (4th Cir. 1944)), where any excess value went back to the transferor. The speaker’s “favorite” entities to which any excess should revert are public charities and donor advised funds, private foundations, and lifetime QTIPS and GRATs (with different trustees and beneficiaries) (in that order).

The speaker also recommended filing a gift tax return to start the statute of limitation running and make sure to report consistent with the formula, reflect the formula in the gift tax return, and attach all formula transfer documents and appraisals to satisfy the adequate disclosure rules.


The IRS is looking at § 7872 issues and, especially where family members are involved, whether the note is a bona fide loan or a gift. Factors the IRS looks at include the interest, repayment schedule, collateral, demand for payment, records, and a reasonable expectation of repayment.


Make sure to comply with § 2702 and operate the trust pursuant to its terms. The IRS looks at the valuation on transfer and whether the transfer is actually a disguised gift. Consider using a Wandry formula (based on values as finally determined for federal estate and gift tax issues). See Wandry, T.C. Memo 2012-88 (March 26, 2012).


See US v. Marshall. There is a split in the circuits whether the liability of a transferee is limited to the value of the gift received or is unlimited to include interest. Consider filing a gift tax return to start the statute running.

2:00 - 2:50 SCINs and Private Annuities: Disappearing Value or Disappearing Strategies?

(Financial Assets Series, Focus Series) Steve R. Akers For clients with “shortened” life expectancies, planners often consider sales for self-canceling installment notes (SCINs) or private annuities. Both of these strategies have come under IRS attack in recent cases. The underlying viability of these strategies, the tax effects (income, gift and estate tax) of these strategies, and practical planning considerations are addressed.

Reporter: Kimon Karas We are reporting here only the more significant highlights of this session. A more detailed analysis will be contained in the coverage of Special Session 1-B Planning with SCINS and Private Annuities on Tuesday afternoon.

Steve gave a very enlightened presentation on the topic together with an extensive outline of the subject matter.

He provided an overview of some of the nuances of each topic that will be further explored and discussed in the special session. Steve discussed the each topic as a way to move appreciation to younger family members for persons with a life expectancy less than what the tables would otherwise proscribe for such person.

Steve commenced his presentation discussing SCINs. Due to recent developments Steve cautioned against using SCINS until further guidance is issued or case law developments arise.

A drawback of an intrafamily installment sales or sale to a grantor trust is the potential inclusion in the seller’s gross estate for the unpaid obligation at death. One alternative is to use a self-cancelling installment note (SCIN), a debt instrument providing that the obligation is cancelled upon grantor’s death. The leading case is Estate of Moss where Tax Court held remaining payments due at seller’s death was not includable in estate because the ‘cancellation provision was a bargained for consideration provided by the decedent for the stock’s purchase.’ However if SCIN is cancelled by reason of seller’s death during note term, the deferred gain likely will be recognized as income the question being whether on decedent’s final return or estate’s income tax return. See Frane, income recognized on estate’s initial income return as IRD.

A recent development is CCA 201320033, where the IRS concluded that Section 7520 tables do not apply to SCINs.

Assets were transferred to grantor trusts in return for SCINs, some with substantial principal premium and some with substantial interest premium. Following the CCA is the recently docketed Tax Court case, Estate of Davidson.

In Davidson decedent entered into large sale transactions for SCINs. The sales were for notes providing for annual interest payments and balloon payments after 5-years. Decedent died within six months of transaction without receiving any note payments. At time of transactions the Section 7520 tables reflected a life expectancy in excess of 5 years. Evidence presented by four medical experts (two from the estate and two from IRS) who all opined that decedent had a greater than 50% probability of living at least one year at time of transactions. IRS raises two arguments that: 1)SCIN transactions are not bona fide and the notes provide no consideration and 2) in the alternative if SCINs are bona fide, they should not be valued under Section 7520 but rather under willing/buyer/seller analysis. IRS argues that Section 7520 applies only to valuing annuities and life estates. Steve suggests case most likely will be settled and if so, we still may be left with no guidance except the IRS’s announced position that Section 7520 is not applicable to SCINs.

Steve then turned to a discussion of private annuities which he favors in light of recent developments relating to SCINs. It is clear in a private annuity the Section 7520 actuarial tables apply. In a private annuity transaction individual transfers property to a younger family member or trust in return for a promise to pay a fixed amount periodically for remainder of individual’s lifetime. Annuity can be structured as a deferred annuity, a graduated annuity, or for a fixed number of years or until the individual’s death, whichever first occurs (stated term annuity).

Private annuities can be useful in following situations:

1. An individual in poor health, not terminally ill under regulations, but whose life expectancy is less than tables otherwise provide.

2. Individual can self-select asset(s) subject to the sale.

3. Provides cash flow.

4. Hedge to other planning techniques that require longer time periods to capture the intended transfer tax benefits.

Advantages include the following:

1. Shifts future appreciation.

2. No gift tax.

3. Wealth shift if transaction can be structured with a GST-exempt trust.

Disadvantages include the following:

1. Individual outlives life expectancy.

2. If proposed regulations issued in 2006 become final (for private annuities entered into after 10/18/06 with a 4/18/07 effective date), seller is immediately taxed on difference between value of annuity and seller’s basis for asset sold. Proposed regulation creates strong incentive for future private annuity transactions be with grantor trusts. Under prior law (pre proposed regulations) gain recognition is deferred and recognized pro rata as annuity payments are made with portion of payment being capital gain and balance ordinary income. Prior to proposed regulations an annuity has three possible components: i)recovery of capital; ii)capital gain; and iii) the balance which is ordinary income; i.e. recovery of basis over seller’s life expectancy; gain based on present value of annuity (capital gain until total gain is realized-when annuitant outlives life expectancy-thereafter payments are ordinary income; and balance is ordinary income. If annuitant outlives life expectancy all annuity payments are ordinary income.

3. Payor receives no interest deduction and no immediate full basis in the property. After transferor’s death buyer’s basis equals the total annuity payments actually made.

4. Potential 2036/2038 inclusion if the payor does not have ability to make the annuity payments.

5. Potentially impractical for older persons.

The distinction between a private annuity and installment sale based on GCM 39503 that provides an annuity is determined to exist if the stated maximum amount would not be received by the individual until after the individual’s life expectancy.

The three significant issues to address with the private annuity are the Sections 2036/2038 issues, the valuation using tables under Section 7520, and the exhaustion test.

Section 2036 concern arises if there is a question regarding the ability to make the annuity payments. A particular concern if the sale is made to a trust without significant assets or other ability to make the payments. If Section 2036 applies there should be a Section 2043 offset based on the value of the annuity at the time of transfer.

Consider same strategies to avoid Section 2036 as one uses in order to avoid Section 2036 argument regarding sales to grantor trusts, including among others transfer assets to a trust with substantial corpus, seed trust in advance of private annuity transaction, sale should be negotiated between parties, and annuity amount should not be tied to or equal to the income generated by the trust.

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