Charitable Deduction - QTIP

Charitable Deduction - QTIP

News story posted in Field Service Advice on 16 April 1999| comments
audience: National Publication | last updated: 18 May 2011
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Summary

In FSA 1999-923, the IRS advised that although a surviving spouse's initial transfer of stock from a qualified terminable interest property ("QTIP") trust to the charitable remainder beneficiary of the QTIP was a non-qualified split interest transfer for gift tax purposes, the circumstances were such that it was not worth litigating over the gift tax charitable deduction. The IRS also advised that more facts would have to be gathered to determine if the actuarial tables were properly used.

FSA 1999-923

PGDC SUMMARY:

In this Field Service Advice, the IRS advised that (i) although a surviving spouse's initial transfer of stock from a QTIP trust to the charitable remainder beneficiary of the trust was a transfer of a non-qualified split interest under Code Section 2522, the facts were not favorable for litigation over the charitable gift tax deduction; and (ii) more facts would be needed to determine if the surviving spouse's actual life expectancy on the dates of the gifts justified use of the IRS actuarial tables.

The surviving spouse gave a portion of the stock in the QTIP trust which had been created by her late husband to the charity on one date, while retaining an interest in the trust. At a later date, she gave the remainder of the stock to the charity. She was suffering from incurable cancer at the time of both gifts and died a few days after the second gift. Noting that state law provides that the surviving spouse had no legal or equitable interest in the individual assets of the QTIP trust but only a right to enforce the payment of her income interest for life, the IRS advised that the first gift must be considered an assignment of an income interest from an undivided portion of the trust corpus as a whole and not an assignment of an income interest in any specific asset. However, the IRS indicated that a charitable gift tax deduction is allowable for the second gift because the second gift did not constitute a split interest transfer. The IRS concluded that the charitable gift tax deduction issue with respect to the first gift should not be litigated in this case because it would be difficult to demonstrate that any actual abuses of the type that originally led to the adoption of the split interest rules occurred during the months between the two gifts.

POINTS TO PONDER:

What kind of things might the IRS view as split interest abuses appropriate for litigation?

FULL TEXT:

INTERNAL REVENUE SERVICE

MEMORANDUM

WHEARD/1mr

CC:FS:P&SI



date: February 9, 1993

to: District Counsel, * * * (* * * Sub-office)
CC:* * *
Attn:* * *
from: Assistant Chief Counsel (Field Service) CC:FS
subject: * * *

TL-N-1167-93
Heard MacEachen Miscavich
Charitable Deduction, QTIP Property
2519 2523

This is in response to your request for Field Service Advice dated November 6, 1992.

ISSUES

1. Has the donor retained an interest in property transferred to charity thereby creating a "split interest" that does not satisfy the requirements for a gift tax charitable deduction under section 2522(c)(2) of the Internal Revenue Code?

2. May the actuarial tables be disregarded where the donor was suffering from an incurable cancer at the time of the gift, and in fact died * * * days later?

CONCLUSIONS

1. We agree that the donor transferred a nondeductible split interest. As a practical matter, however, the facts do not make a good case for successful litigation as the split interest merged shortly after its creation and all interests have in fact passed to charity. Under these facts, we would not be likely to prevail in court. Consequently, we recommend that the charitable deduction be allowed.

2. If medical evidence can be secured indicating that there was less than a five percent chance that the donor would survive more than one year after the transfer, the actuarial tables may be disregarded.

STATEMENT OF FACTS

* * * (donor) is the surviving spouse of * * * who died * * * Under his Will, the residue of his estate passed to the * * *. Under the * * * terms of the trust, income was payable to donor for life. * * * estate elected to treat the trust as qualified terminable interest property (QTIP) under section 2056(b)(7) of the Code.

The trust provides that upon donor's death, the remaining assets are to be distributed to * * * (the "Foundation"). The Foundation is exempt from federal income taxation under section 501(c)(3) and is an organization described in each of sections 170(c), 2055(a), and 2522(a)(2); gifts to the Foundation are deductible for income, estate and gift tax purposes.

For purposes of the following discussion, we assume that the corpus of the trust consisted of two blocks of stock, * * * shares of * * * and * * * shares of * * *. On * * * donor allegedly transferred to the Foundation all of her interest in the * * * shares. Donor filed a gift tax return for the year ended * * * in which she claimed a charitable deduction for a gift to the Foundation of "* * * shares of * * * common stock."

On * * * donor transferred to the Foundation all of her interest in * * * shares of * * * Donor filed a gift tax return for the year ended * * * in which she claimed a charitable deduction for a gift to the Foundation of "* * * shares of * * * common stock."

At the time of both gifts, donor was afflicted with an incurable physical condition. Donor died as a result of this condition on * * *

DISCUSSION

The initial question presented is how donor's gift is properly characterized for federal tax purposes.

We understand that the trust is governed by * * * law. Under * * * law, the interest of a beneficiary in an express trust is an equitable right to enforce the trust against the trustee, and creates no property interest in the beneficiary. "Every express trust, . . . shall vest the whole estate in the trustees, in law and in equity, subject only to the execution of the trust; and the person for whose benefit the trust was created, shall take no estate or interest in the lands, but may enforce the performance of the trust in equity." (emphasis added) * * *

In * * * it was held that the * * * beneficiary of an * * * trust had no property interest upon which the * * * could be applied. The beneficiary has no specific rights to any particular items of property in the trust, the interest being limited to what was established in the trust instrument, and the trustee can convey both a legal and equitable title in individual trust assets to a bona fide purchaser for value. See * * *

Notwithstanding the fact that the trust contained only two blocks of stock, it is clear that under local law donor held no legal or equitable interest in the individual assets, but only a right to enforce the terms of the trust, i.e., to enforce the payment of her life estate.

The interest which passed to donor was an income interest in the trust corpus as a whole, rather than an income interest in each individual asset of the trust. The "property" subject to donor's qualifying income interest for life (and to which the QTIP election applies) is the trust corpus as a whole, rather than each particular asset that may be in the trust at any given time. See TAM 9116003. Thus, we agree with the examiner that the assignment of the income from the * * * stock must be considered a transfer of an undivided portion of donor's income interest in the QTIP trust, and not as an assignment of an income interest in any specific stock.

Analysis

I.R.C. section 2519

Under section 2511(a), the transfer of an income interest in QTIP property constitutes a gift for gift tax purposes. Section 2519(a) provides that any disposition of all or part of a qualifying income interest for life in QTIP property is treated as the transfer of "all interests in such property other than the qualifying income interest." Thus, under sections 2511(a) and 2519(a), where a surviving spouse transfers all or part of a qualifying income interest for life, the transfer of the income interest also results in the deemed transfer of the entire remainder interest in the QTIP trust (even though only a portion of the income interest was transferred). See Estate of Higgins v. Commissioner, 91 T.C. 61, 70 (1988) (disposition of any part of income interest results in deemed transfer of entire remainder interest in trust).

The examples contained in the proposed regulations under section 2519 are consistent with this approach. For example: in Example (4) of section 25.2519-1(h), a spouse is given a life interest in a trust worth $400,000. A QTIP election is made for half of the trust. The spouse deeds 40% of her interest to her children. Under section 2511 she is treated as making a gift of the entire remainder interest in the QTIP property of $150,000 (which is the fair market value of the entire QTIP property less the $50,000 value of the life interest). Similarly, in Example (5), the disposition of only a portion of the spouse's life interest results in the deemed transfer of the entire QTIP remainder interest.

A question has arisen as to whether this deemed transfer treatment carries over into other provisions of Chapter 12, in particular, section 2522. We note that section 2519 provides "For purposes of this chapter and Chapter 11, any disposition . . ." Thus it would appear donor is treated as the transferor of the remainder for all purposes of the gift and estate tax. This interpretation is consistent with the entire QTIP scheme. When a QTIP election is made with respect to property in which a surviving spouse possesses a qualifying income interest for life, then that property is treated as the spouse's for transfer tax purposes, i.e., it is includible in the gross estate of the surviving spouse for estate tax purposes, and is treated as transferred by the surviving spouse for gift tax purposes, despite the fact that, under local law, it was disposed of by the predeceasing spouse. See, e.g., Prop. Treas. Reg. section 25.2519- 1(h), ex. (4) (spouse is treated as transferor of her QTIP income and remainder interest).

We are aware that section 2519 contains no provision comparable to section 2044(c). Such a provision may not have been thought to be necessary in light of the broad introductory language of section 2519(a), which is not found in section 2044(a). In any event, we believe that a deduction is available under section 2522, despite the fact that the surviving spouse is merely the deemed transferor under section 2519.

I.R.C. section 2522

In * * * donor disposed of a portion of her income interest in the trust measured by the value of the * * * stock. The transfer of the income interest is a gift for purposes of section 2511. Under section 2519 she is deemed to have transferred the entire trust remainder. The question presented is whether the * * * gift was one of a split interest within the meaning of section 2522 of the Code, resulting in the disallowance of the charitable deduction. Section 2522(c)(2) and Treas. Reg. section 25.2522(c)-3(c)(1)(i) provide that where a donor transfers an interest in property to a qualified recipient, and retains an interest in the same property (or transfers that interest for private purposes), no deduction is allowed for the interest transferred to charity unless it is in a qualified form. Since the transfer in this case was not in a qualified form, the narrow issue is whether the taxpayer retained an interest in the same "property" that was transferred.

The examples under Treas. Reg. section 25.2522(c)- 3(c)(1)(i) illustrate that when a transferor retains an income interest in trust (or transfers that interest for private purposes), and transfers a remainder interest in the same trust to charity, the transferor has created a split interest. See Exs. (1), (2), (4), and (5).

We agree that donor has created a nondeductible split interest. In * * *, under sections 2511 and 2519, donor is treated as transferring to charity a partial income interest plus the entire remainder interest, while retaining a partial income interest in that same trust property. Thus, after the * * * transfer, the same donor had transferred an interest to charity while retaining an interest in that same property. /1/ These are the very circumstances which led to the enactment of section 2522(c). The transfer of property subject to a retained interest constitutes a disqualified split interest, since the transferred interest is not in the form of a charitable remainder trust described in section 664.

On the other hand, after the * * * transfer, donor retained no interest in the trust. The * * * transfer did not constitute a split interest transfer. A deduction is allowable under section 2522 to the extent of the value of the life estate transferred to charity.

Notwithstanding the fact that the * * * transfer resulted in a nondeductible split interest, we do not believe that this issue should be pursued on these facts. Charitable deduction cases are best litigated on facts where the government can demonstrate the abuses which led to the addition of the split interest rules. While this case clearly presents the potential for abuse, we doubt that the government could demonstrate any actual abuse during the * * * month period during which the split interest persisted. This is very similar to the circumstances delineated under section 2055(e)(3)(F), permitting a deduction for certain split interests where the private interest is terminated by the death of the beneficiary prior to the due date of the estate tax return. Further, in a somewhat analogous situation the Service has permitted a charitable deduction where the surviving spouse timely elected to take against the will. See Rev. Rul. 78-152, 1978-1 CB 296 (election resulted in remainder interest vesting immediately in charity; deduction allowed despite the fact that under the will there was a split interest). See also In re Larus, 33 AFTR2d 74-1453 (N.Y. Surr. Ct.) for an example of the lengths to which a court might go to facilitate a charitable deduction (will construed as creating two separate trusts, one exclusively noncharitable and one which contained a qualified remainder interest, in order to allow a deduction for the otherwise qualified remainder interest passing to charity).

On the other hand, we believe that this position could be successfully defended under facts where we could more clearly demonstrate the abuses inherent in split interest. For example, if a surviving spouse transferred her income interest to her child and continued to survive, charity would receive no immediate benefit. On those facts the potential for abuse could be mere credibly demonstrated.

Accordingly, we recommend that the split interest issue be conceded on these facts.

Use of Actuarial Tables

You have also asked whether the actuarial tables are applicable given the taxpayer's state of health and proximity of death. Given our conclusion above, this analysis is probably relevant only for income tax purposes.

The actuarial tables of Treas. Reg. section 25.2512-5 are provided as an administrative convenience, and their general use has long been approved by the courts. See Simpson v. United States, 252 U.S. 547 (1920) and Ithaca Trust v. United States, 279 U.S. 151 (1929). The actuarial tables properly apply to the vast majority of individual life interests, even though the health of a particular individual may be better or worse than that of the average person of the same age. Occasionally, however, the actual facts of an individual's condition are so exceptional as to justify departure from the tables.

Where there is sufficient evidence regarding the actual life expectancy of a life tenant, the presumptive correctness of the Treasury tables will be overcome. Miami Beach First National Bank v. United States, 443 F. 2d 116, 119 (5th Cir. 1971). In the following cases, the Tax Court recognized exceptional medical circumstances that precluded the use of tables: Estate of Denbigh v. Commissioner, 7 T.C. 387 (1946) (life tenant suffered from terminal cancer and died from this cancer 18 months after valuation date, consistent with her doctor's opinion that she could not possibly live more than one or two years); Estate of Jennings v. Commissioner, 10 T.C. 323 (1948) (life tenant had suffered fifth stroke in January 1940, leaving him with loss of memory and partial paralysis and remained in this condition until his death in November 1941, two months after valuation date; medical opinion was that "his reasonable life expectancy was not more than one year from the date of decedent's death"); Huntington National Bank v. Commissioner, 13 T.C. 760 (1949) (life tenant with numerous maladies, though none described as terminal, was total invalid for last two years of her life and died seven months after valuation date; Court found "life expectancy was not greater than one year" based on family physician's opinion that "she would pass away most any time"); Estate of Butler v. Commissioner, 18 T.C. 914 (1952) (life tenant suffered from terminal cancer and died from this cancer five months after valuation date; Court found "her life expectancy was not more than one year"); and Estate of Hoelzel v. Commissioner, 28 T.C. 384 (1957) (life tenant suffered from terminal lung cancer and died from this cancer 15 months after valuation date; her surgeon and physician were of the opinion that she could live a maximum of about a year and a half, and Court found that her "life expectancy . . . did not exceed 1 year").

Based on the above and the death of the donor * * * days after the * * * gift, it may be appropriate to disregard the tables. Examination will need to develop evidence as to taxpayer's actual life expectancy at the time the gift was made rather than simply relying on the fact that death occurred shortly after the gift. Specifically, evidence will have to be developed that the probability that the taxpayer would survive a year or more was "so remote as to be negligible." Rev. Rul. 80-80, 1980-1 C.B. 194. The phrase "so remote as to be negligible" has been defined as a five percent chance. See Rev. Rul. 70-452 1970-2 C.B. 199. At a minimum, this determination will require a doctor's opinion. If a doctor's opinion can be secured that there was less than a five percent probability that the taxpayer would live more than one year after the date of the gift, then the actuarial tables may be disregarded. The valuation of the taxpayer's life interest under these circumstances would be based on her actual life expectancy at the time the gift was made.

Please refer any questions on these issues to Bill Heard at (202) 622-7830.

This document includes confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. This document should not be disclosed to anyone outside the IRS, including the taxpayer involved, and its use within the IRS should be limited to those with a need to review the document in relation to the subject matter or case discussed herein. This document also is tax information of the instant taxpayer which is subject to I.R.C. section 6103.

Daniel J. Wiles
By: Robert B. Miscavich, Jr.
Senior Technician Reviewer
Passthroughs and Special
Industries Branch

FOOTNOTE

/1/ In addition, under section 2519 and the proposed regulations, the taxpayer is treated as retaining a proportional interest in all of the assets of the trust. See example 5 of Prop. Treas. Reg. section 25.2519-(1)(h) regarding the application of section 2036 to a deemed transfer under section 2519.

END OF FOOTNOTE

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