Ron Aucutt’s “Top Ten” Estate Planning and Estate Tax Developments of 2011

December 21, 2011

Number Ten: The Defined Value Clause Good News: Petter v. Commissioner, 653 F.3d 1012 (9th Cir. 2011), aff’g T.C. Memo 2009-280

This was the third recent case to affirm the technique of donating a nonmarketable asset, such as an interest in a family limited partnership or LLC, by transferring a total specified interest but allocating a specified dollar value to family members and any excess to charity. Similar outcomes had previously been achieved in McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006), rev’g 120 T.C. 358 (2003), and Estate of Christiansen v. Commissioner, 130 T.C. 1 (2008) (reviewed by the Court), aff’d, 586 F.3d 1061 (8th Cir. 2009). When this technique works, it effectively prevents the assessment of any gift tax or estate tax deficiency, because any increase in value on audit merely increases charity’s share and is absorbed by the charitable deduction. Typically, assets are thereby transferred to family members with significant valuation discounts.

In Petter, Judge Holmes, who had written the majority Tax Court opinion in Christiansen, distinguished Commissioner v. Procter, 142 F.2d 824 (4th Cir.), cert. denied, 323 U.S. 756 (1944), rev’g & rem’g 2 TCM [CCH] 429 (1943), which “became the cornerstone of a body of law regarding ‘savings clauses,’” holding them invalid “conditions subsequent” and “contrary to public policy” because they discourage collection of tax, obstruct the administration of justice, and would require courts to render unauthorized declaratory judgments. Judge Holmes summed up:

In Christiansen, we … found that the later audit did not change what the donor had given, but instead triggered final allocation of the shares that the donees received. 130 T.C. at 15. The distinction is between a donor who gives away a fixed set of rights with uncertain value – that’s Christiansen – and a donor who tries to take property back – that’s Procter. The Christiansen formula was sufficiently different from the Procter formula that we held it did not raise the same policy problems.

A shorthand for this distinction is that savings clauses are void, but formula clauses are fine.

Petter attracted attention because it was appealed to the Court of Appeals for the Ninth Circuit, a court sometimes viewed as taxpayer unfriendly. Curiously, in the Ninth Circuit, the Government did not argue the “public policy” element of Procter but relied on the argument “that part of the gifts to the charitable foundations were subject to a condition precedent – an IRS audit – in violation of Treasury Regulations 25.2522(c)-3(b)(1),” which provides that no gift tax charitable deduction is allowed for a transfer to charity that is dependent on a future act or “a precedent event” for the transfer to be effective. The Ninth Circuit rejected that argument and thereby gave aid and comfort to the use of such defined value formulas. [But see Development Number Five below.]

Number Nine: A Deductible Whole with Undetermined Marital and Charitable Parts: Letter Ruling 201117005 (Jan. 5, 2011)

This letter ruling involved, among other things, a proposed testamentary charitable remainder unitrust (CRUT) that was to be distributed under a somewhat unusual formula. While one-fifth of the unitrust amount each year would go to the surviving spouse, four-fifths of the unitrust amount would be distributed either to the spouse or to a private foundation (which was also the charitable remainder beneficiary) in the trustees’ discretion. If the surviving spouse remarried, the spouse was to receive only the one-fifth portion of the unitrust amount and any amount of the remaining four-fifths portion of the unitrust amount that was necessary to ensure that the amount received by the spouse was not de minimis.

The Service held that upon the taxpayer’s death the entire value of the assets distributed to the CRUT would be deductible in calculating the taxable estate, because all the value of the CRUT would pass to either charity or the surviving spouse, even though the respective values passing to charity and the surviving spouse could not be determined. In looking at the legislative history, the Service concluded that when a taxpayer establishes a testamentary CRUT in which the surviving spouse is the only non-charitable beneficiary, the estate tax marital deduction will completely offset the value of the assets distributed to the CRUT after deducting the value of the remainder interest passing to the charity, so there will be no estate tax attributed to the CRUT.

This common sense result opens up an opportunity for flexibility without creating tax uncertainty.

Number Eight: Crackdown on Tax Strategy Patents

President Obama signed the Leahy-Smith America Invents Act, Public Law 112-29, on September 16, 2011. Section 14 of the Act provides that tax strategies are not patentable because they are “deemed insufficient to differentiate a claimed invention from the prior art.” The tax strategies provision applies to any patent pending and any patent issued after the date of enactment, September 16, 2011. Therefore, for example, the statute does not invalidate the so-called “SOGRAT” patent, No. 6,567,790, which deals with the funding of a grantor remainder annuity trust with nonqualified stock options and was adjudged to be valid and enforceable in a stipulated consent judgment in Wealth Transfer Group, Inc. v. Rowe, Case No. 3:06CV00024 (D. Conn. 2007). The director of the U.S. Patent and Trademark Office, however, has now initiated a review of the validity of the SOGRAT patent.

Because patents on techniques designed to save estate tax can inhibit the use of otherwise useful techniques in ways both clients and advisors often find arbitrary and unfair, it is a welcome development that Congress has denounced such patents, even prospectively, and that as a result such patents might be on the way to extinction.

Number Seven: Valuation Activism in the Tax Court: Estate of Giustina v. Commissioner, T.C. Memo 2011‑141; Estate of Gallagher v. Commissioner, T.C. Memo 2011-148

In these cases, the Tax Court subjected the reports of the executors’ appraisers (as well as the IRS experts) to an excruciating line-by-line review and to what, it seems, can fairly be described as vigorous and exhaustive second-guessing.

For example, in Giustina, Judge Morrison valued a 41.128 percent limited partnership interest in a partnership conducting forestry operations by giving a 75 percent weight to a cash flow method and a 25 percent weight to an asset value method. Because the partnership’s asset value of $151 million was much greater than the value of $52 million determined by the cash flow method, assigning any weight to the asset value greatly increased the value subject to estate tax. The court did this even though there was no evidence that a sale or liquidation was anticipated and, indeed, as the court summarized, “[t]he Giustina family had a long history of acquiring and retaining timberlands.” The court assumed that although the owner of a 41.128 percent limited partnership interest “could not alone cause the partnership to sell the timberlands,” it could join with other limited partners to compile the two-thirds vote necessary to replace the general partners or to dissolve the partnership.

Gallagher involved the valuation of approximately 15 percent of the interest in a closely held newspaper publishing business. Judge Halpern rejected both the executor’s and the Service’s experts’ selections of publicly traded guideline companies for comparison. He also rejected the factors used by each expert in applying the discounted cash flow method. But he ultimately allowed a combined minority and lack-of-marketability discount of almost 47 percent.

Together these cases illustrate that, probably on a judge-specific basis, an executor or donor who takes an estate or gift tax valuation case to the Tax Court, even involving an interest in an active business, can be in for a tedious and unpredictable time.

Number Six: Healthcare in the Supreme Court: Florida et al. v. Dep’t of Health & Human Services, et al., 648 F.3d 1235 (11th Cir. 2011), cert. granted Nov. 14, 2011 (No. 11-398)

By agreeing to hear constitutional objections to the Patient Protection and Affordable Care Act, the U.S. Supreme Court virtually guaranteed a decision next summer, before the November presidential and congressional elections. When the decision is announced, the winners will be validated and the losers will be energized (assuming that the Court’s opinion makes it that clear who the winners and losers are), and the elections will almost certainly be affected in some way. The outcome of the elections might be very significant in determining the look and level of the estate, gift, and GST taxes for a generation or longer. In addition, the opinion itself might affect the way legislation, including tax legislation, is enacted in the future.

Number Five: The Defined Value Bad News: Hendrix v. Commissioner, T.C. Memo 2011-133

Petter (Development Number Ten discussed above) provided good news regarding the use of defined value formulas. Hendrix, while also affirming the use of that technique, sounded a sobering note.

Hendrix is the fourth case, after McCord, Christiansen, and Petter, to approve the use of a defined value clause, with the excess going to charity. But in so doing, Judge Paris emphasized the size and sophistication of the charity, the early participation of the charity and its counsel in crafting the transaction, the charity’s engagement of its own independent appraiser, the charity’s fiduciary obligation to ensure that it received the number of shares to which it was entitled, and the fundamental public policy of encouraging gifts to charity. As a result, the opinion is a reminder that all of the recent defined value formula cases have involved charity (not a return of property to the grantor or redirection of the assets elsewhere) and a warning that arm’s-length negotiations with the charity might be required, or at least will be given substantial weight.

In other words, Hendrix warns that the use of defined value formulas affirmed in the recent cases might be much narrower than first meets the eye (at least in the eyes of the Tax Court).

Number Four: The November 23rd Million-Dollar-Exemption Rumor

Although a rumor that the congressional deficit-reduction “supercommittee” would propose a return of the gift tax exemption to $1 million, effective immediately on November 23, 2011, was viewed as bogus by many observers, including the McGuireWoods Private Wealth Services Group, it received extremely widespread attention and doubtless precipitated a significant amount of transfers.

The rumor turned out to be false. But it revealed the intense hunger of the estate planning community for any kind of news about the stabilization of the estate, gift, and GST tax environment.

Number Three: The First Administrative Guidance Since the Fall of 2009

There was no significant administrative estate tax guidance from October 2009 until the beginning of August 2011. Apparently, the Senate’s inaction in December 2009 that allowed the 2010 carryover basis law to take effect and the sweeping compromise that Congress enacted in December 2010 had been as unexpected and distracting for the authors of administrative guidance as they were for the estate planning community.

But since the beginning of August, Treasury and the IRS have addressed seven of the seventeen items under the heading of “Gifts and Estates and Trusts” in the Treasury-IRS Priority Guidance Plan for the 12 months beginning July 1, 2011, as follows:

Item 1, “Regulations under §67 regarding miscellaneous itemized deductions of trusts and estates.” On September 6, 2011, the IRS withdrew the proposed regulations published in 2007 and released new proposed regulations.

Item 6, “Guidance under §1022 concerning estates of decedents who die during 2010.” The IRS released Rev. Proc. 2011-41, 2011-35 I.R.B. 188, and Notice 2011-66, 2011-35 I.R.B. 179, on August 8, 2011, and Notice 2011-76, 2011-40 I.R.B. 479, on September 13, 2011.

Item 7, “Guidance on portability of Unified Credit between spouses under §2010(c).” Notice 2011-82, 2011-42 I.R.B. 516, released on September 29, 2011, addressed some issues related to the election of portability and asked for comments on regulations Treasury and the IRS intend to issue.

Item 8, “Regulations under §2032(a) regarding imposition of restrictions on estate assets during the six month alternate valuation period.” On November 18, 2011, the IRS withdrew the proposed regulations published in 2008 and released new proposed regulations.

Item 9, “Final regulations under §2036 regarding graduated grantor retained annuity trusts.” Those regulations were published on November 8, 2011.

Item 10, “Revenue ruling on whether a grantor’s retention of a power to substitute trust assets in exchange for assets of equal value, held in a nonfiduciary capacity, will cause insurance policies held in the trust to be includible in the grantor’s gross estate under §2042.” This was published on December 5, 2011, as Rev. Rul. 2011-28, 2011-49 I.R.B. 830.

Item 12, “Revenue procedure providing procedures for filing protective claims for refunds for amounts deductible under §2053.” This project was completed by Rev. Proc. 2011-48, 2011-42 I.R.B. 527, released on October 14, 2011.

Notably, two of those projects (items 1 and 8) were addressed by the withdrawal of proposed regulations and the adoption of different approaches in re-proposed regulations. This reflects humility and carefulness even in a time of catching up.

All of this is significant to estate planning advisors, because administrative guidance – especially the issuance of regulations with its process of notice and comment – often lends itself better than legislation to the development of holistic, sensitive, and workable solutions that have public acceptance.

Number Two: The Step Transaction Doctrine and 9-9-9 [No, Not That 9-9-9]: Linton v. United States, 630 F.3d 1211 (9th Cir. 2011), aff’g in part, rev’g in part, and rem’g 638 F. Supp 2d 1277 (D. Wash. 2009)

In this decision, the Ninth Circuit remanded a District Court decision against the taxpayer to permit evidence of a nine -day interval between the funding of the LLC and the gift of LLC interests, but its footnote 9 sounds the alarm that some interval of time, of uncertain length, is indeed necessary.

This largely taxpayer-friendly decision, again from a reputed taxpayer-unfriendly court of appeals (as in Development Number Ten discussed above), struck down and remanded a district court’s fusion under the step transaction doctrine of the funding of an LLC and the purported gifts of LLC interests. Specifically, the Court of Appeals directed the District Court to resolve the ambiguity between the date of January 22, 2003, which appeared on the documents funding the LLC and making gifts of LLC interests, and the date of January 31, 2003, which some evidence suggested should have been placed on the gift documents.

The good news for taxpayers was that the court appeared to have little use for application of any step transaction analysis. But the bad news, in footnote 9, is that the court ominously suggested that a waiting period between funding and transfers might still be required. Citing Holman v. Commissioner, 130 T.C. 170, 189 (2008), aff’d, 601 F.3d 763 (8th Cir. 2010), and Gross v. Commissioner, T.C. Memo 2008-221, n.5, the court stated:

To obtain favorable tax treatment, the Lintons needed to transfer assets to the LLC and then wait at least some amount of time before they gifted the LLC interests to their children. The waiting period would subject the gifted assets to some risk of changed valuation before they were transferred, through the LLC, to the children’s trusts. That risk would make the two transactions distinct for tax purposes. (The government has not challenged that the nine days between January 22 and January 31 is a sufficiently long period to make the transactions distinct, notwithstanding that some of the value transferred to the LLC was cash….)

It is obviously of great concern that interests in an LLC or partnership that might have been created for the specific purpose of facilitating gifts cannot be the subject of gifts until the lapse of a period of time that is entirely undefined and subjective. The reference to a “risk of changed valuation” is of little help in a context where it is often the very lack of a market that drives the valuation if not the entire transaction. Linton joins Holman and Gross in warning that this uncertainty will continue to loom over such transactions.

Number One: They Listen to Us: The “Sensible Estate Tax Act of 2011” (H.R. 3467)

The “Sensible Estate Tax Act of 2011,” H.R. 3467, introduced on November 17, 2011, by Congressman Jim McDermott (D-WA), would reduce the estate and gift tax exemptions to $1 million, effective in 2012. Quixotically, it would index that amount for inflation since 2001, but would appear to begin that indexing in 2013, not 2012, with the result that the current exemption of $5,000,000 would apparently drop to $1,000,000 in 2012 and then jump to about $1,340,000 in 2013 (assuming 2011 inflation rates). If indexing began in 2012, which is the likely intent, the 2012 exemption would be about $1,310,000.

H.R. 3467 would also restore the top 55 percent rate, but for taxable estates over $10 million, and after 2012 all the rate bracket amounts would also be indexed for inflation, which would make the 55 percent rate effective for taxable estates over about $13,430,000.

As a significant tax increase, H.R. 3467 has no future in the current Republican-led House of Representatives. But it is of foremost significance for its attention to subsidiary technical issues and its careful and effective drafting to address those issues:

Section 2(c) of H.R. 3467 would prevent the notorious “claw back” that might otherwise operate to recapture some or all of the benefit of today’s large gift tax exemption if the donor dies when the estate tax exemption is lower. It does this by providing that the applicable exclusion amount used to calculate the hypothetical gift tax to subtract under section 2001(b)(2) may never exceed the applicable exclusion amount used to compute the tentative estate tax.

Section 2(d) of H.R. 3467 would correct a divergence between the statutory “portability” language and the legislative history, by confirming that the legislative history reflected true congressional intent.

Section 5 of H.R. 3467 would flesh out the statutory language implementing an Administration proposal to require the estate tax value (not the heir’s after-the-fact opinion of date-of-death value) to be used as the recipient’s basis for income tax purposes. Specifically,

  • new sections 1014(f)(1) and 1015(f)(1) would require the value used to determine basis in the hands of the recipient for all income tax purposes generally to be no greater than the value “as finally determined” for estate or gift tax purposes,
  • a new section 6035 would require each executor or donor required to file an estate or gift tax return to report to the Service and to each person receiving any interest in property from a decedent or donor the value of all such interests as reported on the estate or gift tax return “and such other information with respect to such interest as the Secretary may prescribe,”
  • new sections 1014(f)(2) and 1015(f)(2) would require the value used to determine basis to be no greater than the value reported on that statement if “the final value … has not been determined,”
  • new sections 1014(f)(3) and 1015(f)(3) would authorize Treasury by regulations to “provide exceptions” to the application of these rules,
  • new section 6035(c) would authorize Treasury to prescribe implementing regulations, including the application of these rules to situations where no estate or gift tax return is required and “situations in which the surviving joint tenant or other recipient may have better information than the executor regarding the basis or fair market value of the property,” and
  • both the failure to report under section 6035 and the failure to use a consistent basis under section 1014(f) or 1015(f) would be subject to penalties.

The references in proposed sections 1014(f)(1) and 1015(f)(1) to the value “as finally determined” for estate or gift tax purposes allay concerns raised by a publication in September 2009 by the staff of the Joint Committee on Taxation that income tax basis might be limited to the value reported on an estate tax return, even if that value is increased in an estate tax audit. The exception in proposed sections 1014(f)(2) and 1015(f)(2) when “the final value … has not been determined” seems to be a necessary compromise, although it would inevitably influence the liquidation decisions of executors and heirs.

This attention to technical issues at the staff level is a source of great relief and reassurance about any estate tax legislation Congress might entertain in 2012 or early 2013. The political decisions – rates, exemptions, effective dates, and the like – and the timing of those decisions are impossible to predict. But it is good to know that the congressional staffs are as ready as they can be to pull workable technical language from the shelf on short notice to fit whatever political solution emerges. In the main, such drafting at the technical level worked well in December 2010, and it would be welcome again whenever Congress acts. We have learned from recent experience that the technical details of statutory language can sometimes create as much heartburn as the macro political choices themselves. Thus, ahead-of-the-curve staff attention to those details earns the first place in this list of 2011 developments.


We recognize that readers may disagree with some or all of Ron’s top ten picks, and that is understandable because subjective judgments like this are based on perspective and experience, not science. We do hope that this list of developments will help you not only in understanding some of the favorable and not so favorable developments that occurred in 2011 but also in using them to benefit your clients and customers in 2012 and beyond. We do wish every reader a joyous holiday season and prosperous 2012.

Fiduciary Advisory Services and Private Wealth Services

McGuireWoods’ Fiduciary Advisory Services and Private Wealth Services Teams stand ready to advise individuals, financial institutions, and other clients about planning, tax, and fiduciary matters. McGuireWoods’ Private Wealth Services Group has been ranked by Chambers, the international rating service for attorneys, as one of the top wealth management legal practices in the country for several years. Please click here for a full listing of our lawyers and their locations.