Opinion
2458-22 2459-22 2460-22
10-17-2023
BRUCE E. MCDOUGALL, DONOR, ET AL., Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
James S. Halpern, Judge.
These consolidated cases involve the gift tax liabilities, for the taxable year ended December 31, 2016, of Bruce McDougall (Bruce) and his children, Linda Lewis (Linda) and Peter McDougall (Peter). The gifts respondent alleges relate to assets held in a trust (Residuary Trust) created under the will of Bruce's deceased spouse, Clotilde.
Bruce was a life beneficiary of the Residuary Trust. He also had a power to appoint, by his own will, the principal of the Residuary Trust to or among Clotilde's descendants. If Bruce had died without having exercised his power of appointment, the assets of the Residuary Trust would have been divided between Clotilde's children and the children of any child who did not survive Bruce.
Bruce was the personal representative of Clotilde's estate. In that capacity, on the Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, filed by Clotilde's estate, Bruce made an election under section 2056(b)(7) to treat as qualified terminable interest property (QTIP) the property that funded the Residual Trust.
Effective October 31, 2016, Bruce, Linda, and Peter entered into an agreement that the parties refer to as the Nonjudicial Agreement. Section 2 of that agreement provides: "The parties hereby agree that the [Residuary] Trust shall be commuted and the entire balance of the Trust shall be distributed outright and free of trust to Bruce."
On the same day that the Nonjudicial Agreement became effective, Bruce transferred to trusts established for the benefit of Linda, Peter, and their descendants (Children's Trusts) substantially all of the assets distributed to him from the Residuary Trust in exchange for promissory notes.
Section 2001(a) imposes a tax "on the transfer of the taxable estate" of U.S. citizens or residents. The value of a decedent's taxable estate equals his gross estate less allowable deductions. § 2051. Section 2033 includes in a decedent's gross estate "the value of all property to the extent of the interest therein of the decedent at the time of his death." Section 2056(a) allows a deduction for the value of property that passes from the decedent to his surviving spouse. The marital deduction generally does not apply, however, to terminable interests, such as an income interest for life. § 2056(b)(1). Property passing from a predeceasing spouse to a surviving spouse can qualify for the marital deduction, however, if (1) the surviving spouse has a qualifying income interest in the property for life, and (2) the predeceasing spouse makes an election under section 2056(b)(7). (Property that meets those conditions is classified as QTIP. § 2056(b)(7)(B)(i).) If the surviving spouse disposes of his qualifying income interest for life in QTIP, he is treated as having transferred all of the interests in the property other than his qualifying income interest. § 2519(a). If, instead, the surviving spouse retains his qualifying income interest in the QTIP until his death, the value of the QTIP is included in the surviving spouse's estate. § 2044.
Statutory references are to the Internal Revenue Code, Title 26, in effect for the years in issue, and regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.).
Respondent has moved for partial summary judgment that, among other things, (1) the commutation and termination of the Residuary Trust effected a "disposition," for purposes of section 2519, of Bruce's qualifying income interest for life in the trust property, and (2) the distribution to Bruce of all of the trust property to Bruce effected taxable gifts by Linda and Peter to their father of their shares of the trust property. Alternatively, respondent asks for judgment that, if the commutation of the Residual Trust and the distribution of all the trust assets to Bruce did not, by themselves, effect a disposition for purposes of section 2519, those transactions, together with Bruce's transfer of substantially all of the trust assets to the Children's Trusts did effect a "disposition." Petitioners have moved for summary judgment "that no taxable gifts occurred and that no gift tax deficiencies exist."
On October 10, 2023, we held a conference call with the parties' counsel during which we discussed questions we had previously provided them. We list those questions (in abbreviated form) below. Questions 1 through 9 are directed to respondent. Questions 10 through 12 are directed to petitioners.
1. In asking for summary judgment that, under the terms of the Nonjudicial Agreement, Bruce effected a "disposition of all or part of [his] qualifying income interest for life in" the property of the Residuary Trust, within the meaning of section 2519, how does respondent interpret the term "disposition" as used in that section?
2. In particular, does respondent advocate the position advanced in Revenue Ruling 98-8, 1998-1 C.B. 541, that "[t]he term 'disposition,' as used in § 2519, applies broadly in circumstances in which the surviving spouse's right to receive the income is relinquished or otherwise terminated, by whatever means"? If so, can respondent cite authority for that position other than the revenue ruling? The ruling itself purports to rely on H. Rep. No. 97-201, at 161 (1981), which states that property subject to a QTIP election is subject to transfer taxes if the surviving spouse "disposes (either by gift, sale, or otherwise) of all or part of the qualifying income interest." The committee report thus supports the proposition that the term "disposition," as used in section 2519, is not limited to gifts and sales. That the term is not limited to gifts and sales, however, does not establish that any termination of an income interest, by any means, is a disposition. How does respondent get from "not just gifts and sales" to "termination by whatever means"?
3. Assuming that section 2 of the Nonjudicial Agreement effected two transactions (a pro rata distribution of assets of the Residuary Trust to Bruce, Linda, and Peter and a subsequent transfer by Linda and Peter to Bruce of their shares of the trust assets), does respondent's position that the commutation and termination of the Residuary Trust effected a disposition, within the meaning of section 2519, rest on treating those two transactions as separate? If so, on what grounds is it appropriate to separate the two transactions for the purpose of determining whether a "disposition" occurred? If respondent's position does not rest on treating the transactions as separate, under what definition of "disposition" would both transactions (pro rata distribution and subsequent transfer by Linda and Peter to Bruce) have effected a disposition of Bruce's qualifying income interest for life in the trust assets? Put differently, if the pro rata distribution of trust assets alone would have effected a disposition, could the second step transfer from Linda and Peter to Bruce be viewed as having effectively "undone" the disposition?
As noted below, petitioners apparently dispute that the Nonjudicial Agreement effected two transactions.
4. Respondent asserts that allowing the portion of that Residuary Trust property with a value attributable to Linda and Peter's remainder interests to escape transfer tax under either section 2044 or 2519 "would be contrary to the QTIP statutory scheme and legislative history." The property that would escape transfer tax under either section 2044 or 2519, however, would (if not gifted or consumed before Bruce's death) be included in his estate under section 2033. As long as QTIP (if not consumed) is subject to gift or estate tax when transferred by the surviving spouse, does it matter, for purposes of the QTIP policies, what specific provision results in the imposition of tax?
5. Respondent contends that consideration of "hypothetical estate tax returns at certain moments of time . . . [is] irrelevant." How does respondent square that contention with the analysis articulated in Revenue Ruling 98-8, in which the Service considered the effect of the transactions in issue on the taxable estate of a surviving spouse? Does the ruling not establish that consideration of the impact of transactions on the taxable estates of the participants is relevant in determining whether the transactions effected a section 2519 disposition?
6. Respondent's alternative position would be moot if the transaction(s) effected by the Nonjudicial Agreement themselves effected a "disposition." If the Nonjudicial Agreement did not, by itself effect a disposition, how did the assets-for-notes exchange complete a disposition? In other words, what definition of "disposition" would encompass all the transactions but not those effected by the Nonjudicial Agreement?
7. Respondent contends that the "fact pattern" of the present cases, is "almost identical to that of Estate of Kite." In Estate of Kite, we relied on a recast of the transactions in issue to conclude that they involved a section 2519 "disposition." In particular, we found "that the termination of the QTIP trusts and the following immediate transfer of the QTIP trust assets to the Kite children are treated as a single transaction for purposes of section 2519." Estate of Kite, T.C. Memo. 2013-43, at *41. In actual form, the trust assets were first distributed to Mrs. Kite and she then sold those assets to her children in exchange for a deferred annuity. Our recast of the transaction reordered the steps, treating it as a sale by Mrs. Kite of her income interest in the trust followed by a distribution of the trust assets to the children. As recast, the disposition of Mrs. Kite's income interest (taking the form of a sale) was obvious. We reasoned that respecting the transaction's form-that is, giving effect to the "intermediary step" of "terminating the QTIP trusts before selling the QTIP trust assets to the Kite children"-would "circumvent the QTIP regime and avoid any transfer tax imposed by section 2519." Id. Our concern obviously rested on the premise that the distribution of the trust assets to Mrs. Kite-the analogue to the transactions effected by section 2 of the Nonjudicial Agreement-would not have resulted in a section 2519 disposition. Consequently, whatever support Estate of Kite might provide for respondent's alternative position, does it not undermine respondent's primary position that the commutation of the Residuary Trust and the distribution of all trust assets to Bruce effected a disposition without regard to Bruce's subsequent exchange of trust assets for promissory notes?
8. How does respondent understand the policy concerns underlying the analysis in Estate of Kite? In the present cases, how would the policies underlying the QTIP rules be undermined were we to conclude that (1) the transaction(s) effected by section 2 of the Nonjudicial Agreement must be viewed independently of the assets-for-notes exchange for the purpose of applying section 2519, and (2) so viewed, the section 2 transaction(s) did not effect a section 2519 disposition?
9. Petitioners claim that Treasury Regulation § 25.2519-1(e) supports the proposition that the transactions in issues did not trigger section 2519. That section provides: "The exercise by any person of a power to appoint qualified terminable interest property to the donee spouse is not treated as a disposition under section 2519, even though the donee spouse subsequently disposes of the appointed property." Respondent counters that petitioners' "analogy" to Treasury Regulation § 25.2519-1(e) fails both factually and legally. As a factual matter, the transactions effected by section 2 of the Nonjudicial Agreement did not involve the exercise of a power of appointment. And as a legal matter, respondent observes, "no one had a power to appoint all the Residuary . . . Trust assets to Bruce." Instead, Bruce received the trust assets by reason of (1) the commutation of the trust, and (2) Linda and Peter's agreement to allow Bruce to receive the portion of the trust assets to which they would otherwise have been entitled.
Respondent's observation that Treasury Regulation § 25.2519-1(e) does not directly apply to petitioners' cases may miss their point. The regulation may inform the interpretation of the term "disposition," as used in section 2519. What understanding of "disposition" supports the position adopted in Treasury Regulation § 25.2519-1(e) that a surviving spouse's acquisition of outright ownership of QTIP by reason of the exercise of a power of appointment in the surviving spouse's favor is not "treated as a disposition under section 2519?" The regulation can be read as a specific example of a more general proposition that no section 2519 disposition results from one or more transactions that augment a surviving spouse's interest in QTIP without diminishing the surviving spouse's interest in any other QTIP. (A similar proposition seems to underlie the rule provided in section 2056(b)(7)(B)(ii) that the ability to appoint property to anyone other than the surviving spouse disqualifies the property from being QTIP but the ability to appoint in the surviving spouse's favor does not.) If that is how Treasury Regulation § 25.2519-1(e) should be understood, would that general proposition not apply equally to the transactions effected by section 2 of the Nonjudicial Agreement? If the regulation should not be read to support that more general proposition, on what grounds should it instead be given a narrower reading?
10. Petitioners argue that, if we accept that section 2519 has not been triggered, "neither Linda nor Peter should be considered as having made a gift." Linda and Peter, petitioners contend, "were in no different position before and after the NJA." Petitioners apparently view the Nonjudicial Agreement as having effected just one transaction, in which the assets of the Residuary Trust went directly from the trust to Bruce, bypassing Linda and Peter. But the children would have been entitled shares of the trust assets commensurate with their interests in the trust had they not agreed to allow their father to receive all the trust assets. Why did Linda and Peter's agreement to allow Bruce to receive the trust assets to which they would otherwise have been entitled in the commutation not effect a transfer of those assets-by gift-from Linda and Peter to Bruce?
11. Petitioners' argument that the transactions effected by section 2 of the Nonjudicial Agreement did not effect a "disposition," within the meaning of section 2519, depends on Linda and Peter's agreement to allow Bruce to receive all the trust assets. Petitioners, as we understand them, accept that, in the absence of that agreement, the commutation of the Residuary Trust would have effected a disposition of Bruce's qualifying income interest within the meaning of section 2519. And yet, for the purpose of determining whether Linda and Peter made taxable gifts to Bruce, petitioners seem to be asking us to ignore any constructive transfer by Linda and Peter to Bruce. How do petitioners explain that apparent inconsistency? Why should we acknowledge Bruce's acquisition of trust assets attributable to Linda and Peter's interests in the trust for the purpose of determining whether a section 2519 disposition occurred but not give effect to constructive transfers of those assets by Linda and Peter to Bruce for the purpose of determining whether they made taxable gifts under section 2511? Are petitioners not trying to have it both ways?
12. Petitioners argue that, if Bruce made a section 2519 disposition of his qualifying income interest, that disposition should not result in a taxable gift because it, and Linda and Peter's transfer to Bruce of their shares of the Residuary Trust assets, were offsetting, reciprocal gifts. Why should the application of section 2519 to Bruce determine whether Linda and Peter made transfers to him?
As stated during the call, it would be helpful to have each party address in writing those questions directed to him or them. Accordingly, it is
ORDERED that respondent shall, on or before November 27, 2023, submit a memorandum with written responses to questions 1 through 9 above. It is further
ORDERED that petitioners shall, on or before the same date, submit a memorandum with written responses to questions 10 through 12. It is further
ORDERED that, if either party, after receiving the other's memorandum, wishes to provide a response, he or she shall request leave to do so within 10 days after such receipt.