IRS Revenue Ruling
1998-8

 
Code Secs. 2519, 2044, 2056, 2511, 2512

<<FULL TEXT>>

26 CFR 25.2519-1: Dispositions of certain life estates.
(Also sections 2044: 2056, 2511; 2512; 20.2044-1, 20.2056(b)-7; 25.2511-1;
25.25124)

Disposition of qualifying income interest. If a surviving spouse
acquires the remainder interest in a trust subject to a QTIP election
under section 2056(b)(7) of the Code in connection with the transfer by
the surviving spouse of property or cash to the holder of the remainder
interest, the surviving spouse makes a gift under sections 2511, 2512, and
2519 of the Code.


REV. RUL. 98-8

ISSUE

What are the gift tax consequences to the surviving spouse of the
acquisition by the surviving spouse of the remainder interest in a trust
subject to a qualified terminable interest property (Q TIP) election under
section 2056(b)(7) of the Internal Revenue Code?



FACTS

The decedent, D, died in 1993 survived by S, D's spouse. Under the
terms of D's will, a trust (the Q TIP Trust) was established under which S
was to receive all of the trust income, payable at least annually, for S's
life. On S's death, the remainder was to be distributed outright to C, D's
adult child. S was not given a general power of appointment over the trust
property.

On the federal estate tax return filed for D's estate, the executor
made an election under section 2056(b)(7) to treat the trust property as
QTIP, and a marital deduction was allowed to D's estate for the value of
the property passing from D to the Q TIP Trust.

Subsequently, S, C, and the trustee of the Q TIP Trust entered into the
following transaction: (1) S acquired C's remainder interest in the Q TIP
Trust; (2) S gave C a promissory note in the face amount of x dollars (the
value of the remainder interest) for the remainder interest; (3) the
trustee distributed all of the Q TIP Trust assets (having a value of x + y
dollars) to S; and (4) S thereupon paid x dollars from those assets to C
in satisfaction of the promissory note.

At the conclusion of the transaction, the Q TIP Trust was terminated; S
held Q TIP Trust assets having a value of y dollars (which was equal to
the value of S's life interest in the trust); and C held assets having a
value of x dollars (which was equal to the value of the remainder interest
in the trust). S contended that the transaction was not subject to gift
tax because S received full and adequate consideration (the x dollar
remainder interest in the Q TIP Trust) in exchange for the x dollar
promissory note given by S TO C.


LAW AND ANALYSIS

Section 2044(a) provides that the value of the gross estate includes
the value of any property described in section 2044(b) in which the
decedent had a qualifying income interest for life. Section 2044(b)
provides that section 2044 applies to any property if a deduction was
allowed with respect to the transfer of the property to the decedent under
section 2056(b)(7).

Section 2056(a) provides that the value of the taxable estate is,
except as limited by section 2056(b), determined by deducting from the
value of the gross estate an amount equal to the value of any interest in
property that passes or has passed from the decedent to the surviving
spouse.

Under section 2056(b)(1), if an interest passing to the surviving
spouse will terminate, no deduction is allowed with respect to such
interest if, after termination of the spouse's interest, an interest in
the property passes or has passed (for less than an adequate and full
consideration in money or money's worth) from the decedent to any person
other than the surviving spouse (or the estate of such spouse).

Section 2056(b)(7)(A) provides that qualified terminable interest
property, for purposes of section 2056(a), is treated as passing to the
surviving spouse, and no part of such property is treated as passing to
any person other than the surviving spouse. In general, qualified
terminable interest property is property in which the spouse receives a
qualifying income interest for life, and with respect to which the
executor makes an election to treat the property as QTIP.

Section 2511(a) provides that the gift tax applies whether the transfer
is in trust or otherwise, whether the gift is direct or indirect, and
whether the property is real or personal, tangible or intangible.

Section 2512(b) provides that where property is transferred for less
than an adequate and full consideration in money or money's worth, the
amount by which the value of the property exceeds the value of the
consideration is deemed a gift.

Section 2519(a) provides that any disposition of all or part of a
qualifying income interest for life in any property to which the section
applies is treated as a transfer of all interests in the property other
than the qualifying income interest. Section 2519(b) provides that the
section applies to any property if a deduction was allowed with respect to
the transfer of such property to the donor under section 2056(b)(7).

The estate tax marital deduction provisions are intended to provide a
special tax benefit that allows property to pass to the surviving spouse
without the decedent's estate paying tax on its value. Tax is deferred on
the transfer until the surviving spouse either dies or makes a lifetime
disposition of the property. Under either circumstance, a transfer (estate
or gift) tax is paid. United States v. Stapf, 375 U.S. 118, 128 (1963),
1964-1 (Part 1) C.B. 535, 537; Estate of Clayton v. Commissioner, 976 F.2d
1486, 1491 (5th Cir. 1992); Estate of Letts v. Commissioner, 109 T.C. 290
(1997), ("It is a basic policy of the marital deduction that property that
passes untaxed from a predeceasing spouse to a surviving spouse is
included in the estate of the surviving spouse.")

The statutory scheme of the QTIP provisions is consistent with this
congressional intent. Thus, a marital deduction is allowed under section
2056(b)(7) for property passing from a decedent to a QTIP trust in which
the surviving spouse possesses a lifetime income interest. Sections 2519
and 2044 act to defer the taxable event on the marital deduction property
only so long as the surviving spouse continues to hold the lifetime income
interest.

Under section 2519, if a surviving spouse disposes of any part of the
qualifying income interest, the spouse is treated as making a gift of the
remainder interest in the underlying property (i.e., all interests in the
property other than the income interest). Correspondingly, under section
2511, the disposition of the income interest by the spouse is treated as a
gift, to the extent the income interest is transferred to another for less
than adequate consideration.

The term "disposition," as used in section 2519, applies broadly to
circumstances in which the surviving spouse's right to receive the income
is relinquished or otherwise terminated, by whatever means. See H. Rep.
No. 201, 97th Cong., 1st Sess. 161 (1981) that states:

The bill provides that property subject to a [QTIP election] will be
subject to transfer taxes at the earlier of (1) the date on which the
spouse disposes (either by gift, sale, or otherwise) of all or part of the
qualifying income interest, or (2) upon the spouse's death.

A commutation, which is a proportionate division of trust property
between the life beneficiary and remainderman based on the respective
values of their interests is, in the context of a QTIP trust, a taxable
disposition by the spouse of the qualifying income interest, resulting in
a gift under section 2519 of the value of the remainder interest. The
commutation of the spouse's income interest in the QTIP trust is
essentially a sale of the income interest by the spouse to the trustee (or
the remainderman) in exchange for an amount equal to the value of the
income interest. Sales and commutations are expressly characterized as
dispositions in the applicable legislative history and regulations.
Section 25.2519-1(g), Example 2 (illustrating that the sale by the spouse
of the spouse's income interest to the trust remaindermen is a disposition
of the income interest); section 25.2519-1(f) providing that "[T]he sale
of qualified terminable interest property, followed by the payment to the
donee-spouse of a portion of the proceeds equal to the value of the
donee-spouse's income interest, is considered a disposition of the
qualifying income interest". See also, Estate of Novotny v. Commissioner,
93 T.C. 12 (1989), in which the surviving spouse and remainderman divided
the sale proceeds of QTIP property proportionately on the basis of the
respective values of their interests; the court indicated that the
commutation constituted a disposition by the spouse of the income interest
for purposes of section 2519 and was thus subject to gift tax.

There is little distinction between the sale and commutation
transactions treated as dispositions in the regulations and the
transaction presented here, where S acquired the remainder interest. In
both cases, after the transaction the spouse's income interest in the
trust is terminated and the spouse receives outright ownership of property
having a net value equal to the value of the spouse's income interest.
Similarly, the remainderman receives ownership of property equal in value
to the remainder interest. Thus, the transaction in the instant case
essentially effectuates a commutation of S's income interest in the trust,
a transaction that is a disposition of S's income interest under section
2519. Therefore, under section 2519, S is regarded as making a gift of x
dollars, the value of the remainder interest in the QTIP Trust. Section
25.2519-1(f).

This conclusion that S has made a gift is also supported by an
additional analysis. S acquired an asset (the remainder interest in the
QTIP Trust) that is already subject to inclusion in S's transfer tax base
under section 2044. In analogous situations, the courts have recognized
that the receipt of an asset that does not effectively increase the value
of the recipient's gross estate does not constitute adequate consideration
for purposes of the gift and estate tax. See Commissioner v. Wemyss, 324
U.S. 303, 307 (1945), 1945 C.B. 416, ("The section taxing as gifts
transfers that are not made for 'adequate and full [money] consideration'
aims to reach those transfers which are withdrawn from the donor's
estate.")

A companion case to Commissioner v. Wemyss, Merrill v. Fahs, 324 U.S.
308 (1945), 1945 C.B. 418, and the cases that preceded it, involved
situations where A, an individual, transferred property to B, A's spouse
(or future spouse), in exchange for B's relinquishment of marital rights
in A's property. The Court held that B's relinquishment of the marital
rights did not constitute adequate and full consideration for A's transfer
because the assets subject to the marital rights were already includible
in A's taxable estate. The property subject to dower and marital rights is
clearly included in the gross estate of the property owner. Thus, to
conclude that the relinquishment of dower and marital rights by the spouse
of the property owner constituted adequate and full consideration for a
transfer by the property owner for gift tax purposes would effectively
subvert the legislative intent and statutory scheme of the gift tax
provisions. Merrill v. Fahs, at 311-312. See also, Commissioner v.
Bristol, 121 F.2d 129, 136 (1st Cir. 1941).

Likewise, in the present situation, property subject to the QTIP
election was intended to be subject to either gift or estate tax. S's
receipt of the remainder interest does not increase the value of S's
taxable estate because that property is already subject to inclusion in
S's taxable estate under section 2044. Rather, S's issuance of the note
results in a depletion of S's taxable estate that is not offset by S's
receipt of the remainder interest. Thus, for estate and gift tax purposes,
S's receipt of the remainder interest cannot constitute adequate and full
consideration under section 2512 for the promissory note transferred by S
to C. As was the case in Merrill v. Fahs, any other result would subvert
the legislative intent and statutory scheme underlying section 2056(b)(7).
Therefore, under section 2511, S has made a gift to C equal to the value
of the promissory note S gave to C.

In addition, a gift tax would be imposed under the above alternative
rationales even if S acquired only a portion of C's remainder interest;
e.g., S acquired 60 percent of C's remainder interest. If, under
applicable state law, such a transaction results in a partial termination
of the trust, S would be treated as disposing of part of S's income
interest in the trust, and the commutation analysis would apply. See,
e.g., Restatement (Second) of Trusts section 340(2) (1959). See also,
section 25.2519-1(g), Example 4, (illustrating the estate and gift tax
consequences of the disposition of a portion of the spouse's income
interest). If the trust does not terminate, S would nonetheless be treated
as making a transfer under sections 2511 and 2512 for less than adequate
and full consideration to the extent of the value of the property or cash
S transfers in exchange for the partial remainder interest.

Further, the conclusion of this revenue ruling would be the same if S
transferred to C property or cash rather than the promissory note. The
economic effect of the transaction is identical, regardless whether S uses
S's own funds to finance the transaction or gives a promissory note and
discharges the note using some of the QTIP Trust assets received in the
transaction. Thus, the result is the same for transfer tax purposes.


HOLDING

If a surviving spouse acquires the remainder interest in a trust
subject to a QTIP election under section 2056(b)(7) in connection with the
transfer by the surviving spouse of property or cash to the holder of the
remainder interest, the surviving spouse makes a gift both under section
2519 and under sections 2511 and 2512. The amount of the gift is equal to
the greater of (i) the value of the remainder interest (pursuant to
section 2519), or (ii) the value of the property or cash transferred to
the holder of the remainder interest (pursuant to sections 2511 and 2512).


DRAFTING INFORMATION

The principal author of this revenue ruling is Deborah Ryan of the
office of Assistant Chief Counsel (Passthroughs and Special Industries.
For further information regarding this revenue ruling contact Ms. Ryan on
(202) 622-3090 (not a toll-free call).

<<END RULING>>

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