COMMISSIONER V HOGLE

Husband created a trust to give the income to his wife in 1922, a year with no gift tax. IRS now tries to gift tax each year’s income in later years after the gift tax was enacted.

The issue is when was the gift complete for gift tax purposes. The answer is clear; it is when the donor has parted with control over the subject of the gift. Note the doctrine that income from a trust may be income taxed to the creator. These are called grantor trusts and here the income indeed was taxed to Hogle because he had too much power over trust investments. That, however, did not affect the completeness of the gift.

SMITH V SHAUGHNESSY

Smith gave his wife a life estate but if she died first the corpus reverted to him; he also created a remainder, but the identity of the remainderman was contingent and the wife could appoint the remainder to anyone. The issue: what taxable gifts were made?

The life estate was a gift (not today because it was in favor of a spouse), and the reversion was not a gift because Smith kept it; the sole issue was whether the remainder is a gift.

He claims it is not a gift because the remainder will be taxable in his estate.

SMITH V SHAUGHNESSY CONTINUED

Taxpayer argued that if the IRS were correct the remainder would be taxed twice, once as a gift and later in his estate when he died. That is not true, and later in the course we will examine why that is so.

Today, property subject to a reversion (§2037) is includible in the gross estate if the value of the reversion exceeds 5%, determined on an actuarial basis. We study this doctrine later.

How do we value these SPLIT INTEREST GIFTS? What is a split interest gift?

Shouldn’t Smith be penalized for arrogance in retaining a reversion when he was 72 and the life tenant, his wife, was only 44?

LOCKARD AND GRANTOR TRUSTS

In Lockard, [footnote, p. 76] a wife gave her husband the income from some property for 6 years at which time it reverted back to her. Though she was income taxable on the income, it was held that she also made a gift, which was valued with actuarial tables.

Note the four types of grantor trusts listed on page 77. The undeservedly popular “living trust” is an example of a grantor trust.

DO TRUSTS SAVE ON TAXES?

Here is a bright-line rule: trusts do not save on taxes. Trusts are very useful in estate planning, but only to

manage property for the benefit of heirs or donees that cannot or will not manage or invest it for their best interests.

Trusts [and estates] have the highest income tax rates of all entities; they reach the highest income tax bracket (35% in 2009) at only $10,050 of income while a married couple do not reach the 35% income tax bracket until their income exceeds $336,550.

THE “KIDDIE” TAX

In days of yore parents created trusts for their children. The child was taxed on the trust’s income. (More about how that works later in the course.) Mom and Dad do this for both income and estate tax saving reasons for they are in the former high income tax bracket of 70% and the child is in the 15% bracket. Besides, this was a great way to build up a college fund for the child.

So, Congress enacted the “kiddie tax” which taxes the little sweetheart on his unearned income at his parents highest marginal tax rate, until the child is 18 years old to be raised to 19 and then to age 24 for students. Thereafter the child’s income tax rate depends on his filing status and income.

GRITS, GRATS AND GRUTS

Your author introduces you to §2702 way too early in this course, and I will defer most of it until later, but here is an example of what it is intended to prevent and what can still be done.

Father, age 60, has a home worth $1.5 million; he gives it to children in the year 2009, but reserves the use of the house for a term of 10 years; the IRS published interest rate is 10%; the value of the term of years is about $600,000, which you obtain from IRS actuarial tables. This is a grantor retained income trust(GRIT) and only a principal or secondary residence qualifies for this treatment.

GRATS ETC CONTINUED

So the gift is only $900,000, (fmv of $1,500,000 minus the value of the term of years, $900,000) and within the exemption in 2009. Dad must live the ten years, but if he does, $1.5 million is gone from his estate plus any appreciation in the value of the house during the ten year term. If he fails to live for ten years he is no worse off than if he did nothing.

Had this been any other type of property, §2702, IRC provides that the value of the gift would be $1.5 million with no reduction for the value of the retained interest unless it qualified as a grantor retained annuity trust (GRAT) or a grantor retained unitrust.(GRUT)

Good Advice. When you are in

deep trouble, keep your mouth

shut and try to look

inconspicuous.

Good Advice. When you are in

deep trouble, keep your mouth

shut and try to look

inconspicuous.

BURNET V GUGGENHEIM

This case illustrates the problem of a grantor reserving powers over an otherwise completed gift.

Taxpayer’s gift in 1917 was revocable; the first gift tax was enacted in 1924; taxpayer surrendered his power to revoke the gift in 1925. Had he waited until 1926 to surrender the power top revoke the gift tax would have expired.

You will never fall into this trap because you know that a revocable gift is no gift at all. In fact for tax purposes it is nothing.

Guggenheim’s tax planner was –0- for 3; his timing could not have been worse.

Gift by Donor’s check

When is a gift by check effective? Say the Donor gives his 20 children $12,000 each, both on 12/31/2008 and 1/1/2009 and dies on 1/3/2009. How many annual exemptions are available? The answer depends on when the check was cashed.

Metzger’s Estate [ft. p. 88] held that if check is presented for payment before the year end, the date of the gift relates back to the delivery of the check to the bank even though the payor bank pays the check after January 1. Why? The donor in Metzger did not die before the checked cleared the bank. Other case law holds that if the donor died between the delivery of the check and when it cleared the bank the gift is only effective when the check clears the payee bank. So CASH THAT CHECK QUICKLY. If you don’t there will be no annual exemption for the 2008 gift.

GIFTS MADE UNDER A POWER OF ATTORNEY

Two Virginia tax court cases illustrate this point. In Casey v CIR, 948 F.2d 895 (4th Cir. 1991) the power of attorney form said the agent could “do anything I can do.” The agent made gifts, and the tax court held that language was not sufficient to make gifts under Virginia law. The Virginia legislature was steamed and quickly passed a law that such language was sufficient to authorize gifts, and made the new law retroactive. IRS tried again in another Virginia case with identical facts, Ridenour v. CIR, 93-41 TCM, but the tax court finally got the message and held for the taxpayer.

§30.1-30-06, NDCC provides that a clause in a power of attorney giving the agent power to do whatever the principal can do authorizes gifts. In our firm we have always included the power to make gifts in our power of attorney forms.

GIFTS MADE BY DEPOSITS TO A JOINT ACCOUNT.

Mom and daughter create a joint bank account, be it checking, savings, a certificate of deposit or whatever. Mom deposits $100,000; each has a 50% interest in the funds under state law. Has a gift occurred?

Note 5, page [89], cites the regulation to the effect that no gift occurs until the donee withdraws some funds. The revenue ruling cited there reaches the same result for brokerage accounts.

What if mom buys a farm for $100,000 but takes title jointly with her daughter? Has mom made a gift?

SANFORD’S ESTATE

This case is just a repeat of Guggenheim and should not be in the casebook.

Revocable transfers are ignored in the tax law. They are not gifts, the property is still income taxed to the transferor, and the property will be included in the donor’s estate tax return when he dies. Revocable transfers have NO tax effect whatsoever.

SANFORD’S ESTATE

Sanford’s personal representative argued that the gift should be complete when made [1913 and 1919] since the principal of the trust would be included in his estate when he died. Again the argument is that the same property should not be taxed twice.

There are several situations where a gift is taxed but will also be brought back into the estate upon death. However, there is no “double taxation” since the amount of any lifetime exemption [applicable credit] used to reduce the gift tax is restored, and any gift tax paid becomes a credit against the estate tax. Your author badly describes this process on p. 94.

EXCEPTIONS TO THE SANFORD RULE

The grantor may retain the power to change beneficial interests and still have a completed gift in three situations, to wit: [footnote 1, p. 93, 94]

Where the grantor retains a fiduciary duty limited by an ascertainable standard.

The grantor requires the consent of a person having a substantial adverse interest to any change.

The power only affects the time or manner of enjoyment of the corpus.

CAMP V COMMISSIONER

In 1932, just before the re-enactment of the gift tax, Camp created a trust for his wife Alida for life. The trust was revocable with the consent from either half brother Ridgly or Camp’s mom. Was there a completed gift at that time? No, because Camp could revoke the gift and Ridgly didn’t care if he did; Ridgly had no interest in the trust.

In 1937 the trust was amended to give Camp the power to amend only with Alida’s consent. Is the gift complete now? Certainly the life estate to Alida was , since she could veto any change. How about the remainder, which was to go to Camp’s issue or Ridgley? Did Alida have an interest adverse to her husband modifying the remainder?

CAMP COMPLETED

In 1946 the trust was amended to become irrevocable. Only then was the gift of the remainder complete.

Camp is in the casebook to illustrate the “substantial adverse interest” principle. Note that there is an equivalent income tax provision.

Bright line rule. A revocable gift is a nothing! It is not a gift, the property will be included in the donor’s estate, and the income will be taxed to the donor during his lifetime.