BERGANS ESTATE

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BERGANS ESTATE

• Sarah gave her sister 133,000 to support her for
  the rest of her life IRS claims this is a
  reserved life estate and taxable in Sarahs
  estate when she died as well as a taxable gift
  when made.
• The court finds it is a private (as opposed to a
  commercial) annuity.
• How did court determine that the annuity had a
  value of 32,400?
• How much is included in her estate? Nothing that
  is the beauty of a private annuity.

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More Bergans Estate

• What if it cost 20,000 rather than 6250 to
  support Sarah each year how would this affect
  the amount of the gift? Well, the size of the
  gift decreases and the amount of the sale price
  increases. It cost more for an annuity paying
  20,000 a year than 6250 a year. Moreover, a
  promise to pay 20,000 a year is worth more than
  a promise to pay 6250 a year.
• d

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BERGENS ESTATE EXPLAINED

• Sarah received a right to 6250 a year when she
  was 74 years old. The present value of that
  income stream for her life was 32,400. Since
  she transferred property worth 133,662 for that
  income stream the difference is a gift .
• Moreover, she sold the property for the
  32,400. If her basis is 10,000 she has income
  tax gain of 22,400. Actually her basis should be
  32,400. Why?

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PRIVATE ANNUITIES

• Note the Fabric case, p. 296 where mom died
  quickly after creating the private annuity the
  saving was the tax on more than 1 million of
  values.
• Part of the amount paid to the annuitant is
  treated as interest income, and taxable as such,
  but strangely is not deductible by the payor.
• A private annuity can be a great estate plan,
  especially if the annuitant dies quickly.
• How can we distinguish between a reserved life
  estate and a private annuity?

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PRIVATE ANNUITY MATH

• Mom sells land to son for a private annuity of
  either a) 2000 a month, or b) 3000 a month.
  Mom will live for 20 years or 240 months, per the
  life expectancy tables. Moms basis in the land
  is 100,000 and the land is worth 500,000.
• Assume the present value of the 2000 payment is
  200,000, and the present value of the 3000
  payment is 300,000. The formula to determine the
  amount of income and the size of the gift is the
  number of payments times the yearly payment
  reduced to present value, less basis to measure
  the amount of income, and less fair market value
  to measure the size of the gift.

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PRIVATE ANNUITY MATH CONTINUED

• Private annuities are part sale, part gift the
  2000 payment produces income, reduced to present
  value of 200,000 less basis of 100,000, or
  100,000 gain, while the 3000 payment produces
  gain of 200,000, that is present value of
  300,000 minus basis.
• The 2000 payment is a gift of 300,000 (fmv,
  500,000 less present value of 200,000, and
  the 3000 payment results in a gift of
  200,000 hence, the amount of gain and size of
  the gift is determined by the amount of the
  annuity payment.

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US V ALLEN, 293 F2d 916 (9th Cir. 1961)

• Mom gave a remainder to her children, reserving a
  life estate and later learned of her mistake.
  Her advisor told her to sell her life estate for
  its value, 140,000, and she did, to a son. The
  theory was that this was a sale for a good and
  adequate consideration. The full value of the
  property was 900,000
• When she died, the full value of the property was
  included in her estate. The court held that
  good consideration means the amount that would
  be included in the estate.

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DAMBROSIOS ESTATE

• This could be a big deal The cause of this
  problem occurred in 1932 with the haste with
  which 2036 was enacted.
• Remember Allen, where mom sold her life estate
  long after she had retained it, and the court
  there said the price had to be the value of the
  fee.
• Here, mom sold the remainder for its agreed fair
  market value and kept a life estate. She
  received an annuity from a family corporation for
  the value of the remainder.

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DAMBROSIO, CONT

• The key is consideration. 2036 exempts the
  inclusion of a life estate if received for an
  adequate and full consideration. The court
  states that mom will get as much back as she gave
  up in the form of income from the life interest,
  and that accumulated income will be included in
  her estate.
• However, in fact she received only 592,078 from
  the annuity she received for the remainder, and
  23,500 from her life estate before she died.
  But that is because she died quickly. Moreover,
  since this was a family corporation the flow of
  dividends to her could be planned. Still the
  estate avoided tax on the full value, 2,350,000.

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DAMBROSIOS ESTATE

• The court notes that the Allen rule requiring a
  remainder to be sold for the value of the fee is
  stupid. It would never and could never be done.
• One would only follow this plan if mom would
  promise to die soon and little income was
  expected to be paid. Is Allen still good law?
  Who knows the 9th circuit agrees with
  DeAmbrosias Estate.
• In a concurring opinion in Allen, under a
  strict reading of Section 2036, the judge said
  that if a life estate had ever been retained the
  full value of the property would be included in
  the estate though the fee had been sold years ago.

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DAMBROSIA CONT

• After Sec 2702 was enacted, DeAmbrosias transfer
  would be a gift of the full amount, 2,350,000,
  unless it was a qualified GRIT, GRAT or GRUT. It
  would not be difficult to qualify such a transfer
  in this way, but the life estate would have to
  bear a minimum interest rate.
• In DAmbrosio, there was no gift to anyone as
  the value of the annuity was equal to the value
  of the remainder.
• IRS tried, but failed to get certiorari to the
  Supreme Court.
• I said in last years slide that I would wait for
  the IRS to concede this issue With 3 circuits in
  favor of DeAmbrosio it may be time to utilize it.
  

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OLD COLONY TRUST

• Just another grantor retains too much power
  case here he as trustee could cut off income
  to the beneficiaries if in the best interest of
  the child. The best interests of the child is
  not an ascertainable standard.
• The decision is probably in the casebook because
  of the silly rope burn comment, page 313. This
  pithy comment has been oft quoted
• Who was the trustee what would be the result if
  the trustee had been a bank?

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U.S. V O MALLEY

• Fabrice, the grantor, foolishly was one of the
  trustees who could pay out the income or
  accumulate it. IRS said his estate should include
  all the property including the income after he
  funded the trust.
• The only good argument made by the estate was
  that Fabrice had not transferred the income
  that accumulated in the 12 years after he funded
  the trust. The statute 2036(a)(2) only
  reaches a transfer where the transferor
  retained the power to designate the persons who
  shall possess or enjoy the property or income
  therefrom.

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OMalley Continued

• The majority somehow finds a transfer of the
  income. It absolutely defies reasoning that one
  can transfer something one does not have. Maybe,
  by not paying out the income each year he
  transferred it to accumulated status.
• The dissent would only tax the original funding
  of the trust in 1936 and 1937.
• The majority opinion is nevertheless good law.
  However, you will never name the grantor as
  trustee nor give him these powers.

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U.S. V BYRUM

• The donor reserved the right to vote stock in a
  family corporation he gave to a trust for his
  children IRS claims this is a reservation of
  the right to enjoy the property and requires its
  inclusion in his estate under 2036.
• IRS made some other silly arguments too, but
  loses, so IRS went whining to Congress in 1976
  as if this was a large loophole.
• I will describe why this was a hollow victory for
  the IRS, and why we now use partnerships in
  their various forms.

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THE ANTI-BYRUM STATUTE

• When parents give stock in their family
  corporation they are careful to retain control.
  For example, mom and dad give 49 of the stock to
  the children and keep 25.5 each. The kids will
  never outvote the parents. There are also
  significant valuation advantages to only giving
  minority interests.
• The parents could also get proxies from the kids
  after the gift. Unless the children are
  exceptionally stupid they will willingly sign
  proxies.

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MORE ON THE ANTI-BYRUM STATUTE

• We dont form corporations for our clients today,
  and havent since 1993. The reason is that the
  tax law does not favor non-publicly traded
  corporations. Instead we form one of the various
  forms of partnerships with limited liability,
  such as LLCs, LLPs, LLLPs, PLLPs or even the old
  LPs. What are these.
• The anti-Byrum statute applies only to
  corporations.

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GOVERNANCE AND FINANCIAL INTERESTS IN AN LLC

• North Dakota and Minnesota recognize both
  governance and financial interests in an LLC the
  financial members do not vote, but have equal
  claim to the assets. They are much like
  preferred stockholders in a corporation.
• Example mom and dad form an LLC and are the
  governors, with a 2 interest in income and
  capital their children have a 98 interest, but
  only a financial interest they cannot vote.
• The LLC then borrows 10 million to construct a
  building, and pays it off in 10 years mom and
  dad moved 9.8 million plus the appreciation on
  the building out of their estates. There was no
  gift tax when the LLC was formed. Why? It had
  no assets and when it did the mortgage was equal
  to the value of the assets..