Qualified Interests, 9222-9224 [05-3589]
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9222
Federal Register / Vol. 70, No. 37 / Friday, February 25, 2005 / Rules and Regulations
2000 taxes that remain unpaid, Z is the
proper party to sign the consent to extend the
period of limitations.
Example 2. The facts are the same as in
Example 1, except that in 2002, the IRS
determines that X miscalculated and
underreported its income tax liability for
2000. Because Z is the successor to X and is
liable for X’s 2000 taxes that remain unpaid,
the deficiency may be assessed against Z and,
in the event that Z fails to pay the liability
after notice and demand, a general tax lien
will arise against all of Z’s property and
rights to property.
DEPARTMENT OF THE TREASURY
*
SUMMARY: This document contains final
regulations amending the regulations
under the gift tax special valuation rules
to provide that a unitrust or annuity
interest payable for a specified term of
years to the grantor, or to the grantor’s
estate if the grantor dies prior to the
expiration of the term, is a qualified
interest for the specified term. The final
regulations also clarify that the
exception treating a spouse’s revocable
successor interest as a retained qualified
interest applies only if the spouse’s
annuity or unitrust interest, standing
alone, would constitute a qualified
interest that meets the requirements of
§ 25.2702–3(d)(3), but for the grantor’s
revocation power.
DATES: The regulations are effective July
26, 2004.
FOR FURTHER INFORMATION CONTACT: Juli
Ro Kim (202) 622–3090 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
*
*
*
*
(e) Effective date. (1) Except as
otherwise provided in this paragraph
(e), the rules of this section apply as of
January 1, 1997, except that paragraph
(b)(6) of this section applies on or after
January 14, 2002, to a business entity
wholly owned by a foreign government
regardless of any prior entity
classification, and paragraph (c)(2)(ii) of
this section applies to taxable years
beginning after January 12, 2001. The
reference to the Finnish, Maltese, and
Norwegian entities in paragraph (b)(8)(i)
of this section is applicable on
November 29, 1999. The reference to the
Trinidadian entity in paragraph (b)(8)(i)
of this section applies to entities formed
on or after November 29, 1999. Any
Maltese or Norwegian entity that
becomes an eligible entity as a result of
paragraph (b)(8)(i) of this section in
effect on November 29, 1999, may elect
by February 14, 2000, to be classified for
Federal tax purposes as an entity other
than a corporation retroactive to any
period from and including January 1,
1997. Any Finnish entity that becomes
an eligible entity as a result of paragraph
(b)(8)(i) of this section in effect on
November 29, 1999, may elect by
February 14, 2000, to be classified for
Federal tax purposes as an entity other
than a corporation retroactive to any
period from and including September 1,
1997. However, paragraph (d)(3)(i)(D) of
this section applies on or after October
22, 2003.
(2) Paragraph (c)(2)(iii) of this section
applies on or after April 1, 2004.
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
Approved: February 15, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the
Treasury.
[FR Doc. 05–3587 Filed 2–24–05; 8:45 am]
BILLING CODE 4830–01–P
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Internal Revenue Service
26 CFR Part 25
[TD 9181]
RIN 1545–BB72
Qualified Interests
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:
Background
On July 26, 2004, the IRS published
in the Federal Register (69 FR 44476) a
notice of proposed rulemaking (REG–
163679–02) conforming the gift tax
regulations defining a qualified interest
for purposes of section 2702 to the Tax
Court’s decision in Walton v.
Commissioner, 115 T.C. 589 (2000), acq.
in result, Notice 2003–72, 2003–2 C.B.
964. In Walton, the court declared
Example 5 of § 25.2702–3(e) to be
invalid. The notice of proposed
rulemaking also clarifies those parts of
the regulations under section 2702
addressing revocable spousal interests
that were at issue in Schott v.
Commissioner, 319 F.3d 1203 (9th Cir.
2003), rev’g and remanding T.C.M.
2001–110, and Cook v. Commissioner,
269 F.3d 854 (7th Cir. 2001), aff’g 115
T.C. 15 (2000).
No public hearing was requested or
held, but one written comment and
some telephone comments were
received. After consideration of all the
comments, the proposed regulations are
adopted as amended by this Treasury
decision, and the corresponding
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proposed regulations are removed. The
comments and revisions to the proposed
regulations are discussed below.
Summary of Comments
Generally, the commentators agreed
with the amendments conforming the
regulations to the Walton decision.
Several commentators requested that the
regulations address the amount
includible in the grantor’s gross estate
with respect to a Walton-type grantor
retained annuity trust (GRAT), if the
grantor dies during the GRAT term,
including the application of Rev. Rul.
82–105 (1982–1 C.B. 133). In addition,
several commentators requested
guidance regarding the application of
section 2035 if the grantor dies within
three years after termination of the term
of the GRAT (or grantor retained
unitrust (GRUT)). These suggestions
were not adopted. The determination of
the amount includable in the grantor’s
gross estate is an issue different from
and governed by different Code sections
than the definition of a qualified interest
for purposes of section 2702, and is thus
beyond the scope of this project.
However, Treasury and IRS will
consider addressing that issue in future
guidance.
Regarding the proposed regulations
addressing revocable spousal interests,
commentators suggested that section
2702 was enacted to avoid valuation
problems and that, because the value of
the contingent revocable spousal
interest at issue in Schott v.
Commissioner is readily determinable
using actuarial tables, such an interest
should be a qualified interest (as the
Ninth Circuit concluded in Schott).
Treasury and the IRS continue to
believe that the proposed regulations
properly implement section 2702 and
the policy underlying the statute.
Uncertainty in valuation is not the only
valuation inaccuracy that the statute
was intended to correct. A valuation
inaccuracy is also present when the
value of a retained interest is increased
through the use of a joint and survivor
(or two-life) annuity or unitrust interest
if there is no certainty that the
survivorship interest will ever be paid.
The revocable spousal interest involved
in Schott may best be described as
speculative, because it takes effect, if at
all, only if the grantor fails to survive
the term of the trust, and the duration
of the interest, if it takes effect at all, is
dependent on the portion of the term
remaining at the grantor’s death. The
existing regulations make it clear that
the ability to actuarially determine an
interest is not sufficient to secure
recognition of that interest as a qualified
interest for purposes of section 2702.
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Under Example 1 of § 25.2702–2(d)(1),
neither a retained income interest for
life nor a contingent reversionary
interest in trust corpus payable to the
grantor’s estate if the grantor dies prior
to the expiration of the trust term is a
qualified interest, notwithstanding that
the present value of both the income
interest and the contingent reversion is
readily determinable actuarially. Just as
the contingent reversion in Example 1
would increase the value of the retained
interest without any certainty that the
reversion would ever be paid, a
revocable spousal interest of the kind at
issue in Schott would similarly increase
the value of the retained interest
without any certainty that the spouse’s
survivorship interest would ever be
paid.
Some commentators requested that
the regulations also confirm the gift tax
consequences of the lapse of the
grantor’s retained right to revoke the
spouse’s successor interest, for example
when that revocation right lapses at the
end of the GRAT term and the spouse’s
successor interest becomes operative. In
response, language has been added to
§ 25.2702–3(e), Example 8, to clarify
that the grantor makes a completed gift
to the spouse when the revocation right
lapses on the expiration of the grantor’s
retained term (the grantor having
survived the term and not having
exercised the revocation right). See
§ 25.2511–2(f).
Other commentators suggested that
the regulations also address the
treatment of a revocable spousal interest
in a Walton-type GRAT when the
grantor’s spouse is given a revocable
survivor interest in the annuity
payments to be made during the balance
of the fixed term of the GRAT remaining
after the grantor’s death. Specifically, if
the grantor dies prior to the expiration
of the fixed GRAT term, the annuity
interest is payable to the spouse for the
balance of that term, subject to the
grantor’s power to revoke the spousal
interest or, if the spousal interest is
revoked, then to the grantor’s estate for
the balance of the fixed term. The
commentators suggested that regardless
of whether the grantor dies during the
stated term or survives, the annuity or
unitrust interest will be paid for a fixed
term of years either to the grantor, the
surviving spouse, or the grantor’s estate.
Accordingly, the commentators
suggested that the interest is payable in
all events for a fixed term, and is
therefore a qualified interest. The
commentators’ suggestion would extend
the concept espoused by the Tax Court
in Walton of an ‘‘undifferentiated unit’’
consisting of the grantor and the
grantor’s estate (see 115 T.C. at 603) to
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include the grantor, the grantor’s estate,
and the grantor’s spouse. Treasury and
the IRS do not believe that the Tax
Court opinion supports this extension.
The spouse’s revocable successor
interest is an interest separate and
distinct from the interest of the grantor
and the grantor’s estate. Further, the use
of the spouse’s life expectancy in
valuing the retained interest would
increase the value of that interest
without any guarantee that the spouse
would actually receive any part of that
interest. For these reasons, the spouse’s
revocable successor interest described
above does not satisfy the requirements
of a qualified interest. Accordingly, this
suggestion was not adopted.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations, and, because these
regulations do not impose on small
entities a collection of information
requirement, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the
Internal Revenue Code, the Notice of
Proposed Rulemaking preceding these
regulations was submitted to the Small
Business Administration for comment
on their impact on small business.
Drafting Information
The principal author of these
regulations is Juli Ro Kim, Office of the
Associate Chief Counsel (Passthroughs
and Special Industries), IRS. Other
personnel from the IRS and Treasury
Department participated in their
development.
List of Subjects in 26 CFR Part 25
Gift taxes, Reporting and
recordkeeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 25 is
amended as follows:
I
PART 25—GIFT TAX; GIFTS MADE
AFTER DECEMBER 31, 1954
Paragraph 1. The authority citation for
part 25 continues to read, in part, as
follows:
I
Authority: 25 U.S.C. 7805 * * *
I Par. 2. In § 25.2702–0, the table is
amended as follows:
I 1. The entries for § 25.2702–2(a)(5)
through § 25.2702–2(a)(9) are
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9223
redesignated as § 25.2702–2(a)(6)
through § 25.2702–2(a)(10), respectively.
I 2. A new entry for § 25.2702–2(a)(5) is
added.
I 3. The entries for § 25.2702–3(d)(2)
through § 25.2702–3(d)(4) are
redesignated as § 25.2702–3(d)(3)
through § 25.2702–3(d)(5), respectively.
I 4. A new entry for § 25.2702–3(d)(2) is
added.
I 5. An entry for § 25.2702–3(d)(6) is
added.
The additions read as follows:
§ 25.2702–0
*
*
Table of contents.
*
*
*
§ 25.2702–2 Definitions and valuation rules.
(a) * * *
(5) Holder.
*
*
*
§ 25.2702–3
*
*
*
*
Qualified interests.
*
*
*
(d) * * *
(2) Contingencies.
*
*
*
*
*
(6) Use of debt obligations to satisfy the
annuity or unitrust payment obligation.
*
*
*
*
*
I Par. 3. Section 25.2702–2 is amended
as follows:
I 1. Paragraphs (a)(5) through (a)(9) are
redesignated as paragraphs (a)(6)
through (a)(10), respectively.
I 2. A new paragraph (a)(5) is added.
I 3. In newly designated paragraph
(a)(6), the second sentence is removed
and two sentences are added in its place.
I 4. In paragraph (d)(1), Example 6 and
Example 7 are removed.
I 5. In paragraph (d)(2), introductory
text, the language ‘‘Examples 8–10’’ is
revised to read ‘‘Examples 6 through 8’’.
I 6. In paragraph (d)(2), Examples 8, 9
and 10 are redesignated Examples 6, 7
and 8, respectively.
The additions read as follows:
§ 25.2702–2
rules.
Definitions and valuation
(a) * * *
(5) Holder. The holder is the person
to whom the annuity or unitrust interest
is payable during the fixed term of that
interest. References to holder shall also
include the estate of that person.
(6) * * * If a transferor retains a power
to revoke a qualified annuity interest or
qualified unitrust interest of the
transferor’s spouse, then the revocable
qualified annuity or unitrust interest of
the transferor’s spouse is treated as a
retained qualified interest of the
transferor. In order for the transferor to
be treated as having retained a qualified
interest under the preceding sentence,
the interest of the transferor’s spouse
(the successor holder) must be an
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interest that meets the requirements of
a qualified annuity interest in
accordance with § 25.2702–3(b) and (d),
or a qualified unitrust interest in
accordance with § 25.2702–3(c) and (d),
but for the transferor’s retained power to
revoke the interest. * * *
*
*
*
*
*
I Par. 4. Section 25.2702–3 is amended
as follows:
I 1. Paragraphs (d)(2) through (d)(5) are
redesignated as paragraphs (d)(3)
through (d)(6), respectively.
I 2. A new paragraph (d)(2) is added.
I 3. In newly designated paragraph
(d)(4), the first two sentences are revised.
I 4. Newly designated paragraph (d)(5) is
revised.
I 5. In paragraph (e), Example 5, the last
sentence is revised.
I 6. In paragraph (e), Example 6, the last
sentence is removed and two new
sentences are added in its place.
I 7. In paragraph (e), new Example 8 and
new Example 9 are added.
The revisions and additions read as
follows:
§ 25.2702–3
Qualified interests.
*
*
*
*
*
(d) * * *
(2) Contingencies. A holder’s qualified
interest must be payable in any event to
or for the benefit of the holder for the
fixed term of that interest. Thus,
payment of the interest cannot be
subject to any contingency other than
either the survival of the holder until
the commencement, or throughout the
term, of that holder’s interest, or, in the
case of a revocable interest described in
§ 25.2702–2(a)(6), the transferor’s right
to revoke the qualified interest of that
transferor’s spouse.
*
*
*
*
*
(4) Term of the annuity or unitrust
interest. The governing instrument must
fix the term of the annuity or unitrust
and the term of the interest must be
fixed and ascertainable at the creation of
the trust. The term must be for the life
of the holder, for a specified term of
years, or for the shorter (but not the
longer) of those periods. * * *
(5) Commutation. The governing
instrument must prohibit commutation
(prepayment) of the interest of the
holder.
*
*
*
*
*
(e) * * *
Example 5. * * * The interest of A (and A’s
estate) to receive the unitrust amount for the
specified term of 10 years in all events is a
qualified unitrust interest for a term of 10
years.
Example 6. * * * As in Example 5, the
interest of A (and A’s estate) to receive the
unitrust amount for a specified term of 10
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years in all events is a qualified unitrust
interest for a term of 10 years. However, the
right of A’s estate to continue to receive the
unitrust amount after the expiration of the
10-year term if A dies within that 10-year
period is not fixed and ascertainable at the
creation of the interest and is not a qualified
unitrust interest.
*
*
*
*
*
Example 8. A transfers property to an
irrevocable trust, retaining the right to
receive an annuity equal to 6 percent of the
initial net fair market value of the trust
property for 10 years, or until A’s prior death.
At the expiration of the 10-year term, or on
A’s death prior to the expiration of the 10year term, the annuity is to be paid to B, A’s
spouse, if then living, for 10 years or until
B’s prior death. A retains an inter vivos and
testamentary power to revoke B’s interest
during the initial 10-year term. If not
exercised by A during the initial 10-year term
(whether during A’s life or on A’s death), A’s
right to revoke B’s interest will lapse upon
either A’s death during the 10-year term, or
the expiration of A’s 10-year term (assuming
A survives the term). Upon expiration of B’s
interest (or on the expiration of A’s interest
if A revokes B’s interest or if B predeceases
A), the trust terminates and the trust corpus
is payable to A’s child. Because A has made
a completed gift of the remainder interest, the
transfer of property to the trust is not
incomplete as to all interests in the property
and section 2702 applies. A’s annuity interest
(A’s right to receive the annuity for 10 years,
or until A’s prior death) is a retained interest
that is a qualified annuity interest under
paragraphs (b) and (d) of this section. In
addition, because A has retained the power
to revoke B’s interest, B’s interest is treated
as an interest retained by A for purposes of
section 2702. B’s successive annuity interest
otherwise satisfies the requirements for a
qualified interest contained in paragraph (d)
of this section, but for A’s power to revoke.
The term of B’s interest is specified in the
governing instrument and is fixed and
ascertainable at the creation of the trust, and
B’s right to receive the annuity is contingent
only on B’s survival, and A’s power to
revoke. Following the expiration of A’s
interest, the annuity is to be paid for a 10year term or for B’s (the successor holder’s)
life, whichever is shorter. Accordingly, A is
treated as retaining B’s revocable qualified
annuity interest pursuant to § 25.2702–
2(a)(6). Because both A’s interest and B’s
interest are treated as qualified interests
retained by A, the value of the gift is the
value of the property transferred to the trust
less the value of both A’s qualified interest
and B’s qualified interest (subject to A’s
power to revoke), each valued as a single-life
annuity. If A survives the 10-year term
without having revoked B’s interest, then A’s
power to revoke lapses and A will make a
completed gift to B at that time. Further, if
A revokes B’s interest prior to the
commencement of that interest, A is treated
as making an additional completed gift at
that time to A’s child. In either case, the
amount of the gift would be the present value
of B’s interest determined under section 7520
and the applicable regulations, as of the date
the revocation power lapses or the interest is
revoked. See § 25.2511–2(f).
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Example 9. (i) A transfers property to an
irrevocable trust, retaining the right to
receive 6 percent of the initial net fair market
value of the trust property for 10 years, or
until A’s prior death. If A survives the 10year term, the trust terminates and the trust
corpus is payable to A’s child. If A dies prior
to the expiration of the 10-year term, the
annuity is payable to B, A’s spouse, if then
living, for the balance of the 10-year term, or
until B’s prior death. A retains the right to
revoke B’s interest. Upon expiration of B’s
interest (or upon A’s death if A revokes B’s
interest or if B predeceases A), the trust
terminates and the trust corpus is payable to
A’s child. As is the case in Example 8, A’s
retained annuity interest (A’s right to receive
the annuity for 10 years, or until A’s prior
death) is a qualified annuity interest under
paragraphs (b) and (d) of this section.
However, B’s interest does not meet the
requirements of paragraph (d) of this section.
The term of B’s annuity is not fixed and
ascertainable at the creation of the trust,
because it is not payable for the life of B, a
specified term of years, or for the shorter of
those periods. Rather, B’s annuity is payable
for an unspecified period that will depend
upon the number of years left in the original
term after A’s death. Further, B’s annuity is
payable only if A dies prior to the expiration
of the 10-year term. Thus, payment of B’s
annuity is not dependent solely on B’s
survival, but rather is dependent on A’s
failure to survive.
(ii) Accordingly, the amount of the gift is
the fair market value of the property
transferred to the trust reduced by the value
of A’s qualified interest (A’s right to receive
the stated annuity for 10 years or until A’s
prior death). B’s interest is not a qualified
interest and is thus valued at zero under
section 2702.
*
*
*
*
*
I Par. 5. Section 25.2702–7 is amended
by adding two sentences at the end of the
section to read as follows:
§ 25.2702–7
Effective dates.
* * * Section 25.2702–2(a)(5), the
second and third sentences of
§ 25.2702–2(a)(6), § 25.2702–3(d)(2), the
first two sentences of § 25.2702–3(d)(4),
the last sentence of § 25.2702–3(e),
Example 5, the last two sentences of
§ 25.2702–3(e), Example 6, and
§ 25.2702–3(e), Examples 8 and 9, apply
for trusts created on or after July 26,
2004. However, the Internal Revenue
Service will not challenge any prior
application of the changes to Examples
5 and 6 in § 25.2702–3(e).
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
Approved: February 15, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the
Treasury.
[FR Doc. 05–3589 Filed 2–24–05; 8:45 am]
BILLING CODE 4830–01–P
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Agencies
[Federal Register Volume 70, Number 37 (Friday, February 25, 2005)]
[Rules and Regulations]
[Pages 9222-9224]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-3589]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 25
[TD 9181]
RIN 1545-BB72
Qualified Interests
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations amending the
regulations under the gift tax special valuation rules to provide that
a unitrust or annuity interest payable for a specified term of years to
the grantor, or to the grantor's estate if the grantor dies prior to
the expiration of the term, is a qualified interest for the specified
term. The final regulations also clarify that the exception treating a
spouse's revocable successor interest as a retained qualified interest
applies only if the spouse's annuity or unitrust interest, standing
alone, would constitute a qualified interest that meets the
requirements of Sec. 25.2702-3(d)(3), but for the grantor's revocation
power.
DATES: The regulations are effective July 26, 2004.
FOR FURTHER INFORMATION CONTACT: Juli Ro Kim (202) 622-3090 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On July 26, 2004, the IRS published in the Federal Register (69 FR
44476) a notice of proposed rulemaking (REG-163679-02) conforming the
gift tax regulations defining a qualified interest for purposes of
section 2702 to the Tax Court's decision in Walton v. Commissioner, 115
T.C. 589 (2000), acq. in result, Notice 2003-72, 2003-2 C.B. 964. In
Walton, the court declared Example 5 of Sec. 25.2702-3(e) to be
invalid. The notice of proposed rulemaking also clarifies those parts
of the regulations under section 2702 addressing revocable spousal
interests that were at issue in Schott v. Commissioner, 319 F.3d 1203
(9th Cir. 2003), rev'g and remanding T.C.M. 2001-110, and Cook v.
Commissioner, 269 F.3d 854 (7th Cir. 2001), aff'g 115 T.C. 15 (2000).
No public hearing was requested or held, but one written comment
and some telephone comments were received. After consideration of all
the comments, the proposed regulations are adopted as amended by this
Treasury decision, and the corresponding proposed regulations are
removed. The comments and revisions to the proposed regulations are
discussed below.
Summary of Comments
Generally, the commentators agreed with the amendments conforming
the regulations to the Walton decision. Several commentators requested
that the regulations address the amount includible in the grantor's
gross estate with respect to a Walton-type grantor retained annuity
trust (GRAT), if the grantor dies during the GRAT term, including the
application of Rev. Rul. 82-105 (1982-1 C.B. 133). In addition, several
commentators requested guidance regarding the application of section
2035 if the grantor dies within three years after termination of the
term of the GRAT (or grantor retained unitrust (GRUT)). These
suggestions were not adopted. The determination of the amount
includable in the grantor's gross estate is an issue different from and
governed by different Code sections than the definition of a qualified
interest for purposes of section 2702, and is thus beyond the scope of
this project. However, Treasury and IRS will consider addressing that
issue in future guidance.
Regarding the proposed regulations addressing revocable spousal
interests, commentators suggested that section 2702 was enacted to
avoid valuation problems and that, because the value of the contingent
revocable spousal interest at issue in Schott v. Commissioner is
readily determinable using actuarial tables, such an interest should be
a qualified interest (as the Ninth Circuit concluded in Schott).
Treasury and the IRS continue to believe that the proposed
regulations properly implement section 2702 and the policy underlying
the statute. Uncertainty in valuation is not the only valuation
inaccuracy that the statute was intended to correct. A valuation
inaccuracy is also present when the value of a retained interest is
increased through the use of a joint and survivor (or two-life) annuity
or unitrust interest if there is no certainty that the survivorship
interest will ever be paid. The revocable spousal interest involved in
Schott may best be described as speculative, because it takes effect,
if at all, only if the grantor fails to survive the term of the trust,
and the duration of the interest, if it takes effect at all, is
dependent on the portion of the term remaining at the grantor's death.
The existing regulations make it clear that the ability to actuarially
determine an interest is not sufficient to secure recognition of that
interest as a qualified interest for purposes of section 2702.
[[Page 9223]]
Under Example 1 of Sec. 25.2702-2(d)(1), neither a retained income
interest for life nor a contingent reversionary interest in trust
corpus payable to the grantor's estate if the grantor dies prior to the
expiration of the trust term is a qualified interest, notwithstanding
that the present value of both the income interest and the contingent
reversion is readily determinable actuarially. Just as the contingent
reversion in Example 1 would increase the value of the retained
interest without any certainty that the reversion would ever be paid, a
revocable spousal interest of the kind at issue in Schott would
similarly increase the value of the retained interest without any
certainty that the spouse's survivorship interest would ever be paid.
Some commentators requested that the regulations also confirm the
gift tax consequences of the lapse of the grantor's retained right to
revoke the spouse's successor interest, for example when that
revocation right lapses at the end of the GRAT term and the spouse's
successor interest becomes operative. In response, language has been
added to Sec. 25.2702-3(e), Example 8, to clarify that the grantor
makes a completed gift to the spouse when the revocation right lapses
on the expiration of the grantor's retained term (the grantor having
survived the term and not having exercised the revocation right). See
Sec. 25.2511-2(f).
Other commentators suggested that the regulations also address the
treatment of a revocable spousal interest in a Walton-type GRAT when
the grantor's spouse is given a revocable survivor interest in the
annuity payments to be made during the balance of the fixed term of the
GRAT remaining after the grantor's death. Specifically, if the grantor
dies prior to the expiration of the fixed GRAT term, the annuity
interest is payable to the spouse for the balance of that term, subject
to the grantor's power to revoke the spousal interest or, if the
spousal interest is revoked, then to the grantor's estate for the
balance of the fixed term. The commentators suggested that regardless
of whether the grantor dies during the stated term or survives, the
annuity or unitrust interest will be paid for a fixed term of years
either to the grantor, the surviving spouse, or the grantor's estate.
Accordingly, the commentators suggested that the interest is payable in
all events for a fixed term, and is therefore a qualified interest. The
commentators' suggestion would extend the concept espoused by the Tax
Court in Walton of an ``undifferentiated unit'' consisting of the
grantor and the grantor's estate (see 115 T.C. at 603) to include the
grantor, the grantor's estate, and the grantor's spouse. Treasury and
the IRS do not believe that the Tax Court opinion supports this
extension. The spouse's revocable successor interest is an interest
separate and distinct from the interest of the grantor and the
grantor's estate. Further, the use of the spouse's life expectancy in
valuing the retained interest would increase the value of that interest
without any guarantee that the spouse would actually receive any part
of that interest. For these reasons, the spouse's revocable successor
interest described above does not satisfy the requirements of a
qualified interest. Accordingly, this suggestion was not adopted.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and, because
these regulations do not impose on small entities a collection of
information requirement, the Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to section 7805(f) of the Internal
Revenue Code, the Notice of Proposed Rulemaking preceding these
regulations was submitted to the Small Business Administration for
comment on their impact on small business.
Drafting Information
The principal author of these regulations is Juli Ro Kim, Office of
the Associate Chief Counsel (Passthroughs and Special Industries), IRS.
Other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 25
Gift taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
0
Accordingly, 26 CFR part 25 is amended as follows:
PART 25--GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954
0
Paragraph 1. The authority citation for part 25 continues to read, in
part, as follows:
Authority: 25 U.S.C. 7805 * * *
0
Par. 2. In Sec. 25.2702-0, the table is amended as follows:
0
1. The entries for Sec. 25.2702-2(a)(5) through Sec. 25.2702-2(a)(9)
are redesignated as Sec. 25.2702-2(a)(6) through Sec. 25.2702-
2(a)(10), respectively.
0
2. A new entry for Sec. 25.2702-2(a)(5) is added.
0
3. The entries for Sec. 25.2702-3(d)(2) through Sec. 25.2702-3(d)(4)
are redesignated as Sec. 25.2702-3(d)(3) through Sec. 25.2702-
3(d)(5), respectively.
0
4. A new entry for Sec. 25.2702-3(d)(2) is added.
0
5. An entry for Sec. 25.2702-3(d)(6) is added.
The additions read as follows:
Sec. 25.2702-0 Table of contents.
* * * * *
Sec. 25.2702-2 Definitions and valuation rules.
(a) * * *
(5) Holder.
* * * * *
Sec. 25.2702-3 Qualified interests.
* * * * *
(d) * * *
(2) Contingencies.
* * * * *
(6) Use of debt obligations to satisfy the annuity or unitrust
payment obligation.
* * * * *
0
Par. 3. Section 25.2702-2 is amended as follows:
0
1. Paragraphs (a)(5) through (a)(9) are redesignated as paragraphs
(a)(6) through (a)(10), respectively.
0
2. A new paragraph (a)(5) is added.
0
3. In newly designated paragraph (a)(6), the second sentence is removed
and two sentences are added in its place.
0
4. In paragraph (d)(1), Example 6 and Example 7 are removed.
0
5. In paragraph (d)(2), introductory text, the language ``Examples 8-
10'' is revised to read ``Examples 6 through 8''.
0
6. In paragraph (d)(2), Examples 8, 9 and 10 are redesignated Examples
6, 7 and 8, respectively.
The additions read as follows:
Sec. 25.2702-2 Definitions and valuation rules.
(a) * * *
(5) Holder. The holder is the person to whom the annuity or
unitrust interest is payable during the fixed term of that interest.
References to holder shall also include the estate of that person.
(6) * * * If a transferor retains a power to revoke a qualified
annuity interest or qualified unitrust interest of the transferor's
spouse, then the revocable qualified annuity or unitrust interest of
the transferor's spouse is treated as a retained qualified interest of
the transferor. In order for the transferor to be treated as having
retained a qualified interest under the preceding sentence, the
interest of the transferor's spouse (the successor holder) must be an
[[Page 9224]]
interest that meets the requirements of a qualified annuity interest in
accordance with Sec. 25.2702-3(b) and (d), or a qualified unitrust
interest in accordance with Sec. 25.2702-3(c) and (d), but for the
transferor's retained power to revoke the interest. * * *
* * * * *
0
Par. 4. Section 25.2702-3 is amended as follows:
0
1. Paragraphs (d)(2) through (d)(5) are redesignated as paragraphs
(d)(3) through (d)(6), respectively.
0
2. A new paragraph (d)(2) is added.
0
3. In newly designated paragraph (d)(4), the first two sentences are
revised.
0
4. Newly designated paragraph (d)(5) is revised.
0
5. In paragraph (e), Example 5, the last sentence is revised.
0
6. In paragraph (e), Example 6, the last sentence is removed and two
new sentences are added in its place.
0
7. In paragraph (e), new Example 8 and new Example 9 are added.
The revisions and additions read as follows:
Sec. 25.2702-3 Qualified interests.
* * * * *
(d) * * *
(2) Contingencies. A holder's qualified interest must be payable in
any event to or for the benefit of the holder for the fixed term of
that interest. Thus, payment of the interest cannot be subject to any
contingency other than either the survival of the holder until the
commencement, or throughout the term, of that holder's interest, or, in
the case of a revocable interest described in Sec. 25.2702-2(a)(6),
the transferor's right to revoke the qualified interest of that
transferor's spouse.
* * * * *
(4) Term of the annuity or unitrust interest. The governing
instrument must fix the term of the annuity or unitrust and the term of
the interest must be fixed and ascertainable at the creation of the
trust. The term must be for the life of the holder, for a specified
term of years, or for the shorter (but not the longer) of those
periods. * * *
(5) Commutation. The governing instrument must prohibit commutation
(prepayment) of the interest of the holder.
* * * * *
(e) * * *
Example 5. * * * The interest of A (and A's estate) to receive
the unitrust amount for the specified term of 10 years in all events
is a qualified unitrust interest for a term of 10 years.
Example 6. * * * As in Example 5, the interest of A (and A's
estate) to receive the unitrust amount for a specified term of 10
years in all events is a qualified unitrust interest for a term of
10 years. However, the right of A's estate to continue to receive
the unitrust amount after the expiration of the 10-year term if A
dies within that 10-year period is not fixed and ascertainable at
the creation of the interest and is not a qualified unitrust
interest.
* * * * *
Example 8. A transfers property to an irrevocable trust,
retaining the right to receive an annuity equal to 6 percent of the
initial net fair market value of the trust property for 10 years, or
until A's prior death. At the expiration of the 10-year term, or on
A's death prior to the expiration of the 10-year term, the annuity
is to be paid to B, A's spouse, if then living, for 10 years or
until B's prior death. A retains an inter vivos and testamentary
power to revoke B's interest during the initial 10-year term. If not
exercised by A during the initial 10-year term (whether during A's
life or on A's death), A's right to revoke B's interest will lapse
upon either A's death during the 10-year term, or the expiration of
A's 10-year term (assuming A survives the term). Upon expiration of
B's interest (or on the expiration of A's interest if A revokes B's
interest or if B predeceases A), the trust terminates and the trust
corpus is payable to A's child. Because A has made a completed gift
of the remainder interest, the transfer of property to the trust is
not incomplete as to all interests in the property and section 2702
applies. A's annuity interest (A's right to receive the annuity for
10 years, or until A's prior death) is a retained interest that is a
qualified annuity interest under paragraphs (b) and (d) of this
section. In addition, because A has retained the power to revoke B's
interest, B's interest is treated as an interest retained by A for
purposes of section 2702. B's successive annuity interest otherwise
satisfies the requirements for a qualified interest contained in
paragraph (d) of this section, but for A's power to revoke. The term
of B's interest is specified in the governing instrument and is
fixed and ascertainable at the creation of the trust, and B's right
to receive the annuity is contingent only on B's survival, and A's
power to revoke. Following the expiration of A's interest, the
annuity is to be paid for a 10-year term or for B's (the successor
holder's) life, whichever is shorter. Accordingly, A is treated as
retaining B's revocable qualified annuity interest pursuant to Sec.
25.2702-2(a)(6). Because both A's interest and B's interest are
treated as qualified interests retained by A, the value of the gift
is the value of the property transferred to the trust less the value
of both A's qualified interest and B's qualified interest (subject
to A's power to revoke), each valued as a single-life annuity. If A
survives the 10-year term without having revoked B's interest, then
A's power to revoke lapses and A will make a completed gift to B at
that time. Further, if A revokes B's interest prior to the
commencement of that interest, A is treated as making an additional
completed gift at that time to A's child. In either case, the amount
of the gift would be the present value of B's interest determined
under section 7520 and the applicable regulations, as of the date
the revocation power lapses or the interest is revoked. See Sec.
25.2511-2(f).
Example 9. (i) A transfers property to an irrevocable trust,
retaining the right to receive 6 percent of the initial net fair
market value of the trust property for 10 years, or until A's prior
death. If A survives the 10-year term, the trust terminates and the
trust corpus is payable to A's child. If A dies prior to the
expiration of the 10-year term, the annuity is payable to B, A's
spouse, if then living, for the balance of the 10-year term, or
until B's prior death. A retains the right to revoke B's interest.
Upon expiration of B's interest (or upon A's death if A revokes B's
interest or if B predeceases A), the trust terminates and the trust
corpus is payable to A's child. As is the case in Example 8, A's
retained annuity interest (A's right to receive the annuity for 10
years, or until A's prior death) is a qualified annuity interest
under paragraphs (b) and (d) of this section. However, B's interest
does not meet the requirements of paragraph (d) of this section. The
term of B's annuity is not fixed and ascertainable at the creation
of the trust, because it is not payable for the life of B, a
specified term of years, or for the shorter of those periods.
Rather, B's annuity is payable for an unspecified period that will
depend upon the number of years left in the original term after A's
death. Further, B's annuity is payable only if A dies prior to the
expiration of the 10-year term. Thus, payment of B's annuity is not
dependent solely on B's survival, but rather is dependent on A's
failure to survive.
(ii) Accordingly, the amount of the gift is the fair market
value of the property transferred to the trust reduced by the value
of A's qualified interest (A's right to receive the stated annuity
for 10 years or until A's prior death). B's interest is not a
qualified interest and is thus valued at zero under section 2702.
* * * * *
0
Par. 5. Section 25.2702-7 is amended by adding two sentences at the end
of the section to read as follows:
Sec. 25.2702-7 Effective dates.
* * * Section 25.2702-2(a)(5), the second and third sentences of
Sec. 25.2702-2(a)(6), Sec. 25.2702-3(d)(2), the first two sentences
of Sec. 25.2702-3(d)(4), the last sentence of Sec. 25.2702-3(e),
Example 5, the last two sentences of Sec. 25.2702-3(e), Example 6, and
Sec. 25.2702-3(e), Examples 8 and 9, apply for trusts created on or
after July 26, 2004. However, the Internal Revenue Service will not
challenge any prior application of the changes to Examples 5 and 6 in
Sec. 25.2702-3(e).
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Approved: February 15, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-3589 Filed 2-24-05; 8:45 am]
BILLING CODE 4830-01-P