Grantor Retained Interest Trusts-Application of Sections 2036 and 2039, 40173-40179 [E8-15941]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 135 (Monday, July 14, 2008)]
[Rules and Regulations]
[Pages 40173-40179]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-15941]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 20

[TD 9414]
RIN 1545-BE52


Grantor Retained Interest Trusts--Application of Sections 2036 
and 2039

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations providing guidance on 
the portion of property transferred to a trust or otherwise, that is 
properly includible in a grantor's gross estate under Internal Revenue 
Code (Code) sections 2036 and 2039 if the grantor has retained the use 
of the property or the right to an annuity, unitrust, or other payment 
from such property for life, for any period not ascertainable without 
reference to the grantor's death, or for a period that does not in fact 
end before the grantor's death. The final regulations affect estates 
that are required to file Form 706, United States Estate (and 
Generation-Skipping Transfer) Tax Return.

DATES: Effective Date: These regulations are effective on July 14, 
2008.
    Applicability Date: For dates of applicability, see Sec.  20.2036-
1(c)(3) and Sec.  20.2039-1(f).

FOR FURTHER INFORMATION CONTACT: Theresa M. Melchiorre at (202) 622-
3090 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    On June 7, 2007, proposed regulations (REG-119097-05) were 
published in the Federal Register [72 FR 31487]. The proposed 
regulations contain proposed amendments to the Estate Tax Regulations 
[26 CFR part 20] providing guidance on the portion of a trust properly 
includible in a grantor's gross estate under sections 2036 and 2039 if 
the grantor retained the use of property in the trust or the right to 
an annuity, unitrust, or other payment from the trust for life, for any 
period not ascertainable without reference to the grantor's death, or 
for a period that does not in fact end before the grantor's death. The 
trusts that were the subject of the proposed regulations include 
without limitation certain charitable remainder trusts (collectively 
CRTs) such as charitable remainder annuity trusts (CRATs) within the 
meaning of section 664(d)(1), charitable remainder unitrusts (CRUTs) 
within the meaning of section 664(d)(2) or (d)(3), and charitable 
remainder trusts that do not qualify under section 664, as well as 
other trusts established by a grantor (collectively GRTs) such as 
grantor retained annuity trusts (GRATs), grantor retained unitrusts 
(GRUTs), and various forms of grantor retained income trusts (GRITs), 
such as qualified personal residence trusts (QPRTs) and personal 
residence trusts (PRTs). A CRT was within the scope of the proposed 
regulations whether or not the CRT met the qualifications of section 
664(d)(1), (d)(2), or (d)(3) because either the CRT was created prior 
to 1969, there was a defect in the drafting of the CRT, there was no 
intention to qualify the CRT for the charitable deduction, or for any 
other reason. A GRT was within the scope of the proposed regulations 
whether or not the grantor's retained interest was a ``qualified 
interest'' as defined in section 2702(b).
    The proposed regulations incorporate the guidance provided in Rev. 
Rul. 76-273, 1976-2 CB 268, and Rev. Rul. 82-105, 1982-1 CB 133, by 
proposing to amend Sec.  20.2036-1 to provide that the portion of the 
corpus of a CRT and GRT includible in the decedent's gross estate under 
section 2036 is that portion of the trust corpus necessary to generate 
a return sufficient to provide the decedent's retained annuity, 
unitrust, or other payment. See Sec.  601.601(d)(2)(ii)(b). The 
proposed regulations provide that, in cases where both section 2036 and 
section 2039 could apply to a retained annuity, unitrust, or other 
payment in a CRT or a GRT, section 2036 (and therefore, when 
applicable, section 2035), rather than section 2039, will be applied. 
Accordingly, the proposed regulations also amend Sec.  20.2039-1 by 
providing that section 2039 generally shall not be applied to an 
annuity, unitrust, or other payment retained by a deceased grantor in a 
CRT or GRT.
    Written comments were received on the proposed regulations, and a 
public hearing was held on September 26, 2007. The proposed 
regulations, with certain changes made in response to the written and 
oral comments received, are adopted as final regulations. Although the 
final regulations provide guidance as to the Code section 
(specifically, section 2036 or 2039) to be applied in certain 
circumstances when each of those sections applies to the same trust, 
the final regulations are not to be construed to foreclose the 
possibility that any applicable section of the Code (sections 2035 
through 2039, or any other section) properly may be applied in the 
future by the IRS in appropriate circumstances beyond those described 
in the final regulations.

Summary of Comments and Explanation of Provisions

References to the Terms GRAT and GRUT

    A commentator recommended that the terms ``GRAT'' (grantor retained 
annuity trust) and ``GRUT'' (grantor retained unitrust) in the proposed 
regulations be replaced with references to Sec.  25.2702-3(b) and (c) 
because the terms GRAT and GRUT are not statutory or regulatory terms 
in the Code. In response, the final regulations include both the 
Treasury Regulation citations and the terms GRAT and GRUT.

Application of Section 2036 to a Retained Interest in a GRAT or a GRUT

    A commentator suggested that section 2036 is not applicable to a 
retained annuity interest in a GRAT to the extent the retained annuity 
interest is not payable from trust income. The commentator takes the 
position that the retained annuity interest is payable from principal 
and/or income, in kind or in cash, and the size of the annuity payment 
is not defined in relation to trust income. Instead, the commentator 
suggests that the annuity is defined as a fraction or percentage of the 
value of the GRAT's original principal, and accordingly, pursuant to 
section 2033, only the present value of any unpaid annuity payments as 
of a particular date or event, valued using section 7520, should be 
includible in the deceased grantor's gross estate. The commentator 
opined that section 2036 includes a portion of the trust in the gross 
estate only to the extent that the trust's income must be used to pay 
the retained annuity.
    Another commentator suggested that the method in the proposed 
regulations for calculating the portion of GRAT or GRUT corpus 
includible in the deceased grantor's gross estate under section 2036 
results in an overstatement of the property required to produce the 
retained annuity because the method

[[Page 40174]]

calculates the property necessary to produce the full dollar value of a 
fixed annuity over the actuarial life expectancy of the decedent as of 
the date of death, rather than for the actual term of years. Instead, 
the commentator stated that the method to be applied should value the 
retained annuity or unitrust interest, rather than the property in the 
trust required to produce the retained interest.
    In addition, it has come to the attention of the IRS and Treasury 
Department that certain taxpayers have stated that section 2036 should 
not be applied to an annuity when the actuarial value of the present 
value of the remainder interest in the trust is zero, on the theory 
that the annuity was acquired for full and adequate consideration.
    The IRS and Treasury Department have carefully considered these 
arguments and analyses. The IRS and Treasury Department believe, 
however, that these positions are not consistent with the language of 
section 2036(a)(1), its legislative history, and the case law 
interpreting this section, which require the inclusion in the gross 
estate of property over which a decedent has retained a ``string'' (the 
possession or enjoyment of, or the right to the income from the 
transferred property) for at least one of the required statutory 
periods (hereinafter referred to as a lifetime interest). This section 
was enacted in response to a concern that a donor might otherwise be 
able to remove property from the donor's gross estate by giving that 
property away before death while retaining the use or benefit of the 
property. Thus, section 2036 requires inclusion in the gross estate of 
the property subject to the ``string'', rather than the ``string'' or 
retained interest itself. For section 2036 purposes, if the grantor 
retains the possession or enjoyment of, or the right to the income 
from, the transferred property for life, for any period not 
ascertainable without reference to the grantor's death, or for a period 
which does not in fact end before the grantor's death, the value of the 
property over which the grantor retained the interest is includible in 
the grantor's gross estate. The interest retained by the grantor of a 
GRAT or GRUT who dies during the term of the GRAT or GRUT is a retained 
lifetime interest because the grantor is retaining the possession or 
enjoyment of, or the right to the income from, the transferred property 
for one of the statutorily required time periods. Section 2036(a)(1), 
accordingly, includes in the grantor's gross estate all or a portion of 
the corpus of the GRAT or GRUT. To conclude otherwise would be to 
ignore the unambiguous statutory language and the intent of section 
2036.
    This conclusion is supported by the legislative history and the 
U.S. Supreme Court's interpretation of section 2036 and its 
predecessors. See Commissioner v. Church, 335 U.S. 632, 637-638 (1949); 
64 Cong. Rec. H10729 (July 10, 1916) (statements of Messrs. Elston and 
Kitchin); 71 Cong. Rec. S7078-7079 (March 3, 1931) (statement of 
Senator Smoot); and 71 Cong. Rec. H7198-7199 (March 3, 1931) (statement 
of Mr. Hawley).
    In Church, the Court interpreted the possession and enjoyment 
clause in section 811(c) (the predecessor to section 2036) in keeping 
with its historic interpretation. Church, 335 U.S. at 645. The Court 
held that the term ``possession and enjoyment'' in section 811(c) 
includes in the transferor's gross estate property passing at the 
transferor's death in which the transferor has retained any type of 
lifetime interest (for example, income, a life estate, reverter, etc., 
contingent or otherwise, expressly stated in the transfer document or 
by operation of state law) that delayed the beneficiaries' actual use 
of the transferred property. The Court stated, ``It thus sweeps into 
the gross estate all property the ultimate possession or enjoyment of 
which is held in suspense until the moment of the decedent's death or 
thereafter. * * * Testamentary dispositions of an inter vivos nature 
cannot escape the force of this section by hiding behind legal niceties 
contained in devices and forms created by conveyancers.'' Church, 335 
U.S. at 646, quoting Goldstone v. United States, 325 U.S. 687 (1945) 
and citing Helvering v. Hallock, 309 U.S. 106 (1940). See, also, 
Spiegel's Estate v. Commissioner, 335 U.S. 701 (1949).
    In the Act of Oct. 25, 1949, ch. 720, 63 Stat. 891 (1949) (codified 
at 26 U.S.C. 811(c)(1949)) (1949 Act), Congress amended section 811(c) 
to include interests retained for a term of years. H.R. Rep. No. 81-
1412 at 9 (1949) (Conf. Report). The Conference Report states, in 
relevant part, that the ``income interests described by section 
811(c)(1)(B) [the predecessor to section 2036] and by similar language 
elsewhere in the conference amendments include reserved rights to the 
income from transferred property and rights to possess or enjoy non-
income-producing property [i.e. corpus].'' Id. at 11.
    The IRS and Treasury Department believe, based upon the broad 
statutory language in section 2036, as well as its legislative history 
and relevant case law, that under section 2036, every type of lifetime 
interest in property (annuity, income, use or enjoyment of the 
transferred property, etc.) retained for the requisite time period 
constitutes the retained possession and enjoyment of the transferred 
property or the income therefrom, causing inclusion of the transferred 
property in the transferor's gross estate. This is true regardless of 
the extent to which the retained interest is paid from the income or 
the corpus of the transferred property. This interpretation is 
consistent with the legislative intent specifically expressed by 
Congress in the 1949 Act's amendment to section 811(c) as well as with 
the Supreme Court's decision in Northeastern Pennsylvania National Bank 
& Trust Company v. United States, 387 U.S. 213 (1967). In that case, 
the Court held that a bequest to the decedent's spouse of a fixed 
monthly stipend, payable from trust income or corpus, satisfied the 
requirement of section 2056(b)(5) that the spouse receive all the 
income from a specific portion of trust corpus. The specific portion of 
corpus qualifying for the marital deduction was determined by computing 
the amount of corpus necessary to produce the guaranteed monthly 
payment, assuming a fixed rate of return.
    In addition, this interpretation is consistent with the regulations 
under section 662. For trust accounting purposes, Sec.  1.662(a)-2(c) 
defines the phrase ``the amount of income for the taxable year required 
to be distributed currently'' to include any amount required to be paid 
out of income or corpus, limited by the amount of income received by 
the estate or trust for the taxable year and not paid, credited, or 
required to be distributed to other beneficiaries for the taxable year. 
Thus, an annuity required to be paid in all events (whether out of 
income or corpus) would qualify as income required to be distributed 
currently to the extent there is income (as defined in section 643(b)) 
not paid, credited, or required to be distributed to other 
beneficiaries for the taxable year. If an annuity or a portion of an 
annuity is deemed to be income required to be distributed currently, it 
is treated in all respects in the same manner as an amount of taxable 
income. The phrase ``the amount of income for the taxable year required 
to be distributed currently'' also includes any amount required to be 
paid during the taxable year in all events (whether out of income or 
corpus) pursuant to a court order or decree or under local law, by a 
decedent's estate as an allowance or award for the support of the 
decedent's widow or other dependent for a limited period during the 
administration of the

[[Page 40175]]

estate to the extent there is income (as defined in section 643(b)) of 
the estate for the taxable year not paid, credited, or required to be 
distributed to other beneficiaries.
    With regard to the commentator's suggestion that section 2036 
applies only to the extent that the trust principal alone is 
insufficient to fully satisfy the annuity payment, the IRS and Treasury 
Department believe that this would condition the estate tax treatment 
on the nature and performance of the investments selected by the 
trustee. The application of section 2036 should not be dependent on 
either the trustee's exercise of his or her discretion to invest in 
income or nonincome producing assets, or the actual performance of the 
trust assets.
    With regard to the position of certain taxpayers that the full and 
adequate consideration exception under section 2036 is satisfied when 
the present value of the remainder interest is zero, the IRS and 
Treasury Department believe that this exception to section 2036 does 
not apply. There is a significant difference between the bona fide sale 
of property to a third party in exchange for an annuity, and the 
retention of an annuity interest in property transferred to a third 
party. In the bona fide sale, there is a negotiation and agreement 
between two parties, each of whom is the owner of a property interest 
before the sale; each uses his or her own property to provide 
consideration to the other in exchange for the property interest to be 
received from the other in the sale. When the transferor retains an 
annuity or similar interest in the transferred property (as in the case 
of a GRAT or GRUT), the transferor is not selling the transferred 
property to a third party in exchange for an annuity because there is 
no other owner of property negotiating or engaging in a sale 
transaction with the transferor. The transferor, instead, is 
transferring the property subject to a retained possession and 
enjoyment of, or right to, the income from the property. If the grantor 
retains the interest for life, for any period not ascertainable without 
reference to the grantor's death, or for a period that does not in fact 
end before the grantor's death, the property is subject to inclusion in 
the grantor's gross estate under section 2036.
    The portion of the GRAT or GRUT corpus includible in the deceased 
grantor's gross estate is that portion, valued as of the grantor's 
death (or the section 2032 alternate valuation date, if applicable), 
necessary to yield that annual annuity, unitrust, or other payment 
without reducing or invading principal. This portion is determined by 
using the section 7520 interest rate in effect on the decedent's date 
of death (or on the alternate valuation date, if applicable). The IRS 
has interpreted retained annuity interests under section 2036 in this 
manner since the enactment of this section in 1916. See Regulations 37 
(revised, 1919), Article 24 at 22 (Revenue Act of 1918) or Treasury 
Department, Treasury Decisions under Internal Revenue Law of the United 
States, Vol. 21 (Jan.-Dec., 1919), TD 2910, Art. 24 at 771; Regulations 
37 (revised, January, 1921), Article 24 at 20 (Revenue Act of 1918) or 
Treasury Department, Treasury Decisions under Internal Revenue Law of 
the United States, Vol. 23 (Jan.-Dec., 1921), TD 3145, Art. 24 at 299; 
Regulations 63 (1922 Edition), Article 20 at 21 (Revenue Act of 1921) 
or Treasury Department, Treasury Decisions under Internal Revenue Law 
of the United States, Vol. 24 (Jan.-Dec., 1922), TD 3384, Art. 20 at 
1057; Regulations 68 (1924 Edition), Article 18 at 27 (Revenue Act of 
1924) or Treasury Department, Treasury Decisions under Internal Revenue 
Law of the United States, Vol. 27 (Jan.-Dec., 1925), TD 3683, Art. 18 
at 107; Regulations 70 (1926 Edition), Article 18 at 25 (Revenue Act of 
1926) or Treasury Department, Treasury Decisions under Internal Revenue 
Law of the United States, Vol. 28 (Jan.-Dec., 1926), TD 3918, Art. 18 
at 451; and Regulations 70 (1929 Edition), Article 18 at 27-28 (Revenue 
Act of 1926). The IRS confirmed this interpretation in Rev. Rul. 76-273 
and Rev. Rul. 82-105. Although this guidance predates the advent of 
GRATs and GRUTs, the analysis and holdings of this guidance 
consistently has been applied to GRATs, GRUTs, and similar trust 
arrangements.

Pooled Income Funds

    A commentator requested that the regulations be expanded to discuss 
their impact on both newer (under three years old) and more mature 
(over three years old) pooled income funds. The age of the fund 
determines the formula to be used to determine the fund's rate of 
return, and thus the value of the charitable gift: Funds that are at 
least three years old use the highest of the three last taxable years' 
rates of return; funds that are less than three years old generally use 
the highest of the three calendar-year annual averages of the section 
7520 rates minus 1 percent. See Sec.  1.642(c)-6(e)(3) and (4). This 
distinction based on the duration of the fund, however, is not relevant 
for purposes of determining the amount included in the transferor's 
gross estate under section 2036 because the retained interest is the 
right to all of the income, thus mandating the inclusion of the entire 
share of the fund's corpus attributable to the transferor. A pooled 
income fund example has been added to the final regulations as Example 
5 in Sec.  20.2036-1(c)(2).

Remainder Interest in Personal Residences and Farms

    A commentator requested that the regulations be expanded to discuss 
the estate tax implications for charitable gifts of remainder interests 
in personal residences and farms. The calculation of the charitable 
deduction is beyond the scope of these final regulations. Example 2 of 
Sec.  20.2036-1(c)(1), however, has been added in the final regulations 
to confirm that, if the transferor transferred a personal residence to 
a third person while retaining the right to use the personal residence 
for life or for a term of years, and if the transferor died during that 
term, the fair market value of the residence on the date of death is 
includible in the transferor's gross estate under section 2036.

Alternate Valuation Date

    A commentator questioned whether the proposed regulations imply 
that the portion of the trust includible in the grantor's gross estate 
when the estate has made a section 2032 election is to be determined 
with reference to the section 7520 rate in effect on the alternate 
valuation date. The commentator has requested an explanation of why the 
change in the section 7520 rate is not a change in value due only to 
the mere lapse of time under Sec.  20.2032-1(f).
    When a section 2032 election is made, the section 7520 interest 
rate (but not the mortality factor) on the alternate valuation date is 
used to determine the portion of trust corpus includible in the 
grantor's gross estate under section 2036. The section 7520 interest 
rate reflects changes due to market conditions, which is permitted 
under section 2032. Mortality factors are not necessary to determine 
the portion of trust corpus includible in the grantor's gross estate 
under section 2036 because under section 2036 the dispositive factor is 
whether the interest was retained for the requisite statutory period, 
not the length of the period remaining at the transferor's death. See 
Sec.  20.2032-1(f) in cases where the mortality factor is applicable 
and the alternate valuation method under section 2032 is elected.

[[Page 40176]]

Alternate Valuation Date Example

    A commentator requested an example that illustrates how the rules 
of Sec.  20.2032-1(d) affect the trust's value and how required annuity 
payments made after the date of death but before the alternate 
valuation date affect the estate inclusion computation. Any such 
example, which would properly belong in the regulations under section 
2032, is beyond the scope of these final regulations.

Examples of CRAT and CRUT for a Term of Years

    A commentator requested that the regulation be expanded to include 
examples or a discussion of the estate tax implications for a donor who 
creates a CRAT or a CRUT for a term of years. In response to this 
comment, Examples 1 and 3 of Sec.  20.2036-1(c)(2) are amended in the 
final regulations to provide that, if the grantor instead had retained 
an interest in a CRAT or a CRUT for a term of years and had died during 
the term, the inclusion under section 2036 would be the same as when 
the grantor retained an interest for life in the CRAT or CRUT.

Graduated GRAT Example

    A commentator requested that examples be provided that address a 
GRAT from which the grantor receives increasing annuity payments. The 
commentator suggested two alternative methods for valuing the annuity 
and requested that the IRS provide guidance on the appropriate method. 
The IRS and Treasury Department agree that such an example would be 
helpful and appropriate but believe the issue requires further 
consideration.

Example Illustrating Proposed Sec.  20.2036-1(c)(1)

    A commentator recommended that the example found in Sec.  20.2036-
1(c)(1)(ii) illustrating the provisions of Sec.  20.2036-1(c)(1)(i) be 
changed by replacing the reference to D's spouse (E), with D's child 
(C), to avoid complications with section 2523. The commentator also 
explained that, even if D dies before E, D has a right at death to more 
than one-half of trust income because D has the right to the entire 
trust income in the event E dies before D. The IRS and Treasury 
Department agree that this example should be provided in the 
regulations under section 2036, but believe the issue requires further 
consideration.

Proposed Title for Sec.  20.2036-1(c)(2)

    A commentator suggested that the title of proposed regulation Sec.  
20.2036-1(c)(2) be changed to ``Retained annuity, unitrust, and other 
income interests in trusts.'' This comment is adopted because this 
regulation addresses retained interests in trust income and corpus.

Examples 1 and 3 of Proposed Sec.  20.2036-1(c)(2)

    A commentator recommended that Examples 1 and 3 of proposed 
regulation Sec.  20.2036-1(c)(2) state that, if D's executor elects to 
use the alternate valuation date and also elects to use the interest 
rate component for either of the two months preceding the alternate 
valuation date, then under Sec.  1.664-2(c) of the Income Tax 
Regulations, the section 7520 rate and the mortality table for that 
month should be used for purposes of determining: (1) The portion of 
trust corpus includible in D's estate; (2) the value of C's continuing 
annuity interest; and (3) the charitable deduction available for the 
portion of the CRAT included in D's estate.
    The choice as to the monthly interest rate to be used to determine 
the portion of trust corpus includible in D's estate and the value of 
C's continuing annuity interest present no issues under section 2036, 
and are addressed by section 7520. Mortality factors, however, 
generally are not necessary to determine the portion of trust corpus 
includible in the grantor's gross estate under section 2036. In cases 
where a mortality factor is applicable and the alternate valuation 
method under section 2032 is elected, taxpayers are directed to Sec.  
20.2032-1(f). The calculation of the charitable deduction is beyond the 
scope of these regulations. Accordingly, the issues raised in this 
comment will not be addressed in these final regulations.

Example 1 of Proposed Sec.  20.2036-1(c)(2)

    A commentator had several comments with respect to this example. 
The commentator pointed out that the trust in the example fails the 10 
percent remainder requirement set forth in section 664(d)(1)(D). In 
response, Example 1 has been modified in the final regulations so that 
the trust meets this requirement.
    Second, the commentator concluded that the charitable deduction of 
$30,024.80 arrived at in the example would be correct only if it is 
assumed that the annuity payments to C were paid entirely from the 
portion of the trust that is includible in D's gross estate. The 
commentator suggested that there is no basis for this assumption, and 
that C's annuity payments are made from the trust as a whole and should 
be allocated between the included and excluded portion of the trust in 
proportion to the relative values of each. This approach results in a 
charitable deduction of $86,683 ($200,000 reduced by two-thirds of the 
value of C's annuity). In response, it has been determined that it is 
beyond the scope of the final regulations to address the calculation of 
the charitable deduction. Accordingly, the charitable deduction 
calculations in Example 1 and Example 3 of Sec.  20.2036-1(c)(2) have 
been removed from the final regulations.
    The commentator requested that the regulations include a statement 
that, if an inter vivos CRAT is properly formed and subsequently 
included in the grantor's gross estate, the requirements under section 
664(d) for qualification as a CRAT do not need to be retested at the 
time of the grantor's death for purposes of determining whether the 
grantor's estate is entitled to a charitable deduction for the value of 
the remainder interest in the CRAT. This issue is governed by section 
664 and is beyond the scope of the final regulations.
    Finally, the commentator suggested that Example 1 be expanded to 
include a right retained by D to revoke C's annuity interest or to 
change the identity of the charitable remainderman and to confirm the 
impact of these retained powers on the charitable deduction. Example 1 
in Sec.  20.2036-1(c)(2) is expanded in the final regulations to 
include the scenario that D may revoke C's annuity interest or change 
the identity of the charitable remainderman. The example cites to 
section 2038 for the inclusion of property in the gross estate on 
account of such retained powers.

Example 2 of Proposed Sec.  20.2036-1(c)(2)

    A commentator suggested that the sentence, ``No additional 
contributions were made to the Trust after D's transfer at the creation 
of the Trust'' be removed or changed to reflect that no additional 
contributions may be made to a GRAT. In response, the final regulations 
adopt this comment.
    A commentator suggested that the example address the amount 
includible in D's gross estate when the trust is payable to D's estate 
after D's death. In response, Example 2 of Sec.  20.2036-1(c)(2) is 
modified in the final regulations to provide that the portion of trust 
corpus includible in D's estate under section 2036 is that portion 
necessary to support D's retained interest at the moment before D's 
death (calculated as directed in the example). Thus, it is not material 
whether annuity payments are made to D's estate after D's death.

[[Page 40177]]

Effect on Other Documents

    The following documents are obsolete as of July 14, 2008:
    Rev. Rul. 76-273 (1976-2 CB 268).
    Rev. Rul. 82-105 (1982-1 CB 133).

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 Code, the 
notice of proposed rulemaking preceding this regulation was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Theresa M. Melchiorre, 
Office of Chief Counsel, IRS.

List of Subjects in 26 CFR Part 20

    Estate taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 20 is amended as follows:

PART 20--ESTATE TAX; ESTATES OF DECEDENTS DYING AFTER AUGUST 16, 
1954

0
Paragraph 1. The authority citation for part 20 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 20.2036-1 is amended by:
0
1. Revising paragraph (a).
0
2. Designating the undesignated text following paragraph (a)(3)(ii) as 
paragraph (c)(1)(i) and adding new paragraph headings.
0
3. Adding paragraphs (c)(1)(ii), (c)(2), and (c)(3).
    The revisions and additions read as follows:


Sec.  20.2036-1  Transfers with retained life estate.

    (a) In general. A decedent's gross estate includes under section 
2036 the value of any interest in property transferred by the decedent 
after March 3, 1931, whether in trust or otherwise, except to the 
extent that the transfer was for an adequate and full consideration in 
money or money's worth (see Sec.  20.2043-1), if the decedent retained 
or reserved--
    (1) For his life;
    (2) For any period not ascertainable without reference to his death 
(if the transfer was made after June 6, 1932); or
    (3) For any period which does not in fact end before his death:
    (i) The use, possession, right to income, or other enjoyment of the 
transferred property.
* * * * *
    (c) Retained or reserved interest--(1) Amount included in gross 
estate--(i) In general. * * *
    (ii) Examples. The application of paragraph (c)(1)(i) of this 
section is illustrated in the following examples:

    Example 1. [Reserved].
    Example 2. D transferred D's personal residence to D's child 
(C), but retained the right to use the residence for a term of 
years. D dies during the term. At D's death, the fair market value 
of the personal residence is includible in D's gross estate under 
section 2036(a)(1) because D retained the right to use the residence 
for a period that did not in fact end before D's death.

    (2) Retained annuity, unitrust, and other income interests in 
trusts--(i) In general. This paragraph (c)(2) applies to a grantor's 
retained use of an asset held in trust or a retained annuity, unitrust, 
or other interest in any trust (other than a trust constituting an 
employee benefit) including without limitation the following 
(collectively referred to in this paragraph (c)(2) as ``trusts''): 
Certain charitable remainder trusts (collectively CRTs) such as a 
charitable remainder annuity trust (CRAT) within the meaning of section 
664(d)(1), a charitable remainder unitrust (CRUT) within the meaning of 
section 664(d)(2) or (d)(3), and any charitable remainder trust that 
does not qualify under section 664(d), whether because the CRT was 
created prior to 1969, there was a defect in the drafting of the CRT, 
there was no intention to qualify the CRT for the charitable deduction, 
or otherwise; other trusts established by a grantor (collectively GRTs) 
such as a grantor retained annuity trust (GRAT) paying out a qualified 
annuity interest within the meaning of Sec.  25.2702-3(b) of this 
chapter, a grantor retained unitrust (GRUT) paying out a qualified 
unitrust interest within the meaning of Sec.  25.2702-3(c) of this 
chapter; and various other forms of grantor retained income trusts 
(GRITs) whether or not the grantor's retained interest is a qualified 
interest as defined in section 2702(b), including without limitation a 
qualified personal residence trust (QPRT) within the meaning of Sec.  
25.2702-5(c) of this chapter and a personal residence trust (PRT) 
within the meaning of Sec.  25.2702-5(b) of this chapter. If a decedent 
transferred property into such a trust and retained or reserved the 
right to use such property, or the right to an annuity, unitrust, or 
other interest in such trust with respect to the property decedent so 
transferred for decedent's life, any period not ascertainable without 
reference to the decedent's death, or for a period that does not in 
fact end before the decedent's death, then the decedent's right to use 
the property or the retained annuity, unitrust, or other interest 
(whether payable from income and/or principal) constitutes the 
retention of the possession or enjoyment of, or the right to the income 
from, the property for purposes of section 2036. The portion of the 
trust's corpus includible in the decedent's gross estate for Federal 
estate tax purposes is that portion of the trust corpus necessary to 
provide the decedent's retained use or retained annuity, unitrust, or 
other payment (without reducing or invading principal) as determined in 
accordance with Sec.  20.2031-7 (or Sec.  20.2031-7A, if applicable). 
The portion of the trust's corpus includible in the decedent's gross 
estate under section 2036, however, shall not exceed the fair market 
value of the trust's corpus at the decedent's date of death.
    (ii) Graduated retained interests. [Reserved].
    (iii) Examples. The application of paragraphs (c)(2)(i) and 
(c)(2)(ii) of this section are illustrated in the following examples:

    Example 1. (i) Decedent (D) transferred $100,000 to an inter 
vivos trust that qualifies as a CRAT under section 664(d)(1). The 
trust agreement provides for an annuity of $7,500 to be paid each 
year to D for D's life, then to D's child (C) for C's life, with the 
remainder to be distributed upon the survivor's death to N, a 
charitable organization described in sections 170(c), 2055(a), and 
2522(a). The annuity is payable to D or C, as the case may be, 
annually on each December 31st. D dies in September 2006, survived 
by C who was then age 40. On D's death, the value of the trust 
assets was $300,000 and the section 7520 interest rate was 6 
percent. D's executor does not elect to use the alternate valuation 
date.
    (ii) The amount of corpus with respect to which D retained the 
right to the income, and thus the amount includible in D's gross 
estate under section 2036, is that amount of corpus necessary to 
yield the annual annuity payment to D (without reducing or invading 
principal). In this case, the formula for determining the amount of 
corpus necessary to yield the annual annuity payment to D is: annual 
annuity / section 7520 interest rate =

[[Page 40178]]

amount includible under section 2036. The amount of corpus necessary 
to yield the annual annuity is $7,500 / .06 = $125,000. Therefore, 
$125,000 is includible in D's gross estate under section 2036(a)(1). 
(The result would be the same if D had retained an interest in the 
CRAT for a term of years and had died during the term. The result 
also would be the same if D had irrevocably relinquished D's annuity 
interest less than 3 years prior to D's death because of the 
application of section 2035.) If, instead, the trust agreement had 
provided that D could revoke C's annuity interest or change the 
identity of the charitable remainderman, see section 2038 with 
regard to the portion of the trust to be included in the gross 
estate on account of such a retained power to revoke. Under the 
facts presented, section 2039 does not apply to include any amount 
in D's gross estate by reason of this retained annuity. See Sec.  
20.2039-1(e).
    Example 2. (i) D transferred $100,000 to a GRAT in which D's 
annuity is a qualified interest described in section 2702(b). The 
trust agreement provides for an annuity of $12,000 per year to be 
paid to D for a term of ten years or until D's earlier death. The 
annuity amount is payable in twelve equal installments at the end of 
each month. At the expiration of the term of years or on D's earlier 
death, the remainder is to be distributed to D's child (C). D dies 
prior to the expiration of the ten-year term. On the date of D's 
death, the value of the trust assets is $300,000 and the section 
7520 interest rate is 6 percent. D's executor does not elect to use 
the alternate valuation date.
    (ii) The amount of corpus with respect to which D retained the 
right to the income, and thus the amount includible in D's gross 
estate under section 2036, is that amount of corpus necessary to 
yield the annual annuity payment to D (without reducing or invading 
principal). In this case, the formula for determining the amount of 
corpus necessary to yield the annual annuity payment to D is: annual 
annuity (adjusted for monthly payments) / section 7520 interest rate 
= amount includible under section 2036. The Table K adjustment 
factor for monthly annuity payments in this case is 1.0272. Thus, 
the amount of corpus necessary to yield the annual annuity is 
($12,000 x 1.0272) / .06 = $205,440. Therefore, $205,440 is 
includible in D's gross estate under section 2036(a)(1). If, 
instead, the trust agreement had provided that the annuity was to be 
paid to D during D's life and to D's estate for the balance of the 
10-year term if D died during that term, then the portion of trust 
corpus includible in D's gross estate would still be as calculated 
in this paragraph. It is not material whether payments are made to 
D's estate after D's death. Under the facts presented, section 2039 
does not apply to include any amount in D's gross estate by reason 
of this retained annuity. See Sec.  20.2039-1(e).
    Example 3. (i) In 2000, D created a CRUT within the meaning of 
section 664(d)(2). The trust instrument directs the trustee to hold, 
invest, and reinvest the corpus of the trust and to pay to D for D's 
life, and then to D's child (C) for C's life, in equal quarterly 
installments payable at the end of each calendar quarter, an amount 
equal to 6 percent of the fair market value of the trust as valued 
on December 15 of the prior taxable year of the trust. At the 
termination of the trust, the then-remaining corpus, together with 
any and all accrued income, is to be distributed to N, a charitable 
organization described in sections 170(c), 2055(a), and 2522(a). D 
dies in 2006, survived by C, who was then age 55. The value of the 
trust assets on D's death was $300,000. D's executor does not elect 
to use the alternate valuation date and, as a result, D's executor 
does not choose to use the section 7520 interest rate for either of 
the two months prior to D's death.
    (ii) The amount of the corpus with respect to which D retained 
the right to the income, and thus the amount includible in D's gross 
estate under section 2036(a)(1), is that amount of corpus necessary 
to yield the unitrust payments. In this case, such amount of corpus 
is determined by dividing the trust's equivalent income interest 
rate by the section 7520 rate (which was 6 percent at the time of 
D's death). The equivalent income interest rate is determined by 
dividing the trust's adjusted payout rate by the excess of 1 over 
the adjusted payout rate. Based on Sec.  1.664-4(e)(3) of this 
chapter, the appropriate adjusted payout rate for the trust at D's 
death is 5.786 percent (6 percent x .964365). Thus, the equivalent 
income interest rate is 6.141 percent (5.786 percent / (1--5.786 
percent)). The ratio of the equivalent interest rate to the assumed 
interest rate under section 7520 is 102.35 percent (6.141 percent / 
6 percent). Because this exceeds 100 percent, D's retained payout 
interest exceeds a full income interest in the trust, and D 
effectively retained the income from all the assets transferred to 
the trust. Accordingly, because D retained for life an interest at 
least equal to the right to all income from all the property 
transferred by D to the CRUT, the entire value of the corpus of the 
CRUT is includible in D's gross estate under section 2036(a)(1). 
(The result would be the same if D had retained, instead, an 
interest in the CRUT for a term of years and had died during the 
term.) Under the facts presented, section 2039 does not apply to 
include any amount in D's gross estate by reason of D's retained 
unitrust interest. See Sec.  20.2039-1(e).
    (iii) If, instead, D had retained the right to a unitrust amount 
having an adjusted payout for which the corresponding equivalent 
interest rate would have been less than the 6 percent assumed 
interest rate of section 7520, then a correspondingly reduced 
proportion of the trust corpus would be includible in D's gross 
estate under section 2036(a)(1). Alternatively, if the interest 
retained by D was instead only one-half of the 6 percent unitrust 
interest, then the amount included in D's estate would be the amount 
needed to produce a 3 percent unitrust interest. All of the results 
in this Example 3 would be the same if the trust had been a GRUT 
instead of a CRUT.
    Example 4. During life, D established a 15-year GRIT for the 
benefit of individuals who are not members of D's family within the 
meaning of section 2704(c)(2). D retained the right to receive all 
of the net income from the GRIT, payable annually, during the GRIT's 
term. D dies during the GRIT's term. D's executor does not elect to 
use the alternate valuation date. In this case, the GRIT's corpus is 
includible in D's gross estate under section 2036(a)(1) because D 
retained the right to receive all of the income from the GRIT for a 
period that did not in fact end before D's death. If, instead, D had 
retained the right to receive 60 percent of the GRIT's net income, 
then 60 percent of the GRIT's corpus would have been includible in 
D's gross estate under section 2036. Under the facts presented, 
section 2039 does not apply to include any amount in D's gross 
estate by reason of D's retained interest. See Sec.  20.2039-1(e).
    Example 5. In 2003, D transferred $10X to a pooled income fund 
that conforms to Rev. Proc. 88-53, 1988-2 CB 712 (1988) in exchange 
for 1 unit in the fund. D is to receive all of the income from that 
1 unit during D's life. Upon D's death, D's child (C), is to receive 
D's income interest for C's life. In 2008, D dies. D's executor does 
not elect to use the alternate valuation date. In this case, the 
fair market value of D's 1 unit in the pooled income fund is 
includible in D's gross estate under section 2036(a)(1) because D 
retained the right to receive all of the income from that unit for a 
period that did not in fact end before D's death. See Sec.  
601.601(d)(2)(ii)(b) of this chapter.

    Example 6. D transferred D's personal residence to a trust that 
met the requirements of a qualified personal residence trust (QPRT) 
as set forth in Sec.  25.2702-5(c) of this chapter. Pursuant to the 
terms of the QPRT, D retained the right to use the residence for 10 
years or until D's prior death. D dies before the end of the term. 
D's executor does not elect to use the alternate valuation date. In 
this case, the fair market value of the QPRT's assets on the date of 
D's death are includible in D's gross estate under section 
2036(a)(1) because D retained the right to use the residence for a 
period that did not in fact end before D's death.

    (3) Effective/applicability dates. Paragraphs (a) and (c)(1)(i) of 
this section are applicable to the estates of decedents dying after 
August 16, 1954. Paragraphs (c)(1)(ii) and (c)(2) of this section apply 
to the estates of decedents dying on or after July 14, 2008.

0
Par. 3. Section 20.2039-1 is amended by:
0
1. Revising paragraph (a).
0
2. Adding new paragraphs (e) and (f).
    The revision and addition reads as follows:


Sec.  20.2039-1  Annuities.

    (a) In general. A decedent's gross estate includes under section 
2039(a) and (b) the value of an annuity or other payment receivable by 
any beneficiary by reason of surviving the decedent under certain 
agreements or plans to the extent that the value of the annuity or 
other payment is attributable to contributions made by the decedent or 
his employer. Sections 2039(a) and (b), however, have no application to 
an

[[Page 40179]]

amount which constitutes the proceeds of insurance under a policy on 
the decedent's life. Paragraph (b) of this section describes the 
agreements or plans to which section 2039(a) and (b) applies; paragraph 
(c) of this section provides rules for determining the amount 
includible in the decedent's gross estate; paragraph (d) of this 
section distinguishes proceeds of life insurance; and paragraph (e) of 
this section distinguishes annuity, unitrust, and other interests 
retained by a decedent in certain trusts.
    The fact that an annuity or other payment is not includible in a 
decedent's gross estate under section 2039(a) and (b) does not mean 
that it is not includible under some other section of part III of 
subchapter A of chapter 11. However, see section 2039(c) and (d) and 
Sec.  20.2039-2 for rules relating to the exclusion from a decedent's 
gross estate of annuities and other payments under certain ``qualified 
plans.'' Further, the fact that an annuity or other payment may be 
includible under section 2039(a) will not preclude the application of 
another section of chapter 11 with regard to that interest. For annuity 
interests in trust, see paragraph (e)(1) of this section.
* * * * *
    (e) No application to certain trusts. Section 2039 shall not be 
applied to include in a decedent's gross estate all or any portion of a 
trust (other than a trust constituting an employee benefit, but 
including those described in the following sentence) if the decedent 
retained a right to use property of the trust or retained an annuity, 
unitrust, or other interest in the trust, in either case as described 
in section 2036. Such trusts include without limitation the following 
(collectively referred to in this paragraph (e) as ``trusts''): Certain 
charitable remainder trusts (collectively CRTs) such as a charitable 
remainder annuity trust (CRAT) within the meaning of section 664(d)(1), 
a charitable remainder unitrust (CRUT) within the meaning of section 
664(d)(2) or (d)(3), and any other charitable remainder trust that does 
not qualify under section 664(d), whether because the CRT was created 
prior to 1969, there was a defect in the drafting of the CRT, there was 
no intention to qualify the CRT for the charitable deduction, or 
otherwise; other trusts established by a grantor (collectively GRTs) 
such as a grantor retained annuity trust (GRAT) paying out a qualified 
annuity interest within the meaning of Sec.  25.2702-3(b) of this 
chapter, a grantor retained unitrust (GRUT) paying out a qualified 
unitrust interest within the meaning of Sec.  25.2702-3(c) of this 
chapter; and various forms of grantor retained income trusts (GRITs) 
whether or not the grantor's retained interest is a qualified interest 
as defined in section 2702(b), including without limitation a qualified 
personal residence trust (QPRT) within the meaning of Sec.  25.2702-
5(c) of this chapter and a personal residence trust (PRT) within the 
meaning of Sec.  25.2702-5(b) of this chapter. For purposes of 
determining the extent to which a retained interest causes all or a 
portion of a trust to be included in a decedent's gross estate, see 
Sec.  20.2036-1(c)(1), (2), and (3).
    (f) Effective/applicability dates. The first, second, and fourth 
sentences in paragraph (a) of this section are applicable to the 
estates of decedents dying after August 16, 1954. The fifth sentence of 
paragraph (a) of this section is applicable to the estates of decedents 
dying on or after October 27, 1972, and to the estates of decedents for 
which the period for filing a claim for credit or refund of an estate 
tax overpayment ends on or after October 27, 1972. The third, sixth, 
and seventh sentences of paragraph (a) of this section and all of 
paragraph (e) of this section are applicable to the estates of 
decedents dying on or after July 14, 2008.

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
    Approved: July 4, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E8-15941 Filed 7-11-08; 8:45 am]
BILLING CODE 4830-01-P