The US Tax Court has held that gift tax is not applicable on assets distribution to surviving spouse pursuant to non-judicial agreement.
The bench of Justice Toro opined that in the qualified terminable interest property (QTIP) regime the gift tax implications will lie on the termination of a QTIP marital trust (Residuary Trust). The implications further lies on the distribution of all the assets of the Residuary Trust to the surviving spouse pursuant to a nonjudicial agreement among the surviving spouse and his children who held remainder interests in the Residuary Trust. Subsequent sale of substantially all of those assets by the surviving spouse to trusts for the benefit of the children in exchange for promissory notes.
Background
Upon D’s death in 2011, the residuary of her estate passed, under the terms of her will, to a trust (Residuary Trust) in which S, her husband, had an income interest and their two children (C1 and C2) had remainder interests. S, as representative of D’s estate, elected under I.R.C. § 2056(b)(7) to treat the Residuary Trust property as qualified terminable interest property.
In 2016, S, C1, and C2 entered into an agreement under which the Residuary Trust was commuted and all its assets were distributed to S. S promptly sold some of the assets he received from the Residuary Trust to other trusts established for the benefit of children and grand-children, in exchange for promissory notes.
S, C1, and C2 separately filed gift tax returns for 2016 and reported that the transactions described resulted in offsetting reciprocal gifts and no gift tax.
The department (R) examined the gift tax returns and issued a Notice of Deficiency to each of S, C1, and C2 determining that the commutation of the Residuary Trust resulted in gifts from S to C1 and C2 under I.R.C. § 2519 and the agreement resulted in gifts from C1 and C2 to S of the remainder interests in the Residuary Trust under I.R.C. § 2511.
S, C1, and C2 filed a Motion for Summary Judgment seeking a ruling that no taxable gifts occurred under the transactions described above.
R filed a Motion for Partial Summary Judgement seeking rulings that the agreement to commute the Residuary Trust was a disposition of S’s qualifying income interest pursuant to I.R.C. § 2519 and resulted in gift tax liability for S, the agreement to commute the Residuary Trust resulted in gifts to S by C1 and C2 under I.R.C. § 2511, and S’s deemed gift under I.R.C. § 2519 and C1’s and C2’s gifts to S are not offsetting reciprocal gifts.
In the alternative to ruling R requests a ruling that the commutation coupled with the transfer of the Residuary Trust property in exchange for promissory notes is a disposition of S’s qualifying income interest under I.R.C. § 2519 and resulted in gift tax liability for S.
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Conclusion
The Court held that Bruce did not actually receive the Residuary Trust assets by exercise of a power of appointment. Therefore, Treasury Regulation § 25.2519-1(e) does not apply to the transactions in issue. Nonetheless, the regulation provides further support for a conclusion that can readily be reached on the basis of the statutory text alone: Because the exercise of a power of appointment in Bruce’s favour would not have been a disposition, the transactions effected by section 2 of the Nonjudicial Agreement should not have affected a disposition either.
Case Title: Bruce E. Mcdougall, Donor, Et Al. V. Commissioner Of Internal Revenue
Case No.: Docket Nos. 2458-22, 2459-22
Date: 17/09/2024
