2021’s Top 10 Estate and Tax Developments

Each year Ronald D. Aucutt provides a summary of the top 10 estate planning and tax developments from the prior calendar year for the American College of Trust and Estate Council (ACTEC.) What follows are what Mr. Aucutt’s believes are the most important developments for 2021. His first, which I will omit, is the impact of COVID, which comes as no surprise.

1. Closing Letter Fees: The IRS will issue an estate closing letter for a fee of $67.00. [REG 300.13, CCA 202142010.] Note that the issuance of a closing letter will not by itself preclude the IRS from reopening a federal estate tax examination.
2. Split-Dollar Life Insurance: In Estate of Morrissette, 146 Tax Court 171 (April 13, 2021) payments of life insurance premiums were paid by the mother’s loans to three separate trusts. The policies insured the lives of her three sons. The mother loaned in the 4 years before her death $29.9 million towards those premium payments. On the mother’s death, those note receivables were valued at $7,479,000 million on her estate tax return (which the estate later increased to $10,499,000.) The Tax Court held that some discounting was appropriate for the mother’s outstanding  loans to ILITs made to pay the insurance premiums to reflect time use of money, i.e. the loan to the ILIT was not due to be repaid until the insured-son’s death (a long time off in light of the sons’ life expectancies). The Tax Court found an estate tax deficiency of $12,575,459 and assessed an underpayment penalty of $3,232,339.
3. John Doe Summons to Lawyers: The law firm had a client (unnamed) who apparently opened investment accounts in the Isle of Man and the British Virgin Islands. The IRS sent the law firm a summons seeking 32,000 documents for “U.S. taxpayers who at any time over 23 years (1995 to 2017) used the services of the law firm to acquire, establish, operate or control a foreign bank account.” The law firm responded to the summons with a blanket assertion of privilege. In Taylor Lohmeyer law Firm PLLC v. U.S. 123 AFTR 2d 2019-1847, affirmed 957 F.3d 505 (April 24, 2021) the Court found that the law firm’s blanket assertion of the attorney-client privilege is disfavored, and was rejected by the Court. This decision sent a chill to every law firm that assists clients with sophisticated, sometimes ‘pushing the envelop’ planning strategies. Apparently the law firm’s targeted client settled with the IRS, paying $4.0 million in taxes and $5.0 million in penalties.
4. Michael Jackson Estate:  Michael died back in 2009. It was only in 2021 that the Tax Court finally resolved the dispute over the size of Michael’s taxable estate, in an extensive 265 page opinion. The dispute in value centered on the value the the celebrity’s image and likeness. The estate reported a value for Michael’s image and likeness at $2,105 on his estate tax return. The judge placed a value of $4,153,912 for his name and likeness. For the Trust that held 50% of Michael’s Sony Records and some Beatles copyrights, the estate placed a value of $0.00 yet the judge found a value of $2,207,351. For a second Trust that held Michael’s company Mijac Music, which held all the rights to his music, the judge placed a value of $107,313,561. Why this case, Estate of Michael Jackson, Tax Court Memo 2021-48 (May 3, 2021) is important, is because the court permitted the IRS appraisers to use post-death events in their valuation projections. The judge said, in part of his decision: “It was predictable that Jackson’s death would free-up the businesspeople around him to turn a profit from his legacy, without supporting his extravagent lifestyle.” Fair market value is supposed to be determined as of the date-of-death, without using any future events or foreseeability projections. In addition, the estate’s appraiser sought to ‘tax affect’ the two Trust  that held the music interests, which is based on an assumption that only a C corporation would be the willing buyer of the trusts’ assets (a C corporation with double taxation.) The judge reject the tax-affecting approach saying there was no reason to assume that only a C corporation would acquire the assets as a ‘willing buyer.
5. Splitting Gifts and Bequests: IRC 2513 permits spouses to split gifts, so that each spouse is presumed to make a gift of 50%. In Smaldino v. Commissioner, Tax Court Memo 2021-137 (November 10, 2021), Mr. Smaldino gave a 49% interest in an LLC to his wife. She prompty gave that LLC membership interest to a dynasty trust her husband had established. The Court agreed with the IRS that, in effect, Mr. Smaldino made the gift to the trust, not his wife. The result was a taxable gift and gift taxes owed because, unlike Mrs. Smaldino, Mr. Smaldino did not have enough applicable exemption amount available to fully cover the gift tax. Failing to adhere to LLC formalities and some confused dates on some of the steps the spousal gift and subsequent gift to the trust involved was sufficient to cause the Court to collapse the gift to the wife and treat it as a gift from her husband, the source of the LLC units, to the trust. Despite the unlimited marital deduction from which we all take comfort, the step-transaction doctrine can still apply to cause one spouse to incur a gift tax.
   In Estate of Warne, Tax Court Memo 2021-17 (February 18, 2021)  Mrs. Warne owned 100% of a real estate LLC. She bequeathed a 75% LLC interest to a private foundation and the remaining 25% LL interest to her church. The LLC was appraised for federal estate tax purposes at over $24 million. The IRS successfully argued to the Tax Court that the charitable bequests were subject to valuation discounts, particuarly the 25% gift of LLC units to her church. The result was a loss of over $4 million in federal estate tax charitable deduction. If the gift of 100% had been made to a donor advised fund, and then the 25% interest  ‘regifted’ to the church, the full $24 million would have qualified for the federal estate tax charitable deduction.
   In Buck v. U.S. 128 AFTR2d 2021-6043 (D. Conn, September 24, 2021)  a father gave equal gifts, in equal amounts over 4 consecutive years to two sons (amounting to 48% to each) in several tracts of timberland. The IRS argued that a valuation discount should only be available to the donor of a fractional interest if the donor then held such a fractional interest before the gift, rather than viewing several simultaneous gift portions of the property as fractional interests in the hands of the donor. In short, the IRS position was that the owner of 100% could not give fractional interests from that 100% and claim a valuation discount for the fractional interests so gifted. The judge rejected the IRS’s novel argument [which was a departure from the IRS’s own Revenue Ruling 93-12.] “Under applicable law the gifts here are not a single 96% interest but 2 48% interests given to 2 different donee’s, and the gifts must be valued separate at the time of the transfer.”
6. Donor Advised Funds: Two separate decisions with regard to lawsuits against donor advised funds made the news last year. In Fairbairn v. Fidelity Charitable Gift Fund (ND California, February 26, 2021) the donors sued Fidelity for not following donor-imposed conditions on the sale of the gifted publicly traded stock to their DAF. In Pinkert v. Schwab Charitable Fund (ND California, June 17, 2021)the claim was that Fidelity could have found lower investment fees to handle the stock that wascontributed to that DAF. The taxpayers lost both lawsuits. The key to each decision is that a donor advised fund, operated by a public charity, must have exclusive controlover the assets contributed to it, which is a condition to the donor’s charitable contribution tax deduction. [IRC 170(f)(18)(B).] If a donor wants to retain some level of control over the asset to be gifted to charity, then a private foundation should be used instead of a DAF.
7. Deemed Realization: The Treasury’s Greenbook (May 28, 2021) proposed to tax the ‘deemed realization’ of accumulated appreciation upon transfers by gift or at death. It identified this as a future priority for the government. While these ‘deemed realization’ proposals surfaced in many of the tax bills that were proposed in 2021, albeit in various forms and with dollar amount exceptions, none became the law. The concern though is that while these bills did not become law in 2021, there is still an increasing need for tax revenues, and the deemed realization tax seems to be working fairly well in Canada. In short, we have not heard the last of the repeal of the step-up in basis’ on death rule.
8. Anti-Clawback: With the scheduled drop in the applicable exemption amount starting in 2026, there was the concern that the use of the temporarily increased applicable exemption amount could cause a recapture of the unpaid gift tax when the donor’s estate tax is calculated (and the value of lifetime gifts are added back into the taxable estate base.) This concern was assumed to have been addressed by the IRS when it issued Regulation 20.2010-1(c), what many call the anti-clawback rule. While we thought that concern was resolved with that Regulation, clawback appeared once again in the Treasury IRS Priority Guidance Plan, issued on September 9, 2021. This topic was identified by the IRS as: “Whether gifts that are includible in the donor’s gross estate should be excepted from the special rule of 20.2010-1(c).” In short, there is some concern that an anti-abuse rule associated with clawback is now an active IRS project that may surface sometime in 2022.
9. Proposed Income Taxes for Trusts and Estates: Recall that trusts and estates reach the highest marginal federal income tax bracket when their income exceeds $13,450. Some of the bills submitted in Congress last year proposed to add a 5% and 8% surtax on top of the highest marginal income tax rate that a trust or estate faces, e.g. an effect tax rate of 45% on income of $500,000 or more. Add to this the other proposal to expose income from a ‘trade or business’ held by an estate or trust to the net investment income tax, i.e. another 3.8% surtax [IRC 1411(C)(1)(A)(i)] and it appears that trusts and estates are now targeted, along with the uber-wealthy, for dramatic income tax increases. While these two proposals did not make their way into law in 2021, the risk is that the trusts are now viewed either as an abusive tax shelter by Congress, or as a desired source of ‘easy’ income tax revenues.