IN The Annenberg Estate, the US Tax Court determined whether the termination of a qualified marital property trust with an indefinite interest (QTIP) for the benefit of a surviving spouse, and the subsequent sale by the surviving spouse of property previously held in the QTIP trust, resulted in tax liability for the gift as the surviving spouse in accordance with Article 2519 of the Internal Revenue Code. The court held that IRC 2519 did not apply to the transfers as asserted by the Internal Revenue Service; therefore, the surviving spouse made no gift.
QTIP trust ended
In March 2008, Alvin Anenberg passed away, survived by his wife Sally, Alvin's children and grandchildren. As a result of Alvin's death, various assets were passed to a QTIP trust for Sally's benefit. In March 2012, the QTIP trust was terminated with the consent of all beneficiaries (Sally and the remaining beneficiaries) pursuant to CCalifornia Probate Code Section 15403 and the assets were distributed directly to Sally. At the time of termination, the fair market value (FMV) of the QTIP trust property was $25,450,000 and the FMV of Sally's lifetime income interest was $2,599,463. In August 2012, Sally made two gifts of $1,632,622 of the property received from the termination of the QTIP trust to trusts for the benefit of Alvin's descendants. In September 2012, Sally sold some of the QTIP trust property to funds for the benefit of Alvin's descendants in exchange for 9-year promissory notes, which paid her interest at the applicable federal rate. Sally reported these transfers on her timely filed 2012 gift tax return.
The IRS asserts gift tax deficiencies
Sally died in 2016. In 2020, the IRS asserted that Sally's estate was responsible for a gift tax deficiency of more than $9 million due to the termination of the QTIP trusts and Sally's subsequent sale of the property she received from the conclusion. The IRS' reasoning was that when the QTIP trust terminated, Sally disposed of her qualified life income interest in the trust within the meaning of IRC Section 2519 at one of two times: (1) when she agreed to the termination of the trust and accepted the distribution of its assets to her, or (2) when she sold the assets received in exchange for the promissory notes. The IRS claimed that either of these two events was a sufficient “disposition” to trigger Article 2519. Under section 2519, any disposition of a surviving spouse's income interest in a QTIP trust is treated as if the surviving spouse transferred 100% of the remainder interest in the trust.
No transfer by gift
The court agreed with the estate's argument that Sally's purported transfer of the remainder interest in the QTIP trust resulted in her actual receipt of the unencumbered remainder interest. At the end of the day, she gave nothing of value as a result of the supposed transfer. Therefore, Sally's agreement to terminate the QTIP trust and accept its assets did not result in a gift by Sally pursuant to section 2519. Even if Sally were deemed to have transferred the remainder interest (note that the court expressly did not analyze whether a “disposition” occurred within the meaning of section 2519, finding no need to analyze the case in light of other conclusions), no value passed from Sally to anyone else because Sally (and no one else) ultimately received all of the property held from the QTIP trust as part of the termination of the QTIP trust.
Sale of shares
The court further agreed with the estate's counterargument to the IRS's second assertion that a gift would have occurred upon Sally's sale of the assets received from the QTIP note trust. The court held that section 2519 did not apply to Sally's sale of assets because Sally's income interest had already been terminated with the termination of the QTIP trust. Therefore, once the QTIP trust is terminated, the normal estate and gift tax rules (rather than section 2519, which specifically applies to a transfer of a qualified income interest in a QTIP trust) apply to the subsequent transfer of Sally's assets she received and the gift tax would not apply to Sally's sale of the assets for their FMV.