• The repurchase agreement does not affect the company's valuation–IN Estate of Connelly v. United States, No. 23-146 (June 6, 2024), the US Supreme Court agreed with the Internal Revenue Service that life insurance proceeds paid to a business were not offset by the business' obligation to repay the decedent's ownership in the company. As a result, the value of the business includes the value of the insurance proceeds for the purpose of calculating the estate tax liability.
Two brothers, Michael and Thomas Connelly, were the sole shareholders of their building supply business. They had signed an agreement aimed at keeping the business within the family, which provided that on the death of each, the survivor would buy the deceased brother's shares, or the business would redeem them. The business purchased life insurance policies on the lives of the two brothers to implement the plan. When Michael passed away, Thomas chose not to buy his brother's shares and therefore, the business was obliged to buy them.
Both parties agreed that the life insurance proceeds should be included in the value of the business, but Michael's estate argued that the company's obligation to repay Michael's shares was a liability that should also be taken into account when valuing the business at the date of Michael's death.
The Supreme Court disagreed. The court considered the redemption to be a neutral economic event, reasoning that even though the business would have less funds after the redemption, the remaining shareholder's interest would increase accordingly, leaving them in a similar economic position. Additionally, under Section 26 USC 2033, a decedent's gross estate is assessed “at the time of his death,” and therefore, assessment should not stop until the insurance proceeds are used for the redemption.
• Revenue Procedure 2024-22 provides guidance for Internal Revenue Code Section 501(c)(3) tax-exempt organizations regarding organizational requirements and exempt purposes–To qualify for IRC Section 501(c)(3) tax-exempt status, organizations must ensure that, upon dissolution, any remaining assets are distributed to exempt purposes, as opposed to individual beneficiaries. Organizations can either establish a qualifying plan of distribution in their controlling documents or rely on the operation of state law to meet federal requirements. The assets of an organization will be considered dedicated to an exempt purpose if, after dissolution, those assets are distributed: (1) to one or more exempt purposes; (2) to the federal government; (3) to a state or local government; (4) for public purposes; or (5) by a court to another organization for general purposes of the dissolving organization.
The IRS restated this crucial point in Rev. Proc. 2024-22. Previous instructions, Rev. Proc. 82-2, were based on state law and provided a summary of different results based on different state laws. However, as state laws changed, Rev. Proc. 82-2 was becoming obsolete and ineffective. The new revenue procedure revokes previous guidance, emphasizes the importance of compliance, and provides resources for properly drafting control documents without all the state-by-state examples. If relying on applicable state law rather than creating a qualifying distribution plan, each organization is responsible for verifying that the requirements are met.
• Nebraska Supreme Court Holds Trust Exempted Specific Real Estate from Withholding Estate Tax–IN Shaddick v. Hessler, 316 Neb. 600 (May 10, 2024), the Nebraska Supreme Court held that express tax-splitting provisions in a decedent's revocable trust violated the state law rule that all beneficiaries share proportionately the burden of the inheritance tax.
Michael Hessler created a revocable trust as part of his initial estate plan. Later, he changed his faith to leave his home completely and without faith in his girlfriend, Lori J. Miller. The remainder of his estate passed equally to his children. Michael's children argued that Lori should be responsible for a pro rata share of the estate tax. However, Lori noted a provision in the trust that specifically assigned the estate tax burden to the remainder beneficiaries. The court agreed with Lori and affirmed the lower court's decision.
The default provisions of the Nebraska Revised Statutes state that the estate tax must be divided proportionately by the beneficiaries, unless otherwise directed. Michael's trust stated, in relevant part, that “The Successor Trustee shall pay from this trust all inheritance and estate taxes due to the Settlor's death, whether or not such taxes relate to trust property.” The court found that such a direction, along with the direct, specific distribution of the decedent's home to Lori, meant that the taxes would be paid by the trust “off the top” and that the home was removed from consideration. The court relied on its 2015 decision in On Shell's property, in which similar language shifted the tax burden to the decedent's estate.
• The Tax Court analyzes the gift tax liability under IRC Section 2519 for the termination of a surviving widow's qualified terminable property trust (QTIP)–IN Estate of Sally J. Anenber v. Commissioner, 162 TC No. 9 (May 20, 2024), the Tax Court addressed whether section 2519 applied when a QTIP trust was terminated with the consent of the beneficiaries and the approval of the local superior court pursuant to the local probate code.
The QTIP trust held shares of heiress Sally Anenber's closely held business. When the local superior court approved the termination, the entire QTIP trust was immediately distributed to Sally. Six months later, Sally sold the business shares to her late husband's children in exchange for promissory notes.
Under section 2519, a transfer of an income interest in a QTIP trust is treated as a transfer of trust principal. Section 2519 is intended to ensure that QTIP property will be taxed if it passes through the surviving spouse's lifetime.
The IRS argued that Sally triggered Section 2519 by terminating the QTIP trust or selling the stock as a disposition of her income interest and, as a result, the transfer is treated as a taxable gift. The decedent's estate argued that (1) neither event was a “disposition” under section 2519, and (2) even if so, neither “disposition” was a gift.
The court ruled that no gift was made when Sally terminated the QTIP because she received all of the underlying property. This transfer was not free and she never relinquished dominance or control.
The court further rejected the notion that the subsequent transfer of the stock triggered Section 2519 because at that point, Sally owned the stock outright and there was no transfer of an income interest in a QTIP. In short, Sally did not make a transfer when the termination of the QTIP occurred, and when she made a transfer later, she no longer held the income interest. At no time (at the time of termination or sale) were both conditions of section 2519 satisfied. Nor did Sally have a disposition of her income interest in the QTIP trust.
The policy goals of Section 2519 and Section 2044 are to ensure that the transfer tax is imposed when the property leaves the spouse's hands. When the QTIP trust ended, no property left Sally's hands. And when she later sold the shares, she received payment in the form of promissory notes, keeping the value in her taxable estate. The underlying purpose of section 2519 is not relevant here.
Ask if the children made a gift to Sally if they accepted the termination and court-approved distribution of the QTIP trust to Sally.