T.C. Memo. 2006-56
UNITED STATES TAX COURT
ESTATE OF CLAUDE C. FOCARDI, DECEASED,
NINA M. FOCARDI, PERSONAL REPRESENTATIVE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
NINA M. FOCARDI, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 1892-03, 3130-03. Filed March 27, 2006.
Edward F. Koren and Douglas A. Wright, for petitioners.
Stephen R. Takeuchi, for respondent.
MEMORANDUM OPINION
LARO, Judge: In docket No. 1892-03, Estate of Claude C.
Focardi, Deceased (decedent), Nina M. Focardi, Personal
Representative, petitioned the Court to redetermine respondent’s
determination of deficiencies of $903,784 and $3,123 in the
-2-
estate’s Federal gift tax for 1996 and 1997, respectively. In
docket No. 3130-03, Nina M. Focardi (Focardi) petitioned the
Court to redetermine respondent’s determination of deficiencies
of $824,019 and $3,123 in Focardi’s Federal gift tax for 1996 and
1997, respectively. The cases resulting from these petitions
were consolidated for purposes of trial, briefing, and opinion.
Following the parties’ stipulation of the applicable value
of the stock discussed herein1 and the submission of these cases
under Rule 122, we now decide whether the respective revocable
spousal interests contained in four grantor retained annuity
trusts (GRATs) are qualified interests under section 2702(b).2
We hold they are not. We also decide whether the GRATs created
annuities that are valued on the basis of their stated term of
years (as opposed to annuities that are valued on the basis of
the actuarial life of the particular grantor) in that the
documents establishing the GRATs state that the spousal interests
1
The parties’ stipulation as to the applicable value of the
relevant stock resulted from their submission of that issue to
binding arbitration. The arbitrator concluded that the
applicable value of each share of that stock was $4.46.
2
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, Rule references
are to the Tax Court Rules of Practice and Procedure, and
references to the regulations under sec. 2702 are to those
regulations before amendment by T.D. 9181, 70 Fed. Reg. 9222
(Feb. 25, 2005). The amendments to those regulations are not
applicable here in that they apply to trusts created on or after
July 26, 2004 (the date the amendments were published in proposed
form in the Federal Register). See sec. 25.2702-7, Gift Tax
Regs., as amended by T.D. 9181, supra.
-3-
are to be disregarded if they are not qualified interests, and
such disregard makes each annuity one for its set term of years.
We hold that the GRATs do not create annuities for their stated
term of years.
Background
1. Preface
All facts were set forth in stipulations or contained in the
exhibits submitted therewith. We find the facts accordingly.
Focardi is decedent’s surviving spouse and the personal
representative of his estate. When the petition was filed in
docket no. 3130-03, Nina M. Focardi resided in St. Petersburg,
Florida. When the petition was filed in docket No. 1892-03, the
“legal address” of decedent’s estate was in St. Petersburg,
Florida.
2. Docket No. 1892-03
On October 25, 1996, decedent transferred 817,500 shares of
stock of Great Bay Distributors, Inc. (Great Bay), into a trust
(decedent 2-year GRAT) named “Claude C. Focardi Two Year Grantor
Retained Annuity Trust”. On the same day, decedent transferred
817,500 shares of Great Bay stock into a trust (decedent 4-year
GRAT) named “Claude C. Focardi Four Year Grantor Retained Annuity
Trust”. The terms of the instruments establishing the decedent
2-year GRAT and the decedent 4-year GRAT (collectively, decedent
GRATs) were identical in all material regards except for the
-4-
annuity term and the percentage used to calculate the amount of
the first annuity payment.
On April 14, 1997 and 1998, decedent filed a Form 709,
United States Gift (and Generation-Skipping Transfer) Tax Return,
for 1996 and 1997, respectively, reporting that his October 25,
1996, transfer was a gift for Federal gift tax purposes. On the
1996 return, decedent calculated the value of that gift by
reducing the value of his transferred shares by the actuarially
determined value of a 2-life annuity under section 7520; i.e.,
the present value of the annuity payable until the earlier of (1)
the end of the applicable 2- or 4-year term or (2) the deaths of
both decedent and Focardi. On the 1997 return, decedent reported
gifts for prior periods inclusive of the taxable gifts reported
on his Form 709 for 1996.
Respondent determined that decedent’s gift tax for 1996 must
be calculated by reducing the value of decedent’s transferred
shares by the value of a single-life annuity; i.e., the present
value of the annuity payable until the earlier of (1) the end of
the applicable 2- or 4-year period or (2) the death of decedent.
Respondent also determined a gift tax deficiency for 1997 due to
the increase in prior year gifts as a result of his determination
for 1996.
-5-
3. Docket No. 3130-03
On October 25, 1996, Focardi transferred 817,500 shares of
Great Bay stock into a trust (Focardi 2-year GRAT) named
“Nina M. Focardi Two Year GRAT”. On the same day, Focardi
transferred 817,500 shares of Great Bay stock into a trust
(Focardi 4-year GRAT) named “Nina M. Focardi Four Year GRAT”.
The terms of the instruments establishing the Focardi 2-year GRAT
and the Focardi 4-year GRAT (collectively, Focardi GRATs) were
identical in all material regards except for the annuity term and
the percentage used to calculate the amount of the first annuity
payment.
On April 14, 1997 and 1998, Focardi filed a Form 709 for
1996 and 1997, respectively, reporting that her October 25, 1996,
transfer was a gift for Federal gift tax purposes. On the 1996
return, Focardi calculated the value of that gift by reducing the
value of her transferred shares by the actuarially determined
value of a 2-life annuity under section 7520; i.e., the present
value of the annuity payable until the earlier of (1) the end of
the applicable 2- or 4-year term or (2) the deaths of both
decedent and Focardi. On the 1997 return, Focardi reported gifts
from prior periods inclusive of the taxable gifts reported on her
Form 709 for 1996.
Respondent determined that Focardi’s gift tax for 1996 must
be calculated by reducing the value of Focardi’s transferred
-6-
shares by the value of a single-life annuity; i.e., the present
value of the annuity payable until the earlier of (1) the end of
the applicable 2- or 4-year term or (2) the death of Focardi.
Respondent also determined a gift tax deficiency for 1997 due to
the increase in prior year gifts as a result of his determination
for 1996.
4. Relevant Trust Provisions
Each of the instruments establishing the decedent GRATs
states in relevant part as follows:
ARTICLE FOUR: Irrevocable Provision. This
agreement and the trust it creates are irrevocable, and
neither all nor part can be altered, amended, revoked,
or terminated prior to the time specified in this
agreement, by me, Trustee, or anyone else. * * *
ARTICLE FIVE: Administration of Trust Estate.
Trustee shall hold, administer, and distribute the
trust estate as follows:
A. Annuity Term. During the period beginning on
the date of this agreement and ending on the date [“2"
in the case of the decedent 2-year GRAT and “4" in the
case of the decedent 4-year GRAT] years thereafter (the
“Annuity Term”), Trustee shall pay to me from the net
income, or (to the extent that net income is
insufficient) from the principal, of the trust an
annuity (the “Annuity”) in an amount equal to
[“51.2535" in the case of the decedent 2-year GRAT and
“22.9876" in the case of the decedent 4-year GRAT]
percent of the initial fair market value of the assets
contributed to the trust as finally determined for
federal tax purposes. The annuity will increase by
twenty percent (20%) each year during the Annuity Term,
* * * If I die before the expiration of the Annuity
Term, the Trustee shall pay to my estate any part of
the Annuity that is accrued and undistributed at my
death, based on a daily proration through the date of
my death. * * * The remaining trust assets are to be
-7-
administered and distributed as provided elsewhere in
this agreement. * * *
B. Termination of Trust. Except as otherwise
provided in this agreement, at the end of the Annuity
Term, Trustee shall distribute the remaining net
income, if any, and principal of the trust not required
to be paid out in satisfaction of the final Annuity
payment, as provided in Article Six below.
C. Annual Payment, Additional Contributions, Etc.
During the Annuity Term and until the final Annuity
payment has been made, the following provisions will
apply with respect to the trust estate:
1. Trustee shall distribute the Annuity in
at least one annual payment at the end of each taxable
year, except for the taxable year in which the Annuity
Term ends, when that payment will be made by the end of
the Annuity Term. If Trustee deems it to be desirable,
Trustee may pay less than the full Annuity during any
taxable year, but Trustee must pay any unpaid amount no
later than the due date for filing the trust’s income
tax return for that taxable year, without regard to
extensions. In addition, Trustee may, in its sole and
absolute discretion, distribute all or a portion of the
Annuity in monthly, quarterly, semi-annual installments
or at any other time the Trustee deems appropriate,
subject to the time limitations of the prior sentence.
* * * * * * *
D. Qualified Annuity Interest. I intend that my
retained annuity interest in this trust (and the
annuity interest of my wife[1] if she survives me and
receives the Annuity under paragraph E below) be a
“qualified annuity interest” as defined in Code section
2702(b)(1) and Treasury Regulation Section 25.2702-3(b)
and (d). All provisions of this agreement are to be
interpreted accordingly and any provision of this
agreement inconsistent with that intention is to be of
no effect. In furtherance of this intention, I
specifically empower Trustee to amend this trust during
the Annuity Term for the sole purpose of complying with
the requirements of the foregoing Code section and
Treasury Regulations, and any such amendment will apply
retroactively to the inception of the trust. No power,
right, or duty under this agreement will be effective
-8-
or exercisable to the extent that it would cause my
retained annuity interest (or my wife’s interest, if
any) hereunder to fail to qualify as a “qualified
annuity interest” under Code section 2702(b)(1) and
Treasury Regulation Section 25.2702-3(b) and (d).
E. Revocable Contingent Spousal Annuity Trust.
If, and only if, I die before the Annuity Term ends, my
wife survives me, and I have not exercised my right to
revoke all or a portion of my wife’s interest under
this agreement, then to the extent that I have not
revoked such interest, Trustee shall hold the remaining
trust assets in a marital trust for my wife. Trustee
shall administer that marital trust for the lifetime of
my wife as follows:
1. Trustee shall pay to my wife, or if she
is deceased, to her estate, as an annuitant, the
remaining Annuity which would have been paid to me if I
had survived. The amount, time of payment, source of
payment (except the provision for adding accumulated
income to principal), proration, and adjustments of the
Annuity will be the same as the provisions for payment
of “qualified annuity interest” (defined in paragraph D
of this Article Five) to me if I had been living.
Trustee shall not make any distributions from the
marital trust to or for the benefit of anyone other
than my wife while my wife is living.
2. During the Annuity Term, the Trustee also
shall pay from the date of my death all the income that
exceeds the Annuity to or for the benefit of my wife at
least annually. After the Annuity Term, Trustee shall
pay the income to or for the benefit of my wife for her
lifetime at least annually.
* * * * * * *
G. If I Die During Trust Term and My Wife Does Not
Receive Annuity. If, and only if, I die before the
Annuity Term ends, and either I have revoked in whole
or in part my wife’s interest under this agreement or
my wife does not survive me, then the trust assets
subject to such revocation or the remaining trust
assets in the event my wife does not survive me, as the
case may be, are to be distributed to or in trust for
such appointees as I shall appoint by my Will. In the
-9-
absence of such an appointment, the remaining trust
assets shall be distributed to my estate.
* * * * * * *
ARTICLE SIX: Ultimate Distribution. Upon the
expiration of the Annuity Term, all the remaining
income and principal of this trust, if any, are to be
divided into equal shares and distributed outright and
free of trust to my then living children. If a child
of mine predeceases me, his or her share is to be
distributed to his or her estate.
1
The decedent GRATs state that “References to ‘my wife’
means [sic] NINA M. FOCARDI.”
Each of the instruments establishing the Focardi GRATs has
dispositive provisions similar to the quoted parts of the
decedent GRATs, except that (1) the word “wife” is used in lieu
of “husband”, and the word “husband” is used in lieu of “wife”,
(2) changes have been made to gender-related pronouns, and
(3) Article Five B states that “Trustee shall administer and
distribute” in lieu of “Trustee shall distribute”.
Discussion
A tax is generally imposed on a taxpayer’s transfer of
property by gift. See sec. 2501(a)(1). The amount of the gift
equals the fair market value of the transferred property as of
the date of the gift. See sec. 2512(a); sec. 25.2512-1, Gift Tax
Regs. Where property is transferred in trust with the donor
retaining an interest in the property,3 the value of the gift
3
For purposes of sec. 2702, when a transferor retains the
right to revoke a qualified annuity interest of the transferor’s
(continued...)
-10-
generally is the value of the property transferred, less the
value of the donor’s retained interest. See sec. 25.2512-5A(e),
Gift Tax Regs.; see also sec. 25.2702-2(a)(3), Gift Tax Regs.
(the term “retained” means held by the same individual both
before and after the transfer). If a gift in trust is to a
family member, however, the value of the gift is determined by
reference to section 2702(a)(2). See sec. 2702(a)(1). Section
2702(a)(2)(A) provides that the value of a retained interest that
is not a qualified interest is zero (thus, the value of the gift
is the value of the entire property). Section 2702(a)(2)(B)
provides that the value of a retained interest that is a
qualified interest is determined under section 7520.
Section 2702(b) defines the term “qualified interest” as:
(1) any interest which consists of the right to
receive fixed amounts payable not less frequently than
annually,
(2) any interest which consists of the right to
receive amounts which are payable not less frequently
than annually and are a fixed percentage of the fair
market value of the property in the trust (determined
annually), and
3
(...continued)
spouse, the transferor is considered to have retained that
interest for Federal gift tax purposes. See Cook v.
Commissioner, 269 F.3d 854, 858 (7th Cir. 2001), affg. 115 T.C.
15 (2000); Cook v. Commissioner, 115 T.C. at 24; sec.
25.2702-2(a)(5), Gift Tax Regs.; see also sec. 25.2702-2(d)(1),
Example (6), Gift Tax Regs. A transfer of an interest in
property with respect to which there are one or more term
interests is treated as a transfer of an interest in a trust.
See sec. 2702(c)(1). A term interest is an interest for life or
for a term of years. See sec. 2702(c)(3).
-11-
(3) any noncontingent remainder interest if all of
the other interests in the trust consist of interests
described in paragraph (1) or (2).
The regulations interpret this definition to include “a qualified
annuity interest, a qualified unitrust interest, or a qualified
remainder interest” and state that the “Retention of a power to
revoke a qualified annuity interest (or unitrust interest) of the
transferor’s spouse is treated as the retention of a qualified
annuity interest (or unitrust interest).”4 Sec. 25.2702-2(a)(5),
Gift Tax Regs. The regulations explain that a qualified annuity
interest is “an irrevocable right to receive a fixed amount * * *
payable to (or for the benefit of) the holder of the annuity
interest" for each taxable year of the term and that a qualified
unitrust interest is “an irrevocable right to receive payment
periodically, but not less frequently than annually, of a fixed
percentage of the net fair market value of the trust assets,
determined annually.” Sec. 25.2702-3(b)(1)(i) and (c)(1)(i),
Gift Tax Regs. See generally sec. 25.2702-3(f), Gift Tax Regs.,
(defines the term “qualified remainder interest”). The
regulations also explain that in the case of a qualified annuity
interest, a fixed amount is either a set dollar amount or a set
4
This latter statement reflects a taxpayer-favorable rule
that was added to the regulations without comment. The rule is
not required by either the statute or the legislative history
thereunder. See 136 Cong. Rec. 30485, 30536-30540 (1990). See
generally Bogdanski, “GRAT Valuation: The Ninth Circuit Takes
its Schott”, 30 Est. Plan. 304, 306 (June 2003).
-12-
portion (not to exceed 120 percent of the set portion payable in
the preceding year) of the initial fair market value of the
property transferred to the trust as finally determined for
Federal tax purposes, and that the fixed amount must be payable
periodically but not less frequently than annually. See sec.
25.2702-3(b)(1)(ii), Gift Tax Regs. The regulations require that
the trust instrument: (1) “prohibit distributions from the trust
to or for the benefit of any person other than the holder of the
qualified annuity or unitrust interest during the term of the
qualified interest”, sec. 25.2702-3(d)(2), Gift Tax Regs., and
(2) “fix the term of the annuity or unitrust interest * * * for
the life of the term holder, for a specified term of years, or
for the shorter (but not the longer) of those periods”, sec.
25.2702-3(d)(3), Gift Tax Regs.
Respondent argues that the spousal interests at issue were
not qualified interests because: (1) The spousal interests were
contingent on the grantor’s failing to survive the applicable 2-
or 4-year term (in other words, the interests were not fixed and
ascertainable), and (2) the spousal interests were not payable
for the life of the term holder, for a term of years, or for the
shorter of those periods. As respondent sees it, each grantor’s
retained annuity is a qualified interest to the extent that it is
payable for a term of years or the grantor’s earlier death, but
not to the extent it continues for the surviving spouse for the
-13-
remainder of the term or until the surviving spouse’s earlier
death.
Petitioners argue that the spousal interests were qualified
interests in that they were “fixed and ascertainable interests
existing for a specified term of years, for the life of the term
holders, or for the shorter of the two.” Petitioners assert that
the GRATs operated in the same manner as the GRATs in Schott v.
Commissioner, 319 F.3d 1203 (9th Cir. 2003), revg. and remanding
T.C. Memo. 2001-110, which the Court of Appeals for the Ninth
Circuit held were qualified interests under section 2702(b).
Petitioners stress that the Court of Appeals for the Ninth
Circuit concluded in Schott that section 25.2702-2(d)(1),
Example (7), Gift Tax Regs., establishes, contrary to
respondent’s position both there and here, that a spousal
interest is not disqualified simply because it is contingent upon
a spouse’s surviving the grantor.5 Petitioners recognize that
5
Sec. 25.2702-2(d)(1), Example (6) and Example (7), Gift
Tax Regs., states:
Example (6). A transfers property to an
irrevocable trust, retaining the right to receive the
income for 10 years. Upon expiration of 10 years, the
income of the trust is payable to A’s spouse for 10
years if living. Upon expiration of the spouse’s
interest, the trust terminates and the trust corpus is
payable to A’s child. A retains the right to revoke
the spouse’s interest. Because the transfer of
property to the trust is not incomplete as to all
interests in the property (i.e., A has made a completed
gift of the remainder interest), section 2702 applies.
(continued...)
-14-
this Court and the Court of Appeals for the Seventh Circuit in
Cook v. Commissioner, 115 T.C. 15 (2000), affd. 269 F.3d 854 (7th
Cir. 2001), held that the GRATs there, which were similar to the
GRATs here, were not qualified interests because they were
contingent. Petitioners argue that Cook is factually
distinguishable from this case and Schott in that the GRATs in
Cook, unlike the GRATs here and in Schott, involved a further
contingency that the grantor and spouse remain married.
We agree with respondent that the spousal interests at issue
are not qualified interests. The spouse in no case will ever
receive any payments from the GRATs if the grantor survives the
applicable 2- or 4-year term, because the interests by their
terms are payable only if the grantor predeceases the spouse
during the applicable term. The interests, therefore, are not
fixed and ascertainable upon the inception of the trusts, as is
5
(...continued)
A’s power to revoke the spouse’s term interest is
treated as a retained interest for purposes of section
2702. Because no interest retained by A is a qualified
interest, the amount of the gift is the fair market
value of the property transferred to the trust.
Example (7). The facts are the same as in Example
6, except that both the term interest retained by A and
the interest transferred to A’s spouse (subject to A’s
right of revocation) are qualified annuity or unitrust
interests. The amount of the gift is the fair market
value of the property transferred to the trust reduced
by the value of both A’s qualified interest and the
value of the qualified interest transferred to A’s
spouse (subject to A’s power to revoke).
-15-
required by the regulations. The term of the spousal annuity, if
it does become payable on account of the grantor’s death within
the 2- or 4-year term, also is dependent on when the grantor dies
and, in particular, on how much of the term remains at the
grantor’s death. Thus, neither the vesting nor the duration of
the spousal interests is fixed and ascertainable upon the
inception of the trusts in that both depend on the death of the
grantor within a specified period. Given that the regulations
require that “The governing instrument * * * fix the term of the
annuity or unitrust interest”, sec. 25.2702-3(d)(3), Gift Tax
Regs., we believe that the term of the spousal interests must be
fixed and ascertainable upon the inception of the trusts in order
to be qualified interests, see Cook v. Commissioner, 115 T.C. at
23-26. In contrast with petitioners’ reading of section 2702, we
do not read section 2702 or the regulations thereunder to allow
transferors such as decedent and Focardi to reduce the value of a
remainder interest simply by assigning a value to a spousal
interest which may never take effect. See id.
Each spousal interest also is not a qualified interest in
that it fails the duration requirement of section
25.2702-3(d)(3), Gift Tax Regs., that a term extend for the life
of the term holder, for a specified term of years, or for the
shorter of those periods. The instruments establishing the GRATs
stand in marked contrast to section 25.2702-2(d)(1), Example (7),
-16-
Gift Tax Regs., where the 10-year revocable spousal interest is
in all events payable to the spouse beginning at the end of the
grantor’s 10-year term. The spousal annuity in that example
meets the duration rule of section 25.2702-3(d)(3), Gift Tax
Regs., in that the 10-year interests of both the grantor and the
spouse are upon creation of the trust fixed and ascertainable.
In other words, the spousal interest in the example is not
contingent upon the grantor’s death before the expiration of the
initial 10-year term but is dependent on the spouse’s survival of
that term. If the spouse survives until the start of the spousal
interest, he or she will receive that interest in all events
(subject to the grantor’s retained right of revocation).
Petitioners rely primarily upon Schott v. Commissioner,
319 F.3d 1203 (9th Cir. 2003), to support their view that the
spousal interests at issue are qualified interests. In Schott v.
Commissioner, supra at 1207, the Court of Appeals for the Ninth
Circuit held that “the Commissioner’s interpretation of * * *
[section 25.2702-2(d)(1), Example (7), Gift Tax Regs.,] to
exclude the contingency of the spouse’s being alive at the time
her annuity begins is unreasonable and invalid” and that a “two-
life annuity, based on the lives of the grantor and spouse with a
limit of fifteen years, falls ‘within the class of easily valued
rights’ that Congress meant to qualify.” The GRAT there provided
for fixed annuity payments to the grantor until the earlier of
-17-
the grantor’s death or 15 years. If the grantor died before the
end of the 15-year term and the grantor’s spouse survived the
grantor, the annuity was to be paid to the spouse for the
remainder of the 15-year term. The grantor retained the right to
revoke the spouse’s interest.
The case of Schott v. Commissioner, supra, does not require
that we accept petitioners’ conclusion that the spousal interests
in issue were qualified interests. We do not believe that the
ability to easily value a spousal interest is the linchpin for a
finding that the spousal interest is a qualified interest. The
legislative history under section 2702 indicates that Congress
enacted section 2702 intending to “curb potential valuation abuse
associated with intrafamily transfers of wealth”. Cook v.
Commissioner, 269 F.3d at 858; see also 136 Cong. Rec. at
30537-30538 (1990). The possibility of such an abuse is present
where, as here, it is not certain at the outset of the trusts
that payments will ever be made under a survivorship annuity. We
understand the lawmaker’s intent for section 2702 is to ensure
that a retained interest be fixed and ascertainable at the
creation of a trust in order to reduce the value of the gift of a
remainder interest. See Cook v. Commissioner, 269 F.3d at 858.
If, as petitioners claim, gifts in trust could be reduced by the
value of spousal interests which are contingent and which never
take effect, the retained interests would have the potential for
-18-
overvaluation, and the gift of the remainder would have the
potential for undervaluation. We consider such treatment to be
contrary to the lawmaker’s intent for section 2702. See id.
This Court and the Court of Appeals for the Seventh Circuit
opined on the subject matter at hand in Cook v. Commissioner,
supra. The Court of Appeals for the Ninth Circuit did not
acknowledge disagreement with Cook but distinguished Cook on the
ground that Cook, unlike Schott, involved an expressed
contingency that the spouses remain married at the time of the
grantor/spouse’s death. In Cook, the GRATs stated that an
annuity would be paid to the grantor until the earlier of 5 years
or the grantor's death. If the grantor survived the 5-year term,
the remaining trust property would pass to a separate trust
benefiting the grantor’s son. If the grantor died before the end
of the 5-year term and was married to the grantor’s spouse at the
time of death, all remaining trust property would pass to a
contingent marital annuity trust, pursuant to which the grantor’s
spouse would receive the annuity amount for the balance of the
5-year term. Upon the earlier of the end of the 5-year term or
the death of the grantor's spouse, the remaining trust assets
would pass to a separate trust benefiting the grantor's son. The
grantor reserved the power to revoke the successor interest of
the spouse.
-19-
This Court held that the spousal interests in Cook v.
Commissioner, supra, were not qualified interests because, among
other reasons, they were neither fixed nor ascertainable upon the
inception of the trusts. On appeal, the Court of Appeals for the
Seventh Circuit agreed. That court noted that the spouse’s
interest might never vest and stated that allowing a reduction
for tax purposes of a gift made in trust for an “ephemeral
interest” would invite abuse. Cook v. Commissioner, 269 F.3d at
858. That court concluded that the spousal interests were
contingent, and not fixed and ascertainable, because the spouse
was entitled to receive the interest only if the spouse survived
the grantor, and only then, if the spouse and grantor remained
married. Given the fact that marital trusts are present both
here and in Cook, and that the opinions in Schott did not mention
a marital trust there, we believe that the decision in Cook
applies here with more vigor and force than the decision in
Schott v. Commissioner, 319 F.3d 1203 (9th Cir. 2003). Such is
especially so given our reading of the instruments establishing
the GRATs at issue to reveal a strong implicit understanding of a
marriage contingency for any payment under the spousal
interests.6
6
We also note that sec. 25.2702-2(a)(5), Gift Tax Regs.,
requires that the successor annuitant be the grantor’s spouse in
order to apply the rule that the grantor’s retention of a power
to revoke a qualified annuity interest (or unitrust interest) is
(continued...)
-20-
Our view is further supported by the well-established
principle that the judiciary should accord substantial deference
to the Commissioner’s interpretation of Treasury regulations, see
Jewett v. Commissioner, 455 U.S. 305, 318 (1982); Ford Motor Co.
v. Milhollin, 444 U.S. 555, 565-566 (1980); Blessitt v. Ret. Plan
for Employees of Dixie Engine Co., 848 F.2d 1164, 1167-1168 (11th
Cir. 1988) (en banc); see also Anderson Bros. Ford v. Valencia,
452 U.S. 205, 219 (1981) (“absent some obvious repugnance to the
statute, the * * * [agency’s] regulation implementing this
legislation should be accepted by the courts, as should the * * *
[agency’s] interpretation of its own regulation”),7 and the fact
that the Treasury Department has recently amended its regulations
on this subject to clarify the rules applicable to revocable
spousal interests and to clarify its view that section 2702 was
enacted to overcome both (1) a problem concerning an uncertainty
6
(...continued)
the retention of a qualified annuity interest (or unitrust
interest). Thus, absent an explicit marriage contingency in this
case, such a contingency is implicit. See generally Kozusko,
“Commentary on Schott v. Commissioner”, 28 Tax Mgmt. Est., Gifts
& Tr. J. 165, 166 (2003).
7
Of course, as we have just recently noted, deference is
not required to the extent that the regulation is incompatible
with the plain meaning of the text of the statute that it
purports to construe. See Swallows Holding, Ltd. v.
Commissioner, 126 T.C. (2006); see also Natl. Muffler Dealers
Association v. United States, 440 U.S. 472, 477 (1979)
(interpretative Federal tax regulation is reasonable only if it
“harmonizes with the plain language of the statute, its origin,
and its purpose”).
-21-
in valuation and (2) an inaccuracy in valuation caused by an
uncertainty that a survivorship interest will never be paid. See
T.D. 9181, 70 Fed. Reg. 9222 (Feb. 25, 2005). As to the
requirement of substantial deference, such a requirement would
appear to be at its strongest here, where the regulation in
question (i.e., the rule that allows a retention of a right to
revoke not to be considered a retention for purposes of section
2702) does not appear in the statute or in its legislative
history, but is a creation of the Treasury Department. As to the
recent amendments to the regulations, those regulations state
specifically that revocable spousal interests such as those here
are not qualified interests.8 They also include provisions that
(1) define the word “holder” to mean the person to whom the
qualified interest is payable during the term, see current sec.
25.2702-2(a)(5), Gift Tax Regs.; (2) require that a spousal
interest subject to a revocation power independently meet the
regulatory requirements for a qualified interest, but for the
transferor's power to revoke, see current sec. 25.2702-2(a)(6),
Gift Tax Regs.; and (3) state that a qualified interest may only
be contingent on the survival of the holder, see current sec.
25.2702-3(d)(2), Gift Tax Regs. The amendments also add to the
regulations a new example that illustrates a revocable spousal
8
As mentioned supra note 2, those amendments are not
applicable here in that they apply to trusts created on or after
July 26, 2004.
-22-
interest that is a qualified interest. See current section
25.2702-3(e), Example (8), Gift Tax Regs. This new example is
consistent with section 25.2702-2(d)(1), Example (7), Gift Tax
Regs., on which respondent relies here. A second example added
to the regulations; i.e., current section 25.2702-3(e), Example
(9), Gift Tax Regs., further illustrates that revocable spousal
interests such as those here are not qualified interests. New
Example (9) states:
Example 9. (i) A transfers property to an
irrevocable trust, retaining the right to receive 6
percent of the initial net fair market value of the
trust property for 10 years, or until A's prior death.
If A survives the 10-year term, the trust terminates
and the trust corpus is payable to A's child. If A
dies prior to the expiration of the 10-year term, the
annuity is payable to B, A's spouse, if then living,
for the balance of the 10-year term, or until B's prior
death. A retains the right to revoke B's interest.
Upon expiration of B's interest (or upon A's death if A
revokes B's interest or if B predeceases A), the trust
terminates and the trust corpus is payable to A's
child. As is the case in Example 8, A's retained
annuity interest (A's right to receive the annuity for
10 years, or until A's prior death) is a qualified
annuity interest under paragraphs (b) and (d) of this
section. However, B's interest does not meet the
requirements of paragraph (d) of this section. The
term of B's annuity is not fixed and ascertainable at
the creation of the trust, because it is not payable
for the life of B, a specified term of years, or for
the shorter of those periods. Rather, B's annuity is
payable for an unspecified period that will depend upon
the number of years left in the original term after A's
death. Further, B's annuity is payable only if A dies
prior to the expiration of the 10-year term. Thus,
payment of B's annuity is not dependent solely on B's
survival, but rather is dependent on A's failure to
survive.
-23-
(ii) Accordingly, the amount of the gift is the
fair market value of the property transferred to the
trust reduced by the value of A's qualified interest
(A's right to receive the stated annuity for 10 years
or until A's prior death). B's interest is not a
qualified interest and is thus valued at zero under
section 2702.
Petitioners argue alternatively that this Court, if we
conclude that the spousal interests in the GRATs are not
qualified interests, must disregard those interests in that the
instruments establishing the GRATs state as much. Petitioners
point the Court to Article Five D, which states that “No power,
right, or duty under the agreement will be effective or
exercisable to the extent that it would cause my retained annuity
interest (or my wife’s [husband’s] interest, if any) hereunder to
fail to qualify as a ‘qualified annuity interest’ under I.R.C.
§ 2702(b)(1)”. Petitioners assert that the quoted text operates
to invalidate the spousal interests in that those interests are
not qualified interests. Petitioners conclude that each GRAT is
now simply a GRAT for a set term of either 2 or 4 years, as the
case may be, and should be treated as such.
We reject petitioners’ alternative argument. We do not
believe that petitioners are entitled at this time to treat each
GRAT in issue as one of a set term of years simply because the
GRATs state that our determination that the spousal interests are
not qualified interests essentially means that the spousal gift
is revoked. Such a “savings clause” is ineffective for Federal
-24-
transfer tax purposes, and we give it no respect. See
Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944); Ward v.
Commissioner, 87 T.C. 78 (1986); Harwood v. Commissioner, 82 T.C.
239 (1984), affd. without published opinion 786 F.2d 1174 (9th
Cir. 1986). See generally Rev. Rul. 65-144, 1965-1 C.B. 442.
We hold for respondent. We have considered all arguments by
petitioners for a contrary holding and find those arguments not
discussed herein to be without merit. To reflect the
arbitrator’s valuation of the Great Bay stock,
Decisions will be entered
under Rule 155.