NewsNotes

Lesli S. Laffie, J.D., LL.M.

IRS Acquiesces in Walton Miscellaneous Inflation Adjustments Federal Tax Refund Check (Box) Passthrough Entities Tax Payments for Nonresidents (Box)

From the IRS

IRS Acquiesces in Walton

According to Notice 2003-72, the IRS has decided to follow the Tax Courts holding in Audrey J. Walton, 115 TC 589 (2000), that Regs. Sec. 25.2702-3(e), Example 5, is invalid. (For background, see Whitlock and McNamara, Significant Recent Developments in Estate Planning (Part II), TTA, Sept. 2001.) Accordingly, on the facts presented in that example, the IRS will treat a retained unitrust interest payable to a taxpayer or his or her estate as a qualified interest payable for a 10-year term.

Overview: Sec. 2702 provides special rules for valuing gifts in trust when the donor or an applicable family member retains a trust interest. If the retained interest is not a qualified interest, it is valued at zero; the gift is the entire value of the transferred property. If the retained interest is a qualified interest, the interest is valued under Sec. 7520 using the prescribed actuarial tables and interest rates; the gift is the value of the transferred property reduced by the retained interests value. 

Under Sec. 2702(b), a qualified interest is (1) one that consists of a right to receive fixed amounts payable not less frequently than annually (a qualified annuity interest); (2) one that consists of a rightpayable at least annuallyto receive a fixed percentage of the trust corpuss net fair market value, determined annually (a qualified unitrust interest); and (3) a right to receive a noncontingent remainder interest if all the other interests in the trust are qualified annuity or unitrust interests (a qualified remainder interest). Under Regs. Sec. 25.2702-3(d)(3), the qualified annuity or unitrust interest must be payable for the life of the term holder, for a specified term of years, or for the shorter (but not longer) of those periods.

In Regs. Sec. 25.2702-3(e), Example 5, A transfers property to an irrevocable trust, retaining the right to receive a unitrust amount for 10 years. If A dies within the 10-year term, the unitrust amount is to be paid to As estate for the balance of the term. The example concludes that As interest is a qualified unitrust interest to the extent of the right to receive the unitrust amount for 10 years or until As prior death. However, the unitrust amount payable to As estate if A dies within the trust term is not a qualified interest.

In Walton, the grantor established a grantor retained annuity trust, pursuant to which she was to receive an annuity for two years. If the grantor died before the expiration of the two-year term, the annuity was to be paid to her estate for the balance of the term. On expiration of the term, the trust corpus was to be distributed to a designated remainder beneficiary.

After considering Sec. 2702s legislative history and purpose, the Tax Court held that Example 5 is an unreasonable interpretation and invalid extension of Sec. 2702. It concluded that a retained annuity payable for a specified term of years to the grantor (or to the grantors estate if he or she dies before expiration of the term), is a qualified interest under Sec. 2702 for the specified term of years.

Acquiescence: The IRS acquiesces in the Tax Courts decision. Accordingly, on the facts presented in Regs. Sec.  25.2702-3(e), Example 5, it will treat the retained unitrust interest payable to A or As estate as a qualified interest payable for a 10-year term. The regulations will be revised to conform to Notice 2003-72.

Miscellaneous Inflation Adjustments

Mileage allowance: Rev. Proc. 2003-76 provides that the 2004 business mileage allowance will be 37.5 per mile; the moving, medical and charitable mileage allowance will be 14 per mile. In addition, after 2003, businesses may use the mileage allowance if they use four or fewer automobiles for business simultaneously (currently, the allowance is restricted to one business automobile).

Social Security wage base: According to the Social Security Administration (see www.ssa.gov/OACT/COLA/cbb.html), the Social Security wage base will rise to $87,900 in 2004, from $87,000 in 2003.

Nanny tax threshold: For 2004, FICA withholding will not be required for domestic employees who earn $1,400 or less annually (no increase from 2003).