Recent Trends in Estate and Gift Tax Law 2025, IRC 2036 and Related Tax Law

“Recent Trends in Estate and Gift Tax Law 2025, IRC 2036 and Related Tax Law” that is the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is ACTEC Fellow Connie Tromble Eyster of Boulder, Colorado.

Recent case law and pronouncements by the IRS have indicated the need for increased caution in our estate and tax planning as it relates to the estate tax inclusion rules under Internal Revenue Code Section 2036. Not only must we continue to adhere to the law as it’s currently written and settled case law, but we may be well advised to note overall trends as demonstrated by emerging cases and statements from the IRS.

ACTEC Fellow Jennifer Jordan McCall of Silicon Valley, California, joins us today to help us understand this topic. Welcome, Jenny.

Recent Tax Court Rulings

Jennifer Jordan McCall: Thanks, Connie. I’d like to talk about some of the cases that have recently been handed down by the Tax Court and also some pronouncements from the IRS over the last few years, which have enforced my view that we should not only respond literally to the pronouncements of the Tax Court and, of course, comply with the statutes and the cases that have been presented, but also see a trend in terms of what might be evolving.

Because, when our clients make decisions today – for example, about what kind of interests they might retain in assets that they have transferred – their actual tax won’t be computed on their estate, of course, until they die, which could be two decades later or more. So we should be thinking a little bit about trends in terms of what could happen next so that the planning we do for our clients is not only compliant with the law today but has longevity, and so the clients can be protected if they die, and they haven’t been back to see us several more times before they do die.

The other thing is that this expanding reach of the Tax Court and the IRS, in terms of what they consider a taxable gift or includable in the estate for estate tax purposes, reinforces that lately the government has been more literal in enforcing rules that we might suspect could be a problem but previously were not being enforced.

Anenberg v. Commissioner – 162 T.C. No. 9

One example is the Anenberg case, which was handed down last year—162 Tax Court Number 9 (Anenberg v. Commissioner, 162 T.C. No. 9, May 20, 2024). In that case, the wife was a beneficiary of two marital trusts that were established at her husband’s death. They went to court and petitioned. The wife and her two children, who were the remaindermen, went to court and successfully petitioned the court to terminate the trust and distribute all the assets to the wife. Later, the wife gave shares of a closely held company received from the QTIP trust to trusts for the children, and then she sold her remaining shares in the company – received from the trust to trusts for the children – and took back a promissory note.

The IRS said that the termination of the QTIP trust and the subsequent sale of shares of the company stock was a disposition of the wife’s qualifying income interest for life under Section 2519, resulting in a taxable gift. The Tax Court went through a discussion of what they called “the legal fiction,” that the surviving spouse owns 100% of the QTIP even though it’s only just a partial income interest under property law principals. And, for that reason, the court said that the wife had not made a gift. A transfer alone is insufficient to create a gift tax liability – there must be a gratuitous transfer, not just a transfer to create a taxable gift. Therefore, the court in Anenberg held that the termination of the marital trust did not result in a taxable gift by the wife.

Now it’s interesting because it fits into a context of the Chief Counsel Memorandum – which we will discuss in a minute – but it tells us that, in this case, the wife received back all the property of the trust, even though she was only entitled to the income interest under property law principles. But, because under 2519 she was deemed to own the whole thing – they didn’t see the termination as causing any taxable transfer by the wife, which is somewhat intuitive.

McDougall v. Commissioner – 163 T.C. No. 5

But compare that to McDougall (McDougall v. Commissioner), another case handed down last year – 163 Tax Court Number 5. As in Anenberg, a QTIP trust was terminated by agreement of the beneficiaries, with all the trust assets distributed to the surviving spouse. The QTIP trust paid income, in this case, to the husband and the principal in the trustee’s discretion for his health, maintenance, and support in his accustomed manner of living.

Then, the husband and his two children – who were the remainder beneficiaries of the marital trust – entered into a non-judicial agreement to terminate the trust in favor of the husband so he could engage in estate planning. Upon termination, the husband sold the assets received to a new trust for the children in exchange for promissory notes.

In this case, again, the IRS said that each of the husband and his children had a gift tax deficiency because of 2519, and for the children too because they had given the husband the remainder interest. Here, the Tax Court said the same thing as in Anenberg – they dismissed the IRS’s argument the husband made a gift as a result of the QTIP termination and brought up that QTIP legal fiction idea – that he had the same thing before and after because he’s deemed to own the whole trust under 2519, so getting it from the kids doesn’t affect his gift tax liability, but notably the court said that the children had made a gift to the husband by giving up their remainder interest. It doesn’t matter that the husband was deemed to own the whole QTIP property with respect to the legal fiction because the children did own valuable rights to the QTIP trust, which they transferred to him. In other words, the parties’ economic positions had changed. The children had remainder interests and then they gave them back to their dad. As we know, the father had sold them assets for a note, but that again is not a gratuitous transfer as we know from 2004-64 – its really the fact that the kids gave back the remainder interest to the dad.

The reason this is interesting in the context of our conversation today is that we have seen cases where children say: “Oh, that’s OK, Dad can have the trust for now.”  And that kind of gift from the remainderman is not generally treated as a taxable gift. Another example would be –  let’s say that the child is a co-trustee of a trust, and in that context agrees that a big principal distribution can go to the surviving spouse from a trust of where the child might be a remainderman and/or a co-trustee. In that context, where the child’s a remainderman, it isn’t technically a gift if the child says: “Great, go ahead and take that” – because otherwise it would have gone into the remainder interest. That kind of gift has not been enforced as a taxable gift but, under McDougall, we see that maybe there is going to be more of that kind of enforcement.

Takeaways from Anenberg and McDougall

So, the takeaways from these cases are:

• The termination of a QTIP trust by distributing all assets to the spouse does not trigger Section 2519 – it is not a disposition by the spouse.
• But, if the termination requires the consent of remainder beneficiaries, they may be making a taxable gift to the spouse beneficiary.
• And, of course, if there is unlimited discretion of the trustee to distribute principal to the spouse and you do that – well then obviously it’s not a gift by the remaindermen because they don’t have a real vested right to the remainder because it could have always gone to the spouse.

So, a couple of takeaways:

• Maybe we want to have more flexibility in distributing more principal to the surviving spouse so as to avoid this potential gift from the remainderman, which might be enforced as under the McDougall
• And, also, if we are going to terminate a trust, we may want to have a binding agreement before the termination occurs that the spouse is going to, in fact, give all the remainder to the children less the value of the remaining income interest, or something like that. And in reliance on that agreement that they terminate, now the kids won’t have it as such that they are giving up something and making a taxable gift.

In any event, we ought to think about this because we may have a filing obligation and we don’t want to have a penalty for failure to file.

Section 2036

In a similar context, in the law pertaining to Section 2036, there has been evolving inclusion by the Tax Court where there is either an implied agreement for the person who transfers assets to have access to that property or a right to control the enjoyment of the income – the right to the entitlement to the income or the principal.

Whereas under Byrom (Ex Parte Byrom), originally, the court said a controlling shareholder has a fiduciary duty to the other shareholders. That has been eroded by the Powell case – saying that if certain rights are held by the person who transferred stock, they have an implied agreement or indirect control over those assets. In Powell (Powell v. Comm’r), it was the right to block a liquidation or a dissolution of the company that led to inclusion of all the assets that had been transferred in that person’s estate.

And there have been several other cases evolving from Strangi (Strangi v. Commissioner), which was a bad facts case that we know, into Powell and now lately into other areas. So what I would like to say – if you have transferred interests in a company, but you control that interest you transferred directly or indirectly, we should exercise caution because I think there has been increasing inclusion by the Tax Court.

The other pronouncement by the IRS that relates to this is Chief Counsel Advice 20235-2018. It’s interesting because it relates to the same kind of issue that was raised in Anenberg and McDougall. In this case, the IRS took a position in a litigation context where the children agreed in a non-judicial settlement to allow the trustee to distribute trust property back to the grantor to reimburse the grantor for income tax, where that had not been originally included in the trust agreement from the outset. That consent by the remaindermen to permit that reimbursement for income tax to the grantor was a gift by the children. And the IRS saying this caused concern in the trusts and estates community because it’s somewhat inconsistent with Revenue Ruling 2004-64, which laid out the rules and said that it would not be a gift if the trust permits the reimbursement of income tax to the grantor. In this case, the IRS distinguished 2004-64 and said – because the trust did not explicitly permit that at the beginning, if you add it later, now the kids are making a gift to the grantor because they’re allowing their entitlement to the remainder to be eroded.

Final Thoughts

So it’s similar to Anenberg and McDougall, and it is not a revocation of 2004-64. In order to revoke a revenue ruling you have to have a revenue procedure or a new statute or Supreme Court ruling, but it is a cautionary sign that the IRS is starting to look at indirect gifts from remaindermen back to the grantor. So I would say that that type of enforcement combined with the broader inclusion in the estate of assets that have been distributed by a grantor because of implied agreement to control or right to control the entitlement to income or principal – that is broadening and should be taken into account in our planning.

Connie Eyster: Jenny, that is such an interesting perspective. We thank you so much for summarizing the case law, the CCA, and these trends, because they’re going to be so important for us going forward. So we appreciate your time today, and thanks again for joining us.

Additional Resources:

• Use of Asset Protection Trusts for Estate Tax Planning Purposes (Jan 2025)
• Estate Planning in 2024 (May 2024)
• The IRS Ruling on Modifying a Grantor Trust (April 2024)

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