This could have been a very short Capital Letter, because it is about the March 16, 2010, Update of the 2009-2010 Treasury-IRS Priority Guidance Plan, which says practically nothing. When the Plan was originally released on November 24, 2009, it was the subject of Capital Letter Number 22, entitled “Treasury and IRS Publish Modest Priority Guidance Plan for 2009-10.” The Plan included only two new projects under the heading “Gifts and Estates and Trusts,” guidance on whether a grantor’s power to substitute trust assets in will cause insurance policies held in the trust to be includible in the grantor’s gross estate and guidance under section 2801 regarding the tax imposed on citizens and residents who receive gifts or bequests from expatriates.
The projects on the original Plan that seemed most likely to be completed relatively soon, perhaps by the end of 2009, included Item 1 (“Regulations under §67 regarding miscellaneous itemized deductions of a trust or estate”), Item 2 (“Final regulations under §642(c) concerning the ordering rules for charitable payments made by a charitable lead trust”), Item 8 (“Guidance providing procedures for filing and perfecting protective claims for refunds for amounts deductible under §2053”), and Item 12 (“Regulations under §2642(g) regarding extensions of time to make allocations of the generation-skipping transfer tax exemption”). But none of those have been completed. Indeed, as the March 16, 2010, Update confirms, no progress has been made on any project under the heading “Gifts and Estates and Trusts” in the original Plan.
One New Project
The Update adds one additional project to the Priority Guidance Plan under the heading “Gifts and Estates and Trusts,” entitled simply “Guidance under section 2511(c)” and annotated as already published by Notice 2010-19, 2010-7 I.R.B. 404. Section 2511(c), added by the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) with an effective date of January 1, 2010, was reportedly intended to reinforce the redefined post-estate tax role of the gift tax as a backstop to the income tax. As amended by a technical correction in 2002, it provides:
(c) Treatment of Certain Transfers in Trust.—Notwithstanding any other provision of this section and except as provided in regulations, a transfer in trust shall be treated as a transfer of property by gift, unless the trust is treated as wholly owned by the donor or the donor’s spouse under subpart E of part I of subchapter J of chapter 1.
Once it became apparent that the 2010 law enacted in 2001 was going to take effect after all, section 2511(c) generated an avalanche of comment, including speculation that a transfer to a trust treated as wholly owned by the grantor for income tax purposes would never be treated as a gift, so that if the grantor trust is designed to avoid any of the “string” provisions of sections 2036 through 2043 that would bring the value of the trust property into the transferor’s gross estate, the property can eventually pass to the transferor’s descendants or other beneficiaries without passing through either the gift tax or estate tax system. Apparently to repudiate such speculation, Notice 2010-19 stated:
Some taxpayers may have inaccurately interpreted section 2511(c) as excluding from the gift tax transfers to a trust treated as wholly owned by the donor or the donor’s spouse under subpart E of part I of subchapter J of chapter 1, even though those transfers would otherwise be taxable under Chapter 12. The provisions of Chapter 12 regarding the substantive law applicable to the gift tax were not amended by EGTRRA, and those provisions continue to apply to all transfers made by donors during 2010. Section 2511(c) is an addition to those substantive law provisions and is applicable to transfers made in 2010. Section 2511(c) broadens the types of transfers subject to the transfer tax under Chapter 12 to include certain transfers to trusts that, before 2010, would have been considered incomplete and, thus, not subject to the gift tax. Accordingly, each transfer made in 2010 to a trust that is not treated as wholly owned by the donor or the donor’s spouse under subpart E of part I of subchapter J of chapter 1 is considered to be a transfer by gift of the entire interest in the property under section 2511(c). The provisions of Chapter 12 as in effect on December 31, 2009, continue to apply (both before and during 2010) to all transfers made to any other trust to determine whether the transfer is subject to gift tax.
Although there is still much mystery about section 2511(c), it appears from Notice 2010-19 that the IRS views it as subjecting to gift tax at least some transfers to non-grantor trusts that would not have been subject to gift tax before 2010, possibly including so-called Delaware Incomplete Nongrantor (or “DING”) Trusts permitted as self-settled asset-protection vehicles under the laws of Delaware and a few other states. While that alone is likely to be controversial, the Notice takes a conspicuous step beyond the statute when it states that each transfer in 2010 to a trust that is not a wholly-owned grantor trust is a transfer by gift of “the entire interest” in the property. The statute states only that such a transfer is “a transfer of property by gift,” not necessarily a gift of “the entire interest” in the property. For example, inter vivos charitable remainder trusts cannot be grantor trusts but historically have been given a settled treatment for tax purposes that certainly does not countenance subjecting the “entire” transfer to gift tax. Perhaps the answer is that to the extent of the interest payable to the grantor (or effectively retained by the grantor through the power to revoke, for example, the succeeding interest of the grantor’s spouse) the grantor hasn’t even made a “transfer”; the only “transfer” is the charitable remainder, which escapes gift tax by reason of the charitable deduction, something the 2002 technical correction makes clear. But the legislative history of the 2002 amendment itself is arguably unfriendly to that reasoning. Joint Committee on Taxation, Technical Explanation of the “Job Creation and Worker Assistance Act of 2002” (JCX-12-02), at 38 (2002). In any event, amid the other challenging uncertainties of 2010 it can be exasperating to have one more unruly statute like section 2511(c) to deal with.
The Unanticipated Distraction of Statutory Instability
This contemplation of section 2511(c) highlights another fact of life that undoubtedly explains why we have witnessed no other progress under the 2009-2010 Priority Guidance Plan – Treasury and the IRS are as distracted by the unanticipated need to figure out what 2010 law means as any of us. Small comfort, but at least a plausible theory.
Back to the Slow-Moving Priority Guidance Plan: The 2% Floor
We saw further evidence of this handcuffing on April 1, 2010, when the IRS released Notice 2010-32, extending its no-unbundling-of-unitary fees pronouncements to 2009 fiduciary income tax returns. Previously, Notices 2008-32 and 2008-116, reacting to the Supreme Court’s unanimous holding in Michael J. Knight, Trustee v. Commissioner, 552 U.S. 181 (2008), that trust investment advisory fees are subject to the “2% floor” of section 67(a) of the Internal Revenue Code, reassured fiduciaries that they would not be required to “unbundle” unitary fiduciary fees to separately state the components subject to the 2% floor on 2007 and 2008 income tax returns. Notice 2010-32 relieves trustees of the need to unbundle their fees for 2009 returns as well.
As stated above, “Regulations under §67 regarding miscellaneous itemized deductions of a trust or estate” is Item 1 on the Treasury-IRS 2009-2010 Priority Guidance Plan. It is possible that the final regulations were near completion before the end of 2009 and that the IRS did not expect to extend the relief from “unbundling” for another year. If so, this may be another example of how the inability of Congress to act before the end of 2009 to stabilize the estate tax law for 2010 has created a distraction for those in the Government who write tax guidance as well as for fiduciaries, clients, and estate planners who must follow that guidance.
Of course, the application of the 2% floor to trusts is complex and controversial, and Capital Letters is not an impartial observer, as its author himself became a victim of the perplexing language of section 67(e) in Scott v. United States, 328 F.3d 132 (4th Cir. 2003). I submitted comments to the IRS that concluded “as a matter of sound tax policy and old-fashioned self-restraint, the final regulations should affirm that fiduciary administration expenses, including the costs of investment advice, in decedents’ estates and in trusts with more than one beneficiary, will not be subject to the 2% floor.” Meanwhile, Notice 2010-32 concludes by stating that, in contrast to bundled fees, “[p]ayments by the fiduciary to third parties for expenses subject to the 2-percent floor are readily identifiable and must be treated separately from the otherwise Bundled Fiduciary Fee.” It should be remembered, however, that in the absence of final regulations the only such expenses that have been definitively held to be subject to the 2% floor are the investment advisory fees at issue in Knight and the other decided cases. Even with regard to investment advisory fees, the Supreme Court acknowledged:
It is conceivable, moreover, that a trust may have an unusual investment objective, or may require a specialized balancing of the interests of various parties, such that a reasonable comparison with individual investors would be improper. In such a case, the incremental cost of expert advice beyond what would normally be required for the ordinary taxpayer would not be subject to the 2% floor. Here, however, the Trust has not asserted that its investment objective or its requisite balancing of competing interests was distinctive. Accordingly, we conclude that the investment advisory fees incurred by the Trust are subject to the 2% floor.
Capital Letters does not doubt the ability of trustees to recognize the need for “specialized balancing” of beneficiaries’ interests and to employ a bit of self-help “reverse unbundling” to quantify such fully deductible “incremental” costs in cases where that effort is justified.
And Back Again to the Statutory Distraction
Although the health care reform effort in both the House and the Senate has left bitter feelings, its completion has at least freed up some time for lawmakers to tackle other items. The new Ways and Means Committee Chair, Sandy Levin, is focused and grasps issues as well as anyone, but the real impasse over an estate tax solution may still be in the Senate and perhaps between the House and Senate. When opportunities for serious work on a solution present themselves between mid-month and the end of May, a lot of ACTEC Fellows and other estate planners will be paying attention.