Estate of Sally J. Anenberg, Donor, Deceased, Steven B. Anenberg, Executor and Special Administrator, 162 T.C. 9, filed 5/20/24, plays a variation on the Unsinkable Virginia V. Kite. For the story of Virginia V., see my blogpost “Transferred Part Means Transferred All,” 10/25/13.

Before Sally became the late Sally, the canny trustee of her late husband’s QTIPs, stepson Steve, got Sally and the remaindermen to agree to terminate the trusts under CA law, whereby vesting in Sally all the shares of the C Corp she and late husband owned. Then Sally sold said shares to the remaindermen in exchange for nine-year, AFR-interest bearing, secured and partly-guaranteed promissory notes with face value equal to FMV of shares.

IRS wants summary J that termination of trust was a transfer by Sally without consideration, therefore gift taxable, per Section 2519.

No, says Judge Emin (“Eminent”) Toro, and so say all the Tax Court bench.

QTIPs are an exception to an exception to an exception, 162 T. C. 9, at p. 9. For the marital estate tax deduction, property must vest in surviving spouse on death of first to die. If less than 100% vests, deduction limited to what does vest. But if a qualified terminable income interest in property (QTIP) vests in survivor, entire worth of property is deductible if executor so elects, even if remainder goes to others. See Section 2056(b)(7)(B). The idea is that the married individuals are a unit, so estate tax falls upon second to die. And any disposition of the QTIP income interest by survivor is a disposition of the entire QTIP property, thus triggering potential gift tax. Estate tax and gift tax are pari materia, operating together.

IRS claims Sally made a gift of the property, either when she consented to termination of the QTIP trusts and got the C Corp stock, or when she sold the stock for the notes.

“In the Estate’s view, the … transactions, taken together, amount to no more than a permissible conversion of Sally’s qualifying income interest for life in the QTIP into an equivalent interest in other property. Under the applicable regulations, the Estate says, such conversions are not a disposition under section 2519. And in the alternative, the Estate argues, even if there was a disposition when Sally received the Trust’s assets or later sold the shares, no gift tax is due because Sally did not make a gift. Instead, Sally received full and adequate consideration for the property she was deemed to transfer.” 162 T. C. 9, at p. 13.

Judge Eminent agrees with the Estate.

The termination wasn’t a gift, as Sally swapped her interest in the trusts for the stock itself. Thus no diminution of Sally’s taxable estate. There was no remainder, and no control over the stock, that she gave away.

As for the sale of the stock for the notes, that happened after the QTIP trusts terminated, hence Section 2519, which sank the Unsinkable Virginia V., was no longer in play.

“It is axiomatic that a surviving spouse must hold a qualifying income interest for life to implicate section 2519. Such a property interest is defined by the Code and exists only when the surviving spouse is entitled to all income from the property, payable annually or more frequently, or has a usufruct interest for life in the property, and no person (including the surviving spouse) has the power to appoint any part of the property to any person other than the surviving spouse (unless such power is exercisable only after the death of the surviving spouse). See I.R.C. § 2056(b)(7)(B)(ii); Treas. Reg. § 20.2056(b)-7(d)(1). When the [CA] Superior Court terminated the Marital Trusts, the property interest Sally received was outright ownership of the [C Corp] shares, not an income interest. And because the Marital Trusts terminated, the property interest Sally received was unencumbered by any restrictions that were placed on it while it was in the Trusts, including restrictions that would have limited distributions to individuals other than Sally. For these reasons, Sally no longer held a qualifying income interest for life as defined by section 2056(b)(7)(B)(ii). Consequently, her sale of the Al-Sal shares for promissory notes could not trigger section 2519.” 162 T. C. 9, at p. 19. (Footnotes omitted).

The Unsinkable Virginia V.’s advisers were trying too hard. The annuity deal she got was a real Bialystok (named after the famous Producer), guaranteed to crater, so Virginia V.’s estate would get nothing. Here, however, IRS did not urge form-over-substance, because Sally got the stock.

All IRS’ arguments depended upon the trust property leaving the surviving spouse’s hands. Here it didn’t.

Taishoff says, note this is partial summary J for stepson Steve. The worth of the notes Sally owned at date of her death remains to be determined.

But however this ultimately plays out, a Taishoff “Good Job, First Class,” goes to the late Sally’s trusty attorneys.