By Deborah M. Beers, Esq.
Buchanan Ingersoll & Rooney, Washington, DC
Mikel et ux v. Commissioner,1 involved a challenge to approximately 60 gift tax annual exclusions2 claimed by the taxpayers, husband and wife, on their 2007 gift tax returns, which were filed in 2011. After the application of these annual exclusions and the taxpayers' unified credits, their gift tax returns showed no federal gift tax due.
The IRS's challenge to the claimed exclusions was based on its contention that the donees did not receive a "present interest in property" – i.e., an unrestricted right to the immediate use, possession, or enjoyment of property.3 The IRS determined that "the beneficiaries lacked legally enforceable rights to withdraw funds from the trust and hence that taxpayers had made gifts of future, not present, interests."
On cross-motions for partial summary judgment, the Tax Court, in a memorandum opinion, ruled for the taxpayers, holding that they had made gifts of present interest in property in 2007.
The Trust. During 2007 each taxpayer made gifts to the IEM Family Trust (the "Trust") with an asserted value of $1,631,000. In December 2011, the taxpayers filed separate gift tax returns reporting these gifts and claiming, under § 2503(b), annual exclusions of $720,000 each. The claimed annual exclusions were based on the contention that each taxpayer's gift included a $12,000 gift of a present interest to each of the trust's 60 beneficiaries.
On June 7, 2007, taxpayers as grantors and Salomon Mikel (the grantors' son) as trustee of the Trust. The trust's beneficiaries were taxpayers' children and lineal descendants and their respective spouses. On June 15, 2007, taxpayers jointly transferred to the trust property with an asserted value of $3,262,000. The Trust at the time allegedly had 60 beneficiaries, many of whom were under 18 years of age.
The Withdrawal Rights. The trust granted each beneficiary the power, during the year in which the trust was created and during any subsequent year when property was added, to withdraw property from the Trust in an amount equal to the lesser of a formula-derived amount and "[t]he maximum federal gift tax exclusion under section 2503(b) * * * in effect at the time of the transfer."
The trustees were required to, and apparently did, notify the beneficiaries of their withdrawal rights in a timely fashion. The withdrawal rights were required to be exercised in writing by the beneficiary or the beneficiary's guardian and generally lapsed if not exercised within 30 days of such notice. The Trust declaration states that the trustees, upon receipt of a timely withdrawal demand, "shall immediately distribute to such beneficiary or Guardian the properties allocable to them, free of trust." The declaration states that this instruction shall be construed to effect the grantors' intention that "transfers to the trust * * * [qualify] for the federal gift tax annual exclusion." The Tax Court noted that "[t]here is no evidence of any prearranged plan or understanding among taxpayers and the beneficiaries that would prevent the latter from exercising their withdrawal rights."
Discretionary Distributions. The Trust indenture also empowered the trustees, "in their sole and absolute discretion," to make discretionary distributions during the term of the trust for the health, education, maintenance, or support of any beneficiary or family member. In exercising this discretion the trustees were empowered to distribute "at any time and from time to time, any amount of income or principal (even to the extent of all)." The declaration specifies that "[t]he judgment of the Trustees as to the amounts of such payments and the advisability thereof shall be final and conclusive" upon all beneficiaries and other persons interested in the trust.
Any dispute concerning the proper interpretation of the declaration of trust was required to be "submitted to arbitration before a panel consisting of three persons of the Orthodox Jewish faith [called in Hebrew a beth din]." The panel is directed, in the event of any dispute, to "enforce the provisions of this Declaration * * * and give any party the rights he is entitled to under New York law."
In Terrorem Clause. The Trust also contained an "in terrorem" provision which provided that: In the event a beneficiary of the Trust shall directly or indirectly institute, conduct or in any manner whatever take part in or aid in any proceeding to oppose the distribution of the Trust Estate, or files any action in a court of law, or challenges any distribution set forth in this Trust in any court, arbitration panel or any other manner, then in such event the provision herein made for such beneficiary shall thereupon be revoked and such beneficiary shall be excluded from any participation in the Trust Estate * * *.
In ruling in favor of the taxpayers, the Tax Court noted that, on its face, the Trust gave each beneficiary an unrestricted right to withdraw the annual exclusion amount. The IRS nevertheless asserted that the In Terrorem clause rendered the withdrawal rights unenforceable and, thus, illusory.
"Respondent starts by hypothesizing that the trustees might refuse, without legal basis, to honor a timely withdrawal demand. In that event, * * * the declaration would require the beneficiary to submit the dispute to a beth din. If the beth din, again without legal basis, sustained the trustees' refusal to honor the demand, respondent agrees that the beneficiary could seek redress in a New York court despite the State's general reluctance to disturb arbitral decisions. But a beneficiary would be extremely reluctant to go to court, respondent insists, because he would thereupon forfeit all his rights under the trust by virtue of [the] in terrorem clause. Practically speaking, therefore, respondent contends that the beneficiaries' withdrawal rights are "illusory" and do not constitute a `present interest in property.'"
The court noted that the analysis in both the Crummey and Cristofani cases, above, as well as IRS administrative rulings,4 recognize that "[w]hen a trust instrument gives a beneficiary the power to demand immediate possession [and enjoyment] of corpus [or income], the beneficiary has received a present interest."
The court also saw flaws in the government's argument regarding the in terrorem clause as follows:
On the second point, the court observed that the in terrorem clause provided that a beneficiary would forfeit his or her rights if he or she initiated a proceeding "to oppose the distribution of the Trust Estate," or filed an action in a court of law or with an arbitration panel to challenge any distribution.
"The evident purpose of the in terrorem provision is to backstop * * * by discouraging legal actions seeking to challenge the trustees' "absolute and unreviewable discretion" concerning discretionary distributions from the trust. * * * A beneficiary who filed suit to compel the trustees to honor a timely withdrawal demand would not be "opposing or challenging" any distribution (discretionary or otherwise) from the trust. Because the beneficiary's action would not be covered by the in terrorem provision, that provision logically would not dissuade him from seeking judicial enforcement of his rights.
* * *
Crummey, 397 F.2d at 88; Estate of Cristofani, 97 T.C. at 84. Assuming arguendo that the beneficiaries' withdrawal rights must be enforceable in State court, we conclude that this remedy, which respondent concedes was literally available, was also practically available because the in terrorem provision, properly construed, would not deter beneficiaries from pursuing judicial relief. We will accordingly grant taxpayers' motion for summary judgment to the extent consistent with this opinion and deny respondent's motion for partial summary judgment."
The Tax Court concluded that the beneficiaries of the Trust possessed a "present interest in property" because they had, during 2007, an unconditional right to withdraw property from the trust and their withdrawal demands could not be "legally resisted" by the trustees.
We note (and the court also noted) that the government did not cite the Second Circuit case of Stifel v. Commissioner,5 which applied a slightly less generous test for the existence of a present interest where a withdrawal right is held by a minor beneficiary. In that case, which preceded Cristofani, above, the Second Circuit (to which Mikel would be appealable) held that a court should determine whether a minor beneficiary is likely to receive present enjoyment of trust property by examining the trust instrument, the State law as to minors, and the financial and other circumstances of the parties. The test in Cristofani, which focuses solely on the beneficiaries' legal rights to withdraw, and not the remoteness of their interests in the trust – which in Mikel, given the number of beneficiaries, must have been tenuous in many cases – would appear to supersede this earlier analysis.
For more information, in the Tax Management Portfolios, see Lischer, 845 T.M., Gifts, Slade, 807 T.M., Personal Life Insurance Trusts, Lischer, 846 T.M., Gifts to Minors, and in Tax Practice Series, see ¶6350, Estate Planning, ¶6330, Gift Tax Exclusions, Deductions and Tax Computation.
Copyright©2015 by The Bureau of National Affairs, Inc.
2 Section 2503(b)(1) provides an exclusion from taxable gifts for gifts (other than gifts of future interests in property) made to a donee in an amount that is indexed for inflation. For gifts made during 2007, the exclusion was $12,000 per donee. Rev. Proc. 2006-53, 2006-2 C.B. 996, 1006, §3.32.
3 Reg. §25.2503-3(a) and §25.2503-3(b). See Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), rev'g in part T.C. Memo 1966-144; Cristofani v. Commissioner, 97 T.C. 74 (1991), AOD 1992-9 (Apr. 6, 1992) and AOD 1996-10 (July 15, 1996).
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