Advanced Markets Central Intelligence
Advanced Markets
Central Intelligence
November 2011
IN THIS ISSUE
• NEW FINAL REGULATIONS UNDER IRC §2036 • SALE OF A MARITAL TRUST’S LIMITED PARTNERSHIPS
• FLORIDA DISTRICT COURT VOIDS POLICY AB INITIO NOT SELF-DEALING
AFTER CONTESTABILITY PERIOD FOR LACK OF • IRS ALLOWS “DIRECT” TRANSFER OF IRA
INSURABLE INTEREST, BASED ON STOLI FRAUD PROCEEDS TO BENEFICIARY’S IRA FOLLOWING
• TAX COURT ALLOWS ESTATE DEDUCTION OF MALFEASANCE BY FIDUCIARY
INTEREST ON LOAN FROM DECEDENT’S TRUST • CASE IN POINT: BASIC ESTATE PLANNING
• UNDISCOUNTED VALUE OF PARTNERSHIP ASSETS
INCLUDED IN DECEDENT’S GROSS ESTATE
New Final Regulations Under IRC §2036
T.D. 9555 (affecting IRS Reg. §20.2036-1), November 7, 2011
In 2007, the IRS released proposed regulations concerning the method of determining whether assets
owned by a trust will be included in the estate of the grantor of the trust, where the grantor has
retained some degree of enjoyment of those assets for life (or for a period that does not, in
fact, end before the grantor’s death). In 2008, those regulations were made final, but the issues
underlying certain of the comments received on the 2007 proposed regulations were reserved to
be addressed at a later date. That date has arrived.
IRC §2036 provides, in the main, that “[t]he value of the gross estate shall include the value of
all property … which the decedent has at any time made a transfer (except in case of a bona fide
sale …), by trust or otherwise, under which he has retained for his life or for any period not
ascertainable without reference to his death or for any period which does not in fact end before his
death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the
right, either alone or in conjunction with any person, to designate the persons who shall possess or
enjoy the property or the income there from.”
The new final regulations address the possibility of double-counting, to attempt to prevent the
inclusion of property both under IRC §2036 and, separately, under IRC §2033 (that includes
any “[p]roperty in which the decedent had an interest”). In summary, the new regulations provide
that if property is included under §2036, it should not be included also under §2033. The new
regulations also address the amount includible at death in instances where a grantor is entitled to
receive income jointly with another taxpayer. In essence, this is accomplished by adopting an
example provided in the proposed regulations. In the example, the grantor’s estate includes the value
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of that portion of the property attributable to the grantor’s income interest and that portion attributable to
the other taxpayer’s income interest, reduced by the present value of the other taxpayer’s interest at the time
of death. This is intended to account for the possibility that the grantor might have (although, in fact, did
not) survived the other taxpayer and become entitled to the additional income.
A grantor may retain an income interest that only becomes effective upon the termination, if ever during
the grantor’s life, of another taxpayer’s interest. In such an instance, where the grantor dies before the
income interest becomes effective, the new final regulations provide that the grantor’s estate includes that
amount that would have been necessary, as determined using the §7520 rate in effect at the time of the
grantor’s death, to produce the income amount had the grantor lived long enough to receive it, again,
reduced by the present value of the other taxpayer’s ongoing interest. This calculation is intended to account
for the value of the possibility that the grantor might have survived.
The new final regulations also provide the method of calculating the amount includible in the grantor’s
estate where the grantor was entitled to an increasing annuity amount. IRS Reg. §20.2036-1(c )(2) and the
examples that follow it accomplish this by factoring the sources of two components of the income interest:
the assets from which the original annuity is derived (“base amount”) and the assets from which the annuity
amounts in excess of the original annuity are derived (“corpus amount”).
While these calculations seem byzantine, the examples included in the final regulations are very helpful in
illustrating the proper interpretation and application of the provisions to real world numbers. At any rate,
it is well worth taking note of these regulations, regardless of their inaccessibility, as the arrangements to
which their provisions apply are exceedingly common in current estate planning at virtually all levels.
Florida District Court Voids Policy ab initio After Contestability Period for
Lack of Insurable Interest, Based on STOLI Fraud
Pruco Life Insurance Company v. Brasner, et al., Case No. 10-80804-CIV, November 14, 2011
This holding follows hot on the heels of PHL Variable Insurance Company v. Price Dawe 2006 Insurance
Trust, et al., C.A. No. 10-964 (Del. 2011) and Lincoln v. Price Dawe 2006 Insurance Trust, et al., C.A. 09-
506 (Del. 2011) (see our discussion of these cases in the October 2011 John Hancock Central Intelligence)
and the conclusion is based on the same reasoning: if a policy is void ab initio for want of insurable interest
at the time of the issue of the policy, then the contestability period provisions of the policy document never
come into being and therefore cannot bar a challenge.
Facts: Married Taxpayers BH and BW attended seminars where they learned of a concept that promised to
provide them with “free life insurance.” At the time, Taxpayers did not want or, they felt, need life insurance,
but were inclined to take what was freely offered. (At the time, Taxpayers had a net worth of $600K to
$700K.) Their accountant put them in contact with Steven M. Brasner, an insurance producer licensed with
Insurer. Taxpayers decided to permit Mr. Brasner pursue life insurance on BW’s life.
Taxpayers testified that they never paid a premium on the policy ultimately obtained by Mr. Brasner, nor
would they have, if asked. In fact, given their assets, they could not have afforded the scheduled premium.
They testified that they never intended to own or control the policy and always understood that the policy
would ultimately be owned by a third party unless BW died within the first two policy years.
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Mr. Brasner arranged for a third-party vendor to prepare an Inspection Report concerning the income and
assets of Taxpayers. Notwithstanding the actual network of Taxpayers being $600K to $700K, the
Inspection Report stated that Taxpayers had an annual income of $250,000 and a net worth of $10,450,000
comprising real estate, securities and cash equivalents.
A month before the policy was even applied for, the policy was preapproved for nonrecourse premium
financing loan which would be administered by Coventry and lent by Bank of America. The policy was
issued directly to the Taxpayers, though the initial premium payment was funded by Coventry, which
transferred funds to Taxpayers to make the payment. Two months after the policy was issued, it was
transferred (by Coventry under Taxpayer BW’s power of attorney) to a trust that Taxpayers had no
knowledge of, according to their testimony. All subsequent premium payments were funded via the
nonrecourse premium financing loan with Bank of America. Coventry was reimbursed for the initial
premium payment from loan proceeds.
Two years later, a Coventry employee, posing as an employee of the trust company that was then the record
owner of the policy, contacted the Pruco call center to get information concerning the policy, including
whether the contestability period had expired. She was told that it had. A week later, Coventry purchased
the policy from Bank of America under the nonrecourse loan arrangement. Pruco received a request to
change the owner and beneficiary of the policy to the Agent of Coventry. Subsequently, Pruco filed a
complaint against the Agent owner, Mr. Brasner, and other defendants. In the matter being reviewed here,
Pruco moved for summary judgment on the basis that the policy was void ab initio. Pruco claims that it
should be entitled to retain all premiums paid thus far. Agent moves to deny the motion for summary
judgment but claims that, if the policy is void or voided, it is entitled to return of premiums paid. Agent
argues that the summary judgment also must fail because the complaint was filed after the expiration of the
contestability period,
Ruling: The court found that, because the insured never intended to own, control, or pay for the policy,
there was never valid insurable interest and, for this reason, the policy never existed under the law of the
jurisdiction. Furthermore, because the policy never came into existence, the contestability period written
into the policy contract provisions never came into existence either and therefore cannot be relied upon to
bar a challenge to the validity of the contract.
As to the claim for return of the premiums paid, the court had a harder time, but ultimately determined
that the matter was settled by existing law in Florida, citing TTSI Irrevocable Trust v. Reliastar Life Ins. Co.,
60 So. 3d 1148 (Fla. Dist. Ct. App. 2011). Under TTSI, because the policy was procured by fraud, the
Insurer is not obligated to return the premiums. (Under general provisions of Florida law, absent fraud,
when a policy is found to be void ab initio, the owner of the policy is generally entitled to a return of all
premiums paid.) That the Agent was not a party to the fraud is not persuasive, since avenues of recourse
exist for the Agent to recover from the perpetrators of the fraud.
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Tax Court Allows Estate Deduction of Interest on Loan from Decedent’s Trust
Estate of Duncan v. Commissioner, T.C. Memo. 2011-255, October 31, 2011
Facts: Decedent Taxpayer was, in life, one of three heirs to a successful oil and gas business, and the share
of each was held and managed by the trustee of an irrevocable trust (“Trust 1”) established at the death of
Decedent’s father. During Decedent’s lifetime, the trust was for the benefit of Decedent, his wife, and his
descendants, and Decedent held a power of appointment over the assets remaining at his death. Decedent
very successfully grew both the breadth and value of his property during his lifetime. During his lifetime,
Decedent established a revocable trust (“Trust 2”) which he then funded with a significant part of his assets.
Trust 2 become irrevocable upon his death and was a primary beneficiary of his estate. Decedent died in
2006 and exercised his power of appointment over Trust 1, appointing the assets to be distributed according
to the provisions of Trust 2.
At the time of Decedent’s death, he owned real estate across the American West and Southwest. Much of
Decedent’s assets were owned by the now-irrevocable Trust 2, but were includible in Decedent’s estate for
estate tax purposes. The estate lacked sufficient liquidity to easily pay the estate taxes in excess of $11
million, so the executors chose to finance the estate taxes; Trust 1 lent $6,475,516 to Trust 2 in return for
a 15-year note at 6.7%, with all principal and interest payable upon termination of the note. Prepayment
was not permitted under the terms of the note. (The 15-year note was justified, the executors determined,
due to the volatile nature of the oil and gas business.) The beneficiaries of Trust 2 and the estate are
substantially the same. The estate filed its estate tax return, claiming an interest deduction of $10,653,826
for the amount paid and payable to Trust 1 from Trust 2 under the note. The IRS denied the deduction and
reported an estate tax deficiency of $4,900,760 based on the denial.
Ruling: The Tax Court held for the estate of Taxpayer, and allowed the so-called Graegin loan interest
deduction (from Graegin v. Commissioner, T.C. Memo 1998-477, standing for the principle that interest on
such loans may be deducted by an estate under proper circumstances). Notwithstanding that Trust 1, Trust
2 and the estate had essentially the same fiduciaries and beneficiaries, the court pointed out that each was
an independent entity under the law and subject to its own duties. The court accepted the business decision
to employ a 15-year note to spread the risk of the volatility of the oil and gas price effects. Finally, the court
found the interest rate to be acceptable and that due diligence was used to determine a rate that was fair for
all parties within their duties. The court expressly rejected the suggestion by the IRS that the rate used could
not be greater than the applicable federal rate (as well and not less than) because different risks warrant
different rates.
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Undiscounted Value of Partnership Assets Included in Decedent’s Gross Estate
Estate of Liljestrand v. Comm’r, T.C. Memo. 2011-259, November 2, 2011
Facts: It has been a big month for IRC §2036, it would seem. Decedent Taxpayer was a resident of Hawaii
and died testate there, where his will was probated. Throughout his life, Taxpayer accumulated numerous
real estate holdings which were eventually held in a revocable trust of which Taxpayer and one of his sons
were co-trustees. Due to certain provisions of the law of the jurisdiction respecting beneficiaries’ rights and
powers limiting trustees’ actions, it was decided that the property would be better held in a family limited
partnership. In 1997, Taxpayer created and funded the partnership with the real estate holdings then valued
at approximately $5,915,000. Taxpayer then made gifts of the limited partnership interests among his four
children in 1998 and 1999.
However, the valuation of the interests transferred, as recorded by Taxpayer’s advisors, is questionable, and
at odds with values suggested by appraisers engaged to fix precisely those values. Also, the recorded values
of the gifts far exceeded the annual exclusion available to the Taxpayer, and yet no gift tax returns were filed
until 2005, after Taxpayer’s death. The partnership did not open a bank account in its own name until 1999;
until that time, income earned by the partnership assets was arbitrarily deposited in the bank account of the
revocable trust. Furthermore, in 1998 and 1999, Taxpayer reported income and expenses from the
partnership real estate assets on his own income tax returns for those years.
Late in 1999, Taxpayer’s accountant brought these deficiencies of practice to the attention of the Taxpayer
and sought to correct them. The partnership applied for and received a Taxpayer Identification Number and
opened a bank account. However, beginning in 1999, the partnership began to pay personal expenses of the
Taxpayer and made disproportionate distributions in Taxpayer’s favor to offset shortfalls in his income.
Partnership assets were used to pay for college expenses for Taxpayer’s grandchildren, to fund gifts to family
members, and to pay the salaries of Taxpayer’s household staff. Taxpayer died in 2004 and reported an estate
value of $5,696,011 and an estate tax of $2,370,000. The IRS reported an estate tax deficiency of
$2,573,171, based on the value (at the time of Taxpayer’s death) of the real estate transferred by Taxpayer
to the partnership.
Ruling: The court held that the assets were properly included in the taxable estate of Taxpayer because they
were includible under IRC §2036. The court noted especially that the “transfer” was not a bona fide sale for
full and adequate consideration, and the Taxpayer had retained the beneficial enjoyment of the assets after
the transfer. The Taxpayer had treated partnership assets as his own, depositing partnership income in his
own accounts (and those of his revocable trust), the partnership had paid the Taxpayer’s personal expenses,
and the partnership had made disproportionate distributions to the Taxpayer.
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Sale of a Marital Trust’s Limited Partnerships Not Self-Dealing
PLR 201145026, November 10, 2011
Facts: Taxpayer was the sole beneficiary of a marital deduction trust established by her decedent husband,
which granted her a general power of appointment over the undistributed income and principal of this trust.
The marital trust owned interests in four limited partnerships, which interests were subject to buy/sell
agreements. The buy/sell agreements provide that if a partner/owner attempts to transfer an interest in the
limited partnership, then the limited partnership is required to buy said interests for their fair market value
to be paid in cash or partnership property.
During her life, Taxpayer created a testamentary charitable lead trust. Upon her death, Taxpayer exercised
her power of appointment and appointed a portion of the limited partnership interests owned by the marital
trust to the charitable lead trust. This triggered the provision of the buy/sell agreement that required the
limited partnership to purchase the bequeathed portion of the marital trust assets for an amount determined
according to the valuation provisions of the buy/sell agreement. The payment was made in cash. The estate
of Taxpayer requested this ruling that the proposed sale of the limited partnership interests qualify for an
estate administration exception to IRS Reg. §53.4941(d)-1(b)(3) so as not to constitute acts of self-dealing
under IRC §4941.
Ruling: Generally, IRC §4941 and the regulations thereunder provide for the imposition of tax on acts of
“self-dealing” between a disqualified person (as defined by the section) and a private foundation such as the
charitable lead trust. The definition of “self-dealing” includes direct or indirect sale, exchange, or leasing of
property between the private foundation and a disqualified person. IRS Reg. §53.4941(d)-1(b)(3) provides
a broad exception to the definition of self-dealing for some transfers of property to a private foundation as
part of the administration of an estate, where particular requirements are met. As threshold matters, the
Service found that both the Taxpayer and each of the limited partnerships were disqualified persons with
respect to the charitable lead trust and that the sale of the partnership interests upon transfer of such
interests to the charitable lead trust was self-dealing as defined by the statute and its regulations, unless an
exception applied. However, the Service found that all four prongs of the exception under IRS Reg.
§53.4941(d)-1(b)(3) were met, and thus the transfers were not taxable as self-dealing under IRC §4941.
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IRS Allows “Direct” Transfer of IRA Proceeds to Beneficiary’s IRA Following
Malfeasance by Fiduciary
PLR 201139011, September 30, 2011
Facts: At age 13, Taxpayer was named as the sole beneficiary of her unmarried father’s qualified plan.
Although she was then a minor, Taxpayer was nonetheless entitled to elect a direct trustee-to-trustee transfer
of the balance of her father’s qualified plan to an IRA in her own name. M (Taxpayer’s mother and guardian)
did not elect such a trustee-to-trustee transfer, but rather ordered a lump-sum distribution of the full balance
of the qualified plan. M then reported the distribution and paid the income tax incurred.
Less than a year later, a conservatorship petition was filed (it is not clear by whom) and suit was filed to
contest the order of the lump-sum distribution. The court concluded that M had mishandled and misspent
the assets of Taxpayer and ordered M to repay the amount of the distribution (reduced by a few accidentally
legitimate expenses paid by M). Taxpayer requested the ruling that (1) she is entitled to accomplish the
direct trustee-to-trustee transfer to an IRA in her own name funded with the amount reimbursed by M and
that (2) as such, she is neither required to report the distribution for the tax year in which it was made nor
to pay income tax and any portion of that amount.
Ruling: The Service determined that Taxpayer was entitled upon the death of her father to a direct trustee-
to-trustee transfer to an IRA in her own name and that, but for the malfeasance of her fiduciary M, she could
have accomplished such a transfer. Thus — although we feel a long, long leap is made here — Taxpayer is
entitled to a refund of the income taxes paid on the lump-sum distribution and may fund an IRA in her own
name as if it were a direct trustee-to-trustee transfer. As a result, as well, Taxpayer need not include the
lump-sum distribution as part of her taxable income in the tax year in which the distribution took place.
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CASE IN POINT: BASIC ESTATE PLANNING
Initial Call to Advanced Markets: August 2011
Client Profile: Male & Female married couple, both age 45, with three minor children, $20M estate.
Insurance Need: Death benefit protection to help meet college expenses and estate liquidity needs.
Initial Discussion: In mid-2011, the producer and the Advanced Markets Consultant (AMC) discussed the
needs of the married couple, whose main priority was to provide for their children’s college education in the
event of premature death. The couple had done minimal estate planning but were aware of the benefits of
beginning that process.
Solution: Using the JH Solutions software and estate planning calculator, the AMC provided the producer
with projections for potential estate taxes on the clients’ estate based on a 46-year joint life expectancy.1 By
varying factors such as growth in the estate and possible estate tax levels, projected estate taxes could be
shown to range from $20M to $40M. Looking at gifting as a planning mechanism, the couple was unwilling
to make gifts of a large portion of their estate in order to take advantage of current tax laws, but they were
open to exploring a smaller gift. As a result, the AMC developed a proposal in which the couple would
establish an Irrevocable Life Insurance Trust (ILIT) to which they would make a gift of just over $1M.
Assuming annual ILIT growth of about 5%, the ILIT would be able to afford ongoing premiums of about
$50K on a $14M current assumption survivorship policy on the couple’s lives. Under such projections,
assuming current law, upwards of $1.5M in estate taxes could be saved and over $12.5M more wealth
transferred at life expectancy. The couple also discussed with their legal advisors the incorporation of
provisions allowing access to ILIT funds during lifetime.
Summary: The tools and expertise available from Advanced Markets enabled the couple to implement an
estate plan that would make effective use of their newly discovered planning capacity.
Case Closed: September 2011.
1. Based on Valuation Basic Tables 2008.
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ONE YEAR LIBOR RATE PRIME RATE
As of November 17, 2011: 0.98% As of November 17, 2011: 3.25%
IRC SECTION 7520 RATE
December 2011 1.6%
November 2011 1.4%
October 2011 1.4%
September 2011 2.0%
The §7520 rate is used to value GRITs, QPRTs, CRATs, CLUTs, CLATs, private annuities, life interest, remainder and reversionary interests.
To value a charitable gift for income, gift, or estate tax charitable deduction purposes, use either the rate for the month of the actual
gift/transfer or the rate from either of the two previous months (use the highest of the three months for the largest charitable deduction).
APPLICABLE FEDERAL RATES – NOVEMBER 2011
Annual Semi Annual Quarterly Monthly
Short-term 0.19% 0.19% 0.19% 0.19%
Mid-term 1.20% 1.20% 1.20% 1.20%
Long-term 2.67% 2.65% 2.64% 2.64%
APPLICABLE FEDERAL RATES – DECEMBER 2011
Annual Semi Annual Quarterly Monthly
Short-term 0.20% 0.20% 0.20% 0.20%
Mid-term 1.27% 1.27% 1.27% 1.27%
Long-term 2.80% 2.78% 2.77% 2.76%
For more information on various planning topics or to request the John Hancock Advanced Markets
suite of marketing and educational tools, including the JH Solutions concept software, please call
John Hancock’s Advanced Markets Group at 1-888-266-7498 and press #4.
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(888)266-7498, option 3 or option 4; 197 Clarendon Street, C-07-01, Boston, MA 02116; www.jhsalesnet.com.
This material does not constitute tax, legal or accounting advice and neither John Hancock nor any of its agents, employees or registered representatives are in the business of
offering such advice. It was not intended or written for use and cannot be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing
of the transactions or topics it addresses. Comments on taxation are based on John Hancock’s understanding of current tax law, which is subject to change. Anyone interested in
these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisors.
Insurance products are issued by: John Hancock Life Insurance Company (U.S.A.), Boston, MA 02116 (not licensed in New York) and John Hancock Life Insurance Company of New
York, Valhalla, NY 10595.
MLINY11221115923
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