Turning The Tables: When Do The IRS Actuarial Tables Not Apply?
Lawrence P. Katzenstein
All references are to the Internal Revenue Code (“Code”) unless otherwise indicated. “GRAT” refers to grantor retained annuity trust; “GRIT,” to grantor retained income trust; and “Service,” to the Internal Revenue Service. A. Introduction 1. Quite a few years have passed since the enactment of section 7520. Section 7520 mandates the use of prescribed interest rates and mortality tables for computing a wide variety of actuarial factors. Almost as important as when a taxpayer must use the Service’s actuarial tables is the question of when interests are not valued under section 7520, but are instead valued under other actuarial regimes, or simply by recourse to general valuation principles. 2. The question of when a taxpayer should use the actuarial tables has been a source of tension between the Service and the courts. This same question has caused tension between the Tax Court and the federal appeals courts.
Lawrence P. Katzenstein is a partner in Thompson Coburn, LLP, St. Louis, Missouri. He is the author of the Tiger Tables Actuarial Software, and is a member of the adjunct faculty of the Graduate Tax Program, Washington University School of Law, and the American College of Trust and Estate Counsel A complete set of the course materials from which this outline was drawn may be purchased from ALI-ABA. Call 1-800-CLE-NEWS and ask for Customer Service. Have the order number of the course materials—SJ073—handy. 31
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B. Purpose Of Actuarial Tables 1. The purpose of actuarial tables is to provide a uniform, standardized method of calculating interests that would otherwise be difficult, if not impossible, to calculate in individual cases. 2. Mortality. For example, in an ideal world, you should determine the value of a gift to a charitable remainder trust for the life of an individual by reference to that individual’s exact life expectancy. However, we do not live in an ideal world, and it is impossible to determine the exact life expectancy of most individuals. Therefore, we use averages of broad population groups, except when reference to such tables would be unrealistic because of increased mortality risk. 3. Rates Of Return. Similarly, in valuing income interests, the tables prescribe what rate of return to use, and that rate of return changes monthly. Again, in an ideal world, we would look at the underlying assets and predict exactly what that mix of assets—and any assets into which those assets might be converted—would produce. That is not an attainable goal and, therefore, we use average of rates of return, namely, prescribed interest rates issued monthly by the Service. C. Statutory Background 1. General. Let’s start with a look at some of the non-controversial areas where the Code and regulations tell us we may not use the tables and look at how the Service has applied those rules. Section 7520 is brief enough that we will quote it in its entirety:
“Sec. 7520. VALUATION TABLES (a) General Rule.—For purposes of this title, the value of any annuity, any interest for life or a term of years, or any remainder or reversionary interest shall be determined— (1) under tables prescribed by the Secretary, and (2) by using an interest rate (rounded to the nearest 2/10ths of 1 percent) equal to 120 percent of the Federal midterm rate in effect under section 1274(d)(1) for the month in which the valuation date falls. If an income, estate, or gift tax charitable contribution is allowable for any part of the property transferred, the taxpayer may elect to use such Federal midterm rate for either of the 2 months preceding the month in which the valuation date falls for purposes of paragraph (2). In the case of transfers of more than 1 interest in the same property with respect to which the taxpayer may use the same rate under paragraph (2), the taxpayer shall use the same rate with respect to each such interest.
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(b) SECTION NOT TO APPLY FOR CERTAIN PURPOSES.—This section shall not apply for purposes of part I of subchapter D of chapter 1 or any other provision specified in regulations. (c) Tables.— (1) In general.—The tables prescribed by the Secretary for purposes of subsection (a) shall contain valuation factors for a series of interest rate categories. (2) Initial table.—Not later than the day 3 months after the date of the enactment of this section, the Secretary shall prescribe initial tables for purposes of subsection (a). Such tables may be based on the same mortality experience as used for purposes of section 2031 on the date of the enactment of this section. (3) Revision for recent mortality charges.—Not later than December 31, 1989, the Secretary shall revise the initial tables prescribed for purposes of subsection (a) to take into account the most recent mortality experience available as of the time of such revision. Such tables shall be revised not less frequently than once each 10 years thereafter to take into account the most recent mortality experience available as of the time of the revision. (d) VALUATION DATE.—For purposes of this section, the term “valuation date” means the date as of which the valuation is made. (e) TABLES TO INCLUDE FORMULAS.—For purposes of this section, the term “tables” includes formulas.”
2. When The Tables Don’t Apply According To The Code. The Code itself provides only two instances when the tables prescribed under section 7520 will not apply. a. Retirement Plan Exception. Section 7520(b) provides that the tables will not apply for purposes of Part 1 of subchapter D of chapter 1. That reference is to the rules for pension, profit-sharing, and other retirement plans. Those sections have their own separate, prescribed rules for determining actuarial values. b. The Regulatory Exception Provision. We will concentrate on the second exception. Section 7520(b) provides that the tables will not apply in the case of “any other provision specified in regulations.” Congress, therefore, left it to the Service to describe when the tables may not be used. We do not here examine the interesting administrative law issue of whether this extremely broad grant of authority to determine the very scope of the statute is lawful. Some of the instances in which the tables will not apply will be obvious (such as cases in which death is imminent), but the Code provision gives the Service broad discretion in delineating areas where the tables simply will not apply.
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3. Threshold Questions. Several threshold questions present themselves. a. Method Of Making Exceptions. The statute says that section 7520 shall not apply for purposes of part I of subchapter D of chapter 1 or any other provision specified in regulations. Does this mean that the Service may not make exceptions to the application of section 7520 other than by the formal regulatory process? Can it, for example, through an announcement or less formal method decree that the 7520 actuarial methodology will not apply? Although the statute seems to require that a formal regulatory process must countermand even abusive misuses of the tables, the Service does not always see it that way. Congress in enacting section 7520, if it thought about it at all, may have felt that only the formal regulatory process would give sufficient review and notice to taxpayers of the Service’s intent to depart from the uniform system established by the tables. Moreover, in some cases, the Service has in fact countered abuses by issuing regulations. For example, it dealt with the so-called ghoul or vulture charitable lead trust, which used a measuring life unrelated to the grantor or grantor’s family, by amending the transfer tax regulations. Treasury Decision 8923, filed with the 66 Fed. Reg. effective on January 5, 2001, 2001-1 C.B. 485. i. On the other hand, in its section 7520 regulations, the Service has permitted itself to bypass the regulatory process. The regulations state that section 7520 does not apply to “any other sections of the Internal Revenue Code to the extent provided by the Internal Revenue Service in revenue rulings or revenue procedures.” Treas. Reg. §20.7520-3(a)(9). ii. If Congress provides that the Service may make exceptions to the applicability of section 7520 only by regulation, can the Service by regulation provide that it can also make exceptions by ruling or revenue procedure? That is an unanswered question. b. Effective Date. Another interesting threshold question, dealt with in only one published case, is whether exceptions to the tables existed at all between the enactment of section 7520 and the date on which the Service issued its regulations concerning when the tables could not be used. Remember, section 7520 says that you must use the tables except when the regulations provide otherwise. The Service did not issue regulations providing otherwise in final form until December 12, 1995. Could the estate of a decedent who died in, say, 1993 use the tables to compute a section 2013 credit in a case when death was clearly imminent? Literally, the statute seems to require that result. On the other hand, does prior law, namely the