Wealth Management Update - November 2014

November Interest Rates for GRATs, Sales to Defective Grantor Trusts, Intra-Family Loans and Split Interest Charitable Trusts

The November Section 7520 rate for use with estate planning techniques such as CRTs, CLTs, QPRTs and GRATs is 2.2%, unchanged from October. The November applicable federal rate ("AFR") for use with a sale to a defective grantor trust, self-canceling installment note ("SCIN") or intra-family loan with a note having a duration of 3-9 years (the mid-term rate, compounded annually) is 1.9%, up 0.05% from October.

Lower rates work best with GRATs, CLTs, sales to defective grantor trusts, private annuities, SCINs and intra-family loans. The low AFR presents a potentially rewarding opportunity to fund GRATs and sell assets to intentionally defective grantor trusts in November.

Clients also should continue to consider "refinancing" existing intra-family loans. The AFRs (based on annual compounding) used in connection with intra-family loans are 0.39% for loans with a term of 3 years or less, 1.9% for loans with a term between 3 and 9 years, and 2.91% for loans with a term of longer than 9 years.

Thus, for example, if a 9-year loan is made to a child, and the child can invest the funds and obtain a return in excess of 1.9%, the child will be able to keep any returns over 1.9%. These same rates are used in connection with sales to defective grantor trusts.

Significant fractional ownership interest discount permitted for artwork partially owned by estate. Estate of Elkins v. Commissioner, 5th Cir., No. 13-60472, 2014 BL 255704, September 15, 2014.

For purposes of computing the estate tax, the Fifth Circuit held that discounts ranging from 51.69% to 79.74% were appropriate for determining the value of an estate's undivided fractional interest in each of 64 pieces of art. The decedent and his wife owned the 64 pieces of art as community property. Part of the wife's 50% share was transferred by means of a Grantor Retained Income Trust and a disclaimer at the predeceased wife's death to their three children. As a result, at the decedent's death, the artworks were owned fractionally by the decedent and his three children. The estate contended that a 44.75% discount was appropriate and supported its valuation by calling several art valuation experts to the stand. The commissioner took the position that no discount should be applied but failed to adduce any expert in support of this argument. The Tax Court held that a "nominal" 10% discount was appropriate. On appeal, the Fifth Circuit held that there was no viable factual basis for the Tax Court's 10% holding. On the contrary, the estate's experts were "uncontradicted, unimpeached, and eminently credible." Therefore, a refund of $14,359,508.21, plus statutory interest, was due to the estate.

This case may represent a significant victory for taxpayers because, historically, the IRS has taken the position that fractional interest discounts were inapplicable (or at least severely limited) in the context of gifted or devised artwork. The IRS has maintained that, unlike land or business interests, the value of artwork is in the ability to use it as an aesthetic or decorative ornament. Therefore, it is argued, dividing the ownership of a piece of art should not result in a discount if the use of the artwork remains essentially unchanged (e.g., if it continues to hang on the wall in the home of the donor). However, it is unclear whether the reach of the Elkins decision will be limited due to the IRS' uncharacteristic reliance on conclusory arguments rather than on expert opinions and other evidence. In addition, it is unclear whether the reasoning in Elkins will be adopted by jurisdictions outside the Fifth Circuit.

Testimony of New York attorney who supervised execution was sufficient to admit a Will to probate where witnesses invoked their Fifth Amendment right and refused to testify. Matter of Buchting, 111 A.D.3d 1114, (NY App. Div. 3d Dep't October 7, 2013).

A decedent's surviving spouse sought to probate the decedent's Will in a New York probate proceeding. The two execution witnesses to the Will refused to testify, invoking their 5th Amendment rights against self-incrimination. However, the attorney-draftsman who oversaw the execution ceremony testified before the Court. The decedent's children from a prior marriage objected to admission of the Will on the grounds of lack of due execution, lack of testamentary capacity and undue influence. The Surrogate's Court of Greene County admitted the Will to probate, finding that there was prima facie evidence of due execution. The Appellate Division, Third Department, found that although there was sufficient unrebutted evidence of due execution, the Will should not have been admitted, pending development of the testamentary capacity and undue influence issues.

The Court began its analysis by reciting the rule that to establish due execution, the proponent of the Will must produce the attesting witnesses unless an exception applies. Invocation of the 5th amendment is "akin to a failure to recall," and thus, the Will could be admitted under the Surrogate's Court Procedure Act ("SCPA") Section 1405(3), which provides "Where an attesting witness has forgotten the occurrence or testifies against the execution of the Will and at least 1 other attesting witness has been examined, the will may be admitted to probate upon the testimony of the other witness or witnesses and such other facts as would be sufficient to...