KEY WORDS: Marital Deduction; Tenancy by the Entirety; Marriage Contracts
EXECUTIVE SUMMARY: In this private letter ruling, the IRS held that an arrangement whereby two spouses proposed to limit what the survivor between them could do with the deceased spouse’s half interest would not qualify for the marital deduction. In so doing the IRS distinguished Rev. Rul. 71-51 by determining that under the proposed arrangement, unlike the facts in Rev. Rul. 71-51, the property would be passing by operation of law instead of pursuant to the agreement.
FACTS: Al and Beatrix, husband and wife, own a parcel of real estate as tenants by the entirety. They proposed to enter into an agreement that would restrict what the survivor between them could do with the deceased spouse’s half interest, thinking that such an arrangement would qualify for the estate tax marital deduction at the first spouse’s death. However, to be on the safe side they sought guidance in the form of a private letter ruling from the National Office of the IRS.
In the arrangement, the agreement will provide that on the death of the first spouse to die, one half of the value of the property must be held in trust during the surviving spouse’s (“Survivor”) lifetime. The Survivor may exchange his or her own separate property for the portion of the property to be held in the trust. The Survivor will receive the other half of the property outright. The trust, in Article II, will provide for the Survivor to receive the trust income. If the Survivor: (i) does not remarry, or (ii) remarries and certain conditions are met, he or she may receive principal in the trustee’s absolute discretion. The remaining principal will be distributed to designated remaindermen at the Survivor’s death.
The couple argued that the proposed arrangement would qualify for the estate tax marital deduction under IRC Sec. 2056 by way of IRC Sec. 2040 and cited Rev. Rul. 71-51 as authority for their position.
The IRS disagreed. The IRS pointed out that in Rev. Rul. 71-51, the spouses owned the subject property as joint tenants with rights of survivorship and decided to restrict the ultimate disposition of the property by entering into an irrevocable joint and mutual will in which the property would be held in trust for the benefit of the surviving spouse for his or her lifetime. The issue in Rev. Rul. 71-51 was whether the arrangement met the marital deduction requirement in IRC Sec. 2056 that the property pass from one spouse to the other. In Rev. Rul. 71-51, the IRS ruled that the arrangement would qualify for the estate tax marital deduction because the surviving joint tenant would take by virtue of the agreement that originally created the joint tenancy instead of by the joint and mutual will.
In the subject ruling, the IRS distinguished Rev. Rul. 71-51 by finding that:
[T]he Agreement and consequent Trust constitute a binding contract creating rights and interests that supersede and extinguish those of the tenancy by the entirety. At the death of the first spouse to die, the Property is nontestamentary in character and passes in accordance with State law. Thus, Rev. Rul. 71-51 is not applicable. For this reason, we are providing no further comment on the tax consequences of the transaction.
COMMENTS: The ruling is a little surprising given the lax attitude that has developed with respect to the marital deduction, which certainly has increased exponentially in the 41 years that has elapsed since Rev. Rul. 71-51. However this ruling is altogether unexpected and seems to be correct. Caution is advised any time that a couple seeks to limit what the survivor between them can do with jointly owned property, which is common, particularly in blended family relationships. Those who seek to get out of the taxation rain under the apparently small umbrella of Rev. Rul. 71-51 are urged to follow the facts of that ruling to the letter.
CITES: PLR 201216005; IRC Secs. 2040 and 2056; Awtry Est. v. Comr., 221 F. 2d 749 (2nd Cir. 1955); Rev. Rul. 71-51.