Estate of Susan R. Block, Julie B. Saffir and Peter A. Block, Executors

United States Tax Court
T.C. Memo. 2023-30ESTATE OF SUSAN R. BLOCK, DECEASED, JULIE B. SAFFIR
AND PETER A. BLOCK, EXECUTORS,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 10618-19. Filed March 13, 2023.
—————
Mark H. Neikrie, for petitioners.
Molly H. Donohue and Nina P. Ching, for respondent.
MEMORANDUM OPINION
COPELAND, Judge: This case was submitted to the Court fully
stipulated pursuant to Rule 122. 1 In a Notice of Deficiency dated
March 21, 2019, respondent determined a total estate tax deficiency of
$140,085 for the Estate of Susan R. Block (Estate). After concessions, 2
the only issue remaining before the Court is whether the Estate qualifies
under section 2055(a) for a deduction from the value of the gross estate
1 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code, Title 26 U.S.C. (I.R.C. or Code), in effect at all relevant times, all
regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in
effect at all relevant times, and all Rule references are to the Tax Court Rules of
Practice and Procedure. Some dollar amounts are rounded.
2 The Estate concedes a higher value of real property owned by decedent at her
death than the value reported. The parties agree that the Estate incurred a larger
amount of administrative expenses than what was reported on the estate tax return,
and that the Estate will qualify for a further deduction for legal expenses incurred
during this litigation.
Served 03/13/23
2
[*2] for the transfer of the remainder interest of the Harriet Katz Trust
(Katz Trust).
Background
The facts have been stipulated by the parties. The Stipulation of
Facts (with attached Exhibits) and the First Supplemental Stipulation
of Facts are incorporated by this reference. When the Petition was filed,
the Estate was administered in Connecticut, and Executor Julie Saffir
and Executor Peter Block (co-executors) resided in California.
I. Execution and Amendment of the Katz Trust Instrument
Ms. Block lived in Connecticut at all relevant times, including at
her death on October 21, 2015. On September 2, 1997, Ms. Block settled
the Susan Rubin Block Revocable Trust (Trust). On September 17,
2015, she executed a will that remained in effect at her death and that
provided for the transfer of her residuary estate to the Trust, whose
terms she amended and restated on the same day. Ms. Block, Ms. Saffir,
and Mr. Block were named as the initial co-trustees. Upon Ms. Block’s
death the following month, the Trust became irrevocable pursuant to
Article 1.2 of the Trust instrument. Thereafter, Ms. Saffir and Mr. Block
were the only co-trustees of the Trust. The Trust is governed by the laws
of the State of Connecticut.
In Article 4 of the Trust instrument, Ms. Block provided for a
subtrust, the Katz Trust, to be funded upon her death. The Katz Trust
would exist for the benefit of Ms. Block’s sister, Harriet Katz (Harriet),
and then for the benefit of Harriet’s spouse, I.W. Katz (I.W.), should he
survive Harriet. Article 4 provides that upon the death of both Harriet
and I.W., the property remaining in the Katz Trust shall be distributed
to the Jewish Community Foundation of Greater Hartford, Inc.
(Foundation). The Foundation is a charitable organization as described
in sections 170(c) and 2055(a). The co-trustees of the Katz Trust are the
same as the co-trustees of the Trust.
Article 4.1 of the Trust instrument states that Ms. Block intends
the Katz Trust to be “a charitable remainder annuity trust, within the
meaning of Rev. Proc. 2003-57 and § 664(d)(1) of the Code, and the terms
of this Section shall be construed to give maximum effect to such intent.”
Article 4.1(A) directs that an “annuity amount” be paid to Harriet during
her life (or to I.W. if he survives her), in an amount “equal to the greater
of: (a) all net income, or (b) the sum of Fifty Thousand Dollars ($50,000),
3
[*3] at least annually.” In addition, Article 4.1(I) of the Trust
instrument provides:
Following [Ms. Block’s] death this entire Trust, including
THE HARRIET KATZ TRUST, shall be irrevocable.
However, the Trustee shall have the power, acting alone,
to amend THE HARRIET KATZ TRUST from time to time
in any manner required for the sole purpose of ensuring
that THE HARRIET KATZ TRUST qualifies and continues
to qualify as a charitable remainder annuity trust within
the meaning of § 664(d)(1) of the Code. The Trustee may
not, however, change the annuity period, the annuity
amount, or the identity of the Recipient [of the annuity
amount].
After respondent initiated an examination of the Estate’s Form
706, United States Estate (and Generation-Skipping Transfer) Tax
Return, in August 2017, the co-trustees executed an amendment to the
Trust instrument (First Amendment) with an effective date of October
21, 2015, (Ms. Block’s date of death). The First Amendment’s stated
purpose was to revise Article 4.1(A) to provide that the trustees shall
pay from the Katz Trust to Harriet for her life, and to I.W. should he
survive Harriet, “an annuity amount equal to the sum of Fifty Thousand
Dollars ($50,000), at least annually.” The First Amendment removed
“all net income” from the determination of the “annuity amount.” 3
II. Katz Trust Income
The Katz Trust was funded with assets having a date-of-death
fair market value of $761,000. At all relevant times, all assets have been
held in the Katz Trust’s brokerage account. The chart that follows lists
the annual income generated by the Katz Trust’s assets and the balance
in its brokerage account as of December 31 of years 2016–19:
3 As explained below, we need not determine whether the First Amendment
was effective under the terms of the Trust and Connecticut law.
4
[*4] Amount of Income Earned Balance in Brokerage
Year
During Year Account as of Dec. 31
2016 $29,190 $691,066
2017 23,666 677,348
2018 23,380 633,859
2019 22,242 630,123
The Katz Trust has paid $50,000 each year to Harriet from 2015 through
at least 2019.
III. The Estate Tax Return and Notice of Deficiency
The co-executors timely filed the Estate’s Form 706 on or before
the filing deadline of July 21, 2016. On that return, the Estate deducted
from the value of the gross estate (among other things) the present value
of the charitable remainder interest of the Katz Trust, which the Estate
calculated on the basis of an annuity amount of $50,000 and the
actuarial life expectancies of Harriet and I.W. The Internal Revenue
Service (IRS) initiated an examination of the return in August 2017. At
the conclusion of the examination, the IRS issued the Notice of
Deficiency, in which it disallowed the entirety of the Estate’s claimed
charitable deduction of $352,085 in connection with the Katz Trust. To
date, the co-trustees of the Trust have not commenced any judicial
proceeding to reform any provisions of the Trust instrument.
Discussion
I. Burden of Proof
In general, determinations in a notice of deficiency are presumed
correct, and the taxpayer bears the burden of proving error. Rule 142(a);
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch v.
Helvering, 290 U.S. 111, 115 (1933). The Estate does not contend, and
the evidence does not establish, that the burden of proof shifts to
respondent under section 7491(a) as to any issue of fact. Accordingly,
the Estate bears the burden of proof with respect to contesting the
deficiency determinations.
5
[*5] II. Split-Interest Charitable Deductions
For purposes of the federal estate tax, section 2055(a) generally
allows a deduction from the value of a decedent’s gross estate for
transfers for charitable purposes. However, Congress attached special
conditions in the case of charitable bequests in the form of split-interest
transfers. Such a transfer occurs “where an interest in property passes
to a charitable beneficiary while an interest in the same property also
passes to a noncharitable beneficiary for less than full and adequate
consideration.” Estate of Schaefer v. Commissioner, 145 T.C. 134, 138
(2015); see also I.R.C. § 2055(e)(2). Section 2055(e)(2)(A) disallows a
deduction for the charitable remainder portion of a split interest
transfer unless (i) the remainder passes in trust and (ii) the trust is a
charitable remainder annuity trust (CRAT), see I.R.C. § 664(d)(1), a
charitable remainder unitrust (CRUT), see id. para. (2), or a pooled
income fund (PIF), see I.R.C. § 642(c)(5).
Congress imposed the section 2055(e)(2)(A) requirement for split-
interest remainders in order to remove the “incentive to favor the income
beneficiary over the remainder beneficiary by means of manipulating
the trust’s investments.” Estate of Schaefer, 145 T.C. at 138 (quoting
H.R. Rep. No. 91-413, pt. 1, at 59 (1969), as reprinted in 1969-3 C.B. 200,
238; S. Rep. No. 91-552, at 88 (1969), as reprinted in 1969-3 C.B. 423,
480). It had come to Congress’ attention that taxpayers were claiming
charitable deductions for bequests of remainder interests in trusts by
making valuation assumptions that were inconsistent with the way the
trust assets were actually managed. Where trust assets were invested
to maximize the income interest (for instance, investing in stocks that
pay high dividends or bonds that pay high interest), the value eventually
passing to charity through the remainder interest might bear little
relationship to the deduction previously taken. 4 Because of this
potential for abuse of charitable remainder deductions, Congress
4 Before enactment of section 2055(e)(2)(A), the charitable remainder deduction
was computed on the assumption that the trust assets would grow by 3.5% per year.
See H.R. Rep. No. 91-413, pt. 1, at 58, as reprinted in 1969-3 C.B. at 237. The more
general point is that estimating a present value for an unfixed income interest—and
thus for the charitable remainder—requires certain upfront assumptions about rates
of current return. (In most or all states, a trust that calls for the annual payment of
“net income” is generally required to pay out only the “current” portion of the return—
such as interest, dividends, and rent—as opposed to sale proceeds or unrealized
appreciation. See, e.g., Uniform Principal and Income Act § 102(4) (Unif. L. Comm’n
2008) (providing a default definition of “income” for trust instruments, viz, “money or
property that a fiduciary receives as current return from a principal asset”).). These
assumptions are necessarily blunt and therefore create scope for arbitrage.
6
[*6] mandated that the annual payout to the noncharitable income
beneficiaries be a fixed dollar amount (in the case of CRATs) or a fixed
percentage of value of the trust assets (in the case of CRUTs). 5 See
Estate of Gillespie v. Commissioner, 75 T.C. 374, 376–78 (1980); Estate
of Tamulis v. Commissioner, T.C. Memo. 2006-183, 92 T.C.M. (CCH)
189, aff’d, 509 F.3d 343 (7th Cir. 2007); see also H.R. Rep. No. 91-413,
pt. 1, at 58–60, as reprinted in 1969-3 C.B. at 237–39; S. Rep. No. 91-
552, at 86–87, as reprinted in 1969-3 C.B. at 479–80.
If a trust initially fails to qualify as a CRAT or a CRUT, the
settlor’s estate still may take a charitable deduction if there is a
“qualified reformation” of the trust. I.R.C. § 2055(e)(3)(A). A qualified
reformation cannot occur unless the remainder interest is a “reformable
interest” under section 2055(e)(3)(B), meaning that in the pre-reform
trust (1) the remainder interest is exclusively charitable and (2) all
payments to the noncharitable beneficiaries are “expressed either in
specified dollar amounts or a fixed percentage of the fair market value
of the property.” 6 I.R.C. § 2055(e)(3)(C)(i) and (ii). There is an exception
to the “specified dollar or fixed percentage” requirement: An initially
nonfixed interest will be excused if, within 90 days after the due date for
the estate tax return, a judicial proceeding is commenced that results in
the trust qualifying as a CRAT or a CRUT, retroactive to the date of the
decedent’s death. § 2055(e)(3)(C)(iii). In such a case, the remainder is
deemed a reformable interest just so long as the pre-reform trust
designated it as exclusively charitable.
III. CRATs
Section 664(d)(1) generally defines a CRAT as a trust with the
following four characteristics:
A. “[A] sum certain (which is not less than 5 percent nor more
than 50 percent of the initial fair market value of all
property placed in trust) is to be paid, not less often than
annually,” to the income beneficiaries, at least one of which
5 Alternatively, the income interest may be nonfixed, but only if the trust is a
PIF, meaning that it is managed by the charitable organization that holds the
remainder interest. See I.R.C. § 642(c)(5). A PIF’s charity-based governance
inherently protects against abuse.
6 There are a number of other requirements, besides having a charitable
remainder and a fixed income interest, for a trust to qualify as a CRAT or a CRUT.
(These are discussed below in the case of CRATs.) Therefore, the qualified reformation
rules do not require the trust to already be a CRAT or a CRUT.
7
[*7] is not a charitable organization. In the case of individual
beneficiaries, the annuity may last for either a set period
of years (not to exceed 20) or the individual’s remaining
lifetime. I.R.C. § 664(d)(1)(A).
B. No payments other than the annuity may be made to the
noncharitable beneficiaries. I.R.C. § 664(d)(1)(B).
C. At the end of the annuity period, the entire remainder is to
be transferred to one or more charitable organizations.
I.R.C. § 664(d)(1)(C); see also Treas. Reg. § 1.664-2(a)(6)(i).
D. The present value of the remainder interest, determined at
the time of the trust’s funding, is at least 10% of the initial
fair market value of the trust assets. I.R.C. § 664(d)(1)(D);
see also Treas. Reg. § 1.664-2(c). 7
A “sum certain” is defined by Treasury Regulation § 1.664-2(a)(1)(ii) to
mean “a stated dollar amount which is the same either as to each
recipient or as to the total amount payable for each year of [the annuity]
period.”
A trust that qualifies as a CRAT is exempt from income taxation
(although it is subject to an excise tax on unrelated business taxable
income, as defined in section 512). I.R.C. § 664(c).
IV. Attempted Reformation of the Katz Trust
Article 4.1(A) of the Trust instrument, as it stood on the date of
Ms. Block’s death, directed the trustees to pay to Harriet or I.W. an
“annuity amount equal to the greater of: (a) all net income, or (b) the
sum of Fifty Thousand Dollars ($50,000), at least annually.” This
provision is not limited to a specific stated dollar amount and therefore
violates the requirement of section 664 that the annuity of a CRAT be a
“sum certain.” Consequently, the Katz Trust did not qualify as a CRAT
at the time of Ms. Block’s death (nor, we should note, as a CRUT or a
PIF), and the charitable remainder of the Katz Trust was not a
reformable interest under the default rules—that is, before considering
the exception for judicial reformations (which can excuse an income
7 Treasury Regulation § 1.664-2(b) further provides that a trust is not a CRAT
unless the trust instrument forbids additional contributions to the candidate CRAT
after its initial funding. Article 4.1(E) of the Trust instrument contains this
prohibition.
8
[*8] interest that is not expressed as either a sum certain or a fixed
percentage of trust assets).
The Estate argues that the First Amendment to the Trust
instrument effected a qualified reformation. However, since the First
Amendment could not have done so under the default rules, the only
remaining possibility was a judicial reformation. Yet the exception for
judicial reformations clearly does not apply here. First, the First
Amendment was executed sometime after August 2017, far beyond the
90-day period following the due date for the estate tax return (July 21,
2016). Second, the amendment was instituted by the co-trustees alone,
rather than by a court. Therefore, the First Amendment fails both
components of the exception.
Petitioners ask us to deem the Estate to have substantially
complied with the exception. We decline to do so. As we have previously
observed, Congress made clear that the rules for qualified reformations
are to be construed strictly, in order to prevent abuse of the charitable
deduction. See Estate of Tamulis, 92 T.C.M. (CCH) at 192–93.
Specifically, Congress was concerned that if the reformation regime
were overly lenient, taxpayers would not reform trusts to comply with
the split-interest rules unless and until the IRS discovered defects upon
audit. As the reports of both the House Committee on Ways and Means
and the Senate Finance Committee explained:
In order to prevent [such strategic wait-and-see tactics]
from occurring, the committee believes that, in order for a
governing instrument of a charitable split-interest
contribution to be reformable, either (1) the creator had to
make a bona fide attempt to comply with the 1969 Act rules
[requiring the trust to be either a CRAT or a CRUT] or (2)
the taxpayer must initiate reformation proceedings before
the Internal Revenue Service could reasonably be expected
to begin audit. The committee believes that these rules will
permit the correction of major, obvious defects (such as
where the “income” interest is not expressed as an annuity
interest or a unitrust interest) so long as the taxpayer
initiates reformation proceedings before audit, while
allowing the correction of minor defects (such as defects in
determining the correct payout in short taxable years, in
years of additional contributions, etc.) upon audit so long
as there was a good faith attempt to comply with the 1969
9
[*9] Act rules (i.e., the payout is basically expressed as an
annuity interest or a unitrust interest).
H.R. Rep. No. 98-432, pt. 2, at 1516–17 (1984); Staff of the S. Comm. on
Fin., 98th Cong., Deficit Reduction Act of 1984: Explanation of
Provisions Approved by the Committee on March 21, 1984, S. Prt. No.
98-169, vol. 1, at 731–32 (Comm. Print 1984).
Accordingly, this Court strictly construes the exception for
judicial reformations. See, e.g., Estate of Hall v. Commissioner, 93 T.C.
745 (1989) (finding no qualified reformation of a trust that required net
income payments to the income beneficiary, because a judicial
proceeding was not timely commenced); Estate of Tamulis, 92 T.C.M.
(CCH) 189 (finding no qualified reformation of a trust that required net
income payments to income beneficiaries, despite statement of intent on
estate tax return for payments to be limited to 5% of trust assets). Even
if we were to find that the First Amendment was effective for purposes
of Connecticut law, it did not effect a qualified reformation for purposes
of section 2055(e).
Congress provided no exception for cases, like this one, where the
income payment would likely never vary from a fixed amount (based on
the initial size of the trust assets and the wording of the income payment
provision), or where the co-trustees have in fact always paid the income
beneficiaries a fixed amount. We cannot craft an exception that
Congress did not provide for. See Henry Schein, Inc. v. Archer & White
Sales, Inc., 139 S. Ct. 524, 530 (2019).
V. Revenue Procedures 2003-57 and 2003-59
The Estate also argues that Revenue Procedure 2003-57, 2003-2
C.B. 257, and Revenue Procedure 2003-59, 2003-2 C.B. 268 (together,
Revenue Procedures), allow a trustee to act alone, without court
involvement, to amend the terms of a trust at any time to ensure it both
qualifies as a CRAT and retroactively qualifies for an estate tax
charitable deduction. The Estate argues that the Revenue Procedures
are binding upon respondent. We have indeed held that the IRS is
generally obligated to follow published administrative positions,
including revenue procedures. See Dixon v. Commissioner, 141 T.C. 173,
188 (2013) (citing Rauenhorst v. Commissioner, 119 T.C. 157, 171–73
(2002)). However, the Revenue Procedures at issue here are unavailing
for the Estate.
10
[*10] The Revenue Procedures provide sample language for a trust to
qualify as a CRAT under section 664. For instance, the following is a
sample “Limited Power of Amendment” provision:
This trust is irrevocable. However, the Trustee shall have
the power, acting alone, to amend the trust from time to
time in any manner required for the sole purpose of
ensuring that the trust qualifies and continues to qualify
as a charitable remainder annuity trust within the
meaning of § 664(d)(1) of the Code.
Rev. Proc. 2003-57, § 4, 2003-2 C.B. at 258; Rev. Proc. 2003-59, § 4,
2003-2 C.B. at 270.
The Estate notes that this sample provision in the Revenue
Procedures does not specify a time limit for amending the trust, nor does
it require judicial intervention. However, the corollary provisions of the
Revenue Procedures must also be considered. Of note, one of the other
sample provisions in each Revenue Procedure specifies that the annuity
amount is “[a number no less than 5 and no more than 50] percent of the
initial net fair market value of all property passing to this trust as
finally determined for federal estate tax purposes.” Rev. Proc. 2003-57,
§ 4, 2003-2 C.B. at 258 (alteration in original); Rev. Proc. 2003-59, § 4,
2003-2 C.B. at 269 (alteration in original). Therefore, the nonjudicial
reformation contemplated by the “Limited Power of Amendment”
provision does not involve corrections for “major, obvious defects,” such
as a provision that allows annual payments to the income beneficiary in
the amount equal to the greater of all net income or $50,000. Major
defects, “such as where the ‘income’ interest is not expressed as an
annuity interest,” require a judicial proceeding to be commenced before
an IRS audit might begin (per section 2055(e)(3)(C)(iii)). See also H.R.
Rep. No. 98-432, pt. 2, at 1517; S. Prt. No. 98-169, vol. 1, at 732.
Moreover, each of the Revenue Procedures cautions: “A trust
instrument that contains substantive provisions in addition to those
provided in . . . this revenue procedure . . . will not necessarily be
disqualified, but neither will that trust be assured of qualification under
the provisions of this revenue procedure.” Rev. Proc. 2003-57, § 3, 2003-2
C.B. at 257 (emphasis added); Rev. Proc. 2003-59, § 3, 2003-2 C.B. at 269
(emphasis added). The pre-amendment Katz Trust did contain a
substantive provision beyond those provided in the Revenue
Procedures—namely, the direction that the income beneficiary receives
“all net income” if that should exceed $50,000. Because this direction
11
[*11] squarely violates the paramount rule for CRATs, the Katz Trust
falls outside of the Revenue Procedures’ representations regarding
eligibility for a charitable deduction.
VI. Construction of the Pre-Amendment Katz Trust
The Estate notes that Article 4.1(A) of the original Trust
instrument called for an “annuity amount equal to the greater of: (a) all
net income, or (b) the sum of Fifty Thousand Dollars ($50,000), at least
annually.” (Emphasis added.) Moreover, the flush text of Article 4.1
states that Ms. Block intends for the Katz Trust to be “a charitable
remainder annuity trust, within the meaning of Rev. Proc. 2003-57 and
§ 664(d)(1) of the Code, and the terms of this Section shall be construed
to give maximum effect to such intent.” These two provisions, according
to the Estate, show that the Katz Trust was a CRAT from the beginning
and that the First Amendment merely confirmed this characterization.
After all, an “annuity amount” as defined in the Code and regulations is
a “sum certain” and so is incompatible with a “net income” provision.
We understand the Estate to be arguing that the “all net income”
provision of Article 4.1(A) was void ab initio, so that no qualified
reformation—let alone a judicial proceeding—was necessary for the
Katz Trust to be a CRAT. We will assume for the sake of argument that
under Connecticut law, the original Article 4.1(A) was ambiguous and
that, under the Connecticut canons of construction, the phrase “all net
income” was ineffectual. But that assumption does not necessarily
entail that the Katz Trust was a CRAT from the beginning. That matter
will depend on the proper construction of section 664(d)(1)(A), which
provides that a CRAT is (among other things) a trust “from which a sum
certain . . . is to be paid, not less often than annually, to one or more
persons.” Perhaps this provision could lead to two interpretations,
either (1) the trust’s governing instrument unambiguously provides for
a sum-certain annuity or (2) the governing instrument once properly
construed (such that any and all ambiguities are resolved in accordance
with applicable state law) provides for a sum-certain annuity.
The first interpretation accords much more soundly with
Congress’ intent with regard to section 664. That intent was, as
discussed above, to deny both income and estate tax charitable
deductions for remainder interests unless the amount going annually to
the noncharitable beneficiaries is certain and unmanipulable. See H.R.
Rep. No. 91-413, pt. 1, at 59, as reprinted in 1969-3 C.B. at 238; S. Rep.
No. 91-552, at 88, as reprinted in 1969-3 C.B. at 480. If we were to find
12
[*12] that trusts can be CRATs when the noncharitable payment is
simply more likely than not required to be a sum certain, we would
subvert Congress’ evident goal of removing as much uncertainty as
possible from the preset-value calculation of remainder interests.
Therefore, we conclude that under the proper interpretation of section
664(d), the pre-amendment Katz Trust was not a CRAT. And because
the trustees did not effect a qualified judicial reformation, the entire
charitable deduction must be denied under section 2055(e).
We have considered all the arguments made by the parties and,
to the extent they are not addressed herein, we find them to be moot,
irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered under Rule 155.