Tax Court rules no gift tax on shares received or sold after trust termination.

The Tax Court ruled that an estate was not liable for gift tax on shares received from a terminated marital trust. The case involved a taxpayer, Sally, whose estate faced IRS scrutiny over transactions tied to qualified terminable interest property (QTIP). The court found no evidence of gratuitous transfers. Thus, the taxpayer’s estate avoided over $9 million in gift tax liability.

Understanding the Situation

After her husband’s passing in 2008, the marital trust held shares from their family business, Al-Sal. The trust provided Sally with income for life while her late husband’s children were contingent beneficiaries. The marital deduction under QTIP rules was applied, ensuring the trust’s value avoided estate taxes.

In 2012, the marital trust was terminated, and Sally received the shares outright. That same year, she made gifts of some shares to her stepchildren. She then sold the remaining shares to family members in exchange for promissory notes. Sally reported and paid gift tax on the gifted shares but excluded the sale of shares from her gift tax return.

The IRS later issued a notice, claiming the termination and subsequent sale constituted a taxable gift. According to the IRS, Sally’s estate owed $9 million in gift tax and penalties.

Tax Court’s Findings

The Tax Court sided with Sally’s estate. It clarified that gift tax applies only when there is a “gratuitous transfer.” In this case, Sally did not make a gift.

Here’s why:

1. Ownership Transition: After the trust’s termination, Sally owned the shares outright. Before that, she held only a lifetime income interest. Receiving the shares was not a gift but a change in ownership.
2. Consideration Received: The sale of shares for promissory notes provided Sally with adequate consideration. This transaction lacked the elements of a gift.
3. QTIP Rules: Sally’s sale of shares did not trigger Code Sec. 2519. This rule applies when there’s a disposition of qualifying income interest in QTIP property. After the trust terminated, Sally no longer had such an interest.

Key Takeaways for Taxpayers

This case highlights important points in estate and gift tax law:

• Transfers resulting from trust termination may not always trigger gift tax liability.
• A transaction must meet the criteria of a gratuitous transfer to qualify as a gift.
• Proper documentation of consideration received can protect taxpayers from unnecessary tax liabilities.

Tax laws can be complex, especially with marital trusts and QTIP property. Consulting a tax professional ensures accurate compliance and strategic planning.

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