Federal Tax Day - Current, J.1, Value of Gift Upon Trust Termination Determined (Lewis, TCM), (Jul 21, 2026)

The value of gifts made by two donors to their father upon the termination of a trust created under their mother's will, which allowed him to receive all of the trust assets, was determined without a reduction attributed to the father's limited power of appointment, with a reduction for the gift tax that would have been owed to the father under Code Sec. 2207A, and without applying the Code Sec. 7520 valuation tables.

In a prior decision, the court concluded that an agreement to terminate a qualified terminable interest property (QTIP) trust and the distribution of the assets to the father did not result in a taxable gift by the father. However, the agreement did result in taxable gifts by the donors to their father of their remainder interests (B. McDougall, Donor,Dec. 62,500, 163 TC -, No. 5). The court stated that the value of the gifts by the donors was equal to the value of the distribution to which they would have been entitled under their mother's will upon the termination of the trust if they had not agreed to terminate the trust and distribute all property to their father.

Impact of the Testamentary Limited Power of Appointment

If the donors and their father had not agreed to a specific distribution of the trust property upon termination of the trust, the will would have given each beneficiary a distribution of assets with a value equal to the beneficiary's interest in the trust. Both parties used a discounted cashflow analysis to value the trust interests. Because this requires consideration of future distributions that would have been made to the beneficiaries if the trust had not been terminated, the limited power of appointment must be considered. If the trust had been terminated without specifying the division of assets, the trustee would assume, in accordance with the mother's will, that the trust assets would be distributed in equal shares to the donors upon the father's death.

Impact of the Right to Recovery of Gift Tax

If the parties had terminated the trust without specifying the distribution of assets, the father would have been treated as transferring all the interests in the trust property other than his qualifying income interest for life, which would have been a taxable gift. The father would have owed gift tax and would have been entitled to recover that gift tax from the donors. Because the court concluded that the donors' gifts were valued by comparing what actually happened to what would have happened under the decedent's will, the donors' gifts to their father were reduced by his right to reimbursement.

Application of Valuation Tables and Life Expectancy

The valuation tables did not apply in determining the value of the donors' gifts because the question of the donors' entitlements to the trust assets upon termination of the trust was a matter of state law. In addition, the donors' valuation expert adjusting the father's life expectancy due to his income was inappropriate.

L.M. Lewis, TC Memo. 2026-58, Dec. 62,871(M)