Probate and Trust Article

August, 2007

New Proposed Regulations on
IRC §2036 and §2039 Inclusion

By Jim Roberts



On June 6, 2007, the IRS published new proposed regulations that provide guidance on what part of a trust is includable in a deceased settlor’s estate under Sections 2036 and 2039 if the settlor retained the use of the trust property or the right to an annuity or other income from the trust for life (or some term that doesn’t actually end before death). Many practitioners would immediately surmise that 100% would be included, but there are revenue rulings to the contrary.

Rev. Rul. 76- 273, 1976-2 C.B. 268 and Rev. Rul. 82-105, 1982-1 C.B 133 are spotlighted in the preamble of the proposed regulations. Basically, the IRS explained that these rulings can provide a means for claiming only a part of the value of a trust in the decedent’s estate. The IRS explained that the new proposed regulations are designed to incorporate those rulings into the regulations, and also modify the existing regulations to update them with changes in the law.

In addition, the preamble explained that the proposed changes to the 2039 regulations were intended to point the practitioner back to 2036 for computational rules.

Basically, the new proposed regulations say that the amount includable is determined by taking the income stream the decedent was receiving, and then, using the 7520 rate in effect at the death of the decedent (or the alternate valuation date, whichever is applicable to the estate), determine what amount of money would have been required to produce that stream of income. If the principal needed would have been less than 100% of the trust, the estate inclusion is only that percentage. If the principal needed would have been more than 100% of the trust, then the amount includable is limited to the trust assets.

The illustrations are very helpful. In one, the regulations assume a husband and wife create a trust, with a mandatory income distribution clause, half to the husband and half to the wife, with the survivor getting all. For the spouse who dies first, only half the trust principal is includable in the decedent’s estate and the survivor’s estate must include 100%.

In another example, the trust is a CRAT funded with $100,000, and the annual annuity payment to the settlor is $12,000. At the settlor’s death, the trust has grown to $300,000 and the 7520 rate at that time is 6%. Only $200,000 is required, at 6%, to pay $12,000 per year, so only $200,000 is includable in the estate. And the result is the same if the settlor had relinquished his annuity payment within 3 years of death.

Another example is basically the same, except using a GRAT with monthly payments, and the regulations prescribe adjusting the 7520 rate with the monthly payments factor. As a result, $205,440 is includable.

When the switch to unitrusts is made, the computation becomes considerably more complicated. Same facts as above, with a CRUT, and the proposed regulations say, “ In this case, such amount of corpus is determined by dividing the trust's equivalent income interest rate by the section 7520 rate (which was 6 percent at the time of D's death). The equivalent income interest rate is determined by dividing the trust's adjusted payout rate by the excess of 1 over the adjusted payout rate. Based on section 1.664-4(e)(3) of the Income Tax Regulations, the appropriate adjusted payout rate for the trust at D's death is 5.786 percent (6 percent x .964365). Thus, the equivalent income interest rate is 6.141 percent (5.786 percent / (1 - 5.786 percent)). The ratio of the equivalent interest rate to the assumed interest rate under section 7520 is 102.35 percent (6.141 percent / 6 percent).” Because the percentage is more than 100%, the entire trust corpus is includable. And if the computation had produced a percentage less than 100%, that percentage would be the included amount.

Moving on to GRITs, a trust in favor of non-family members (Section 2704(c)(2)) with a provision paying all of the income to the settlor who dies before the end of the trust term, mandates that 100% of the trust assets be included in the deceased settlor’s estate. The same result occurs with a QPRT.

These new proposed regulations, in part, renumber some parts of the existing regulations. Those renumbering provisions will be effective for decedent’s dying after August 16, 2007. But the bulk of the proposed regulations will be effective when Treasury publishes its adoption of them in the Federal Register.