Three Whacks at Wealth Transfer Tax Reform: Retained-Interest Transfers, Generation-Skipping Trusts, and Flp Valuation Discounts

By Dodge, Joseph M. | Boston College Law Review, January 1, 2016 | Go to article overview

Three Whacks at Wealth Transfer Tax Reform: Retained-Interest Transfers, Generation-Skipping Trusts, and Flp Valuation Discounts


Dodge, Joseph M., Boston College Law Review


INTRODUCTION

Although this author personally favors replacing the federal wealth transfer (gift/estate/generation-skipping) taxes with an accessions tax,1 Congress has been reluctant to abandon existing tax systems.2 Accordingly, a more realistic tack is to address reform of current law. The tax aim of a wealth transfer tax is to raise some revenue with reasonable efficiency and minimal economic distortion. The non-tax aim is to curb undue accumulations of unearned, gratuitously received wealth by individuals. Since about 1980, the wealth transfer taxes have not done a very good job in terms of their aims. The post-1980 period has seen an increase in wealth inequalities among classes, especially at the very top,3 that has coincided with a drastic weakening of the wealth transfer taxes-both by legislation4 and the failure to address loopholes that are exploited by transactions that make little or no sense apart from tax avoidance.5 That the wealth transfer tax is barely alive politically,6 despite being limited to about 0.1% of decedents,7 is itself a symptom of the undue concentration of wealth and political influence.

Despite the bleak short-term prospects for reform, the political climate could change, and that possibility makes it worthwhile to advance some proposals. This Article concentrates on three problem areas that revolve around the timing of the taxable event. The overriding thesis is that timing rules should be the servant of accurate (i.e., ex post) valuations of the taxable transfers. Part I proposes a hard-to-complete approach for gifts under which income and corpus will (or can) return to the donor.8 Part II proposes that the current generation-skipping tax be replaced by one imposed only upon taxable distributions; three alternative solutions are proposed for determining rates and exemptions.9 Part III deals with the imposition, and later lapse or removal, of taxmotivated restrictions on property obtained by using legal entities (such as family limited partnerships, or "FLPs") to hold investment property.10

I. TRANSFERS WITH RETAINED INTERESTS AND POWERS11

The essential characteristic of an inter vivos wealth transfer with a retained interest or power in the transferred property (a "string" or "hybrid" transfer)12 is that the transferor has not parted with all incidents of ownership over the property.13 The issue is whether the transfer should be taxed in whole or in part under the gift tax when initially made, or at a later time when the retained interest or power terminates, which can occur no later than the transferor's death.14 The correct solution is to tax retained-interest transfers (broadly construed to include powers to revoke and possibilities of receiving back income or corpus) when the interest expires, but otherwise to tax transfers when made.

A. Problems with Existing Law

The 1916 estate tax and later (1924, 1932) gift tax 15 were never fully in sync with respect to string transfers. The estate tax aimed to include "testamentary" hybrid transfers in the gross estate,16 and the gift tax reached gifts of property or interests therein (valued using actuarial tables)17 that were "complete" (not subject to a retained power to revoke, alter, or amend).18 In the meantime, the estate tax string-transfer provision evolved into current Internal Revenue Code ("I.R.C.") §§ 2036-2038.19 Under these provisions, an inter vivos transfer (or a portion thereof)20 is included in the gross estate if the transferor retains: (1) possession or enjoyment of the property or an income right therein,21 (2) a reversion which, just prior to the transferor's death, is worth more than five percent of the value of the property,22 or (3) a power to alter the beneficial enjoyment of income or to revoke, alter, or amend the transfer.23 In 1990, Congress added § 2702, which treats certain, but not all, retained interests as having a zero value for gift tax purposes.24 Thus, certain non-gifts are treated as gifts! …

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