n-03-72.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Qualified Interests

Notice 2003-72

PURPOSE

This notice announces that the Internal Revenue Service will follow the Tax
Court's decision in Walton v. Commissioner, 115 T.C. 589 (2000), holding that
§ 25.2702-3(e), Example 5, of the Gift Tax Regulations is invalid.

BACKGROUND

Section 2702 provides special rules for valuing gifts in trust when the donor or an
applicable family member retains an interest in the trust. If the retained interest is not a
qualified interest, the interest is valued at zero, and the amount of the gift is the entire
value of the transferred property. If the retained interest is a qualified interest, the
interest is valued under § 7520 using prescribed actuarial tables and interest rates, and the
amount of the gift is the value of the transferred property reduced by the value of the
retained interest. Under § 2702(b), a qualified interest is: (1) an interest that consists of a
right to receive fixed amounts payable not less frequently than annually (a qualified
annuity interest); (2) an interest that consists of a right, payable at least annually, to
receive a fixed percentage of the net fair market value of the trust corpus determined
annually (a qualified unitrust interest); and (3) a right to receive a noncontingent
remainder interest if all other interests in the trust are qualified annuity or unitrust
interests (a qualified remainder interest). Under § 25.2702-3(d)(3), the qualified annuity
or unitrust interest must be payable, "for the life of the term holder, for a specified term
of years, or for the shorter (but not longer) of those periods."

In Example 5 of § 25.2702-3(e), A transfers property to an irrevocable trust,
retaining the right to receive a unitrust amount for 10 years. If A dies within the 10-year
term, the unitrust amount is to be paid to A's estate for the balance of the term. The
example concludes that A's interest is a qualified unitrust interest to the extent of the right
to receive the unitrust amount for 10 years or until A's prior death. However, the unitrust
amount payable to A's estate if A dies within the term of the trust is not a qualified
interest.

In Walton v. Commissioner, the Tax Court considered a situation similar to that
presented in Example 5. In Walton, the grantor established a grantor retained annuity
trust, pursuant to which the grantor was to receive an annuity for a term of 2 years. If the
grantor died before the expiration of the 2-year term, the annuity was to be paid to the
grantor's estate for the balance of the term. Upon expiration of the 2-year term, the trust
corpus was to be distributed to a designated remainder beneficiary. After considering the
legislative history and purpose of § 2702, the Court held that Example 5 is an
unreasonable interpretation and invalid extension of § 2702. The Court concluded that a

retained annuity payable for a specified term of years to the grantor, or to the grantor's
estate if the grantor dies prior to expiration of the term, is a qualified interest under §
2702 for the specified term of years.

IRS ACQUIESCENCE

The IRS acquiesces in the Tax Court's decision. Accordingly, in the fact situation
presented in § 25.2702-3(e), Example 5, the Internal Revenue Service will treat the
retained unitrust interest payable to A or A's estate as a qualified interest payable for a
10-year term. The regulations will be revised to conform to this notice.

DRAFTING INFORMATION

The principal author of this notice is Scott S. Landes of the Office of Associate
Chief Counsel (Passthroughs and Special Industries). For further information regarding
this notice, contact Mr. Landes at (202) 622-3090 (not a toll-free call).