Rev. Rul. 2008-35
Table of Contents
- DRAFTING INFORMATION
Transfer tax valuation of interest in restricted management account. This ruling addresses whether an interest in a restricted management account (RMA) will be valued for transfer tax purposes without any reduction or discount for the restrictions imposed by the RMA agreement.
In determining the value for federal gift and estate tax purposes of any part or all of a restricted management account (RMA), do the restrictions imposed by the RMA agreement result in a value that is less than the full fair market value of the assets in the RMA?
In year 1, A, as the Depositor, enters into an agreement with Bank M pursuant to which A agrees to deposit marketable securities and cash into an account described as an RMA with Bank M. A was advised that the terms of the RMA were designed to enhance the investment performance of the portfolio by allowing Bank M and any investment advisor appointed by Bank M to maximize the portfolio’s long term performance without the risk of withdrawal of assets from the RMA before the expiration of the selected term of the RMA. Bank M agreed to accept a reduced investment management fee because Bank M was guaranteed a fee over the fixed term of the RMA.
During the term of the agreement, Bank M will manage the RMA and have complete discretion regarding investment of the assets held in the RMA. A will retain a property interest under applicable law in the assets held within the RMA and Bank M has no property rights with respect to assets in the account. All dividends, interest, and other income earned within the RMA is to be retained and reinvested, and no distributions of income or principal may be made from the RMA during the agreement term, except as otherwise noted in the agreement. The Depositor may nominate an investment advisor to be appointed by Bank M, but Bank M will have the power to select and replace the investment advisor during the term of the agreement. The agreement provides that it shall terminate on the fifth anniversary of the date of its execution. However, the term may be extended at any time by the Depositor, with the consent of Bank M. On the expiration of the term of the agreement, the assets in the RMA are to be paid to the Depositor or to the Depositor’s legal representative if the Depositor is no longer living.
During the term of the agreement, the Depositor, with the consent of Bank M, may assign or transfer all or any part of the RMA to a permitted transferee, defined in the agreement as a spouse, parent, or descendant of the Depositor, or to the estate or a trust for the benefit of a permitted transferee. If the Depositor exercises the assignment power with respect to only a part of the RMA, Bank M will create a separate RMA in the name of the designated transferee, and will select the assets (equal in value to the amount designated by the Depositor) to be transferred to the separate RMA. The terms of the agreement will apply to the new RMA, the recipient of the new RMA will be bound by the terms of the agreement, and the recipient will become the Depositor of the new RMA for purposes of the agreement. The recipient, as the new Depositor, will have a property interest under applicable law in the assets held within the new RMA. The RMA agreement is binding on the new Depositor’s heirs, successors, transferees, executors and administrators.
All securities in the RMA requiring registration are to be inscribed in the name of Bank M’s nominee and negotiability is to be provided by Bank M as custodian. Bank M issues Forms 1099 to A with respect to income generated by assets held within the RMA. Purchasers of securities from the RMA are not subject to the restrictions imposed by the RMA agreement.
A funds the RMA in Year 1 with marketable securities and cash having a total fair market value of $50x. In Year 2, when the total fair market value of the assets held in the RMA is $60x, A assigns one-sixth of the RMA to A’s child, B. In accordance with the terms of the agreement, Bank M establishes a new RMA with B designated as the Depositor, selects assets held in A’s RMA then having a fair market value of $10x, and transfers those assets to B’s RMA. The new RMA is subject to the terms of the same agreement and will terminate at the same time as specified in the agreement, unless B, as the Depositor of the new RMA, extends the termination date of that RMA.
In Year 3 with Bank M’s consent, A extends the term of A’s RMA to Year 7. A dies in Year 4. At the time of A’s death, the fair market value of the assets held in A’s RMA is $55x.
Section 2501 imposes a tax on the transfer of property by gift by an individual. Section 2511(a) provides that the tax imposed by section 2501 applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.
Section 2512(a) provides that if a gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift. Section 25.2512-1 of the Gift Tax Regulations provides that the value of the transferred property is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of the relevant facts.
Section 2031(a) provides that the value of the gross estate of a decedent includes the value at the date of death of all property, real or personal, tangible or intangible, wherever situated. Section 20.2031-1(b) of the Estate Tax Regulations provides that, in general, the value of every item of property includible in the decedent’s gross estate is its fair market value at the time of the decedent’s death, which is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. Section 20.2031-2(g) provides that if the decedent holds a trading account with a broker, all securities belonging to the decedent and held by the broker at the date of death must be included at their fair market value as of the applicable valuation date, even if pledged to secure a debt. Similarly, under section 20.2031-5, the amount of cash belonging to the decedent at the date of death, whether in the possession of the decedent or another person, or deposited with a bank, is included in the gross estate.
Section 2036(a) provides that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life, or for any period not ascertainable without reference to his death, or for any period which does not in fact end before his death — (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.
Section 2703(a)(2) provides that, for federal estate, gift, and generation-skipping transfer tax purposes, the value of any property shall be determined without regard to any restriction on the right to sell or use such property. Under section 2703(b), section 2703(a)(2) does not apply to a restriction (1) that is a bona fide business arrangement; (2) that is not a device to transfer property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth; and (3) whose terms are comparable to similar arrangements entered into by persons in an arm’s length transaction. Section 25.2703-1(b)(2) confirms that each of the three requirements described in section 2703(b) must be independently satisfied for a right or restriction to meet this exception. Although Congress, in enacting section 2703, focused primarily on below-market buy-sell agreements, the legislative history of that section confirms that it is to have a broad application. Section 25.2703-1(a)(3) further clarifies that a right or restriction may be contained in a partnership agreement, articles of incorporation, corporate bylaws, a shareholders’ agreement, or any other agreement, or may be implicit in the capital structure of an entity.
The willing buyer-willing seller test, applicable for both estate and gift tax purposes, is an objective test to be applied without reference to a specific donor, decedent, or his or her beneficiaries. In Smith ex. rel. Estate of Smith v. United States, 391 F.3d 621, 628 (5th Cir. 2004), the court concluded that, in determining the estate tax value of retirement accounts that could not be sold, “[a]pplying the [willing buyer-willing seller] test appropriately . . . entails looking at what a hypothetical buyer would pay for the assets in the Retirement Accounts.” Accordingly, no discount was allowed for the anticipated income tax that would be incurred if the assets were distributed to the account beneficiaries. See also Estate of Kahn v. Commissioner, 125 T.C. 227, 237-240 (2005) (reaching a similar conclusion and denying a marketability discount with respect to an individual retirement account).
The fair market value of all property transferred during life or owned at death by A, including marketable securities and cash, is the amount subject to transfer tax, even if that property is held in an account with a broker, deposited with a bank, or in the possession of another person. The interposition of the RMA agreement to manage A’s assets, reduces neither the fair market value of the transferred property for gift tax purposes nor the fair market value of the property included in A’s gross estate for estate tax purposes. A at all times retains a property interest under applicable law in the assets in the RMA, and Bank M has no such interest in any of the assets. Notwithstanding the restrictions on A’s ability to withdraw assets from the RMA and on A’s ability to terminate or transfer an interest in the RMA (in this case, to anyone other than the natural objects of A’s bounty), A remains the sole and outright owner of the assets in the RMA and the income from those assets. A has not changed the nature of A’s property by entering into the RMA agreement. Consequently, A’s assets held in the RMA constitute the property to be valued for gift and estate tax purposes.
In substance, the RMA agreement is a management contract between the owner of property and the person agreeing to serve as the property manager. Any restrictions imposed by the RMA agreement relate primarily to the performance of the management contract (e.g., by establishing and ensuring a long-term investment horizon to be pursued by the manager, and an appropriate fee in light of this circumstance), rather than to substantive restrictions on the underlying assets held in the RMA. Any restrictions on the ability to withdraw assets, terminate the agreement, or transfer interests in the RMA do not impact the price at which those assets would change hands between a willing buyer and a willing seller and, thus, do not affect the value of the assets in the RMA. In this regard, the RMA is comparable to the retirement fund and the individual retirement account at issue in the Smith and Kahn cases, above, in which the fair market value of assets within a particular type of account was held to not be affected by the value of those assets in the hands of the ultimate beneficiary. Further, the situation presented with respect to A’s RMA is similar to that presented where the owner of a parcel of rental real estate enters into a contract with a property manager relating to the management of that property. The existence of the management contract has no effect on the fair market value of the real property subject to that contract.
In addition to the above analysis under sections 2511, 2512, and 2031, other Internal Revenue Code sections apply in determining that the amount subject to federal transfer tax is the fair market value of the assets in the RMA. Specifically, section 2036 applies to A’s retained interest in the assets of the RMA and section 2703(a)(2) applies to disregard the restrictions on the sale or use of property for federal transfer tax valuation purposes. Further, to the extent A has the ability to terminate the relationship with Bank M under state law principles of agency, the amount subject to federal transfer tax is the fair market value of the assets in the RMA.
The fair market value of an interest in an RMA for gift and estate tax purposes is determined based on the fair market value of the assets held in the RMA without any reduction or discount to reflect restrictions imposed by the RMA agreement on the transfer of any part or all of the RMA or on the use of the assets held in the RMA. Accordingly, A’s gift to B in Year 2 is valued at $10X, the full fair market value of the assets transferred into B’s separate RMA. Similarly, the amount to be included in A’s gross estate for estate tax purposes with respect to the RMA is $55X, the full fair market value of the assets in the RMA at A’s death.
The principal author of this revenue ruling is Karlene M. Lesho of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this revenue ruling, contact Ms. Lesho at (202) 622-3090 (not a toll-free call).