Actuarial Tables Exceptions

Federal RegisterJun 10, 1994

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SUMMARY: This document contains proposed amendments to the income,

estate, and gift tax regulations under the Internal Revenue Code

relating to exceptions to the use of standard valuation tables for

valuing annuities, interests for life or a term of years, and remainder

or reversionary interests. These amendments are necessary in order to

provide guidance consistent with court decisions that call for

deviation from the use of standard valuation tables in valuing those

interests. The proposed regulations would apply in valuing all

interests that would, but for the exceptions, be valued under section

7520 of the Code.

DATES: Written comments and requests for a public hearing must be

received by August 9, 1994.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R ([PS-26-93]), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered to: CC:DOM:CORP:T:R ([PS-26-93]), room 5228, Internal Revenue

Service, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: William L. Blodgett, telephone (202)

622-3090 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed regulations (26 CFR 1.7520-3(b),

20.7520-3(b), and 25.7520-3(b)) for the valuation of certain partial

interests in property under section 7520 of the Internal Revenue Code

(Code), as added by section 5031 of the Technical and Miscellaneous

Revenue Act of 1988, when the use of standard actuarial tables would

produce unreasonable results.

The regulations are proposed to be effective for valuation dates

occurring after the date the regulations are published as final

regulations in the Federal Register.

Explanation of Provisions

Section 7520(a), which is effective after April 30, 1989, provides

that the value of annuities, interests for life or a term of years, and

remainder or reversionary interests is to be determined under tables

published by the IRS based on an interest rate equal to 120 percent of

the applicable Federal mid-term rate (rounded to the nearest two-tenths

of one percent) in effect under section 1274(d)(1) for the month in

which the valuation date falls. Section 7520(b) provides that section

7520 shall not apply for purposes of any provision specified in

regulations. The Conference Report to the Technical and Miscellaneous

Revenue Act of 1988, H.R. Conf. Rep. No. 1104, 100th Cong., 2d Sess.

113 (1988), 1988-3 C.B. 603, explains that section 7520 does not apply

to ``situations specified in Treasury regulations.''

The IRS has never attempted to include in the regulations all of

the different actuarial factors that could apply to the many different

kinds of vested and contingent annuity, income, and remainder interests

that can arise in tax administration. The actuarial tables that have

been set forth in the regulations from time to time have listed only

those factors that are most frequently needed by taxpayers. Generally,

these actuarial tables have included the one-life annuity, income, and

remainder factors for ages 0 through 109 and the term-certain annuity,

income, and remainder factors for periods of 1 through 60 years. These

one-life and term-certain factors are often referred to in this notice

of proposed rulemaking as ``standard actuarial factors'' or ``standard

section 7520 actuarial factors.''

Other standard actuarial factors that are less frequently needed by

taxpayers are included in tables that have been separately published by

the IRS from time to time and that may be purchased from the Government

Printing Office. The tables in these books include two-life actuarial

factors, as well as many one-life factors and term-certain factors not

found in the regulations tables. These publications also include a

number of examples that illustrate how to compute special section 7520

actuarial factors such as the annuity, income, or remainder factor for

a period limited to the lesser of a term certain or a lifetime. Special

actuarial factors have for many years been referred to as such in the

regulations. See, for example, Sec. 20.2055-2(f)(5).

Other special section 7520 actuarial factors that may apply to more

unusual situations may be computed by the taxpayer or, upon request, by

the Internal Revenue Service for the taxpayer, by using actuarial

methods consistent with those used to compute the standard section 7520

actuarial factors that appear in the tables in the regulations and in

the Service's publications. Examples of these more unusual situations

include an annuity payable for more than two lives, a right to income

for a term certain or until the prior death of the first to die of two

individuals, and the right to receive a remainder after a term certain

if an individual survives the term.

In calculating a standard section 7520 actuarial factor, certain

assumptions are made. For all standard section 7520 actuarial factors

in the single-life and term-certain tables in Sec. 20.2031-7(d), the

interest rate for enjoyment or the postponement of enjoyment is the

applicable section 7520 rate. In the case of a life annuity, income, or

remainder factor, the basis for mortality rates for measuring lives is

the data in Table 80 CNSMT. However, in unusual situations, where

special section 7520 actuarial factors must be computed, one or more

alternative assumptions may be appropriate. For example, if the actual

income is known to be below applicable standards, the section 7520

interest rate may not be used to project the trust income yield.

Similarly, if a measuring life is classified as terminally ill, the

standard mortality data from Table 80 CNSMT may not be used as the

mortality basis. But, even though one or both of these exceptions is

applicable in a case, the section 7520 interest rate will ordinarily be

used to discount the value of the right to any postponed enjoyment.

In cases requiring the valuation of ordinary annuities, income

interests, and remainder and reversionary interests, the courts have

consistently recognized the need to use the standard actuarial factors

prescribed by the regulations. See Ithaca Trust v. United States, 279

U.S. 151 (1929).

However, the courts have recognized that the use of the standard

actuarial factors is inappropriate in certain cases. Robinette v.

Helvering, 318 U.S. 184 (1943) (reversionary interest with several

interdependent contingencies); Stark v. United States, 477 F.2d 131

(8th Cir. 1973), cert. denied, 414 U.S. 975 (1973) (closely held stock

that was not publicly traded and paid no dividends); O'Reilly v.

Commissioner, 973 F.2d 1403 (8th Cir. 1992), rem'd, T.C.M. 1994-61

(disparity between .2 percent yield and 10 percent tables produced

unrealistic and unreasonable result); and Commissioner v. Estate of

Sternberger, 348 U.S. 187 (1955) (charitable bequest that would occur

only if decedent's unmarried daughter died without issue surviving her

and her mother). In addition, the courts have held that the standard

actuarial factors cannot be used if the measuring life is terminally

ill. Estate of McLendon v. Commissioner, T.C.M. 1993-459; Estate of

Jennings v. Commissioner, 10 T.C. 323 (1948); and Estate of Denbigh v.

Commissioner, 7 T.C. 387 (1946). See Rev. Rul. 80-80, 1980-1 C.B. 194,

which provides that, in cases where the individual's death is imminent,

the taxpayer may not use standard actuarial factors prescribed by the

regulations. See also, Carter v. United States, 921 F.2d 63 (5th Cir.

1991), where the court refused to ascribe value to an income interest

for purposes of the section 2013 credit where death of the measuring

life was simultaneous with that of the decedent.

In Shapiro v. Commissioner, T.C. Memo 1993-483 (1993), the Tax

Court allowed the taxpayer to improperly value an annuity with a

standard one-life annuity actuarial factor from Table A in

Sec. 20.2031-7(f) in a situation in which the annuity could have

exhausted the fund from which the annuity was to be paid before the

death of the annuitant. The Internal Revenue Service believes that the

annuity factor that should have been used in this case is a special

annuity factor for the right to receive annual payments for 4 years or

until the prior death of the annuitant. See Rev. Rul. 77-454, 1977-2

C.B. 351. See also Moffett v. Commissioner, 269 F.2d 738 (4th Cir.

1959), and United States v. Dean, 224 f.2d 26 (1st Cir. 1955).

Therefore, the Service will not follow the result in Shapiro.

Sections 1.7520-3(a), 20.7520-3(a), and 25.7520-3(a) set forth

specific Code sections that are exempt from the valuation rules of

section 7520. The proposed regulations contained in this notice

describe other areas in which the valuation methodology applicable to

standard and special section 7520 actuarial factors is not to be used.

Generally, if the interest in property that is to be valued is not an

ordinary annuity, income interest, or remainder interest, the standard

annuity, income, and remainder factors in the tables of factors set

forth in the regulations and IRS publications cannot be used. In some

cases in which the standard factors from the regulations and

publications tables cannot be used, a special factor may be computed by

the taxpayer or by the Service upon the request of the taxpayer. In

other cases where standard or special factors may not be used, the

property interest may be valued using other valuation techniques.

Depending upon the facts and circumstances, a property interest that

cannot be valued using the standard or special section 7520 factors may

have no ascertainable value.

The proposed regulations establish two primary tests to determine

whether the fair market value of the interest is computed by use of the

standard section 7520 actuarial factors found in the regulations and

IRS publications. The first test is whether the instrument of transfer

provides the beneficiary with the degree of beneficial enjoyment that

is consistent with the type of property interest that the standard

valuation tables are designed to measure. In this regard, the rights of

an annuity beneficiary must be adequately defined and, if the annuity

is payable from a group of assets, the value of the assets must be

sufficient to support all of the annuity payments. Similarly, the

rights of an income beneficiary must be consistent with the rights of

an outright owner of the property interest for the same period of time,

and the rights of a remainder or reversionary beneficiary must be

protected against invasion or erosion of the corpus.

The second test in the proposed regulations addresses the mortality

component of the transferred interest. The Internal Revenue Service

previously addressed this issue in Rev. Rul. 66-307, 1966-2 C.B. 429,

and Rev. Rul 80-80. Rev. Rul. 66-307 set forth the rule that the value

of a life or remainder interest would be determined by taking into

account the health of the life tenant if it was known on the valuation

date that the life tenant was afflicted with a fatal and incurable

disease in its advanced stages and that the life tenant could not

survive for more than a brief period of time. Rev. Rul. 80-80 clarified

the ``brief period'' test in Rev. Rul. 66-307, and stated that the

standard life actuarial factors are to be applied to value the interest

unless death is clearly imminent. In the view of the Service, because

the test for determining whether death is imminent set forth in Rev.

Rul. 66-307 and Rev. Rul. 80-80 does not satisfactorily quantify the

probability of death occurring within 1 year from the valuation date,

this test may permit the use of standard actuarial factors in

inappropriate situations. These regulations propose to explicitly

quantify the applicable standard for purposes of applying this test.

Under the proposed regulations, if an individual who is a measuring

life of the interest being transferred is known to be terminally ill,

the mortality test of the proposed regulations is not satisfied and a

special section 7502 actuarial factor, rather than a standard actuarial

factor must be used in valuing the interest. Terminal illness is

defined in the proposed regulations as an incurable illness or other

deteriorating physical condition that would substantially reduce a

person's life expectancy to the extent that there is at least a 50

percent probability that the individual will not survive for more than

1 year from the valuation date. Exceptions are made in the regulations

for special situations under sections 2013, 2037, and 2042.

In the case of the simultaneous death of the transferor and an

individual who is the measuring life of a property interest, the

proposed regulations specifically preclude use of the standard factors

in the tables to value that interest. This is pertinent in determining

the previously taxed property credit under section 2013 and reaffirms

the position of the Fifth Circuit in the Carter case.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and, therefore, an initial Regulatory

Flexibility Analysis is not required. Pursuant to section 7805(f) of

the Internal Revenue Code, this notice of proposed rulemaking will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments that are submitted

timely (preferably a signed original and eight copies) to the Internal

Revenue Service. In particular, the Service invites comments on whether

the proposed definition of terminal illness adequately deals with

certain illnesses that are known to cause death in a short period of

time but are often diagnosed more than 1 year before death. All

comments will be available for public inspection and copying. A public

hearing may be scheduled if requested in writing by a person that

timely submits written comments. If a public hearing is scheduled,

notice of the date, time, and place for the hearing will be published

in the Federal Register.

Drafting Information

The principal author of these proposed regulations is William L.

Blodgett, Office of Assistant Chief Counsel (Passthroughs and Special

Industries), Internal Revenue Service. However, other personnel from

the IRS and Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 20

Estate taxes, Reporting and recordkeeping requirements.

26 CFR Part 25

Gift taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1, 20 and 25 are proposed to be amended

as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.7520-3 is amended by adding the text of paragraph

(b) to read as follows:

Sec. 1.7520-3 Limitation on the application of section 7520.

* * * * *

(b) Other limitations on the application of section 7520-- (1) In

general--(i) Ordinary beneficial interests. For purposes of this

section:

(A) An ordinary annuity interest is the right to receive a fixed

dollar amount at the end of each year during one or more measuring

lives or for some other defined period. A standard section 7520 annuity

factor for an ordinary annuity interest represents the present worth of

the right to receive $1.00 per year for a defined period, using the

interest rate prescribed under section 7520 for the appropriate month.

If an annuity interest is payable more often than annually or is

payable at the beginning of each period, a special adjustment must be

made in any computation with a standard section 7520 annuity factor.

(B) An ordinary income interest is the right to receive the income

from, or the use of, property during one or more measuring lives or for

some other defined period. A standard section 7520 income factor for an

ordinary income interest represents the present worth of the right to

receive the income from $1.00 for a defined period, using the interest

rate prescribed under section 7520 for the appropriate month.

receive an interest in property at the end of one or more measuring

lives or for some other defined period. A standard section 7520

remainder factor for an ordinary remainder or reversionary interest

represents the present worth of the right to receive $1.00 at the end

of a defined period, using the interest rate prescribed under section

7520 for the appropriate month.

(ii) Certain restricted beneficial interests. A restricted

beneficial interest is an annuity, income, remainder, or reversionary

interest that is subject to a contingency, power, or other restriction,

whether the restriction is provided for by the terms of the trust,

will, or other governing instrument or is caused by other

circumstances. In general, a standard section 7520 annuity, income, or

remainder factor may not be used to value a restricted beneficial

interest. However, a special section 7520 annuity, income, or remainder

factor may be used to value a restricted beneficial interest under some

circumstances. See Example 2 in Sec. 1.7520-3(b)(4), which illustrates

a situation where a special section 7520 actuarial factor is needed to

take into account the shorter life expectancy of the terminally ill

measuring life. See Sec. 1.7520-1(c) for requesting a special factor

from the Internal Revenue Service.

(iii) Other beneficial interests. If, under the provisions of

Sec. 1.7520-3(b), the interest rate and mortality components prescribed

under section 7520 are not applicable in determining the value of any

annuity, income, remainder, or reversionary interest, the actual fair

market value of the interest (determined without regard to section

7520) is based on all of the facts and circumstances if and to the

extent permitted by the Internal Revenue Code provision applicable to

the property interest.

(2) Provisions of governing instrument and other limitations on

source of payment--(i) Annuities. A standard section 7520 annuity

factor is not to be used to determine the present value of an annuity

for a specified term of years or the life of one or more individuals

unless the effect of the trust, will, or other governing instrument is

to ensure that the annuity will be paid for the entire defined period.

In the case of an annuity payable from a trust or other limited fund,

the annuity is not considered payable for the entire defined period if,

considering the applicable section 7520 interest rate, the annuity is

expected to exhaust the fund before the last possible annuity payment

is made in full. For this purpose, it must be assumed that it is

possible for each measuring life to survive until age 110, because

every standard section 7520 life annuity factor is calculated on the

basis of that assumption. If it is determined that the trust or other

fund from which an annuity is to be paid may exhaust before the end of

the defined period of the annuity, it will be necessary to calculate a

special section 7520 annuity factor that takes into account the facts

and circumstances that may exhaust the trust or fund.

(ii) Income and similar interests--(A) Beneficial enjoyment. A

standard section 7520 income factor for an ordinary income interest is

not to be used to determine the present value of an income or similar

interest in trust for a term of years or for the life of one or more

individuals unless the effect of the trust, will, or other governing

instrument is to provide the income beneficiary with that degree of

beneficial enjoyment of the property during the term of the income

interest that the principles of the law of trusts accord to a person

who is unqualifiedly designated as the income beneficiary of a trust

for a similar period of time. This degree of beneficial enjoyment is

provided only if it was the transferor's intent, as manifested by the

provisions of the governing instrument and the surrounding

circumstances, that the trust provide an income interest for the income

beneficiary during the specified period of time that is consistent with

the value of the trust corpus and with its preservation. In determining

whether a trust arrangement evidences that intention, the treatment

required or permitted with respect to individual items must be

considered in relation to the entire system provided for in the

administration of the subject trust. Similarly, in determining the

present value of the right to use tangible property (whether or not in

trust) for one or more measuring lives or other specified period of

time, the interest rate component prescribed under section 7520 and

Sec. 1.7520-1 is not to be used unless, during the specified period,

the beneficiary is entitled to that degree of use, possession, and

enjoyment of the property that an outright owner would be entitled to

exercise during a similar period of time.

(B) Diversions of income and corpus. A standard section 7520 income

factor for an ordinary income interest is not to be used to value an

income interest or similar interest in property for a term of years or

for one or more measuring lives if--

(1) The trust, will, or other governing instrument requires or

permits the beneficiary's income or other enjoyment to be withheld,

diverted, or accumulated for another person's benefit without the

consent of the income beneficiary; or

(2) The governing instrument requires or permits trust corpus to be

withdrawn from the trust for another person's benefit during the income

beneficiary's term of enjoyment without the consent of and

accountability to the income beneficiary for such diversion.

(iii) Remainder and reversionary interests. A standard section 7520

remainder interest factor for an ordinary remainder or reversionary

interest is not to be used to determine the present value of a

remainder or reversionary interest (whether in trust or otherwise)

unless, consistent with the preservation and protection that the law of

trusts would provide for a person who is unqualifiedly designated as

the remainder beneficiary of a trust for a similar duration, the effect

of the administrative and dispositive provisions for the interest or

interests that precede the remainder or reversionary interest is to

assure that the property will be adequately preserved and protected

from erosion, invasion, depletion, or damage until the remainder or

reversionary interest takes effect in possession and enjoyment. This

degree of preservation and protection is provided only if it was the

transferor's intent, as manifested by the provisions of the arrangement

and the surrounding circumstances, that the entire disposition provide

the remainder or reversionary beneficiary with an undiminished interest

in the property transferred.

(iv) Pooled income fund interests. In general, pooled income funds

are created and administered to achieve a special rate of return. A

beneficial interest in a pooled income fund is not ordinarily valued

using a standard section 7520 income or remainder interest factor. The

present value of a beneficial interest in a pooled income fund is

determined according to rules and special remainder factors prescribed

in Sec. 1.642(c)-6.

(3) Mortality component. The mortality component prescribed under

section 7520 is not to be used to determine the present value of an

annuity, income interest, remainder interest, or reversionary interest

if an individual who is a measuring life for the interest dies or is

terminally ill at the time of the transaction. For purposes of this

paragraph (b)(3), an individual who is known to have an incurable

illness or other deteriorating physical condition is considered

terminally ill if there is at least a 50 percent probability that the

individual will die within 1 year.

(4) Examples. The provisions of this paragraph (b) are illustrated

by the following examples:

Example 1.--Annuity funded with unproductive property. The

taxpayer transfers corporation stock worth $1,000,000 to a trust.

The trust provides for a 6 percent ($60,000 per year) annuity in

cash or other property to be paid to a charitable organization for

25 years and for the remainder to be distributed to the donor's

child. The trust specifically authorizes, but does not require, the

trustee to retain the shares of stock. The section 7520 interest

rate for the month of the transfer is 8.2 percent. The corporation

has paid no dividends on this stock during the past 5 years, and

there is no indication that this policy will change in the near

future. Under applicable state law, the corporation is considered to

be a sound investment for a trust with diversified investments

because the corporation's practice of retaining its earnings has

caused the value of the corporation stock to grow commensurately

each year. Considering the 6 percent annuity payout rate and the 8.2

percent section 7520 interest rate, the trust corpus is considered

sufficient to pay this annuity for the entire 25-year term of the

trust, or even indefinitely. Thus, though the trust assets not

likely to earn dividend income during the term of the trust, the

assets would be assumed to appreciate at the rate of 8.2 percent per

year if there were no income. Therefore, the trust's sole investment

in this corporation is not expected to adversely affect the interest

of either the annuitant or the remainder beneficiary. Although it

appears that neither beneficiary would be able to compel the trustee

to make the trust corpus produce investment income, the annuity

interest in this case is considered to be an ordinary annuity

interest, and the standard section 7520 annuity factor may be used

to determine the present value of the annuity. In this case, the

section 7520 annuity factor would represent the right to receive

$1.00 per year for a term of 25 years.

Example 2.--Terminal illness. The taxpayer transfers property

worth $1,000,000, to a charitable remainder unitrust described in

section 664(d)(2) and Sec. 1.664-3. The trust provides for a fixed-

percentage 7 percent unitrust benefit (each annual payment is equal

to 7 percent of the trust assets as valued at the beginning of each

year) to be paid quarterly to an individual beneficiary for life and

for the remainder to be distributed to a charitable organization. At

the time the trust is created, the individual beneficiary is age 60

and has been diagnosed with an incurable illness and there is at

least a 50 percent probability of the individual dying within 1

year. Because there is at least a 50 percent probability that this

beneficiary will die within 1 year, the standard section 7520

unitrust remainder factor for a person age 60 from the valuation

tables may not be used to determine the present value of the

charitable remainder interest. Instead, a special unitrust remainder

factor must be computed that is based on the section 7520 interest

rate and that takes into account the projection of the individual

beneficiary's actual life expectancy.

(5) Additional limitations. Section 7520 does not apply to the

extent provided by the Internal Revenue Service in revenue rulings or

revenue procedures.

(6) Effective date. The provisions of paragraph (b) of this section

are effective with respect to transactions after the date these

regulations are published as final regulations in the Federal Register.

PART 20--ESTATE TAX; ESTATES OF DECEDENTS DYING AFTER AUGUST 16,

1954

Par. 3. The authority citation for part 20 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 4. Section 20.7520-3 is amended by adding the text of

paragraph (b) to read as follows:

Sec. 20.7520-3 Limitation on the application of section 7520.

* * * * *

(b) Other limitations on the application of section 7520--(1) In