In Estate of Margot Stewart et al.v. Commissioner; No. 07-5370 (9 Aug 2010), the Second Circuit vacated and remanded a Tax Court opinion. Under the decision, a gift of 49% of a residence with retention of possession and enjoyment by the decedent will be revalued by the Tax Court to determine a partial gift to the son.

Mother Margot Stewart and son Brandon were co-owners since 1989 of a home in East Hampton, New York. This property was rented each summer and they did not divide the rental income. Rather, each person took turns one year receiving the checks and therefore would receive the full payment.

Decedent Margot also owned a five-story brownstone residence in Manhattan. That home was the principal residence for both the decedent and Brandon. Decedent decided to rent the top three floors for $9,000 per month to a financial services business. She and son Brandon lived in the lower two floors of the Brownstone.

In December of 1999, decedent was diagnosed with pancreatic cancer. On May 9, 2000, she deeded 49% of the Brownstone home to son Brandon. She resided in the home and received the $9,000 per month rent payments until her death on November 27, 2000.

The estate filed an IRS Form 709 Gift Tax Return with a 42.5% discount on the gift of the 49% interest and included the 51% interest in the home in her IRS Form 706 Estate Tax Return. The IRS issued a deficiency and claimed that she had retained under Sec. 2036(a) the "possession and enjoyment" of the property and included 100% of the value in her estate.

The Court of Appeals determined that the primary issue was whether she had retained "possession or enjoyment" of the entire property. The Tax Court determined that when she made the 49% gift on May 9, 2000 there was an "implied agreement" that she would continue to reside in the home and receive the rental income.

However, the Court of Appeals determined that while she did benefit from the implied agreement to reside in the home for life, there must be an apportionment of the 49% interest. Because there was a co-tenancy between herself and Brandon and an implied agreement to share the rent on both the Brownstone and the East Hampton property, the case was remanded to the Tax Court for an apportionment of the property interests between Brandon and the decedent.

Dissenting Judge Livingston wrote a strongly-worded opinion that chastised the majority. Judge Livingston pointed out that decedent Margot retained exactly the same possession and enjoyment after the 49% gift that she had before the gift. In her view, the decision by the other two judges creates a huge loophole in Sec. 2036(a). Under all prior decisions, the retention of an interest resulted in 100% inclusion. If the courts are now going to be required to quantify the percentage gifted and the percentage included, there will in the future be "easy dodges by future tax avoiders."

In ILM 200738013, issued Aug. 9, 2007, the IRS set forth guidelines for charitable deduction appraisals of gifts of façade easements.

Generally, under Sec. 170(f)(3), there is not deduction for gifts of less than an entire interest. However, Sec. 170(f)(3)(B)(iii) permits a partial interest gift of a qualified conservation easement to produce a charitable deduction.

The easement must be granted in perpetuity and the gift made to a qualified organization. The qualified organization is expected to monitor the easement to insure that the terms are followed in perpetuity.

One of the types of easements that are permitted is a façade easement. In order to simplify the process, some appraisers have appraised the property and then attempted to apply a percentage reduction in value to determine the value of the easement. Frequently, the reduction in value has been between 10% and 20% of the underlying property fair market value.

The IRS noted that there is no "generally recognized percentage by which an easement reduces the value of property." The appropriate method for determining property is to value the property "both before and after the donation." An appraiser must specify the value of the property, the specific reasons for the reduction in value, and the claimed value of the property after the creation of the façade easement. The charitable deduction will be the difference between the original value and the reduced value after creation of the easement.

In Announcement 2007-87; 2007-40 IRB 753 (1 Oct 2007), Treasury issued an advance notice of proposed rulemaking. In essence, Treasury is requesting comments regarding the regulations that will be issued for Type III Supporting Organizations (SOs).

In the Pension Protection Act of 2006, Treasury was directed to issue regulations in four areas. These are (i) payout requirements for non-functionally intergrated Type III SOs, (ii) how to determine that a Type III SO is functionally intergrated, (iii) the methods for Type III SOs organized as trusts to show responsiveness and (iv) the information Type III SOs must provide to supported organizations.

Supporting organizations under Sec. 509(a)(3) must satisfy an organizational test, an operational test, a relationship test and a disqualified person control test. Generally, supporting organizations are Type I or controlled by the public charity, Type II or brother-sister organizations or Type III SOs. The Type III SO must meet a "responsiveness test" and an "integral part test".

PPA 2006 creates multiple new requirements for the Type III SO. The Announcement specifically addresses payout requirements for Type III SOs that are not functionally integrated, criteria for determining a Type III SO is functionally integrated, a responsiveness test for Type III SOs that are trusts and information given to the supported organizations.

Functionally Integrated Type III SO Test

A Type III SO will be functionally integrated if it meets three requirements. It must meet the "but for" test in Reg. 1.509(a)-(4)(i)(3)(ii). Second, it must fulfill an expenditure test under Sec. 4942(j)(3)(A). Third, it must comply with an assets test.

The expenditure test will require expenditure of 5% of aggregate fair market value or the adjusted net income, which ever is a lower amount. The assets test will require utilization of 65% of assets directly for the exempt purpose.

Not Functionally Integrated (NFI) Type III SO Payouts

There will be a payout requirement for NFI Type III SOs. This payout requirement will be similar to the Sec. 4942 private foundation requirement of 5% of aggregate asset fair market value each year. The qualifying distributions will also include reasonable and necessary administrative expenses.

In addition to the 5% payout, the NFI Type III SO must distribute the minimum payout to no more than 5 publicly supported organizations. However, existing Type III SOs that pay out 85% of income may potentially be grandfathered under the future regulations.

Responsiveness Test For Type III SO Trusts

If the Type III SO is a trust, then it must show that there is a "close, continuous working relationship with the officers, directors or trustees of the publicly supported organizations."

Information To Supported Organizations

The announcement "solicits comments" as to what information should be required from an NFI TYPE III SO to the supported organizations.