Central Intelligence. Certain Estate Tax Relief Act of February 2009 IN THIS ISSUE H.R. 436

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1 IN THIS ISSUE H.R. 436: CERTAIN ESTATE TAX RELIEF ACT OF 2009 Advanced Markets Central Intelligence February 2009 NOTICE : UPDATE FOR ACTUARIAL TABLES UNDER 7520 Advanced Markets Central Intelligence ESTATE OF LITCHFIELD V. CIR: DISCOUNTS GIVEN TO CORPORATE INTERESTS HELD IN ESTATE NEGRON V. U.S.: IRS ANNUITY TABLES VALUE LOTTERY WINNINGS FOR ESTATE TAXES AMERICAN GENERAL INS. CO. V. SCHOENTHAL LLC: INSURANCE POLICY RESCINDED REINERT V. CIR: TERMINATION OF LIFE INSURANCE POLICY TRIGGERS TAXABLE INCOME PLR : GRANDFATHERED PRIVATE SPLIT DOLLAR AGREEMENT PLR : CHARITY-OWNED LLC CAN PARTICIPATE IN 403(B) PLAN PLR : BUSINESS RECAPITALIZATION TRIGGERS 2701 CASE-IN-POINT: PRIVATE FINANCING CASE H.R. 436 Certain Estate Tax Relief Act of 2009 Representative Pomeroy (D-ND) introduced H.R. 436, Certain Estate Tax Relief Act of 2009, a bill that freezes the lifetime estate tax exemption at $3.5 million per decedent and retains the 2009 estate tax rate ceiling of 45%. The bill also phases out the effect of the graduated estate tax rates and unified credit on estates over $10 million. The bill does not directly address the generation-skipping transfer (GST) tax exemption, but as it is tied to the estate tax exemption amount, presumably the GST tax exemption amount would also be $3.5 million per person. In addition to preserving the 2009 estate tax numbers, the bill seeks to reduce the availability of valuation discounts for gift and estate tax purposes. It is well-settled law that the fair market value of an asset is the price at which the asset would change hands between a willing seller and a willing buyer, both being in possession of all of the relevant facts. This willing buyer, in the case of nonpublicly traded assets, would take into account both the degree of control the purchaser would have over the underlying assets and the ability to re-sell the interests at a later date. These considerations have given rise to the commonly taken discounts for lack of control and lack of marketability. While the lack-of-control and lack-of-marketability discounts are recognized in the case of unrelated third-parties interacting at arm s length, they are less accepted in the case of transactions between related parties and family members. Courts have generally upheld discounts for lack of control and lack of marketability in the estate and gift tax context. However, the Internal Revenue Service has consistently taken the opposing view, both in audits and in litigation, that valuation discounts for lack of control and lack of marketability are not appropriate in the estate and gift tax context. Page 1 of 12. Not valid without all pages.

2 H.R. 436 presents a standard, for estate and gift tax purposes, that is sympathetic with the Service s position that the lack-of-control and lack-of-marketability interest discounts are not available. Under H. R. 436, in the case of the transfer of any interest in an entity, other than an interest which is actively traded: (A) the value of any non-business assets held by the entity shall be determined as if the transferor had transferred such assets directly to the transferee (and no valuation discount shall be allowed with respect to such nonbusiness assets), and (B) the non-business assets shall not be taken into account in determining the value of the interest in the entity. The bill also contains a 10% look-through rule, under which, if a non-business asset of an entity consists of a 10% interest in any other entity, the 10% interest will be disregarded and the entity will be treated as holding its ratable share of the assets of the other entity. Finally, the bill attacks minority interest discounts by providing that, in the case of the transfer of any interest in an entity other than an interest which is actively traded, no discount shall be allowed by reason of the fact that the transferee does not have control of the entity if the transferee and his/her family members have control of the entity. Discounts Granted to S-Corporation Interests Owned in Estate ESTATE OF MARJORIE LITCHFIELD ET AL. V. CIR, T.C. MEMO Facts: Decedent s estate held interests in two closely held S-Corporations, Litchfield Realty Co. (LRC) and Litchfield Securities Co. (LSC). As of the valuation date, LRC had a net asset value of $33,174,196 with built-in capital gains of $28,762,306. LSC s net asset value on the valuation date was $52,824,413 with $38,984,799 of built-in capital gains. The capital gains tax rate applicable to LRC and LSC was between 35.5% and 39.1%. The estate s valuation expert prepared a valuation report in which he discounted the estate s 43.1% stock interest in LRC by 17.4% for built-in capital gains taxes, by 14.8% for lack of control and by 36% for lack of marketability. The estate s expert opined that LRC had a valuation date fair market value of $6,475,000. The estate s expert valued the estate s 22.96% interest in LSC with a 23.56% discount for built-in capital gains, an 11.9% lack-of-control discount and a 29.7% discount for lack of marketability, giving the estate s interest in LSC a discounted value of $5,748,000. The estate timely filed its estate tax return, reporting a federal estate tax liability of $22,396,609. In response, the Service opened an audit of the decedent s estate tax return, at the conclusion of which the estate received a notice of deficiency. The Service valued the estate s interest in LRC at $10,300,207 and in LSC at $8,762,783. The estate and the Service agreed as to the net asset value of both LRC and LSC, leaving the Tax Court to determine the percentage discount that should be used for built-in capital gains taxes, lack of control and lack of marketability. Ruling: The Tax Court began by emphasizing that the resolution of valuation issues typically involves an approximation by the parties, by the experts and by the court and that a court s valuation does not need to be tied to specific testimony or evidence if it is within the range of values supported by the evidence. Both parties experts used the net asset valuation method in their appraisals of the fair market value of the estate s minority LRC and LSC stock interests. Page 2 of 12. Not valid without all pages.

3 When discussing the nature and applicability of the various discounts at issue in this case, the Court pointed out that knowledgeable buyers would also negotiate discounts in the price of the stock to estimate, on the basis of current tax laws, the corporate capital gain liabilities due upon sale or disposition of the corporation s assets. The Court then proceeded to compare the two experts valuation reports. For the builtin gains discount, the estate s expert consulted with the officers and board of directors of LRC and LSC concerning their plans for selling the corporation s assets, reviewed board meeting minutes and tracked historical asset sales. In contrast, the Service s expert based his built-in capital gains discount solely on LRC and LSC s historical asset sales. The Court held that the expert s assumptions relating to asset turnover were based on more accurate data and accepted the estate s expert s built-in gains discounts of 17.4% and 23.6%, for LRC and LSC, respectively. For the lack-of-control discount, the Court noted that both experts, using slightly different data sets, calculated similar lack-of-control discounts for LRC s farmland and related assets. In addition, both experts used lack-of-control discounts for LRC s securities that were lower than those discounts for LRC s farmland and related assets. However, the estate s expert used a weighted average to account for the fact that LRC has significantly more farmland than securities, whereas the Service s expert used a straight average that would only have been appropriate had LRC s farmland and securities holdings been roughly equivalent. Because of the Service s expert s failure to take into account the difference between LRC s assets, the Court held that the estate s expert s 14.8% lack-of-control discount for the estate s LRC minority stock interest was appropriate. The Court then noted that the Service s expert applied the same 5% discount to LSC s securities as he applied to LRC s securities, even though the estate s 22.96% interest in LSC was significantly smaller than its interest in LRC. Because the Service s expert failed to take the smaller holding in LSC into account, the Court held that the estate s expert s 11.9% lack-of-control discount for LSC was appropriate. When determining the lack-of-marketability discount, the Court found that the estate s expert s respective 36% and 29.7% discounts for LRC and LSC to be high. In addition, the Court stated that the estate s expert used some outdated data relating to restricted stock discounts, giving him higher marketability discounts than those reflected in benchmark studies that included all components of lack-of-marketability discounts. Then, without explaining its reasoning, the Court concluded that discounts for lack of marketability of 25% and 20% should apply to the estate s respective LRC and LSC minority stock interests. As a result of its calculated discounts, the Court found that the estate s 43.1% interest in LRC was worth $7,546,725 and its 22.96% interest in LSC was worth $6,530,790. Those respective values were $1,071,725 and $782,790 higher than the estate s expert calculated, and were $2,753,482 and $2,231,993 less than the values determined by the IRS expert. IRS Annuity Tables Used to Value Lottery Winnings Held in Estate CAROL NEGRON ET AL V. U.S., NO (U.S. COURT OF APPEALS FOR THE SIXTH CIRCUIT) Facts: Decedents Lopatkovich and Susteric and one other person won the Ohio Super Lotto jackpot of $20 million on January 19, Both Lopatkovich and Susteric died in 2001 with fifteen more lottery payments remaining. Those payments were not assignable and could not be used as collateral. Carol Negron, who was appointed executrix of both estates, elected for each estate to receive a lump-sum settlement of the remaining prize awards pursuant to Ohio Rev. Code Ann Page 3 of 12. Not valid without all pages.

4 Lopatkovich s and Susteric s estates both reported that the remaining fifteen payments had an asset value of $2,275,867, based upon the amount received as a lump-sum distribution from the Ohio Lottery Commission, which used a 9.0% discounting rate in computing the amount of such distribution. The Service audited the Lopatkovich estate tax return and determined the value of the fifteen remaining annual payments to be $2,775,209, based on the IRS annuity tables found in 7520, increasing Lopatkovich s estate tax liability by $330,302. The Service also audited the Susteric estate tax return and determined that the fifteen payments had a value, under the IRS annuity tables of 7520, of $2,668,118, increasing Susteric s estate tax liability by $141,175. Negron paid the additional estate taxes due on both estates and filed a claim for refund. That claim for refund was denied, which generated a suit between Negron and the IRS in the District Court for the Northern District of Ohio (No. 1:05-cv-02305). During that suit, both parties filed a Motion for Summary Judgment, leaving the District Court to decide how to value the remaining lottery payments for a decedent s estate under The District Court found that the IRS s annuity tables had to be used unless it was shown that the result is so unrealistic and unreasonable that either some modification in the prescribed method should be made or a complete departure from the method of valuation should be taken. When departing from the annuity tables, however, the plaintiff bears a substantial burden of demonstrating that: (1) the value ascribed by the tables is unrealistic and unreasonable, and (2) there is a more reasonable and realistic means by which to determine fair market value. The District Court then held that Negron had demonstrated that the value ascribed by the annuity was unrealistic and unreasonable, but that expert testimony was needed to determine the more reasonable means of calculating the fair market value. This holding allowed the District Court to grant a portion of the estate s Summary Judgment Motion. Before the District Court determined the reasonable means of calculating the value of the annuity, the Service appealed the decision that the annuity tables resulted in an unreasonable and unrealistic value. That appeal was heard by the Sixth Circuit Court of Appeals. Sixth Circuit Ruling: The Sixth Circuit began with a summary of the District Court s ruling, noting that Negron argues that it is unreasonable that the estates should be taxed on a distribution amount in excess of what was actually received. The different results were due to the different discount rates used by the Ohio Lottery Commission and the Service. Ohio approximated the value of the unpaid annuity as if it had been a lump sum from the beginning and the Service valued the annuities as an ongoing annuity or a continuing stream of periodic payments. The Sixth Circuit then said that despite the differences in discount rates and resulting calculations, the IRC and Treasury Regulations provide a reasonable and proper framework for calculating federal tax liability. Under Treas. Reg (b), the decedent has a right to receive an annuity if, immediately before death, she had an enforceable right to receive payments in the future. The fair market value of annuities is the present value of such annuities, determined using the standard IRS annuity tables in Treas. Reg (d), if the valuation date is after April 30, However, (b)(1)(ii) (iii) states that if the interest rate and mortality components of the table do not apply when valuing a particular annuity, then the fair market value of this other beneficial interest should be calculated based on all of the facts and circumstances. It is this language that gave rise to the District Court s decision in this case and that has given rise to a split among the Circuit Courts when they are asked to determine the fair market value of lottery payments. Page 4 of 12. Not valid without all pages.

5 In order to explain the legal history of its decision, the Sixth Circuit gave a quick review of the split between the Circuit Courts. The Ninth Circuit, first to address the issue, reasoned that the right to transfer is one of the most essential sticks in the bundle of property rights and that the statutory restrictions on transfer reduced the fair market value of the right to receive future lottery payments. The Ninth Circuit found that the IRS annuity tables did not accurately reflect the economic realty and reached an alternative determination of fair market value. The Second Circuit agreed with the Ninth Circuit s reasoning that the transfer restrictions reduced fair market value. The Fifth Circuit disagreed with the Second and Ninth Circuits that marketability restrictions should be considered when valuing a lottery prize. The Fifth Circuit reasoned that the IRS annuity tables did not produce unreasonable results because the non-marketability of a private annuity is an assumption underlying the annuity tables. A District Court in New Hampshire also declined to follow the Second and Ninth Circuits, finding instead that the IRS annuity tables produced a reasonable valuation of remaining lottery payments. In this case, the Sixth Circuit found that the overarching goal of the tax code is to impose a tax on the value of all of the decedent s property, to the extent of the decedent s interest, at the time of death. The Treasury Regulations generally provide that the value of every item of property is its fair market value and that the fair market value of an annuity is its present value using the IRS annuity tables. Given this finding, the Sixth Circuit ruled that the IRS properly used the annuity tables to value the remaining lottery payments for estate tax purposes. Material Misrepresentation Justifies Rescission of Life Insurance AMERICAN GENERAL LIFE INSURANCE CO V. SCHOENTHAL FAMILY LLC ET AL, NO (U.S. COURT OF APPEALS ELEVENTH CIRCUIT) Facts: Samuel Schoenthal applied for a policy of life insurance from American General in conjunction with his participation in the Liberty Premium Finance Program. The various entities that comprised the finance program worked together to finance a high-value life insurance policy that Schoenthal would have been otherwise unable to afford. In exchange, the entities reserved for themselves the vast majority of the expected payout of the policy. HK Ventures, Inc., an independent contractor that sold American General life insurance policies, learned that Schoenthal was looking to purchase life insurance. The president of HK Ventures discussed Schoenthal s financial condition with him and witnessed Schoenthal s signing of the application. On September 7, 2004, Schoenthal submitted an application to American General, on which he listed his net worth as $10,700,000 and his annual income as $150,000+. The Schoenthal Family LLC was named as the owner and beneficiary of the policy and the premium payor. American General approved the application and issued a policy in the amount of $7,000,000. Immediately after the policy was issued it was assigned to Liberty One Funding Trust. After Schoenthal died in July 2005, American General conducted a contestable claim investigation. The investigation revealed that Schoenthal s net worth was $160,000 and his annual income was approximately $7,200. The conclusion of American General s contestability review of the Schoenthal policy was that based upon the income and net worth figures developed in the investigation, American General would have declined to issue the $7,000,000 policy. Page 5 of 12. Not valid without all pages.

6 On March 24, 2006, American General denied the claim on Schoenthal s policy, filed a complaint with the District Court to rescind the policy and asked the Court for permission to return the premiums it had received under the policy. The District Court ruled in favor of American General, granting its Motion for Summary Judgment. The Schoenthal Family LLC and Liberty One Funding Trust (the Beneficiaries ) appealed the District Court s decision to exclude the testimony of their expert witness, to allow the testimony of American General s expert witness, and the Court s grant of Summary Judgment in favor of American General. Ruling: In the appeal, the Beneficiaries contended that the District Court abused its discretion when it admitted American General s expert s testimony regarding general insurance industry financial underwriting standards and risk management issues because the expert was unqualified and his testimony was unreliable and contradictory. The Appeals Court found that based on the record, the District Court did not abuse its discretion when it concluded that American General s expert s lengthy experience qualified him to testify and that the expert s testimony was reliable. As for the Beneficiaries expert, the District Court held that his expert testimony would not create a genuine question of material fact about the materiality of Schoenthal s misrepresentations. The Appeals Court stated that the test for materiality under Georgia law is the objective standard of conduct of a prudent insurer and that the Beneficiaries failed to explain how their expert s testimony would create a genuine question of material fact about that issue. Based on the record and Georgia law, the Appeals Court concluded that the district court did not abuse its discretion in allowing American General s expert s testimony and excluding the Beneficiaries expert s testimony. The Beneficiaries argued that the District Court erred when it granted Summary Judgment in favor of American General for three reasons: (i) determining the materiality of Schoenthal s misrepresentations required that the District Court consider the actual conduct of American General when it approved the Schoenthal policy; (ii) genuine questions of material fact exist about the materiality of Schoenthal s misrepresentations; and (iii) the policy issued by American General requires for rescission actual reliance by the insurer on a material misrepresentation by the insured. The Appeals Court held that all three of the Beneficiaries arguments failed. The Appeals Court upheld the District Court s grant of Summary Judgment in favor of American General, allowing American General to rescind the Schoenthal policy because of the material misrepresentations on Schoenthal s application. Termination of Life Insurance Policy Triggers Taxable Income KENNETH F. REINERT V. CIR, T.C. SUMMARY OPINION Facts: On July 17, 1958, Reinert ( Taxpayer ) purchased a life insurance policy from Northwestern Mutual Life Insurance Co. ( Northwestern ). The face amount of the policy was $10,000 and the $52.40 premium was payable every 4 months until July 17, 2035, or until petitioner s 65th birthday, at which time the policy would be fully paid. In 2005, when the cash value of the policy was $29,933.78, the outstanding loan balance against the cash value was $28,492.40, and the total premiums paid totaled $8, Northwestern treated the interest on the loans, under the terms of the policy, as additional loans against the cash value of the policy. Page 6 of 12. Not valid without all pages.

7 The terms of the policy also stipulated that if the indebtedness equals or exceeds the cash value at any time, the policy will terminate thirty-one days after a notice of termination has been mailed to the last known address of the policy owner. At the end of December 2004, Northwestern sent the Taxpayer a notice that the loan amount would soon exceed the cash value and the policy would terminate. The notice also advised that termination would trigger a taxable event and would result in reportable ordinary income. Taxpayer, who believed that termination of the policy was not a taxable event while surrender of the policy was, did not pay down the outstanding loan against his policy. On February 21, 2005, Taxpayer received from Northwestern a form entitled Surrender of Policy for Cash Value along with a $1, check representing the residual cash value after repaying the loan balance. Taxpayer signed the form and endorsed and cashed the check. In January 2006, the Taxpayer received a Form 1099-R for his 2005 tax year from Northwestern reflecting a gross distribution of $29, and a taxable amount of $21, Taxpayer did not report this amount as taxable income on his 2005 tax return and the IRS determined a $5,368 income tax deficiency and a $1,074 accuracy-related penalty under 6662(a). The Tax Court, in an opinion under 7463(b), which established that the opinion cannot be treated as precedent, was asked to determine whether the $21, that the Taxpayer received is taxable income due to the termination of his life insurance policy and whether Taxpayer is liable for an accuracy-related penalty under 6662(a). Ruling: The Tax Court reviewed sections 72(e)(1)(A)(i), (5)(A) and (5)(C), which generally provide that an amount received in connection with a life insurance contract, which is not received as an annuity, constitutes gross income to the extent that the amount received exceeds the investment in the contract. Section 72(e) causes the increases in value of insurance contracts to be taxable when the policy ends prior to the payment of an annuity. This situation is one that permits the deferral of the reporting of income until a triggering event. In that light, the Tax Court, noting that this case was substantially similar to the circumstances in Atwood v. CIR, T.C. Memo , states that it could not see a distinction between the termination and the surrender of an insurance policy for purposes of the recognition of gain under 72(e). The Tax Court stated that the controlling fact was that the policy had been terminated and no contractual relationship continued between the Taxpayer and Northwestern. Accordingly, the Tax Court held that the Taxpayer had $21, of taxable income as determined by the Service. The Tax Court then addressed whether the Taxpayer was liable for an accuracy-related penalty under 6662(a) on the underpayment of his 2005 income taxes. Section 6662(a) imposes a 20% penalty on the portion of an underpayment of tax attributable to a substantial understatement of income tax, which is defined by 6662(d)(1)(A) as an understatement that exceeds the greater of 10% of the tax required to be shown or $5,000. Taxpayer reported $2,853 of tax and as a result, his tax was understated by $5,368, an amount that is more than 10% of the tax required and more than $5,000. Therefore, the Tax Court held that the Taxpayer is liable for the accuracy-related penalty. Update for Actuarial Tables under Section 7520 NOTICE : IRB (2/11/09) In Treasury Decision 8886 (T.D. 8886), the Service prescribed the tables needed for valuations of annuities, terms certain, reversions and remainders after April 30, This Treasury Decision contains regulations Page 7 of 12. Not valid without all pages.

8 under 664, 2031, and 7520 and provides actuarial tables with interest rates required for the valuation computations. Those interest rates are 120% of the mid-term Applicable Federal Rate for the month of valuation. The tables prescribed in T.D have interest rates that start at 4.2%; however, recently 120% of the mid-term applicable rate fell below 2.2% and none of the T.D tables provides factors for interest rates below 2.2%. As a result, the Service released Notice , which provides extensions to the existing valuation tables for interest rates below 2.2%. PLR Shared Premiums Okay in Grandfathered Private Split Dollar Facts: Taxpayer created two irrevocable trusts ( Trust A and Trust B ), both designed to benefit Taxpayer s Spouse and children. The trustees of Trusts A and B have purchased a single-life insurance policy on the life of the Taxpayer and have entered into an agreement ( Agreement ) to share ownership of the policy. Under the Agreement, Trust A will pay annually the portion of the required premium equal to the Computer Term Cost of the policy (defined as the amount at risk or the difference between policy cash value and aggregate death benefit) and Trust B will pay the balance of the premium. On the Taxpayer s death, Trust B is to receive a portion of the death benefit equal to Trust B s share of the Policy Account and Trust A is to receive the balance of the death benefit. The Policy Account is the sum of all premiums paid by the trusts plus all earnings credited to the policy, less any charges made against the account, including withdrawals from the policy. If the Agreement is terminated during the Taxpayer s life, Trust B has the option to require Trust A to surrender its interest in the policy so that Trust B becomes the sole owner of the policy. If Trust B does not exercise its option, then Trust A has the same option to take sole ownership of the policy. If neither trust exercises its option, then the policy s cash values are split in proportion to each Trust s respective share of the Policy Account. Both trustees hold all ownership interests in the policy and the mutual consent of both trustees is required to exercise those ownership interests. The Taxpayer has requested the following rulings: (1) the allocation of policy costs and benefits between Trust A and Trust B, pursuant to the Agreement, will not result in any imputed transfers between Trust A and Trust B that would constitute indirect gifts by the trust beneficiaries for federal gift tax purposes; and (2) the insurance proceeds payable to Trusts A and B will not be includible in the gross estate of the Taxpayer under Ruling: The Service first held that the taxation of the split-dollar life insurance agreement between Trust A and Trust B is not subject to (d) through (g) and because the Agreement was entered into on or before September 17, 2003, and has not been materially modified after that date. Therefore, taxation of the Agreement is determined under prior law. In this case, the Agreement was executed on Date X, and has not been modified. Accordingly, the rules promulgated in T.D do not apply with respect to the Agreement. Under the Agreement, the Service concluded that the payment of premiums each year by Trust A and Trust B pursuant to the terms of the Agreement, does not result in a transfer between Trust A and Trust B that would result in a gift subject to gift tax, by the trust beneficiaries under 2511, provided that the amounts paid by Trust A for the life insurance benefit that the trust received under the Agreement was at least equal to the amount prescribed under Rev. Rul and Notice Page 8 of 12. Not valid without all pages.

9 The Service then concluded that in this case, the Taxpayer does not possess any incidents of ownership in the policy under the terms of the Agreement, as described, or under the terms of Trust A or Trust B. Accordingly, the portion of the proceeds of the policy payable to Trust A and Trust B will not be includable in the gross estate of the Taxpayer. The Service specifically did not express an opinion regarding any gift tax consequences if Trust B borrows against the cash surrender value of the policy or the cash surrender value is utilized to pay any portion of the premium. PLR Members of Charity-Owned LLC Can Participate in 403(b) Plan Facts: Employer is a multi-facility health system providing medical and optical services to the general public in State. Employer is an organization described in 501(c)(3) which is exempt from tax under 501(a). Company is a single member limited liability company ( LLC ) organized under the laws of State. Employer formally owned X% of Company and unrelated optometrists owned Y%. On December 31, 2003, Employer purchased the remaining Y% interest from the unrelated individuals thereby converting Company into a single member LLC. Company is currently a disregarded entity for federal tax purposes pursuant to the default classification rules of (b). Employer sponsors Plan for the benefit of its employees; Plan is intended to meet all the requirements of an annuity purchase plan under 403(b) of the Code. Employees of Employer are currently eligible to make contributions pursuant to salary reduction agreements under Plan. Employer proposes to extend participation in Plan to employees of Company on the same basis as employees of Employer. Under 403(b)(1)(A)(i), participation in the Plan is conditioned on employment by an organization described in 501(c)(3) that is exempt from tax under 501(a). Employer has presented that Company is an entity whose status is disregarded from an organization described in 501(c)(3) that is exempt from tax under 501(a). Company itself is not an organization described in 501(c)(3) that is exempt from tax under 501(a). Employer plans to have Company adopt Plan and permit employees of Company to participate in Plan subject to the terms and conditions of Plan. A ruling is requested that for purposes of 403(b), employees of Company will be treated as employed by Employer, which is the sole member of Company, and will be eligible to participate in Plan. Ruling: The Service concluded that since Company has not filed Form 8832, making an election to be classified as an association under the rules of (a), it is disregarded for federal tax purposes pursuant to the default classification rules under (b). Company also has not filed Form 1023 seeking a determination letter of tax-exempt status. Thus, for purposes of , Company is treated in the same manner as a sole proprietorship, brand or division of its owner, Employer. Therefore, the employees of Company will be treated as employees of Employer for purposes of 403(b). Accordingly, the Service held that for purposes of the requirements of 403(b), employees of Company will be treated as employed by Employer and eligible to participate in Plan. Page 9 of 12. Not valid without all pages.

10 PLR Business Recapitalization Triggers 2701 Facts: Taxpayer and his brother each received gifts of stock from their parents between Year 1 and Year 2. In Year 3 (prior to 1990), Taxpayer s parents exchanged their remaining shares of common stock for preferred stock. Taxpayer and his brother each inherited 50% of their parent s preferred stock. On Date 1, Taxpayer and his brother each exchanged X shares of common voting stock for Y non-cumulative preferred shares of stock. After the transaction, Taxpayer and his brother each controlled 50% of Corporation s common voting stock. Taxpayer and Spouse failed to report the exchange of voting stock for non-cumulative preferred stock on their Date 1 gift tax returns and as a result no elections were made pursuant to (c)(2) to treat the distribution right in the preferred stock as a qualified distribution right. On Date 2, Taxpayer s accounting firm and estate planning attorney were informed of the exchange of voting stock for non-cumulative preferred stock and determined that the transaction was subject to 2701 and should have been reported on the Date 1 gift tax returns. Taxpayer and his spouse intend to file amended Date 1 gift tax returns, reporting the exchange of voting stock for non-cumulative preferred stock and electing, under (c)(2), to treat the distribution right in the preferred stock as a qualified payment right. Taxpayer has requested a ruling that the elections attached to the amended Date 1 gift tax returns will satisfy the requirements of (c)(2) and, as such, will be a valid election under 2701(c)(3). Ruling: Section 2701 applies when two tests are met: (i) an interest in a corporation or partnership is transferred to or for the benefit of individuals in the same or lower generation as the transferor, and (ii) a specified interest in the corporation or partnership is retained by individuals in the same or higher generation as the transferor. If 2701 applies to the transaction, the 2701(a)(3)(A) provides that the value of a distribution right is zero unless the distribution right consisted of a right to receive a qualified payment. A qualified payment right is a right to receive a distribution that is a dividend payable on a periodic basis (at least annually) under any cumulative preferred stock. A qualified payment right is valued without the application of 2701, so it has a value other than zero. A transferor (such as the Taxpayer whose distribution right was non-cumulative) may elect to treat his or her distribution right as a qualified payment by electing under (c)(2) to treat the distribution right as a qualified payment. This election has to be made on the gift tax return reporting the transfer. Since the Taxpayer and his Spouse did not report the transfer on their Date 1 gift tax returns, the Service held that they could amend the Date 1 gift tax returns and make the election under (c)(2). In addition, the Service held that the election under (c)(2) would be a valid election, meaning that the distribution rights would not have to be valid at zero as required by Page 10 of 12. Not valid without all pages.

11 NEW IN 2009: CASE-IN-POINT Our new monthly Case-In-Point section will bring you actual, recent Advanced Markets cases. Check in each month for examples of the ways that our team s focus on client and advisor concerns, case design expertise, consultation process and software capability translate into real-life solutions. Initial Call to Advanced Markets: October 2007 CLIENT PROFILE Status: Married Couple: Male, Age 54, Preferred Non Smoker and Female, Age 53, Super Preferred Non Smoker. Two children. Net Worth: $35,000,000 of which securities represented 75%. Current Lifetime Giving Plan: Gift tax-free annual exclusions were already being used in other planning and $1M of the couple s $2M lifetime gift tax exemption was available for future planning. Need: Additional $15M survivorship life insurance for estate liquidity. Client Concerns: Keep current planning in place and do additional planning without incurring any gift taxes. Most importantly, the couple did not want to commit to a long-term funding arrangement. SOLUTION Joseph Scianna, Advanced Markets Senior Consultant, designed several scenarios. The clients, with the help of their insurance advisor and the client s advisory team, preferred the scenario which illustrated a lumpsum privately financed note made to an irrevocable life insurance trust, from which insurance payments would be made. 1 The lump sum was calculated to take into account the amount needed to repay the note in year 13, after 10 years of premium payments. Joe, with the help of the Advanced Markets proprietary JH Solutions software, calculated that it would take a $3,000,000 lump sum of cash made to the trust to fund the 10 annual premiums of $150,000 for 9 years on a John Hancock Survivorship UL policy (05PROSULG), following a first-year premium gift of $1,000,000, the clients joint remaining lifetime exemption. This $3,000,000 figure was based on an assumed 7.8% trust side fund that would accumulate to repay the loan principal, including accrued interest payments, in year 13. The privately financed note was established as a long-term note subject to the then applicable federal rate of 4.4% of interest. Clients expressed concern that the side-fund rate assumption of 7.8% might be too high. Joe then provided two what if scenarios to illustrate the shortfall in loan repayment if the side-fund earned only 5%, as well as refinancing the note in year 13 at the lower assumed side fund rate. Although there would be sufficient funds to pay the premiums over the 10-year period at the 5% assumed side-fund scenario, there would not be sufficient assets to repay the loan in year 13 under the 5% return assumption. Joe was able to alleviate these concerns by then illustrating the feasibility of refinancing the note, if necessary, under a 30-year note arrangement that utilized the trust side fund to pay loan interest annually, with a loan principal repayment from death proceeds. Case Closed: April Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including the generation-skipping transfer tax). Failure to do so could result in adverse tax treatments of trust proceeds. Insurance data is taken from an illustration. Non-insurance data is taken from a hypothetical calculation. It assumes a hypothetical rate of return and may not be used to project or predict investment results. Page 11 of 12. Not valid without all pages.

12 ONE YEAR LIBOR RATE As of February 18, 2009: 2.09% IRC SECTION 7520 RATE February % January % December % The 7520 rate is used to value GRITs, QPRTs, CRATs, CLUTs, CLATs, private annuities, life interest, remainder and reversionary interests. To value a charitable gift for income, gift, or estate tax charitable deduction purposes, use either the rate for the month of the actual gift/transfer or the rate from either of the two previous months (use the highest of the three months for the largest charitable deduction). APPLICABLE FEDERAL RATES FEBRUARY Annual Semi Annual Quarterly Monthly Short-term AFRs loans (3 years or less) 0.60%.60%.60%.60% Mid-term AFR (More than 3 years up to and including 9 years) 1.65% 1.64% 1.64% 1.63% Long-term AFRs (More than 9 years) 2.96% 2.94% 2.93% 2.92% REMINDER: Electronic Distribution of Advanced Markets Group Materials is Available. Central Intelligence and its companion piece, Sales Strategy, are printed on a quarterly basis. If you d like to receive Central Intelligence on a monthly basis, it is available by . To receive the monthly edition of Central Intelligence, please send a request to advancedmarkets@jhancock.com. In addition, monthly editions of Central Intelligence and Sales Strategy are available on our website at The Advanced Markets Group also sends a monthly electronic newsletter which features a popular estate or business planning concept. To be included on this distribution list, please send an to advancedmarkets@jhancock.com. Central Intelligence is produced by John Hancock s Advanced Markets Group. We can be reached at (888) , option 3 or option 4; 197 Clarendon Street, C-07-01, Boston, MA 02116; Guaranteed product features are dependent upon minimum premium requirements and the claims paying ability of the issuer. Insurance policies and/or associated riders and features may not be available in all states. This material does not constitute tax, legal or accounting advice and neither John Hancock nor any of its agents, employees or registered representatives are in the business of offering such advice. It was not intended or written for use and cannot be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Comments on taxation are based on John Hancock s understanding of current tax law, which is subject to change. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisors. Central Intelligence is a summary of information. It is not a promotion of any strategy discussed herein. PLRs are merely an IRS interpretation of law and are only binding upon the taxpayers to whom they are issued. Insurance products are issued by John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in New York) and John Hancock Life Insurance Company of New York, Valhalla, NY John Hancock. All rights reserved. IM /09 MLINY Page 12 of 12. Not valid without all pages.