Tax Court Values Each Child's Gift at $35.1 Million After Early End of QTIP Trust

The U.S. Tax Court ruled on July 20 that two adult children made taxable gifts of about $35.1 million each when they agreed to wind up their late mother's marital trust and hand its assets to their father. The memorandum opinion in Lewis v. Commissioner and the companion McDougall case, T.C. Memo. 2026-58, landed between the IRS's claim of $53.4 million per child and the family's position that each gift was worth about $156,000, according to summaries by Current Federal Tax Developments and KPMG.

What happened

Clotilde McDougall died in December 2011. Her will created a residuary trust, holding mostly real estate business interests, that paid all of its income to her husband, Bruce, with principal available for his health and support. Bruce held a limited power to direct the remainder among her descendants at his death. If he did not use it, the assets would pass equally to the children. As personal representative, Bruce made a qualified terminable interest property election, which let the estate claim a marital deduction and defer transfer tax until the trust ended.

On October 31, 2016, the family signed a nonjudicial agreement ending the trust early. All of its assets, worth $117,604,143, went outright to Bruce, with no reserve for taxes. KPMG notes that he later sold portions to trusts for the children in exchange for promissory notes.

What the court decided

Ending a QTIP trust early triggers two sets of consequences. Under Section 2519, the surviving spouse is treated as making a gift of the remainder. Separately, the children who give up their remainder rights make gifts of their own. The dispute was over how to value the children's gifts.

• State law, not federal tables, controls. The court held that Washington law determines what the remainder interests were worth. The actuarial tables under Section 7520 may inform the analysis but are not binding.
• The unexercised power is ignored. Under state law a trustee would assume Bruce's power of appointment would not be used, so the remainders were valued as passing equally to the children.
• An avoided tax bill reduces the gift. Section 2207A normally gives a surviving spouse the right to recover gift tax on a Section 2519 transfer from the people who receive the property. By giving the assets to Bruce, the children escaped that reimbursement duty, and the court required their gifts to be reduced accordingly. It did so by dividing the pre-tax remainder value by 1.4, reflecting a 40% rate.
• No discount for health. The court refused to shorten Bruce's life expectancy by five years based on his $2.2 million of 2015 adjusted gross income and general claims of good health, without fuller actuarial evidence.

The IRS ultimately accepted a figure of $35,141,321 per child, derived from a remainder value of $49,197,850 divided by 1.4.

The after-tax math

The net-gift adjustment is the part of the ruling most likely to be cited in future planning. Example, illustrative round numbers: suppose a child's remainder interest is worth $14 million before tax considerations. If ending the trust relieves that child of a duty to reimburse gift tax on the spouse's deemed transfer, the court's approach would divide $14 million by 1.4, producing a taxable gift of $10 million. The $4 million difference represents the tax the child no longer has to fund.

Even with that reduction, a gift of this size would consume a large share of a person's lifetime exemption, and any excess would be taxed. That is why terminations of marital trusts are rarely tax-free for the next generation, even when the assets move to a parent rather than to the children.

Moves to discuss with your advisor

Families holding QTIP trusts sometimes consider commutations or early terminations to simplify administration, fund sales to grantor trusts or unlock illiquid assets. The ruling suggests several questions worth raising with an estate attorney: how the governing state's trust law would value each beneficiary's interest; whether the Section 2207A reimbursement right has been waived or preserved; how powers of appointment are treated on termination; and whether gift tax returns fully describe the transaction and valuation method. Actuarial assumptions about a spouse's health also need documentary support if they depart from standard tables.

What to watch

A memorandum opinion carries less precedential weight than a regular Tax Court opinion, and either side may appeal. Practitioners will be watching whether other courts adopt the state-law approach to valuing remainder interests and the 1.4 divisor for avoided reimbursement obligations, both of which could shape how families structure QTIP terminations going forward.

After TAX is an independent publication. Articles are general information, not tax, legal or investment advice. Consult a licensed professional about your situation.