TWO-LIFE ANNUITY INTEREST IN GRAT IS QUALIFIED INTEREST.

Rachel Wollitzer, Attorney, Tax Division, Department of Justice, Washington, D.C., for the respondent-appellee.

Ellen K. Harrison, Amicus Curiae The American College of Trust and Estate Counsel.

[1] Stephen C. Schott and Patricia A. Schott petition for review of a judgment of the Tax Court sustaining a deficiency in gift tax assessed by the Commissioner of Internal Revenue (the Commissioner). The question presented is whether the two-life annuity retained by the Schotts in their grantor-retained annuity trusts (GRATs) is an interest qualified under 26 U.S.C. § 2702 and so to be subtracted from the value of the gift. We hold that the interest does qualify under Treasury Regulations § 25.2702 and so reverse the Tax Court.

[3] On May 31, 1994, Stephen C. Schott, aged fifty-five, transferred 11,400 shares of nonvoting common stock of SCS Development to himself as trustee of the Stephen C. Schott Qualified Annuity Trust, also a GRAT. The terms of the annuity payments in the trust in material respects were identical with those of the trust established by his wife. For the Stephen C. Schott Trust, if the grantor survived the fifteen-year term, the assets remaining in the GRAT would be held in trust for the grantor's spouse, if then living, or otherwise for the grantor's descendants. For the Patricia A. Schott Trust, if the grantor survived the fifteen-year term, the assets remaining in the GRAT would be held in trust for the grantor's descendants.

[4] The Schotts each filed gift tax returns for 1994, showing the fair market value of the transfer to each trust as $4,046.197, the value of each two-life annuity created as $4,010,238 to be subtracted from the total transferred, leaving two taxable gifts of $35,959. The Commissioner found the annuities not to be qualified and assessed gift tax deficiencies of $126,680 against Patricia A. Schott and of $137,953 against Stephen C. Schott.

[6] The Schotts petition this court for review.

[10] The Commissioner argues that the Schott spouses have contingent and therefore unqualified interests, but that the provision in Example 7 that the spouse be living does not make that gift "contingent" and therefore unqualified. The distinction is not apparent. Neither the statute nor the regulations exclude contingent interests as such. Every annuity given to a person, if living, is contingent on that person's survival: yet life annuities as such are not excluded by the statute or the regulations.

[11] The Commissioner argues that the date when the spouse's interest begins is not fixed because that date depends on the grantor's death. This argument merely restates an unfounded objection to life annuities. As the end of the grantor's life can be ascertained with acceptable probability by an annuity table, so can the date and duration of the spouse's annuity be ascertained with acceptable probability.

[12] The Commissioner points to Treas. Reg. § 25.2702- 3(d)(3) that states: "The term must be for the life of the term holder, for a specified term of years, or for the shorter (but not the longer) of those periods." The Commissioner argues that as "term holder" is in the singular, the use of the lives of two term holders is excluded. But singulars normally include plurals, just as "he" normally includes "she." See, for example, 1 U.S.C. § 1; Treas. Reg. § 403.5.

[13] The Commissioner cites Cook v. Commissioner, 269 F.3d 854, 858 (7th Cir. 2001). Cook did treat an annuity to a grantor and spouse, if living, as unqualified; but there was an additional contingency in the trust, which could not be ascertained by any annuity table. The contingency was that the grantor and spouse be married at the time the spouse's annuity began. This contingency is different from the contingency necessarily built into interests dependent on a life.

[14] The Commissioner contends that his position is not contrary to Walton, 115 T.C. at 603-04. That decision held an annuity to be qualified when it was in trust to the grantor for two years or until she died, whichever came first, the rest of the annuity in event of her death to her estate; the remainder to designated beneficiaries. The Commissioner contended that the interest of her estate was contingent and therefore unqualified; the Commissioner relied on Treas. Reg. § 25.2702-3(e) Example 5 for his position. The Example reads as follows:

[15] We need not go as far as the Tax Court to hold a regulation unreasonable and invalid. We hold only that the Commissioner's interpretation of Example 7 to exclude the contingency of the spouse being alive at the time her annuity begins is unreasonable and invalid. The annuity created by each Schott trust for the lives of the grantor and spouse or fifteen years is as qualified as the annuity in Example 7 paying a fixed amount for ten years to the grantor, then to the spouse if living. As the Tax Court pointed out, "the principal objective of section 2702 was to prevent undervaluation of gifted interests." Id. at 600. A two-life annuity, based on the lives of the grantor and spouse with a limit of fifteen years, falls "within the class of easily valued rights" that Congress meant to qualify. See id.

[16] The judgment of the Tax Court is accordingly REVERSED, and the case is REMANDED for entry of judgment for the Schotts.