[Federal Register Volume 59, Number 111 (Friday, June 10, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-12295]


[[Page Unknown]]

[Federal Register: June 10, 1994]


DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 20, and 25

[PS-26-93]
RIN 1545-AR56

 

Actuarial Tables Exceptions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

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.
    (C) An ordinary remainder or reversionary interest is the right to 
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 
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.
    (C) An ordinary remainder or reversionary interest is the right to 
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 any 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 4 in Sec. 20.7520-3(b)(2)(iv) and Example 2 
in Sec. 20.7520-3(b)(4), which illustrate situations where special 
section 7520 actuarial factors are needed to take into account 
limitations on beneficial interests. See Sec. 20.7520-1(c) for 
requesting a special factor from the Internal Revenue Service.
    (iii) Other beneficial interests. If, under the provisions of 
Sec. 20.7520-3(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 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 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. 20.7520-1 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 without the 
consent of the income beneficiary during the income beneficiary's term 
of enjoyment and without 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 of this chapter (Income Tax Regulations).
    (v) Examples. The provisions of this paragraph (b)(2) are 
illustrated by the following examples:

    Example 1.--Unproductive property. The decedent's will provides 
for a bequest of corporation stock to a trust under the terms of 
which all of the trust income is payable to the decedent's child for 
life. After the death of the life income beneficiary, the trust is 
to terminate and the trust property is to be distributed to the 
decedent's grandchild. The trust specifically authorizes, but does 
not require, the trustee to retain the shares of stock. 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 an adequately sound growth 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 increase commensurately each year. The facts and circumstances, 
including applicable state law, indicate that the life income 
beneficiary would not be able to compel the trustee to make the 
trust corpus productive in conformity with the requirements for a 
lifetime trust income interest under applicable local law. 
Therefore, the life income interest in this case is considered 
nonproductive. Consequently, the income interest may not be valued 
actuarially under this section.
    Example 2.--Beneficiary's right to make trust productive. The 
facts are the same as in Example 1, except that the trustee is not 
specifically authorized to retain the shares of stock. Further, the 
terms of the trust specifically provide that the life income 
beneficiary may require the trustee to make the trust corpus 
productive consistent with income yield standards for trusts under 
applicable state law. Under that law, the minimum rate of income 
that a productive trust may produce is substantially below the 
section 7520 interest rate for the month of the decedent's death. In 
this case, because the income beneficiary has the right to compel 
the trustee to make the trust productive for purposes of applicable 
local law during the beneficiary's lifetime, the income interest is 
considered an ordinary income interest for purposes of this 
paragraph, and the standard section 7520 life income interest factor 
may be used to determine the present value of the income interest.
    Example 3.--Discretionary invasion of corpus. The decedent 
transfers property to a trust under the terms of which all of the 
trust income is to be paid to the decedent's child for life and the 
remainder of the trust is to be distributed to a grandchild. The 
trust authorizes the trustee without restriction to distribute 
corpus to the decedent's surviving spouse for the spouse's comfort 
and happiness. In this case, because the trustee's power to invade 
trust corpus is unrestricted, the exercise of the power could result 
in the termination of the income interest at any time. Consequently, 
the income interest is not considered an ordinary income interest 
for purposes of this paragraph, and may not be valued actuarially 
under this section.
    Example 4.--Limited invasion of corpus. The decedent bequeaths 
property to a trust under the terms of which all of the trust income 
is to be paid to the decedent's child for life and the remainder is 
to be distributed to the decedent's grandchild. The trust authorizes 
the child to withdraw up to $5,000 per year from the trust corpus. 
In this case, the child's power to invade trust corpus is limited to 
an ascertainable amount each year. Annual invasions of any amount 
would be expected to progressively diminish the property from which 
the child's income is paid. Consequently, the income interest is not 
considered an ordinary income interest for purposes of this 
paragraph, and the standard section 7520 income interest factor may 
not be used to determine the present value of the income interest. 
Nevertheless, the present value of the child's income interest is 
ascertainable by making a special actuarial calculation that would 
take into account not only the initial value of the trust corpus, 
the section 7520 interest rate for the month of the transfer, and 
the mortality component for the child's age, but also the assumption 
that the trust corpus will decline at the rate of $5,000 each year 
during the child's lifetime. The child's right to receive an amount 
not in excess of $5,000 per year may be separately valued in this 
instance and, assuming the trust corpus would not exhaust before the 
child would attain age 110, would be considered an ordinary annuity 
interest.
    Example 5.--Power to consume. The decedent devises a life estate 
in 3 parcels of real estate to the surviving spouse with the 
remainder to a child. The decedent also confers upon the spouse an 
unrestricted power to consume the property, which includes the right 
to sell part or all of the property and to use the proceeds for the 
spouse's support, comfort, happiness, and other purposes. Any 
portion of the property or its sale proceeds remaining at the death 
of the surviving spouse is to vest by operation of law in the child 
at that time. In this case, the surviving spouse's power to consume 
the corpus is unrestricted, and the exercise of the power could 
entirely exhaust the remainder interest during the life of the 
spouse. Consequently, the remainder interest is not considered an 
ordinary remainder interest for purposes of this paragraph and may 
not be valued actuarially under this section.

    (3) Mortality component--(i) Terminal illness cases. Except as 
provided in paragraph (b)(3)(ii) of this section, 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 dies 
or is terminally ill at the time of the decedent's death. 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.
    (ii) Exceptions. If, in the case of the allowance of the credit for 
tax on a prior transfer under section 2013, the tax in the transferor's 
estate was finally determined without regard to the fact that one or 
more measuring lives were terminally ill at the time of the 
transferor's death, the value of any transferred interest dependent on 
any of those lives shall be determined for purposes of section 2013 
without regard to the fact that those measuring lives were terminally 
ill. In addition, the value of a decedent's reversionary interest under 
section 2037(b) or 2042(2) shall be determined without regard to the 
physical condition of the decedent immediately before death.
    (4) Examples. The provisions of paragraph (b)(3) of this section 
are illustrated by the following examples:

    Example 1.--Simultaneous deaths. The decedent's will establishes 
a trust to pay income to the decedent's surviving spouse for life. 
The will provides that, upon the spouse's death, or if the spouse 
fails to survive the decedent, the trust property is to pass to the 
decedent's children. The decedent and the decedent's spouse die 
simultaneously in an accident under circumstances in which it was 
impossible to determine who survived the other. Applicable state law 
presumes that the decedent died first with the result that the 
property interest is considered to have passed in trust for the 
benefit of the spouse for life, after which the remainder is to be 
distributed to the decedent's children. Therefore, the spouse's life 
income interest may not be valued under this section.
    Example 2.--Terminal illness. The decedent bequeaths $1,000,000 
to a trust under the terms of which the trustee is to pay $103,000 
per year to a charitable organization during the life of the 
decedent's child. Upon the death of the child, the remainder in the 
trust is to be distributed to the decedent's grandchild. The child, 
who is age 60, has been diagnosed with an incurable illness, and 
there is at least a 50 percent probability of the child dying within 
1 year. The section 7520 interest rate for the month of the 
decedent's death is 10.6 percent. The standard life annuity factor 
for a person age 60 (7.4230) may not be used to determine the 
present value of the charitable organization's annuity interest 
because there is at least a 50 percent probability that the 
measuring life will die within 1 year. Instead, a special section 
7520 annuity factor must be computed that takes into account the 
projection of the child'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 this paragraph (b) are 
effective with respect to estates of decedents dying after the date 
these regulations are published as final regulations in the Federal 
Register.

PART 25--GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954

    Par. 5. The authority citation for part 25 continues to read in 
part as follows:

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

    Par. 6. Section 25.7520-3 is amended by adding the text of 
paragraph (b) to read as follows:


Sec. 25.7520-3  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. However, 
in the case of certain gifts made after October 8, 1990, if the donor 
does not retain a qualified annuity, unitrust, or reversionary 
interest, the value of any interest retained by the donor is considered 
to be zero if the remainder beneficiary is a member of the donor's 
family. See Sec. 25.2702-2.
    (C) An ordinary remainder or reversionary interest is the right to 
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 any 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 Examples 3, 4, and 5 in Sec. 25.7520-3(b)(2)(iv) and 
the Example in Sec. 25.7520-3(b)(4), which illustrate situations in 
which special section 7520 actuarial factors are needed to take into 
account limitations on beneficial interests. See Sec. 25.7520-1(c) for 
requesting a special factor from the Internal Revenue Service.
    (iii) Other beneficial interests. If, under the provisions of 
Sec. 25.7520-3(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 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. 25.7520-1 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 without the 
consent of the income beneficiary during the income beneficiary's term 
of enjoyment and without 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 of this chapter (Income Tax Regulations).
    (v) Examples. The provisions of this paragraph (b)(2) are 
illustrated by the following examples:

    Example 1.--Unproductive property. The donor transfers 
corporation stock to a trust under the terms of which all of the 
trust income is payable to a child for life. After the death of the 
life income beneficiary, the trust is to terminate and the trust 
property is to be distributed to a grandchild. The trust 
specifically authorizes, but does not require, the trustee to retain 
the shares of stock. 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 an adequately sound growth 
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 increase commensurately each year. 
The facts and circumstances, including applicable state law, 
indicate that the income beneficiary would not have the legal right 
to compel the trustee to make the trust corpus productive in 
conformity with the requirements for a lifetime trust income 
interest under applicable local law. Therefore, the life income 
interest in this case is considered nonproductive. Consequently, the 
income interest may not be valued actuarially under this section.
    Example 2.--Beneficiary's right to make trust productive. The 
facts are the same as in Example 1, except that the trustee is not 
specifically authorized to retain the shares of corporation stock. 
Further, the terms of the trust specifically provide that the life 
income beneficiary may require the trustee to make the trust corpus 
productive consistent with income yield standards for trusts under 
applicable state law. Under that law, the minimum rate of income 
that a productive trust may produce is substantially below the 
section 7520 interest rate on the valuation date. In this case, 
because the income beneficiary has the right to compel the trustee 
to make the trust productive for purposes of applicable local law 
during the beneficiary's lifetime, the income interest is considered 
an ordinary income interest for purposes of this paragraph, and the 
standard section 7520 life income factor may be used to determine 
the value of the income interest. However, in the case of gifts made 
after October 8, 1990, if the donor was the life income beneficiary, 
the value of the income interest would be considered to be zero in 
this situation. See Sec. 25.2702-2.
    Example 3.--Annuity trust funded with unproductive property. The 
donor, who is age 60, transfers corporation stock worth $1,000,000 
to a trust. The trust will pay a 6 percent ($60,000 per year) 
annuity in cash or other property to the donor for 10 years or until 
the donor's prior death. Upon the termination of the trust, the 
trust property is to be distributed to the donor's child. The 
section 7520 rate for the month of the transfer is 8.2 percent. The 
corporation has paid no dividends on the 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 
10-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 annuity beneficiary or the 
remainder beneficiary. The trust specifically authorizes, but does 
not require, the trustee to retain the shares of stock. 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 a 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 10 years or the prior death of a person age 60.
    Example 4.--Unitrust funded with unproductive property. The 
facts are the same as in Example 3, except that the donor has 
retained a unitrust interest equal to 7 percent of the value of the 
trust property, valued as of the beginning of each year. Although 
the trust corpus is nonincome producing, the present value of the 
donor's retained unitrust interest may be determined by using the 
section 7520 unitrust factor for a term of years or a prior death.
    Example 5.--Eroding corpus in an annuity trust. The donor, who 
is age 60 and in normal health, transfers property worth $1,000,000 
to a trust. The trust will pay a 10 percent ($100,000 per year) 
annuity to a charitable organization for the life of the donor, and 
the remainder is to be distributed to the donor's child. The section 
7520 rate for the month of the transfer is 6.8 percent. Because the 
10 percent annuity payout rate exceeds the 6.8 percent income and 
growth rate that the trust is expected to experience each year, the 
annuity payout must be assumed to progressively erode the corpus. 
Using an interest rate of 6.8 percent, an annuity payout of $100,000 
per year will exhaust a $1,000,000 trust corpus in 18 years. The 
final payment at the end of the 18th year will consist of a partial 
payment of $32,712. Under section 7520, the standard life annuity 
factors are based on the assumption that any person may survive 
until age 110. This means that the standard life annuity factor for 
age 60 (9.8585) takes into account the separate probabilities that a 
person age 60 may survive to receive each of 50 different annuity 
payments. However, in the present case, because of the eroding 
corpus, the person age 60 can be assumed to receive no more than 17 
$100,000 annuity payments, regardless of how long that person might 
survive. Therefore, the standard life annuity factor for a person 
age 60 (9.8585) is not applicable in this case, and special section 
7520 annuity factors that take into account the 18-year limitation 
on the annuity payout must be used. The special annuity factor for 
the present value of the right to receive $1.00 per year for 17 
years or until the prior death of a person age 60 is $8.6121, and 
the special factor for the present value of the right to receive 
$1.00 in 18 years if a person age 60 survives is $.1836. The present 
value of the charitable annuity interest is $867,269 ($100,000 X 
8.6121 plus $32,712 X .1836).

    (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 dies or is terminally ill at 
the time the gift is completed. 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) Example. The provisions of paragraph (b)(3) of this section are 
illustrated by the following example:

    Example.--Terminal illness. The donor transfers property worth 
$1,000,000 to a child in exchange for the child's promise to pay the 
donor $103,000 per year for the donor's life. The donor is age 60 
but has been diagnosed with an incurable illness and has at least a 
50 percent probability of dying within 1 year. The section 7520 
interest rate for the month of the transfer is 10.6 percent, and the 
standard annuity factor at that interest rate for a person age 60 in 
normal health is 7.4230. Thus, if the donor were not terminally ill, 
the present value of the annuity would be $764,569 ($103,000 X 
7.4230). Because there is at least a 50 percent probability that the 
donor will not survive for 1 more year, the standard section 7520 
annuity factor may not be used to determine the present value of the 
donor's annuity interest. Instead, a special section 7520 annuity 
factor must be computed that takes into account the projection of 
the donor'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 this paragraph are effective 
with respect to gifts made after [the date these regulations are 
published as final regulations in the Federal Register].
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-12295 Filed 6-9-94; 8:45 am]
BILLING CODE 4830-01-U