[Federal Register Volume 60, Number 239 (Wednesday, December 13, 1995)]
[Rules and Regulations]
[Pages 63913-63922]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30272]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 20, and 25

[TD 8630]
RIN 1545-AR56


Actuarial Tables Exceptions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final income, estate, and gift tax 
regulations relating to exceptions to the use of the valuation tables 
in the regulations for valuing annuities, interests for life or a term 
of years, and remainder or reversionary interests, the valuation of 
which was the subject of final regulations published on June 10, 1994. 
These regulations are necessary in order to provide guidance consistent 
with court decisions concluding that the valuation tables are not to be 
used in certain situations.

EFFECTIVE DATE: These regulations are effective December 13, 1995.

FOR FURTHER INFORMATION CONTACT: William L. Blodgett, telephone (202) 
622-3090 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On June 10, 1994, the IRS published in the Federal Register (59 FR 
30100) final income tax regulations under sections 170, 642, 664 and 
7520 of the Internal Revenue Code (Code), and final estate and gift tax 
regulations under sections 2031, 2512 and 7520 of the Code providing 
actuarial tables to be used in valuing annuities, interests for life or 
a term of years, and remainder or reversionary interests under section 
7520. On June 10, 1994, the IRS also published in the Federal Register 
(59 FR 30180) proposed amendments to the income, estate, and gift tax 
regulations prescribing circumstances when the published actuarial 
tables cannot be used to value interests. This regulation finalizes 
those amendments.
    Written comments responding to the notice of proposed rulemaking 
were received. Requests for a public hearing were also received but 
were subsequently withdrawn. After consideration of all the comments 
received, those amendments are revised and adopted by this Treasury 
decision.

Explanation of Provisions

    Section 7520(a), which is effective for transfers 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. Section 7520(e) provides 
that, for purposes of section 7520, the term tables includes formulas. 
Section 7520(b) provides that section 7520 shall not apply for purposes 
of any provision specified in regulations. The Conference Report 
accompanying 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), states that section 7520 does not apply in ``situations specified 
in Treasury regulations.'' A summary of the principal comments received 
and revisions made in the final regulations in response to those 
comments is provided below.

1. Valuation of Annuities, Income Interests, etc.

    Under the proposed regulations, the tables cannot be used if the 
instrument of transfer does not provide the beneficiary of the annuity, 
income interest, or remainder interest with the degree of beneficial 
enjoyment that is consistent with the traditional character of that 
property interest under applicable local law. One comment letter 
suggested that, as a result of enactment of section 2702, it may no 
longer be necessary to prescribe special rules in the case of a trust 
corpus consisting of nonproductive property. It was decided to retain 
these rules because this issue will continue to arise in certain 
situations where section 2702 does not apply; e.g., the valuation of a 
gift of an income interest for purposes of determining the section 
2503(b) gift tax exclusion; the valuation of the bequest of an income 
interest for purposes of the section 2013 estate tax credit.
    In response to comments, the final regulations provide additional 
guidance for determining under what circumstances a life tenant or term 
certain beneficiary of tangible property possesses adequate beneficial 
use such that the tables would be used to value the interest.
    A number of comments were received on the valuation of an annuity 
that is payable from a trust corpus that will exhaust prior to the 
annuitant reaching the presumed terminal age prescribed by the tables 
(age 110). Under the proposed regulations, the interest would be 
valued, not as a right to receive the annuity for the life of the 
annuitant, but rather as the right to receive the annuity for the 
shorter of the life of the annuitant or the date on which the corpus 
will exhaust. One commentator agreed that the possibility of exhaustion 
of corpus should be taken into account in cases of relatively severe 
underfunding of the trust. However, it was suggested that, if the 
underfunding was relatively less severe, it should be disregarded. 
After further consideration of this issue, the IRS has concluded that 
the method described in the proposed regulations for determining the 
value of the annuity is consistent with fundamental principles for 
determining present value and long-standing IRS position. See, Rev. 
Rul. 77-454 (1977-2 C.B. 351); Rev. Rul. 70-452 (1970-2 C.B. 199); 
Moffett v. Commissioner, 269 F.2d 738 (4th Cir. 1959); United States v. 
Dean, 224 F.2d 26 (1st Cir. 1955). However, in response to requests, 
the explanation of the methodology and computation has been amplified.

2. Terminal Illness

    Under the proposed regulations, the tables cannot be used if the 
individual, who is the measuring life with respect to the property 
interest, is terminally ill. Under the proposed regulations, the 
individual is terminally ill if that individual was known to have an 
incurable illness or deteriorating physical condition such that there 
is at 

[[Page 63914]]
least a 50 percent probability that the individual will die within one 
year.
    One commentator suggested that the value of a property interest 
that is dependent upon a measuring life should be determined in all 
events based on the mortality component contained in Table 80CNSMT 
(which is based on the life experience of the general population), 
rather than a mortality component that reflects the actual terminally 
ill condition of the individual. The commentator also suggested that if 
departure from the actuarial tables is deemed appropriate in the case 
of terminally ill individuals, then the standard in Rev. Rul. 80-80 
(1980-1 C.B. 194), which is not explicitly expressed in the form of a 
percentage probability of survival (as is the standard in the proposed 
regulations), adequately differentiates between individuals that should 
not be considered terminally ill and those that should. This 
commentator also questioned whether a percentage probability standard, 
such as the one used in the proposed regulations, would be feasible to 
administer.
    The IRS continues to believe that mortality tables such as Table 
80CNSMT should not be used to predict the survival probabilities of an 
individual whose time of death is reasonably predictable based on the 
facts presented. To determine whether the proposed test for classifying 
an individual as terminally ill would be feasible, the IRS consulted 
with a number of medical specialists. Medical experts called upon to 
assess the probability of survival of a terminally ill individual base 
their assessment on statistical compilations of the percentage of 
individuals who survive for a specified period of time when suffering 
with a particular disease. Thus, the IRS believes that a test for 
classifying an individual as terminally ill can reasonably be based 
upon the probability of survival for a specified period of time.
    One commentator suggested that the mortality test should take into 
account the actual period of survival after the transfer. For example, 
if the individual actually survived for one year, that individual 
should not be deemed to have been terminally ill. Although post-
transaction events are not ordinarily determinative for valuation 
purposes, such events may provide evidence of value as of the valuation 
date. Accordingly, the final regulations provide a presumption that if 
the individual who is the measuring life survives for eighteen months 
or longer after the transfer, that individual shall be presumed to have 
not been terminally ill on the date of the transfer unless the contrary 
is established by clear and convincing evidence.
    The commentator also questioned whether the proposed test for 
classifying an individual as terminally ill would result in the 
classification of elderly people suffering from the general infirmities 
of old age as ``terminally ill.'' The IRS continues to believe that the 
test should be consistently applied to people of all ages. Under the 
regulations, the individual must be inflicted with an incurable illness 
or other deteriorating physical condition that is life threatening. 
Thus, elderly people suffering from the general infirmities of old age, 
but not from a specific incurable life-threatening illness, would not 
be considered terminally ill under the test. Consequently, if an 
elderly person has one or more illnesses, none of which, standing alone 
or considered together, is life-threatening, that person would not be 
considered to be terminally ill.
    The same commentator suggested that ``knowledge'' of the terminal 
illness should be limited to actual knowledge by the taxpayer or the 
decedent, rather than to ``knowledge'' by any of the parties involved. 
However, limitation of the requisite ``knowledge'' to the taxpayer or 
decedent would present a significant burden to the IRS regarding proof 
and would present opportunities for easy circumvention. Thus, the IRS 
believes that the requirement that the condition of the individual be 
``known,'' although not necessarily by the taxpayer or decedent, is 
reasonable.
    Commentators suggested that the regulations should make it clear 
that a special actuarial factor taking into account a transferor's 
terminal illness may be used in valuing a transfer to a pooled income 
fund. The final regulations incorporate that suggestion.
    Comments were received that the language in Sec. 20.7520-
3(b)(3)(ii) of the proposed regulations regarding the valuation of a 
property interest that is based upon a terminally ill measuring life, 
for purposes of determining the applicable credit for tax on prior 
transfers under section 2013, was ambiguous. Generally, if the final 
determination of the estate tax liability in the transferor's estate 
was dependent on the valuation of the life interest received by the 
transferee, then the value of the property transferred, for purposes of 
determining the credit allowable for the transferee's estate, is the 
value determined previously for the transferor's estate. Section 
20.7520-3(b)(3)(ii) of the final regulations clarifies this rule. The 
IRS invites comments on whether the value of a reversionary interest 
under section 673 should be determined without regard to the physical 
condition of the decedent immediately before death, a related issue 
that was raised by commentators.

3. Application of Actuarial Tables

    One commentator suggested that the tables prescribed by the 
regulations must be used for valuing all interests transferred between 
April 30, 1989 (the effective date of section 7520) and December 13, 
1995 (the effective date of the regulations). However, these 
regulations generally adopt principles established in case law and 
published IRS positions. See, e.g., O'Reilly v. Commissioner, 973 F.2d 
1403 (8th Cir. 1992), rem'd, T.C.M. 1994-61 (underproductive income 
interest); Estate of McLendon v. Commissioner, T.C.M. 1993-459; Rev. 
Rul. 80-80 (1980-1 C.B. 194) (terminal illness of measuring life); 
Moffett v. Commissioner, 269 F.2d 738 (4th Cir. 1959); Rev. Rul. 77-454 
(1977-2 C.B. 351) (exhausting corpus). There is no indication that 
Congress intended to supersede this well-established case law and 
administrative ruling position when it enacted section 7520. 
Consequently, in the case of transfers prior to the effective date of 
these regulations, the question of whether a particular interest must 
be valued based on the tables will be resolved based on applicable case 
law and revenue rulings.

Special Analyses

    It has been determined that this Treasury decision 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, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal author of these regulations is William L. Blodgett, 
Office of Assistant Chief Counsel (Passthroughs and Special 
Industries), IRS. However, other personnel from the IRS and Treasury 
Department participated in their development. 

[[Page 63915]]


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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1, 20 and 25 are 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 revising paragraph (b) and 
adding a sentence at the end of paragraph (c) 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 use of $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 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 paragraph (b)(4) Example 2 of this section, 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 this 
paragraph (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 may not 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 at the valuation 
date of the transfer, 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. For example, for a fixed annuity payable 
annually at the end of each year, if the amount of the annuity payment 
(expressed as a percentage of the initial corpus) is less than or equal 
to the applicable section 7520 interest rate at the date of the 
transfer, the corpus is assumed to be sufficient to make all payments. 
If the percentage exceeds the applicable section 7520 interest rate and 
the annuity is for a definite term of years, multiply the annual 
annuity amount by the Table B term certain annuity factor, as described 
in Sec. 1.7520-1(c)(1), for the number of years of the defined period. 
If the percentage exceeds the applicable section 7520 interest rate and 
the annuity is payable for the life of one or more individuals, 
multiply the annual annuity amount by the Table B annuity factor for 
110 years minus the age of the youngest individual. If the result 
exceeds the limited fund, the annuity may exhaust the fund, and it will 
be necessary to calculate a special section 7520 annuity factor that 
takes into account the exhaustion of the trust or fund. This 
computation would be modified, if appropriate, to take into account 
annuities with different payment terms. See Sec. 25.7520-3(b)(2)(v) 
Example 5 of this chapter, which provides an illustration involving an 
annuity trust that is subject to exhaustion.
    (ii) Income and similar interests--(A) Beneficial enjoyment. A 
standard section 7520 income factor for an ordinary income interest may 
not 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 

[[Page 63916]]
value of the right to use tangible property (whether or not in trust) 
for one or more measuring lives or for some other specified period of 
time, the interest rate component prescribed under section 7520 and 
Sec. 1.7520-1 may not be used unless, during the specified period, the 
effect of the trust, will or other governing instrument is to provide 
the beneficiary with that degree of use, possession, and enjoyment of 
the property during the term of interest that applicable state law 
accords to a person who is unqualifiedly designated as a life tenant or 
term holder for a similar period of time.
    (B) Diversions of income and corpus. A standard section 7520 income 
factor for an ordinary income interest may not 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 may not 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 
(e.g., 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 at the time of the 
termination of the prior interest.
    (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 and, when applicable, the rules set forth in 
paragraph (b)(3) of this section, if the individual who is the 
measuring life is terminally ill at the time of the transfer.
    (3) Mortality component. The mortality component prescribed under 
section 7520 may not 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 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. However, if the individual survives for eighteen months 
or longer after the date of the transaction, that individual shall be 
presumed to have not been terminally ill at the time of the transaction 
unless the contrary is established by clear and convincing evidence.
    (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 that satisfies fiduciary standards. 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. 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. 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. Assuming the presumption in paragraph (b)(3) of this section 
does not apply, 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 as may otherwise be provided by the Commissioner.
    (c) * * * The provisions of paragraph (b) of this section are 
effective with respect to transactions after December 13, 1995.

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 revising paragraph (b) and 
adding a sentence at the end of paragraph (c) 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 

[[Page 63917]]
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 use of $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 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 paragraphs (b)(2)(v) Example 4 and (b)(4) Example 1 
of this section, 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 this 
paragraph (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 may not 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 at the valuation 
date of the transfer, 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. For example, for a fixed annuity payable 
annually at the end of each year, if the amount of the annuity payment 
(expressed as a percentage of the initial corpus) is less than or equal 
to the applicable section 7520 interest rate at the date of the 
transfer, the corpus is assumed to be sufficient to make all payments. 
If the percentage exceeds the applicable section 7520 interest rate and 
the annuity is for a definite term of years, multiply the annual 
annuity amount by the Table B term certain annuity factor, as described 
in Sec. 20.7520-1(c)(1), for the number of years of the defined period. 
If the percentage exceeds the applicable section 7520 interest rate and 
the annuity is payable for the life of one or more individuals, 
multiply the annual annuity amount by the Table B annuity factor for 
110 years minus the age of the youngest individual. If the result 
exceeds the limited fund, the annuity may exhaust the fund, and it will 
be necessary to calculate a special section 7520 annuity factor that 
takes into account the exhaustion of the trust or fund. This 
computation would be modified, if appropriate, to take into account 
annuities with different payment terms. See Sec. 25.7520-3(b)(2)(v) 
Example 5 of this chapter, which provides an illustration involving an 
annuity trust that is subject to exhaustion.
    (ii) Income and similar interests--(A) Beneficial enjoyment. A 
standard section 7520 income factor for an ordinary income interest may 
not 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 for some other specified 
period of time, the interest rate component prescribed under section 
7520 and Sec. 1.7520-1 of this chapter may not be used unless, during 
the specified period, the effect of the trust, will or other governing 
instrument is to provide the beneficiary with that degree of use, 
possession, and enjoyment of the property during the term of interest 
that applicable state law accords to a person who is unqualifiedly 
designated as a life tenant or term holder for a similar period of 
time.
    (B) Diversions of income and corpus. A standard section 7520 income 
factor for an ordinary income interest may not 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 may not be used to determine the present 

[[Page 63918]]
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 (e.g., 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 
at the time of the termination of the prior interest.
    (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 and, when applicable, the rules set 
forth under paragraph (b)(3) of this section if the individual who is 
the measuring life is terminally ill at the time of the transfer.
    (v) Examples. The provisions of this paragraph (b)(2) are 
illustrated by the following examples:

    Example 1. Unproductive property. A died, survived by B and C. B 
died two years after A. A's will provided for a bequest of 
corporation stock in trust under the terms of which all of the trust 
income was paid to B for life. After the death of B, the trust 
terminated and the trust property was distributed to C. The trust 
specifically authorized, but did not require, the trustee to retain 
the shares of stock. The corporation paid no dividends on this stock 
during the 5 years before A's death and the 2 years before B's 
death. There was no indication that this policy would change after 
A's death. Under applicable state law, the corporation is considered 
to be a sound investment that satisfies fiduciary standards. The 
facts and circumstances, including applicable state law, indicate 
that B did 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, B's life income interest in this case is considered 
nonproductive. Consequently, B's 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 B, 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 A's death. In this case, 
because B 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 B's income interest.
    Example 3. Discretionary invasion of corpus. The decedent, A, 
transferred property to a trust under the terms of which all of the 
trust income is to be paid to A'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 
A'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, A, 
bequeathed property to a trust under the terms of which all of the 
trust income is to be paid to A's child for life and the remainder 
is to be distributed to A'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, A, devised a life 
estate in 3 parcels of real estate to A's surviving spouse with the 
remainder to a child, or, if the child doesn't survive, to the 
child's estate. A also conferred 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. The child predeceased the surviving spouse. 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 that is includible in the child's estate 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. Except as provided 
in paragraph (b)(3)(ii) of this section, the mortality component 
prescribed under section 7520 may not 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 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. However, if the individual survives 
for eighteen months or longer after the date of the decedent's death, 
that individual shall be presumed to have not been terminally ill at 
the date of death unless the contrary is established by clear and 
convincing evidence.
    (ii) Terminal illness exceptions. In the case of the allowance of 
the credit for tax on a prior transfer under section 2013, if a final 
determination of the federal estate tax liability of the transferor's 
estate has been made under circumstances that required valuation of the 
life interest received by the transferee, the value of the property 
transferred, for purposes of the credit allowable to the transferee's 
estate, shall be the value determined previously in the transferor's 
estate. Otherwise, for purposes of section 2013, the provisions of 
paragraph (b)(3)(i) of this section shall govern in valuing the 
property transferred. The value of a decedent's reversionary interest 
under sections 2037(b) and 2042(2) shall be determined without regard 
to the physical condition, immediately before the decedent's death, of 
the individual who is the measuring life. 

[[Page 63919]]

    (iii) Death resulting from common accidents. The mortality 
component prescribed under section 7520 may not be used to determine 
the present value of an annuity, income interest, remainder interest, 
or reversionary interest if the decedent, and the individual who is the 
measuring life, die as a result of a common accident or other 
occurrence.
    (4) Examples. The provisions of paragraph (b)(3) of this section 
are illustrated by the following examples:

    Example 1. 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. Assuming the presumption provided for in paragraph (b)(3)(i) 
of this section does not apply, the standard life annuity factor for 
a person age 60 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 child, who is 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.
    Example 2. Deaths resulting from common accidents, etc. 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, upon the 
decedent's death 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. Even if the terms of the will and 
applicable state law presume 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, the 
spouse's life income interest may not be valued by use of the 
mortality component described under section 7520. The result would 
be the same even if it was established that the spouse survived the 
decedent.

    (5) Additional limitations. Section 7520 does not apply to the 
extent as may otherwise be provided by the Commissioner.
    (c) * * * The provisions of paragraph (b) of this section are 
effective with respect to estates of decedents dying after December 13, 
1995.

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. In the list below, for each section indicated in the left 
column, remove the language in the middle column and add the language 
in the right column:

----------------------------------------------------------------------------------------------------------------
            Section                      Remove                                    Add                          
----------------------------------------------------------------------------------------------------------------
25.2522(c)-3(c)(2)(i) 6th        (e)(2) (ii), (iii),     (c)(2) (ii), (iii), and (iv).                          
 sentence.                        and (iv).                                                                     
25.2522(c)-3(c)(2) (vi)(a) 2nd   Subdivision (v).......  Paragraph (c)(2)(vi).                                  
 sentence.                                                                                                      
25.2522(c)-3(c)(2) (vii)(a) 2nd  Subdivision (vi)......  Paragraph (c)(2)(vii).                                 
 sentence.                                                                                                      
25.2522(c)-3(d)(2) introductory  Subdivision (iv), (v),  Paragraph (c)(2) (v), (vi), or (vii).                  
 text.                            or (vi) of paragraph                                                          
                                  (c)(2).                                                                       
25.2522(c)-3(d)(2) (iv) 1st      Paragraph (c)(2)(v)...  Paragraph (c)(2)(vi).                                  
 sentence.                                                                                                      
25.2522(c)-3(d)(2)(iv), Example  Paragraph (c)(2)(v)...  Paragraph (c)(2)(vi).                                  
 (1) 1st sentence.                                                                                              
25.2522(c)-3(d)(2)(iv), Example  Paragraph (c)(2)(v)...  Paragraph (c)(2)(vi).                                  
 (2) 1st sentence.                                                                                              
25.2522(c)-3(d)(2)(iv), Example  Paragraph (c)(2)(v)...  Paragraph (c)(2)(vi).                                  
 (3) 1st sentence (each place                                                                                   
 it appears).                                                                                                   
25.2522(c)-3(d)(2)(iv), Example  Paragraph (c)(2)(v)(e)  Paragraph (c)(2)(vi)(e)                                
 (4) last sentence.                                                                                             
25.2522(c)-3(d)(2)(v)..........  Paragraph (c)(2)(vi)..  Paragraph (c)(2)(vii).                                 
----------------------------------------------------------------------------------------------------------------

    Par. 7. Section 25.7520-3 is amended by revising paragraph (b) and 
adding a sentence at the end of paragraph (c) 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 use of $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 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 paragraphs 

[[Page 63920]]
(b)(2)(v) Example 5 and (b)(4) of this section, 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 this 
paragraph (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 may not 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 on the valuation 
date of the transfer, 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. For example, for a fixed annuity payable 
annually at the end of each year, if the amount of the annuity payment 
(expressed as a percentage of the initial corpus) is less than or equal 
to the applicable section 7520 interest rate at the date of the 
transfer, the corpus is assumed to be sufficient to make all payments. 
If the percentage exceeds the applicable section 7520 interest rate and 
the annuity is for a definite term of years, multiply the annual 
annuity amount by the Table B term certain annuity factor, as described 
in Sec. 25.7520-1(c)(1), for the number of years of the defined period. 
If the percentage exceeds the applicable section 7520 interest rate and 
the annuity is payable for the life of one or more individuals, 
multiply the annual annuity amount by the Table B annuity factor for 
110 years minus the age of the youngest individual. If the result 
exceeds the limited fund, the annuity may exhaust the fund, and it will 
be necessary to calculate a special section 7520 annuity factor that 
takes into account the exhaustion of the trust or fund. This 
computation would be modified, if appropriate, to take into account 
annuities with different payment terms.
    (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 for some other specified 
period of time, the interest rate component prescribed under section 
7520 and Sec. 1.7520-1 of this chapter may not be used unless, during 
the specified period, the effect of the trust, will or other governing 
instrument is to provide the beneficiary with that degree of use, 
possession, and enjoyment of the property during the term of interest 
that applicable state law accords to a person who is unqualifiedly 
designated as a life tenant or term holder for a similar period of 
time.
    (B) Diversions of income and corpus. A standard section 7520 income 
factor for an ordinary income interest may not 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 may not 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 
(e.g., 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 at the time of the 
termination of the prior interest.
    (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 and, when applicable, the rules set 
forth under paragraph (b)(3) of this section if the individual who is 
the measuring life is terminally ill at the time of the transfer.
    (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 for life. Considering the applicable 
federal rate under section 7520 and the appropriate life estate 
factor for a person A's age, the value of A's income interest, if 
valued under this section, would 

[[Page 63921]]
be $10,000. After A's death, the trust is to terminate and the trust 
property is to be distributed to B. 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 a sound investment that satisfies 
fiduciary standards. 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, A's 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 A, the income beneficiary, has the right to compel the 
trustee to make the trust productive for purposes of applicable 
local law during A'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 A's 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 that satisfies fiduciary 
standards. 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. 
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. 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. (i) 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, payable annually, and the remainder will be distributed to 
the donor's child. The section 7520 rate for the month of the 
transfer is 6.8 percent. First, it is necessary to determine whether 
the annuity may exhaust the corpus before all annuity payments are 
made. Because it is assumed that any measuring life may survive 
until age 110, any life annuity could require payments until the 
measuring life reaches age 110. Based on a section 7520 interest 
rate of 6.8 percent, the determination of whether the annuity may 
exhaust the corpus before the annuity payments are made is computed 
as follows:


Age to which life annuity may continue................          110     
Less: Age of measuring life at date of transfer.......           60     
                                                       -----------------
      Number of years annuity may continue............           50     
Annual annuity payment................................     $100,000.00  
Times: Table B annuity factor for 50 years............           14.1577
                                                       -----------------
      Present value of term certain annuity...........    1,415,770.00  
                                                                        

    (ii) Since the present value of an annuity for a term of 50 
years exceeds the corpus, the annuity may exhaust the trust before 
all payments are made. Consequently, the annuity must be valued as 
an annuity payable for a term of years or until the prior death of 
the annuitant, with the term of years determined by when the fund 
will be exhausted by the annuity payments.
    (iii) Using factors based on Table 80CNSMT at 6.8 percent, it is 
determined that the fund will be sufficient to make 17 annual 
payments, but not to make the entire 18th payment. Specifically, the 
initial corpus will be able to make payments of $67,287.26 per year 
for 17 years plus payments of $32,712.74 per year for 18 years. The 
annuity is valued by adding the value of the two separate temporary 
annuities.
    (iv) Based on Table H of Publication 1457 (a copy of this 
publication may be purchased from the Superintendent of Documents, 
United States Government Printing Office, Washington, DC 20402), the 
present value of an annuity of $67,287.26 per year payable for 17 
years or until the prior death of a person aged 60 is $579,484.61 
($67,287.26  x  8.6121). The present value of an annuity of 
$32,712.74 per year payable for 18 years or until the prior death of 
a person aged 60 is $287,731.45 ($32,712.74  x  8.7957). Thus, the 
present value of the charitable annuity interest is $867,216.06 
($579,484.61 + $287,731.45).

    (3) Mortality component. The mortality component prescribed under 
section 7520 may not 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. However, if the individual survives for eighteen months 
or longer after the date the gift is completed, that individual shall 
be presumed to have not been terminally ill at the date the gift was 
completed unless the contrary is established by clear and convincing 
evidence.
    (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 

[[Page 63922]]
annuity would be $764,569 ($103,000  x  7.4230). Assuming the 
presumption provided in paragraph (b)(3) of this section does not 
apply, because there is at least a 50 percent probability that the 
donor will die within 1 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 as may otherwise be provided by the Commissioner.
    (c) * * * The provisions of paragraph (b) of this section are 
effective with respect to gifts made after December 13, 1995.
Michael P. Dolan,
Acting Commissioner of Internal Revenue.

    Approved: October 29, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-30272 Filed 12-12-95; 8:45 am]
BILLING CODE 4830-01-U