## Facts

- In 1993, Audrey J. Walton owned 7,223,478 shares of Wal-Mart stock and created two substantially identical, irrevocable grantor retained annuity trusts (GRATs).
- Each GRAT was funded with 3,611,739 shares valued at $27.6875 per share, for an initial fair market value of $100,000,023.56 per trust.
- Each GRAT had a two-year term and required annuity payments to Walton equal to 49.35% of the initial trust value in year one and 59.22% in year two, payable from income and, if necessary, principal; excess income was added to principal.
- If Walton died during the two-year term, the remaining scheduled annuity payments were payable to her estate; during the term, no payments could be made to anyone other than Walton or her estate, and commutation was barred.
- Each GRAT had a different daughter as the remainder beneficiary.
- Walton reported the gifts of the remainder interests on her 1993 gift-tax return at $0, asserting the present value of her retained annuity equaled or exceeded the value transferred.
- The Commissioner determined a 1993 gift-tax deficiency of $4,532,776.82, valuing each remainder interest at roughly $3.8 million by reducing the value of Walton’s retained interest to reflect mortality (treating the estate’s post-death annuity right as diminishing the retained annuity).
- The parties submitted the case fully stipulated; the Tax Court decided the legal valuation issues without trial.

## Issues

1. For a GRAT under I.R.C. § 2702 where unpaid annuity amounts during the term are payable to the grantor’s estate if the grantor dies, must the retained annuity be valued as a term-of-years qualified interest without mortality adjustment, or as an interest for the shorter of the stated term or the grantor’s life?
2. Is Treas. Reg. § 25.2702-3(e), Example (5), which treats such an annuity as limited by the grantor’s life for valuation purposes, a valid interpretation of § 2702?

## Decision

- The Tax Court held for Walton.
- Walton’s retained annuity interest was a “qualified interest” under § 2702 and had to be valued as an annuity for the full stated two-year term using § 7520 actuarial tables, without regard to the possibility of Walton’s death during the term.
- The estate’s contingent right to receive annuity payments if Walton died during the term was treated as part of Walton’s retained interest, not as a separate transferred interest.
- Treas. Reg. § 25.2702-3(e), Example (5), was held invalid as an unreasonable interpretation of § 2702.
- The court directed that any remaining computational matters be resolved under Rule 155.

## Legal Principles

- Under § 2702, the value of a gift from a transfer in trust to family members equals the value transferred minus the value of the transferor’s retained “qualified interest.”
- A fixed annuity payable for a stated term of years can qualify under § 2702(b) when the instrument fixes amounts and restricts term distributions to the grantor (or, if provided, the grantor’s estate), with no commutation.
- When the retained qualified interest is an annuity for a term of years, it is valued under § 7520 as a term-certain annuity, not as life-contingent, even though death could occur before the term ends.
- A provision directing unpaid term annuity payments to the grantor’s estate upon death does not create a separate gift; it continues the grantor’s retained interest through the grantor’s legal successor for the remaining fixed term.
- A regulation example that recharacterizes a term-of-years qualified annuity as limited by the grantor’s life contradicts § 2702’s treatment of qualified interests and is invalid to that extent.

## Conclusion

The Tax Court ruled that a GRAT annuity payable to the grantor for a fixed term, with any unpaid amounts payable to the grantor’s estate if death occurs during the term, is valued as a term-of-years qualified interest under §§ 2702 and 7520, and it rejected a regulation example that imposed a life-contingent limitation that increased the taxable gift.


Walton v. Commissioner, 115 T.C. 589 (2000)