                        T.C. Memo. 2006-56



                      UNITED STATES TAX COURT



              ESTATE OF CLAUDE C. FOCARDI, DECEASED,
     NINA M. FOCARDI, PERSONAL REPRESENTATIVE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

                 NINA M. FOCARDI, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 1892-03, 3130-03.       Filed March 27, 2006.



     Edward F. Koren and Douglas A. Wright, for petitioners.

     Stephen R. Takeuchi, for respondent.



                        MEMORANDUM OPINION


     LARO, Judge:   In docket No. 1892-03, Estate of Claude C.

Focardi, Deceased (decedent), Nina M. Focardi, Personal

Representative, petitioned the Court to redetermine respondent’s

determination of deficiencies of $903,784 and $3,123 in the
                                -2-

estate’s Federal gift tax for 1996 and 1997, respectively.   In

docket No. 3130-03, Nina M. Focardi (Focardi) petitioned the

Court to redetermine respondent’s determination of deficiencies

of $824,019 and $3,123 in Focardi’s Federal gift tax for 1996 and

1997, respectively.   The cases resulting from these petitions

were consolidated for purposes of trial, briefing, and opinion.

     Following the parties’ stipulation of the applicable value

of the stock discussed herein1 and the submission of these cases

under Rule 122, we now decide whether the respective revocable

spousal interests contained in four grantor retained annuity

trusts (GRATs) are qualified interests under section 2702(b).2

We hold they are not.   We also decide whether the GRATs created

annuities that are valued on the basis of their stated term of

years (as opposed to annuities that are valued on the basis of

the actuarial life of the particular grantor) in that the

documents establishing the GRATs state that the spousal interests


     1
       The parties’ stipulation as to the applicable value of the
relevant stock resulted from their submission of that issue to
binding arbitration. The arbitrator concluded that the
applicable value of each share of that stock was $4.46.
     2
       Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, Rule references
are to the Tax Court Rules of Practice and Procedure, and
references to the regulations under sec. 2702 are to those
regulations before amendment by T.D. 9181, 70 Fed. Reg. 9222
(Feb. 25, 2005). The amendments to those regulations are not
applicable here in that they apply to trusts created on or after
July 26, 2004 (the date the amendments were published in proposed
form in the Federal Register). See sec. 25.2702-7, Gift Tax
Regs., as amended by T.D. 9181, supra.
                                 -3-

are to be disregarded if they are not qualified interests, and

such disregard makes each annuity one for its set term of years.

We hold that the GRATs do not create annuities for their stated

term of years.

                             Background

1.   Preface

      All facts were set forth in stipulations or contained in the

exhibits submitted therewith.   We find the facts accordingly.

Focardi is decedent’s surviving spouse and the personal

representative of his estate.   When the petition was filed in

docket no. 3130-03, Nina M. Focardi resided in St. Petersburg,

Florida.    When the petition was filed in docket No. 1892-03, the

“legal address” of decedent’s estate was in St. Petersburg,

Florida.

2.   Docket No. 1892-03

      On October 25, 1996, decedent transferred 817,500 shares of

stock of Great Bay Distributors, Inc. (Great Bay), into a trust

(decedent 2-year GRAT) named “Claude C. Focardi Two Year Grantor

Retained Annuity Trust”.   On the same day, decedent transferred

817,500 shares of Great Bay stock into a trust (decedent 4-year

GRAT) named “Claude C. Focardi Four Year Grantor Retained Annuity

Trust”.    The terms of the instruments establishing the decedent

2-year GRAT and the decedent 4-year GRAT (collectively, decedent

GRATs) were identical in all material regards except for the
                                -4-

annuity term and the percentage used to calculate the amount of

the first annuity payment.

     On April 14, 1997 and 1998, decedent filed a Form 709,

United States Gift (and Generation-Skipping Transfer) Tax Return,

for 1996 and 1997, respectively, reporting that his October 25,

1996, transfer was a gift for Federal gift tax purposes.   On the

1996 return, decedent calculated the value of that gift by

reducing the value of his transferred shares by the actuarially

determined value of a 2-life annuity under section 7520; i.e.,

the present value of the annuity payable until the earlier of (1)

the end of the applicable 2- or 4-year term or (2) the deaths of

both decedent and Focardi.   On the 1997 return, decedent reported

gifts for prior periods inclusive of the taxable gifts reported

on his Form 709 for 1996.

     Respondent determined that decedent’s gift tax for 1996 must

be calculated by reducing the value of decedent’s transferred

shares by the value of a single-life annuity; i.e., the present

value of the annuity payable until the earlier of (1) the end of

the applicable 2- or 4-year period or (2) the death of decedent.

Respondent also determined a gift tax deficiency for 1997 due to

the increase in prior year gifts as a result of his determination

for 1996.
                                  -5-

3.   Docket No. 3130-03

      On October 25, 1996, Focardi transferred 817,500 shares of

Great Bay stock into a trust (Focardi 2-year GRAT) named

“Nina M. Focardi Two Year GRAT”.    On the same day, Focardi

transferred 817,500 shares of Great Bay stock into a trust

(Focardi 4-year GRAT) named “Nina M. Focardi Four Year GRAT”.

The terms of the instruments establishing the Focardi 2-year GRAT

and the Focardi 4-year GRAT (collectively, Focardi GRATs) were

identical in all material regards except for the annuity term and

the percentage used to calculate the amount of the first annuity

payment.

      On April 14, 1997 and 1998, Focardi filed a Form 709 for

1996 and 1997, respectively, reporting that her October 25, 1996,

transfer was a gift for Federal gift tax purposes.    On the 1996

return, Focardi calculated the value of that gift by reducing the

value of her transferred shares by the actuarially determined

value of a 2-life annuity under section 7520; i.e., the present

value of the annuity payable until the earlier of (1) the end of

the applicable 2- or 4-year term or (2) the deaths of both

decedent and Focardi.     On the 1997 return, Focardi reported gifts

from prior periods inclusive of the taxable gifts reported on her

Form 709 for 1996.

      Respondent determined that Focardi’s gift tax for 1996 must

be calculated by reducing the value of Focardi’s transferred
                                 -6-

shares by the value of a single-life annuity; i.e., the present

value of the annuity payable until the earlier of (1) the end of

the applicable 2- or 4-year term or (2) the death of Focardi.

Respondent also determined a gift tax deficiency for 1997 due to

the increase in prior year gifts as a result of his determination

for 1996.

4.   Relevant Trust Provisions

      Each of the instruments establishing the decedent GRATs

states in relevant part as follows:

           ARTICLE FOUR: Irrevocable Provision. This
      agreement and the trust it creates are irrevocable, and
      neither all nor part can be altered, amended, revoked,
      or terminated prior to the time specified in this
      agreement, by me, Trustee, or anyone else. * * *

           ARTICLE FIVE: Administration of Trust Estate.
      Trustee shall hold, administer, and distribute the
      trust estate as follows:

          A. Annuity Term. During the period beginning on
     the date of this agreement and ending on the date [“2"
     in the case of the decedent 2-year GRAT and “4" in the
     case of the decedent 4-year GRAT] years thereafter (the
     “Annuity Term”), Trustee shall pay to me from the net
     income, or (to the extent that net income is
     insufficient) from the principal, of the trust an
     annuity (the “Annuity”) in an amount equal to
     [“51.2535" in the case of the decedent 2-year GRAT and
     “22.9876" in the case of the decedent 4-year GRAT]
     percent of the initial fair market value of the assets
     contributed to the trust as finally determined for
     federal tax purposes. The annuity will increase by
     twenty percent (20%) each year during the Annuity Term,
     * * * If I die before the expiration of the Annuity
     Term, the Trustee shall pay to my estate any part of
     the Annuity that is accrued and undistributed at my
     death, based on a daily proration through the date of
     my death. * * * The remaining trust assets are to be
                          -7-

administered and distributed as provided elsewhere in
this agreement. * * *

     B. Termination of Trust. Except as otherwise
provided in this agreement, at the end of the Annuity
Term, Trustee shall distribute the remaining net
income, if any, and principal of the trust not required
to be paid out in satisfaction of the final Annuity
payment, as provided in Article Six below.

     C. Annual Payment, Additional Contributions, Etc.
During the Annuity Term and until the final Annuity
payment has been made, the following provisions will
apply with respect to the trust estate:

          1. Trustee shall distribute the Annuity in
at least one annual payment at the end of each taxable
year, except for the taxable year in which the Annuity
Term ends, when that payment will be made by the end of
the Annuity Term. If Trustee deems it to be desirable,
Trustee may pay less than the full Annuity during any
taxable year, but Trustee must pay any unpaid amount no
later than the due date for filing the trust’s income
tax return for that taxable year, without regard to
extensions. In addition, Trustee may, in its sole and
absolute discretion, distribute all or a portion of the
Annuity in monthly, quarterly, semi-annual installments
or at any other time the Trustee deems appropriate,
subject to the time limitations of the prior sentence.

          *    *    *    *      *   *   *

     D. Qualified Annuity Interest. I intend that my
retained annuity interest in this trust (and the
annuity interest of my wife[1] if she survives me and
receives the Annuity under paragraph E below) be a
“qualified annuity interest” as defined in Code section
2702(b)(1) and Treasury Regulation Section 25.2702-3(b)
and (d). All provisions of this agreement are to be
interpreted accordingly and any provision of this
agreement inconsistent with that intention is to be of
no effect. In furtherance of this intention, I
specifically empower Trustee to amend this trust during
the Annuity Term for the sole purpose of complying with
the requirements of the foregoing Code section and
Treasury Regulations, and any such amendment will apply
retroactively to the inception of the trust. No power,
right, or duty under this agreement will be effective
                          -8-

or exercisable to the extent that it would cause my
retained annuity interest (or my wife’s interest, if
any) hereunder to fail to qualify as a “qualified
annuity interest” under Code section 2702(b)(1) and
Treasury Regulation Section 25.2702-3(b) and (d).

     E. Revocable Contingent Spousal Annuity Trust.
If, and only if, I die before the Annuity Term ends, my
wife survives me, and I have not exercised my right to
revoke all or a portion of my wife’s interest under
this agreement, then to the extent that I have not
revoked such interest, Trustee shall hold the remaining
trust assets in a marital trust for my wife. Trustee
shall administer that marital trust for the lifetime of
my wife as follows:

          1. Trustee shall pay to my wife, or if she
is deceased, to her estate, as an annuitant, the
remaining Annuity which would have been paid to me if I
had survived. The amount, time of payment, source of
payment (except the provision for adding accumulated
income to principal), proration, and adjustments of the
Annuity will be the same as the provisions for payment
of “qualified annuity interest” (defined in paragraph D
of this Article Five) to me if I had been living.
Trustee shall not make any distributions from the
marital trust to or for the benefit of anyone other
than my wife while my wife is living.

          2. During the Annuity Term, the Trustee also
shall pay from the date of my death all the income that
exceeds the Annuity to or for the benefit of my wife at
least annually. After the Annuity Term, Trustee shall
pay the income to or for the benefit of my wife for her
lifetime at least annually.

          *    *    *    *      *   *   *

     G. If I Die During Trust Term and My Wife Does Not
Receive Annuity. If, and only if, I die before the
Annuity Term ends, and either I have revoked in whole
or in part my wife’s interest under this agreement or
my wife does not survive me, then the trust assets
subject to such revocation or the remaining trust
assets in the event my wife does not survive me, as the
case may be, are to be distributed to or in trust for
such appointees as I shall appoint by my Will. In the
                                   -9-

     absence of such an appointment, the remaining trust
     assets shall be distributed to my estate.

                 *    *     *     *      *   *   *

          ARTICLE SIX: Ultimate Distribution. Upon the
     expiration of the Annuity Term, all the remaining
     income and principal of this trust, if any, are to be
     divided into equal shares and distributed outright and
     free of trust to my then living children. If a child
     of mine predeceases me, his or her share is to be
     distributed to his or her estate.
            1
           The decedent GRATs state that “References to ‘my wife’
     means [sic] NINA M. FOCARDI.”

Each of the instruments establishing the Focardi GRATs has

dispositive provisions similar to the quoted parts of the

decedent GRATs, except that (1) the word “wife” is used in lieu

of “husband”, and the word “husband” is used in lieu of “wife”,

(2) changes have been made to gender-related pronouns, and

(3) Article Five B states that “Trustee shall administer and

distribute” in lieu of “Trustee shall distribute”.

                                Discussion

     A tax is generally imposed on a taxpayer’s transfer of

property by gift.    See sec. 2501(a)(1).    The amount of the gift

equals the fair market value of the transferred property as of

the date of the gift.     See sec. 2512(a); sec. 25.2512-1, Gift Tax

Regs.    Where property is transferred in trust with the donor

retaining an interest in the property,3 the value of the gift


     3
       For purposes of sec. 2702, when a transferor retains the
right to revoke a qualified annuity interest of the transferor’s
                                                   (continued...)
                              -10-

generally is the value of the property transferred, less the

value of the donor’s retained interest.    See sec. 25.2512-5A(e),

Gift Tax Regs.; see also sec. 25.2702-2(a)(3), Gift Tax Regs.

(the term “retained” means held by the same individual both

before and after the transfer).    If a gift in trust is to a

family member, however, the value of the gift is determined by

reference to section 2702(a)(2).    See sec. 2702(a)(1).   Section

2702(a)(2)(A) provides that the value of a retained interest that

is not a qualified interest is zero (thus, the value of the gift

is the value of the entire property).    Section 2702(a)(2)(B)

provides that the value of a retained interest that is a

qualified interest is determined under section 7520.

     Section 2702(b) defines the term “qualified interest” as:

          (1) any interest which consists of the right to
     receive fixed amounts payable not less frequently than
     annually,

          (2) any interest which consists of the right to
     receive amounts which are payable not less frequently
     than annually and are a fixed percentage of the fair
     market value of the property in the trust (determined
     annually), and


     3
      (...continued)
spouse, the transferor is considered to have retained that
interest for Federal gift tax purposes. See Cook v.
Commissioner, 269 F.3d 854, 858 (7th Cir. 2001), affg. 115 T.C.
15 (2000); Cook v. Commissioner, 115 T.C. at 24; sec.
25.2702-2(a)(5), Gift Tax Regs.; see also sec. 25.2702-2(d)(1),
Example (6), Gift Tax Regs. A transfer of an interest in
property with respect to which there are one or more term
interests is treated as a transfer of an interest in a trust.
See sec. 2702(c)(1). A term interest is an interest for life or
for a term of years. See sec. 2702(c)(3).
                               -11-

          (3) any noncontingent remainder interest if all of
     the other interests in the trust consist of interests
     described in paragraph (1) or (2).

The regulations interpret this definition to include “a qualified

annuity interest, a qualified unitrust interest, or a qualified

remainder interest” and state that the “Retention of a power to

revoke a qualified annuity interest (or unitrust interest) of the

transferor’s spouse is treated as the retention of a qualified

annuity interest (or unitrust interest).”4   Sec. 25.2702-2(a)(5),

Gift Tax Regs.   The regulations explain that a qualified annuity

interest is “an irrevocable right to receive a fixed amount * * *

payable to (or for the benefit of) the holder of the annuity

interest" for each taxable year of the term and that a qualified

unitrust interest is “an irrevocable right to receive payment

periodically, but not less frequently than annually, of a fixed

percentage of the net fair market value of the trust assets,

determined annually.”   Sec. 25.2702-3(b)(1)(i) and (c)(1)(i),

Gift Tax Regs.   See generally sec. 25.2702-3(f), Gift Tax Regs.,

(defines the term “qualified remainder interest”).   The

regulations also explain that in the case of a qualified annuity

interest, a fixed amount is either a set dollar amount or a set



     4
       This latter statement reflects a taxpayer-favorable rule
that was added to the regulations without comment. The rule is
not required by either the statute or the legislative history
thereunder. See 136 Cong. Rec. 30485, 30536-30540 (1990). See
generally Bogdanski, “GRAT Valuation: The Ninth Circuit Takes
its Schott”, 30 Est. Plan. 304, 306 (June 2003).
                               -12-

portion (not to exceed 120 percent of the set portion payable in

the preceding year) of the initial fair market value of the

property transferred to the trust as finally determined for

Federal tax purposes, and that the fixed amount must be payable

periodically but not less frequently than annually.   See sec.

25.2702-3(b)(1)(ii), Gift Tax Regs.   The regulations require that

the trust instrument:   (1) “prohibit distributions from the trust

to or for the benefit of any person other than the holder of the

qualified annuity or unitrust interest during the term of the

qualified interest”, sec. 25.2702-3(d)(2), Gift Tax Regs., and

(2) “fix the term of the annuity or unitrust interest * * * for

the life of the term holder, for a specified term of years, or

for the shorter (but not the longer) of those periods”, sec.

25.2702-3(d)(3), Gift Tax Regs.

     Respondent argues that the spousal interests at issue were

not qualified interests because:   (1) The spousal interests were

contingent on the grantor’s failing to survive the applicable 2-

or 4-year term (in other words, the interests were not fixed and

ascertainable), and (2) the spousal interests were not payable

for the life of the term holder, for a term of years, or for the

shorter of those periods.   As respondent sees it, each grantor’s

retained annuity is a qualified interest to the extent that it is

payable for a term of years or the grantor’s earlier death, but

not to the extent it continues for the surviving spouse for the
                              -13-

remainder of the term or until the surviving spouse’s earlier

death.

     Petitioners argue that the spousal interests were qualified

interests in that they were “fixed and ascertainable interests

existing for a specified term of years, for the life of the term

holders, or for the shorter of the two.”   Petitioners assert that

the GRATs operated in the same manner as the GRATs in Schott v.

Commissioner, 319 F.3d 1203 (9th Cir. 2003), revg. and remanding

T.C. Memo. 2001-110, which the Court of Appeals for the Ninth

Circuit held were qualified interests under section 2702(b).

Petitioners stress that the Court of Appeals for the Ninth

Circuit concluded in Schott that section 25.2702-2(d)(1),

Example (7), Gift Tax Regs., establishes, contrary to

respondent’s position both there and here, that a spousal

interest is not disqualified simply because it is contingent upon

a spouse’s surviving the grantor.5   Petitioners recognize that


     5
       Sec. 25.2702-2(d)(1), Example (6) and Example (7), Gift
Tax Regs., states:

          Example (6). A transfers property to an
     irrevocable trust, retaining the right to receive the
     income for 10 years. Upon expiration of 10 years, the
     income of the trust is payable to A’s spouse for 10
     years if living. Upon expiration of the spouse’s
     interest, the trust terminates and the trust corpus is
     payable to A’s child. A retains the right to revoke
     the spouse’s interest. Because the transfer of
     property to the trust is not incomplete as to all
     interests in the property (i.e., A has made a completed
     gift of the remainder interest), section 2702 applies.
                                                   (continued...)
                                -14-

this Court and the Court of Appeals for the Seventh Circuit in

Cook v. Commissioner, 115 T.C. 15 (2000), affd. 269 F.3d 854 (7th

Cir. 2001), held that the GRATs there, which were similar to the

GRATs here, were not qualified interests because they were

contingent.   Petitioners argue that Cook is factually

distinguishable from this case and Schott in that the GRATs in

Cook, unlike the GRATs here and in Schott, involved a further

contingency that the grantor and spouse remain married.

     We agree with respondent that the spousal interests at issue

are not qualified interests.    The spouse in no case will ever

receive any payments from the GRATs if the grantor survives the

applicable 2- or 4-year term, because the interests by their

terms are payable only if the grantor predeceases the spouse

during the applicable term.    The interests, therefore, are not

fixed and ascertainable upon the inception of the trusts, as is



     5
      (...continued)
     A’s power to revoke the spouse’s term interest is
     treated as a retained interest for purposes of section
     2702. Because no interest retained by A is a qualified
     interest, the amount of the gift is the fair market
     value of the property transferred to the trust.

          Example (7). The facts are the same as in Example
     6, except that both the term interest retained by A and
     the interest transferred to A’s spouse (subject to A’s
     right of revocation) are qualified annuity or unitrust
     interests. The amount of the gift is the fair market
     value of the property transferred to the trust reduced
     by the value of both A’s qualified interest and the
     value of the qualified interest transferred to A’s
     spouse (subject to A’s power to revoke).
                               -15-

required by the regulations.   The term of the spousal annuity, if

it does become payable on account of the grantor’s death within

the 2- or 4-year term, also is dependent on when the grantor dies

and, in particular, on how much of the term remains at the

grantor’s death.   Thus, neither the vesting nor the duration of

the spousal interests is fixed and ascertainable upon the

inception of the trusts in that both depend on the death of the

grantor within a specified period.    Given that the regulations

require that “The governing instrument * * * fix the term of the

annuity or unitrust interest”, sec. 25.2702-3(d)(3), Gift Tax

Regs., we believe that the term of the spousal interests must be

fixed and ascertainable upon the inception of the trusts in order

to be qualified interests, see Cook v. Commissioner, 115 T.C. at

23-26.   In contrast with petitioners’ reading of section 2702, we

do not read section 2702 or the regulations thereunder to allow

transferors such as decedent and Focardi to reduce the value of a

remainder interest simply by assigning a value to a spousal

interest which may never take effect.   See id.

     Each spousal interest also is not a qualified interest in

that it fails the duration requirement of section

25.2702-3(d)(3), Gift Tax Regs., that a term extend for the life

of the term holder, for a specified term of years, or for the

shorter of those periods.   The instruments establishing the GRATs

stand in marked contrast to section 25.2702-2(d)(1), Example (7),
                               -16-

Gift Tax Regs., where the 10-year revocable spousal interest is

in all events payable to the spouse beginning at the end of the

grantor’s 10-year term.   The spousal annuity in that example

meets the duration rule of section 25.2702-3(d)(3), Gift Tax

Regs., in that the 10-year interests of both the grantor and the

spouse are upon creation of the trust fixed and ascertainable.

In other words, the spousal interest in the example is not

contingent upon the grantor’s death before the expiration of the

initial 10-year term but is dependent on the spouse’s survival of

that term.   If the spouse survives until the start of the spousal

interest, he or she will receive that interest in all events

(subject to the grantor’s retained right of revocation).

     Petitioners rely primarily upon Schott v. Commissioner,

319 F.3d 1203 (9th Cir. 2003), to support their view that the

spousal interests at issue are qualified interests.   In Schott v.

Commissioner, supra at 1207, the Court of Appeals for the Ninth

Circuit held that “the Commissioner’s interpretation of * * *

[section 25.2702-2(d)(1), Example (7), Gift Tax Regs.,] to

exclude the contingency of the spouse’s being alive at the time

her annuity begins is unreasonable and invalid” and that a “two-

life annuity, based on the lives of the grantor and spouse with a

limit of fifteen years, falls ‘within the class of easily valued

rights’ that Congress meant to qualify.”   The GRAT there provided

for fixed annuity payments to the grantor until the earlier of
                                 -17-

the grantor’s death or 15 years.     If the grantor died before the

end of the 15-year term and the grantor’s spouse survived the

grantor, the annuity was to be paid to the spouse for the

remainder of the 15-year term.    The grantor retained the right to

revoke the spouse’s interest.

     The case of Schott v. Commissioner, supra, does not require

that we accept petitioners’ conclusion that the spousal interests

in issue were qualified interests.      We do not believe that the

ability to easily value a spousal interest is the linchpin for a

finding that the spousal interest is a qualified interest.       The

legislative history under section 2702 indicates that Congress

enacted section 2702 intending to “curb potential valuation abuse

associated with intrafamily transfers of wealth”.      Cook v.

Commissioner, 269 F.3d at 858; see also 136 Cong. Rec. at

30537-30538 (1990).   The possibility of such an abuse is present

where, as here, it is not certain at the outset of the trusts

that payments will ever be made under a survivorship annuity.        We

understand the lawmaker’s intent for section 2702 is to ensure

that a retained interest be fixed and ascertainable at the

creation of a trust in order to reduce the value of the gift of a

remainder interest.   See Cook v. Commissioner, 269 F.3d at 858.

If, as petitioners claim, gifts in trust could be reduced by the

value of spousal interests which are contingent and which never

take effect, the retained interests would have the potential for
                                -18-

overvaluation, and the gift of the remainder would have the

potential for undervaluation.   We consider such treatment to be

contrary to the lawmaker’s intent for section 2702.   See id.

     This Court and the Court of Appeals for the Seventh Circuit

opined on the subject matter at hand in Cook v. Commissioner,

supra.   The Court of Appeals for the Ninth Circuit did not

acknowledge disagreement with Cook but distinguished Cook on the

ground that Cook, unlike Schott, involved an expressed

contingency that the spouses remain married at the time of the

grantor/spouse’s death.   In Cook, the GRATs stated that an

annuity would be paid to the grantor until the earlier of 5 years

or the grantor's death.   If the grantor survived the 5-year term,

the remaining trust property would pass to a separate trust

benefiting the grantor’s son.   If the grantor died before the end

of the 5-year term and was married to the grantor’s spouse at the

time of death, all remaining trust property would pass to a

contingent marital annuity trust, pursuant to which the grantor’s

spouse would receive the annuity amount for the balance of the

5-year term.   Upon the earlier of the end of the 5-year term or

the death of the grantor's spouse, the remaining trust assets

would pass to a separate trust benefiting the grantor's son.    The

grantor reserved the power to revoke the successor interest of

the spouse.
                                   -19-

       This Court held that the spousal interests in Cook v.

Commissioner, supra, were not qualified interests because, among

other reasons, they were neither fixed nor ascertainable upon the

inception of the trusts.       On appeal, the Court of Appeals for the

Seventh Circuit agreed.       That court noted that the spouse’s

interest might never vest and stated that allowing a reduction

for tax purposes of a gift made in trust for an “ephemeral

interest” would invite abuse.       Cook v. Commissioner, 269 F.3d at

858.       That court concluded that the spousal interests were

contingent, and not fixed and ascertainable, because the spouse

was entitled to receive the interest only if the spouse survived

the grantor, and only then, if the spouse and grantor remained

married.       Given the fact that marital trusts are present both

here and in Cook, and that the opinions in Schott did not mention

a marital trust there, we believe that the decision in Cook

applies here with more vigor and force than the decision in

Schott v. Commissioner, 319 F.3d 1203 (9th Cir. 2003).       Such is

especially so given our reading of the instruments establishing

the GRATs at issue to reveal a strong implicit understanding of a

marriage contingency for any payment under the spousal

interests.6


       6
       We also note that sec. 25.2702-2(a)(5), Gift Tax Regs.,
requires that the successor annuitant be the grantor’s spouse in
order to apply the rule that the grantor’s retention of a power
to revoke a qualified annuity interest (or unitrust interest) is
                                                   (continued...)
                              -20-

     Our view is further supported by the well-established

principle that the judiciary should accord substantial deference

to the Commissioner’s interpretation of Treasury regulations, see

Jewett v. Commissioner, 455 U.S. 305, 318 (1982); Ford Motor Co.

v. Milhollin, 444 U.S. 555, 565-566 (1980); Blessitt v. Ret. Plan

for Employees of Dixie Engine Co., 848 F.2d 1164, 1167-1168 (11th

Cir. 1988) (en banc); see also Anderson Bros. Ford v. Valencia,

452 U.S. 205, 219 (1981) (“absent some obvious repugnance to the

statute, the * * * [agency’s] regulation implementing this

legislation should be accepted by the courts, as should the * * *

[agency’s] interpretation of its own regulation”),7 and the fact

that the Treasury Department has recently amended its regulations

on this subject to clarify the rules applicable to revocable

spousal interests and to clarify its view that section 2702 was

enacted to overcome both (1) a problem concerning an uncertainty



     6
      (...continued)
the retention of a qualified annuity interest (or unitrust
interest). Thus, absent an explicit marriage contingency in this
case, such a contingency is implicit. See generally Kozusko,
“Commentary on Schott v. Commissioner”, 28 Tax Mgmt. Est., Gifts
& Tr. J. 165, 166 (2003).
     7
       Of course, as we have just recently noted, deference is
not required to the extent that the regulation is incompatible
with the plain meaning of the text of the statute that it
purports to construe. See Swallows Holding, Ltd. v.
Commissioner, 126 T.C.     (2006); see also Natl. Muffler Dealers
Association v. United States, 440 U.S. 472, 477 (1979)
(interpretative Federal tax regulation is reasonable only if it
“harmonizes with the plain language of the statute, its origin,
and its purpose”).
                                -21-

in valuation and (2) an inaccuracy in valuation caused by an

uncertainty that a survivorship interest will never be paid.    See

T.D. 9181, 70 Fed. Reg. 9222 (Feb. 25, 2005).   As to the

requirement of substantial deference, such a requirement would

appear to be at its strongest here, where the regulation in

question (i.e., the rule that allows a retention of a right to

revoke not to be considered a retention for purposes of section

2702) does not appear in the statute or in its legislative

history, but is a creation of the Treasury Department.   As to the

recent amendments to the regulations, those regulations state

specifically that revocable spousal interests such as those here

are not qualified interests.8   They also include provisions that

(1) define the word “holder” to mean the person to whom the

qualified interest is payable during the term, see current sec.

25.2702-2(a)(5), Gift Tax Regs.; (2) require that a spousal

interest subject to a revocation power independently meet the

regulatory requirements for a qualified interest, but for the

transferor's power to revoke, see current sec. 25.2702-2(a)(6),

Gift Tax Regs.; and (3) state that a qualified interest may only

be contingent on the survival of the holder, see current sec.

25.2702-3(d)(2), Gift Tax Regs.   The amendments also add to the

regulations a new example that illustrates a revocable spousal


     8
       As mentioned supra note 2, those amendments are not
applicable here in that they apply to trusts created on or after
July 26, 2004.
                              -22-

interest that is a qualified interest.    See current section

25.2702-3(e), Example (8), Gift Tax Regs.    This new example is

consistent with section 25.2702-2(d)(1), Example (7), Gift Tax

Regs., on which respondent relies here.   A second example added

to the regulations; i.e., current section 25.2702-3(e), Example

(9), Gift Tax Regs., further illustrates that revocable spousal

interests such as those here are not qualified interests.   New

Example (9) states:

          Example 9. (i) A transfers property to an
     irrevocable trust, retaining the right to receive 6
     percent of the initial net fair market value of the
     trust property for 10 years, or until A's prior death.
     If A survives the 10-year term, the trust terminates
     and the trust corpus is payable to A's child. If A
     dies prior to the expiration of the 10-year term, the
     annuity is payable to B, A's spouse, if then living,
     for the balance of the 10-year term, or until B's prior
     death. A retains the right to revoke B's interest.
     Upon expiration of B's interest (or upon A's death if A
     revokes B's interest or if B predeceases A), the trust
     terminates and the trust corpus is payable to A's
     child. As is the case in Example 8, A's retained
     annuity interest (A's right to receive the annuity for
     10 years, or until A's prior death) is a qualified
     annuity interest under paragraphs (b) and (d) of this
     section. However, B's interest does not meet the
     requirements of paragraph (d) of this section. The
     term of B's annuity is not fixed and ascertainable at
     the creation of the trust, because it is not payable
     for the life of B, a specified term of years, or for
     the shorter of those periods. Rather, B's annuity is
     payable for an unspecified period that will depend upon
     the number of years left in the original term after A's
     death. Further, B's annuity is payable only if A dies
     prior to the expiration of the 10-year term. Thus,
     payment of B's annuity is not dependent solely on B's
     survival, but rather is dependent on A's failure to
     survive.
                               -23-

          (ii) Accordingly, the amount of the gift is the
     fair market value of the property transferred to the
     trust reduced by the value of A's qualified interest
     (A's right to receive the stated annuity for 10 years
     or until A's prior death). B's interest is not a
     qualified interest and is thus valued at zero under
     section 2702.

     Petitioners argue alternatively that this Court, if we

conclude that the spousal interests in the GRATs are not

qualified interests, must disregard those interests in that the

instruments establishing the GRATs state as much.   Petitioners

point the Court to Article Five D, which states that “No power,

right, or duty under the agreement will be effective or

exercisable to the extent that it would cause my retained annuity

interest (or my wife’s [husband’s] interest, if any) hereunder to

fail to qualify as a ‘qualified annuity interest’ under I.R.C.

§ 2702(b)(1)”.   Petitioners assert that the quoted text operates

to invalidate the spousal interests in that those interests are

not qualified interests.   Petitioners conclude that each GRAT is

now simply a GRAT for a set term of either 2 or 4 years, as the

case may be, and should be treated as such.

     We reject petitioners’ alternative argument.   We do not

believe that petitioners are entitled at this time to treat each

GRAT in issue as one of a set term of years simply because the

GRATs state that our determination that the spousal interests are

not qualified interests essentially means that the spousal gift

is revoked.   Such a “savings clause” is ineffective for Federal
                               -24-

transfer tax purposes, and we give it no respect.       See

Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944); Ward v.

Commissioner, 87 T.C. 78 (1986); Harwood v. Commissioner, 82 T.C.

239 (1984), affd. without published opinion 786 F.2d 1174 (9th

Cir. 1986).   See generally Rev. Rul. 65-144, 1965-1 C.B. 442.

     We hold for respondent.   We have considered all arguments by

petitioners for a contrary holding and find those arguments not

discussed herein to be without merit.    To reflect the

arbitrator’s valuation of the Great Bay stock,


                                           Decisions will be entered

                                      under Rule 155.
