In the
United States Court of Appeals
For the Seventh Circuit

No. 01-1471

William A. Cook and Gayle T. Cook,

Petitioners-Appellants,

v.

Commissioner of the Internal Revenue Service,

Respondent-Appellee.

Appeal from the United States Tax Court.
No. 257-99--Arthur L. Nims, III, Judge.

Argued September 14, 2001--Decided October 22, 2001


  Before Flaum, Chief Judge, and Manion, and
Williams, Circuit Judges.

  Flaum, Chief Judge. William A. Cook and
Gayle T. Cook challenge a determination
by the Tax Court that the spousal
interests created in their respective
Grantor Retained Annuity Trusts are not
"qualified interests" within the meaning
of 26 U.S.C. sec. 2702, and are therefore
not entitled to exemptions from gift tax
liability. For the reasons stated herein,
we affirm the decision of the Tax Court.


I.   BACKGROUND

  In 1963, William and Gayle Cook
established a business in their home to
market and manufacture medical devices
used during minimally invasive surgical
procedures. That business, now called
Cook Group Incorporated ("CGI"), grew
considerably over time and is now a
multi-million dollar corporation.

  In 1993, William and Gayle Cook
separately established two Grantor
Retained Annuity Trusts ("GRATs")./1 In
1995, William and Gayle Cook again
established two separate GRATs.
  The 1993 GRATs established by the Cooks
are very similar. On June 7, 1993,
William Cook transferred 12,600 shares of
Class A common stock of CGI into his
GRAT. Gayle Cook transferred the same
amount of Class A stock of CGI into her
GRAT on the same day. Both GRATs provided
for annual payments of 23.999% of the
initial fair market value of the trust
corpus, for a period of five years, to
the respective grantors. Each GRAT also
provided that, in the event that a
grantor survived the five year term of
his or her annuity, the remaining trust
property would be used to establish a
separate trust for the Cooks’ son, Carl.

  If, however, the grantor of a trust died
before the expiration of the five-year
term, the remaining trust property would
be disposed of under a Contingent Marital
Annuity Trust ("CMAT"). Under the CMAT,
the surviving spouse would receive the
same annual payments for the remainder of
the deceased grantor’s five-year annuity
term. If the surviving spouse died before
the expiration of that term, the
remaining CMAT assets would be used to
form a separate trust for Carl Cook.

  The 1993 GRATs were irrevocable except
that, in each, the grantor retained the
right to revoke the surviving spouse’s
designation as a successor annuitant. In
addition, the 1993 GRATs provided that
the spousal interests contained in each
GRAT were contingent upon the grantor and
spouse remaining married.

  The 1995 GRATs were similarly
structured. On August 30, 1995, William
Cook transferred 14,360 shares of CGI
stock into his GRAT and Gayle Cook
transferred 11,300 shares of CGI stock
into hers. William Cook’s 1995 GRAT
provided that he would receive an annual
payment for a period of three years. The
annuity amount for each year was to be
determined by multiplying the initial
fair market value of the trust corpus by
.3175 for year one and by .3810 and
.4572, for years two and three
respectively. If he survived the three
year term, the remaining trust property
would be used to fund a separate trust
for Carl Cook.

  Gayle Cook’s 1995 GRAT provided that she
would receive annual payments for a term
of five years. The annual annuity amount
was determined by multiplying the initial
fair market value of the trust by .168940
for year one and by .202728, .242736,
.2919283, and .3503139, for years two
through five respectively. If she
survived the five year term, the
remaining trust property would be used to
fund a separate trust for Carl Cook.

  The 1995 GRATs also made provisions in
the event a grantor died before the
expiration of his or her annuity term. If
a grantor died before the expiration of
his or her annuity term, the remaining
trust property would be disposed through
a CMAT, with the surviving spouse
receiving the remaining payments from the
grantor’s annuity term. Like the 1993
GRATs, the 1995 GRATs provided that spou
sal interests were contingent upon the
Cooks remaining married. Similarly, each
grantor reserved the right to revoke his
or her spouse’s designation as a
surviving annuitant.

  Both William and Gayle Cook filed gift
tax returns for 1993 and 1995. In
reporting the taxable value of their
respective GRATs, both of the Cooks
determined that the value of the dual-
life annuities that they had created were
exempt from gift tax liability./2 The
Commissioner of the Internal Revenue
Service disagreed. According to the
Commissioner, the spousal interests
contained in each GRAT did not meet the
requirements of 26 U.S.C. sec. 2702 and,
accordingly, were not "qualified
interests" exempted from gift tax
liability. Instead, the Commissioner
concluded that only the grantors’
individual interests could be considered
"qualified interests."

  The Cooks contested the Commissioner’s
determinations in the Tax Court. After
initial proceedings, the Cooks eventually
filed a motion for partial summary
judgment, claiming that the spousal
annuities contained in their GRATs were
"qualified interests" and should
therefore not be subject to gift tax
liability. The Commissioner filed a cross
motion for summary judgment, arguing that
the spousal interests should not be
exempted from an imposition of the gift
tax.

  The Tax Court entered judgment against
the Cooks. According to the court, the
spousal interests contained were not
"qualified interests" and, therefore,
should be subject to the gift tax.

  William and Gayle Cook now appeal the
Tax Court’s decision to this court.
II.    DISCUSSION

  For gift tax purposes, when a donor
makes a gift in trust to a family member,
the value of the gift, and whether that
gift contains exemptions for "qualified
interests," is determined by section 2702
of the Internal Revenue Code. A donor can
avoid gift tax liability only on those
portions of the transfer that are deemed
to be "qualified interests." Under
section 2702, a "qualified interest" is:

(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 trust (determined
annually), and

(3) any non-contingent remainder interest
if all of the other interests in the
trust consist of interests described in
paragraphs (1) or (2).

26 U.S.C. sec. 2702(b) (emphasis added).

  The lower court found that the spousal
interests contained the Cooks’ respective
GRATs were not "qualified interests"
because: (1) the terms of the spousal
interests were contingent, not fixed, and
not ascertainable at the trusts’
inceptions and; (2) they failed to adhere
to proper durational requirements.

  We review the lower court’s grant of
summary judgment in favor of the
Commissioner de novo. See e.g., Warsco v.
Preferred Technical Group, 258 F.3d 557,
563 (7th Cir. 2001).

A.    Contingency of the Spousal Interests

  In determining that the spousal
interests contained in the Cooks’ GRATs
were contingent, the Tax Court relied
upon regulations promulgated under
section 2702. These regulations state
that "[t]he governing instrument [of a
GRAT] must fix the term of the annuity or
the unitrust interest." Treas. Regs. sec.
25.2702-3(d)(3), Gift Tax Regs.
Specifically, the lower court relied upon
language stating that a particular
interest was non-contingent because its
terms were "fixed and ascertainable at
the creation of the interest." Treas.
Regs. sec. 25.2702-3(e), Example 6, Gift
Tax Regs. Relying upon Example 6, the
court interpreted these regulations to
mean that the terms of a remainder
interest must be fixed and ascertainable
at the inception of the trust. The lower
court made this interpretation after
examining several examples contained in
the regulations promulgated under section
2702.

  In their appeal, the Cooks claim that
the "fixed and ascertainable" standard
applied by the Tax Court is both
inappropriate and illogical. According to
the Cooks, the "fixed and ascertainable"
standard should not be employed because
it appears only in a demonstrative
example to a regulation and not in the
regulation itself. Furthermore, in
opposition to the "fixed and
ascertainable" standard, the Cooks cite
Walton v. Comm. of the I.R.S., 115 T.C.
589 (2000). In that case, a grantor
created a trust that provided her fixed
annual payments. Id. In the event of the
grantor’s death, the annual payments were
to continue to her estate for the
remainder of the annuity term. Id. The
court did not, however, disqualify these
remainder payments as contingent because
they would vest upon the grantor’s death.
Id. According to the Cooks, the spousal
interests contained their GRATs are
identical to the remainder interests
discussed in Walton and are no less
valid.

  We find the Cooks’ arguments in this
regard unavailing. First, the fact that
the "fixed and ascertainable" standard
comes from an example contained in a
regulation, rather than the body of a
regulation, is of no import, as examples
set forth in regulations remain
persuasive authority so long as they do
not conflict with the regulations
themselves. Freeport Country Club v.
United States, 430 F.2d 986, 992 (7th
Cir. 1970). Second, Walton is
distinguishable from the case at bar. In
Walton, the contingent annuity payments
were made payable to the grantor’s estate
in the event of the grantor’s death. The
Tax Court properly treated the annuity in
question as one for a term of years
because a grantor cannot make a gift to
himself or to his estate.

  It is clear that, in drafting section
2702, Congress intended to curb potential
valuation abuse associated with intra-
family transfers of wealth. 136 Cong.
Rec. 30,538 (1990). The clearest way to
curb against such valuation abuse is to
make sure that terms of any gift are
"fixed." We agree with the Tax Court’s
interpretation and find that, in order to
be considered non-contingent, the terms
of a remainder interest in a GRAT must be
fixed and ascertainable at a trust’s
inception.

  When we examine the terms of the Cooks’
respective GRATs, we also agree that the
spousal interests contained in each are
not "qualified interests" under section
2702. First and foremost, the interests
are contingent. Under both the 1993 and
1995 GRATs, a spouse is entitled to
income only if: (1) the spouse survived
the grantor and; (2) the spouse and the
grantor have remained married. With
these pre-conditions in place, it is
possible (perhaps even probable) that a
spouse’s interest might never vest. If,
for tax purposes, the value of a gift
made in trust can be reduced by an
ephemeral interest, the potential for
valuation abuse increases
considerably./3 In light of this
concern, and the fact that the residual
interests contained in the Cooks’ GRATs
leave open the possibility for
manipulation, we hold that they are not
"qualified interests."

B.   Durational Requirement

  In addition to their contingent nature,
the Tax Court also found that the spousal
interests contained in the Cooks’ 1993
and 1995 GRATs were not "qualified
interests" because they violated the
durational requirements of Treas. Reg.
sec. 25.2702-3(d)(3). We agree with the
Tax Court on this point as well.

  When, as here, a grantor retains the
right to revoke a spousal interest, the
spousal interest itself is considered to
be retained by the grantor. A grantor-
retained interest must "be for the life
of the term holder, or for a specified
term of years, or for the shorter (but
not the longer) of those periods." Id.
(emphasis added). In the case at bar, the
spousal interests created by the Cooks
can exist for the life of the grantor or
for a term of years, regardless of which
term is shorter./4 As both the Tax
Court and the appropriate regulations
have demonstrated, this is impermissible.


III.   CONCLUSION

  Because the spousal interests created by
the Cooks in their respective GRATs are
not fixed and ascertainable and those
interests violate the appropriate
durational requirements, we Affirm the
decision of the Tax Court.

FOOTNOTES
/1 A GRAT is a vehicle that allows a grantor to
irrevocably set aside funds, in trust, for an
identified beneficiary and still retain, for a
set number of years, a pre-determined annual
income from the corpus of the trust.

/2 The value of the sum exempted from gift tax
liability was determined through the use of
actuarial calculations.

/3 Indeed, one does not need to go very far afield
to imagine the lengths to which an ingenious tax
evader might go to avoid gift tax liability. A
particularly wily individual might exploit a
loophole by marrying and divorcing all for the
purposes of lessening the taxable value of a gift
to his or her family members.

/4 The Cooks argue that the durational requirement
of section 25.2072-3(d)(3) should be interpreted
to accord with the rules governing Charitable
Trusts. See, e.g., I.R.C. sec. 1.664-2(d) (the
term of a qualified annuity under a charitable
trust may be "for a term of years (not in excess
of 20 years) or for the life or lives of such
individual or individuals.") According to the
Cooks, the spousal interests they have created
should be measured against two lives, rather than
one. However, Congress did not include the term
"lives" when it drafted the language of section
2702.
