Linda M. Lewis, Donor, Petitioner v. Commissioner of Internal Revenue, Respondent; Peter F. McDougall, Donor, Petitioner v. Commissioner of Internal Revenue, Respondent, T.C. Memo. 2026-58, Docket Nos. 2459-22, 2460-22 (July 20, 2026)

In estate planning, the premature termination of a trust can trigger unexpected gift tax consequences. In the consolidated cases of Linda M. Lewis v. Commissioner and Peter F. McDougall v. Commissioner, T.C. Memo. 2026-58, the United States Tax Court resolved a critical valuation dispute arising from the termination of a qualified terminable interest property (QTIP) trust. Having previously determined that the remainder beneficiaries made taxable gifts by allowing their father to receive the entirety of the trust's assets upon termination, the court was tasked with valuing those gifts.

The court’s opinion is highly technical, addressing the interplay between federal tax valuation statutes, such as I.R.C. § 7520 and I.R.C. § 2207A, and Washington state trust law. The Tax Court held that state law, rather than the actuarial tables of I.R.C. § 7520, governs the underlying property entitlements upon trust termination. Additionally, the court ruled that the value of the gifts must be reduced by the remainder beneficiaries' avoided obligation to reimburse the primary beneficiary for gift taxes under I.R.C. § 2207A(b). This article examines the facts, statutory framework, legal analysis, and key take-aways of this landmark decision for tax professionals.

Factual Background and Trust Architecture

The petitioners, Linda M. Lewis and Peter F. McDougall, along with their father, Bruce McDougall, were the beneficiaries of a Residuary Trust created under the will of Clotilde McDougall, who died in December 2011. Clotilde’s estate primarily consisted of her share of a real estate business inherited from her father.

Under the terms of Clotilde's will, the trustee was required to distribute the Residuary Trust’s net income to Bruce at least annually. The trustee was also authorized, in its discretion, to distribute principal to Bruce "to provide for [Bruce’s] health, maintenance and support in his accustomed manner of living." Bruce held a testamentary limited power to appoint the principal of the Residuary Trust among Clotilde's descendants. In the event Bruce did not exercise this power of appointment, the remainder was to be "divided into equal shares, one share for each of [Clotilde’s] children who is then living and one share for each of [her] children who is then deceased with children then living."

Crucially, Section 12.8 of Clotilde’s will provided that, upon the termination of any trust created under the will, the trustee was to distribute the trust assets among its beneficiaries. While the distributions did not have to be pro rata, they were required to be made "so long as the distributees receive assets of a value equal to the value of their respective interest in the trust at the time of distribution." The will also contained a standard spendthrift clause.

As personal representative of Clotilde's estate, Bruce made a qualified terminable interest property (QTIP) election under I.R.C. § 2056(b)(7) with respect to the Residuary Trust assets. This election allowed Clotilde's estate to receive a marital deduction for the full value of the trust assets, deferring transfer taxes until Bruce’s death.

On June 21, 2016, Bruce executed a will attempting to exercise his testamentary limited power of appointment. The will directed that, upon his death, all remaining principal and undistributed income of the Residuary Trust be distributed to the Bruce McDougall Revocable Trust, which would subsequently allocate assets among Bruce’s descendants.

On October 31, 2016, the petitioners and Bruce entered into a Nonjudicial Agreement to terminate the Residuary Trust. Section 2 of this agreement provided that "the Trust shall be commuted and the entire remaining balance of the Trust shall be distributed outright and free of trust to Bruce." The agreement did not establish any reserve for the payment of transfer taxes. The parties stipulated that the Residuary Trust assets had a fair market value of $117,604,143 on the date of termination.

The Nonjudicial Agreement and Prior Taxable Gift Ruling

The valuation dispute in Lewis v. Commissioner arose directly from the court's prior decision in McDougall v. Commissioner, 163 T.C. 112 (2024). In that earlier summary judgment proceeding, the court examined the tax consequences of the Nonjudicial Agreement under the QTIP regime.

Generally, under I.R.C. § 2519(a), if a surviving spouse disposes of a qualifying income interest in QTIP, the spouse is treated as having made a deemed gift of "all interests in [the QTIP] other than the qualifying income interest." In McDougall, the court concluded that because Bruce ended up owning the trust assets outright and free of trust, he did not make a gift under I.R.C. § 2519, aligning with the principles of Estate of Anenberg v. Commissioner, 162 T.C. 199 (2024).

However, the Tax Court reached the opposite conclusion regarding the children. The court observed that "[b]efore the implementation of the Nonjudicial Agreement," Linda and Peter "held valuable rights, i.e., the remainder interests in the QTIP." By consenting to the transfer of all trust assets to Bruce, they gave up those valuable remainder interests and "received nothing in return." The court held that "[b]y giving up something for nothing," the children engaged in "quintessential gratuitous transfers and are therefore subject to gift tax under sections 2501 and 2511."

In a subsequent order dated April 25, 2025, the court clarified the measure of these gifts. It concluded that "[t]he ‘valuable rights’ [Linda and Peter] gave up were the rights they would have had under section 12.8 of Clotilde’s will had they not agreed in section 2 of the Nonjudicial Agreement that all trust property would be distributed to Bruce." Thus, the value of the taxable gifts equaled the value of the terminating distributions the children would have been entitled to receive under the terms of the will had they not agreed to distribute everything to their father.

The Core Valuation Conflict and Taxpayers' Request for Relief

At trial, the parties presented vastly divergent valuations. The Commissioner asserted that Linda and Peter each made a taxable gift of $53,408,746. In contrast, the taxpayers argued that each gift had a value of only $156,000, or in the alternative, no more than $34.9 million.

This massive discrepancy centered on four technical issues:

Whether the valuation of the remainder interests must reflect a deep discount due to Bruce’s testamentary limited power of appointment.
Whether the gifts should be reduced by the net gift mechanism under I.R.C. § 2207A to reflect the children's avoided reimbursement obligation.
Whether the remainder interests must be valued using the actuarial tables prescribed under I.R.C. § 7520.
Whether Bruce’s life expectancy should be adjusted downward by five years from standard actuarial tables due to his high income and perceived good health.

To support their positions, the taxpayers relied on the expert testimony of David Eckstein, a business valuation specialist, who utilized a discounted cash flow (DCF) methodology under three alternative scenarios.

Scenario I took into account Bruce’s income interest but disregarded his power of appointment and his discretionary principal rights. In his supplemental report, Eckstein initially valued the remainder interests at $53.21 million each, but after applying lack of marketability and lack of control discounts (which he subsequently prorated and effectively undid), and dividing by 1.4 to reflect a net gift tax adjustment under I.R.C. § 2207A, he calculated a "Post-Reimbursement Right Allocation" of $36.6 million each.
Scenario II factored in Bruce’s discretionary right to principal by increasing the discount rate (analogous to assuming Bruce would receive $16.2 million in principal distributions). This resulted in a net gift value of $34.9 million each (or $37.4 million if Bruce's actual age was used).
Scenario III factored in Bruce’s limited power of appointment, concluding that the remainder beneficiaries had only a "remote probability of receiving any cash flow," yielding a nominal remainder value of $156,000 each.

The Commissioner's expert, David Fuller, rejected the DCF model in favor of the "subtraction method," deriving the value of the remainder interests by subtracting the value of the income interest from the trust's net asset value ($117,604,143). Under his baseline projection, Fuller valued each remainder interest at $49,197,850 (or $51,793,550 in an alternative calculation).

Court's Analysis: State Law Precludes Section 7520 Table Valuation

The Commissioner’s primary position was that the Nonjudicial Agreement transformed the remainder interests into "prototypical property interest[s] that can (and must) be valued under section 7520." The taxpayers argued that because of Bruce's power of appointment and principal rights, the remainders were "restricted beneficial interests" exempt from the tables under Treas. Reg. § 25.7520-3(b)(1)(ii).

The Tax Court agreed with the taxpayers that the tables did not apply, but on a more fundamental legal ground. Judge Halpern emphasized the classic tenet of federal tax jurisprudence that state law defines property rights, while federal law governs their taxation. Citing Morgan v. Commissioner, 309 U.S. 78, 80 (1940), and Helvering v. Stuart, 317 U.S. 154, 161 (1942), the court noted that "[g]rantees under deeds, wills and trusts . . . take according to the rule of the state law" and "[t]he power to transfer or distribute assets of a trust is essentially a matter of local law."

While the plain language of I.R.C. § 7520(a) states that remainder interests "shall be determined" under prescribed tables, the court pointed out that the Commissioner selectively omitted the statute's opening words: "For purposes of this title."

Judge Halpern explained that a trustee tasked with dividing the trust assets under Section 12.8 of Clotilde's will would be determining the beneficiaries' substantive property rights under Washington state law, not making a determination "in the first instance, for purposes of the Code." Consequently, the court held:

"A trustee might look to the section 7520 tables for guidance, but we do not agree that those tables would be determinative... we think not."

Because the core valuation metric was what the children would have received under state law upon a hypothetical termination of the trust, the rigid actuarial tables of I.R.C. § 7520 did not dictate the result.

The Impact of the Testamentary Limited Power of Appointment under State Law

The court next turned to whether the trustee, operating under Section 12.8 of Clotilde's will, would reduce the value of the children’s terminating distributions due to Bruce's testamentary limited power of appointment. Under Washington state law, the court’s "paramount duty in construing wills is to give effect to the testator’s intent.", citing Schreiner v. Riemcke (In re Estate of Riemcke), 497 P.2d 1319, 1323 (Wash. 1972).

The taxpayers' expert's Scenario III assumed that because Bruce had executed a will exercising the power of appointment in favor of his revocable trust, the children's interest was practically worthless ($156,000). Under this view, the trustee would have been forced to distribute nearly all of the $117,604,143 in trust assets to Bruce.

The court flatly rejected this argument as "manifestly contrary to the intent reflected in Clotilde’s will." Judge Halpern observed:

"had Clotilde wanted to leave all her assets to Bruce she could easily have done so by bequeathing all her property to him free of trust, and her estate could still have utilized the marital deduction to defer transfer taxes until Bruce’s death."

By creating a trust and limiting Bruce's rights, Clotilde expressed a clear intent that Bruce should not have outright ownership. Therefore, the court concluded that if the parties had agreed to terminate the trust on October 31, 2016, without specifying a division of assets, a Washington state court would have required the trustee to assume that the trust assets would have been distributed in equal shares to the children upon Bruce's death, ignoring the testamentary power of appointment. The court found the Scenario III analysis "unhelpful because it implicitly rests on a view of Washington state law that we regard as incorrect."

Net Gift Treatment and the Avoided Section 2207A Reimbursement Obligation

The taxpayers achieved a significant victory on the application of I.R.C. § 2207A. Under the QTIP rules, if the children had received terminating distributions equal to their remainder interests, Bruce would have been deemed to have made a transfer of the remainder under I.R.C. § 2519(a), resulting in a substantial gift tax liability. Under I.R.C. § 2207A(b), Bruce would have had a statutory right to recover those gift taxes from the children.

Under Treas. Reg. § 25.2519-1(c)(4), a surviving spouse's gift tax recovery right reduces the amount of the deemed gift, creating an "interrelated computation" identical to a standard net gift, where the donee assumes the tax liability.

The Commissioner argued that this hypothetical gift tax was "too speculative" to reduce the value of the children's remainder interests, pointing out that no gift tax was actually paid or reserved under the Nonjudicial Agreement.

The Tax Court rejected this argument. Because the gift made by the children must be measured by comparing what actually occurred against what would have occurred had they received their proper distributions under Clotilde’s will, the court had to evaluate the hypothetical transaction. If they had received their distributions, Bruce would have owed gift tax and would have recovered it from them under I.R.C. § 2207A(b). Accordingly, the court ruled:

"what Linda and Peter each gave up, therefore, is the distribution he or she would have received net of the avoided liability to reimburse Bruce for gift tax."

Consequently, the value of the gifts had to be reduced under the net gift framework, dividing the pre-reimbursement remainder values by 1.4 (reflecting the 40% maximum marginal gift tax rate).

The Standard for Departing from Actuarial Life Expectancy Tables

The final issue concerned Bruce's life expectancy. The taxpayers' expert treated Bruce as being five years younger than his actual age of 85 because of his high income (2015 AGI of approximately $2.2 million, placing him in the top 1% of taxpayers) and Linda’s informal testimony that he was in "good health" and "mentally sharp". Eckstein cited a study in the Journal of the American Medical Association (JAMA) showing that high-earning males have longer life expectancies.

The Tax Court rejected this downward age adjustment, stating:

"B’s high income alone does not justify departing from standard actuarial tables to determine his life expectancy."

Judge Halpern explained that standard actuarial tables rely on the law of large numbers to provide reasonable estimates. He noted that adjusting these tables "to take into account some, but not all, factors unique to a particular individual would introduce bias and, in our judgment, would be methodologically questionable." Bruce's income was only one of many relevant factors, and the expert failed to conduct a comprehensive study. Eckstein did not review Bruce's medical records, did not interview Bruce, was not an actuary, and did not consult an actuary. The court therefore concluded that Bruce's life expectancy must be determined on the basis of his actual age on the date of termination.

Conclusion and Valuation Application

Based on the legal holdings, the court evaluated the final figures. The Commissioner conceded that if the I.R.C. § 7520 tables did not apply and the gifts were reduced under I.R.C. § 2207A, the value of each gift was no more than $35,141,321 (representing Fuller's baseline remainder valuation of $49,197,850 divided by 1.4).

Meanwhile, the taxpayers’ expert's Scenario II analysis—when corrected to use Bruce's actual age—valued each remainder interest at $37,400,000. This corrected taxpayer valuation was actually higher than the Commissioner's conceded net gift value of $35,141,321.

Because the court confirmed that the conditions of the Commissioner's concession were fully met, Judge Halpern held the Commissioner to his concession:

"Having determined that the conditions on which respondent based his concession have been met, we hold respondent to that concession and find that Linda and Peter each made a gift to Bruce of $35,141,321."

This decision reinforces a critical principle for tax professionals: while federal statutes dictate how property is taxed, state law remains the ultimate arbiter of the underlying property rights being valued. When trusts are terminated or commuted, planners must carefully analyze state law construct and the net-gift reimbursement mechanics of I.R.C. § 2207A.

Prepared with assistance from NotebookLM.