In an annual tradition, Ronald Aucutt, a McGuireWoods partner and chair emeritus of the firm’s private wealth services group, with help from his McGuireWoods colleagues, has identified the following as the top ten estate planning and estate tax developments of 2017. Ron is a past president of The American College of Trust and Estate Counsel; an observer and frequent participant in the formation of tax policy and regulatory and interpretive guidance in Washington, D.C.; and the editor of the Recent Developments materials that are presented each year at the Heckerling Institute on Estate Planning.
Number Ten: Challenges to the Substantiation of Charitable Contributions, Including Conservation Easements
Documentation of Charitable Contributions in General. In 2017, the Tax Court denied charitable contribution deductions in a number of cases because of inadequate documentation. In Oatman v. Commissioner, T.C. Memo. 2017-17 (Jan. 17, 2017), and Luczaj & Associates v. Commissioner, T.C. Memo. 2017-42 (March 8, 2017), there was no “contemporaneous written acknowledgment” from the donee organization, as section 170(f)(8)(A) requires in the case of any contribution of $250 or more.
In Izen, Jr. v. Commissioner, 148 T.C. No. 5 (March 1, 2017), a deduction claimed for the donation of a one-half interest in a 40-year-old Hawker-Siddley DH125-400A private jet to the Houston Aeronautical Heritage Society failed to meet the special requirements of section 170(f)(12) for contributions of used vehicles, including a contemporaneous written acknowledgment. Revealingly, the deduction claimed for the donation of the one-half interest was $338,080, while the entire plane had been purchased only three years earlier for only $42,000.
In RERI Holdings I, LLC v. Commissioner, 149 T.C. No. 1 (July 3, 2017), the donor of an LLC interest that was subject to a prior estate-for-years included an Appraisal Summary (Form 8283) with its income tax return, but the Appraisal Summary failed to disclose the basis in the donated LLC interest. As in Izen, basis information would have been very important, as the donor had purchased the LLC interest for only $2,950,000, while the deduction it claimed for the contribution 17 months later was $33,019,000. To make matters appear even worse, two years after receiving the LLC interest the donee sold it for only $1,940,000 to another LLC owned indirectly by the donor.
In Ohde v. Commissioner, T.C. Memo. 2017-137 (July 10, 2017), taxpayers claimed contributions to Goodwill Industries in 2011 of over 20,000 items with a value of $145,000. This was a part of a series of such deductions from 2007 through 2013 totaling over a half million dollars. For each delivery to Goodwill, the taxpayers obtained only a one-page generic receipt stating no quantities or values. The court found none of the taxpayers’ testimony to be credible.
Certain Syndicated Conservation Easements Now Listed Transactions. Notice 2017-10, 2017-4 I.R.B. 544 (Jan. 23, 2017), identified as “listed transactions” what it described as “conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amount invested.” As listed transactions, they must be reported by taxpayers, other participants, investors, and advisors under sections 6111 and 6112.
And Conservation Easement Litigation Continues. What seems to be a never-ending stream of litigation over contributions of conservation easements continued in 2017. The taxpayers lost, for failure to meet substantive and procedural requirements, in RP Golf v. Commissioner, 860 F.3d 1096 (8th Cir. Feb. 7, 2017), aff’g T.C. Memo. 2016-80 (liens not subordinated); Palmolive Building Investors, LLC v. Commissioner, 149 T.C. No. 18 (Oct. 10, 2017) (liens not subordinated); Ten Twenty Six Investors v. Commissioner, T.C. Memo. 2017-115 (June 15, 2017) (deed not recorded); Partita Partners LLC v. United States, ___ F. Supp. 3d ___ (S.D.N.Y. July 10, 2017) (entire façade not preserved); and Salt Point Timber, LLC v. Commissioner, T.C. Memo. 2017-245 (Dec. 11, 2017) (permitting replacement of the easement by a “comparable conservation easement” could permit the holder of the replacement easement to be an entity other than a “qualified organization” as defined in section 170(h)(3)).
This year, though, a couple taxpayers actually won. In 310 Retail, LLC v. Commissioner, T.C. Memo. 2017-164 (Aug. 24, 2017), and Big River Development, L.P. v. Commissioner, T.C. Memo. 2017-166 (Aug. 28, 2017), the Tax Court found that the “contemporaneous written acknowledgment” requirement could be satisfied by the deed itself. But the deeds in those cases included special details in the description of the property and discussion of consideration received that a typical deed might not include.
And one case continues with no final resolution. In BC Ranch, II, L.P. v. Commissioner, 867 F.3d 547 (5th Cir. Aug. 11, 2017), rev’g and rem’g Bosque Canyon Ranch, L.P. v. Commissioner, T.C. Memo. 2015-130, Bosque Canyon Ranch had bought a 3,729-acre tract of land for nearly $5 million and sold limited partnership interests that entitled the owners to build on specific 5-acre “homesites” within the tract. In 2005, Bosque Canyon gave a conservation easement over 1,750 acres of the land to the North American Land Trust and claimed an $8.5 million charitable contribution deduction. In 2007, BC Ranch II granted an additional conservation easement and claimed a $7.5 million charitable contribution deduction. The boundaries of the “homesites” within the donated easement property could be modified (with the donee’s approval). After almost four weeks of trial, the Tax Court held that the easement therefore was not perpetual and did not qualify, and upheld a gross valuation misstatement penalty. In a 2-1 decision, the Fifth Circuit vacated that holding of the Tax Court because what it viewed as “tweaking” the boundaries of the homesites could change neither the size of the homesites nor the ultimate exterior boundaries of the easement property. But that did not end the litigation, as the Fifth Circuit remanded the case to the Tax Court to consider other issues, including valuation.
Comment: In some of the taxpayer losses, extreme “too-good-to-be-true” facts could be signs of abusive taxpayer positions. In others, it is hard to tell because the cases are decided on grounds of procedure or documentation. To the extent that entirely legitimate deductions are being denied, the lesson is to be careful and avoid incomplete reporting. In any event, it appears that the IRS may challenge documentation because that is more objective and therefore easier than, for example, challenging valuation, in effect giving the IRS at least two bites at the apple.
Most of the taxpayer losses in the conservation easement cases involve what appear to be careless or uninformed omissions, and one can almost feel sorry for the courts that have to deal with those omissions. Salt Point Timber, however, appears to be an exception. In what looks like an effort to provide flexibility and simplify administration, the easement document provided that
in the event that (i) any of the [transferred property] is transferred to the owner of an adjacent property …, (ii) the adjacent property is encumbered by a comparable conservation easement and (iii) the owner of the adjacent property and the holder of the conservation easement agree to modify the conservation easement on the adjacent property to encumber the transferred property by the adjacent property’s conservation easement, the parties agree to amend this easement to release the transferred property from this easement.
In other words, if adjoining properties encumbered by comparable conservation easements were held by the same owner, the two easements could be replaced by just one of those easements. But, because this provision did not specifically require the replacement “comparable conservation easement” to be held by a “qualified organization” as defined in section 170(h)(3), the Tax Court held that the replacement easement did not have to be held by a qualified organization and therefore the opportunity for substitution disqualified the contribution. The court stated that “[the easement’s] omission of any restriction regarding the type of entity that can hold the replacement easement suggests that there is no such restriction” (page 17), that “the reference to ‘comparable’ easements is most naturally interpreted as a reference to the comparability of the terms of the easements, not the owner of the easement” (pages 18-19), and that “[h]ad the parties to the easement intended a replacement easement to be held by a ‘qualified organization’, they could have easily written such a restriction into … the easement” (page 19). Addressing the taxpayer’s argument that the possibility of such a replacement was “so remote as to be negligible” and therefore disregarded under Reg. §1.170A-14(g)(3), the court stated in part that “[i]t is … significant that [the parties to the easement] bothered to put [the replacement provision] in the easement” (page 21).
A much more satisfying analysis would have noted that the parties “bothered” to state that the replacement easement must be “comparable,” and that a significant element of comparability – perhaps the most significant element in a conservation easement setting – is comparability of tax treatment, which among other things would require a qualified organization to hold the easement. With a $2,130,000 charitable deduction at stake, it should not be surprising if the Tax Court’s strained holding is appealed and the Court of Appeals for the Fourth Circuit reverses it.
Conservation easements – aren’t they odd? They save a view AND save a wad. Two will win and five will lose, While BC Ranch FOREVER sues, And some are just about façade.
Number Nine: Decline of State Estate Taxation
In 2001 nearly every state had a “pick-up” or “soak-up” or “sponge” estate tax that conformed to the federal credit for state death taxes under section 2011. The phase-out of the federal credit under the 2001 Tax Act caused the corresponding phase-out of state estate taxes in states that totally conformed to the credit, whatever it happened to be. Since then, other states have eliminated their estate taxes, either altogether or simply by conforming them to the federal credit that no longer exists.
Delaware and New Jersey eliminated their estate taxes as of January 1, 2018. Delaware now does not tax transfers at death. New Jersey still has an inheritance tax of up to 16 percent on transfers to sisters, brothers, daughters-in-law, sons-in-law, and others, but it does not apply to transfers to spouses, parents, grandparents, descendants, or charitable organizations. Meanwhile, Connecticut increased its estate and gift tax exemption to $2,600,000 for 2018, to $3,600,000 for 2019, and to the federal exemption in 2020. The District of Columbia modified legislation passed in 2015 to make its exemption equal to the federal exemption. Minnesota increased its exemption from $1,800,000 to $2,100,000 retroactively for 2017, to $2,400,000 for 2018, to $2,700,000 for 2019, and to $3,000,000 after 2019.
Delaware’s action leaves only 17 jurisdictions with their own estate or inheritance tax. Those 17 jurisdictions are Connecticut, the District of Columbia, Hawaii, Illinois, Iowa (inheritance tax only), Kentucky (inheritance tax only), Maine, Maryland, Massachusetts, Minnesota, Nebraska (county inheritance tax only), New Jersey (inheritance tax only), New York, Oregon, Rhode Island, Vermont, and Washington. But even with no estate tax in two-thirds of the states, consideration of state taxes by estate planners in those states might be important because people could move to a state with an estate tax or could merely own property in such a state. The ownership of property could create some surprises, as in the case of a 2015 Advisory Opinion of the New York State Department of Taxation and Finance (TSB-A-15(1)M (May 29, 2015)) that an interest in a single-member Delaware limited liability company treated as a disregarded entity that owned New York real property would not be treated as an intangible asset but would be subject to New York estate tax. In addition, taxes in states where children and other beneficiaries might live could affect the design of long-term trusts. In an estate subject to the 40 percent federal estate tax, a state tax rate of 16 percent, deductible for federal tax purposes under section 2058, results in a net burden of 9.6 percent (0.16 × (1 – 0.4)).
A state death tax once was a credit ’Till Congress said it wouldn’t let it. Since Two Thousand and One We’ve been having such fun, As one by one states say “Forget it!”
Number Eight: Measured Retroactive Relief for Same-Sex Married Couples
In United States v. Windsor, 111 AFTR 2d 2013-2385, 133 S.Ct. 2675, 186 L.Ed.2d 808 (2013), the Supreme Court ruled that the Constitution required the federal government to recognize same-sex marriages that were recognized by state law. Presumably that meant that such marriages had always been entitled to federal recognition, because the Constitution had not changed in this respect. But the claims of some federal tax benefits for such couples were barred by the statute of limitations.
Notice 2017-15, 2017-6 I.R.B. 783 (Jan. 17, 2017), has now resolved that tension by explicitly allowing the retroactive recalculation of marital deductions and generation assignments for purposes of determining the currently remaining applicable exclusion amount for estate and gift tax purposes and GST exemption for generation-skipping transfer (GST) tax purposes, even if the statute of limitations has run for the years in which those marital deductions and generation assignments were originally determined. That relief is obtained by filing a new or revised gift or estate tax return with the notation “FILED PURSUANT TO NOTICE 2017-15” at the top.
If the applicable statute of limitations has run, however, Notice 2017-15 does not permit a late election to split gifts under section 2513, or to make a QTIP or QDOT election without “9100 relief” under Reg. §301.9100-3. Likewise, Notice 2017-15 does not allow claims for refund of tax paid if those claims are barred by the statute of limitations.
Notice 2017-15 seems to strike a reasonable balance between the constitutional rights of married couples and the principle of repose that underlies statutes of limitations. Moreover, the restraint shown in Notice 2017-15 with regard to years closed by the statute of limitations works both ways. For example, if one spouse in a same-sex marriage created a grantor retained income trust (GRIT) since 1990 with the other spouse as the remainder beneficiary, that remainder beneficiary is now a “member of the family” and the GRIT would be subject to the special valuation rules of section 2702, but the IRS is not allowed to collect any gift tax that such a transfer would generate today. As pointed out in Number Two of the 2013 Top Ten:
Marital status confers a number of tax advantages, including gift-splitting (sections 2513(a) and 2652(a)(2)), the marital deduction (sections 2056 and 2523), portability of the estate and gift tax unified credit (section 2010(c)), per se same generation assignment (section 2651(c)) and reverse-QTIP elections (section 2652(a)(3)) for GST tax purposes, the availability of disclaimers even if the property passes for the disclaimant’s benefit (section 2518(b)(4)(A)), a personal exemption (section 151(b)) [eliminated through 2025 by the 2017 Tax Act], the nonrecognition of gain on transfers between spouses (section 1041(a)), expanded eligibility to exclude gain from the sale of a principal residence (section 121(b)(2)(A)), and treatment of spouses as one shareholder of an S corporation (section 1361(c)(1)).
Marriage also presents some potential tax disadvantages, such as treatment of a spouse as a member of the family under chapter 14 (sections 2701(e)(1) and 2704(c)(2)) (which would prevent the use of a GRIT, for example), disallowance of losses (sections 267(c)(4) and 707(b)), disallowance of a stepped-up basis in certain cases (section 1014(e)(1)(B)), attribution of stock ownership (section 318(a)(1)), and status as a disqualified person under the private foundation rules (section 4946(d)).
Other tax attributes that attach to marriage can be good or bad, depending on the circumstances. This includes the filing of a joint income tax return itself (section 6013), which can be a benefit when one spouse has all or most of the income, but can produce a “marriage penalty” [made worse by the 2017 Tax Act] when both have significant income, and married persons in such cases cannot elect the more advantageous filing as single taxpayers. Similarly, married status can make it easier to qualify a trust as a grantor trust (sections 672(e) and 677(a)(1)), whether that is desirable or undesirable.
Number Seven: Growing Legislative Acceptance of Asset Protection Trusts
Effective February 5, 2017, Michigan became the eighteenth state to authorize self-settled asset protection trusts by statute. Those 18 states are Alaska, Colorado, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming.
Like other states, Michigan requires a Michigan trustee and the custody of or record-keeping for at least some of the trust property to be maintained in Michigan. Similarly, to protect against transfers to avoid current creditors, Michigan requires an affidavit confirming the grantor’s solvency after the transfer.
While Michigan maintains the trend toward the adoption of such legislation, a majority of states and the District of Columbia are still without such legislation. It is notable that no case is known in which a court has ruled that a resident of a state without such a statute may invoke the statute of another state.
Number Six: Developments with Portability on Several Fronts
The 2010 Tax Act provided for the portability of a deceased spouse’s unused exclusion amount (which the regulations call the “DSUE amount”) to the surviving spouse, beginning in 2011. The 2012 Tax Act made portability permanent. Under section 2010(c)(5)(A), however, portability is not allowed unless elected on a timely filed estate tax return for the estate of the predeceased spouse. Many have questioned the need for such an election – why wouldn’t portability always be desirable? – but, while the need for an election was criticized when portability was proposed and discussed in 2006 and 2008, it was retained in every legislative version. Inevitably, the need for an affirmative election of portability has required further relief and interpretation.
Relief for Late Elections. Executors of estates below the threshold requiring the filing of an estate tax return are still able to file a return solely to elect portability (a “portability-only return”). Notice 2012-21, 2012-10 I.R.B. 450, reported that the IRS had received comments
that the executors of estates of decedents dying in 2011, particularly during the early part of 2011, did not have the benefit of guidance on electing portability of the decedent’s DSUE amount and, further, that executors of estates having assets with a value not in excess of $5,000,000 might not have known about the requirement to file Form 706 to make the portability election at all.
Accordingly, Notice 2012-21 granted an automatic six-month extension of time to file a portability-only return and make a portability election. For the same reasons, and also to provide an opportunity to elect portability to surviving spouses of same-sex marriages only recently recognized under United States v. Windsor, 111 AFTR 2d 2013-2385, 133 S.Ct. 2675, 186 L.Ed.2d 808 (2013) (discussed in Number Eight), Rev. Proc. 2014-18, 2014-7 I.R.B. 513, provided a simplified method for obtaining an extension of time to file a portability-only return through December 31, 2014.
Rev. Proc. 2017-34, 2017-26 I.R.B. 1282 (June 9, 2017), further extended the time to file portability-only returns to the later of January 2, 2018, or the second anniversary of the decedent’s death. In effect, this means that
- the temporary relief granted by Notice 2012-21 and Rev. Proc. 2014-18 was extended once again through January 2, 2018, for all decedents dying after December 31, 2010, and before January 3, 2016; and
- permanent relief is granted through the second anniversary of the decedent’s death for all decedents dying after January 2, 2016.
Explaining the choice of the second anniversary of the decedent’s death, the revenue procedure states:
In providing this relief, Treasury and the Service have considered requests received for a permanent and unlimited extension, but also have considered both the statutory requirement of a timely filed return and the prejudice to the government from a lack of available records and current appraisals resulting from a long delay between a decedent’s death and the filing of an estate tax return for that decedent’s estate …
… Making the simplified method of this revenue procedure available after January 2, 2018, to estates during the two-year period immediately following the decedent’s date of death should not unduly compromise the ability of the taxpayer or the Service to compute and verify the DSUE amount because the necessary records are likely to be available during that period. In addition, limiting the availability of this simplified method to that two-year period could be beneficial to the surviving spouse or the surviving spouse’s estate in two ways. First, it increases the likelihood that the portability election will be made before the surviving spouse or the executor of the surviving spouse’s estate is required to file a gift or estate tax return, thus eliminating the need to file such a return without claiming any DSUE amount and then, after the portability election has been made, having to either file a supplemental return or file a claim for a credit or refund. Second, if the allowance of the portability election made pursuant to this revenue procedure and the corresponding revised computation of the surviving spouse’s applicable credit amount would result in a credit or refund of the surviving spouse’s gift or estate tax, the availability of the simplified method during the two-year period may reduce the risk that the period under § 6511 for filing a claim for that credit or refund (generally, extending three years from the date of filing or, if later, two years from the date of payment) would expire before the portability election could be made pursuant to this revenue procedure.
It is possible to quarrel with that reasoning, especially with the math comparing two years after the predeceased spouse’s death to three years after the surviving spouse files a return, but the revenue procedure reflects a thoughtful effort to balance the competing considerations. Because this two year rule (since January 2 the only rule) is now permanent, it is unlikely that the IRS contemplates any further extensions or similar relief.
Limited Re-Examination of Predeceased Spouse’s Return. When a portability election has been made, section 2010(c)(5)(B) allows the IRS to re-examine the first estate tax return, even after the statute of limitations has run, for the limited purpose of determining the correct DSUE amount available to the surviving spouse. If that statute of limitations has run, the IRS is permitted in such a re-examination only to reduce or eliminate the surviving spouse’s DSUE amount. It cannot, for example, assess additional estate tax with respect to the first return. As the limited opportunity for same-sex married couples to retroactively recalculate available exemptions going forward (discussed in Number Eight) seems like a reasonable administrative balance, so does this limited opportunity to re-examine the estate tax return of a predeceased spouse seem like a reasonable legislative balance between the desirability for fairness and the need for repose.
Even so, in Estate of Sower v. Commissioner, 149 T.C. No. 11 (Sept. 11, 2017), a surviving spouse’s executor resisted that re-examination, asserting among other things, that (i) the first estate had received a closing letter, (ii) this was an “impermissible second examination,” and (iii) it was an unconstitutional denial of due process. Not surprisingly, the Tax Court rejected all these arguments, allowed the re-examination, and reduced the DSUE amount on the basis of the findings of that examination.
Executor’s Duty to Elect Portability. In In re Vose, 390 P.3d 238 (Okla. Jan. 17, 2017), the Oklahoma Supreme Court unanimously held that making a portability election is part of the executor’s duty and the executor cannot refuse the surviving spouse’s request to make the election. In this case, Mr. Vose was the surviving spouse and Mr. Lee was the executor (administrator). Predictably, Lee was the decedent’s son from a prior marriage, and he and Vose apparently did not get along. Vose had relinquished his rights to a share of the estate in a 2006 antenuptial agreement and did not have any interest in the estate other than his interest in portability of the available DSUE amount.
The Oklahoma Supreme Court reasoned that, despite the fact that Vose was not an heir and had no potential right to an intestate share, section 2010
grants Vose a potential interest in a part of Decedent’s estate under the control of Lee as the administrator. Vose may have a pecuniary interest as the surviving spouse in the portability of the DSUE independent of his ability to take as an heir.
One cringes at the notion that portability is “a part of Decedent’s estate,” perhaps carrying a taxable value. Portability cannot be used or transferred by the predeceased spouse; in effect it is created by the election after the spouse dies and can be used only by the surviving spouse. The court seemed to acknowledge that, in addressing Lee’s argument that in the antenuptial agreement Vose had waived his standing to press his DSUE point, by stating:
The portable DSUE amount is not simple property acquired by one party over the course of the marriage according to existing laws in effect when the agreement was made. It is an interest created by the federal tax code that was an impossibility at the time the antenuptial agreement between Vose and Decedent was created (2006).
Again seeming to touch on the nature of portability as an estate asset, the court cited Lee’s argument that “since the DSUE is valuable only to Vose, while at the same time being an estate asset under Lee’s complete control, he should be allowed to demand consideration from Vose in exchange for making the election,” and added that “Vose has also agreed to pay any costs associated with preparing the necessary return.”
Comment: Aside from the ominous implications that portability is a valuable estate asset, the Vose opinion leaves many questions about the scope of its holding. Would the outcome have been the same if the antenuptial agreement had been signed after the 2010 Tax Act had first enacted portability or the 2012 Tax Act had made it permanent? Would the outcome have been different if Vose had not paid the costs of preparing the estate tax return? What would be the tax consequences if Vose had actually compensated Lee for making the election, above and beyond those costs? What role is there for the legitimate objective reasons there might be for not making a portability election – when, for example, the return for the predeceased spouse’s estate is properly prepared but reflects debatable interpretations or a gift history involving aggressive valuations, and the executor simply doesn’t want the return to get undue attention, especially if the surviving spouse is elderly or ill and may not survive until the statute of limitations runs?
And wasn’t portability supposed to simplify the administration of estates, especially smaller estates below the requirements for filing an estate tax return? Would those who advocated it and voted for it even recognize, for example, now widely discussed techniques for using portability proactively in larger estates to gain a larger basis step-up when the surviving spouse dies? Perhaps combined with asset protection or GST exemption allocations? Or what would they think simply about the tension reflected in a scenario like that in Vose?
Finally, one lesson from Vose is that portability should be discussed, and addressed both in any premarital agreement and in estate planning documents. Even so, the challenge would still be anticipating the scenarios in which a portability election might not be suitable. And documenting in a public record scenarios that might identify potential vulnerability of the first estate tax return does not seem like a good idea.
The survivor went to court To force DSUE to port. The courts said yes, But what a mess When simple concepts we contort.
Number Five: Continued Tension between Congress and the IRS
The House of Representatives Republican leadership released a “Blueprint” for “A Better Way: Our Vision for a Confident America” on June 23, 2016 (Number Two in the 2016 Top Ten). After the 2016 election, the Blueprint was one of the pillars of what became the 2017 Tax Act (Number One in this Top Ten). It announced (at page 5):
This Blueprint will achieve three important goals:
- It will fuel job creation and deliver opportunity for all Americans.
- It will simplify the broken tax code and make it fairer and less burdensome.
- It will transform the broken IRS into an agency focused on customer service.
Thus, matched with the economy and the tax code, transforming “the broken IRS” comprised one-third of the Blueprint’s fundamental objectives. Later (at page 7), the Blueprint elaborated its view of the IRS as “a broken tax collection agency that continues to fail the American people.”
This, of course, was the fallout from years (if not decades) of suspicion, particularly on the part of the Republican leadership (although it was also observed, perhaps not quite as dramatically, in the Democratic congressional leadership during Republican Administrations). The suspicion was aggravated by allegations in 2013 of politically-motivated discriminatory treatment of citizens, destruction of emails, and so forth, and by both excessive partisan accusations and excessive partisan defenses during that time. And of course it was aggravated by a growing bitterness, even hostility, in some segments of society toward the IRS, which sometimes is a proxy for all of what some see as excessively intrusive government.
This suspicion naturally has been reflected in relentless reductions of the IRS budget. The Internal Revenue Service Advisory Council (IRSAC), a group of independent, dedicated, and thoughtful professionals with whom I was privileged to serve from 2014 through 2016, wrote this in its 2017 annual Report of November 15, 2017 (page 12):
Regrettably, overall funding for the IRS has decreased dramatically – by approximately $1 billion – since [Fiscal Year] 2010, even though the requirements imposed by Congress have expanded during the same period. The agency’s increased workload is attributable not only to population growth and economic expansion, but to the enactment of the Patient Protection and Affordable Care Act (ACA), the Foreign Account Tax Compliance Act (FATCA), and other complex laws, which spawned the need for guidance and educational outreach as well as enforcement initiatives to ensure compliance.
Today we would add the 2017 Tax Act as another expansion, and another pending budget cut of about $120 million as another confirmation of the short-sighted congressional reaction.
This tension has produced two negative consequences. The first, of course, is a decline in IRS professional resources, resulting in failure to collect taxes that should be paid, decline and delay in guidance projects, difficulties in obtaining closing letters and lien releases, occasional suspension of the issuance of certain letter rulings, terrible telephone service, and dramatic reductions in training, forcing upon taxpayers a shrinking, untrained work force. On page 4 of the Preface to her 2017 Annual Report to Congress, released January 10, 2018, National Taxpayer Advocate Nina E. Olson bluntly stated: “The IRS has reduced its employee training budget by nearly 75 percent since FY 2009.” Tax professionals are used to audit encounters being adversarial, but dealing with examiners unfamiliar with the law and basic estate planning techniques is unusually exasperating. Sometimes the unfortunate result is an approach to audit of “throwing everything against the wall to see what sticks,” as case law seems to bear out.
The second, and not as obvious, consequence has been the distraction of Congress itself from the policy considerations that ought to be paramount in designing major tax legislation. Even after early May 2017, when Republican leaders said that IRS reform would be separated from tax reform, those same leaders were frequently heard tying tax reform to the “broken IRS” in their stump speeches. This distraction may have hindered Congress from focusing on tax reform like some in Congress wanted to. Ultimately, it probably slowed the process that met the leadership’s sliding objective of getting tax legislation enacted by Christmas.
The Internal Revenue Service Made some in Congress nervous, But when training funds tumble, Making auditors stumble, The public will grumble, “What did WE do to deserve this?”
[Okay, the poem is one line longer than it should be, but, like the IRS budget, what can be cut?]
Number Four: Withdrawal of the Proposed Section 2704 Regulations
Proposed Regulations under the special valuation rules of section 2704, released August 2, 2016, and published in the Federal Register August 4, 2016 (81 Fed. Reg. 51413), were instantly controversial. As detailed in Numbers Four and Three of the 2016 Top Ten, the controversy was not just between tax professionals and the IRS, it was among tax professionals themselves. Many tax professionals read the proposed regulations as the elimination of “all discounts” and an attack on family businesses, reinforced by the hostility toward the IRS in some segments of society mentioned in Number Five. I took a narrower view of the intended scope (and, read benevolently, the actual scope) of the regulations and viewed their improvement through the notice and comment process as a way to possibly secure an explicit exception for family-owned operating business and in any event make progress toward clarity of rules that would reduce controversies and avoid frustrating fact-specific and sometimes judge-specific case law.
In 2017, the broader view of the proposed regulations, fueled by the partisanship discussed in this year’s Number Five and last year’s Number Three, prevailed. Executive Order 13789 (April 21, 2017), 82 Fed. Reg. 19317 (April 26, 2017), directed the Treasury Department to identify regulations, including proposed regulations, issued on or after January 1, 2016, that “(i) impose an undue financial burden on United States taxpayers, (ii) add undue complexity to the Federal tax laws, or (iii) exceed the statutory authority of the Internal Revenue Service.” In its first report in response to that directive, dated June 22, 2017, Treasury identified eight such regulations, including the proposed regulations under section 2704. This was reported in Notice 2017-38 (July 7, 2017), 2017-30 I.R.B. 147 (July 24, 2017). In its second Report (Oct. 2, 2017), 82 Fed. Reg. 48013 (Oct. 16, 2017), Treasury, referring to the Proposed Regulations as “a web of dense rules and definitions,” concluded:
After reviewing these comments, Treasury and the IRS now believe that the proposed regulations’ approach to the problem of artificial valuation discounts is unworkable. … In light of these concerns, Treasury and the IRS currently believe that these proposed regulations should be withdrawn in their entirety.
They were withdrawn on October 20, 2017. 82 Fed. Reg. 48779.
Comment: Unlike the discussions of all the other seven regulations identified in Notice 2017-38, no reference was made to modifications that could salvage the regulations. Neither was the door explicitly closed to re-proposal of the regulations with modifications. But in view of the announced conclusion that “the proposed regulations’ approach to the problem of artificial valuation discounts is unworkable,” a problem that a few tweaks and changes of vocabulary are not apt to fix, re-proposal seems unlikely in the near future. Incidentally, the word “artificial” had not been used in the proposed regulations or their preamble to describe the discounts that were being targeted; if it had been, the drafters might have been spared at least some of the firestorm of criticism.
Reprise (my view):
The Service thinks people need more Regulations for 2704, But the public mistook them And wrongly forsook them, And now they’re not here anymore.
Second Reprise (for the sake of balance):
The Service thinks people need more Regulations for 2704, But what were they thinking That the draft was so stinking That now it’s not here anymore?
Number Three: An Extreme Family Limited Partnership Case
Just as 2017 saw in the withdrawal of the proposed section 2704 regulations a missed opportunity to reduce frustrating fact-specific and judge-specific case law, it also saw one of the most frustrating fact-specific and judge-specific estate and gift tax cases in a long time.
“Bad Facts Make Bad Law.” In Estate of Powell v. Commissioner, 148 T.C. No. 18 (May 18, 2017) (reviewed by the Court), the decedent’s son, acting under a power of attorney from the decedent, contributed approximately $10 million in cash and marketable securities to a limited partnership and took back, on the decedent’s behalf, a 99 percent limited partner interest. That son and his brother contributed unsecured promissory notes and took back a 1 percent general partner interest. On the same day, the son with the power of attorney contributed the decedent’s limited partner interest to a charitable lead annuity trust (CLAT). Already, the son on both sides of the transaction, the disproportionate contributions to the partnership, and the flimsy contributions by the general partners signaled this as a “bad facts” cases. But then the decedent died seven days later (with the same son as executor). Seven concurring judges viewed this as “what is best described as aggressive deathbed tax planning.”
Senior Judge Halpern, writing for only a plurality (eight judges, while nine judges concurred, seven in an opinion and two in the result only) found that section 2036(a)(2) applied to the decedent’s transfer. The application of section 2036(a)(2), implying control of an entity and not just benefit from the entity as under section 2036(a)(1), was unprecedented in a case involving a decedent who held only a limited partner interest. Although Estate of Strangi v. Commissioner, T.C. Memo. 2003-145, aff’d, 417 F.3d 468 (5th Cir. 2005), had involved similar facts, Mr. Strangi had been a director and 47-percent shareholder of the corporate general partner. Moreover, while the Tax Court did rely on section 2036(a)(2) as an alternative to its section 2036(a)(1) holding in Strangi, the Court of Appeals for the Fifth Circuit, in footnote 7 of its affirmance, explicitly stated:
Because we hold that the transferred assets were properly included in the taxable estate under § 2036(a)(1), we do not reach the Commissioner’s alternative contention that Strangi retained the “right ... to designate the persons who shall possess or enjoy the property”, thus triggering inclusion under § 2036(a)(2).
Judge Halpern, on the other hand, having decided Powell on the basis of section 2036(a)(2), did not address section 2036(a)(1) or 2038.
The executor’s counsel apparently did not even contest the application of section 2036 or 2038, other than to point out that the limited partner interest had been given to the CLAT pursuant to the power of attorney and was not held by the decedent at death. Unfortunately for that litigation strategy, the power to make gifts under the power of attorney was limited to annual exclusion gifts to the decedent’s issue. And even if the transfer to the CLAT had been successful in cutting off exposure under section 2036, wouldn’t section 2035(a) have brought the value of the property back into the decedent’s gross estate? And that’s assuming that the CLAT annuity interest measured by the life of someone who died a week later would have had much value anyway.
Section 2043 and Double Taxation. On his own, Judge Halpern explored a convoluted and seemingly unnecessary analysis of the effect of section 2043, which had not been raised, argued, or briefed by either of the parties. The opinion echoes themes like “recycling” and “pooling” that have been used to evaluate family limited partnerships in other contexts (see Estate of Harper v. Commissioner, T.C. Memo. 2002-121) and invents its own metaphor of "doughnuts" and "doughnut holes" to refer, respectively, to retained interests and valuation discounts. While repeatedly using words like “limits” and “limiting” to refer to section 2043, the opinion, in footnote 7, observes that the result could be “a duplicative transfer tax” (translated double taxation) in some cases, although not this case.
Comment: Seventeen judges participated in the Powell case. Eight judges, counting Judge Halpern, joined Judge Halpern’s opinion. Judges Foley and Paris concurred in the result only, while Judge Lauber, joined by six other judges, wrote a concurring opinion. Thus, while there was no dissent from what should have been a very easy decision in a case with extremely bad facts, Judge Halpern’s opinion did not even speak for a majority of the judges. Judge Lauber wrote that “[t]he Court’s exploration of section 2043(a) seems to me a solution in search of a problem.” Yet we now have a Tax Court opinion, dignified by the caption “Reviewed by the Court,” that is one of the least understandable opinions ever seen. With stretched IRS resources (discussed in Number Five) and reduced hope for relevant regulatory guidance (discussed in Number Four), a path to finding control in a totally nonvoting interest and the temptation of a new and open-ended “duplicative transfer tax” theory are just what the audit of gift and estate tax returns needs!
There once was a case named Powell That made all estate planners howl, ‘Cause the court’s logic got twisted When Petitioner persisted Instead of just throwing in the towel.
Number Two: The Regulatory Environment in the Trump Administration
Trump Administration Initiatives. On January 30, 2017, ten days after his inauguration, President Trump issued Executive Order 13771, titled “Reducing Regulation and Controlling Regulatory Costs.” It requires that whenever a federal department or agency proposes a significant new regulation, it must identify at least two existing regulations to be repealed. It also requires that the net cost of the new regulation, taking into account the savings from the accompanying repeal, be “no greater than zero.” These principles do not self-evidently apply to tax regulations (which really do not “regulate” in the sense this Executive Order apparently contemplates). Eventually Treasury, the IRS, and the Office of Management and Budget (OMB) should be able to figure that out.
This was followed on February 24, 2017, by Executive Order 13777, titled “Enforcing the Regulatory Reform Agenda.” It requires each federal department and agency to designate a Regulatory Reform Officer and establish a Regulatory Reform Task Force. Among other things, each Regulatory Reform Task Force is to review existing regulations and
attempt to identify regulations that:
(i) eliminate jobs, or inhibit job creation;
(ii) are outdated, unnecessary, or ineffective;
(iii) impose costs that exceed benefits;
(iv) create a serious inconsistency or otherwise interfere with regulatory reform initiatives and policies;
(v) are inconsistent with [specified transparency standards]; or
(vi) derive from or implement Executive Orders or other Presidential directives that have been subsequently rescinded or substantially modified.
For purposes of both Executive Orders 13771 and 13777, a “regulation” includes “an agency statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy or to describe the procedure or practice requirements of an agency.” But these requirements do not apply to regulations related to the military, national security, foreign affairs, an agency’s own management or personnel, or any other category the OMB Director exempts. In the tax context, the actions caught by that definition could include revenue rulings, revenue procedures, and perhaps even occasional notices and announcements. The reference to “particular applicability” seems broad enough to include even taxpayer-specific actions like letter rulings, but there is no reason to assume that it would be pushed to such an extreme.
Then of course Executive Order 13789, targeted at Treasury and titled “Identifying and Reducing Tax Regulatory Burdens,” was issued on April 21, 2017, directing the review of recent tax regulations that led to the withdrawal of the proposed regulations under section 2704 discussed in Number Four. In addition to announcing the fate of the eight identified regulations, Treasury’s October 2 Report stated that:
Treasury continues to analyze all recently issued significant regulations and is considering possible reforms of several recent regulations not identified in the June 22 Report [Notice 2017-38]. … In addition, in furtherance of the policies stated in Executive Order 13789, Executive Order 13771, and Executive Order 13777, Treasury and the IRS have initiated a comprehensive review, coordinated by the Treasury Regulatory Reform Task Force, of all tax regulations, regardless of when they were issued. … This review will identify tax regulations that are unnecessary, create undue complexity, impose excessive burdens, or fail to provide clarity and useful guidance, and Treasury and the IRS will pursue reform or revocation of those regulations.
Along this line, in addition to directing an immediate review of all tax regulations issued in 2016 and 2017, Executive Order 13789 had stated:
To ensure that future tax regulations adhere to the policy described in … this order, the Secretary [of the Treasury] and the Director of the Office of Management and Budget shall review and, if appropriate, reconsider the scope and implementation of the existing exemption for certain tax regulations from the review process set forth in Executive Order 12866 and any successor order.
That is a reference to a “regulatory impact assessment.” For example, the Preamble to the August 2, 2016, proposed section 2704 regulations itself included a typical statement that “Certain IRS regulations, including this one, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a regulatory impact assessment is not required.”
Regulatory Impact Assessment. If a “regulatory impact assessment” is required, it must, among other things, include the following information specified in section 6(a)(3)(C) of Executive Order 12866 (signed on September 30, 1993, by President Clinton) (emphasis added):
(i) An assessment, including the underlying analysis, of benefits anticipated from the regulatory action (such as, but not limited to, the promotion of the efficient functioning of the economy and private markets, the enhancement of health and safety, the protection of the natural environment, and the elimination or reduction of discrimination or bias) together with, to the extent feasible, a quantification of those benefits;
(ii) An assessment, including the underlying analysis, of costs anticipated from the regulatory action (such as, but not limited to, the direct cost both to the government in administering the regulation and to businesses and others in complying with the regulation, and any adverse effects on the efficient functioning of the economy, private markets (including productivity, employment, and competitiveness), health, safety, and the natural environment), together with, to the extent feasible, a quantification of those costs; and
(iii) An assessment, including the underlying analysis, of costs and benefits of potentially effective and reasonably feasible alternatives to the planned regulation, identified by the agencies or the public (including improving the current regulation and reasonably viable nonregulatory actions), and an explanation why the planned regulatory action is preferable to the identified potential alternatives.
That regulatory impact assessment, along with a draft of the proposed regulations, must be reviewed within OMB before a proposed regulation is published for public comment. In addition, the public must be informed of the content of the regulatory impact assessment and of any changes made in the draft of the proposed regulations after that draft was submitted to OMB for review. Obviously, that is not information we are accustomed to seeing in connection with tax regulations.
Under section 3(f) of Executive Order 12866, these requirements apply to
any regulatory action that is likely to result in a rule that may:
(1) Have an annual effect on the economy of $100 million or more or adversely affect in a material way the economy, a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local, or tribal governments or communities;
(2) Create a serious inconsistency or otherwise interfere with an action taken or planned by another agency;
(3) Materially alter the budgetary impact of entitlements, grants, user fees, or loan programs or the rights and obligations of recipients thereof; or
(4) Raise novel legal or policy issues arising out of legal mandates, the President’s priorities, or the principles set forth in this Executive order.Heretofore most tax regulations, like the section 2704 proposed regulations, have been considered exempt. But it is easy to see how the application of these criteria – especially the first and possibly the fourth – can involve subjective assumptions and judgments, which Executive Order 13789 has now directed Treasury to “reconsider.” We should anticipate that there will be pressure in the Trump Administration for those assumptions and judgments to be more favorable to taxpayers. The result may be that more regulatory impact assessments will be required, or fewer regulations will be issued, or both.
Treasury-IRS Priority Guidance Plan. The Treasury-IRS Priority Guidance Plan for the 12 months beginning July 1, 2017, was published on October 20, 2017, a bit later than usual (although it rarely if ever has been published by July 1). Of course the entire plan is now at risk of a downgraded priority as the IRS must give its attention to changes and guidance required by the 2017 Tax Act (discussed in Number One). Meanwhile, the introduction to the plan states:
Part 1 of the plan focuses on the eight regulations from 2016 that were identified pursuant to Executive Order 13789 and our intended actions with respect to those regulations. Part 2 of the plan describes certain projects that we have identified as burden reducing and that we believe can be completed in the 8½ months remaining in the plan year. As in the past, we intend to update the plan on a quarterly basis, and additional burden reduction projects may be added. Part 3 of the plan describes the various projects that comprise our implementation of the new statutory partnership audit regime, which has been a topic of significant concern and focus as the statutory rules go into effect on January 1, 2018. Part 4 of the plan, in line with past years’ plans and our long-standing commitment to transparency in the process, describes specific projects by subject area that will be the focus of the balance of our efforts this plan year.
Part 1, titled “E.O. 13789 – Identifying and Reducing Regulatory Burdens” contains eight items, the first of which is the withdrawal of the proposed section 2704 regulations discussed in Number Four. Part 2, titled “Near-Term Burden Reduction,” contains 18 items, including the consistent basis rules and the section 2642(g) regulations. Part 4, titled “General Guidance,” like previous plans and as noted above, “describes specific projects by subject area that will be the focus of the balance of [Treasury’s and the Service’s] efforts this plan year.” It lists 166 items (down from 281 last year), including three items (down from 12 last year) under the heading of “Gifts and Estates and Trusts” – the basis of grantor trust assets at death, restrictions on estate assets during the alternate valuation period, and personal guarantees and present value concepts in determining estate tax deductions. Those five items in Parts 2 and 4 are described and analyzed below:
Consistent Basis Rules. This item is described in the plan as “Regulations under §§1014(f) and 6035 regarding basis consistency between estate and person acquiring property from decedent.” In contrast, the fourth item under the heading of “Gifts and Estates and Trusts” in the 2016-2017 Plan was expressed as “Final regulations under §§1014(f) and 6035 regarding consistent basis reporting between estate and person acquiring property from decedent.” It is not clear what significance should be attached to the removal of the words “Final” and “reporting.” The “reporting” portion of the proposed and temporary regulations published on March 4, 2016 (relating to Form 8971 and its Schedule A), was the most burdensome and controversial (along with a zero basis rule for certain late-discovered property). But it is hard to assume that the current project omits reporting when it still includes the reference to section 6035, which is the reporting statute.
The background and significance of these regulations were discussed in Number Three of the 2015 Top Ten and Number Five of the 2016 Top Ten. The relevant statutes, including sections 1014(f) and 6035, were enacted on July 31, 2015, in the Surface Transportation and Veterans Health Care Choice Improvement Act. The regulations needed to be finalized by January 31, 2017, to permit them to be clearly retroactive under section 7805(b)(2). They were not. Thus, some welcome features of the regulations (such as certain exceptions from reporting in the case of cash, modest amounts of tangible personal property, and property that is sold) will not technically be retroactive, although the IRS should be expected to observe those exceptions as a matter of practice.
It is the disappointing features of the regulations that will be watched most closely as consideration of these regulations proceeds in 2018. First, and perhaps most exasperating, there is Proposed Reg. §1.6035-1(c)(3), which mandates (emphasis added):
If, by the due date [of Form 8971], the executor has not determined what property will be used to satisfy the interest of each beneficiary, the executor must report on the Statement [Form 8971, Schedule A] for each such beneficiary all of the property that the executor could use to satisfy that beneficiary’s interest. Once the exact distribution has been determined, the executor may, but is not required to, file and furnish a supplemental Information Return and Statement.
This is asserted even though a beneficiary who has not yet received (and may never receive) the property has no use for basis information and providing such information serves no discernable purpose of section 1014(f), and even though the statutory requirement of section 6035(a)(1) itself attaches only “to each person acquiring any interest in property.” It seems that the regulations could have carried that linguistic comparison to its logical conclusion by rejecting the assumption that Congress intended to require reporting of information (about specific distributions and distributees) that does not yet exist and therefore requiring Form 8971 and Schedule A only with respect to property that is distributed – in other words, “received” – or “acquired.” In that case, section 6035(a)(3) would be construed to require reporting for property passing upon death or already distributed, whereas property distributed after the estate tax return is filed would be reported on a supplemental Form 8971 and Schedule A within 30 days after the distribution or perhaps on a year-by-year basis. That would be a much more workable and much less burdensome rule.
Second, Proposed Reg. §1.6035-1(f) would impose a seemingly open-ended requirement on the recipient of a Schedule A to in turn file a Schedule A when making any gift or other retransfer of the property that results wholly or partly in a carryover basis for the transferee. But section 1014(a) itself purports to apply only to property acquired “from a decedent,” creating great doubt about the statutory authority for Proposed Reg. §1.6035-1(f), especially when one of the explicit changes Congress made to Treasury’s annual legislative proposal on this subject was to apply it only to transfers at death, not to lifetime gifts.
Third, after-discovered and omitted property that is not reported on an (initial or supplemental) estate tax return before the estate tax statute of limitations runs (thus including all property and omissions discovered after the estate tax statute of limitations runs) would be given a value, and therefore an initial basis, of zero. Proposed Reg. §1.1014-10(c)(3)(i)(B). Moreover, if the after-discovered or omitted property would have increased the gross estate enough to cause an estate tax return to be required, but no estate tax return was filed, the estate tax value of all property subject to the consistency rule would be considered to be zero. Proposed Reg. §10.1014-10(c)(3)(ii). The statutory support for these zero basis rules is also very questionable, because such property appears to be neither “property the final value of which has been determined for purposes of the [estate] tax” within the meaning of section 1014(f)(1)(A) nor property “with respect to which a statement has been furnished under section 6035(a)” within the meaning of section 1014(f)(1)(B), and therefore section 1014(f) by its terms cannot apply.
Thus, it is surprising that this regulation project appears under the heading of “Near-Term Burden Reduction” – UNLESS Treasury and the IRS have figured out that they must eliminate at least those three anomalies from the regulations and are resolved to do so. That would be good news.
Section 2642(g) Regulations. Section 2642(g)(1), added temporarily by the 2001 Tax Act and made permanent by the 2012 Tax Act, directs Treasury to publish regulations providing for extensions of time to allocate GST exemption or to elect out of statutory allocations of GST exemption (when those actions are missed on the applicable return or a return is not filed). Previously, similar extensions of time under Reg. §301.9100-3 (so-called “9100 relief”) were not available in these cases because the deadlines for taking such actions were prescribed by statute, not by regulations. Section 2642(g)(1)(B) adds:
In determining whether to grant relief under this paragraph, the Secretary shall take into account all relevant circumstances, including evidence of intent contained in the trust instrument or instrument of transfer and such other factors as the Secretary deems relevant. For purposes of determining whether to grant relief under this paragraph, the time for making the allocation (or election) shall be treated as if not expressly prescribed by statute.
Promptly after the enactment of the 2001 Tax Act, Notice 2001-50, 2001-2 C.B. 189, acknowledged section 2642(g)(1) and stated that taxpayers may seek extensions of time to take those actions under Reg. §301.9100-3. The IRS has received and granted many requests for such relief over the years since the publication of Notice 2001-50.
Proposed Reg. §26.2642-7 (REG-147775-06) was released on April 16, 2008 – not so promptly, but then it was not so urgent since the publication of Notice 2001-50. When finalized, it will oust Reg. §301.9100-3 in GST exemption cases and become the exclusive basis for seeking the extensions of time Congress mandated in section 2642(g)(1) (except that a simplified procedure for dealing with pre-2001 annual exclusion gifts under Rev. Proc. 2004-46, 2004-2 C.B. 142, will be retained).
The proposed regulations resemble Reg. §301.9100-3, but with some important differences. Under Proposed Reg. §26.2642-7(d)(1), the general standard is still “that the transferor or the executor of the transferor’s estate acted reasonably and in good faith, and that the grant of relief will not prejudice the interests of the Government.” Proposed Reg. §26.2642-7(d)(2) sets forth a “nonexclusive list of factors” to determine whether the transferor or the executor of the transferor’s estate acted reasonably and in good faith, including (i) the intent of the transferor to make a timely allocation or election, (ii) intervening events beyond the control of the transferor or the executor, (iii) lack of awareness of the need to allocate GST exemption to the transfer, despite the exercise of reasonable diligence, (iv) consistency by the transferor, and (v) reasonable reliance on the advice of a qualified tax professional. Proposed Reg. §26.2642-7(d)(3) sets forth a “nonexclusive list of factors” to determine whether the interests of the Government are prejudiced, including (i) the extent to which the request for relief is an effort to benefit from hindsight, (ii) the timing of the request for relief, and (iii) the occurrence and effect of any intervening taxable termination or taxable distribution. Noticeably, the proposed regulations seem to invite more deliberate weighing of all these factors than the identification of one or two dispositive factors as under Reg. §301.9100-3.
“Hindsight,” which could be both a form of bad faith and a way the interests of the Government are prejudiced, seems to be a focus of the proposed regulations. This is probably explained by the obvious distinctive feature of the GST tax – its effects are felt for generations, in contrast to most “9100 relief” elections that affect only the current year or a few years. There simply is more opportunity for “hindsight” over such a long term. Thus, the greater rigor required by the proposed regulations seems to be justified by the nature of the GST tax and consistent with the mandate of section 2642(g)(1)(B) to “take into account all relevant circumstances … and such other factors as the Secretary deems relevant.”
Proposed Reg. §26.2642-7(h)(3)(i)(D) requires a request for relief to be accompanied by “detailed affidavits” from “[e]ach tax professional who advised or was consulted by the transferor or the executor of the transferor’s estate with regard to any aspect of the transfer, the trust, the allocation of GST exemption, and/or the election under section 2632(b)(3) or (c)(5).” The references to “any aspect of the transfer” and “the trust” appear to go beyond the procedural requirement of Reg. §301.9100-3(e)(3) for “detailed affidavits from the individuals having knowledge or information about the events that led to the failure to make a valid regulatory election and to the discovery of the failure.” Presumably professionals who advised only with respect to “the transfer” or “the trust” would have nothing relevant to contribute other than a representation that they did not advise the transferor to make the election, a fact that the transferor’s own affidavit could establish.
In sum, the requirements to comply with the proposed regulations under section 2642(g) would appear to be more comprehensive and onerous than the requirements of the familiar 9100 relief. Now they also appear under the heading of “Near-Term Burden Reduction,” which is also surprising – UNLESS the extensive experience of the IRS with ruling requests under Notice 2001-50 and Reg. §301.9100-3 has shown that less onerous requirements may be sufficient. That would also be good news.
“Guidance on Basis of Grantor Trust Assets at Death Under §1014.” Rev. Proc. 2015-37, 2015-26 I.R.B. 1196, added “[w]hether the assets in a grantor trust receive a section 1014 basis adjustment at the death of the deemed owner of the trust for income tax purposes when those assets are not includible in the gross estate of that owner under chapter 11 of subtitle B of the Internal Revenue Code” to the list of “areas under study in which rulings or determination letters will not be issued until the Service resolves the issue through publication of a revenue ruling, a revenue procedure, regulations, or otherwise.” That designation was continued in Rev. Procs. 2016-3, 2017-3, and 2018-3.
Meanwhile, one day after Rev. Proc. 2015-37 was published in the Internal Revenue Bulletin, Letter Ruling 201544002 (June 30, 2015) held that assets in a revocable trust created by foreign grantors for their U.S. citizen children would receive a stepped-up basis under section 1014(b)(2) at the grantors’ deaths. The ruling acknowledged the no-rule policy of Rev. Proc. 2015-37, but avoided it on the ground that the ruling request had been submitted before the no-rule policy was announced. It is impossible to believe that that was a coincidence, indicating that at least the letter ruling was coordinated with the no-rule position, and possibly the receipt of the ruling request even prompted the no-rule position. That would strongly suggest that the no-rule position was aimed only at foreign trusts, and so might this proposal in the Priority Guidance Plan. But it is also possible that, even if the project originally had such a narrow focus, it has since been expanded or will be expanded in the Trump Administration.
“Final Regulations Under §2032(a) Regarding Imposition of Restrictions on Estate Assets During the Six Month Alternate Valuation Period.” These are the so-called “anti-Kohler regulations,” although the Kohler case itself (Kohler v. Commissioner, T.C. Memo. 2006-152, nonacq., 2008-9 I.R.B. 481) involved a corporate reorganization and the main target of the regulations is likely partial estate distributions or the post-mortem family limited partnership-type repositioning that some might be tempted to try. Examples 7 and 8 of Proposed Reg. §20.2032-1(c)(5) specifically address the discount-bootstrap technique – Example 8 in the context of a limited liability company and Example 7 in the context of real estate – and leave no doubt that changes in value due to “market conditions” do not include the valuation discounts that might appear to be created by partial distributions. Example 1 reaches the same result with respect to the post-death formation of a limited partnership.
Regulations were proposed in 2008 and then withdrawn and re-proposed in 2011 with a different approach in response to public criticism. (The critics of the proposed section 2704 regulations discussed in Number Four should have taken note that such a thing actually is possible!) The regulations should have been near completion for several years.
“Guidance Under §2053 Regarding Personal Guarantees and the Application of Present Value Concepts in Determining the Deductible Amount of Expenses and Claims Against the Estate.” This project, which first appeared in the 2008-09 Plan, is an outgrowth of the project that led to the amendments of the section 2053 regulations in October 2009. The part of this project relating to “present value concepts” is evidently aimed at the leveraged benefit obtained when a claim or expense is paid long after the due date of the estate tax, but the additional estate tax reduction is credited as of, and earns interest from, that due date. Graegin loans (see Estate of Graegin v. Commissioner, T.C. Memo. 1988-477) are an obvious target.
In the Administration of Trump They want regulatory burdens to dump. Does it mean they’ll abort The basis report That has to be done in one lump?
Number One: The 2017 Tax Act
The Number One development of 2017 has to be the 2017 Tax Act. It was known as the “Tax Cuts and Jobs Act” (H.R. 1) while being considered by Congress, but the name was dropped in the end when the Senate parliamentarian ruled that the reference to “Jobs” was not strictly fiscal enough to comply with the “Byrd Rule” for budget reconciliation in the Senate. Its formal title – “An Act To provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” – will be hard to throw around at parties.
The conference agreement on the 2017 Tax Act was approved by the House of Representatives 227-203 on December 19, by the Senate 51-48 early on December 20, and by the House again 224-201 later on December 20 to approve the changes made by the Senate, including the deletion of the name. The votes were very partisan. In the House 12 Republicans voted against it and no Democrat voted for it. In the Senate all the Democrats voted against it and all the Republicans voted for it except Senator McCain, who did not vote. The Act was signed into law by President Trump on December 22 and became Public Law 115-97.
Much has been and will be written and said about the 2017 Tax Act. This alert will be limited to a few broad observations particularly relevant to estate planning. To better understand how to navigate the sweeping changes, McGuireWoods is hosting a series of webinars on the ramifications of the 2017 Tax Act for individuals, corporations, pass-through entities, nonprofit organizations, and other business entities. For additional timely insight on Trump-era developments affecting executive compensation, employee benefits, corporate tax, tax-exempt organizations, and private wealth matters, please visit our newly launched Take Stock: Tax & Employee Benefits Today blog.
No Repeal. The biggest news is that there is no bigger news. The estate and GST taxes are not repealed, not even temporarily. (The original House version of H.R. 1 would have repealed the estate and GST taxes in 2025, but the Senate version did not.) There are no structural or technical changes to the estate, gift, and GST taxes, and no changes to the determination of the basis of property received by gift or upon death.
Doubled Exemptions. The only change is to double the exemptions – technically the basic exclusion amount for estate and gift tax purposes and the GST exemption for GST tax purposes – as both the House version (through 2024) and Senate version (through 2025) would have done. In the final Act, the doubling of the exemptions sunsets January 1, 2026, as in the Senate version, to help the Senate comply with its reconciliation rules. Annual increases in the exemptions, including the initial increase from 2017 to 2018 itself, will be measured, like income tax brackets and other significant numbers under the Act, by a “Chained” Consumer Price Index, which will take into account anticipated consumer shifts from products whose prices increase to products whose prices do not increase or increase at a lower rate, resulting in somewhat slower inflation adjustments over the long term.
“Anti-Clawback” Provisions. The Act retains section 2001(g), redesignated section 2001(g)(1), the “anti-clawback” language added by the 2010 Tax Act to prevent, in effect, gifts exempt from gift tax under the higher exemption from being nevertheless subject to estate tax if the increased exemption were to actually “sunset” – then in 2013 and now in 2026. This is a good lesson the drafters learned after the awkward failure to address such a scenario in the 2001 Tax Act.
The potential for clawback results from the decision made when the gift and estate tax rates were “unified” by the Tax Reform Act of 1976 to replace the historic exemptions ($30,000 for the gift tax and $60,000 for the estate tax) with a credit, because “a tax credit tends to confer more tax savings on small- and medium-sized estates” and therefore “would be more equitable” (H.R. Rep. No. 94-1380, 94th Cong., 2d Sess. 15 (1976)). With estate and gift taxes now viewed as being imposed in effect at a flat rate, and “small- and medium-sized estates” now exempt, that decision now produces little equity but considerable complexity in tax return preparation and, as seen here, in statutory drafting.
In fact, the statutory drafting was apparently so daunting that Congress simply gave up and left completion of the task to Treasury in a new section 2001(g)(2):
(2) Modifications to estate tax payable to reflect different basic exclusion amounts.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out this section with respect to any difference between—
(A) the basic exclusion amount under section 2010(c)(3) applicable at the time of the decedent’s death, and
(B) the basic exclusion amount under such section applicable with respect to any gifts made by the decedent.
This looks simply like authority to do the math to carry out the mandate of the 2010 Tax Act in section 2001(g)(1), although some have expressed concern that it could be used to cut back the benefits to decedents’ estates that the 2017 Tax Act was intended to confer, either by Treasury and IRS drafters not necessarily as committed to the agenda of the current congressional leadership or by a new Administration (which there is certain to be before the doubling of the exemptions sunsets on January 1, 2026).
Qualified Business Income Deduction. Throughout the consideration of H.R. 1 there was great interest in reducing the income tax rate both for corporations and for businesses operated in pass-through entities or sole proprietorships. Indeed, many viewed the latter category as comprising the smaller, family-owned, or closely-held businesses the tax relief should most target, for both economic and political reasons. The House of Representatives came up with a 25 percent net tax rate, and the Senate with a 23 percent deduction, both derived through complicated paths designed in part to limit the benefit to “job creators” and prevent manipulation. (The poster children for manipulation were often lawyers practicing law!) The result largely follows the Senate model, again to help the Senate comply with its reconciliation rules, but at a 20 percent level, and includes adjustments designed to achieve certain fiscal goals or meet the specific concerns of some lawmakers. After some suspense, trusts are included among the pass-through entities receiving the preferential treatment. But in all cases, perhaps particularly for so-called “complex trusts” that share income tax burdens with their beneficiaries, the calculations will be intricate and the outcomes not always intuitive. Considerable income tax modeling will be required in some cases to inform the choice of business entity.
Comment: Well, they’ve done “tax reform.” The biggest since the Tax Reform Act of 1986, some say. Maybe even bigger – or huger – others might say. But it does not seem likely that observers in 30 years will be holding up the 2017 Tax Act as the tax reform standard to match or beat. While there is some simplification to be derived from eliminating or limiting income tax deductions, we are witnessing the anxiety that can cause for those who are accustomed to claiming those deductions. And in this case, while some features of the Act, like the changes to the child tax credit and some parts of the qualified business income deduction, seem to have been designed strategically, many of the changes in deductions and credits seem to have been motivated mainly by a need to hastily plug revenue leaks otherwise created by the cuts in rates.
The idea of designing a tax structure on purpose, and then setting the rates needed to meet a revenue target derived from the need for government services, seems quaint in this political environment. And the notion of comprehensively, thoughtfully, and deliberately addressing taxation, discretionary spending, and entitlements at the same time seems very unrealistic today. Such idealism almost certainly calls for at least a bipartisan effort, another anachronism it seems. After roundly criticizing the Democrats for passing the Patient Protection and Affordable Care Act of 2010 (“Obamacare”) without a single Republican vote, the Republican leadership has seen the same result in the 2017 Tax Act, which is not a recipe for durability. Some Republicans will say that the Democrats refused to participate. Some Democrats will say that the Republicans offered no opportunity to participate. But, as most of us learned in grade school, sharing is a mutual activity, and it is unlikely that either side bears all the blame. In that respect then, there was something bipartisan about it after all.
As for the death tax, we could now wonder whether it will ever be repealed. (Of course doubling the exemption is the same as repeal for those no longer subject to the tax, reportedly about half of the estates that previously would have been taxed.) Many legislators, mostly Republicans, seem just as zealous as ever about repeal, although they also seemed to like the opportunity to spend approximately $80 billion elsewhere. Others, mostly Democrats, seem just as zealous as ever about keeping the estate tax, and the resistance they offer and the threat of rollback when Democrats are back in charge help to make abandoning repeal seem expedient.
In any event, the estate tax will continue to be a planning consideration. Among other things, that portends another surge of gift-giving, maybe in 2018 in case November’s election changes the landscape.
’Twas the month before Christmas, when the Senate and House Made the chances of tax cuts seem as small as a mouse. The tax reform frameworks were made with some care In hopes that somehow the votes would be there.
But some members were nestled so snug in their views That any hint of consensus would sure be big news. And Mitch with his frown and Paul with his grin Were about to despair it would ever begin.
While on the White House lawn there arose such a twitter It just couldn’t help making everyone bitter. And into this, lobbyists flew like a flash, Tore up all restraint and threw lots of cash.
But still we kept hearing from President Donald That this would be HUGER than President Ronald, When what to our wondering eyes should appear The notion that passage soon might be near.
With a devious driver, with such a cynical mix, We knew it a moment it was Politics. With banners of eagles at podiums stood The congressional leaders to do what they could.
GOP leaders knew loss would mean shame, So they rallied their members and called them by name! Now Susan! Now Lisa! Now Corker and Ron! On, Rand Paul! On, Toomey! Hang on, Jeff and John!
And then, in a twinkling, we heard on the floor That some votes were missing that had been there before. As the march toward the tax cuts was turning around, Down the market and poll ratings came with a bound.
Leaders spoke not a word, but went straight to their work, And the trading and twisting went simply berserk. Forcing real reformers to just hold their nose, Tax BREAKS got a nod, and their prospects arose.
So the bill got restructured, from its head to its foot And changes were made that went straight to its root. A bundle of Pork on Uncle Sam’s back, And he looked like a peddler, just opening his pack.
The tweaks how they twinkled! the phase-outs so merry! They all found it grand when it should have been scary! In the Senate, as partisan as it could be, The votes were enough, ’tho they won by just three.
What developed so slowly but finished so quick Was Reconciliation’s arithmetic That said trillions could be lost, but still it’s all right, ’Cause the economy simply will grow out of sight.
The markets came back, the President clapped, And true tax reformers just had to adapt. But I heard Congress exclaim, in a voice like St. Nick’s, “Happy Tax Cuts to all, until Twenty Twenty-Six!”