This outline is a selective and evolving review of the history of the modern federal estate tax. It originated during the attempts to repeal the estate tax in President Clinton’s second term and accelerated with the one-year (2010) “repeal” included in the Economic Growth and Tax Relief Reconciliation Act of 2001. A discussion of the most current developments, including the American Taxpayer Relief Act of 2012, begins on page 69. (State estate and inheritance taxes are tabulated at http://www.mcguirewoods.com/news- resources/publications/taxation/state_death_tax_chart.pdf.)
1.n teRvnuet ofSptmbr8, 1916, s thenitd Stts s on thebink of ntigoldr,onssntdthentsttet,imposdttsof 1pntto10pntontblesttsovr50,000.nthetofh3, 1917,thetsenlyinsdyh,tolvlsof1½pntto15 pnt.npliningtheSntebill,hihouldhvedoubldtsto2 pn20 pnt, theFinneCommittesid:
Such a tax, when used as an emergency measure, is necessarily unequal in operation. Only if continued at the same rate for many years – the period of a generation – does it become equal for all persons in like situation. If levied as a war tax, that is, as a temporary emergency measure, it falls only upon the estates of those who happen to die during the period of the emergency. Particularly is it to be remembered that perhaps a majority of those dying during the war and leaving estates to be taxed will be soldiers and sailors dying in defense of our country. On the other hand, as a permanent measure, such a tax, even at the rates already fixed by existing law, trenches in considerable degree on a sphere which should be reserved to the States.
S. REP. NO. 103, 65TH CONG., 1ST SESS. 14 (1917) (emphasis added).
2.nitsvsionoftheRvnuetof1926,hntheosstsgdom1 pntto20pnt,theouseofRsnttivsisdthesttethtditto80pntofthebsict,hiletheSntevsionouldhveplthesttet.nsupptofl,theineCommittequotdthepts omits1917potthteitliidbov.S.R..52,69C.,1S.8192.nshot,theinneCommitteof1917nd1926mstohve itdthemeumntsinsuppotofdoublingthetxndinsupotof pligthet!he1926ousSnteonn,ofous,tdthe ousepph.
On February 5, 1969, less than two weeks after the inauguration of President Nixon,
Congress published a multi-volume Treasury Department work entitled “Tax Reform Studies and Proposals,” reflecting work that had been overseen by Assistant Secretary of the Treasury for Tax Policy Stanley Surrey during the Kennedy and Johnson Administrations. It included a number of estate and gift tax proposals. The following list of the estate and gift tax proposals gives the date each proposal was eventually enacted in some form:
“Blueprints for Basic Tax Reform” was published by the Treasury Department January 17, 1977, during the last week of the Ford Administration, in response to Secretary of the Treasury William Simon’s lament that the United States should “have a tax system which looks like someone designed it on purpose.” In the context of proposing a comprehensive model of income taxation that depended on a dramatically broader tax base, “Blueprints” assumed that transfers by gift or at death would be recognition events. Such capital gains, whether by gift, at death, or otherwise, would be fully taxed at ordinary income rates, with adjustments to the basis of corporate stock for retained earnings and to the basis of all assets for general price inflation. Pre-enactment gain would be excluded, following the precedent of the “carryover basis at death” rules that were enacted in 1976. “Blueprints” was not embraced by the incoming Carter Administration.
- Imposition of tax only once, when beneficial enjoyment ceases, ignoring retained powers (a proposal that kindled an “easy to complete”/“hard to complete” debate).
- Treatment of all powers of appointment as general powers of appointment if the holder could benefit from them, without regard to complicating concepts such as “ascertainable standards” and “adverse interests.”
- Valuation of fractional interests in an asset at their pro rata share of the value of the asset owned or previously transferred by the transferor or the transferor’s spouse.
- A simplified GST tax (compared to the GST tax enacted in 1976) with a $1 million exemption and a flat rate (in this proposal equal to 80 percent of the top estate tax rate).
- Elimination of the phase-out of the credit for tax on prior transfers from a member of the same or a younger generation.
- Expansion of section 6166 deferral of the payment of estate tax to all cases where the estate lacks sufficient cash or marketable assets, whether or not it holds an interest in a business. Liquidity would be reevaluated annually on an “if you have it send it in” basis (or at least send in 75 percent of it).
- Replacement of the separate rate schedule for calculating the maximum state death tax credit with a maximum credit equal to a flat 5 percent of the taxable estate. This would have resulted in a substantially smaller state death tax credit in most cases.
- Repeal of section 303, which provides for exchange treatment of stock redemptions to pay certain taxes and funeral and administration expenses.
2.hePsidntsxPoposlstotheConssorFinss,oth,nd Simplii”spublisdythehiteouseonMay 29, 1985.ts populylldsy”rhiteouse”rsomtimsRn”in netothetthtonld.RgnsteSyofthesyho sindthetnsmittllttrorsy”dhdbometehieouse hifofstfyMy985.Bsdgnlynsy,itstheoh modl orthexRom t of1986. t ontnd no tnsrtxpoposls.
- Ultimately, the Tax Reform Act of 1986 (Public Law 99-514) did enact a supposedly simpler GST tax (but at a rate equal to 100 percent, not 80 percent, of the top estate tax rate).
- In the Omnibus Budget Reconciliation Act of 1987 (“OBRA”) (Public Law 100-203), the House of Representatives added a repeal of the state death tax credit, a rule valuing interests in family-owned entities at their pro rata share of the total value of all interests in the entity of the same class, and rules regarding “disproportionate” transfers of appreciation in estate freeze transactions. H.R. REP. NO. 100-391, 100TH CONG., 1ST SESS. 1041-44. The
House-Senate conference retained only the estate freeze rules, as section 2036(c) (which in turn was repealed in 1990 and replaced with the supposedly more workable rules of chapter 14).
The proposal would eliminate valuation discounts except as they apply to active businesses. Interests in entities would be required to be valued for transfer tax purposes at a proportional share of the net asset value of the entity to the extent that the entity holds readily marketable assets (including cash, cash equivalents, foreign currency, publicly traded securities, real property, annuities, royalty-producing assets, non-income producing property such as art or collectibles, commodities, options and swaps) at the time of the gift or death. To the extent the entity conducts an active business, the reasonable working capital needs of the business would be treated as part of the active business (i.e., not subject to the limits on valuation discounts). No inference is intended as to the propriety of these discounts under present law.
General Explanations of the Administration’s Revenue Proposals (Feb. 1998) at 129, http://www.treasury.gov/resource-center/tax-policy/Documents/grnbk98.pdf.
- The Clinton Administration’s budget proposals for fiscal 2000 and fiscal 2001 repeated this proposal, except that “readily marketable assets” was changed to “non-business assets” and “the propriety of these discounts under present law” was changed to “whether these discounts are allowable under current law.”
3874, 106th Cong., 2d Sess., introduced on March 9, 2000, by the Ranking Democrat on the House Ways and Means Committee, Rep. Charles Rangel of New York. This bill would have added a new section 2031(d) to the Code, the general rule of which read as follows:
- VALUATION RULES FOR CERTAIN TRANSFERS OF NONBUSINESS
ASSETS—For purposes of this chapter and chapter 12—
- IN GENERAL—In the case of the transfer of any interest in an entity other than an interest which is actively traded (within the meaning of section 1092), the value of such interest shall be determined by taking into account
- the value of such interest's proportionate share of the
nonbusiness assets of such entity (and no valuation discount shall be allowed with respect to such nonbusiness assets ), plus
- the value of such entity determined without regard to the value taken into account under subparagraph (A).
1264, 107th Cong., 1st Sess., which Rep. Rangel introduced on March 26, 2001, partly as an alternative to the Republican proposals that became the 2001 Tax Act:
- VALUATION RULES FOR CERTAIN TRANSFERS OF NONBUSINESS
ASSETS—For purposes of this chapter and chapter 12—
- IN GENERAL—In the case of the transfer of any interest in an entity other than an interest which is actively traded (within the meaning of section 1092)—
- the value of any nonbusiness assets held by the entity shall be determined as if the transferor had transferred such assets directly to the transferee (and no valuation discount shall be allowed with respect to such nonbusiness assets ), and
- the nonbusiness assets shall not be taken into account in determining the value of the interest in the entity.
Rep. Rangel’s 2001 bill would also have added a new section 2031(e) to the Code, to read as follows:
- LIMITATION ON MINORITY DISCOUNTS—For purposes of this chapter and chapter 12, in the case of the transfer of any interest in an entity other than an interest which is actively traded (within the meaning of section 1092), no discount shall be allowed by reason of the fact that the transferee does not have control of such entity if the transferee and members of the family (as defined in section 2032A(e)(2)) of the transferee have control of such entity.
Identical statutory language for new sections 2031(d) and (e) appeared in
H.R. 5008, 107th Cong., 2d Sess. §3 (introduced June 24, 2002, by Rep. Earl Pomeroy (D-ND)), H.R. 1577, 109th Cong., 1st Sess. §4 (introduced April 12, 2005, by Rep. Pomeroy), and H.R. 4242, 110th Cong., 1st Sess. §4 (introduced November 15, 2007, by Rep. Pomeroy).
- Clinton Administration proposals inevitably experienced a bit of a revival after Democrats took control of the Congress and White House. Democratic staff members publicly referred to them as a possible model for legislative drafting. This is perhaps reflected in H.R. 436, the 2009 version of Rep. Pomeroy’s bill, discussed in Part VII.A on page 25.
- The same Clinton Administration’s proposed budgets also recommended the repeal of the personal residence exception from section 2702.
- converted the “unified credit” to an exemption, thereby allowing the exemption to be applied to the top marginal rate rather than to the lower rates as the credit is,
- eliminated the 5 percent surtax that resulted in the 60 percent “bubble” for taxable estates larger than $10 million,
- repealed the estate tax, gift tax, and generation-skipping transfer tax (GST tax), beginning in 2010, and
The changes to the estate, gift, and GST taxes made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (the “2001 Tax Act”) are summarized as follows:
Year-by-Year Summary of the Changes Made by the 2001 Tax Act
Exclusion Lowest rate
5% bubble Yes No
QFOBI Yes No State tax credit
taxpayer to another to avoid or reduce income tax liabilities.
2.naoupl”stt,hethesttetxpilyistidtothedlditin ttsomepointboe2002,theisasttet.Stion2058losa ddutionorthestetxinlultingtheblestt,hihgnly sultdinnittiveorli)lulton.nsomeofthosestts, hov,testtelwosnotllowaddtionorthesttetxinulting thesttetxitsl.isvoidstheittivelultion,butiths the tivesttenddltxts.dlm706nowommotsthe lultionoftxinsuhastteyovidingasptelineaonpge1or lultigatnttivetblestt”ntofllddutionsptttedth ts.hetnttivetxblestt”intis thetblestteorlulting thesttetxbut not thedl t)in suh ast.
Top Marginal Estate Tax Rates
“Decoupled” State with Deduction
“Decoupled” State, No Deduction
“Decoupled” State with Deduction
“Decoupled” State, No Deduction
2013 and Beyond
“Decoupled” State with Deduction
“Decoupled” State, No Deduction
phased increases in the federal unified credit, so that the state exemption is less than the federal exemption. After January 2012, only Delaware, Hawaii, and North Carolina have had exemptions and filing thresholds equal to the federal exclusion amount.
1.or2010,the2001xtdddorbsisulsthtouldhnete yutosndbiisdtminetheinometxbsisfopy quidomaddt,hihisusdtolulteinorlossuponeofthe popyndinsomesstoluledptionddutions.nstdofa bsisqultothelueonthedeofthorltnevlutindt,” lysixmonthsrdth,tebsisstobethevlueonthedteof dth orthednts sis in thepop, whichever is less.
2.ssomhtofasubsttuteorthesttetxmption,hntsstte sllod$1.3millinofbsisinseinsdytheddntspitloss nd ntopting loss ovsndythepitl loss tht ouldhvebnidiftheddntslosssstshdbnsoldorthirirktvlue immditybethedntsdth,hhtheutormyllteto individulsststoliinteupto$1.3millionofthtunlidpition. heutorsbletollotendditionl$3millionofbsisinsetoy ssts pssingtoasuviingspous, ithroutt orin tin kinds oftsts.
- Section 2210(a) stated that “this [estate tax] chapter shall not apply to the estates of decedents dying after December 31, 2009.”
- Section 1014(f) stated that “[t]his section [providing for a stepped-up basis at death for appreciated assets] shall not apply with respect to decedents dying after December 31, 2009.”
- Section 2664 stated that “[t]his [GST tax] chapter shall not apply to generation-skipping transfers after December 31, 2009.” It was the entire chapter that did not apply, not just the tax. All definitions, exemptions, rules, etc. were inapplicable. But the GST tax chapter was inapplicable only in the case of generation-skipping transfers.
- It was well known that the “repeal” of the federal estate tax took effect in 2010, for only one year. In 2011, the 2001 Tax Act was to “sunset” and the estate tax law return to where it would have been without the enactment of the 2001 Tax Act – namely the former 55 percent rate (with a 60 percent “bubble”), a credit for state death taxes, and the $1 million exemption that would have been reached in 2006 under the phased in changes made by the
Taxpayer Relief Act of 1997.
SEC. 901. SUNSET OF PROVISIONS OF ACT.
- IN GENERAL.—All provisions of, and amendments made by, this Act shall not apply—
- to taxable, plan, or limitation years beginning after December 31, 2010, or
- in the case of title V, to estates of decedents dying, gifts made, or generation-skipping transfers, after December 31, 2010.
- APPLICATION OF CERTAIN LAWS.—The Internal Revenue Code of 1986 and the Employee Retirement Income Security Act of 1974 shall be applied and administered to years, estates, gifts, and transfers described in subsection (a) as if the provisions and amendments described in subsection
(a) had never been enacted.
- Section 901 was the only section in the ninth and last title of the 2001 Tax Act, entitled “Compliance with Congressional Budget Act.”
i.heConssionldttof19742.S.C.§621et seq.) psibstepodusyhihCossoptsspndingndtx pioitisinabudtsolutionndimplmntsthosepioitisina stmlindpssofudtonilition.naueddin1985 ndmndin1990,ponsodythelteSntorRobtd- )ndneknonsthedRul,stion313oftheugt t2.S.C.§644)mkstnous”povisionsinbudt onilitionsubjttoapointofdrinthent.tnous”is dindtoinludethedutionofntvnusinsbondthe piodpoviddorinhebutsolution.Sinethe2001bugsolutionnlyodtns,antutionoftsbond thetnthrould ebn ud out ofod.
ii.ApointofodrunrthedRulenbeivdyavoeof60 SntosjustsaSnteilibustrinstgllisltionnbe boknyaoteof60Sntos..R.1836,hihbmethe2001 xt,oiinly psdtheSnt,ony 23,2001,yavoteof62- 38hiletheonepotonthe2001xtpssdtheSte on My26, 2001,yavotefony583..R. 1836, hov, nd62votsonyithasunst”povisioninit.heSntes notskdtovoteonaonsunsttingpl,ndpsumbythevots ejustnotth.ntheSnteonsitionof.R.1836, mndmntstolimintethesttetxpledtdyvotsf 4356nd457.nnmndmnttosvethesttetxonyor sttstrthn $100million s dtd yavoteof4851.
- The “as if … had never been enacted” language of section 901(b) of the 2001 Tax Act attracted a lot of attention and created a lot of speculation and exasperation. This was particularly true in the context of the GST tax. It is
- 9 -
safe to surmise that members of Congress in 2001 did not think about how this language might affect estate planning in 2010 and 2011. Indeed, it is unlikely that they expected the 2001 Tax Act changes to still be in effect without modification and permanence by 2010. It is certain that the “had never been enacted” language was not cobbled together just to torment estate planners nine years later. Indeed, as of 2001, it was not unprecedented repeal, override, or sunset language.
Except to the extent necessary to carry out subsection (d) [which allowed executors of decedents dying from January 1, 1977, to November 6, 1978, to elect the 1976 carryover basis regime, despite its repeal], the Internal Revenue Code of 1954 shall be applied and administered as if the provisions repealed by subsection (a), and the amendments made by those provisions, had not been enacted.
1.ntheonsidtionof.R.2646,themSuiy ndRulnvstmnttof 2002,hihPsidntushsidonMy3,2002,theSnteddpssionofthesnseoftheSnt”thtthesttetxplshouldbemde pmnnt.vnthoughsuhnpssionhdnosttutoyorothrbinding ttsov,itndony56vots,ih42votsopposd,lthouhte toSntosnotvoing SntosnnttofthndomniiofwMio) eRpublins ho d suppotd thepl fthesttetxin thepst.
2.sptofnnthdtoilitteonsidtionofintpovisionsofthe2002nybill.R.4,thedshipftheSntedto llowonsidtionofapoposltomovethesunst”tueofthesttend STtxpl,soththelsduldunrthe2001xttotein2010ouldnolonrbeshduldtosunstnnuy1,2011–mingthe pl, in t, pmnt. hevotes pomid ytend ofune202.
- The repeal measure the Republican leadership agreed to consider would only make the repeal of the estate and GST taxes in 2010 permanent for the years 2011 and beyond. Until 2010, the rates would fall and the unified credit would rise, on the schedule enacted in 2001. The gift tax unified credit would continue to be limited, so as to shelter gifts only up to $1 million, and after 2009 the gift tax would continue in effect, with a 35 percent rate. The state death tax credit would be phased out by 2005, and carryover basis would be enacted as a permanent replacement for the estate tax, beginning in 2010.
- 10 -
reconciliation rules under which the 2001 Tax Act was crafted, and therefore it required the vote of 60 Senators – the same 60-vote requirement that contributed prominently to the odd results in the 2001 Tax Act in the first place.
- The vote was held on June 12, 2002. The vote was 54-44, and the measure therefore failed. (The two Senators not voting supported repeal.)
- Before voting on permanent repeal, the Senate took up alternatives offered by Democratic Senators, including accelerated increases in the unified credit (which failed by a vote of 38-60) and expansion of qualified family-owned business interest (QFOBI) relief (which failed by a vote of 44-54).
1.hetobr22,2003,Washington Post potdhtSntoronlR,n impotntmmbrofteSnteCommitteoninnehohdbnamjor plrintivydvtingpmntlofthesttet,stthttime onsidigndoningthtpositioninhngeorninseintestetx mptionto$15illinprpsonndadseinthesttetxt,bove tht mption, to 15 pnt, theunt inomexteon pitlins.
2.hePost potssilntstoht,ifthi,Sntorloulddooutthe itndSTts,boutdjustmntofbsistdth,ndboutstedth ts.hePost lsootdthtSntorlspoposlhdgindtheintst ofsvlmoticntosndthesuppotofsvlimpotntloists. hetieimplidththeimptusorStorsoposlsthegthof thediitndtheiskthtifamteltdPsidntin2004 pmnnt pl orsubstntil dution ofthettetxould beadd tt.
3.hn,ontobr23,2003,onedytrthePost pot,Sntorluditd thetil.siftolvenodoubt,onthesmedySntorlintoddS.J. Rs.20,topssthesnseoftheConssthtthenumbrofsduing hihthedthtx…ispldthtis,2010]shouldbetndd,pndingthe pmnnt pl oftheth t.”
2.lsointhe2004ltin,theRpublinsmitindontoloftheusend idourstsintheSnt.iivesmoeRpublinsthnthehd bnintheStesinetoovrsPsidnt.hisininteSnte immditytgdalotofspultionboutthenwvotsthtmihtbe vilblerpmnt pl ofthesttet.
- 11 -
support for repeal), some observers attempted to predict the likely votes for repeal in light of the intervening personnel changes. See, e.g., Sullivan, “60-Vote Majority at Hand for Estate Tax Repeal,” TAX NOTES, Nov. 29, 2004, at 1174.
5.tishdrstilltovlutetheintnibletrofihigvotstrthn ountingthm.Avoten2000oramsueoneknwPsidntClintn ouldvto,avotein201oraloronyonerninesinteutu, nd avotein2002 etheounting hdlybndoneenotnssiy inditiveofhowlmksouldvoteonamsueithalistichneof suss,hnitistlynssyorthmtotkesponsibiliyorthir tions s the2006 vots eto sho
2.tthendfuy200,justboetheustss,Sntejoiydr illistfnnsseldamotionflotu”on.R.8,bsilyteSnte omofllingtheqution,”hihquispovlof60Sntos.hnthe SntesshduldtoonneonSptbr6,thedytror, thesonyoemtrthtmhtvenhdofthtlotuemotion,a lotuemotiononthetiveiinovnmntRognitiontof 2005.”
3.Mnhil,ithullpllkig60vots,ompomiseotsontinud.he idaofa15pntt,mntiondinthetobr22,2003,Washington Post, lthouhquiteadptueomthetop55ntteofjustawsond vnthe45pnttoptehidin2007undrpsntl,hdpovd mbydubl,nditmindthettteopnydisussdySntor lndothssteompomisedisussionsdapublicsdo.n ontst,the$15millionmptionlvlpotdintobr2003slusivolloingthe2004tions,themostotnmntiondspitionsn mptionof$10millin.nmiduy2006,8millionsmntiondinthe pss, nd ythend ofuyit s $3.5 million.
- Opponents of repeal of the estate tax asked how Congress could possibly consider huge tax cuts for the nation’s wealthiest families when multitudes on the Gulf Coast had been left with nothing.
stability in tax policy, especially regarding the taxation of saving and investment that would be so important in the Gulf Coast rebuilding effort.
5.nMy2,2006,aSummitorPmnntthxRpl”onvdtthe tionlPssClubinshinton.tssonsodythemiyusinss sttexColition,dptiipntsinluddSntorl,sndMns CommitteMmbrCnssmnnyulhofRM)ho tidom Conssndn,unsssul,ronorofMissouiin2008,ndl ubbd,ssistnttothePsidntoronmicPoliynditrofthe tionlonomicCounil.heonsnsusttheSumitstosppota ompomiseofa15pntt,a$5millionmptioninddoriltion, ndontinudstpppbsisorptdssts,lltiveuy1, 2010.
6.nune8,2006,theSteonsiddalotuemotiontotkeup.R.,hih theousedpssdinpil2005,thustunigthedbetothepostetht hdbnptdbethehuinsflteuust2005.emotions onytotkeup.R.8,otnssiytoppveitbutpossiby tomnditith somthinglikeSntors 15 pnt/$5 million poposl.
- Prior to the vote, however, Senator Kyl had floated the suggestion that he would agree to a second rate of, say, 30 percent, imposed on taxable estates over, say, $30 million. That made it unlikely that the last few necessary Democratic votes would support a 15 percent rate that did not include a 30 percent super-rate.
- The vote was 57-41 in favor of cloture, three votes short of the necessary 60. (The two Senators who did not vote would have voted no.)
On June 22, 2006, by a vote of 269-156, the House of Representatives passed a new bill, H.R. 5638, called the “Permanent Estate Tax Relief Act of 2006” (“PETRA”).
- an initial rate tied to the top income tax rate on general capital gains under section 1(h)(1)(C) (currently 15 percent, but returning to 20 percent in 2011 if Congress does not act),
- gift tax exemptions and rates re-conformed to the estate tax (rather than a special exemption of $1 million and a special rate of 35 percent as in 2010 under current law),
- repeal of the deduction for state death taxes (which itself replaced the phased- out credit for state death taxes in 2005),
$10 million (in 2010 and thereafter), indexed for inflation, if the first spouse to die did not use any exemption – if, for example, the estate of the first spouse to die were left entirely to the surviving spouse.
- This treatment would have to be elected on a timely estate tax return of the first spouse to die, and the Internal Revenue Service would have been authorized to reexamine that return at the time the surviving spouse died, no matter how much time had passed, for the purpose of determining the exemption available to the surviving spouse (but not for the purpose of changing the tax with respect to the first return).
- The Bush Administration, despite its official commitment to full and permanent repeal of the estate tax, announced on June 22 that it supported PETRA “as a constructive step toward full repeal of the death tax.”
- On June 27, Senator Frist announced that PETRA would not be brought to the Senate floor before the Fourth of July recess.
On July 29, 2006, by a somewhat less enthusiastic and less bipartisan vote of 230-180, the House of Representatives passed still another bill, H.R. 5970, called the “Estate Tax and Extension of Tax Relief Act of 2006” (“ETETRA”).
- phasing in the $5 million exemption equivalent in $250,000 annual increments from $3.75 million in 2010 (up from $3.5 million in 2009) to $5 million in 2015,
- delinking the top estate tax rate (but not the initial 15 percent rate) from the capital gains tax rate,
- phasing in the top 30 percent rate in 2 percent annual increments from 40 percent in 2010 (down from 45 percent in 2009) to 30 percent in 2015,
of the sunset, meaning that they again would be scheduled to expire in 2011.
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58. The only Senator to change from his June 8 vote was Senator Byrd (D-WV).
1.eillpobbyvrknowhowtheSneouldhvevotdjustrbor yin2005,iftinahdnotintvnd.Butitislrthteven before Republicans lost control of Congress to the Democrats in the 2006 election, thetortotllhdsimpylosttoomuhttiontohveamninul hneofov. Considrtheolloin:
2.ntor2003,Sntorlspubliyinsistingonullndpmnntpl nddigumosofompomis,butythendof2004hispushora15 pnteinstdofullplsamttrofnlknl.vboetheune8lotuevot,itsundstoodintheSntethtStorl ouldpta30pntteorthelststts–nundstdingthtltr sltdinPRAndR.neillinnsstoompomiseinthis yis ond, it is vyhd to dibysst apuist”position.
On January 27, 2005, the Staff of the Joint Committee on Taxation published a 430-page Report entitled OPTIONS TO IMPROVE TAX COMPLIANCE AND REFORM TAX EXPENDITURES
(JCS-02-05), as requested in February 2004 by Chairman Grassley and Ranking Member Baucus of the Senate Finance Committee. The Report may be viewed at http://www.house.gov/jct/s-2-05.pdf. Under the heading of Estate and Gift Taxation, it presented five proposals estimated to raise revenue by $4.2-4.7 billion over ten years.
Perpetual dynasty trusts are inconsistent with the uniform structure of the estate and gift taxes to impose a transfer tax once every generation. In addition, perpetual dynasty trusts deny equal treatment of all taxpayers because such trusts can only be established in the States that have repealed the mandatory rule against perpetuities.
2.hepoposlouldphibitthellotionofSTmptiontoapptul nsytus”tht is subt ithrto no ueginst pptuitis orasninty ld uleginst ptuitis.fnmpt tust emovd toastteht hpdtheuleintpptuitis,theinluiontioofthetustouldbe hdtoon.Psmbythislttrueuldppyonyiftheltionof thetustpodudahneintheovningl,ndasimilruleuldlso ppyifthesitus sttengd its onigl.)
- For example, the proposal states that it would apply in a state that relaxes its rule against perpetuities to permit the creation of interests for individuals more than three generations younger than the transferor. Presumably, the statutory language would not be harsher than a classical rule against perpetuities, which easily allows transfers to great-great-grandchildren.
- Likewise, rather than an outright prohibition on allocation of GST exemption, as the proposal says, it seems more appropriate to simply limit allocation of the transferor’s GST exemption to a one-time use (permitting a tax-free transfer to grandchildren) and then allow the allocation of GST exemption, again for one-time use, by members of each successive generation also.
The proposal responds to the frequent use of family limited partnerships (“FLPs”) and LLCs to create minority and marketability discounts. … The proposal seeks to curb the use of this strategy frequently employed to manufacture discounts that do not reflect the economics of the transfers during life and after death.
- The basic aggregation rule would value a transferred interest at its pro rata share of the value of the entire interest owned by the transferor before the transfer. For example, a transferred 20 percent interest would be valued at one-fourth the value of an 80 percent interest if the transferor owned an 80 percent interest and at one-half the value of a 40 percent interest if the transferor owned a 40 percent interest.
- The transferee aggregation rule would take into account the interest already owned by the transferee before the transfer, if the transferor does not own a controlling interest. For example, if a person who owns an 80 percent interest transfers a 40 percent interest by gift and the other 40 percent interest at death to the same transferee, the gifted 40 percent interest would be valued at one-half the value of the 80 percent interest originally owned by the donor and the bequeathed 40 percent interest would be valued at one-half of the value of the 80 percent interest ultimately owned by the donee/legatee.
- Interests of spouses would be aggregated with the interests of transferors and transferees. The proposal explicitly (and wisely) rejects any broader family attribution rule “because it is not correct to assume that individuals always will cooperate with one another merely because they are related.”
4.hepoposltsasudpphhihppsdsndtooidthe untinnd ovodhofpvious lisltivepoposls. thss, the sussiveousonhtthetnsoroinlyodndonhtthe tnsendsupith–inontst,ormpl,tothesimpleggtionith thetransferor’s pvious tnss –ould poduesomeuious sults.
- Transferors with multiple transferees – e.g., parents with two or more children – would apparently have more opportunities to use valuation discounts than transferors with only one transferee.
- The results illustrated in the examples, based on the assumption that a majority (i.e., more than 50 percent) represents control, would apparently be easier to avoid in an entity like a limited partnership or LLC, where a 99 percent interest is often a noncontrolling interest.
- Testing valuation discounts ultimately against what the transferee ends up with would encourage successive transfers (retransfers) or transfers split, for example, between a child and a trust for that child’s descendants.
Recent arrangements involving Crummey powers [i.e., lapsing powers of withdrawal from a trust] have extended the “present interest” concept far beyond what the Congress likely contemplated in enacting the gift tax annual exclusion, resulting in significant erosion of the transfer-tax base.
- Limit Crummey powers to “direct, noncontingent beneficiar[ies] of the trust.” This would repudiate the broad use of Crummey powers sustained in Cristofani v. Commissioner, 97 T.C. 74 (1991).
- Limit Crummey powers to powers that never lapse. As the proposal acknowledges, “[t]his option effectively eliminates Crummey powers as a tax planning tool.”
- Limit Crummey powers to cases where “(1) there is no arrangement or understanding to the effect that the powers will not be exercised; and (2) there exists at the time of the creation of such powers a meaningful possibility that they will be exercised. This option requires a facts-and- circumstances analysis of every Crummey power.”
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1.nMh21,2007,inheonttofinliingheisl2008bugtolution S.Con.Rs.21,theSnt,yavoteof971ithonySntorigold- )oppod,ppovdnndmntodyntorusjondy SntosMyniu,kPorR,vnh,nd illlsonF)thtintouldmkete$132billionsupluspojtd or2012vilbetoosttxutsinboth201nd2012,inludingltive tnsion ofthetxutsntd in 2001nd 203.
Then our amendment takes the rest of the surplus and returns it to the hard- working American families who created it. Our amendment devotes the rest of the surplus to the extension and enhancement of tax relief for hard-working American families.
Here are the types of tax relief about which we are talking. We are talking about making the 10-percent [income] tax bracket permanent.…
We are talking about extending the child tax credit.…
We are also talking about continuing the marriage penalty relief…. We are also talking about enhancing the dependent care credit.…
We are talking about improving the adoption credit.…
We are talking about [taking] combat pay [into account] under the earned- income tax credit, otherwise known as the EITC.…
We are talking about reforming the estate tax. We want to try to give American families certainty. We want to support America’s small farmers and ranchers, and in this amendment, we have allowed room for estate tax reform that will do that.
And we talk about returning surplus revenues to hard-working American families.
Madam President, I thank very much Senator Baucus for his leadership on this very important amendment. This amendment is to reassure all those who have benefited from the middle-class tax cuts that those tax cuts will go forward, that those children who are not now currently covered under the SCHIP legislation will have the opportunity to be covered.
The Senator has also provided for small business because we have a number of provisions that are critically important to small business and, of course, to prevent the estate tax from having this bizarre outcome, which is now in the law, where the exemption would go down to $1 million from $3.5 million just two years before. That makes no sense. So the Senator provides for room in this amendment to deal with estate tax reform.
The precise contours of that will be up to, obviously, the Finance Committee.
There is an underlying answer to all these questions; namely, these are questions the Finance Committee is going to address and find the appropriate offsets and deal with the pay-go when it comes up at that time.
- In the context of this budget resolution, of course, “permanently” meant only through 2012 (or perhaps only through 2011, since the tax from 2011 estates would generally be payable in fiscal 2012, which begins October 1, 2012).
- The prospect of extending 2009 law through 2011 or 2012 was intriguing. It reflected some thoughtful attention to the concerns about the instability of the estate tax law, especially as 2010 approached.
- Moreover, by eliminating the repeal year of 2010, an extension actually picked up some revenue to offset the revenue lost in 2011 and 2012. The revenue loss in 2011 and 2012, when the exemption would increase from $1 million (under current law) to $3.5 million, would be complicated by the fact that the top federal rate would go from 39 percent (net of the state death tax
credit) under current law to something like 37.8 percent, 38.8 percent, or 45 percent (as in the table on page 6).
- Since the revenue gain from 2010 would have been a one-time gain, it would not have been available again to mitigate revenue losses, meaning that permanent estate tax reduction would become even more expensive if this extension were enacted.
51. The vote was severely partisan; no Democrat voted for it, and only one Republican (Senator Voinovich) voted against it. The four Senators who voted for cloture on H.R. 8 in June 2006 but not for Senator Kyl’s March 2007 amendment were Senators Baucus, Lincoln (D-AR), Bill Nelson (D-FL), and Ben Nelson (D-NE).
Like the Kyl amendment, our amendment will allow us to accommodate the Landrieu proposal of a $5 million [exemption] and 35 percent [rate] with a surcharge for the largest estates. Unlike the Kyl amendment, this amendment is fiscally responsible and deficit neutral [that is, it will be paid for].
Only four Republicans (Senators Susan Collins and Olympia Snowe of Maine, Richard Lugar of Indiana, and George Voinovich of Ohio) voted for Senator Nelson’s amendment.
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That the conferees on the part of the Senate on the disagreeing votes of the two Houses on the concurrent resolution S. Con. Res. 21 (the concurrent resolution on the budget for fiscal year 2008) be instructed to insist that the final conference report include the Senate position to provide for a reduction in revenues, sufficient to accommodate legislation to provide for permanent death tax relief, with a top marginal rate of no higher than 35%, a lower rate for smaller estates, and with a meaningful exemption that shields smaller estates from having to file estate tax returns, and to permanently extend other family tax relief, so that American families, including farmers and small business owners, can continue to
enjoy higher after-tax levels of income, increasing standards of living, and a growing economy, as contained in the recommended levels and amounts of Title I of S. Con. Res. 21, as passed by the Senate.
- In explaining the motion, Senator Kyl said: “While the motion does not specify that amount, an exemption of $5 million per estate indexed for inflation is what is contemplated.” Id. at S5839.
- Senator Conrad opposed the motion, on the grounds that it was not paid for and that the subject was already covered by the Baucus amendment in the Senate resolution, which he as a Senate conferee would be committed to support. Id.
- Nevertheless, Senator Kyl’s motion passed by a vote of 54-41, with eight Democrats in favor and no Republicans opposed.
Even provisions “sufficient to accommodate” the desired legislation would still leave the implementation up to the tax-writing committees.
- The provisions of the budget resolution applicable to the House of Representatives (section 303(b)(2)) permit
one or more bills, joint resolutions, amendments, motions, or conference reports that provide for tax relief for middle-income families and taxpayers and enhanced economic equity, such as extension of the child tax credit, extension of marriage penalty relief, extension of the 10 percent individual income tax bracket, modification of the Alternative Minimum Tax, elimination of estate taxes on all but a minute fraction of estates by reforming and substantially increasing the unified credit, extension of the research and experimentation tax credit, extension of the deduction for State and local sales taxes, and a tax credit for school construction bonds … provided that such legislation would not increase the deficit or decrease the surplus for the total over the period of fiscal years 2007 through 2012 or the period of fiscal years 2007 through 2017.
H.R. REP. NO. 110-153, 110TH CONG., 1ST SESS. 27 (2007).
- With respect to the corresponding language of the budget resolution applicable to the Senate (section 303(a)), an overview prepared by the staff of the Senate Budget Committee stated:
The Conference Agreement supports middle-class tax relief, including extending marriage penalty relief, the child tax credit, and the 10 percent bracket subject to the pay-as-you-go rule. It also supports reform of the estate tax to protect small businesses and family farms. House provisions include additional procedural protections to help ensure fiscal responsibility.
- The proviso that the contemplated tax relief “not increase the deficit or decrease the surplus for the total over the period of fiscal years 2007 through 2012 or the period of fiscal years 2007 through 2017” – what the Senate
Budget Committee’s overview refers to as “procedural protections to help ensure fiscal responsibility” – could fairly be interpreted to mean that under the budget resolution the Ways and Means Committee would not include any tax relief provisions that were not “paid for” through increases of other taxes or projected budget surpluses. That would have been an especially hard standard to meet in view of the deficits that budgets needed to overcome and the commitment of Ways and Means Committee Chairman Charlie Rangel (D-NY) and other Members of Congress to give priority to the very expensive task of fixing the individual alternative minimum tax (which in the 2012 Tax Act may actually have been accomplished).
This amendment would take the surplus in the budget resolution and give it back to the hard-working American families who earned it. It would make permanent the 10-percent tax bracket. It would make permanent the child tax credit. It would make permanent the marriage penalty relief. And it would make permanent the changes to the dependent care credit. Further, it would make changes to the tax law to honor the sacrifices our men and women in uniform make for us every day. We lower the estate tax to 2009 levels. And it would allow middle-income taxpayers who do not itemize their deductions to nonetheless take a deduction for property taxes.
Mr. President, I thank the chairman of the Finance Committee, Senator Baucus, for this excellent amendment. This will extend the middle-class tax cuts, the 10-percent bracket, the childcare credit, and the marriage penalty relief provisions. All those tax cuts will be extended.
In addition, as I understand it, the chairman of the Finance Committee has crafted an amendment that will include significant estate tax reform because we are now in this unusual situation of where, under current law, the estate tax will go from a $3.5-million exemption per person in 2009 to no estate tax in 2010, and then in 2011, the estate tax comes back with only $1 million exemption per person. The amendment of the Senator from Montana would make certain it stays at $3.5 million and is allowed to rise with inflation.
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- Vice President Cheney had been in the presiding officer’s chair and recognized Senators Salazar and Kyl just before the vote on Senator Salazar’s amendment (id.), but he was no longer in the Senate chamber to break the tie after the vote on Senator Kyl’s amendment
The American people need to understand what is really going on. Each year we pass a budget that, theoretically, allows for a reform of the estate tax, but then we don’t do anything about it. And the budget itself isn’t law. The budget is merely a goal, a blueprint of where we want to go for the year. If you don’t follow it up with a bill, you haven’t done anything. But Members here pat themselves on the back and go back home and tell their constituents that they voted to cut the estate tax. Oh, that is wonderful, people say. But it is never followed up with an actual bill.
So the chairman of the Finance Committee said: Well, he would have the goal of marking up a bill this spring. He has since advised me he has no plans whatsoever for a real bill on estate tax, and said: It won’t happen.
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On October 4, 2007, while the Senate Finance Committee was considering the tax features of an energy, conservation, and agriculture tax package entitled the Heartland, Habitat, Harvest, and Horticulture Act of 2007, Senator Kyl proposed an amendment that would set the estate tax exemption at $5 million indexed for inflation, tie the estate tax rate above $5 million to the capital gains tax income tax rate (currently 15 percent), and add a 30 percent bracket beginning at $25 million. (This is essentially the same as ETETRA.) Senator Kyl withdrew the amendment after Chairman Baucus promised to hold a hearing on estate tax reform “later in the year,” with the goal of marking up a bill in the spring of 2008.
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- the need to clarify, modernize, simplify, and otherwise improve the rules for deferred payment of estate tax under section 6166,
- the “portability” of transfer tax exemptions (and exemption equivalents represented by the unified credit) from deceased spouses to surviving spouses,
The topics provide clues about the “targeted” relief to look for in any legislation (tied to family farms and other family businesses which have been a vocal concern of Senators, especially Democrats like Senator Lincoln). See http://finance.senate.gov/library/hearings/download/?id=57f554d9-c027-42c2-90d7-f740010f59cd.
$17,184,000. Because of the increase in the unified credit to match a $3.5 million exemption, the surtax under H.R. 436 would apply to taxable estates from $10 million all the way up to $41.5 million.
- In other words, the marginal rate between $10 million and $41.5 million would be 50 percent (45 percent plus 5 percent), and the ultimate tax on a taxable estate of $41.5 million, calculated with the 2009 unified credit of
$1,455,800, plus the 5 percent surtax on $31.5 million (the excess over $10 million), would be $18,675,000 – exactly 45 percent of $41.5 million.
- At least the old 5 percent surtax used to work that way when there was a federal credit and no deduction for state death taxes. Today, it would still work that way in “coupled” states where in effect there is no state death tax. Once again, the repeal of the state death tax credit makes the math more complicated in “decoupled” states that impose their own tax. In those states, the actual numbers will depend on the structure of the state tax, but in general the combined federal and state marginal rates for taxable estates between
$10.1 million and $41.5 million will be 56.9 percent in states that conform to the federal deduction for their own state taxes and 58.0 percent in states that have decoupled even from that federal deduction.
- Regardless of the stature or future of H.R. 436 in general, the revival of the surtax idea might gain traction in a revenue-minded and middle-class-focused congressional environment. No idea ever fades away completely.
- If a surtax like this were enacted, it would be one more reason to be careful in providing blanket general powers of appointment in trusts subject to the GST tax, because at least the GST tax is imposed at a flat 45 percent rate.
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what the pre-2002 law would produce in 2011). But that reduction of federal revenue would have been of less magnitude and different composition than might sometimes be assumed, because, if the 2001 Tax Act sunset were allowed to run its course and pre-2002 law, including the credit for state death taxes, returned in 2011, the net federal rate on the largest estates would not increase very much.
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$10 million and then 44 percent over $10.1 million. At a little over $17 million, the net marginal rate would fall to 39 percent, the net rate on all taxable estates above that level. These rates compare to the 2009 net federal marginal rate on the largest estates of 45 percent in “coupled” states, 38.8 percent in ordinary “decoupled” states, and 37.8 percent in “decoupled” states where the state tax itself is not allowed as a deduction in computing the state tax.
Federal Estate Tax Owed
2011 (before 2010 Tax Act)
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The Chairman of the Senate Committee on the Budget may revise the allocations of a committee or committees, aggregates, and other appropriate levels and limits in this resolution for one or more bills, joint resolutions, amendments, motions, or conference reports that would provide for estate tax reform legislation establishing–
- an estate tax exemption level of $5,000,000, indexed for inflation,
- a maximum estate tax rate of 35 percent,
- a reunification of the estate and gift credits, and
- portability of exemption between spouses, and
provided that such legislation would not increase the deficit over either the period of the total of fiscal years 2009 through 2014 or the period of the total of fiscal years 2009 through 2019.
VI.A.7 on page 21) and by Senator Salazar in 2008 (see Part VI.B.4 on page 23) – that is, in Senator Nelson’s words, “[l]ike the Kyl amendment, [but] fiscally responsible and deficit neutral.” In an environment of extreme fiscal challenges, that effect could be very small.
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- In other words, if Husband 1 dies after 2009 without using his full exclusion amount, and his widow, Wife, marries Husband 2 and then dies, Wife’s estate could use her own exclusion amount plus whatever amount of Husband 1’s exclusion amount was not used. Husband 2’s estate could use his own exclusion amount plus whatever amount of Wife’s basic exclusion amount was not used. But Husband 2’s estate could not use any of Husband 1’s unused exclusion amount transmitted through Wife’s estate. Some commentators describe this as requiring privity between the spouses.
- Husband 2’s estate could still use the unused exclusion amount of any number of his predeceased wives (and S. 722 would make that explicit), subject only to the overall limitation that the survivor’s exclusion amount could be no more than doubled.
percent over $5 million, and a rate of 55 percent over $10 million (with these amounts also indexed for inflation after 2010),
- portability of the unified credit between spouses (as in PETRA and ETETRA, not requiring “privity” between spouses as in S. 722).
$202 billion over ten years, or about 37 percent of current-law revenue estimates (compared to 43 percent of current-law estimates for the cost of the Administration proposal to make 2009 estate tax law permanent).
- Under H.R. 3905, in each of the ten years from 2010 through 2019, the estate tax applicable exclusion amount would increase by $150,000 and the top rate would decrease by 1 percent. Thus, by 2019 the exemption and rate would be $5 million and 35 percent, the levels embraced aspirationally by a majority of Senators while considering the fiscal 2010 budget resolution (see part VII.D, beginning on page 28). The $5 million exemption would be indexed for inflation after 2019.
- In addition, the deduction for state death taxes would be reduced 10 percent per year through 2019, when it would be eliminated entirely.
- H.R. 3905 would abandon carryover basis and make permanent the other 2001 transfer tax changes, including the several helpful rules regarding allocation of the GST exemption. But it would not reunify the gift and estate tax exemptions or make the exemption portable between spouses.
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2009 estate tax law but had second thoughts when Majority Leader Steny Hoyer (D-MD) reconvened them and urged them to embrace a permanent solution.
$3.5 million, the gift tax exemption of $1 million, the top rate of 45 percent, a stepped-up basis at death for appreciated assets, a deduction (and no credit) for state death taxes, and the special rules for conservation easements, section 6166, and allocation of GST exemption enacted in 2001.
Twenty-six Democrats voted against the bill. No Republican voted for it.
- The supporters of the bill in the floor debate focused on the need for predictability in planning and the unfairness of carryover basis.
- Those voting no presumably did so mainly because they would have preferred to see the estate tax permanently repealed or more significantly reduced – the House of Representatives then included over 170 members who were among the 272 votes for permanent repeal the last time that issue had come before the House in April 2005. Indeed, the opposition in the floor debate before the vote supported the Berkley-Brady bill (H.R. 3905), which would have phased in a $5 million exemption and 35 percent rate by 2019 and indexed the exemption for inflation after that. A few voting no, however, were Democrats who have expressed a preference for a higher tax, including, for example, a reduction of the exemption to $2 million and a return to a top rate of 55 percent. Other Democrats of that view voted yes.
- By use of the word “permanent,” of course, Senator McConnell was advocating legislation that would eliminate not just all or part of the 2010 repeal year, but also the return to a higher tax in 2011.
- By “portable,” he was affirming the ability of a surviving spouse to use any estate tax exemption available to but not used by the first spouse to die.
- By “unified,” Senator McConnell was supporting the increase of the $1 million gift tax exemption to be equal to the estate tax exemption, as it had
- 31 -
been before 2004.
- By “indexed for inflation,” he was embracing annual increases in the unified exemption with reference to increases in the consumer price index, as the GST exemption was indexed from 1999 through 2003 (and will be indexed again in 2011 unless Congress changes the law).
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Mr. President, clearly, the right public policy is to achieve continuity with respect to the estate tax. If we do not get the estate tax extended, even for a very short period of time, say, 3 months, we would clearly work to do this retroactively so when the law is changed, however it is changed, or if it is extended next year, it will have retroactive application.
$3.5 million. The tax would then be imposed at rates of 45 percent over $3.5 million, 50 percent over $10 million, 55 percent over $50 million, and 65 percent over $500 million.
- The 65 percent rate is cast as a 10 percent “surtax,” but it has the same effect as a 65 percent rate, and it has no ceiling. It replaces the former 5 percent surtax on taxable estates over $10 million.
- Like the former 5 percent surtax, the 10 percent surtax would not affect the GST tax rate, which would be 55 percent as it was before 2002.
- 32 -
This “surtax” is said to replace section 2011(c)(2). The correct reference would be section 2001(c)(2).
3.hsebillsouldbnonorbsis,stoetheditorsttedthts, ndmkepmntteothr2001tnrtxhngs,inludigteuls digllotionofheSTmption. tthyouldnotoomthe itndsttetxptions,indxthempionorbktsorinlion,or mkethemption potblebtn spouss.
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II.E.1.c on page 5), and statutory language implementing the Administration’s revenue proposals regarding basis and GRATs (see Part XVII.B.7 beginning on page 100 and Part XVII.C beginning on page 104).
2.sithSntoruspviouspopols,shsS.722ehdintodud onMh26,2009Ptbinnigone,themndmntould pmnntyinstte209sttetxl,itha45pnttend$3.5million mption,tivenuy1,2010,inddorinltionbinnigin2011. utosofddntshodidin2010ouldbebletoltoutofthestte txintotheorbsisimetthdbn2010l.nasultvidy mystoooodtoetu”ndthuspossiblynovsht,theusill ppntyouldhveltatstmnty ustompltyeofSTtx ovriftht ltion em
targeted to real estate.
- The value of family farmland that met certain qualifications and passed to a “qualified heir” would not be subject to estate tax until it was disposed of by a qualified heir.
- 33 -
million, the statutory cap of $750,000 indexed for inflation since 1999 – would be tied to the applicable exclusion amount ($3.5 million in the Baucus Bill) and would be indexed for inflation beginning in 2011.
- The treatment of a disposition or severance of standing timber on qualified woodland as a recapture event under section 2032A(c)(2)(E) would be made inapplicable to a disposition or severance pursuant to a forest stewardship plan developed under the Cooperative Forestry Assistance Act of 1978, 16
- Certain contributions and sales of qualified conservation easements would likewise not result in recapture under section 2032A.
- The limitation on the exclusion from the gross estate by reason of a qualified conservation easement under section 2031(c) would be increased from
$500,000 to $5 million.
1.nMond,mbr6,2010,Psidntbmannoundon ntionl tlvisionththendtinossionllshddonthemok ofadl”topmitthe2001nd2003inomexuts–thesolldushtuts”–tobetnddortos.hePsdntpotdthtthegmnt inludda or2pntpolltxdtion,a13monthtnsionof mplmntbnitsdsidymymot,ndntnsionofthestte txortos–psmby 2011nd2012–itha$5millionmpionnd a35pntten mptionndtethttnSntorbahimslfhd votdorintheonsidtionoftheisl2009budtsolutiononMh11, 2008, dsibd in Pon pge
2.tpsthttheossionlldsthePsinthdthismntith emostyRpublins,ndtheinitiltionsofRpublinse suppotiv,vnifnotnthusisti,hilesupisdmotsoinlyd ithskptiismorvnhostili.sthedspssd,Rpublinitiismslso mdhilemoemoticsuppotbgntobehd.ntheuseof Rpsnttivsintiul,themoticistnesdidlythesttexpoposl,blivdyytobebothovygnousnd tnous to theoelmnts oftheompomis.
4753) to implement the agreement announced by President Obama. The amendment, offered by the Senate leaders, Senators Harry Reid (D-NV) and Mitch McConnell (R-KY), to an Airport and Airway Trust Fund funding measure
4853,stitldthexRli,mplmntsunRuthoition, nd obCtion t of2010.” t povidd
- an estate tax exemption of $5 million and estate tax top rate of 35 percent, beginning January 1, 2010,
- an opportunity for executors of 2010 estates to elect out of the estate tax into the 2010 carryover basis rules,
- a gift tax exemption of $5 million and a gift tax top rate of 35 percent, beginning January 1, 2011,
- portability of the unified credit (“exemption”) from a deceased spouse to the surviving spouse, as in the December 2010 Baucus Bill, but
- nothing addressing GRATs, consistent basis, targeted relief for real estate, or valuation discounts, and
- nothing to permanently remove the shadows of “sunset” from the other changes made by the 2001 Tax Act, affecting the GST exemption (expanded deemed allocations and elections, retroactive allocations, qualified severances, determinations of value, and relief from late allocations), conservation easements, and section 6166. (All those provisions are only extended for two years.)
1.Stion101)fthexRli,nmplmntnsueRuthoition,nd obCtiontof2010,Publicw11132the2010xt)simpy tnddthesunstintheotdisussdstion901ofthe2001xtorto sypigmbr31,2010”ithmbr31,2012.”sasult, vthigthtsptdtopiettendof2010ssuldto piet thend of2012instd.
of 2010 and were the main engine that drove the extraordinarily intense discussions that led to consideration of the Reid-McConnell Amendment. But, read together with section 304 of the 2010 Tax Act, it also included the new estate, gift, and GST tax provisions introduced by the 2010 Tax Act.
1.itleIofte2010 x t,undrtheingfmpoystteRli,”espilttntiontothestt,it,ndSTts,bueofthe uniquedisuptionofthosetsin2010.Stion301insttdthestexnd pdorbssor2010.Stion302)stblishdnstetppliblelusionmount,ormption,”of$5millionndatopsttetteof35pnt,tivenuy1,2010.tlsoinddtht$5million mptionorinltion,binnigin2012,nd,bingoundintheonttofthe tortnsion, lso ndingin 2012.
In other words, the “progressive” rates, or “run up the brackets,” occurred only below $500,000. The tax value of that run is only $19,200 (35 percent of
$500,000 less the stated tax on $500,000 of $155,800).
3.he$5millionmptinnd35nt,tivenr2010,eabit ofasuis,nditsundstndbleththytttdspiltntion, spilyinthettmptdousemndmnt.hilethestofthesus tndingthe2001txutssimpymintindte2010sttusquothogh2011 nd2012,thesttetx omponntoftheompomisesdint into spts.
- First, unlike the income tax compromises, which prevented, in effect, a tax increase on January 1, 2011, the estate tax deal was a tax increase compared to former 2010 law but represented a tax cut when compared to 2009.
- Second, this tax cut was effective not just in 2011 and 2012, but also, in large part, retroactively in 2010.
- One complication of the attempted repeal of the estate tax in 2001 (to take effect in 2010) and the manner in which it became a reality in 2010 was the abrupt introduction of the modified carryover basis regime of section 1022, without technical corrections, without regulations or other guidance, without forms or instructions, and without much serious study at all. Discomfort with the impending carryover basis regime was a principal argument cited in 2009 by congressional supporters of legislation to make the 2009 law permanent and prevent the 2010 law enacted in 2001 from taking effect. See Part
VII.G.5.a on page 31. Because Congress did not act in 2009, however, the modified carryover basis regime appeared to apply to property passing from a decedent who died in 2010. Ultimately it did apply to such property if the executor elected that the estate tax not apply.
- Under pre-2010 and post-2010 law, and under 2010 law without an election out of estate tax, a decedent’s beneficiaries inherit assets with a basis for computing depreciation and capital gains equal to the fair market value of the assets on the date of the decedent’s death. This basis adjustment is typically referred to as a “basis step-up,” because it is assumed that one’s basis in assets is lower than the fair market value of assets on the date of death. However, the adjustment actually works in both directions, and if the fair market value of an asset on the date of death is lower than the decedent’s basis, the asset’s basis is stepped down for all purposes, so that the beneficiaries inherit the property with a lower basis. One historical reason for the basis adjustment rules is apparently the perceived unfairness of imposing a double tax on a beneficiary who inherited assets – first an estate tax and then a capital gains tax when the executor or beneficiary subsequently sold the asset, especially if the sale was necessary to raise money to pay the estate tax. This reasoning would not fully apply in the absence of an estate tax.
- The basic rule in 2010 under section 1022 was that a decedent’s basis in appreciated property remained equal to the decedent’s basis in the property if the fair market value of the property on the date of death was greater than the decedent’s basis. If the fair market value of an asset on the date of death was less than the decedent’s basis, the basis was stepped down to the fair market value on the date of death, just as it would have been under former law. This rule applied separately to each item of property.
- Under section 1022(a), carryover basis applied to “property acquired from a decedent,” which is defined in section 1022(e). The definition does not cover all property the value of which would have been included in a decedent’s gross estate, such as property that would have been included in the gross estate of a surviving spouse by reason of a QTIP election under section 2056(b)(7) at the first spouse’s death and property that would be included in a decedent’s gross estate under section 2036 solely because the decedent had been the grantor and beneficiary of a grantor retained annuity trust (”GRAT”) or a qualified personal residence trust (“QPRT”).
ii.ntheseofaRTorPR,thebsisfthesstsislikytobethe dntsbsis.mple1ofRv.Po.201141illusttd tht ovrbsisouldnotppytothestsofaPRTifthe ntor didduingthePRT tm nd those ssts pssd to the ntoshild. utifinthtsethosestspassed to the grantor’s estate hih is omon buse it sults in a lor ble it,mple 2ofRv.Po.201141sttdttthnthosesstse subjttoorbss. PsumbytheueoraRTouldbe
the same (except that a reversion to the grantor’s estate would not be as common).
- Section 6018, as applicable to the estate of a decedent who died in 2010 and whose executor elected out of the estate tax, required reporting to the IRS and to recipients of property from the decedent, if the fair market value of all property except cash acquired from the decedent exceeds $1.3 million.
ii.Stion6075,sppibletothestteofaddnthodidin 2010ndhoseutrldoutoftesttet,ppstoquie thepottotheRSm8939)tobeildththetunofthetx imposdyhptr1ortheddntslsttblerthtis,the dntsil1040depil18,2011]orsuhltrdtespidin ultions.”
- In Notice 2011-66, 2011-35 I.R.B. 184, released on August 5, 2011, the IRS provided the first substantive guidance regarding carryover basis and the election. Notice 2011-76, 2011-40 I.R.B. 479, released on September 13, 2011, amplified and modified that guidance. Confirmations and clarifications provided by those Notices include the following.
ii.Form 8939 was to have been filed on or before January 17, 2012. otie201166oiinlyidovmbr15,2011,nd,uious,vn otie201176,hihnnoundthenuy17duedt,sttdtht thesuyptmntndRSintndtoniminultions… tht om 8939 is dueonorboeovmr15,2011.
- Ordinarily Form 8939 would have been filed by the executor appointed by the appropriate probate court.
i.Somtims,hov,theisnosuhuto,suhshnllofthe dntspopyishldjointyorhldintust.nthts,aom 8939,ormultipleoms8939sthesemy,ouldhvebnild ytheustsorothsinpossssionofthtpopytnlld sttutoyutos”trthedinitioninstin2203.otie2011- 66sttdthtifthosettutoyutosdidnotgegdigthe ltion,orttmptdintheggtetollotemoebsisine thnthelwllod,theRSouldnotiy thosesttutoyutostht thyhe90dstoolvethirdis.ftheutosildto solvethirdinsithin90ds,theS,tronsidigll
relevant facts and circumstances disclosed to it, would determine whether the election has been made and how the allocations should be made. As with most “facts and circumstances” judgments, it was impossible to know how the IRS might make those decisions.
ii.nsuppotofthtim,the2010sttetxunom706)postd ontheRSbsiteonSptmbr3,2011theStudyoebr ,ndthem8939postdontobr6,2011,bothinluddthe olloingsnteinhedltionbovehesintelin:I uto)unstndthtify othrpsonilsaom8939orm 706orom706)ithspttothisddntorstt,thtsic] ynendddssllbeshdithsuhson,ndIuto) lsohy qsttht]theRSsheithmethenmendddssof yothrpsonhoisaom8939orom706orom706) ith spt to this dnt orstt”
- The IRS indicated that in general it would not grant extensions of time to file Form 8939 and would not accept a Form 8939 filed late, and that, once made, the Section 1022 Election and basis increase allocations would be irrevocable. There were four explicit exceptions, which Notice 2011-66 called “relief provisions”:
- Property subject to carryover basis or eligible for basis increases had been more accurately identified. For example, property acquired by a decedent within three years before death by gift from anyone other than the decedent’s spouse did not qualify for the basis increases. Likewise, property subject to a general power of appointment was subject to carryover basis but not eligible for basis increases. Property in a QTIP trust for the benefit of a 2010 decedent was not subject to carryover basis at all. These results departed significantly from the estate tax rules with which return preparers had been familiar.
- Historical bases and date-of-death values had been more accurately determined. As expected, many executors had difficulty reconstructing the decedent’s bases in assets. Even the familiar estate tax concept of date-of-death fair market value may have been a challenge in the 2010 economy. Many executors and their advisors got a late start in a climate of rumors that Congress
might change the rules.
(C) The decedent’s tax profile had been more thoroughly studied.
For example, before 2010 many taxpayers may have had little reason to distinguish between capital assets and other assets, especially when those assets, if sold, would have produced a loss and not a gain. Even some taxpayers with loss carryovers may have had little reason to keep strict track of them. Death in 2010 may have made such tax accounting notions relevant for the first time.
- Equitable treatment of respective beneficiaries had been more appropriately determined. Because the burdens of the estate tax and the income tax might not affect all beneficiaries the same way, some executors may have found it difficult both to allocate assets among beneficiaries and to allocate basis increases among assets. After January 17, more equitable approaches may have been crafted, disagreements among beneficiaries may have been addressed, or necessary court approvals may have been obtained.
iii.heRSmygnt100li”lloign utortomndor supplmntaom8939tolloteysisneththsnot pviousynvlidyllotd,”ifdditionlsstsediovdor ifsstseludnhtotie201166stosnRS mintionorinqui”trom8939sild.Suhnuditould ourhnnsstissoldmysrvndstrtheom 8939 sild, hh ns thtmost mul”llotions ouldhve bnilldvisdndinynttheouldhvebnnopottiv” ltions.
- The IRS indicated in Notice 2011-66 that its standards for this relief are likely to be strict, especially when a long time has passed since January 17, 2012.
- But this anticipated strictness may need to be balanced against one of the apparent purposes of the Section 1022 Election, which was to relieve concern for a constitutional challenge to what would otherwise have been a retroactive reinstatement of the estate tax.
- The first such ruling to be published, Letter Ruling 201231003 (April 16, 2012), cited no facts other than “Decedent died in 2010. The executrix for Decedent’s estate retained a qualified tax professional to prepare the Form 8939.” The ruling request was filed January 27, 2012 (only 10 days after the missed due date), and the ruling was issued 80 days later.
- Subsequent rulings have been similar.
- The executor must furnish the required information to each recipient, using a Schedule A to Form 8939, no more than 30 days after the original Form 8939 or any amended or supplemental Form 8939 is filed (basically, by February 16, 2012). Assets not distributed are treated as received by the executor, and the executor must furnish the required information to each recipient as distributions in kind are made.
i.nutomticsimonthtnsionoftimetoilensttetxtunr a2010ddntouldvebnobtindytiyilingam4768, pplitionortnsonofimetoileaRtunnd/orPy.S. sttendtionkipping ns)s.hisstuehththeddntdidbembr17,2010thedteofntmntof the2010 xt, oronortrtt dt
ii.nabkomnolpodu,asimonthtnsionoftmetopay thesttetxslso tomti; otie201176sttd tht theutor isnotquidtosubstntite…theson.” tisnotlryteotie usdtheodsubstntit” nd did not just sy it is not nssyvn to state ason.
The IRS will not impose late filing and late payment penalties under section 6651(a)(1) or (2) on estates of decedents who died after December 31, 2009, and before December 17, 2010, if the estate timely files Form 4768 and then files Form 706 or Form 706-NA and pays the estate tax by March 19, 2012. The IRS also will not impose late filing or late payment penalties under section 6651(a)(1) or (2) on estates of decedents who died after December 16, 2010, and before January 1, 2011, if the estate timely files Form 4768 and then files Form 706 or Form 706-NA and pays the estate tax within 15 months after the decedent's date of death.
Section 6651(a)(1) relates to the failure to file, and section 6651(a)(2) relates to the failure to pay. So not only did this statement make it clear that estates of decedents who died before December 17 and on or after that date would be treated the same, but it also addressed filing and paying with the same language. This confirms that the standard for “substantiating,” or even stating, a reason for an extension of time to pay the tax was a very low standard indeed. But a timely Form 4768 had to be filed.
under section 6651(a)(2) or 6662(a) will be imposed. Such a taxpayer was advised to write “IR Notice 2011-76” across the top of the amended return that was required to report consistently with the Section 1022 Election. The Notice refers only to property “disposed of” and does not apply by its terms to adjustments to depreciation (although an argument for relief based on Notice 2011-76 would appear to be compelling).
- Rev. Proc. 2011-41, 2011-35 I.R.B. 188, also released on August 5, 2011, elaborated the rules governing the allocation of the basis increases discussed below and provided a number of other clarifications, including the following:
iii.Stion4.063)poviddthtthedpitionofpopyinthendsof theipintisdtmidinthesmeyitsinthehndsofthe dnt,usingthesmedptionmthod,ovyiod,nd onvntion.ormpl,iftenthdbndtingnssovra20rpiodnddidtrht,theutororothr ipintillontinuetodpitethtsstonthesmesduleothent 12s.
iv.Stion4.064)lidthtasusnddlossudrthepssivetiviy loss ulssddtobsissinait,notddutiblestth) immdityboeth.heplntionsmstossume tht a ddutionndndditontobsisemoeorlssquivlnt,buty digaddtionthtouldhventnginstodiny inom, this uleould, in t,onvt pitl gin to odinyiom.
vii.Stion4.07liidthtatstmnty ustthtothisequlidahitbleindrtustundrstion664ouldstilquliyifthe utormdeaStion1022ltion,vnthouhtheltionoutof the sttetxouldmnthtnosttetxddutionundrtion 2055sllob,ihouldpprtohedisquliidthetust undrR. §1.6641iiia
- Curiously, Rev. Proc. 2011-41 began by stating that “[t]his revenue procedure provides optional safe harbor guidance under section 1022…,” but many observers commented that it did not provide what are typically viewed as safe harbors. The instructions to Form 8939 included the following:
If the executor makes the Section 1022 Election and follows the provisions of section 4 of Revenue Procedure 2011-41, and takes no return position contrary to any provisions of section 4, the IRS will not challenge the taxpayer’s ability to rely on the provisions of section 4 on either Form 8939 or any other return of tax.
- Publication 4895 generally addressed the same topics as Notices 2011-66 and 2011-76 and Rev. Proc. 2011-41, without adding much that was new.
- The first modification, provided by section 1022(b), was called simply a “basis increase” in the statute, but was called the “General Basis Increase” in Rev. Proc. 2011-41.
- The second modification, provided by section 1022(c), was an additional $3 million increase in basis for property passing to the surviving spouse, called the “Spousal Property Basis Increase.”
- The General Basis Increase was the sum of the “Aggregate Basis Increase,” which was $1.3 million, and the “Carryovers/Unrealized Losses Increase.” The Carryovers/Unrealized Losses Increase in turn had two components:
ii.thesumofthemountofylosssthtoudhvebnlloble undrstion165iftepopyquidomthednthdn soldtirmktvueimmdityboethedntsdth” stion1022bCi.Stion4.022b)ndmple3ofRv. Po.201141mdetlrthtthissndomponntofthe Covs/lidosssneinluddall unlidlosssin pitlsststthemomntoftheddnsdth,ithoutgdto thelimittionsonmmditeddutibiliythtouldppyorinome txpupossinthevtofntull.hs,themountofthoe unlidlosss,int,silbletoinethesisof pptd ssts up tothirirmkt vluet dth
- The basis increases could not increase the basis of any asset in excess of the fair market value of that asset as of the date of the decedent’s death.
- Section 4.04(2) of Rev. Proc. 2011-41 provided that the fair market value of an undivided portion of property for this purpose was a proportionate share of the fair market value of the decedent’s entire interest in that property at death. This provision applied to determine both the fair market value cap on the allocation of basis increase and, in the case of temporal or successive interests, the allocation of the basis increase itself.
$300,000 was devised to three recipients in undivided one-third shares, each share was allocated $100,000 of the decedent’s basis, and the executor could allocate up to $100,000 of basis increase to each one- third share – or to just one or two of those shares. This was true even though the resulting basis of $200,000 for an undivided one-third interest could have exceeded its fair market value as an undivided interest.
ii.utifthelsttedbndvisdtooneonorliendthntoa sondpson,thispovisionouldqui,int,nllotionofto$300,000ofbsisinsetotelstteitsl,notsptytothe liestteorthemnd,ndthesptivebssofthetmpointstsouldbedtmindundrtheuniombsispiniplsstout inR.§§1.1014&.hisusoftelltionuleontmpol intstssonimdytheousontmpolintstsonpe8of theinstutionstoom8939,hihepostdontheRSbsiteon tobr7, 2011.)
- Section 1022(d)(1)(B)(ii) provided that some property interests that were not held through simple outright ownership qualified for the General Basis Increase, including a portion of joint tenancy property, the decedent’s half of community property, the surviving spouse’s half of community property if the deceased spouse owned at least half of the whole community property interest, and property held in trusts that were revocable by the grantor.
- The General Basis Increase could not be applied to some property the value of which would have been included in the decedent’s gross estate if the election out of estate tax had not been made. As noted above (Part VIII.C.2.b on page 37), carryover basis did not apply to a QTIP trust of which the decedent was the beneficiary and may or may not have applied to a GRAT or a QPRT of which the decedent was the grantor. If carryover basis applied, then the General Basis Increase might apply. For example, carryover basis would apply to a QPRT in which the grantor had a reversion in the event of death during the QPRT term, and Example 2 of Rev. Proc. 2011-41 confirmed that the General Basis Increase would also apply. In the case of property subject to the decedent’s general power of appointment, section 4.01(3)(i) of Rev. Proc. 2011-41 clarified that carryover basis applied, but Code section 1022(d)(1)(B)(iii) provided that the General Basis Increase may not be allocated to that property.
- Property acquired by a decedent by gift within three years of the decedent’s date of death from anyone other than the decedent’s spouse also did not
qualify for the General Basis Increase, under section 1022(d)(1)(C).
- A frequent question since carryover basis was enacted in 2001, and especially after it became effective at the beginning of 2010, was whether an executor may allocate basis increases to property that has already been distributed or sold. Section 4.03 of Rev. Proc. 2011-41 said yes. Example 4 of Rev. Proc. 2011-41 even acknowledged that the basis of property that had declined in value after the decedent’s death and was then sold may be increased by allocation of basis increases up to date-of-death value, thus generating a loss on the sale.
- The basis of property eligible for the General Basis Increase could have been increased by an additional $3 million Spousal Property Basis Increase, but not in excess of the fair market value of the property as of the date of the decedent’s death, if and only if such property was transferred to the surviving spouse, outright or as “qualified terminable interest property” for the exclusive benefit of the surviving spouse.
- Section 1022 provided its own definition of “qualified terminable interest property” and did not simply refer to the definition of “qualified terminable interest property” contained in the estate tax marital deduction provision of section 2056. Because the QTIP election in section 2056(b)(7)(B)(i)(III) was omitted from section 1022(c)(5)(A), a so-called Clayton QTIP trust (Estate of Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992); see Reg.
§20.2056(b)-7(d)(3)(i) as amended in 1998), in which the spouse’s mandatory income interest is conditioned on the executor’s QTIP election, was not eligible for the Spousal Property Basis Increase. A general power of appointment marital trust that would qualify for the marital deduction for estate tax purposes would have satisfied the requirements for the Spousal Property Basis Increase, because, as under the estate tax rules, it would not have been a “terminable” interest at all.
- As noted above, the three-year rule did not apply to property acquired by the decedent from the decedent’s spouse unless, during the three-year period, the transferor spouse acquired the property by gift or inter vivos transfer. The law when the estate tax applies (section 1014(e)) limits death-bed transfers to a spouse in order to obtain a step-up in basis when the transferred property was given back to the surviving spouse. The limitations in the carryover basis rules excluded spouses. Property transferred from a healthy spouse to a terminally ill spouse that passed back to the healthy spouse in 2010 was eligible for both the $1.3 million General Basis Increase and the $3 million Spousal Property Basis Increase.
2011-41 confirmed that an executor could allocate the basis increases to property that had already been distributed or sold. With regard to the Spousal Property Basis Increase, section 4.02(3) of Rev. Proc. 2011-41 actually
contemplated allocations to property already distributed to the surviving spouse as those distributions are made. (Notice 2011-66 allowed the filing of additional Forms 8939 for that purpose.) Section 4.02(3) of Rev. Proc. 2011- 41 also allowed allocation of the Spousal Property Basis Increase to property that the executor had sold, but only to the extent that the applicable Form 8939 included documentation that the sale proceeds were appropriately earmarked for the surviving spouse.
- As many expected, the 2010 Tax Act dealt with the “retroactivity” of the 2010 estate tax provisions by permitting an executor to elect out of the estate tax back into the carryover basis regime enacted for 2010 in the 2001 Tax Act. Section 301(c) of the 2010 Tax Act provided that “[s]uch election shall be made at such time and in such manner as the Secretary of the Treasury or the Secretary’s delegate shall provide. Such an election once made shall be revocable only with the consent of the Secretary of the Treasury or the Secretary’s delegate.” It had been hoped that Form 8939 would include an opportunity to make that election or, better, that the filing of Form 8939 itself would be treated as the election. Notice 2011-66 confirmed that.
- The vast majority of executors did not need or want such an election, because they were perfectly satisfied with the reinstated estate tax and a stepped-up basis for appreciated assets.
ii.utifthest”onsstd,ormpl,ofaPtustofhihte dntstheniiyssuvivigspousendinhihthessts hddlindinvlu,plusshndmodstothrsstslssthn$1.3 million,thnthelionmihthvenonsiddinorto psethehhrbssofthesstsinthePustbusethbsis ould bestpddon”unrstion 1014 ifthestetx pplid. nyvnt,intheseofyltonhethent sthebniy ofaPtust,theutorslldvisdnotto ovlookthendtolltetedntsSTmptiontothetust on ShduleR ofFom 8939, ifppopi.
assets, or an assertion that the value of assets transferred during life would be taxed under section 2036, or an assertion that a limited power of appointment held by the decedent was a general power.
- In most estates significantly larger than $5 million, the election out of the estate tax and into carryover basis was a clear choice, because it avoided an estate tax paid sooner and at a presumably higher rate than the additional income tax that was thereby incurred on the sale of appreciated assets. This was a small percentage of 2010 estates, and therefore it was appropriate that the default outcome in the absence of an election was that the reinstated estate tax applied. As noted above, section 7 of Rev. Proc. 2011-41 stated that the IRS expected 7,000 executors to file Form 8939.
In any event, the following factors were among those that should have been considered in making the election between the estate tax and the carryover basis regime:
- Aggressiveness of positions taken and valuation discounts claimed on the decedent’s previously filed gift tax returns and those gift tax returns of the decedent that would have been filed contemporaneously with the estate tax return.
- Comparison of the expense and aggravation associated with filing the estate tax return and filing the Form 8939.
- Whether a compensating equitable adjustment was appropriate, and whether it should be approved by a court.
1.heindingoftheppiblelusionmountin2012illollowthenoml indingulsththvebnpplibetoinometxbktssine1993ndin vioustnsrtxontts–suhsthe$10,00ittxnnulluion,the mimumdseinvluettibutbletospilusevlutionundrstion 2032,themountoflueonhihsttetxddundrstion6166is pbletasilintst,ndthemr$1millionSTmption– sine1999.
2.heinltiondjustmntisomputdyompingtheveonsumrpie indxCP)rthe12monthpiodndingonuust31ofthepingr iththeospondingCPIor2010.hus,theinltiondjutmntto the ppliblelusionmountin2012llbeomutdydividing theCIorthe 12monthsndingut31,2011,yteCIrthe12monthsndiguust 31, 2010.
- But, unlike the typical inflation adjustments on which the indexing is patterned, the result of the calculation will not be rounded down to the next lowest multiple of $10,000. It will be rounded to the nearest multiple of
$10,000 and thus possibly rounded up. If enacted, this will not make a huge difference in practice – obviously not more than $10,000 in any year.
- It will also need to be remembered that the calculation will be repeated every year with reference to the CPI for the 12 months ending August 31, 2010. Because of the rounding rule, it will be a mistake to assume that the applicable exclusion amount for any particular year will simply be inflation- adjusted for the following year. All annual calculations will be redone with reference to the 2010 baseline and then rounded to the nearest multiple of
2011-52, §3.29, 2011-45 I.R.B. 701.
- This was hugely significant, addressing a number of questions that the 2001 Tax Act created for 2010 and 2011 by providing in section 2664 of the Code that the GST tax chapter “shall not apply to generation-skipping transfers after December 31, 2009” and providing in section 901(b) of the 2001 Tax Act, in relevant part, that “[t]he Internal Revenue Code of 1986 … shall be applied and administered to … [generation-skipping transfers after December 31, 2010] as if [Code section 2664] had never been enacted.” For example –
- The technical key for answering all these questions was to allow the GST tax chapter to “apply” without actually resulting in a GST tax. Setting the GST tax rate at zero was the elegantly simple way to accomplish that.
- Because inter vivos transfers in 2010 to trusts that were “direct skips” – for example, where only grandchildren and not children of the donor are beneficiaries – qualified for the “move down” rule of section 2653, so that future distributions to grandchildren when the GST tax rate is not zero will not be taxed, it may be important to have affirmatively elected on the 2010 gift tax return not to permit a deemed allocation of GST exemption under section 2632(b) or (c). This was not always be desirable, however, because the “move down” permits the tax-free skip of only a generation or two, while the allocation of GST exemption would cause a long-term trust to be exempt as long as it lasts.
- But if the 2010 direct skip gift was made outright to a skip person, there were no future GST tax characteristics to protect and no conceivable reason to want GST exemption to be allocated. The IRS acknowledged this in section
II.B of Notice 2011-66, which stated:
[Reg. §26.2632-1(b)(1)(i)] provides that “… a timely filed Form 709 accompanied by payment of the GST tax (as shown on the return with respect to the direct skip) is sufficient to prevent an automatic allocation of GST exemption with respect to the transferred property.” Because it is clear that a 2010 transfer not in trust to a skip person is a direct skip to which the donor would never want to allocate GST exemption, the IRS will interpret the reporting of an inter vivos direct skip not in trust occurring in 2010 on a timely filed Form 709 as constituting the payment of tax (at the rate of zero percent) and therefore as an election out of the automatic allocation of GST exemption to that direct skip. This interpretation also applies to a direct skip not in trust occurring at the close of an estate tax inclusion period (ETIP) in 2010 other than by reason of the donor’s death.
The “payment of tax (at the rate of zero percent)” is certainly an odd notion, but again, like the zero rate itself, it produced the right result.
- The 2010 gift tax return (Form 709) that the IRS posted on its website on March 18, 2011, was consistent with this approach. In Part 3 of Schedule C, the “applicable rate” in column G was filled in as “0,” and column H, which instructed “multiply col. B by col. G,” was also filled in with “0.” Similarly, in the 2010 estate tax return (Form 706) posted on the IRS website on September 3, 2011, line 8 of Part 2 of Schedule R, line 8 of Part 3 of Schedule R, and line 6 of Schedule R-1 all provided for the calculation of “GST tax due” by multiplying the previous line by zero. Meanwhile, the second page of Schedule R-1 (page 26 of the entire return) included the usual comprehensive instructions for trustees about the payment of the (zero) tax.
idea to review all past transfers with generation-skipping potential and use the next gift tax return as an opportunity to affirm, clarify, modify, or make any allocations or elections with respect to the GST exemption.
4.tsonethohtttatestamentary tionskipping tusttdy sonofadntsdthin2010mihtspeSTtxov,busethe popy inthetustouldnothvebnsubjttosttet,ndthethe ouldbenotnso”undrstion26521)ndnoskippson”undr stion 26131. htsult s sd yte2010 xt.
- In the majority of estates for which no election back into carryover basis was made, the GST tax worked fine. The tax rate on direct skips was zero and the GST exemption allocable to trusts created at death was $5 million. If the estate was smaller than $5 million and no estate tax return was filed, the deemed allocation under section 2632(e) ordinarily worked just fine. Only when there were two or more potentially generation-skipping trusts and the total value of all such trusts was greater than the available GST exemption and it was undesirable to permit section 2632(e) to allocate that GST exemption pro rate among those trusts would an affirmative allocation have been needed.
- If the executor elected out of the estate tax into carryover basis, which probably occurred in the largest estates that are likely to include generation- skipping trusts, the result is the same, but the analysis is more complicated. A sentence added to the end of section 301(c) of the Reid-McConnell Amendment, which became the 2010 Tax Act, that had not appeared in the Baucus Bill makes it clear that such an election does not affect the treatment of property placed in a generation-skipping trust as “subject to the tax imposed by chapter 11” for purposes of section 2652(a)(1)(A). Therefore, the decedent is still the “transferor,” “skip persons” are still defined with reference to that transferor under section 2613, and that will govern the taxation of the trust in the future.
- There is no specific reference to the other important way that the GST tax rules are linked to the estate tax rules, which is the definition of the GST exemption in section 2631(c) by reference to the estate tax applicable exclusion amount in section 2010(c). But in section 302(c) the Section 1022 Election is explicitly stated to apply “with respect to chapter 11 of such Code and with respect to property acquired or passing from such decedent (within the meaning of section 1014(b) of such Code)” – in other words, with respect to the suspension of the estate tax and the imposition of carryover basis, not with respect to chapter 13 – meaning that for purposes of section 2631(c) (part of chapter 13) the $5 million applicable exclusion amount in section 2010(c) remained available.
2010 makes the election … to apply the 2010 Tax Act estate tax rules and section 1022 basis rules.” STAFF OF THE JOINT COMMITTEE ON TAXATION, TECHNICAL EXPLANATION OF THE REVENUE PROVISIONS CONTAINED IN THE “TAX RELIEF, UNEMPLOYMENT INSURANCE REAUTHORIZATION, AND JOB CREATION ACT OF 2010” SCHEDULED FOR CONSIDERATION BY THE UNITED STATES SENATE (JCX-55-10) at 50 n.53 (Dec. 10, 2010).
iii.otie201166,smpliidyotie20116,lsoonimdtht STmptionintheseofnltionoutofthesttetxouldbe llotdonShduleRorR1ofom8939,lotionofnsein sisrPopyqudomadnt.heutomticllotion ulspplidiftheutordidnotmk,ortimyvokd,aStion 1022ltion,orildaom8939ithouttthingaShduleRr R1. ot spisin,thseShdus R ndR1 evysimilrto the Shduls R nd R1 thtompyom 706.)
§3.29, 2011-45 I.R.B. 701.
Section 301(d) of the 2010 Tax Act provided that the due date for certain acts was no earlier than nine months after the date of enactment, which was September 17, 2011. Because that was a Saturday, those acts were due no earlier than Monday, September 19, 2011 (although care in this regard is always warranted, especially in the case of disclaimers, which are not returns required to be filed with the IRS and therefore are not clearly covered by sections 7502 and 7503, but are addressed only to the extent Reg. §25.2518-2(c)(2) applies). The acts that were extended are
- This is introduced in section 302(b)(1) of the 2010 Tax Act under the heading “Restoration of unified credit against gift tax.” It is awkward to refer to a “unified” credit since 2004, when the estate tax exemption increased to $1.5 million but the gift tax exemption remained at $1 million, although the credits were still “unified” in the sense that the credit used affected the credit available both for future gifts and for estate tax purposes.
- Under the 2010 Tax Act, the estate and gift tax calculations will again be identical and, in that sense, once again “unified.”
- Beginning in 2012, the gift tax exemption is therefore indexed for inflation, because it will be identical to the indexed estate tax exemption.
- For many donors, a $5.12 million lifetime exemption in 2012, $10.24 million for a married couple, was enough to accomplish estate planning objectives with simple gifts, outright or, more likely for larger gifts, in trust. Because the GST exemption was also $5.12 million, those trusts could be generation- skipping or even perpetual, without any gift or GST tax paid.
- In other cases, more creative use of the gift tax exemption was desirable. Just as the former $1 million dollar exemption could be leveraged, so can the $5 million indexed exemption, except there is five times as much of it. The basic techniques for leveraging the gift tax exemption have not changed and include life insurance, installment sales, AFR loans (including forgiveness), GRATs, QPRTs, and the use of entity-based valuation discounts as in closely held businesses and family limited partnerships.
- In all of these cases, growth in the value of asset following the gift would escape estate tax. And any gift tax paid escapes estate tax if the donor survives for three years after the gift, which reduced the 35 percent gift tax rate to an estate-tax-equivalent rate (or “net gift” or “tax-exclusive” rate) of about 26 percent (0.35 ÷ 1.35). (The tax-exclusive rate corresponding to a 40
percent rate is 28.57 percent (0.4 ÷ 1.4).
- The interest in making gifts in 2012, of course, was fueled by the concern that the large gift tax exemption might not survive into future years, either because Congress would not act and it fell to a $1 million level on January 1,
2012, or because Congress might choose to “deunify” the estate and gift tax exemption again. Married donors could resolve the tension between the desire to use the gift tax exemption while it is available and the desire to save it for future use by forgoing gift-splitting, using the high 2012 exemption of the donor spouse and saving even $1 million of the exemption for future use by the non-donor spouse.
4.hepossibiliyofasugeintsollodyatuntoa$1millionplible lusionmountin203.g.,ifConsshdnottd)lsotdons thtsomeoftheuntittxsvingouldeptu”orldbk” yn ind stetxt dth. his on bout lk”oeom the povisionofomrstion2001b2)hihsshduldtobevivdin 2013)thttrlultngatnttivetxonthesumofthetblesttend djustdtbleitsteissubttdtegtemountoftxhiouldhvenbeundrhptr12i.e.,itt]ithsptoits mdey theddntrmbr31,1976,ifthepovisionsofsubstion) sinttthedntsdth)hihdlsonyithtxts]hdbn ppliblet thetimeofsuh its”
- For a gift in 2011 and death in 2013, for example (if there had been no change in law), this amount would have tended to be greater than the gift tax actually paid, because it would have been calculated on the higher rates in effect in 2013.
- But this amount would have tended to be smaller than the amount of the tentative tax attributable to the adjusted taxable gifts, because it appears that it would have been calculated using the larger unified credit resulting from using the 2011 applicable exclusion amount. Section 2001(b)(2) expressly requires a substitution only of the current rates in section 2001(c) in reconstructing the hypothetical gift tax payable, not a substitution of the current applicable exclusion amount in section 2010(c).
- Because the adjustment under section 2001(b)(2) is a reduction of the estate tax, a reduction of that reduction by using the 2011 applicable exclusion amount will result in an increase in the resulting estate tax. The estate tax (plus the gift tax paid, if any) would ordinarily not be as high as it would have been if the gift had not been made, but it could result in an effective tax on the taxable estate greater than 55 percent.
- Assume an unmarried individual who has never before made a taxable gift makes a $5,000,000 taxable gift in 2011. The “tentative tax” under sections 2502(a)(1) and 2001(c) would be $155,800 plus 35 percent of the excess of the taxable gift over $500,000, or $1,730,800. The unified credit under sections 2505(a) and 2010(c) would be the same ($1,730,800), and the tax payable would be zero.
- Assume that the applicable exclusion amount had returned to $1 million in 2013 and the individual dies in 2013 with a taxable estate of $5,000,000 and,
of course, “adjusted taxable gifts” (the 2011 taxable gift) of $5,000,000. The “tentative [estate] tax” computed under section 2001(b)(1) on the sum of those two amounts would be $1,290,800 plus 55 percent of the excess (of
$10,000,000) over $3,000,000, or $5,140,800.
- In calculating the hypothetical gift tax to subtract under section 2001(b)(2), the “tentative [gift] tax” that would have been computed under sections 2502(a)(1) and 2001(c) in 2011 using 2013 rates would likewise be
$1,290,800 plus 55 percent of the excess (of $5,000,000 in this case) over
$3,000,000, or $2,390,800.
$2,750,000. Because $2,750,000 is exactly 55 percent (the 2013 marginal rate) of $5,000,000 (the taxable estate), this is intuitively the right answer.
iii.fthe2011uniiditelultdusng2013tsutthe 2011ppliblelusionmount,itouldlsobe$1,290,800plus55 pntfthessf$5,000,000)ovr$3,00,000,or$2,390,800. hestion2001b2)dutionouldbeo,ndthesttetxould be$5,140,800$345,800uniiddit)or$4,75,000.(Thus, the cost of clawback would be $4,795,000-$2,750,000, or $2,045,000.)
$345,800 or $2,045,000, and the estate tax would be $5,140,800-
$2,045,000-$345,800 (unified credit) or $2,750,000.
- If the gift had not been made, and the estate tax were computed only on a taxable estate of $10,000,000, it would be $5,140,800-$345,800 (unified credit) or $4,795,000 (the same as in clause iii above). On the other hand, if the 2011 taxable gift of $5,000,000 had been made under 2013 (or 2001) law, a gift tax of $2,045,000 would actually have been paid, and, together with the estate tax (computed under clause iv above) of $2,750,000, the total taxes would also be $4,795,000, confirming that in a static tax structure the computation works right (although if the donor survived for three years the total tax would be reduced by excluding the gift tax paid from the taxable estate).
$5,000,000, which is intuitively what it ought to be to preserve the benefit of the lower tax at the time of the gift, the estate tax would be $2,750,000.
Indeed, if the donor died in 2012 instead of 2013, the “tentative [estate] tax” computed on $10,000,000 would be $155,800 plus 35 percent of the excess of $10,000,000 over $500,000, or $3,480,800; there would be no reduction for gift tax paid, and after the unified credit of $1,730,800 the estate tax would be $1,750,000, which is simply 35 percent of $5,000,000.
- This intuitively correct estate tax of $2,750,000 is less than the amount computed in clause iii above (which is the clawback), but identical to the amount computed in clause iv, suggesting that the solution to the clawback problem might be to simply take the approach illustrated in clause iv.
- This intuitive view of the estate tax (and thus the approach illustrated in clause iv) are supported by legislative history. The wording of section 2001(b)(2) was intended “to prevent the change in rates from having a retroactive effect to gifts made prior to” the phase-in of the lower rates enacted by the Economic Recovery Tax Act of 1981. H.R. REP. NO. 97-201, 97TH CONG., 1ST SESS. 156 (1981). This wording was occasioned by the phased lowering of rates in 1981; it was not needed for the phased increase in the unified credit in 1976, because the increased unified credit is applied after the section 2001(b) calculation, and therefore such increases would take care of themselves. The objective of the calculation was to tax the taxable estate consistently in the proper rate bracket – in other words, to ensure that, as in the gift tax calculation, “previous taxable gifts only affect the starting point in determining the applicable rate.” H.R. REP. NO. 94-1380, 94TH CONG., 2D SESS. 13 (1976). In 1976, the gift tax structure was specifically designed to provide that “the reduction for taxes previously paid is to be based upon the new unified rate schedule even though the gift tax imposed under present [i.e., pre-1977] law may have been less than this amount.” Id. (emphasis added). There is no reason to doubt that Congress would intend the same policy judgment again if the gift tax “may have been less” than a future estate tax and therefore no reason to suspect that Congress would have intended the “clawback” that is now causing speculation and concern.
i.htpoliyjumntouldhvenajustiitionorsynd theRSinomsndinstutionsundrstion7805,ormpl)to ppythesmettmttotheppliblelsionmountinstion 2010)s to thetsin stion 2001; thethnil justiition ouldhvebnthttsndmptionsuniiddits)hvels bntdtogthrindiningthebunofhetxndthoein dtmininghthrahgeins”oudhveatotive t.”
ii.Putnothr,busetherates inston2001)nnotbe ompltyundstoodorpplidptomthebkts,pplibe ditmount,ndpliblelusionmuntthtdinethir option,ultionsorothruidneinludingomsnd instutions)ouldhthissultysimpy ostuingthenein stion 2001b)to thets ofsubstion .
- MODIFICATIONS TO GIFT TAX PAYABLE TO REFLECT DIFFERENT TAX
RATES.—For purposes of applying subsection (b)(2) with respect to 1 or more gifts, the rates of tax under subsection (c) in effect at the decedent’s death shall,
in lieu of the rates of tax in effect at the time of such gifts, be used both to
- the tax imposed by chapter 12 with respect to such gifts, and
- the credit allowed against such tax under section 2505, including in computing—
- the applicable credit amount under section 2505(a)(1), and
- the sum of the amounts allowed as a credit for all preceding periods under section 2505(a)(2).
- Section 2001(g) is not completely clear, in the absence of implementing forms and instructions. It appears to be well-meaning and likely intended, among other things, to prevent any untoward “recapture” or “clawback” of a gift tax exemption in the form of an increased estate tax, including the increased estate tax that could take effect in 2013 if Congress does not act. But section 2011(g) has two limitations:
- Thus, until there were forms, instructions, or other published guidance from the Internal Revenue Service on this subject, there would always have been a certain risk in making gifts in 2011 and 2012. Of course, this became academic when the indexed applicable exclusion amount in the 2010 Tax Act was made permanent by the 2012 Tax Act.
- A similar addition was made to section 2505(a), relating to the treatment of previous gifts in calculating the tax on current gifts, which restores the full cumulative exemption of $1 million for 2010 in most cases.
7.heSnsiblestextof2011,”.R.367,intodudonovmbr17, 2011,yCogssmnimMmott,ouldhveudthe mptionto$1milioninddorinltionsince 2001)ndstoethetop55 pnttertblestts ovr$10 million,thus psntigthepotntil or lbk.utstion2)of.R.3467ouldhvelimintdthesttetlbkyovidinghttheppliblelusionmountusdtolultethe
hypothetical gift tax to subtract under section 2001(b)(2) may never exceed the estate applicable exclusion amount used to compute the tentative estate tax.
- While those references to an effective date of January 1, 2011, are clear enough standing alone, section 302(f) of the 2010 Tax Act states that “[e]xcept as otherwise provided in this subsection, the amendments made by this section shall apply to estates of decedents dying, generation-skipping transfers, and gifts made, after December 31, 2009.” Obviously, the words “this subsection” (which are meaningless, because nothing else is provided in subsection (f)) should be “this section” (which would ratify the January 1, 2011, effective dates in section 302(b). And no one would seriously argue that the general effective date language in section 302(f) should override the specific effective date language in section 302(b).
- The other reference to a specific effective date in section 302 of the 2010 Tax Act (the provision for inflation adjustments “in a calendar year after 2011”) is hardwired into section 2010(c)(2)(B) of the Code itself and is not affected by this glitch.
- A similar, but more consequential, glitch appeared in section 304 of the original Reid-McConnell Amendment, which provided, nonsensically, that “[s]ection 901 of the Economic Growth and Tax Relief Reconciliation Act of 2001 shall apply to the amendments made by this section.” Before Senate action, the word “section” was changed to “title” by unanimous consent, thereby clarifying that the estate, gift, and GST tax amendments would sunset at the end of 2010 as contemplated.
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2.ndrstion20105,potbiliyisnotlodunlsstheutorofthe stteofthedsdspouseilsnsttetxtunonhihsuhmountis omputdndmsnltiononsuhtunthtsuhmountmy beotkn intoount.Suhltion,onemd,shllbeivobl.oltionmybe mdeundrthissubpphifsuhtunisldtrthetimepbdy lwinluding tnsions)oriligsuh tun.”
- Such an election will keep the statute of limitations on that estate tax return open forever, but only for the purpose of determining the amount of unused exemption, not to make adjustments to that return itself. (The regular statute of limitations will prevent any adjustments to the predeceased spouse’s return as such.)
- It is not clear why this election is required for the surviving spouse to use the unused exemption of the predeceased spouse. But such an election was in every legislative version of portability since 2006, despite criticisms. It is possible that Congress thought an election by the predeceased spouse’s executor was necessary in order to keep the return open even for such a limited purpose. See also the explanation in the preamble to the June 2012 temporary regulations in paragraph XIII.B.2.a.i on page 78 below.
- The IRS’s August 25, 2011, draft of the 2011 estate tax return (Form 706) said nothing about portability, which fueled speculation that the “election” of portability required by section 2010(c)(5)(A) would be presumed in the case of any return for a married decedent that provides the information necessary to determine the exclusion amount that was available and the exclusion amount that was used, and therefore the amount of “deceased spousal unused exclusion amount” contemplated by section 2010(c)(4). Arguably part 4 of the August 25 draft did that, because it asked for the customary information about beneficiaries other than charity and the surviving spouse (line 5), as well as all federal gift tax returns (line 7a). (Information about taxable gifts was also collected, as usual, on lines 4 and 7 of the tax computation in Part 2.)
- Sure enough, the updated draft of the instructions for the 2011 return (dated September 2, 2011, but not released until a few days later) ended the speculation and, in the instructions to line 4 of Part 4 (on page 13), provided the much-anticipated, albeit labored, reassurance that “[t]he executor is considered to have elected to allow the surviving spouse to use the decedent’s unused exclusion amount by filing a timely and complete Form 706.” The final instructions posted on the IRS website on September 28, 2011, were the same. Those instructions went on to specify that an executor who did not wish to make the election may (1) attach a statement to that effect to the return, (2) write “No Election under Section 2010(c)(5)” across the top of the return, or (3) simply file no return, if a return is not otherwise required. Notice 2011-82, 2011-42 I.R.B. 516, released on September 29, 2011, confirmed all this.
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prudent to assume that it would be and therefore to consider an election every time a married person dies (unless that person uses the entire exemption or it is very unlikely that the surviving spouse’s total estate will exceed the exemption).
- The House-passed “Permanent Estate Tax Relief Act of 2006” (“PETRA”) (Part IV.E.2 on page 14) and “Estate Tax and Extension of Tax Relief Act of 2006” (“ETETRA”) (see Part IV.F beginning on page 14) avoided complex tracing and anti-abuse rules by simply limiting any decedent’s use of exemptions from previous spouses to the amount of that decedent’s own exemption. In other words, no one could more than double the available exemption by accumulating multiple unused exemptions from previous spouses.
- S. 722 in March 2009 (Part VII.E.4 on page 29) restricted portability still further by limiting the source of unused exemption to a spouse or spouses to whom the decedent had personally been married. Thus, if Husband 1 died without using his full exemption, and his widow, Wife, married Husband 2 and then died, Wife’s estate could use her own exemption plus whatever amount of Husband 1’s exemption had not been not used. Ultimately, Husband 2’s estate could use his own exemption plus whatever amount of Wife’s own exemption had not been used. But Husband 2’s estate could not use any of Husband 1’s unused exemption transmitted through Wife’s estate. Some commentators describe this as requiring “privity” between the spouses.
- The December 2010 “Baucus Bill” amendment (Part VII.J.3 on page 33) went still further by limiting portability to just one predeceased spouse, the “last such” deceased spouse. The 2010 Tax Act followed the December 2010 Baucus Bill in this respect.
4.hselimittions–thesuvivingspoussonmptionnbenomoethn doubldndtheinseislimtdtotheuusdmptionomustone pddspouse–smdundntptinthesehethemption mihtbeddintheutu.uttheodigofthenwlimittiontoustone pdd spousepd to podeasult tht s not intndd.
- The Joint Committee Staff’s Explanation included the following three examples, which did a good job of illustrating what was apparently intended:
- 60 -
Example 1. − Assume that Husband 1 dies in 2011, having made taxable transfers of $3 million and having no taxable estate. An election is made on Husband 1’s estate tax return to permit Wife to use Husband 1’s deceased spousal unused exclusion amount. As of Husband 1’s death, Wife has made no taxable gifts. Thereafter, Wife’s applicable exclusion amount is $7 million (her $5 million basic exclusion amount plus $2 million deceased spousal unused exclusion amount from Husband 1), which she may use for lifetime gifts or for transfers at death.
Example 2. − Assume the same facts as in Example 1, except that Wife subsequently marries Husband 2. Husband 2 also predeceases Wife, having made $4 million in taxable transfers and having no taxable estate. An election is made on Husband 2’s estate tax return to permit Wife to use Husband 2’s deceased spousal unused exclusion amount. Although the combined amount of unused exclusion of Husband 1 and Husband 2 is $3 million ($2 million for Husband 1 and $1 million for Husband 2), only Husband 2’s $1 million unused exclusion is available for use by Wife, because the deceased spousal unused exclusion amount is limited to the lesser of the basic exclusion amount ($5 million) or the unused exclusion of the last deceased spouse of the surviving spouse (here, Husband 2’s $1 million unused exclusion). Thereafter, Wife’s applicable exclusion amount is
$6 million (her $5 million basic exclusion amount plus $1 million deceased spousal unused exclusion amount from Husband 2), which she may use for
lifetime gifts or for transfers at death.
Example 3. − Assume the same facts as in Examples 1 and 2, except that Wife predeceases Husband 2. Following Husband 1’s death, Wife’s applicable exclusion amount is $7 million (her $5 million basic exclusion amount plus $2 million deceased spousal unused exclusion amount from Husband 1). Wife made no taxable transfers and has a taxable estate of $3 million. An election is made on Wife’s estate tax return to permit Husband 2 to use Wife’s deceased spousal unused exclusion amount, which is $4 million (Wife’s $7 million applicable exclusion amount less her $3 million taxable estate). Under the provision, Husband 2’s applicable exclusion amount is increased by $4 million, i.e., the amount of deceased spousal unused exclusion amount of Wife.
TECHNICAL EXPLANATION, supra, at 52-53 (emphasis to Example 3 added).
- The problem with Example 3 is that under section 2010(c)(4)(B) the “deceased spousal unused exclusion amount” that is portable from Wife to Husband 2 is the excess of Wife’s “basic exclusion amount” (which is $5 million) over the amount with respect to which Wife’s tentative tax is determined under section 2001(b)(1) (which is Wife’s taxable estate of $3 million). The excess of $5 million over $3 million is $2 million, not $4 million as in Example 3.
- Even if Wife tried to “use” Husband 1’s deceased spousal unused exclusion amount by making $2 million of taxable gifts and left a taxable estate of only
$1 million, the amount with respect to which Wife’s tentative tax is determined under section 2001(b)(1) would still be $3 million (a $1 million taxable estate plus $2 million of adjusted taxable gifts), and her deceased
- 61 -
spousal unused exclusion amount would still be only $2 million.
- The discrepancy occurred because section 2010(c)(4)(B)(i) used her $5 million basic exclusion amount, while Example 3 used Wife’s $7 million applicable exclusion amount.
- The result in Example 3 was probably intended. When the staff of the Joint Committee on Taxation prepared its GENERAL EXPLANATION OF TAX LEGISLATION ENACTED IN THE 111TH CONGRESS (JCS-2-11, March 2011), it
repeated Example 3 unchanged. Id. at 555.
- On March 23, 2011, the Joint Committee staff published an “Errata” for the General Explanation (JCX-20-11), including just two items – 24 pages of revised budget effect estimates and the following:
On page 555, add the following footnote 1582A to the word “amount” in the next to last sentence in example 3:
The provision adds new section 2010(c)(4), which generally defines “deceased spousal unused exclusion amount” of a surviving spouse as the lesser of (a) the basic exclusion amount, or (b) the excess of (i) the basic exclusion amount of the last deceased spouse of such surviving spouse, over (ii) the amount with respect to which the tentative tax is determined under section 2001(b)(1) on the estate of such deceased spouse. A technical correction may be necessary to replace the reference to the basic exclusion amount of the last deceased spouse of the surviving spouse with a reference to the applicable exclusion amount of such last deceased spouse, so that the statute reflects intent. Applicable exclusion amount is defined in section 2010(c)(2), as amended by the provision.
Section 2(d) of the “Sensible Estate Tax Act of 2011,” H.R. 3467, introduced on November 17, 2011, by Congressman Jim McDermott (D-WA), would have made that change.
5.lthouhthelstntefmpls1nd2onimdthtptbiliys intnddtobeilbleorlitimetssllstnsstth,hnthe lusionmountdindythepotbiliyulsistnsltdintotheuniid dit, its useorlitimeits is limitd ythedution undrstion 2505) ythesumofthemuntslloblesait…orllpdiglndpiods.”snpnsionofmpls1nd2,ssumeieusdthentie$7 millionofppliblelusionmountshehdtrmple1tomkeits hthrbertrmigusbnd2,dthnusbnd2didndshe hdnpplibelusionmountof$6millionsinmple2.fhethmdemoeits, hrllobledit undrtions 2505)nd 210) ouldbethetnttivetxon$6millionstion25051)ddythe tnttivetxonthe$7millionpviousyusdstion20102.nothr ods,sheouldhvenollobleuniidditptto thetntthtutue inltiondjustmntsofthelusionmountovtketht$1million di.Sheouldstillhve$6millionofpplibelusionmount vilbletdth,lthuhitsimptouldbediminishdyteinlsionof
- 62 -
her $7 million gifts in “adjusted taxable gifts” under section 2001(b)(1)(B).
The Treasury Department and the Service anticipate that, as a general rule, married couples will want to ensure that the unused basic exclusion amount of the first spouse to die will be available to the surviving spouse and, thus, that the estates of most (if not all) married decedents dying after December 31, 2010, will want to make the portability election. As indicated above, because the election is to be made on a timely-filed Form 706, the Treasury Department and the Service anticipate a significant increase in the number of Forms 706 that will be filed by the estates of decedents dying after December 31, 2010, and that many of those returns will be filed by the estates of decedents whose gross estates have a value below the applicable exclusion amount.
As a result, the Treasury Department and the Service believe that the procedure for making the portability election on the Form 706 should be as straightforward and uncomplicated as possible to reduce the risk of inadvertently missed elections. To that end, the Treasury Department and the Service have determined that the timely filing of a Form 706, prepared in accordance with the instructions for that form, will constitute the making of a portability election by the estate of a decedent dying after December 31, 2010.
Of course, some might have wondered if the preparation of a Form 706 in accordance with its instructions is really “straightforward and uncomplicated.”
- Thus, the first extended returns for decedents who died January 1, 2011, and the first unextended returns for decedents who died July 1, 2011, were both due April 2, 2012 (because April 1 was a Sunday).
- Notice 2012-21 contained no substantive rules, but it reported that “Treasury and the Service have received comments on a variety of issues.”
1.nmbr16,2009,hnSntruuskdunnimousonnthtthe Sntepuseomitsonsidtionofltheomndppovetnsionof2009tnsrtxlworjusttoorthemonths,Sntor MConnllskdSntorustoetoonsidtionofnmndmnt ltin,sStorMConnlldsibdit,apmnnt,ptbl,nduniid
- 63 -
$5 million exemption that is indexed for inflation, and a 35-percent top rate.” See Part VII.H.2 on page 31. Senator Baucus objected to Senator McConnell’s request, whereupon Senator McConnell objected to Senator Baucus’s request, and all hopes of transfer tax legislation in 2009 died.
- Many observers, including the author of this outline, had long thought that the true congressional consensus in a stand-alone estate bill would arrive at a rate less than 45 percent and an exemption greater than $3.5 million, possibly not going quite as far as 35 percent and $5 million (although 51 Senators did in April 2009), possibly phased in to make it cost less, and possibly accompanied by some revenue raisers to make it look as if they tried to control the cost.
- But to do it all it once, without a phase-in (indeed to do it retroactively to January 1, 2010, for estate and GST tax purposes), to not even pretend to pay for it, to link it to the income tax cuts; to link the income tax cuts in turn to a bad economy, to insist on indexing and portability and “unification” at the same time, and to sunset it all in two years – just teed it up for two more years of contention.
4.Pmnnentulyshivd,ofous,inthe2012xt.SePt X.E.3, binningon e
1.heSnsiblestextof2011,”.R.367,intodudonovmbr17, 2011,yCossmnimMmott,ouldhvedudthestte ndittxmptionsto$1million,tivein2012.uiotil,itould hveinddthtmoutorinltionsince 2001,butouldpprtobintht indingin2013,not212,iththesultthtte2011mptionof$5000,000 ouldppntyhedoppdto$1,000,000in2012ndtnjumpobout
$1,340,000 in 2013 (assuming 2011 inflation rates). If indexing began in 2012, which is the likely intent, the 2012 exemption would have been about $1,310,000.
- Section 2(c) of H.R. 3467 would have prevented the notorious “clawback” that might otherwise operate to recapture some or all of the benefit of today’s
large gift tax exemption if the donor dies when the estate tax exemption is lower. It would have done that by providing that the applicable exclusion amount used to calculate the hypothetical gift tax to subtract under section 2001(b)(2) may never exceed the applicable exclusion amount used to compute the tentative estate tax.
- Section 2(d) of H.R. 3467 would have corrected a divergence between the statutory “portability” language and the legislative history, by confirming that the legislative history reflected true congressional intent.
- Section 5 of H.R. 3467 would have fleshed out the statutory language implementing an Administration proposal to require the estate tax value (not the heir’s after-the-fact opinion of date-of-death value) to be used as the heir’s basis for income tax purposes. Specifically,
ii.anwstion6035ouldhvequdhutorordonorquid toilensteorittxtuntopottoheSviendtopsonivingyintstinpopyomaddntordonorthe vlueofllsuhintstsspotdonthestteorittxtunnd suhothrinomtionithspttosuhintststheStymy psib”
v.nwstion6035)ouldhveuthoidsuytopibe implmnting utions,inluding thepplitionofthseus to situtionshenosteorittxtunisuidndsitutionsin hihthesuvivigjointtnntorothrpintmyvettr inomtionthnteutordigthesisorirmktvlueof thepop,”nd
The references in proposed sections 1014(f)(1) and 1015(f)(1) to the value “as finally determined” for estate or gift tax purposes allay concerns raised by a publication in September 2009 by the staff of the Joint Committee on Taxation that income tax basis might be limited to the value reported on an estate tax return, even if that value is increased in an estate tax audit. The exception in proposed sections 1014(f)(2) and 1015(f)(2) when “the final
value … has not been determined” seems to be a necessary compromise, although it would inevitably influence the liquidation decisions of executors and heirs.
- This attention to technical issues at the staff level was a source of relief and reassurance about any estate tax legislation Congress might entertain.
3.hsebills ould hvelt theit xt its 20112012 te35 nt)th a$5 millionlitimemptonnoninddndnnpotbl.hyoudlso hvestodte2001xtsnmtiction2011,povidngthptspoviddinultions,atnsrintustshllbettdsable itunrtion2503,unlssthetustisttdsholyodytedonor orthedonos spouseudrsubpt EfptIfsubhptrJofptr1.”
1.heMiddleClssxCutt,”S.3393,inodudonuy17,2012,y MjoiyryRid,ouldvetudthestt,git,nd STtxlwly to2009lvls,itha$3.5millionmption,potblebut notindd,ndatop45pntt.Stion201b)ofS.3393inludd povisionsppntyinnddtodliththelbkissu,”butinamnnr tht is moeomplitdnd lss lrthn stion 2)of.R. 3467.
2.hesmelugeppdinadtofS.3412,SntorRidsMiddleClss xCutt”thtpssdtheSnteyaptisnvoteof5148onuy25,but, potdytousmoeonmiddlelssxli,”thesttetxpvisions eltdomthenlvsionofS.3412thtsintodudonuly19.A vitulyidntilbill,.R.15,sintodudintheouseonuy0ythe nkingmbroftes nd Mns Committ, Rp. Sndrvin .
3.Mnhil,thexikePvntiontof2012,”S.3413,intodudonuy 19yinneCommiteRnkingMmbrinthR)ndMinoiy drMithMConnllR)ouldsimplytnd2012l,iluding indingndpotbili,thouh2013.nthiss,similrpovisionsppd intheobPottionndRssionPvntiontof2012,”titleIof.R.8, hihsintodudysndMnsComitteChimnvempR- )onuy24ndpsdyteouseofpsnttivsyalyptisvoteof256171ongust1..R.8sdsindtoboethemiprRliftof2012,traStendmntndouseonune
on January 1, 2013.)
- The rate on qualified dividends raised from 15 percent to 39.6 percent – 43.4 percent with the 3.8 percent Medicare tax on net investment income under section 1411 if adjusted gross income, without regard to the foreign earned income exclusion, exceeds $200,000 ($250,000 in the case of a joint return and $125,000 in the case of a married person filing separately).
- The rate on long-term capital gains raised from 15 percent to 20 percent (23.8 percent with the 3.8 percent Medicare tax).
proprietorships, partnerships, and S corporations).
1.ntheoueofRpsnttivs,207Mmbsofthe113thConssemong the272hovotdortethxRplPmnnytof2005”.R.8) in2005sePtonpe)rthe22osponsosofthethx RplPmnytof2011”.R.1259.dding 47othrnwRpblins sine2005)sults in 254 Mmbs ith possiblenotxorlotxlnins.
2.SyStos in the11th Conssemogte84 ho vod ora35pnt te nd$5millionmptionduingonsidtionoftheisl2009budt solutionin2008sePtone)orthe38osponsosofte thxRplPnnytof2012”S.2242)sePtnpge 66. ddingiveothrwRpublinssine008)sultsin65Sntsith possiblenotxorlotxlnins.
3.uingthenhtofMh2223,2013,inonsdtionofitsvsionofais2014budgtsolution,theSntesomhtpisdits2007nd208vots. nmndmntodySntorohnhuneRS)lloingplofthe sttetxinadeficitnutlysdona453voteafter n mndmnt odySntorMk nr)lloigpl rdution ofthesttetxin arevenuenutl ys povd on a8019 vo.
- The difference, of course, is that Senator Thune’s deficit-neutral repeal could be offset by reduced spending, not necessarily by increased revenue as in Senator Warner’s revenue-neutral proposal – a big difference between Republicans and Democrats these days.
- Senator Warner’s amendment was strange, because he spoke in favor of the estate tax while appearing to propose its repeal, stating that “I personally believe the current estate tax—with a very generous $5 million-per-person exemption, and $10 million per family; an estate tax that only applies to 3,800 families per year—is a fair part of our Tax Code.” 159 CONG. REC. S2285-86 (daily ed. March 22, 2013). But he concluded by stating that “I urge my colleagues, if we want to repeal the estate tax and pay for it, to vote for the Warner amendment.” Id. (emphasis added). And when he was Governor of Virginia he vetoed the General Assembly’s first effort to repeal
Virginia’s estate tax by “coupling” it to the repealed state death tax credit. It fell to his successor, Governor Tim Kaine, another Democrat and now also in the Senate, to eventually sign the Virginia repeal into law. Apparently, Senator Warner’s amendment was a simple attempt at preemption – basically to make a statement that the estate tax should not be repealed, or, by extension, further relaxed, unless it is paid for with revenue offsets.
- But it is likely that some of the 79 Senators who voted with Senator Warner, including all or most of the 46 Senators who voted for Senator Thune’s amendment, meant to express for the record their dissatisfaction with the estate tax.
1.Rtunto2001lwoudhvesultdina55nttethtmihtvebunptbletom.utantminllteontheststsof39 pnt55pntlssthetop16pntsttedthtxdit)ouldpsnt nineofony4pntthtmihtnothvebnoththetoubletooths. helgst vnepiup miht hveomem thesmllst tblestts.)
2.he45nttend$3.5millionmptionof2009lwsuppotdythe dministtion,hihonemihthelookdikeaompomisermpl, btn2001lwnd2012l,sbiningtolooklikethehihtposition.he35pnttend$5millionnddnduniidmption lookd likethenwopomiseormpl, btn 2009 lwnd l.
3.onil,thethxliintiontof200”.R.8,pssdin2000y lgemjoitisinCogssbutvtodyPsdntClintonsePton pge,ouldhveudthetopteom55pntto40.5 percent innine nnulstpsom2001thouh2009.toudlsohvepldthestt, it, ndSTts in 210.)
1.trksofpublicdpivtedisussions,ntbybtntePsintnd theSpkrftheous,thntntheMjoiyndMinoiydsofthe Snt, nd ilytn theiePsidnt ndtheSnteMinoiyd, mndmntto.R.8hihhdbnoiinlypssdytheouseonuust 1,2012–sePtonpe,omlyntitldtheminpRliftof 2012,”sintodudintheSnte y Stos Rid nd MConnll. heStedbtditonwsvendpssditinthee hous ofws yyabitisn voteof898.
- With the 3.8 percent “Medicare tax” on net investment income under section 1411, applicable if adjusted gross income, without regard to the foreign earned income exclusion, exceeds $200,000 ($250,000 in the case of a joint return and $125,000 in the case of a married person filing separately), the top federal rate on investment income is essentially 43.4 percent.
- On earned income, the net investment income tax is 0.9 percent, making the top federal rate 40.5 percent.
$180,000 in the case of itemized deductions and about $270,000 for joint filers and $180,000 for single individuals in the case of the personal exemption.)
8.Mostofthebusinssndindividultnds”etnddortos, 2012nd2013.ebgstbusinsstndsinvolvetheshdtundr stion41,ltdostovyditin)undrstion168,pnsing undrstion179,ndthetiveininginmeptionomtheunt ttion ofinomeofaontolld on potion undrstion 953.
(May 15, 2013).)
- A 40 percent rate produces a “tax-exclusive” gift tax rate of about 28.57 percent, if the donor survives three years after the gift.
- State death taxes are still deductible. As a result, the top marginal combined federal and state estate tax rate is about 48.3 percent in a state with an estate tax that follows the federal deduction under section 2058 for the state tax itself, about 49.6 percent in a state with an estate tax that does not follow that federal deduction, and of course 40 percent in a state with no state estate tax. See the table on page 7. (Some states have very different tax structures.)
There no longer are any “as if … had never been enacted” provisions.
4.nptiu,themption”–thnlytheppliblelusionmountor sttendittxpupossndtheSTmptionorSTtxpuposs–is$5 million,pmnntyindom2011,pmntyuniidthesmeorit txpuposs,ndpmnntypobleoritndsttenotS)tx puposs. htmethe2012mption$5.12millionndthe2013mption
$5.25 million, producing a 2013 unified credit of $2,045,800. The 2014 exemption is $5.34 million. Rev. Proc. 2013-35, 2013-47 I.R.B. 537. That makes the unified credit $2,081,800.
5.heisnolbk”hisisddssdorittxpupossinhelush lnetostion2505)ndtosomextntorsttetxpupossin stion2001)bothofhihenologrsnsttd.utthelsrto thedsttetxlbkisthttheppliblelusionmountilnotdon–tstnotitoututhrossionltionhihpsumblyould inludespiicovisions to pvnt lk.
- Some gifts in 2012, especially at the end of the year, were structured with explicit provisions for a disclaimer, with a redirection in the instrument of the property in the event of a disclaimer. Such disclaimers could be used within nine months after the gift (thus, in some cases, as late as September 2013) to determine the effect of a gift otherwise completed for gift tax purposes in
- A disclaimer or renunciation of an outright gift might cause the property to revert to the would-be donor and be treated as if the gift had never been made. But the applicable state disclaimer law needs to be consulted to see
- A disclaimer by a trustee is more controversial and more doubtful, although broad authority (or even direction) in the instrument creating the trust (and, thus, the instrument creating the office of the trustee) might be helpful.
- Some trusts created in 2012 were designed to qualify as inter vivos QTIP trusts, with the non-donor spouse entitled to all the trust income for life within the meaning of section 2523(f)(2)(B). In some cases, the expectation was that the donor could wait to see if the 2012 gift tax exemption really was reduced in 2013, by congressional action or inaction, and then, if the exemption was reduced, simply forgo the QTIP election and make use of the donor’s now-lost 2012 exemption.
- If the donor chose to use gift tax exemption for the 2012 trust and forwent the QTIP election, the donor’s spouse, and thereby the donor’s household, could have retained the income for the spouse’s life, which might have been one of the objectives of making the spouse a beneficiary. Alternatively, the spouse could have disclaimed all or part of the income interest and thereby permit the trust to accumulate income and continue more efficiently as a generation- skipping trust for descendants. If the spouse disclaimed a mandatory income interest and still retained a right to income or principal in the trustee’s discretion, the disclaimer is still a qualified disclaimer under the explicit exception for spouses in section 2518(b)(4)(A). But under section 2518(b)(4) and Reg. §25.2518-2(e)(2) the disclaiming spouse was not permitted to retain a testamentary power of appointment (or any power of appointment not limited by an ascertainable standard).
- In any event, a QTIP election for a 2012 gift had to have been made by April 15, 2013, or, if the due date of the gift tax return was extended, by October 15, 2013.
- Much discussion of rescission of gifts that are subsequently regretted revolves around the concepts of “mistakes” of fact or law and the recent, oft- cited case of Breakiron v. Gudonis, 106 A.F.T.R. 2d 2010-5999 (D. Mass. 2010). There the taxpayer and his sister were the two beneficiaries of qualified personal residence trusts (QPRTs) created by their parents, following the ten-year QPRT term. The taxpayer sought to disclaim his interest, so the remainder would pass solely to his sister, and was incorrectly
advised by his attorney that he could do so within nine months of the expiration of the QPRT term. Once he had made the disclaimer, he learned that it was untimely and therefore was treated as his taxable gift, resulting in a gift tax of about $2.3 million. The court likened this case to those in which courts had held that “the original transfer was defective ab initio because the original instrument contained a mistake.” It therefore allowed a rescission of the disclaimer nunc pro tunc, stating that “[t]he rescission binds all parties to this action and is conclusive for federal tax purposes.” (The suit was originally brought in a Massachusetts state court, naming the United States as a party. The Justice Department appeared and removed the case to the federal court.)
- But it would be a stretch to compare Breakiron’s attorney’s erroneous advice about what the deadline for a qualified disclaimer was to the inability of advisors in 2012 to know for sure what the gift tax exemption after 2012 would be. And the actual appearance of the Government in the Breakiron litigation was perhaps a fluke and in any event could not be assured in any current rescission action.
- It may be possible to mitigate any remorse over a 2012 gift if the grantor can exchange assets into the trust, such as non-income-producing assets in exchange for assets that produce income the grantor now may wish to have to live on. Such an exchange can be pursuant to a reserved power to substitute assets of equivalent value under section 675(4)(C), or can be a simple exchange with the trustee even in the absence of such a reserved power. If the trust is not a grantor trust, however, the income tax on the capital gain needs to be taken into account.
- In the most serious cases of the donor’s insecurity following the gift, the exchange might even be for the grantor’s promissory note. But see Part XII.D.2.c.ii on page 75.
- The surge of gifts made in 2012 resulted in a surge of gift tax returns filed in 2013, which might suggest that IRS audit resources will be spread thin.
- On the other hand, a Joint Committee on Taxation publication published November 9, 2012, reported that in 2008, there were 38,374 estate tax returns filed, of which 17,172 showed tax due (totaling about $25 billion). STAFF OF THE JOINT COMMITTEE ON TAXATION, MODELING THE FEDERAL REVENUE EFFECTS OF CHANGES IN ESTATE AND GIFT TAXATION (JCX-76-12) at 15,
Table 3 (Nov. 9, 2012). (Gift tax returns in 2008 numbered 257,485, with 9,553 taxable, and $2.843 billion total gift tax. Id. at 16, Table 4.) Projections of the results if 2012 law were made permanent estimated that in 2013, there would be 9,200 estate tax returns filed, of which 3,600 would show tax due (totaling about $11 or $12 billion, say $13 billion to reflect the higher 40 percent rate). Id. at 40, Table A3. This 79 percent drop-off in taxable estate tax returns may well free up resources to audit gift tax returns
- Besides, just as techniques for gift-giving in 2012 were interesting, 2012 gift tax returns are likely to be interesting and to attract attention.
Commissioner, T.C. Memo 2012-88, nonacq., 2012-46 I.R.B., of assigning “a sufficient number of my Units [in an LLC] so that the fair market value of such Units for federal gift tax purposes shall be [stated dollar amounts].”
- The Government appealed Wandry, but dropped the appeal. The IRS issued a nonacquiescence, possibly signaling that it is waiting for cases with “better” facts (“better” for the IRS, “bad” facts for taxpayers). But Wandry itself included some facts that could have been viewed that way, and which should be avoided in 2013 is possible, including
- Such sales proceed under the rather tentative but unquestioned authority of Rev. Rul. 85-13, 1985-1 C.B. 184, and Letter Ruling 9535026, and use notes with section 7872 interest rates with the approval of Frazee v. Commissioner,
98 T.C. 554 (1992), and Estate of True v. Commissioner, T.C. Memo 2001-
167, aff’d on other grounds, 390 F.3d 1210 (10th Cir. 2004).
- If an advisor follows the convention of providing at least 10 percent “equity” in the structure (see Mulligan, “Sale to a Defective Grantor Trust: An Alternative to a GRAT,” 23 Est. Plan. 3, 8 (Jan. 1996)), gifts by a married couple of $10.24 million in 2012 and another $260,000 in 2013 will have provided a fund that can support a purchase of property with a value of $94.5 million, for a total transfer of $105 million.
- A $260,000 gift in 2013 would also provide the occasion to disclose the sale transaction on a gift tax return within the meaning of Reg. §301.6501(c)-1(f).
ii.iitionsythetusetttheoptisquidndsubstitutd y thentreintofquivntvlu,nd…thtthesubstitution pornnoteidinamnnrthtnhitbnitsmongthe tustbniiis.”SeRv.Rul.200822,200816.R..796.his stnddmihtllqieppils,vn,rmpl,ofpomissoy nots,orhihevlueisplytnrndifnintst tepibdystin7872isusd.htonomiyithstion 7872dosnotpludeairmktlueinquyishhlhtdythe lstsntneoftheFrazee opinion,inhihuemblnsttdtheinditnomloushtspondntugssrpimypositionthe pplitionofstion7872,hihismoevobletothetprthn thetditionlirmtvluepph,butehtiyomethe onpt.”razee v. Commissioner, 98 .C. 554, 590 1992.
1.usethe2012itvingsobbythemostntoppotuniytoin- tunethedonosstteplnningobtivs– idntiition of niiis, sltionndsssionoftusts,stndsrdistibutions,gsndvnts ormndtoydistibutins if, dtion, pos ofppointmnt, ndso oth
– the decisions made in designing trusts in 2012 might also be incorporated into the donor’s will, revocable trust, and other estate planning vehicles. There is nothing like irrevocability to sharpen one’s focus.
2.nyvnt,lonmstteplnningdoutsshouldbevidtomke suethtthiromulsstillpodueadsiblesultdspitethehitthedit- shltrdispositiontookomthe2012it,ndthtthoseomulsillok popyinaldofsiniintnnulinltiondjustmnts–sor$120,000 in 2012, $130,000 in 2013, nd $90,000 in 2014.
- The basis of property for purposes of determining gain is the donor’s basis if the property is acquired by gift, but the date-of-death (or alternate valuation date) value if the property passes at death. For low basis assets, it has always been necessary to compare the estate tax saved with the additional income tax on capital gain that may be incurred.
- The estate tax rate is still likely to be higher than the capital gain tax rate in the typical case, but lower estate tax rates and higher capital gains tax rates have made the spread smaller. In the 2012 Tax Act, for example, the top federal estate tax rate was increased by 14.3 percent (from 35 percent to 40 percent) while the top federal general income tax rate on capital gains was increased by 33.3 percent (from 15 percent to 20 percent). As a result, there may be less priority for making leveraged transfers of appreciated assets likely to be sold soon after death.
- For assets subject to depreciation, this observation may be even more true, because depreciation will typically reduce taxes at ordinary, not capital gains, rates.
- In addition, when gift tax is paid, the gift tax is removed from the gross estate if the donor survives for three years after the date of the gift, which saves the estate tax on that tax, effectively turning the 40 percent “tax-inclusive” rate into a 28.57 percent “tax-exclusive” rate.
- In any event, the weight given to basis must be evaluated in light of the likelihood that the asset will be sold. If the trust or other recipients are unlikely to ever sell it (like a “legacy” asset), or if it is likely to be sold during the grantor’s life (like a marketable security in a managed portfolio), the basis will generally not make any difference.
- If the gift is made in trust, the basis can be managed during the donor’s life by swapping assets in and out of the trust, perhaps pursuant to a reserved substitution power. Another person can be authorized to exercise that substitution power under a durable power of attorney. But it must be remembered that there may not be an opportunity to exercise such a power.
$130,000 in 2013 and by $90,000 in 2014.
6.nditisimpotntnottoovlooktheSTmption.faittxorapitl intxmustbepidifaitisd,ttshotmdonsidemihteot ythepnnt,orvylotm,bitofnllotionofSTmption. his is spilyptinnt in s epiorits to hildnheusdit mption,lvingthevilbleSTmptiontrtntheittx mption.
2.mpoyutions..9593,77F.R.36150une18,202)nd idntilpoposdutionsR14183211,id. t36229)elsdon une15,2012,justby18monthstrthetmntofthe2010xtnd thoepmittdytion7805b)tobetotivetonuy1,2011. PublicommntsontepoposdultionseinvitdySptbr17, 2012,ndapublichn,ifqustd,ssduldrtobr18,012,but nooneskdorahingndthehigsnlld.ndrstion 7805,thetmpoy ultionsillpieinthes,onune15,2015, but eshould pt theultions to beinlid ythn.
- Reg. §20.2010-2T(a)(1)-(4) confirms that the portability election must be made on a timely filed estate tax return of the predeceased spouse, that timeliness is determined in the usual way whether or not a return is otherwise required for estate tax purposes, that the election is deemed made by the filing of a return unless it is affirmatively repudiated, and that the election is irrevocable.
i.ithgdtotheduetevnhnatunisnotquidorstte txpuposs,thepmbleplinssmpythtatunquidinodr toltpotbiliyisaquidtunrpupossoftheduedt.he pmbleosontolinththisuleillbnittheRSsll stpshoosingthebnitofptbilityuetheods quidtoomputendviytheSEmunthihishtthe ultionsllthedsdspouslunusdlusionmount]emoe liky tobevilblethetimeofthedthofteistdsdspouse thntthetimeofasusqunttnrytheuvivingspouseyit ortdth,hihouldourmyslt.”heultionsdonot inditeho, ift ll, sh atn miht beuitd.”
- Reg. §20.2010-2T(a)(6) confirms that the election may be made by an appointed executor or administrator of, if there is none, “any person in actual or constructive possession of any property of the decedent.” This reflects the notion of what is often called a “statutory executor,” after the definition in section 2203. Such a “non-appointed executor” could (and often will) be the surviving spouse himself or herself. The regulation adds that a portability election made by a non-appointed executor “cannot be superseded by a contrary election made by another non-appointed executor.”
- In what is perhaps the most significant and welcome provision of the regulations, Reg. §20.2010-2T(a)(7)(ii) provides special rules for reporting the value of property on an estate tax return filed to elect portability but not otherwise required for estate tax purposes (most notably a return for an estate with a value less than the basic exclusion amount).
executor “exercises due diligence to estimate the fair market value of the gross estate.” Reg. §20.2010-2T(a)(7)(ii)(B). Pending the publication of instructions to the estate tax return, the regulations provided that this due diligence could be shown by provision of “the executor’s best estimate, rounded to the nearest $250,000,” of that value. When the instructions were published in October 2012, they included a “Table of Estimated Values” modifying this “nearest $250,000” convention only by requiring that the rounding always be up to the next higher multiple of $250,000, except for a total value greater than $5 million and less than or equal to
$5.12 million (the 2012 applicable exclusion amount), which is rounded to $5.12 million.
ii.Moeiousvlutionofmitlorhitbleddutionpopyis stillnddintheseofomulabqsts,ptildislims,ptil Ptions,splitinsttnss,ndlbiliyrtxttmnt thtistdysuhvlusorhihR.§20.201- 2ii2)its tions 2032, 2032, d 6166 s mpls.
iii.R.§20.20102ii)quisthepotingofonythe dsiption,onship,nd/orbniyofshpop,logith llothrinomtionnssytostblishtheihtofthestt”tothe mitlorhitbleddution.smplsfthislstquimnt, R.§20.20107iiC,Example 1,itsvidnetoviyte titleofhjointyhldsst,toonimththesuvivingspous]is thesolebiiyof]lieinsunepoliyd]suvivornnui, ndtoviythtthennuiyislusivyorthesuvivingspouss] li.”tispossiblethtsuhvidneillulybemoeinsome ss thn theinmtin nomlypovid ith n sttetxtun.
iv.utitislrthtinthepdmeofadoupleithahommodsttniblepsolpop,bnkunt,ndppsn invstmntount–llpossibyjointynd–ndlieinsuend timntbitspbletothesuvivo,thequimntsr ompltingnsttetxtuntoltpotiliy vebnmde ltivymbl,pilyonsidig thtthesuviving spouseis likyto bethenonpointd uto”ith pt to ll thepop.
d. Reg. §§20.2010-2T(d), 20.2010-3T(d), and 25.2505-2T(e) reiterate, without elaboration or example, the authority of the IRS to examine returns of a decedent, after the period of limitations on assessment has run, for the limited purpose of determining the decedent’s DSUE amount, if the portability election has been made. For this purpose, Reg. §20.2010-3T(d) confirms that “the surviving spouse is considered to have a material interest that is affected by the return information of the deceased spouse within the meaning of section 6103(e)(3).” That means the IRS is authorized to disclose the deceased spouse’s estate tax return information to the surviving spouse.
- Invoking “the principle that a statute should not be construed in a manner that renders a provision of that statute superfluous,” “the indicia of legislative
intent reflected in the Technical Explanation and the General Explanation,” and “the express [rulemaking] authority granted by Congress in section 2010(c)(6) and 7805,” the preamble to the temporary regulations resolves the “Example 3” problem (see subdivision VIII.H.4 beginning on page 60) by interpreting the reference in section 2010(c)(4)(B)(i) to the basic exclusion amount to mean the applicable exclusion amount. Reg. §20.2010- 2T(c)(1)(ii)(A) reflects this interpretation.
- In response to several comments, Reg. §20.2010-2T(c)(2) provides that the computation of a predeceased spouse’s DSUE amount would disregard amounts on which gift taxes were paid by the decedent because taxable gifts in that year exceeded the applicable exclusion amount but the larger estate tax applicable exclusion amount on the date of death exceeded the total adjusted taxable gifts.
- Reg. §§20.2010-3T(a) and 25.2505-2T(a) confirm that the DSUE amount of the last deceased spouse dying after 2010 is available both to the surviving spouse for gift tax purposes and to the surviving spouse’s estate for estate tax purposes. Neither remarriage nor divorce will affect that availability, but the death of a subsequent spouse will terminate the availability of the DSUE amount from the previous last deceased spouse. This is true no matter how much DSUE amount, if any, of the previous last deceased spouse is still unused, and whether or not the new last deceased spouse has any DSUE amount or whether or not the executor of the new last deceased spouse even made a portability election.
- Reg. §25.2505-2T(b) creates an ordering rule providing that when the surviving spouse makes a taxable gift, the DSUE amount of the last deceased spouse (at that time) is applied to the surviving spouse’s taxable gifts before the surviving spouse’s own basic exclusion amount. Reg. §§25.2505-2T(c) and 20.2010-3T(b) provide rules that retain the DSUE amounts of a previous last deceased spouse that the surviving spouse has used for previous gifts in the future calculations of either gift tax or estate tax, in order to accommodate the cumulative nature of those tax calculations. The effect of these rules is to permit a surviving spouse, by making gifts, to benefit from the DSUE amounts of more than one predeceased spouse.
- Reg. §20.2010-3T(c)(2) provides that when property of the last deceased spouse has passed to a qualified domestic trust (QDOT) for the surviving spouse, the surviving spouse will not be able to use any of the deceased spouse’s DSUE amount until the final QDOT distribution or the termination of the QDOT, typically upon the surviving spouse’s death. This rule will usually prevent the surviving spouse from using any of the DSUE amount by gift.
- Reg. §§20.2010-3T(e) and 25.2505-2T(f) clarify that the estate of a nonresident who is not a U.S. citizen may not use the DSUE amount of a predeceased spouse, except to the extent allowed under a treaty.
- The temporary regulations reserve §20.2010-2T(c)(3) to address the coordination of the portable unified credit with other credits, such as the credit for tax on prior transfers (section 2013), the credit for foreign death taxes (section 2014), and the credit for death taxes on remainders (section 2015). The preamble asks for further comment on that subject.
- Part 4, line 3b, asking for the identification of all prior spouses and whether the marriage ended by annulment, divorce, or death.
- Part 5, lines 10 and 23, for reporting the “[e]stimated value of assets subject to the special rule of Reg. section 20.2010-2T(a)(7)(ii).” See paragraph 2.c above. Each schedule of the return used for reporting assets (A through I), as well as Schedules M and O used for reporting transfers that qualify for the marital or charitable deduction, includes a Note referring to this special rule. (As stated above, a “Table of Estimated Values” on page 16 of the instructions modifies the “nearest $250,000” convention of the regulations only by requiring that the rounding always be up to the next higher multiple of $250,000, except for a total value greater than $5 million and less than or equal to $5.12 million (the 2012 applicable exclusion amount), which is rounded to $5.12 million.)
- Part 6, Section A, providing that the portability election is made “by completing and timely-filing this return” and providing a box to check to opt out of electing portability. (The instructions, on page 17, state simply that “[i]f an estate files a Form 706 but does not wish to make the portability election, the executor can opt out of the portability election by checking the box indicated in Section A of [Part 6]. If no return is required under section 6018(a), not filing Form 706 will avoid making the election.”)
- Part 6, Section B, asking if any assets are transferred to a QDOT and advising that, if so, any DSUE calculation is only preliminary. See paragraph 2.i above.
4.Anwittxtun,Fom709,sldonovmbr20,2012,tra dthdbnsdinSptmbr2012.tislsoonsistntththe ultions,sllshesttetxtunndinstutions.tinludsanw ShduleC,ithtots,likePt6,Stion,ofthesttetxtun,or SEivdomtelstdsdspousendSEivdmothpddspouss)dpplidyonortoitimeits.”nstionsor theit txtun, ddovmbr19, 2012, elsd ombr29,2012.
- Noting that the IRS had granted extensions of time to make the portability election under Reg. §301.9100-3 (“9100 relief”) in several letter rulings, Rev. Proc. 2014-18 provided that an executor of such a decedent who was not required to file an estate tax return for estate tax purposes and who in fact did not file an estate tax return could simply file the otherwise late estate tax return, prepared in accordance with Reg. §20.2010-2T(a)(7), on or before December 31, 2014, and state at the top of the return “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER
- Rev. Proc. 2014-18 noted that executors who can benefit from this relief include executors of decedents who were legally married to same-sex spouses. Those executors could not have known that portability would be available for same-sex married couples until the Supreme Court decided United States v. Windsor, 570 U.S. , 133 S. Ct. 2675 (2013), on June 26,
2013, and the Service issued Rev. Rul. 2013-17, 2013-38 I.R.B. 201, on August 29, 2013. The relief provided by Rev. Rul. 2014-18, however, applies to all married persons who died in 2011, 2012, and 2013 for whom an estate tax return was not required, not just to same-sex married couples.
- Revenue Procedure 2014-18 provides no relief with respect to decedents who die in 2014 or later. The executors of such decedents have until at least October 1, 2014, to file estate tax returns (or claim automatic extensions) and make the portability election. If they fail to do so, Rev. Proc. 2014-18 confirms that they may continue to seek 9100 relief.
- protection of the expectancy of children from diversion by the surviving spouse, especially in cases of second marriages and blended families, as well as remarriage of the surviving spouse,
spouse remarries, the exemption is reduced, or portability sunsets,
- use of the predeceased spouse’s GST exemption, because portability applies only to the gift and estate taxes (although portability will apparently also be available if the first estate is placed in a QTIP trust for which a reverse-QTIP election is made, if a QTIP election in that case is not disregarded under Rev. Proc. 2001-38, 2001-24 I.R.B. 1335, discussed below),
- avoiding the filing of an estate tax return for the predeceased spouse’s estate, if the estate is not so large as to otherwise require a return, and
- prevention of disclosure of the predeceased spouse’s estate tax return information to the surviving spouse and the surviving spouse’s representatives (see paragraph 2.d on page 79).
- greater perceived security for the surviving spouse by accommodating an outright bequest that confers complete control over the entire estate, without the intervention of a trust,
- avoidance of state estate tax on the first estate in states with an estate tax and no state-only QTIP election.
- a second step-up in basis for appreciated assets at the surviving spouse’s death (which, if the protection of a trust is still desired, could be in a QTIP- style trust, again if a QTIP election in that case is not disregarded under Rev.
Proc. 2001-38), and
- Rev. Proc. 2001-38, 2001-24 I.R.B. 1335, announced circumstances in which the IRS “will disregard [a QTIP] election and treat it as null and void” if “the election was not necessary to reduce the estate tax liability to zero, based on values as finally determined for federal estate tax purposes.” The procedure states that it “does not apply in situations where a partial QTIP election was required with respect to a trust to reduce the estate tax liability and the executor made the election with respect to more trust property than was necessary to reduce the estate tax liability to zero.” The procedure states that it “also does not apply to elections that are stated in terms of a formula designed to reduce the estate tax to zero.”
i.hus,thepdmetohihthepoduepplisisthesehe thetblestteouldhvebnlssthnteppliblelusion mount,sothestteouldnotbesubjttodlsttet, buttheutorlistdsomeorlloftheustppyonShduleMto
the estate tax return and thus made a redundant QTIP election.
ii.Rv.Po.200138isalifmsu.etnsitionlsntbtnthesummyoftheboundlwndtheplntionofthe poblmsttsthtthentnlRvnueSviehsivdqsts orlifinsitutionshensttedenunnssyP ltion.”
- The question is whether a QTIP election made only to support a reverse- QTIP election for GST tax purposes or to gain a second basis step-up at the death of the surviving spouse might be treated as an election that “was not necessary to reduce the estate tax liability to zero” and therefore as “null and void.”
i.hevnepodueosontosttethttostblshthtn ltionisithinthespeofthisvnuepodu,theprmust poduesuiintvidetotht t.ormpl, thetprthe suvivingspousertheuvivingspouss uo]mypodeaoy ofthesttetxtunildythesdspoussstte stblishingthtthetionsnotnssyoduethesttelibiliyto o.”
ii.htsttmnt,tel”oinofRv.Po.200138,theliklihood thtavnepouennounigthevisdministtive obnennotnenltionlyuhoidysttut,nd theunsmlinssofdngthebnitsofaPltiontosmllr sttshilelloigittolgrsttsllsuggstthtaPtion illbestdinsuhas.hisviwisnodythepliit neinR.§20201027ii4)toPltionsin tunsildtoltpobiliybutnotothisequidorsttex puposs sepphon pge
iii.tmyethtthispohouldpp,int,tomkethe onsqunsofaPltionltiveonthebsisofhtouldbe vylog hindsiht.ithspttothesondbsisstpup,tht tulysmstohenapotntilsultrsineRv.Rul.2001- 38 s publishd; it is not lyhgd ypotbili.
- There might be other approaches to address at least the basis issue, including outright distributions to the surviving spouse and “springing” or discretionary general powers of appointment. All such approaches have their own strengths and weaknesses, including the possible loss of protection of the predeceased spouse’s beneficiaries, especially in the case of a second marriage.
2013), which, now that it has been affirmed by the Supreme Court, will extend to same-sex married couples the federal tax benefits available to all married couples, presumably including portability.
(The author acknowledges with appreciation his former partner Lou Mezzullo’s contribution to this list.)
Patriot Act, HIPAA, and charitable governance reform.
1.hisisavysimplendsupisinypopulrthniqu,dspiteitspivlkoflv”tnitsimpyonsonapiortnsrtheitttmnt thtouldhvebnhosntthttmeiftheittxmptionhdotbn smll.tdosnotvnquietheommtmntofyssts,lthouh somtimsaitofshollodypntinsh,hileiu,smoe onsistntithndsuppotiveofthebonaidsftheoiilhtitions alon.
- the policy-holder might be entitled to withdraw accelerated death benefits, reducing the value of the policy that is subject to section 2035(a)(2), while the withdrawn cash is not subject to section 2035(a)(2), or
i.heirmktvluepeofapoliyiftheinsdislosetodthis likytobelosetoteemountofthepoli.hespousssteis notinsdytheiptofthepods,busethtsimpy stos thepuhepietesousepid.Mnhil,hepieidbomtheopusfthelomtust,butisnolorsubjttotion 2035.ssuminghetustisantortutstothepss spous,theisnoinnidstion10411)ndnohein bsisstion1041b,ndthoethetnsrorvleuleof stion 1012)dos nt ppytion 1012.
3.tisotnsidthttheipoltustdotin”nbevoid,vnnspousetsatustinhihtheothrspouehsnintst,ymingthe tustsdint.See Estate of Levy v. Commissioner,.C.Mmo183453 ipltustdotinedidnotppytotuststdyspoussthtbnitd hothrusetheiehdabdlitimelimitdportoppointtust sststooeothrtnhsl,rditos,hrstt,ortheditosofhr stt, hilethehusbndhd no suh po.
A right to distributions subject to an ascertainable standard might be ignored if it is unlikely to be exercised, but that is factual and subjective. A 5% withdrawal right might be valued like a unitrust right, significantly reducing the amount of the trust that is eligible for gift-splitting. An independent trustee’s unlimited discretion would be a problem without an easy solution or limitation. See Reg.
§25.2513-1(b)(4); Rev. Rul. 56-439, 1956-2 C.B. 605; Robertson v.
Commissioner, 26 T.C. 246 (1956), acq., 1956-2 C.B. 8; Falk v. Commissioner,
T.C. Memo 1965-22; Wang v. Commissioner, T.C. Memo 1972-143.
Commissioner, T.C. Memo 2012-88, nonacq., 2012-46 I.R.B.
- Just as in the days when one could drive into a gas station and ask for “five dollars’ worth of regular,” without specifying the number of gallons, there is an intuitive notion that a donor ought to be able to make a gift of any stated amount expressed in the form of “such interest in X Partnership … as has a fair market value of $13,000,” which the IRS approved in Technical Advice Memorandum 8611004 (Nov. 15, 1985).
- In Knight v. Commissioner, 115 T.C. 506 (2000), the Tax Court disregarded the use of such a technique to transfer “that number of limited partnership units in [a partnership] which is equal in value, on the effective date of this transfer, to $600,000.” As a result, the court redetermined the value subject to gift tax. It was generally believed, however, that the result in Knight could have been avoided if the taxpayers had acted more consistently and carefully. Despite the apparent attempt to make a defined-value gift, the gifts shown on the gift tax return were stated merely as percentage interests in the partnership (two 22.3% interests on each return). Moreover, the taxpayers contended in court that such interests were actually worth less than the “defined” value.
- Field Service Advice 200122011 (Feb. 20, 2001) addressed, negatively, the facts generally known to be those at issue in McCord v. Commissioner, 120
T.C. 358 (2003), in which the taxpayers had given limited partnership interests in amounts equal to the donors’ remaining GST exemption to GST- exempt trusts for their sons, a fixed dollar amount in excess of those GST exemptions to their sons directly, and any remaining value to two charities. The IRS refused to respect the valuation clauses, citing Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944), a case with unusual facts in which the court found a provision in a document of transfer that “the excess property hereby transferred which is deemed by [a] court to be subject to gift tax ... shall automatically be deemed not to be included in the conveyance” to be contrary to public policy because it would discourage the collection of tax, would require the courts to rule on a moot issue, and would seek to allow what in effect would be an impermissible declaratory judgment. The IRS acknowledged that the approach in question was not identical to the valuation clause in Procter, because it used a “formula” clause that defined how much was given to each donee, while Procter involved a so-called “savings” clause that required a gift to be “unwound” in the event it was found to be taxable. Nevertheless, the IRS believed the principles of Procter were applicable, because both types of clauses would recharacterize the transaction in a manner that would render any adjustment nontaxable.
- Technical Advice Memoranda 200245053 (July 31, 2002) and 200337012 (May 6, 2003) took the IRS discomfort with defined-value clauses to the next level.
- When McCord itself was decided by the Tax Court, the court essentially avoided the formula issue by dwelling on the fact that the assignment document had used only the term “fair market value” not “fair market value as determined for federal gift tax purposes.”
- In Succession of McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006), the Court of Appeals for the Fifth Circuit reversed the Tax Court totally, scolded the Tax Court majority soundly, and remanded the case to the Tax Court to enter judgment for the taxpayers. The court said that “although the Commissioner relied on several theories before the Tax Court, including … violation-of-public policy [the Procter attack], … he has not advanced any of those theories on appeal. Accordingly, the Commissioner has waived them.” But, in the view of many, the Fifth Circuit said other things that are hard to understand unless the court was comfortable with the use of defined value clauses in that case.
- Estate of Christiansen v. Commissioner, 130 T.C. 1 (2008) (reviewed by the court), addressed the use of value formulas in the different context of a disclaimer of a testamentary transfer. The decedent’s will left her entire estate to her daughter, with the proviso that anything her daughter disclaimed would pass to a charitable lead trust and a charitable foundation. The daughter disclaimed a fractional portion of the estate, with reference to values “finally determined for federal estate tax purposes.” Noting that phrase, the Tax Court, without dissent, rejected the Service’s Procter argument and upheld the disclaimer to the extent of the portion that passed to the foundation. (The court found an unrelated technical problem with the disclaimer to the extent of the portion that passed to the charitable lead trust.) In a pithy eight-page opinion, the Eighth Circuit affirmed. 586 F.3d 1061 (8th Cir. 2009).
- In Estate of Petter v. Commissioner, T.C. Memo 2009-280, the Tax Court upheld gifts and sales to grantor trusts, both defined by dollar amounts “as finally determined for federal gift tax purposes,” with the excess directed to two charitable community foundations. Elaborating on its Christiansen decision, the court stated that “[t]he distinction is between a donor who gives away a fixed set of rights with uncertain value—that’s Christiansen—and a donor who tries to take property back—that’s Procter. … A shorthand for this distinction is that savings clauses are void, but formula clauses are fine.” The court also noted that the Code and Regulations explicitly allow valuation formula clauses, for example to define the payout from a charitable remainder annuity trust or a grantor retained annuity trust, to define marital deduction or credit shelter bequests, and to allocate GST exemption. The court expressed disbelief that Congress and Treasury would allow such valuation formulas if there were a well-established public policy against them. On appeal, the Government did not press the “public policy” Procter argument, and the Ninth Circuit affirmed the taxpayer-friendly decision. 653 F.3d 1012 (9th Cir. 2011).
- Hendrix v. Commissioner, T.C. Memo 2011-133, was the fourth case to approve the use of a defined value clause, with the excess going to charity. The court emphasized the size and sophistication of the charity, the early participation of the charity and its counsel in crafting the transaction, and the charity’s engagement of its own independent appraiser. Hendrix was appealable to the Fifth Circuit, and the court also relied heavily on McCord.
I hereby assign and transfer as gifts, effective as of January 1, 2004, a sufficient number of my Units as a Member of Norseman Capital, LLC, a Colorado limited liability company, so that the fair market value of such Units for federal gift tax purposes shall be as follows: [Here each donor listed children and grandchildren with corresponding dollar amounts.]
Although the number of Units gifted is fixed on the date of the gift, that number is based on the fair market value of the gifted Units, which cannot be known on the date of the gift but must be determined after such date based on all relevant information as of that date.…
4.heoutstssdthenowmilirdistintiontnasvislu,hiatprmynotuseovoidthetximposdystion2501,ndaomula lus,hihisvlid.…Asvislueisoidbueittsaonorthtistotepoyk.…nteothrnd,aomulalu’isvlid buseit mytnss aid st ofhts ith untin vlu.”
It is inconsequential that the adjustment clause reallocates membership units among petitioners and the donees rather than a charitable organization because the reallocations do not alter the transfers. On January 1, 2004, each donee was entitled to a predefined Norseman percentage interest expressed through a formula. The gift documents do not allow for petitioners to “take property back”. Rather, the gift documents correct the allocation of Norseman membership units among petitioners and the donees because the [appraisal] report understated Norseman’s value. The clauses at issue are valid formula clauses.
6.hisisaintingmpison,buseitutstheihtsfthehitble oundtionsinPetter thtethepouo”pintsofyvlueinssof thesttdvlusiththeihtsofthehildndndhildninWandry ho ethepimy ipintsofthesttdvlustmslvs.na,thetsof Wandry etheveofthets in Petter.
- The effect of the increased value in Petter was an increase in what the charitable foundations received, whereas the effect of the increased value in Wandry was a decrease in what the donees received. The analogs in Wandry to the charitable foundations in Petter were the donors themselves, who experienced an increase in what they retained as a result of the increases in
value on audit.
- It is also telling that in the court’s words the effect of the language in the gift documents was to “correct the allocation of Norseman membership units among petitioners and the donees because the [appraisal] report understated Norseman’s value.” Until Wandry, many observers had believed that the courts had approved not “formula transfers” but “formula allocations” of a clearly fixed transfer. In fact, the Wandry court used a variation of the word “allocate” five times to describe the determination of what was transferred and what was retained. But the “allocation” was between the donees and the original donors. “Allocation” to the donors looks a lot like retention by the donors, if not a way to “take property back,” and thus the court might be suggesting that the time-honored distinction between “formula transfers” and “formula allocations” might not be so crucial after all. But it is a cause for concern that the court did not acknowledge that tension, but continued to use “allocation” language to justify what in economic effect defined what was transferred by the donors, not merely how the transferred property was allocated among donees. Again, though, the overall context and thrust of the court’s analysis was that the donors had not sought “to take property back,” but had merely defined what was given on the date of the gift.
7.hus,theisnowatrvitoyinasethtdosnotinvlveapouov” tohiyofyssvlu.heoutonlddyginknligthe bsnefaiydsigthtinEstate of Petter eitdCnss’ ovllpoliyofoingitstohitleonitions.histor ontibutd to ouronlusion, but t s notdtmintiv.”hus,Wandry ppstoblssasimplrtpttnthtmoelosyoomstotheommon snseivedolls’ohoful”pphthtmyobvs,pnty vn theRS in 1985, hvethouht should ok.
- The Action on Decision took the view that “on the date of the gift the taxpayers relinquished all dominion and control over the fixed percentage interests” because “[t]he final determination of value for federal gift tax purposes is an occurrence beyond the taxpayers’ control.” It went on to say that “[i]n Petter, there was no possibility that the transferred property would return to the donor, and thus, the court had no need to consider the extent to which the gift was complete.”
- Although the nonacquiescence could signal that the IRS is waiting for cases with “better” facts (“better” for the IRS, “bad” facts for taxpayers), Wandry itself included some facts that could have been viewed that way, including a 19-month delay for obtaining the appraisal, a description of the gifts on the gift tax returns as straightforward percentage interests without reference to the defined-value formulas, and adjustments to capital accounts rather than percentage interests as the prescribed response to changes in valuation.
9.heistsummyofWandry isthtitisundnibysniintorndig thesopeofthedidssbondtheonttofahitblepouov.ut unliketheitbles,heteihtofsewsnowmultbhinddindvleussithapouo”toahiyththstivy monitodndptiiptdinthetnstion,Wandry dosnotpsnta onsistntboyofxCoutndppllteoutjuispudn,nd,svnthe hitblessho,theRSdosnotpoveoftheinvluethniqu. useitislsoirtospultethtmynd2012tsollodthe pttnofaWandry mul,”eshouldnotbesupisdtoseutues involving Wandry psofdindluetnss.
10.nEstate of Marion Woelbing v. Commissioner xCoutokto.026013, ptitionild.26,013)ndEstate of Donald Woelbing v. Commissioner xCoutokto.026113,ptitionild.26,201,thexCouths bnsdtoonsidrasleyoldolbin,hoondtemoiyof thevotingndnonvotingstokofCmabotois,.,ofnklin, isonsin, themkrofCmxskin epoduts.
- In 2006 Mr. Woelbing sold his nonvoting stock for a $59 million interest- bearing promissory note to a trust that owned insurance policies under a split- dollar arrangement with the company. The sale agreement provided for the number of shares sold to be adjusted if the IRS or a court revalued the stock. The IRS basically ignored the note, doubled the value of the stock to $117 million, included that value in his gross estate, and asserted gift and estate tax negligence and substantial underpayment penalties.
- Among other things, the Tax Court might be obliged to address both the adjustment clause and the possible reliance on the life insurance policies to provide “equity” in the trust to support the purchase.
1.ndrstion14112,the3.8pntMdietxonntinvstmntnomntdinonntioniththePtintPottonndodbeCet,is imposdontheundistributed ntinvstmntinomeofnstteortust,o,if lss,onthedjustdossinomeofthestteortustlssthemountthih the hist39.6pt)inomexbktins–$11,950or213nd
$12,150 for 2014. This effectively makes the total income tax rate on such income 43.4 percent, beginning at that level. And all or virtually all income of a trust will be investment income.
2.usethisnwtxistiveortblesbinnigtrbr31, 2012,utosofthettsofddntshoddboethendf202ould hveltdaislrndingovmbr30,thymptingtheiomein theist11monthsof213omthenwt.oseutosndthetustsof quliidvbletussouldhvelsoldundrstion645tottthe tust s apt ofthesteordl inometxpuposs.
instruments or in commodities within the meaning of section 475(e)(2)). Therefore, the new tax provides an additional reason to avoid the treatment of a business as a “passive activity.”
- Section 469(c)(1) defines “passive activity” as “the conduct of any trade or business … in which the taxpayer does not materially participate.” Section 469(h)(1) defines material participation as involvement in the operations of the activity on a “regular, continuous, and substantial” basis.
- There are no regulations specifically applying the “passive activity” rules to the unique circumstances of estates and trusts.
2003), a federal district judge held that “common sense” and the notion of the “trust” as the “taxpayer” dictate that “material participation” in the context of a trust be determined with reference to the individuals who conduct the business of the trust on behalf of the trust, not just the trustee as the IRS had argued, although, alternatively, the court also found that the activities of the trustee alone were sufficiently “regular, continuous, and substantial.”
- In Technical Advice Memorandum 200733023 (date not given, released August 17, 2007), the IRS rejected the reasoning of the Mattie K. Carter court and, citing a 1986 committee report, reasoned that it was appropriate to look only to the activities of the trust’s fiduciaries, not its employees. The IRS also concluded that “special trustees,” who performed a number of tasks related to the trust’s business but were powerless to commit the trust to a course of action without the approval of the trustees, were not “fiduciaries” for this purpose.
- The IRS took a similar view in Technical Advice Memorandum 201317010 (January 18, 2013). The IRS agreed that a “special trustee” was a fiduciary of the trust, but only as to his insubstantial time spent in voting the stock of two S corporations or in considering sales of stock of those corporations (although one could question what else a trustee does with stock), not as to his presumably regular, continuous, and substantial time spent as president of
one of the corporations. The technical advice memorandum referred to him as “an employee” of the company and did not identify circumstances in which his fiduciary duties to the other trust beneficiaries as special trustee (or even if he had been a regular trustee) would cause his services as president of the company to be performed in his role as trustee with serious regard to those fiduciary duties.
- In Frank Aragona Trust, Paul Aragona, Executive Trustee v. Commissioner, 142 T.C. No. 9 (March 27, 2014), the Tax Court (Judge Morrison) rejected an IRS argument that for purposes of the passive loss rules of section 469 itself a trust in effect could never materially participate in a trade or business.
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the lowest income levels of the beneficiaries. Therefore, because the undistributed net income and adjusted gross income of a trust are both reduced by distributions under sections 651 and 661, it will sometimes be possible to reduce the overall income tax by making such distributions.
- Of course, a trustee will have to be satisfied that the applicable distribution standard (such as “support”) justifies a distribution solely for the purpose of minimizing overall income tax liability.
- In addition, a trustee may have to balance that income tax benefit against purposes of the trust that dictate that income be accumulated for future needs or future generations.
- Drafting can determine the extent to which distributions for tax reasons are encouraged or even permitted.
- This optimism was encouraged by the well-known commitment and cooperation of Senate Finance Committee Chairman Max Baucus (D-MT) and House Ways and Means Committee Chairman Dave Camp (R-MI). Senator Baucus released three working drafts during the week of November 18, 2013, addressing the subjects of international taxation, tax administration and enforcement, and accounting and cost recovery.
- But in December 2013 President Obama announced his intention to nominate Senator Baucus as the Ambassador to China; he has been succeeded as Finance Committee Chairman by Senator Ron Wyden (D-OR). Under House Republican rules, Congressman Camp is in his third and final term as Ways and Means Committee Chairman, and on March 31, 2014, he announced that he will retire from Congress at the end of his current term. His successor as Ways and Means Committee Chairman could be (in order of seniority, which often is not strictly followed by House Republicans) Congressman Sam Johnson or Kevin Brady of Texas, Paul Ryan of Wisconsin, or Devin Nunes of California.
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the foreseeable future.
- A “continuing resolution” meant that the “sequestration” cuts that took effect in January 2013 would continue.
$21 billion of “sequestration” cuts, including Medicare cuts.
- Until February 7, 2014, the debt limit could be raised by presidential action, unless Congress disapproved.
- Meanwhile, the Secretary of the Treasury was authorized to use “extraordinary measures” to meet obligations.
- The Secretary of Health and Human Services was required to report to Congress on verification measures by January 1, 2014. (She did so on December 31, 2013.)
- The Inspector General of the Department of Health and Human Services is required to report to Congress on the effectiveness of measures to prevent fraud under the Patient Protection and Affordable Care Act by July 1, 2014.
civilian workers hired after 2013.
On February 14, 2014, Congressman Jim McDermott (D-WA), introduced the “Sensible Estate Tax Act of 2014” (H.R. 4061), similar to H.R. 3467 that he had introduced in 2011. See Part IX.A beginning on page 64.
The Treasury Department’s “General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals” (popularly called the “Greenbook”) was released on May 11, 2009. See http://www.treas.gov/resource-center/tax-policy/Documents/grnbk09.pdf. An Appendix, on page 125, confirmed that “[e]state and gift taxes are assumed to be extended at parameters in effect for calendar year 2009 (a top rate of 45 percent and an exemption amount of $3.5 million).” At pages 119-23, as revenue raisers dedicated to health care reform, three revenue-raising proposals were described under the heading “Modify Estate and Gift Tax Valuation Discounts and Make Other Reforms,” requiring consistency in value for transfer and income tax purposes, modifying rules on valuation discounts, and requiring a minimum term for GRATs. On page 112, under the heading “Insurance Companies and Products,” the Greenbook proposed to “modify the transfer- for-value rule [applicable to life insurance policies] to ensure that exceptions to that rule would not apply to buyers of polices” in life settlement transactions.
The “General Explanations of the Administration’s Fiscal Year 2011 Revenue Proposals” was released on February 1, 2010. See http://www.treas.gov/resource- center/tax-policy/Documents/greenbk10.pdf. Again, an Appendix, on page 147, stated that “[e]state and gift and GST taxes are assumed to be extended at parameters in effect for calendar year 2009 (a top rate of 45 percent and an exemption amount of $3.5 million).” (The words “and GST” are added in the 2010 Greenbook.) In footnotes on pages 124 and 126, the 2010 Greenbook stated:
The Administration’s baseline assumes that the laws governing the estate, gift and generation-skipping taxes as in effect during 2009 are extended permanently. Consequently, the discussion of Current Law set forth above reflects the applicable law as in effect during 2009.
The 2010 Greenbook included the same estate and gift tax proposals (pages 122- 26), except that they were under the overall heading of “Reduce the Tax Gap and Make Reforms” and not tied to health care reform. The 2010 proposals were identical to the 2009 proposals, except in one detail related to GRATs described below, and on page 69 there was the same life insurance proposal as in the 2009 Greenbook.
The “General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals” was released on February 14, 2011. See http://www.treas.gov/resource- center/tax-policy/Documents/Final%20Greenbook%20Feb%202012.pdf. In a footnote to
the table of contents, the 2011 Greenbook stated, among other things, that “[t]he Administration’s policy proposals reflect changes from a tax baseline that modifies the Budget Enforcement Act baseline by … freezing the estate tax at 2009 levels.” The 2011 Greenbook included the life insurance proposal (page 51) and the same three estate and gift tax proposals (pages 125-28). In addition, at pages 123-24, the 2011 Greenbook includes a proposal to make permanent the portability of unused exemption between spouses and, at pages 129-30, a proposal to generally terminate an allocation of GST exemption to a trust after 90 years.
The “General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals” was released on February 13, 2012 (see http://www.treasury.gov/resource- center/tax-policy/Documents/General-Explanations-FY2013.pdf). The 2012 Greenbook repeated the proposals of the previous Greenbooks (pages 75-82) and added two, a surprisingly broad proposal to apparently subject all grantor trusts to gift or estate tax (page 83) and a noncontroversial proposal to extend the lien on estate tax deferrals under section 6166 (page 84).
The “General Explanations of the Administration’s Fiscal Year 2014 Revenue Proposals” was released on April 10, 2013 (see http://www.treasury.gov/resource- center/tax-policy/Documents/General-Explanations-FY2014.pdf), about two months later than usual. Seven proposals under the heading “Modify Estate and Gift Tax Provisions” (pages 138-48) changed the grantor trust proposal, omitted the valuation discount proposal, and added one new proposal dealing with the GST tax treatment of “health and education exclusion trusts.”
The “General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals” was released on March 4, 2014 (see http://www.treasury.gov/resource- center/tax-policy/Documents/General-Explanations-FY2015.pdf). Nine proposals under the heading “Modify Estate and Gift Tax Provisions” (pages 158-72) included without significant change the seven proposals from 2013, plus two new proposals dealing with the annual gift tax exclusion and the definition of “executor.”
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- Reminiscent of past year’s observations, the 2013 and 2014 Greenbooks states that “ATRA retained a substantial portion of the tax cut provided to the most affluent taxpayers under [the 2010 Tax Act] that we cannot afford to continue. We need an estate tax law that is fair and raises an appropriate
amount of revenue.”
- Even so, there is little indication that Congress is eager to revisit what it just made permanent in January 2013.
1.ndrstion1014,thebsisofpopyquidomantisthe irmtvlueoftepopy ttheteoftheddntsdt,”ith ppopitedjustmntsinstion1014ortheltntelutiondtendso oth.tispossibleortheipintofpopyomaddnttolim,or inometxpuposs,thttheutorsomhowjustotthesttetxvluetoo lo,ndthtthehississhouldbegtrthnthesttetxvlu.sulofous,suhlimsemderthesttuteoflimttionshsunonthe sttetxtun.Suhlimsnbeompidylbteppilsnd othrvidefthel”todthvluetht,longtrdth,ishdto ut.nvokigpinipsofpivi”theSveisbletoinsistonuingthe lorsttetxvluehntheipintsoneoftheutoshosindthe sttetxtun, but othiseit hs hd no tool to noesuh nsistn.
- On September 8, 2009, the staff of the Joint Committee on Taxation released a publication entitled “Description of Revenue Provisions in President’s Fiscal Year 2010 Budget Proposal, Part One: Individual Income Tax, Estate and Gift Tax Provisions” (JCS-2-09). Regarding this Administration Greenbook proposal, the JCT publication stated (emphasis added):
The proposal requires that the basis of property received by reason of death under section 1014 generally must equal the value of that property claimed by the decedent’s estate for estate tax purposes.…
Under the proposal there would be instances in which the value of an asset reported by an executor to an heir differs from the ultimate value of the asset used for estate tax purposes. For example, if the IRS challenges an estate valuation and prevails, the executor will have reported to the heir a valuation that is artificially low, and the heir may arguably be overtaxed on a subsequent sale of the asset. This same problem exists under present law to the extent the initially reported estate tax value is presumptively the heir’s basis. To provide complete consistency between estate tax valuation and basis in the hands of an heir may be impractical as ultimate determination of value for estate tax purposes may depend upon litigation, and an heir may sell an asset before the determination of value for estate tax purposes.
By requiring the value of an asset reported for transfer tax purposes to be reported and used by the heir or donee in determining basis, however, the proposal has the salutary effect of encouraging a more realistic value determination in the first instance. This salutary effect would be lost if there were a relief mechanism for transferees and transferors (and recoupment for the government) if the basis used by transferees differed from the fair market value ultimately determined for transfer tax purposes. Thus, the proposal does not contain any such relief mechanism.
- It is hard to reconcile this with the Greenbook’s statement that “[t]he proposal would require that the basis of the property in the hands of the recipient be no greater than the value of that property as determined for estate or gift tax purposes …” (emphasis added).
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6.hepoposlsstimtdtoisetxvnuevrtnsy $1.87bllionin the2009nbook,$2.103billioninthe2010nbook,$2.095billioninthe 2011 nbook, $2.04 billion in the2012nbook, $1.896 in he2013 nbook,nd $2.501 n the2014 nbook.
- The similar proposal floated by the staff of the Joint Committee on Taxation in 2005, described in Part V.D on page 19, was estimated to raise less than
$50 million over ten years.
- The 2009 Joint Committee on Taxation estimate was $935 million, exactly half the Administration estimate in the 2009 Greenbook.
- A new section 6035(a) would require executors to report to the Service and to each person receiving property from a decedent the fair market value (or other relevant attributes) of all such property. A new section 6035(b) would require donors of gifts to report comparable information, including the donor’s adjusted basis in every case, to the Service and to donees.
The reference to “the timing of the required reporting in the event of adjustments to the reported value subsequent to the filing of an estate of gift tax return” appeared relevant to the JCT staff’s suggestion that basis must be the value originally claimed on an estate tax return, without regard to subsequent adjustments. But, being cast in terms of the “timing” of the “reporting,” it provided some ground for hope, but little clarity. The statutory language did not use the well-understood phrase “as determined for estate or gift tax purposes” that the Greenbooks use, and even the Greenbooks do not use the familiar phrase “as finally determined for estate or gift tax purposes.”
- New sections 1014(f) and 1015(f) would mandate that in the case of any property subject to reporting under section 6035, except as provided in regulations, “the basis of the property in the hands of the person acquiring such property shall be calculated using the information reported to such person ….”
- Both the failure to report under section 6035 and the failure to use a consistent basis under section 1014(f) or 1015(f) would be subject to penalties.
- Among other things, the Baucus Bill would have provided welcome clarification that the basis would be adjusted to the value “as finally determined for purposes of chapter 11.”
- In the case of a sale before the estate tax value is finally determined, the Baucus Bill would have required that the basis reported on the estate tax return be used, thereby adding one more issue to be considered before selling an asset for more than the value on the estate tax return before the estate tax audit is concluded.
1015(a), the basis for determining the donee’s gain can be greater than the gift tax value if that was the donor’s basis. The statutory language in S. 3533 and H.R. 5764 did not imply such a change. Even the current Greenbook proposal that “[t]he basis of property received by gift during the life of the donor must equal the donor’s basis determined under section 1015” is confusing, because section 1015 does not really determine the donor’s basis. New section 1015(f)(2) in H.R. 3467 appropriately clarifies this.
10.Sttutoylugeorhispoposlsimilrtolneinthemr2010 usill)ginpdinstion5oftheSnsiblesttextof 2011,”.R.3467,intodudonovmbr17,2011,y Cossnm Mmott.onssmnMmottsbill,hihouldstea55 pntteontblesttsovr$10millonnda$1milionxmption inddorinltionsine2001,isnotliklytoinmuhsuppotina RpublinldousefRpnttivs,butitisimpotntorthethnil dtigythestfthtitvls.)ndrthisbill,tiveorstendit txtuns ild trtedteoftmnt,
- new sections 1014(f)(1) and 1015(f)(1) would require the value used to determine basis in the hands of the recipient for all income tax purposes generally to be no less than the value “as finally determined” for estate or gift tax purposes,
- a new section 6035 would require each executor or donor required to file an estate or gift tax return to report to the Service and to each person receiving any interest in property from a decedent or donor the value of all such interests as reported on the estate or gift tax return “and such other information with respect to such interest as the Secretary may prescribe,”
- new sections 1014(f)(2) and 1015(f)(2) would require the value used to determine basis to be no less than the value reported on that statement if “the final value … has not been determined,”
- new sections 1014(f)(3) and 1015(f)(3) would authorize Treasury by regulations to “provide exceptions” to the application of these rules,
- new section 6035(c) would authorize Treasury to prescribe implementing regulations, including the application of these rules to situations where no estate or gift tax return is required and “situations in which the surviving joint tenant or other recipient may have better information than the executor regarding the basis or fair market value of the property,” and
- both the failure to report under section 6035 and the failure to use a consistent basis under section 1014(f) or 1015(f) would be subject to penalties.
The references in proposed sections 1014(f)(1) and 1015(f)(1) to the value “as finally determined” for estate or gift tax purposes allay concerns raised by the September 8, 2009, JCT publication discussed above, with the understandable exception of the case where the final estate or gift tax value of an asset has not yet been determined.
- It will not always be easy to get finality under these rules, especially the rules governing the payment of GST tax on taxable terminations occurring at death, which depend on the relevant inclusion ratio. Under Reg. §26.2642-5, this inclusion ratio is not final until the later of the running of the statute of limitations on the transferor’s estate tax or the running of the statute of limitations with respect to the first GST tax return filed using that inclusion ratio.
- The wording of S. 3533 and H.R. 5764 that basis “shall be calculated using the information reported” appears to permit all such allowable adjustments.
- In Van Alen a brother and sister had inherited a cattle ranch from their father in 1994, with a low “special use” estate tax value under section 2032A. They were not executors; their stepmother was. The heirs sold a conservation easement on the land in 2007 and argued that their basis for determining capital gain should be higher than the estate tax value. The court held their basis to the low estate tax value.
- A key to the outcome was that section 1014(a)(3) describes the basis of property acquired from a decedent as “in the case of an election under section 2032A, its value determined under such section.” This is in contrast to the general rule of section 1014(a)(1), which describes the basis as merely “the fair market value of the property at the date of the decedent’s death,” which arguably opens up the opportunity for a non-executor heir to argue that the value “determined” for estate tax purposes was simply too low. In addition, the court pointed to the special use valuation agreement, which the two heirs (one, a minor, by his mother as his guardian ad litem) had signed. Consistently with this rationale for its holding, the court cited Rev. Rul. 54- 97, 1954-1 C.B. 113 (“the value of the property as determined for the purpose of the Federal estate tax … is not conclusive but is a presumptive value which may be rebutted by clear and convincing evidence”), and observed that “it might be reasonable for taxpayers to rely on this revenue ruling if they were calculating their basis under section 1014(a)(1).”
- Surprisingly, however, the court also seemed to view heirs who were not executors as bound by a “duty of consistency” to use the value determined for estate tax purposes as their basis for income tax purposes. The court spoke of a “sufficient identity of interests” between the heirs and the executor and concluded that “[w]e rest our holding on the unequivocal language of section 1014(a)(3).… And we rest it as well on a duty of consistency that is by now
a background principle of tax law.”
- While “consistency” is superficially an appealing objective, the notion that it might apply generally to the basis of an heir who was not an executor may be more novel and more troubling than the court assumed. The court acknowledged that “[t]here are lots of cases that hold that the duty of consistency binds an estate’s beneficiary to a representation made on an estate-tax return if that beneficiary was a fiduciary of the estate.” But the court then went on to say: “But the cases don’t limit us to that situation and instead say that the question of whether there is sufficient identity of interests between the parties making the first and second representation depends on the facts and circumstances of each case.” The problem is that the court cited the same three cases for both propositions, and all three cases involved the basis of an heir who was a co-executor. Thus, Van Alen appears to stand alone for applying a duty of consistency to the basis of an heir who was not an executor, although the Van Alen holding does have the alternative ground of the word “determined” in section 1014(a)(3), applicable only in special use valuation cases.
- Moreover, the Van Alen opinion itself reveals how mischievous a “consistency” requirement might be in this context. The court describes how the audit “went back and forth” and the low value of the ranch could have been a trade for higher values of three other properties. Indeed, the court said: “The bottom line was that the IRS got an increase in the total taxable value of the estate … and an increase in the estate tax” (although later the court said, with specific reference to the ranch, that “[b]oth Shana and Brett [the heirs], and their father’s estate, benefited from a reduced estate tax.” If the heirs benefited from the special use valuation, it was a coincidental detail that is affected by tax apportionment rules and other factors and may not be present in every estate. And, as Van Alen illustrates, executors often settle estate tax audits by trade-offs and for strategic reasons that could have nothing to do with an effort to find the “true” “fair market value” for purposes of section 1014(a)(1). To bind heirs who do not participate in that audit seems quite unfair, and to give the heirs a role in the audit would be monstrously impractical.
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risk of GRATs by requiring a minimum ten-year term.
- Both the Greenbooks and the September 8, 2009, Joint Committee staff’s publication focus on the effect of the proposal in increasing the mortality risk of a GRAT, not necessarily its effect in diminishing the upside from volatility.
- The JCT staff publication noted that even a ten-year GRAT could be used “as a gift tax avoidance tool” and that a ten-year minimum term might encourage the use of GRATs by younger taxpayers. As an alternative way of achieving more accurate valuation, the JCT staff publication suggested valuation of the remainder interest for gift tax purposes at the end of the GRAT term when the remainder is distributed – embracing the “hard to complete” approach floated by the Reagan Administration’s “Treasury I” (Part II.D.1.b on page 3).
- In the single substantive change from the 2009 Greenbook, the 2010 and 2011 Greenbooks added that “[t]he proposal would also include a requirement that the remainder interest have a value greater than zero and would prohibit any decrease in the annuity during the GRAT term.” The 2012 Greenbook clarified that the requirement is “that the remainder interest have a value greater than zero at the time the interest is created” (emphasis added).
- Nevertheless, the 2010, 2011, 2012, and 2013 Greenbooks go on to say, like the 2009 Greenbook, that “a minimum term would not prevent ‘zeroing-out’ the gift tax value of the remainder interest.” Obviously near-zeroing-out is what is meant.
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seven Democrats voted against it. Reminiscent both of the Greenbooks’ explanations and of the 1990 legislative history of section 2702 itself, the House Ways and Means Committee offered the following “Reasons for Change”:
The valuation rates and tables prescribed by section 7520 often produce relative values of the annuity and remainder interests in a GRAT that are not consistent with actual returns on trust assets. As a result, under present law, taxpayers can use GRATs to make gifts of property with little or no transfer tax consequences, so long as the investment return on assets in the trust is greater than the rate of return assumed under section 7520 for purposes of valuing the lead and remainder interests. The Committee believes that such uses of GRATs for gift tax avoidance are inappropriate.
In some cases, for example, taxpayers “zero out” a GRAT by structuring the trust so that the assumed value of the annuity interest under the actuarial tables equals (or nearly equals) the entire value of the property transferred to the trust. Under this strategy, the value of the remainder interest is deemed to be equal to or near zero, and little or no gift tax is paid. In reality, however, a remainder interest in a GRAT often has real and substantial value, because taxpayers may achieve returns on trust assets substantially in excess of the returns assumed under section 7520. Any such excess appreciation passes to the remainder beneficiaries without further transfer tax consequences.
In addition, grantors often structure GRATs with relatively short terms, such as two years, to minimize the risk that the grantor will die during the trust term, causing all or part of the trust assets to be included in the grantor’s estate for estate tax purposes. Because GRATs carry little down-side risk, grantors frequently maintain multiple short-term, zeroed-out GRATs funded with different asset portfolios to improve the grantor’s odds that at least one trust will outperform significantly the section 7520 rate assumptions and thereby allow the grantor to achieve a transfer to the remainder beneficiaries at little or no gift tax cost.
The provision is designed to introduce additional downside risk to the use of GRATs by imposing a requirement that GRATs have a minimum term of 10 years. Relative to shorter-term (e.g., two-year) GRATs, a GRAT with a 10-year term carries greater risk that the grantor will die during the trust term and that the trust assets will be included in the grantor’s estate for estate tax purposes. The provision limits opportunities to inappropriately achieve gift tax-free transfers to family members in situations where gifts of remainder interests in fact have substantial value.
H.R. REP. NO. 111-447, 111TH CONG., 2D SESS. 55-56. (2010) (footnote omitted).
– that is, after the date the President signs it into law.
5486), which the House of Representatives passed by a vote of 247-170 (with five Republicans in favor and eight Democrats against) on June 15, 2010,
- section 8 of the “Responsible Estate Tax Act” (S. 3533 and H.R. 5764), introduced by Senator Sanders on June 24, 2010, and Rep. Linda Sanchez on July 15, 2010 (see Part VII.I.5 on page 33), and
11.hsepovisionsppdininstion301ofthededustmnt ssistnetnsiontof2011,”S.1286,intodudonune28,2011,y SntosCsyP)ndn,nihrofhomsammbrof theinneCommitt.nliketheothrbill,thispoviion,sintodud, ouldhvepplidtoRsunddtrmbr31,2010.hemsto belittleorno hnethtConss ould ss suh ttivelisltion.
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- With currently depressed values, difficulty in predicting the timing of recovery, and relatively low interest rates under section 7520, many clients have recently been opting for GRATs with terms longer than the typical two years anyway.
- But requiring a minimum ten-year term would encourage more customizing of the terms of a GRAT, including greater use of level GRATs or GRATs in which the annuity increases in some years but not others or increases at different rates in different years. For example, the typical 20 percent increase in the annuity payment each year would produce a payment in the tenth year equal to about 5.16 times the payment in the first year.
- A ten-year GRAT might also demand greater monitoring and active management. For example, if the asset originally contributed to the GRAT achieves its anticipated upside early in the ten-year term (maybe in the first year or two as is hoped for with a two-year GRAT), the grantor can withdraw that asset and substitute another asset of equivalent value with upside potential. If the grantor holds that withdrawn appreciated asset until death, this will also permit the asset to receive a stepped-up basis.
- A longer term for the GRAT will also permit a lower payout rate, which could make it easier to fund the annuity payments with cash (as with S corporation stock where the corporation distributes cash to equip its shareholders to pay income tax) and thereby avoid an annual appraisal.
- A lower payout rate could result in a smaller amount includible in the grantor’s gross estate under section 2036 if the grantor dies during the ten- year term. Under Reg. §20.2036-1(c)(2)(i) (promulgated in April 2008) that
includible amount is the amount needed to sustain the retained annuity interest without invasion of principal – that is, in perpetuity. Thus, for example, a ten-year GRAT with a level payout created when the section 7520 rate is 2.0 percent (as it was in September 2011) will require a payout equal to about 11.1 percent of the initial value. If the section 7520 rate when the grantor dies is 5.0 percent (as it was as recently as December 2007), the amount included in the grantor’s gross estate will be 222 percent of the initial value. That would represent a lot of appreciation, but often that is exactly what is hoped for when a GRAT is created. In that case, any appreciation in excess of 122 percent will pass tax-free to the next generation, even if the grantor dies during the ten-year term (unless the GRAT instrument provides for a reversion to the grantor, a general power of appointment, or a similar feature that would result in total inclusion of the date-of-death value in the gross estate).
- This technique is described in Angkatavanich & Yates, “The Preferred Partnership GRAT—A Way Around the ETIP Issue,” 35 ACTEC JOURNAL
289 (2009). In the paradigm addressed in this thoughtful article, the partnership (or LLC) is formed by the prospective grantor’s capital contribution in exchange for the preferred interest and a capital contribution by a GST-tax-exempt generation-skipping trust in exchange for the growth interest in the partnership. The payouts on the preferred interest are structured to be “qualified payments” within the meaning of section 2701(c)(3).
- Even if the grantor dies during the GRAT term, the underlying appreciation in the partnership growth interest will still escape estate tax.
- Moreover, the appreciation in the partnership growth interest will be captured in a generation-skipping trust, unlike the typical GRAT.
1.hispoposl,hihistppdinthe2011nbook,issntily unhdinthe2013nbooknd2014nbookpgs16465.tis minisntofnoptinpsntdytestfoftheointCommiteon tion innuy200. SePt V.A binnigon pge
- Unlike the 2005 option, which would have in effect limited an allocation of GST exemption to one generation, the Greenbook proposal would limit the duration of GST exemption to 90 years, requiring the inclusion ratio of a trust to reset to zero on the ninetieth anniversary of the creation of the trust.
- Like the 2005 option, the Greenbooks cites the repeal or limitation of the Rule Against Perpetuities in many states as the occasion for this proposal. The 2005 option would have been harsher than present law under a classical
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rule against perpetuities, which easily allows transfers to great-great- grandchildren. The current proposal could also be harsher than present law under a classical rule against perpetuities, which would permit some trusts to last longer than 90 years, but it would not be nearly as uneven or arbitrary in that respect.
2.tlstsinetepomutionfRv.Rul.853,19851C..184,inhihthe Sviehldthtnppntslebtnantortustndisntorould notbeddsaseorinometxpupos,thedionntbtnthe ntortustulsndtheitndsttetx ulshsinspidonsidble etiveplnnigith solld detiv”tortusts.
3.tisdtoueththentospmntfinometxonsomonelss inomeisnotonomily quivlnttoat,but,busetetxisthe ntosonobltionundrthentrtustuls,itspsitt.nd slstontortustseotnvdsonoilyquivlnt–orsuior– toRs,butithoutthepoliingfstions2702nd2036orte” stitions ofstion 242)on llotingSTmption.
- Rev. Rul. 2004-64, 2004-2 C.B. 7, addressing the estate tax consequences of provisions regarding the reimbursement of the grantor for income tax on the grantor trust’s income,
- Rev. Rul. 2007-13, 2007-11 I.R.B. 684, holding that the transfer of life insurance contracts between two grantor trusts treated as owned by the same grantor is not a transfer for valuable consideration for purposes of section 101,
estate tax consequences under sections 2036 and 2038 of the grantor’s retention of a section 675(4)(C) power, exercisable in a nonfiduciary capacity, to acquire property held in trust by substituting property of equivalent value,
- Rev. Rul. 2011-28, 2011-49 I.R.B. 830, extending that reassurance to section 2042 and cases where the trust property includes policies of insurance on the grantor’s life, and
- Rev. Proc. 2008-45, 2008-30 I.R.B. 224, promulgating sample inter vivos charitable lead unitrust forms, including forms for both nongrantor and grantor CLUTs, where the feature used to confer grantor trust status is such a substitution power in a person other than the grantor.
To the extent that the income tax rules treat a grantor of a trust as an owner of the trust, the proposal would (1) include the assets of that trust in the gross estate of that grantor for estate tax purposes, (2) subject to gift tax any distribution from the trust to one or more beneficiaries during the grantor’s life, and (3) subject to gift tax the remaining trust assets at any time during the grantor’s life if the grantor ceases to be treated as an owner of the trust for income tax purposes. In addition, the proposal would apply to any non-grantor who is deemed to be an owner of the trust and who engages in a sale, exchange, or comparable transaction with the trust that would have been subject to capital gains tax if the person had not been a deemed owner of the trust. In such a case, the proposal would subject to transfer tax the portion of the trust attributable to the property received by the trust in that transaction, including all retained income therefrom, appreciation thereon, and reinvestments thereof, net of the amount of the consideration received by the person in that transaction. The proposal would reduce the amount subject to transfer tax by the value of any taxable gift made to the trust by the deemed owner. The transfer tax imposed by this proposal would be payable from the trust.
If a person who is a deemed owner under the grantor trust rules of all or a portion of a trust engages in a transaction with that trust that constitutes a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person’s treatment as a deemed owner of the trust, then the portion of the trust attributable to the property received by the trust in that transaction (including all retained income therefrom, appreciation thereon, and reinvestments thereof, net of the amount of the consideration received by the person in that transaction) will be subject to estate tax as part of the gross estate of the deemed owner, will be subject to gift tax at any time during the deemed owner’s life when his or her treatment as a deemed owner of the trust is terminated, and will be treated as a gift by the deemed owner to the extent any distribution is made to
another person (except in discharge of the deemed owner’s obligation to the distributee) during the life of the deemed owner. The proposal would reduce the amount subject to transfer tax by any portion of that amount that was treated as a prior taxable gift by the deemed owner. The transfer tax imposed by this proposal would be payable from the trust.
- The classic paradigm trust deemed owned by a beneficiary for income tax purposes under section 678(a) would likely be included in the beneficiary’s gross estate anyway, because the power described in section 678(a) would essentially be a general power of appointment. Therefore, the changes in this Greenbook from references to “the grantor” to “a deemed owner” may indicate that more sophisticated beneficiary-owned trusts are in view.
- It is no secret that the Service is concerned about such trusts and is watching the developments that might affect such trusts. Rev. Proc. 2013-3, 2013-1
I.R.B. 113, § 4.01(43) included “[w]hether a person will be treated as the owner of any portion of a trust over which that person has a power to withdraw the trust property (or had such power prior to a release or modification, but retains other powers which would cause that person to be the owner of the trust under § 671 if the person were the grantor), other than a power which would constitute a general power of appointment within the meaning of § 2041, if the trust purchases the property from that person with a note and the value of the assets with which the trust was funded by the grantor is nominal compared to the value of the property purchased” among what Rev. Proc. 2013-3 describes as “areas in which rulings or determination letters will not ordinarily be issued.” Rev. Proc. 2014-3, 2014-1 I.R.B. 111, § 4.01(40) is the same.
The proposal would not change the treatment of any trust that is already includable in the grantor’s gross estate under existing provisions of the Internal Revenue Code, including without limitation the following: grantor retained income trusts; grantor retained annuity trusts; personal residence trusts; and qualified personal residence trusts.
- The implication is that the treatment of GRATs, for example, does not have to be changed because GRATs already are treated consistently with the Greenbook proposal. In fact, while it is assumed that all or most GRATs are grantor trusts (which can facilitate payment of the annuity in kind without capital gain), the value of the assets in a long-term GRAT might not be fully included in the grantor’s gross estate, and the termination of a GRAT’s grantor trust status, which may or may not occur at the end of the GRAT term, is not currently treated as a taxable gift.
QPRTs – ordinarily do not acquire assets from the grantor by purchase, so there is no reason to think that they would be affected by this year’s proposal anyway.
10.heneto,Rs,PRs,ndPRTsollodinthe2012 nbookyasitionofthepoposdtivedt,ompnidya netoultoyuthoiy…,inludigthebiliytotetnsition lifortinpsofutomti,piodicontibutionstoisingntor tusts,”uling thespltionthtthepoposl simdtlieinsunetusts, hetheiodicmntofpmiums,hilenottyutomi,”is pilydoneunrthems ofapistinginsuneontt.
11.nontst,theetos,Rs,PRs,ndPRTin te 2013 nbooksollodydislimsthttheoposlouldnotppytoy tusthvingthelusivepuposeofpigddompntionundra nonquliidddmpnstionplnifthestsofsuhtustevlbleto stisylimsoflditosfthent”possibyanetoabbi tust)ortoytustttisantortustsolyy sonofstion677” vidntyaneto lieinsuneusts.
- The passes given to these trusts were no doubt meant to be helpful, and they were helpful, but they only highlighted the tension that remains inherent in the proposal.
- For example, life insurance trusts sometimes can and do acquire assets from the grantor by purchase, including life insurance policies, and those policies are certainly expected to increase in value. The fact that they nevertheless are not covered by the clarified proposal still leaves us wondering what policy lies behind the proposal or what characteristics of estate planning techniques actually offend that policy.
- And the implication that a life insurance trust that purchases a policy from the grantor is covered by the proposal if it has some other grantor trust feature, like a substitution power under section 675(4)(C), even though the economics might be identical, was just as baffling. Probably in response to that, the 2014 Greenbook revises this reference to state: “The proposal … would not apply to any irrevocable trust whose only assets typically consist of one or more life insurance policies on the life of the grantor and/or the grantor’s spouse.”
- This may be the most important feature of the proposal, because, without it, while narrower than last year’s proposal, the proposal is still very broad.
leveraged, no matter what the interest rate is on any promissory note, no matter what the other terms of the note are, and no matter whether the note is still outstanding at the seller’s death. A GRAT, for example, has clear regulatory safe harbors for all those features and “works” for estate tax purposes if it falls within those safe harbors. It would be odd if a simple installment sale to a grantor trust, which is a sale and not a gift, is subjected to harsher gift (and estate) tax treatment than the funding of a GRAT, which actually is a gift.
- But these are complex issues. And for that reason, it may be best, or even crucial, that they be addressed in regulations. So viewed, the changes to this proposal reflected in the 2013 Greenbook, and particularly the implicit promise of workable regulations, should be welcomed.
- Nevertheless, except in the extraordinary event that Treasury and the IRS release an indication of what will be in such regulations before the legislation is enacted, there might still be a gap between enactment and such a release in which a popular and effective estate planning technique will have been chilled.
14.nthe2012nbook,thelmostunliitdoposlsstimtdtoise vnusy$910millionovrtns.nthe2013nbook,theosnsiby noroposlsstimtdtoiseusy$1.087billionvrtn s.n2014,nsstilyundpoposlisstimtdtoisevnuy$1.644 billion ovrtns.
1.lthouhitouldmkenoetosubstntivetxuls,thispopolpge 168inthe2014nook,nwin2012,toxtndthetnrsttexlin undrstion6324)toovrthelstoursndninemonthsofthe potntildlpiodundrstion6166illbevyimpotntsatimttrto somesusss to miybusinsss.
2.spoposd,thishgeouldppybothtothesttsofdntsigonor trtheteofntmntndthesttsofddntshodidboethedte ofntmntifthetnrlinundrstion6324)hdnotpidboe the dteftmnt.Pobbyorttsn,thispoposlisstimtdto inenuey$213million ovrtns.
beneficiaries with interests that are vague enough to avoid being treated as separate shares, the designers of such trusts hope that a non-skip person (the charity) will always have an interest in the trust within the meaning of section 2612(a)(1)(A), and thereby the trust will avoid a GST tax on the taxable termination that would otherwise occur as interests in trusts pass from one generation to another.
- The Greenbook justifies this proposal by stating that “[t]he intent of section 2611(b)(1) is to exempt from GST tax only those payments that are not subject to gift tax, that is, payments made by a living donor directly to the provider of medical care for another person or directly to a school for another person’s tuition.” But section 2611(b)(1) exempts from the definition of a “generation-skipping transfer” “any transfer which, if made inter vivos by an individual, would not be treated as a taxable gift by reason of section 2503(e)….” Certainly that wording was an odd way for Congress to express an intent to limit the exception only to transfers actually made by living individuals (which already are exempt under section 2642(c)(3)(B) anyway).
- Moreover, in contrast with other proposals, the Greenbook proposes that this change would be effective when the bill proposing it is introduced and would apply both to trusts created after that date and to transfers after that date to pre-existing trusts. Such an effective date, used more often in the past, is today rather unusual.
- The extraordinary interpretation of congressional intent and the urgent effective date reveal a really intense reaction to HEETs.
- But, curiously, the proposal would not address the use in any trust of charitable interests to avoid taxable terminations, which arguably could be viewed as abusive and could explain such an intense reaction.
- Meanwhile, a trustee of a trust with broad discretion over distributions could get around this limitation by making a distribution to a non-skip person (and generally there will always be a beneficiary who in effect is a non-skip person under section 2653, leaving aside a charitable or other interest that prevent taxable terminations), who could in turn make the educational or medical payment free of gift tax under section 2503(e) itself. Ironically, the trustee of a more old-fashioned trust with distributions limited, for example, to support, maintenance, and health, might have a harder time doing that.
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Commissioner, 397 F.2d 82 (9th Cir. 1968), and points out that the use of “Crummey powers” has resulted in significant compliance costs, including the costs of giving notices, keeping records, and making retroactive changes to the donor’s gift tax profile if an annual exclusion is disallowed. The Greenbook adds that the cost to the IRS of enforcing the rules is significant too.
2.henbooklsoknoldgsnRSnniththepolitionof Crummey pos,slyinthehndsofpsonsnotlikytovrivea distibutionomthetst,ndlmntstheRSslkofsussinombting suh polition itig Estate of Cristofani v. Commissioner, 97 .C. 74 1991; Kohlsaat v. Commissioner, .C. Mmo 1997212
The proposal would eliminate the present interest requirement for gifts that qualify for the gift tax annual exclusion. Instead, the proposal would define a new category of transfers (without regard to the existence of any withdrawal or put rights), and would impose an annual limit of $50,000 per donor on the donor’s transfers of property within this new category that will qualify for the gift tax annual exclusion. Thus, a donor’s transfers in the new category in a single year in excess of a total amount of $50,000 would be taxable, even if the total gifts to each individual donee did not exceed $14,000. The new category would include transfers in trust (other than to a trust described in section 2642(c)(2)), transfers of interests in passthrough entities, transfers of interests subject to a prohibition on sale, and other transfers of property that, without regard to withdrawal, put, or other such rights in the donee, cannot immediately be liquidated by the donee.
Commissioner, 118 T.C. 279 (2002), aff’d, 335 F.3d 664 (7th Cir. 2003) (interests in an LLC engaged in tree farming); Price v. Commissioner, T.C. Memo 2010-2 (interests in a limited partnership holding marketable stock and commercial real estate); Fisher v. United States, 105 AFTR 2d 2010-1347 (D. Ind. 2010) (interests in an LLC owning undeveloped land on Lake Michigan).
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exempt from GST tax. This latter provision would effectively permit “2503(c) trusts” to any age (not just 21).
- Up to $50,000 annually of “mad money” for anything that’s otherwise impermissible or at least suspect. There wouldn’t even have to be an arguable basis for the annual exclusion under current law. (The Greenbook provides the simple example of “transfers in trust.”)
1.he2014nbooke172)notsthtbusethetxodsdiitionof utoruntypplisonyorpupossofthesttet,nooneiluding theddnssuvivingspousehoildajontinometxtun)sthe uthoiytotonbhfoftheddntithdtoatxlibiliythtose piortotheddntsth.hus,theisnooneithuthoiytondthe sttuteoflimittions,limaund,etoaompomiseorsssmnt,or pusuejudiillifinonntionithteddntsseofatxlibili.” Stion2203povidsamnigfthetmuto’hvritissdin this titlein onntion ith thesttetximposd ythis hpt.
3.hepoposlouldpssymethetxodsdinitionofutor pplibleorlltxpposs,nduthoieshutortodotingon bhlfofthentinonntioniththeddntspthtxlbilitis orobligtionsthtthentouldvedoeifstilllivin.ndditon,the poposlouldntutoy uthoiy todoptulstosolveonlits mongmultipleutos uthoid ythis povsion.”
- Specifically, the Greenbooks pointed out that section 2704(b) provides that certain “applicable restrictions” that would otherwise justify valuation discounts are ignored in intra-family transfers of interests in family- controlled corporations and partnerships, but added that “[j]udicial decisions and the enactment of new statutes in most states have, in effect, made section 2704(b) inapplicable in many situations.”
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- The Greenbooks also stated that “the Internal Revenue Service has identified additional arrangements designed to circumvent the application of section 2704.”
- Section 2704(b) applies to an “applicable restriction,” which section 2704(b)(2) defines as “any restriction (A) which effectively limits the ability of the corporation or partnership to liquidate, and (B) with respect to which either … (i) [t]he restriction lapses, in whole or in part, after the transfer … [or] (ii) [t]he transferor or any member of the transferor’s family, either alone or collectively, has the right after such transfer to remove, in whole or in part, the restriction.” Section 2704(b)(3) provides exceptions for “(A) any commercially reasonable restriction which arises as part of any financing by the corporation or partnership with a person who is not related to the transferor or transferee, or a member of the family of either, or (B) any restriction imposed, or required to be imposed, by any Federal or State law.”
- Under section 2704(b)(4), Treasury has the authority to “provide that other restrictions shall be disregarded in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor’s family if such restriction has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.” Since 2003, a guidance project under section 2704 has been on the Treasury-IRS Priority Guidance Plan. See Part XVIII.A.10 on page 135.
- Disregarded restrictions would “include” restrictions on liquidation of an interest that are measured against standards prescribed in Treasury regulations, not against default state law.
- Although the Greenbooks did not say so, it is possible that the “disregarded restrictions” in view, which “include” certain limitations on liquidation (the current scope of section 2704(b)(2)(A)), may also include other restrictions, such as restrictions on management, distributions, access to information, and transferability. If so, it might call for reconsideration of the famous disclaimer in the 1990 conference report that “[t]hese rules do not affect minority discounts or other discounts available under [former] law.” H.R. REP. NO. 101-964, 101ST CONG., 2D SESS. 1137 (1990). After all, even the
regulation authority under section 2704(b)(4) extends to “other restrictions.”
- On the other hand, the September 8, 2009, Joint Committee staff’s publication stated that “because the proposal targets only marketability discounts, it would not directly address minority discounts that do not accurately reflect the economics of a transfer.” The JCT staff pointed out that other possible approaches include the “look through” rules of the Clinton Administration’s budget proposals (Part II.E.1 on page 4) and the JCT staff’s own 2005 proposals (Part V.B beginning on page 17) and the aggregation
rules of the 2005 proposals and the Reagan Administration’s “Tax Reform for Fairness, Simplicity, and Economic Growth” (“Treasury I”) published by Treasury on November 27, 1984 (Part II.D.1.d on page 3).
- Disregarded restrictions would also include limitations on a transferee’s ability to be admitted as a full partner or other holder of an equity interest, thus apparently denying the opportunity to value a transferred interest as a “mere” “assignee” interest.
- Treasury could by regulations treat certain interests owned by charities or unspecified “others” as if they were owned by the transferor’s family.
- In any event, the Greenbooks were careful to cast their references in terms of “entities,” not just corporations and partnerships.
- Regulations could “create safe harbors to permit taxpayers to draft the governing documents of a family-controlled entity so as to avoid the application of section 2704 if certain standards are met.” While no details were given, it is hard to imagine regulations that prescribe “safe harbor” discounts, and it is particularly odd that a proposal to limit opportunities to “circumvent” section 2704 would contemplate that section 2704 could be avoided simply by the way governing documents are drafted. But perhaps this authority could be used to protect actual family operating businesses or to protect the holder of a restricted noncontrolling interest received from others (including ancestors) if that holder did not create those restrictions and never had a meaningful opportunity to remove those restrictions.
- The Greenbooks promised to “make conforming clarifications with regard to the interaction of this proposal with the transfer tax marital and charitable deductions.” This could override the harsh “reverse-Chenoweth” result seen in Technical Advice Memoranda 9050004 (Aug. 31, 1990) and 9403005 (Oct. 14, 1993) (all stock owned by the decedent valued as a control block in the gross estate, but the marital bequest valued separately for purposes of the marital deduction), relying on Estate of Chenoweth v. Commissioner, 88 T.C. 1577 (1987) (estate of a decedent who owned all the stock of a corporation entitled to prove a control premium for a 51-percent block bequeathed to the surviving spouse for purposes of the marital deduction), and Ahmanson Foundation v. United States, 674 F.2d 761 (9th Cir. 1981). Such a result would reinforce the fairness of the proposal and would be very welcome.
5.hepopolouldvepplidtotnss–itsnddths–trthedteof ntmnt.Consistntithstion2704itsl,thepoposlouldothve pplid to stitions td on rboetobr8, 1990. ndr stion 7805b2,ultionsisudithin18monthsofthedteftmntuldbe totiveto thedteofntmnt.
2009, Joint Committee on Taxation revenue estimates skipped this proposal, because of its lack of specificity – a “failure to score” that diminishes the proposal’s revenue-raising appeal in Congress.)
VII.I.5 on page 33) and Congressman McDermott’s “Sensible Estate Tax Act of 2011” (H.R. 3467) included statutory language for the other Greenbook proposals, they did not implement this proposal (possibly because its revenue effect would be so hard to estimate), but merely reproduced valuation discount provisions from previous bills.
8.he2013nbookmitsthispoposl.utmyhvethohtthtstion 2704b4)lyivssuyttuthoi.Sepphonpe. ndhnthe201204Pioiy uidnePlnsldonust9,2013, itinluddthesmenetoutionsundrstion2704thtpvious Plns hd sine2003 Pt XVIII.A.10 on pe
The Treasury-IRS Priority Guidance Plan for the 12 months beginning July 1, 2013, was released on August 9, 2013, updated on November 20, 2013, through October 31, 2013,
and updated again on January 29, 2014, through December 31, 2013 (available at http://www.irs.gov/pub/irs-utl/2013-2014_pgp_2nd_quarter_update.pdf). It originally contained 324 projects (up only slightly from 317 last year) described as “priorities for allocation of the resources of our offices during the twelve-month period from July 2013 through June 2014 (the plan year). The plan represents projects we intend to work on actively during the plan year and does not place any deadline on completion of projects.” Five projects were added in the first update and 11 projects were added in the second update.
The Plan lists the following 11 projects under the heading of “Gifts and Estates and Trusts”:
- Section 67, added to the Code in 1986, is the source of the limitation of “miscellaneous itemized deductions” to 2 percent of adjusted gross income. In the case of an estate or trust, section 67(e)(1) exempts from the 2 percent floor “costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate.”
- This project, which first appeared in the 2006-07 Plan, addresses the conflict between O’Neill Irrevocable Trust v. Commissioner, 994 F.2d 302 (6th Cir. 1993) (holding that section 67(e)(1) exempts the investment advice expenses of multi-generation trusts), and the opposite holdings in Mellon Bank v. United States, 265 F.3d 1275 (Fed. Cir. 2001), Scott v. United States, 328 F.3d 132 (4th Cir. 2003), and William L. Rudkin Testamentary Trust v.
Commissioner, 467 F.3d 149 (2d Cir. 2006), aff’d sub nom Michael J. Knight, Trustee v. Commissioner, 552 U.S. 181 (2008).
i.nMellon,thedlCiuitoutsttdthtstion671)ttsulyddtibleonythsetustlddministtivepnssthte uniquetothedministtionofatustndnotustomiyiud outsideoftusts.”265.3dt1281.vthss,theoutstdits onlusionmyonheobstionthtinvstmntdviend mnmnt s emmonyiud outsideoftusts.”Id.
ii.nScott,theouthCiuitquotdthenetouniqu”pnssin Mellon,butimmditydddttputsimp,tusttdministtivepnssesubjttothe2pntloorifthy onstitutepnssommonyinudyindiidultps”328 .3dt140.heutorofthisoutlineptiptdinScott ndpsonly itiidthepposofboththepoposdultionsnd theovnmnts litigtion.)
While the Federal and Fourth Circuits’ approach properly focuses the inquiry on the hypothetical situation of costs incurred by individuals as opposed to trusts, that inquiry into whether a given cost is “customarily” or “commonly” incurred by individuals is unnecessary and less consistent with the statutory language. We believe the plain text of §67(e) requires that we determine with certainty that costs could not have been incurred if the property were held by an individual. We therefore hold that the plain meaning of the statute permits a trust to take a full deduction only for those costs that could not have been incurred by an individual property owner.
- Published on July 26, 2007, when that Second Circuit articulation was the most recent judicial word on the subject, the proposed regulations (REG- 128224-06) would have applied the 2 percent floor to all expenses of an estate or trust except expenses that are “unique” to an estate or trust. An expense was considered “unique” only if “an individual could not have incurred that cost in connection with property not held in an estate or trust.”
i.suniqu”iduiytivitis,theostofhihouldbeuly ddutibl,thepoposdultionsitdiduiyountis, quidjudiililins,iduiyinometxtuns,sttetxtuns, distibutionsndommunitionstobnii,illortustontsts oronstutions, nd idiybonds.
ii.smplsofsvisthtenot uniqu”oatustorstt,the ostsofhihwould be subjttothe2pntloo,thepoposd ultionsitdtheutoyndmmntfpop,dvieon invstingortotltun,”pptionofitxtuns,dnsef limsyditosofthentrorddnt,ndtheph,smintnn,i,insn,ormngmntofpopynotusdina tdeorbusinss.
iii.hepopodultinsouldhequidtheunbundling”of unityiduiysrommissions,sosoidntiytheptions ttibutbletotivitisndsvsthtenotuniqu”nde thoesubjttothe2pntloo.ormpl,undrthis poposdppoh,if30pntofatustseisllobleto iduiybondsndountins,iduiyinometxtuns,nd distibutionsndommunitionstobnis,hile70pntf theeisllobletouto,mnnt,ndinvstmntdvi,thn ony 30pntofteeouldhvebnuly dutiblesbovtlin”pns,ndtheothr70pntouldhebn ddutibleonytothetntitdd2pntoftetustquivlntofdjustdgossinom.”nrstion67,the djustd ossinom”ofaustouldhebn lutdtlloblehitbledutions,distibutionddutions,ndthebov- thlineddutionsofyuniqu”pnss.duiyssubjtto the2pntlooroudpilynothvebnddutibl,ndtht ould hvetivyid theost ofthoseiduiysvis.
- The phrase “advice on investing for total return,” as an example of a service that is not unique to an estate or trust, generated a lot of speculation.
i.helititdssheinluddthetps’untthtthe dmndsoftheduyofpudntinvstmntndheduyfimptiliy distinuish invstmnt vieto aiduiyom nvstmnt dvieton individul,spilyintheonttofamultitiontust.hus, thespicetothetotltun”thtisnlntofpudnt invstmntmihthvebndsnpliitpuditionoftumnt.
ii.ntheothrhnd,ituldhvebndsnknolmntthdvieoninvstignotjusttogtirtotltu)buttohlpa iduiyblesussiveintstsotnpssdsintstsin inom”ndinip)lyisdint–mevnuniqu.”f ththdbntheyttinlutionseliid,thnnot to teamodn, ibletusttht minimstheoleofic onptsfiom”ndpinip”mhthvebnplidith hihrinomets.htouldnothvebnheistioyintxl, but it s likyto beoeofthemost idydisussd.
- On January 16, 2008, a unanimous opinion by Chief Justice Roberts affirmed the Second Circuit and held that a trustee’s investment advisory fees are subject to the 2 percent floor.
somewhat ambiguous exception,” “uncertainty,” and “the absence of regulatory guidance” seem to leave the door open for Treasury to provide definitive practical guidance. See Mayo Foundation for Medical Education and Research v. United States, 131 S. Ct. 704 (2011); Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467
U.S. 837, 843 (1984); National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967, 982, 986 (2005).
- As proposed, the original proposed regulations would have applied to “payments made after the date final regulations are published in the Federal Register.” Proposed Reg. §1.67-4(d). The Service received written comments about the proposed regulations and held a public hearing on November 14, 2007.
593, providing, among other things, that comments on the proposed regulations would continue to be welcome through May 27, 2008, but that meanwhile fiduciaries would not be required to “unbundle” a unitary fiduciary fee on 2007 income tax returns.
1372, extending the relief from “unbundling” to 2008 income tax returns.
- On April 1, 2010, the Service released Notice 2010-32, 2010-16 I.R.B. 594, extending the same relief from unbundling to 2009 returns. It is possible that the final regulations on the application of the 2 percent floor to trusts were near completion before the end of 2009 and that the IRS did not expect to extend this relief for another year. If so, this may be another example of how the inability of Congress to act before the end of 2009 to stabilize the estate tax law for 2010 created a distraction.
- On April 13, 2011, the Service released Notice 2011-37, 2011-20 I.R.B. 785, again extending the relief from unbundling. As a departure from the practice of past years, however, Notice 2011-37 does not provide just one more annual extension, that is, for 2010 returns. This time, the extension applies to all “taxable years that begin before the date that the final regulations are published.” In effect, this was at least a two-year extension, because it applied not just to returns for 2010, but also to returns for 2011, which had already begun without final regulations. Put another way, under Notice 2011-37, when final regulations are issued, any “unbundling” requirement will not be applied retroactively to any year that has already begun.
- On September 6, 2011, the Internal Revenue Service withdrew the 2007 proposed regulations and released new proposed regulations.
i.doptingaomultionminisntofthepplteouts’opinionsin Mellon Bank ndScott ndtheSupmeCoutsopinioninKnight,nw PoposdR.§1.674)ouldpovidethtamisllnousitmid ddutionofnstternongntortustissubjttothe2pnt loorifitommonyorustomiyouldbeiudyapothtil
individual holding the same property.” Examples, in Proposed Reg.
§1.67-4(b)(1), are “costs incurred in defense of a claim against the estate, the decedent, or the non-grantor trust that are unrelated to the existence, validity, or administration of the estate or trust.” Other examples, in Proposed Reg. §1.67-4(b)(2), are “ownership costs” that attach to a particular asset, such as “condominium fees, real estate taxes, insurance premiums, maintenance and lawn services, automobile registration and insurance costs, and partnership costs deemed to be passed through to and reportable by a partner.”
ii.ndrPoposdR.1.674b,theostsofppingtxtuns ouldbetidithetoteeoftun.heostsof individulinometxnditxtuns,sllstxtunsra solepopitoshiporatimntpln,elyvidsosts ommonyndustomiyinudyindividulsndthus…subjt tothe2pntloo.”uttheostsoftunshtythirtuee ildonyyutosrtustsenotsubjttothe2pntloo, inludingsttendSTtxtunsndiduiyinometxtuns,of ous, but lso inludigadnts inl inmetxtun.
iii.ndrPoposdR.§1.674b,theostofinvstmntdvieould ontinuetobesubjttothe2pntloo. heisnption,a vitionofthelstpphoftheSupmeCoutsKnight opinio, orspil”invstmntdviettibutbletonunusulinvstmnt objtiveorthendoraspilidbling ftheintstsof viousptisbondtheusulblingofhevigintstsof unt niis ndmindn.”
iv.PoposdR.§1.671)ouldintheuimntorsiletobeunbundld”intoomponntsthtesubjttothe2pntloor ndomponntsthtenot,pttht,undrPoposdR.§1.67- 4,iftheeisnotomputdonnouysis,”onythe invstmntdvieomponntouldhvetobeunbundld,ndouldbe unbundldyysonblemthod.”Pmntsmdeoutofthe bundldetothidpis,orssssdontopofthebundld, orsvissubjttothe2pntloorouldlsohvetobe ountdors.
v.heotieofPopodRulmkinginvitdpublicommntsy mr7,2011,ndommntseivd.PoposdR.§1.67- 4d,sinotie20117,ginpovidsthttheultionsillppy totblesbinningonortrtedtehttheinlultions epublishdintheFlRist.hus,ifinlultionsenot issud boe2014, tyill not ppyuntil the2015 lndr.
- Section 1414 of Chairman Camp’s Discussion Draft, released February 26, 2014, would repeal section 67.
- This project first appeared in the 2008-09 Plan.
- When it published sample charitable lead unitrust forms in Rev. Proc. 2008- 45, 2008-30 I.R.B. 224, and Rev. Proc. 2008-46, 2008-30 I.R.B. 238, the
Service completed a round of sample forms for various split-interest trusts.
- Now the Service apparently intends to go over its work again, to reflect updates in the law, practice, and thinking, at least with respect to charitable remainder trusts. (The 2011-12 Plan added the word “remainder,” which had been implicit by the reference to section 664 anyway.)
2042, 2511, and 2601.
- Privately owned and operated trust companies are becoming an option that families with large trusts are turning to in increasing numbers, and state law authority for such private trust companies is being continually refined.
ii.nte200506,200607,nd200708Pln,itsdsid uidnegdigteonsqnsunriousestate, gift, and generation-skipping transfer tax povisionsofusingamiond ompysthetusteofatust.” heomissonofincome tax issus om thtomultion sa souef onn, buseiomeissushveqntybndssd in the lvnt lttr ulis. nd,intheistsuhlttrulins, ttr Rulins 9841014 nd 9842007uy2,1998,heony issueshtramiondtust ompysaltdorsubodintep”thspttotheliving ntosofvioustuts,ithin the mnig of stion 67, n inometxul
iii.nthe20809nd00910Plns,thediptionsamoe omphnsivendssuigRvneulingdigthe onsqunsundrousinom,stt,it,ndgntionskipping tnsrtxpovisionsofusing amiyndmpysatusteofa tust. Apoposd Rv. Rul. s publishd on ugust 4, 2008.”
guidance would be much easier to finalize than would, for example, amendment of the many regulations that would have to be amended.
- Notice 2008-63, 2008-31 I.R.B. 261, released July 11, 2008, solicited comments on a proposed revenue ruling, affirming favorable tax conclusions with respect to the use of a private trust company.
- The proposed revenue ruling addressed five tax issues faced by trusts of which a private trust company serves as trustee:
While these are not the only issues that the use of private trust companies can present, these are the most common issues. It is especially encouraging to see grantor trust treatment addressed, in view of the omission of income tax from the formulation of this project on the current Plan.
- The proposed revenue ruling posited several trusts, illustrating both the introduction of a private trust company as the trustee of a preexisting trust and the creation of new trusts with a private trust company as the trustee. The trusts had the following features:
- The proposed revenue ruling presented two situations – Situation 1, in which the private trust company is formed under a state statute with certain limitations, and Situation 2, in which the private trust company is formed in a state without such a statute but comparable limitations are included in the governing documents of the private trust company itself.
- The basic premise of the proposed revenue ruling, as stated in the second paragraph of Notice 2008-63, was:
The IRS and the Treasury Department intend that the revenue ruling, once
issued, will confirm certain tax consequences of the use of a private trust company that are not more restrictive than the consequences that could have been achieved by a taxpayer directly, but without permitting a taxpayer to achieve tax consequences through the use of a private trust company that could not have been achieved had the taxpayer acted directly. Comments are specifically requested as to whether or not the draft revenue ruling will achieve that intended result.
- Consistently with this basic premise, the proposed revenue ruling provided that the hypothetical private trust companies it addressed would generally avoid tax problems by the use of certain “firewall” techniques. For example:
i.AistionyistbutionCommit”C)ithlusive uthoiytomkelldisionsdigdistionydistibutions. oemysveontheC,butnombroftheCmy ptiipteinthetivitisoftheCithspttoatustofhih thtCmmbrorhisorhrspouseisanororbnii,orof hihtheniyisapsontohomthtCmmbrrhisr hrspouseos n obligtion ofsuppot.
ii.nSitution2,nmndmntCommit”ithlusiveuthoiyto mndthelntsnsitivelimitionsinhepivteomps ovnigdoumntshiheimposdystuteinSitution1.A mjoiyofthemmsoftemndmntCommittemustbe individulshoenihrmmbsfthevntmiynorsons ltdorsubdinteithinthemningofstion672)toy shholdrftheom.
- A paragraph near the end of the proposed revenue ruling identified three factual details that were not material to the favorable tax conclusions, explicitly confirming that the conclusions would not change if those details changed. No doubt the list of immaterial factual details could be expanded. Some likely examples (not exhaustive):
ii.hessumdquimtofnindndntitionyistibution Committ”orhtustdministdythepivtetustomp, possibyludingadintyoivdboyithasimilrt,a dintommitterdinttusts,ndyptionortustsor ustoms othr thn miymmbs dministd y miod tust ompnis tht oriduiyvis to thepubli.
- This project first appeared in the 2008-09 Plan, where, as in the 2009-10 Plan, it was described as “Guidance under §643 regarding uniform basis rules
- Reg. §§1.1014-4 & -5 provide that the basis of property held in trust or otherwise shared by holders of term and remainder interests is apportioned among the beneficial interests in proportion to the actuarial value of the interests. Section 1001(e) and Reg. §1.1001-1(f) provide that when an interest in property for life or a term of years or an income interest in property in a trust is sold, its basis is generally disregarded, unless the sale is a part of a transaction in which the entire interest in property is transferred.
- Notice 2008-99, 2008-47 I.R.B. 1194, effective October 31, 2008, described a transaction in which the income and remainder beneficiaries of a charitable remainder trust sell their respective interests in a coordinated sale (which arguably could avoid both the disregarded basis rules of section 1001(e) and Reg. §1.1001-1(f) and the rules governing commutation of CRT interests) and stated that “the IRS and Treasury Department are concerned about the manipulation of the uniform basis rules to avoid tax on the sale or other disposition of appreciated assets.” Accordingly, the Notice identified this type of transaction as a reportable “transaction of interest” for purposes of sections 6111 and 6112 and Reg. §1.6011-4(b)(6).
- In Rev. Proc. 2010-3, 2010-1 I.R.B. 110, §4.01(39), the Service identified “[w]hether the termination of a charitable remainder trust before the end of the trust term as defined in the trust’s governing instrument, in a transaction in which the trust beneficiaries receive their actuarial shares of the value of the trust assets, causes the trust to have ceased to qualify as a charitable remainder trust within the meaning of § 664” as an area “in which rulings or determination letters will not ordinarily be issued.” Rev. Proc. 2012-3, 2012- 1 I.R.B. 113, §4.01(39), Rev. Proc. 2013-3, 2013-1 I.R.B. 113, §4.01(40),
and Rev. Proc. 2014-3, 1 I.R.B. 111, §4.01(37) are the same.
- On January 16, 2014, the IRS issued a Notice of Proposed Rulemaking (REG-154890-03), acknowledging three supportive comments in response to Notice 2008-99 and proposing the addition of a new paragraph (c) to Reg.
§1.1014-5 and the addition of new Examples 7 and 8 to redesignated Reg.
§1.1014-5(d). New paragraph (c) would provide that in any joint sale by the holder of the term interest and the charitable remainder beneficiary of their respective interests in a CRT, the taxable beneficiary’s actuarially allocated basis must be reduced by a portion of the trust’s undistributed net ordinary income and undistributed net capital gains for the current and prior taxable years, allocated to the taxable beneficiary on the same actuarial basis.
- Rev. Proc. 2001-38, 2001-24 I.R.B. 1335, announced circumstances in which the IRS “will disregard [a QTIP] election and treat it as null and void” if “the
election was not necessary to reduce the estate tax liability to zero, based on values as finally determined for federal estate tax purposes.” The procedure states that it “does not apply in situations where a partial QTIP election was required with respect to a trust to reduce the estate tax liability and the executor made the election with respect to more trust property than was necessary to reduce the estate tax liability to zero.” The procedure states that it “also does not apply to elections that are stated in terms of a formula designed to reduce the estate tax to zero.”
i.hus,thepdmetohihthepoduepplisisthesehe thetblestteouldhvebnlssthnteppliblelusion mount,sothestteouldnotbesubjttodlsttet, buttheutorlistdsomeorlloftheustppyonShduleMto thesttetxtun nd hus mdeadundnt P tion.
- With portability made permanent in the 2012 Tax Act (see Part XIII.B beginning on page 77), an estate tax return to elect portability might be filed that is not necessary for estate tax purposes because the value of the estate is below the filing requirement. For such a return, the question arises whether a QTIP election made only to support a reverse-QTIP election for GST tax purposes or to gain a second basis step-up at the death of the surviving spouse might be treated as an election that “was not necessary to reduce the estate tax liability to zero” and therefore as “null and void.”
i.hevnepodueosontosttethttostblshthtn ltionisithinthespeofthisvnuepodu,theprmust poduesuiintvidetotht t.ormpl, thetprthe suvivingspousertheuvivingspouss uo]mypodeaoy ofthesttetxtunildythesdspoussstte stblishingthtthetionsnotnssyoduethesttelibiliyto o.”
ii.htsttmnt,tel”oinofRv.Po.200138,theliklihood thtavnepouennounigthevisdministtive obnennotnenltionlyuhoidysttut,nd theunsmlinssofdngthebnitsofaPltiontosmllr sttshilelloigittolgrsttsllsuggstthtaPtion illbestdinsuhas.hisviwisnodythepliit neinR.§20201027ii4)toPltionsin tunsildtoltpobiliybutnotothisequidorsttex pupossepphonpge.Cliigthtsult is vidntyht this nwitm on thePioiyuidnePln is bout.
iii.tmyethtthispohouldpp,int,tomkethe onsqunsofaPltionltiveonthebsisofhtouldbe vylog hindsiht.ithspttothesondbsisstpup,tht tulysmstohenapotntilsultrsineRv.Rul.2001- 38 s publishd; it is not lyhgd ypotbili.
- This first appeared in the 2007-08 Plan.
- Proposed Reg. §20.2032-1(f) (REG-112196-07) was published on April 25, 2008. The preamble appears to view these regulations as the resolution of “[t]wo judicial decisions [that] have interpreted the language of section 2032 and its legislative history differently in determining whether post-death events other than market conditions may be taken into account under the alternate valuation method.”
- In the first of these cases, Flanders v. United States, 347 F. Supp. 95 (N.D. Calif. 1972), after a decedent’s death in 1968, but before the alternate valuation date, the trustee of the decedent’s (formerly) revocable trust, which held a one-half interest in a California ranch, entered into a land conservation agreement pursuant to California law.
ii.Citingthepssionalisltivehistoytothetthtltne vlutionsintndopottnts’sttsinstmyofthe hdshipshihepindtr1929hnmktvludsdvymtillybtnthepiodmthedteofdthnd thedteofdistibutiontothebiiis,”teouthldthtthe vlueduigsultofthepostmotmtofthesuvivingtust” mynot beonsidd in ppigltnteluion.
- The second of these cases was Kohler v. Commissioner, T.C. Memo 2006- 152, nonacq., 2008-9 I.R.B. 481, involving the estate of a shareholder of the well-known family-owned plumbing fixture manufacturer. The executor had received stock in a tax-free corporate reorganization that had been under consideration for about two years before the decedent’s death but was not completed until about two months after the decedent’s death.
§20.2032-1(c)(1) prevents that result by specifically refusing to treat stock surrendered in a tax-free reorganization as “otherwise disposed of” for purposes of section 2032(a)(1).
ii.heoutlsonotdthtthehneofstokmusthvebnorqul vlueortheonitionouldnothvebntestheptihdstipultdltho,ionil,teutsonpisrd dtmindavlueoftheponitionshsof$50.115million ndavlueofthepostognitionshsf$47.010million–a dieofbout6.2pnt.heoutdistinuishd Flanders, hetheposdth tstion itslfdud thevluey88 pnt.
iii.hexCoutinKohler vidthe1935lisltivehistoylidonin Flanders silnt,buseR.§20.2031)omulgtdin 1958)slrndunmbiuousndbusethelisltivehistoy dsibstelpposeofthesttut,nothespicmnigof othisedisposd o’n theontt ofteonitions.”
- The 2008 proposed regulations made no change to Reg. §20.2032-1(c)(1), on which the Kohler court relied. But they invoked “the general purpose of the statute” that was articulated in 1935, relied on in Flanders, and bypassed in Kohler to beef up Reg. §20.2032-1(f), to clarify and emphasize, with both text and examples, that the benefits of alternate valuation are limited to changes in value due to “market conditions.” The 2008 proposed regulations would specifically add “post-death events other than market conditions” to changes in value resulting from the “mere lapse of time,” which are ignored in applying alternate valuation under section 2032(a)(3).
- New proposed regulations (REG-112196-07) were published on November 18, 2011. In contrast to the 2008 approach of ignoring certain intervening events – and thereby potentially valuing assets six months after death on a hypothetical basis – the new approach is to expand the description of intervening events that are regarding as dispositions, triggering alternate valuation as of that date. The expanded list, in Proposed Reg. §20.2032- 1(c)(1)(i), includes distributions, exchanges (whether taxable or not), and contributions to capital or other changes to the capital structure or ownership of an entity, including “[t]he dilution of the decedent’s ownership interest in the entity due to the issuance of additional ownership interests in the entity.” Proposed Reg. §20.2032-1(c)(1)(i)(I)(1). But under Proposed Reg. §20.2032- 1(c)(1)(ii), an exchange of interests in a corporation, partnership, or other entity is not counted if the fair market values of the interests before and after the exchange differ by no more than 5 percent (in contrast to the 6.2 percent difference in Kohler).
- While the 2008 proposed regulations were referred to as the “anti-Kohler regulations,” the most significant impact of these proposed regulations may be felt by efforts to bootstrap an estate into a valuation discount by distributing or otherwise disposing of a minority or other noncontrolling interest within the six-month period after death (valuing it as a minority interest under section 2032(a)(1)) and leaving another minority or noncontrolling interest to be valued six months after death (also valued as a minority interest under section 2032(a)(2)).
i.mpls7nd8ofPoposdR.§20.03215)spiily ddssthedisountbotstpthnique–mple8intheonttofa limitdlibiliyompyndmple7inteonttoflstte– ndlvenodoubtththsinvleduetomktonditions”do notinludethevlutindisountsthtmihtpprtobedy ptil distibutions.
- The 2008 proposed regulations were to be effective April 25, 2008, the date the proposed regulations were published. The new proposed regulations, more traditionally, state that they will be effective when published as final regulations.
- This project first appeared in the 2008-09 Plan. It is an outgrowth of the project that led to the final 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.
i.fthispojtsultsinaddutionofonytepsntvlueofthe pnt,softheduedteofthet,and thedsountteusdinthe lultionofthepstvlueisthesmesteteofintstonthe txund,and theintstisnotsubjttoinometxorthedisount teislso dd ytheinometxt,thn theinvotion of psntlueonpts”mihtmkeylittledneonp.ut it miht quielisltin to omplish ll thsethins.
- It apparently is derived from a request for guidance from the AICPA, first made in a letter to the IRS dated June 26, 2007, which stated:
The issues presented here are best illustrated by considering the following fact pattern:
Taxpayer creates an irrevocable trust, Trust Z, in which a qualified annuity interest (as defined in section 2702(b)) is payable to the taxpayer or his estate for 10 years. Upon the termination of the annuity interest, Trust Z is to be separated into two trusts, Trust A and Trust B. Trust A is for the exclusive benefit of Taxpayer’s children and grandchildren. Trust B is for the exclusive benefit of Taxpayer’s children. Trust A is to receive from Trust Z so much of the Trust Z’s assets as is equal to Taxpayer’s remaining GST exemption, if any. Trust B is to receive from Trust Z the balance of Trust Z’s assets, if any, after funding Trust A. The taxpayer is alive at the end of the 10 years.
Presumably, the transfer to Trust Z is an indirect skip to which GST exemption will be automatically allocated at the end of the ETIP. Will the automatic allocation rules apply to all the assets remaining in Trust Z at that time? If so and if the taxpayer wants to allocate GST exemption only to the assets going to Trust A, the taxpayer should timely elect out of the automatic allocation rules of section 2632(c), and then affirmatively allocate GST exemption only to the assets going into Trust A at the end of the ETIP. Is that possible?
In the alternative, the automatic allocation rules may apply only to the transfer going into Trust A because Trust B is not by definition a GST trust. Because of the application of the ETIP rules, the transfer from the taxpayer for GST purposes would occur only at the time that the assets are funded into Trust A. If that is the case, then the taxpayer does not need to do anything affirmatively to ensure that GST exemption is allocated to Trust A and not Trust B as he or she desires.
It has been our experience that many trusts are structured in a manner similar to the above referenced fact pattern. By letter dated November 10, 2004, the AICPA submitted comments on the proposed regulations on electing out of deemed allocations of GST exemption under section 2632(c). In that letter, guidance was requested on these issues. The preamble to the final regulations (T.D. 9208) acknowledged this request for the inclusion in the regulations of an example addressing the application of the automatic allocation rules for indirect skips in a situation in which a trust subject to an ETIP terminates upon the expiration of the ETIP, at which time the trust assets are distributed to other trusts that may be GST trusts. According to the preamble, the Treasury Department and the Internal Revenue Service believed that this issue was outside the scope of the regulation project and would consider whether to address these issues in separate guidance.
- The background of this project is section 564(a) of the 2001 Tax Act, which added subsection (g)(1) to section 2642, directing 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).
§301.9100-3 (so-called “9100 relief”) were not available, because the deadlines for taking such actions were prescribed by the Code, not by the regulations. The legislative history of the 2001 Tax Act stated that “[n]o inference is intended with respect to the availability of relief from late elections prior to the effective date of [section 2642(g)(1)],” and section 2642(g)(1)(A) itself directs that the regulations published thereunder “shall include procedures for requesting comparable relief with respect to transfers made before the date of the enactment of [section 2642(g)(1)].” 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.
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 Service has received and granted several requests for such relief over the years since the publication of Notice 2001-50.
- In addition, Rev. Proc. 2004-46, 2004-2 C.B. 142, provides a simplified method of dealing with pre-2001 gifts that meet the requirements of the annual gift tax exclusion under section 2503(b) but not the special “tax- vesting” requirements applicable for GST tax purposes to gifts in trust under section 2642(c)(2).
Form 709 had previously been filed for that year.
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 the simplified procedure for dealing with pre-2001 annual exclusion gifts under Rev. Proc. 2004-46 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, (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 reflects hindsight, (ii) the timing of the request for relief, and (iii) 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 a current year. 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, a professional 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. Out of concern about returning to the supercharged “fall on your sword” days before the reformation of the 9100 rules reflected in Rev. Proc. 92-85, 1992-2 C.B. 490, the author of this outline recommended the relaxation of that requirement in a comment letter dated July 3, 2008.
- Section 2642(g)(1), having been enacted by the 2001 Tax Act, was once scheduled to “sunset” on January 1, 2011, then on January 1, 2013, and is now permanent.
- It is apparently intended to address section 2704(b)(4), which states, in the context of corporate or partnership restrictions that are disregarded:
The Secretary may by regulations provide that other restrictions shall be disregarded in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor’s family if such restriction has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.
- From May 2009 until April 2013, the status of this regulation project had to be evaluated in light of the Administration’s related revenue proposal described in Part XVII.J beginning on page 116. The 2013 and 2014 Greenbooks omits that proposal.
- The Heroes Earnings Assistance and Relief Tax Act of 2008 (the “HEART” Act) enacted a new income tax “mark to market” rule when someone expatriates on or after June 17, 2008, and a new succession tax on the receipt of certain gifts or bequests from someone who expatriated on or after June 17, 2008. The new succession tax is provided for in section 2801, comprising all of new chapter 15.
- Referring to the guidance contemplated by this project, Announcement 2009- 57 (released July 16, 2009), states:
The Internal Revenue Service intends to issue guidance under section 2801, as well as a new Form 708 on which to report the receipt of gifts and bequests subject to section 2801. The due date for reporting, and for paying any tax imposed on, the receipt of such gifts or bequests has not yet been determined. The due date will be contained in the guidance, and the guidance will provide a reasonable period of time between the date of issuance of the guidance and the date prescribed for the filing of the return and the payment of the tax.
- This project first appeared on the 2009-2010 Plan. It has consistently been referred to by Treasury and IRS personnel as a top priority, but the implementation of what amounts to a transfer tax on transferees, not transferors or their estates, is quite complicated and challenging.
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sections 5.01(16), (23), and (24) of Rev. Proc. 2013-3, 2013-1 I.R.B. 113, and Rev. Proc. 2014-3, 2014-1 I.R.B. 111, have continued this designation.
- Notice 2011-101 asked for comments from the public by April 25, 2012, on the tax consequences of decanting transactions – the transfer by a trustee of trust principal from an irrevocable “Distributing Trust” to another “Receiving Trust.” Notice 2011-101 asked for comments on the relevance and effect of the following 13 facts and circumstances (as well as the identification of any other factors that might affect the tax consequences):
of the Distributing Trust and/or applicable local law;
- Notice 2011-101 also “encourage[d] the public to suggest a definition for the type of transfer (‘decanting’) this guidance is intended to address” and encouraged responses to consider the contexts of domestic trusts, the domestication of foreign trusts, and transfers to foreign trusts.
- Meanwhile, the IRS said, it “generally will continue to issue PLRs with respect to such transfers that do not result in a change to any beneficial interests and do not result in a change in the applicable rule against perpetuities period.”