In guidance issued late on Friday, August 5, 2011, the Internal Revenue Service (IRS) addresses the right of executors of decedents who died in 2010 to elect out of the estate tax that had been retroactively reinstated for 2010. The guidance announces that the necessary returns will be due November 15 and provides reassurance to executors regarding some investment and administration decisions they must make before then. But the completion of the long-awaited guidance will await publication of the return itself and the accompanying instructions, which is expected soon.

Background

The Economic Growth and Tax Relief Reconciliation Act of 2001 made the federal estate tax inapplicable to decedents dying in 2010 and provided in its place a carryover basis regime under which estates, their beneficiaries, and other distributees would take the decedent’s basis in property, with adjustments. In December 2010, after President Obama had announced “the framework of a deal” on national television, Congress enacted the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“the 2010 Tax Act”). The 2010 Tax Act reinstated the estate tax retroactively for all of 2010, with a $5 million exemption and a 35% rate, but it permitted the executors of 2010 estates to elect out of the estate tax and subject the estate to the modified carryover basis regime that had appeared to be the law all along in 2010. The impact of the 2010 Tax Act on estate planning and administration, including the ability for 2010 executors to elect out of the estate tax and the possible ramifications of the modified carryover basis regime, was discussed in the McGuireWoods Private Wealth Services White Paper, “The 2010 Tax Act’s Impact on Estate Planning and Administration: Making Sense Out of the Confusion.” Many questions about the election and about the implementation of the carryover basis regime itself have beset executors waiting for necessary guidance from the IRS and the Treasury Department.

Notice 2011-66 and Revenue Procedure 2011-41 both issued Friday, August 5, provide some of the necessary guidance. Most importantly, among other things (including some guidance about the 2010 GST tax), Notice 2011-66 announces November 15 as the due date of the return, Form 8939, which executors will use to signify that election (called the “Section 1022 Election”) and to provide the necessary carryover basis information and allocations. Revenue Procedure 2011-41, among other things, elaborates the rules governing the executor’s allocation of the basis increases allowed by the carryover basis law.

The Inflexible November 15 Due Date

Under Notice 2011-66, the Section 1022 Election must be made by filing Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent, on or before November 15, 2011. The same form will be used for reporting and valuing property as required by the carryover basis law and for allocating basis increases.

In general, the IRS will not grant extensions of time to file Form 8939 and will not accept a Form 8939 filed late, and, once made, the Section 1022 Election and basis increase allocations will be irrevocable. As explicit exceptions, the IRS will allow additional Forms 8939 to make additional allocations of Spousal Property Basis Increase as additional property is distributed to the surviving spouse, and will allow other changes to a timely filed Form 8939, except making or revoking a Section 1022 Election, on or before May 15, 2012 (six months after November 15). The IRS also retains the discretion, under “9100 relief” procedures, to allow an executor to amend or supplement a Form 8939 or to file a Form 8939 late, but those procedures are cumbersome and expensive, and we expect the IRS standards for that relief to be quite restrictive. As a result, we recommend that executors of 2010 estates employ all appropriate ticklers, reminders, and advance preparation to meet the November 15 due date.

Competing or Inconsistent Forms 8939

Ordinarily Form 8939 will be filed by the personal representative appointed by the appropriate probate court for the estate of the decedent who died in 2010. Sometimes, however, there is no such personal representative, such as when all of the decedent’s property is held in trust. In that case, a Form 8939, or multiple Forms 8939 as the case may be, will be filed by the trustees or others in possession of that property (often called “statutory executors” after the definition in section 2203 of the Internal Revenue Code). If those statutory executors do not agree regarding the election, or attempt in the aggregate to allocate more basis increase than the law allows, the IRS will give those statutory executors 90 days to resolve their differences. If the executors fail to resolve their differences within 90 days, the IRS, considering all relevant facts and circumstances disclosed to it, will determine whether the election has been made and how the allocations should be made. Obviously, such a procedure would be disorderly and unpredictable, and we recommend that fiduciaries avoid it if at all possible by coordinating their Forms 8939 in advance.

Clarifications of Basis Increases Related to the Timing of Sales and Distributions

The carryover basis law enacted in 2001 allows the executor to allocate up to $3 million to increase the basis of property passing to the surviving spouse (the “Spousal Property Basis Increase”) and up to $1.3 million to increase the basis of any property acquired from the decedent regardless of who receives it (the “Aggregate Basis Increase”). The Aggregate Basis Increase is increased by a “Carryovers/Unrealized Losses Increase,” and the resulting sum, which can be allocated to any property acquired from the decedent, is called the “General Basis Increase.” Section 4.02(2)(b) and Example 3 of Revenue Procedure 2011-41 relieve a long-standing concern about the Carryovers/Unrealized Losses Increase by clarifying that it includes all unrealized losses in capital assets at the moment of the decedent’s death, without regard to the limitations on immediate deductibility that would apply for income tax purposes in the event of a sale. Thus, the amount of those unrealized losses, in effect, becomes available to increase the basis of appreciated assets (but not above their fair market value).

A frequent question since carryover basis was enacted in 2001, and especially since it became effective at the beginning of 2010, is whether an executor may allocate the basis increases to property that has already been distributed or sold. Revenue Procedure 2011-41 says yes. Example 4 even acknowledges that the basis of property that has declined in value since the decedent’s death and is then sold may be increased by allocation of the basis increases up to date-of-death value, thus generating a loss.

With regard to the Spousal Property Basis Increase, section 4.02(3) of Revenue Procedure 2011-41 actually contemplates allocations to property that has already been distributed to the surviving spouse as those distributions are made. As noted above, additional Forms 8939 after the due date are explicitly allowed for that purpose. Section 4.02(3) also allows allocation of the Spousal Property Basis Increase to property that the executor has sold, but only to the extent that the applicable Form 8939 includes documentation that the sale proceeds are appropriately earmarked for the surviving spouse.

Addressing another common concern about carryover basis, section 4.06 of Revenue Procedure 2011-41 confirms that the recipient’s holding period of property acquired from a decedent and subject to the carryover basis rules includes the decedent’s holding period, whether or not the executor allocates any basis increase to the property.

These affirmations of the executor’s discretion to sell or distribute assets and to fund bequests, including bequests to the surviving spouse, in kind or in cash, without undue concern about the timing of the filing of Form 8939 or the length of time a capital asset has been held since the decedent’s death, are welcome clarifications. They would have been even more welcome if they had been issued sooner, but at least they help to liberate an executor’s investment and administration decisions going forward.

Form 8939 and Instructions Still in Process

The publication of these two documents at this time, the confidence with which the November 15 due date is announced, and other indications that these documents are part of a more comprehensive guidance package all suggest that release of the long-awaited Form 8939, its instructions, and the related Publication 4895 cannot be too far behind. The IRS news release announcing the documents stated, perhaps conservatively, that “the IRS expects to issue Form 8939 and the related instructions early this fall.” Once they are issued, the work on perfecting the election out of the estate tax, in those relatively few, typically large, estates for which the election is appropriate, can begin in earnest.