On July 31, 2015, the President signed a new tax law that imposes a new basis reporting obligation on executors. Compliance with the new basis reporting law has been postponed to March 31, 2016, and the IRS recently issued proposed regulations (REG-127923-15) related to the new requirements. In general, the new law requires the executor of a taxable estate to provide a “Statement” to the IRS and each beneficiary notifying them of their income tax basis in property they receive from the estate, within 30 days of filing a Federal Estate Tax Return (Form 706). Assets passing to a trust or entity are reported on a Statement delivered to the trustee or business entity itself, rather than the beneficial owners.
The beneficiary’s initial tax basis in the inherited property is equal to the value of property the beneficiary received, as finally determined for estate tax purposes, which is defined to be the (i) expiration of the statute of limitations, (ii) an uncontested adjustment by the IRS or (iii) determination by a court or settlement with the IRS. The beneficiary is required to use this basis (subject to appropriate post-death adjustments, such as depreciation/amortization) for reporting gain/loss upon disposition of the inherited assets. In the event there are adjustments to the reported value on the 706, then the executor has an obligation to update the Statement with both the IRS and the beneficiary. If a beneficiary disposes of an inherited asset before the estate tax values become final, then the beneficiary is to use the value reported on the 706. The beneficiary may not claim a basis in excess of the value reported on the Statement before the final value has been determined. If the reported values are later adjusted and the income tax statute of limitations period is still open as to the beneficiary’s disposition, then the beneficiary may have an obligation to supplement their prior income tax reporting. An accuracy-related penalty is imposed if a taxpayer reports an inconsistent estate basis.
The basis reporting requirement applies to all assets which increase the estate’s Federal estate tax liability with a few exceptions: cash, income in respect of a decedent, tangible personal property for which an appraisal is not required, and property that is sold or otherwise disposed of by the estate directly. The reporting requirements do not apply to property qualifying for the estate tax charitable or marital deduction. A Statement is not required if a Form 706 is not required (even if a Form 706 is actually filed for other reasons, such as making the portability election or allocating GST exemption).
If an asset that would have increased an estate’s tax liability is omitted from the Form 706 or is discovered after filing the 706, then the basis is deemed to be zero, unless a supplemental Form 706 is filed before the statute of limitations expires. Likewise, if a Form 706 was required but not actually filed, then the basis in the property is treated as being zero until a Form 706 is filed and the final value is determined.If an executor is unsure what property will pass to a beneficiary (e.g., residuary beneficiaries), then the executor is required to report on the Statement all of the property that could be used to satisfy that beneficiary’s inheritance. If the executor is unable to locate a beneficiary, then the executor is required to report that on the information return filed with the IRS and describe the efforts made to locate the beneficiary. If the beneficiary is subsequently located, then the executor must file the Statement within 30 days of locating the beneficiary and supplement its filing with the IRS.
A beneficiary who later gifts inherited property to a family member will be required to file a notice with the IRS disclosing the transfer and notifying the donee of the income tax basis in the property.
This new law is a completely new tax reporting paradigm, and undoubtedly there will be additional commentary and clarification on more detailed issues that will arise. Since many of us advise clients on fiduciary matters and tax consequences of transactions, we must be aware of the new reporting requirements to confirm compliance, whether by an executor or by individuals receiving an inheritance.