Notre Dame 41St Annual Tax and Estate Planning Institute

Notre Dame 41st Annual Tax and Estate Planning Institute

September 17 and 18, 2015

Part 2 of 2

By Martin M. Shenkman, Esq.

Current Developments.
Overview.
A review of significant cases, administrative rulings (both public and private) from the IRS and the states, final and proposed regulations and recent legislation by Congress and the state legislatures. The impact of these recent developments for the future.
IRS Priority Guidance Plan.
Same-Sex marriage guidance (Obergefell v. Hodges).
IRC Sec. 1411 material participation by trusts and estates.
IRC Sec. 1411 NIIT issues.
Guidance on the tax implications of grantor trusts under 1014 at death.
Valuation of promissory notes.
IRC Sec. 2704 restrictions on liquidation of an interests in corporations and partnerships.
IRC Sec. 2801 guidance on gifts or bequests from certain expatriates.
Final Portability Regulations.
Final regulations were issued June 12, 2015. TD 9725.
Treasury has discretion to file a late portability election for smaller estates under the basic exclusion amount, but not for larger estates.
The DUSE for a non-citizen surviving spouse who is a beneficiary of a QDOT is not adjusted after the spouse become a citizen.
Most of the provisions of the temporary regulations were retained.
The mere filing of a return suffices to constitute the portability election.
The executor can revoke the portability election until the filing due date.
The election relates back to the decedent’s date of death.
Filing a complete and proper return is required but special valuation rules are provided for marital and charitable deductions if non return is otherwise required. These rules permit estimates within certain parameters. Reg. Sec. 20.2010-2(a)(7)(ii)(A). This leniency is not permitted if:
If the marital or charitable bequests are based on a formula that divides those bequests with non-charitable/marital.
If less than then the value of the interest included in the gross estate is marital or charitable.
If only a portion of the property qualifies for the marital deduction because of a partial disclaimer or partial QTIP election.
Use the DSUE before the surviving spouse’s basic exclusion amount (“BEA”).
Divorcing a later spouse before he or she dies will preserve the DUSE from the last predeceased spouse.
With a non-citizen surviving spouse a QDOT presents complications. The property in the QDOT is taxed as if it was the deceased spouse’s with the tax due deferred until the death of the surviving spouse. Thus, the DSUE cannot be known until the death of the surviving spouse. Reg. Sec. 20.2010-2(c)(4)(i).
Estate of Elkins v. Comr., 140 TC 82(2013), aff’d in part and rev’d in part, 767 F.2d 443 (5th Cir. 2014).
The taxpayer’s discount on fractional interests in art were accepted because the IRS filed to produce any evidence to rebut the taxpayer’s expert’s determination of discount.
There is no market for fractional interest in art, yet willing buyers/sellers might find a means.
IRC Sec. 7491 if the taxpayer presents sufficient evidence to establish material facts the IRS has the burden to refute those facts. In Elkins it failed to do so.
The Elkins’ court found that the restrictions in a co-tenants’ agreement and lease of art were subject to IRC Sec. 2703.
The court did not discern different discounts for fractional interests of 50% or 73%.
The decedent leased the art pursuant to a rental agreement so that he could have exclusive possession during his lifetime. The rental value was not determined and no rent was paid. The IRS did not raise this issue so this might be an issue in later cases.
Estate of Pulling v. Comr. TC Memo 2015-134.
The IRS argued that landlocked parcels should be aggregated with other adjacent parcels for purposes of determining their highest and best use value.
Some of the parcels with which the IRS argued aggregation were owned by a partnership established long before decedent’s death and in which the decedent owned only a 28% interest.
Family attribution rules did not apply and the Court held that attribution rules should not be extended beyond what Congress provided.
Same-Sex Couples.
Windsor v. US, 133 S. Ct 2675 (2013). DOMA’s definition of marriage as between persons of the opposite sex is unconstitutional.
Obergefell v. Hodges, 135 S. Ct. 2584. State laws that discriminate against same-sex couples are unconstitutional.
Rev. Rule. 2013-17, 2013-38 IRB 11. Federal tax consequences for same-sex couples. Followed state of celebration rule. In light of Obergefell this may no longer matter.
Notice 2014-19, 2014-17 IRB 979. Qualified plans must recognize same-sex marriages.
Estate of Olsen v. Comr., 107 TCM (CCH) 1301 (2014).
The surviving spouse as trustee did not fund and administer the marital and credit shelter trusts under the deceased spouse’s will. Distributions were made during the surviving spouse’s life but it was not clear which trust they came from.
The court had to determine how much remained in the marital trust that was subject to estate tax on the surviving spouse’s death and what remained in the credit shelter trust that would not be subject to tax.
The non-marital credit shelter trust did not give the surviving spouse the right to appoint principal to himself.
The court treated 73% of the distributions to be from the non-marital or credit shelter trust. The court considered that one of three major distributions was deposited in the surviving spouses’ personal bank account which violated the terms of the non-marital trust.
Comment: With the large inflation adjusted exemption many clients will choose not to seek counsel and not to fund credit shelter trusts mandated under old wills. This case might provide some useful guidance as to how to reconstruct the appropriate treatment of an unfunded trust when called upon to do so by the IRS, remainder beneficiaries or others.
Steinberg v. Commissioner, 141 TC 258 (2013).
Consider the gift tax valuation/discount of a net-net gift.
Taxpayer made gifts of cash and securities subject to a net gift agreement. The donees agreed to pay the gift tax incurred on the transfer. The gift and income tax consequences of a net gift are as follows:
For gift tax purposes the donee’s assumption of the gift tax liability reduces the value of the gift.
The donee’s assumption of gift tax liability constituted consideration for the transfer. Consideration results in part-sale/part-gift treatment for income tax purposes.
The net-net component of the transaction was as follows. If a donor dies within three years of making a gift then, the gift tax paid would be included in the donor’s estate. IRC Sec. 2035(b). In Steinberg the gift tax was $32M. This result would be required even if the done agrees to pay the gift tax as if in a net gift situation. In Steinberg the donees agreed to pay any estate tax resulting from the inclusion of the gift tax in the donor’s estate if the donor died within3 years of the gift. Although the net-net component of the agreement was agreed to it does not appear that the donor died within 3 years of death so that this obligation did not have to be met by the donees.
While the Tax Court case considered whether the value of a $109 million gift was reduced by the donees' agreement to reimburse the estate of the donor for any estate tax resulting from the inclusion of the gift tax paid in the donor's gross estate if the donor dies within three years after the gift, i.e., the net-net component, it did not reach a conclusion as to this matter and merely dismissed the motion for summary judgment by the IRS.
It is not clear that the net-net component will have value as it will not necessarily augment the decedent’s estate. If it is deemed to have value that value may depend on the donor’s life expectancy at the time of the gift.
SCIN.
ILM 201330033 addressed a note sale to a grantor trust for an interest only balloon payment self-cancelling installment note. No payments were made as the donor/seller died within six months of the transaction.
The IRS position was the transfer was a taxable gift and the note lacked the indicia of genuine debt.
The ILM also put for the IRS position that the 7520 tables do not apply to the valuation of a note but only to an annuity.
Notice 2008-99.
Uniform basis allocation.
In a IRC Sec. 644 split-interest trust if the charitable remainderman and the taxpayer/lead interest both terminate a CRT by selling their interests at one time, how should basis be allocated to determine gain?
If sold at one time the rules of IRC Sec. 1001(e)(3) apply and basis should be determined under the IRC Sec. 7520 valuation rules.
This could allocate basis to the taxable donor/lead interest holder that result from the CRTs sale of taxable property the gain of which was never allocated to that taxable donor/lead interest holder.
Prop. Reg. Sec. 1.1014-5(c) and (d) the donor/lead interest holder’s share of trust basis is reduced to prevent this.
Rev Proc 2015-37, 2015-26, IRB 1196.
IRS will not issue a ruling addressing whether assets in a grantor trust will receive a basis increase if no estate tax inclusion.
Commentators believe that this may be a response to interpretations of PLR 201245006 that property not included in a decedent’s estate could still qualify for a basis step up. That PLR dealt with an non-resident alien .
IRC Sec. 1014(f).
Enacted as part of the Surface Transportation and Veterans Health Care Choice Improvement Act (HR 3236) July 31, 2015.
Property included in estate for estate tax purposes gets new basis that cannot exceed value reported for federal estate tax purposes.
In various cases taxpayers claimed large fractional interest discount for estate tax valuation purposes but then beneficiaries did not claim same discount for discount and rather used an undiscounted value for income tax purposes.
New 1014(f) says if included in estate value on return must be basis for recipient.
Reporting obligation became effective August 1, 2015 no matter when the decedent died. Even if decedent died before Act must address.
This creates burden of reporting to beneficiaries.
Notice 2015-57 delayed reporting obligations.
What happens with value of assets that are uncertain? If IRS audits and you give in on one issue and horse trade on another. This will have an impact on the beneficiary’s basis. Before this the beneficiary may have taken position that what was on the return was correct.
Comment: Prior to the Act there was no requirement of reporting estate values to a beneficiary. The estates determination of income tax basis for estate tax purposes was, prior to the Act, not binding for income tax purposes on the beneficiaries receiving those assets. Example: Mom bequeaths a rental property to son and son later sells it. Mom’s executor valued the house at the date of Mom’s death at $2 million. Son, a month later, sells the rental property for $2.5 million and reports the income tax basis at $1.5 million paying no capital gains tax. That may have been permissible under prior law, it is no longer acceptable. This complex sounding change has important practical ramifications for anyone serving as an executor or personal representative of an estate or a trustee of a revocable trust subject to these new rules. It will also change the income tax reporting for anyone inheriting assets. These rules appear to be confined to only wealthy taxpayers subject to the estate tax, since they only seem to apply to estates subject to an estate tax. Executors should exercise caution because the estate tax return may require including new information reporting forms to comply with the newly enacted basis consistency requirements. Income tax return filed by anyone who inherited property from a decedent or a revocable trust formed by a decedent, may include new reporting requirements mandating more disclosures concerning gain or loss on the sale or exchange of property acquired from a decedent. These rules will be designed to confirm the compliance with the new rules regarding income tax basis. Where will beneficiaries obtain that information? From the executors. So transmitting appropriate information to beneficiaries will be yet another issue executors will have to address. How can and should this new administrative burden be handled?The executor or personal representative must provide information to each beneficiary as to the basis of assets distributed. New IRC Sec. 6035, “Basis Information To Persons Acquiring Property From Decedent.” How should this be done? Few executors had in the past sent an estate tax return, Form 706, to any beneficiary. While some executors might be tempted to send a copy of the entire return to each beneficiary to meet whatever disclosure obligation is imposed by the IRS, that quantum of disclosure may prove a significant mistake. That much information in the hands of each beneficiary might result in the executor being inundated with questions about valuation, dispositions and anything on the return. It might prove more prudent to have a schedule prepared for each beneficiary providing details as to the assets bequeathed to that particular beneficiary. This, however, will create more administrative costs and professional fees which executors might object to when they do not perceive a tax savings from the incremental efforts.
Estate of Schaefer v. Comr., 145 TC No. 5 (2015).
The Schafer case involved two Net Income Make-up Charitable Remainder Uni-Trusts (“NIMCRUTS”).
The payout CRT must satisfy certain statutory requirements.
The charity’s remainder interest must be10% or more of the initial value of the assets gifted to the CRT. The lower the market interest rates (hence the lower the 7520 rate, and the longer the term of the CRT (or the longer the life expectancy if a payment for life) the greater the risk that this required remainder interest won’t be met because corpus will have to be cannibalized to make the periodic payments to the donor.
The annual payout must be a minimum 5% of the initial value of the property gifted to the CRT (this is an annuity trust or CRAT) or 5% of the annual fair value of the trust assets determined each year (this is a unitrust payment or CRUT).
The payout cannot exceed 50% of the values.
How should the 10% minimum payment to charity be calculated to determine if the CRT is valid? The IRS applied the principals of Rev. Rule. 72-395, 1972-2 CB 340 and Rev. Proc. 2005-54, 2005-1 CB 353. The court concurred. The taxpayer’s position that the existence of the income limitation in the NIMCRUT structure should be factored into the analysis as it would result in more corpus compounding for the charity, even if correct economically, is not to be considered.
US v. Marshall, 771 F.3d 854 (5th Cir. 2014).
Donee of lifetime gift incurs transferee liability because donor did not pay gift tax and the interest on that unpaid tax (incurred during the time for IRS to chase donor then donee). How much interest can the donee be required to pay? If enough time passes the interest charges could make the aggregate of the tax and interest greater than the property involved. Is the aggregate payment by donee capped by value of property received?
The Court held that cannot cap both donor and donee to value of the property. The rationale for this conclusion is that if a maximum or ceiling existed, once the tax due exceed that amount the donee would have no incentive to pay.
Note that the opinion was reissued so that the above citation may not be correct.
State law developments.
SEC v. Wyle Case.
Texas taxpayers trouble with SEC.
Southern District of NY (Manhattan).
Case being talked about is the disgorgement decision.
Jury found Wyle brothers violated securities laws with non-disclosure offshore trusts. What penalty to they incur?
Disgorgement action judge is deciding what penalty to apply.
Judge is looking for hook to justify penalty she is imposing.
The reason they did not disclose was that they feared it would disclose the income tax on trust. So penalty is the income tax and to do so the Court held that the trusts were defective grantor trust. The court went beyond what common tax practice would consider a defective grantor trust.
Speaker sees no implications to grantor trusts generally. Issues were not briefed. There is a separate Tax Court case pending on grantor trust issues that will be the test in this area. It is too early to worry about Wyle.
Comment: The basis for concluding that the trust was a grantor trust was based on the degree of control the grantors exercised over the trust decisions even though they had no legal right to do so. The trustees were required to take direction from trust protectors (the brother’s attorney and 2 employees). The court viewed these protectors as agents and that there was defacto control and therefore it was a grantor trust under IRC Sec. 674.