EDWARD L. PERKINS, BA, JD, LLM (Tax), CPA Partner - Gibson&Perkins, PC Suite W Sixth St Media, PA Adjunct Professor - Villanova Law

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1 EDWARD L. PERKINS, BA, JD, LLM (Tax), CPA Partner - Gibson&Perkins, PC Suite W Sixth St Media, PA Adjunct Professor - Villanova Law School Graduate Tax Program Telephone : tedperkins@gibperk.com

2 Options Affecting the Decedent s Income Tax Options Affecting the Decedent s Income Tax Filing Joint Returns Using Medical Expenses as Income Tax Deductions Accruing Series Bond Interest Requesting Prompt Assessment and Discharge

3 Filing Joint Returns If at the time of death the decedent was married, and if his or her spouse did not remarry during the balance of the year, the Executor may file a joint return. The joint return will include the decedent's income for the period ending on the date of his or her death and the surviving spouse's income for the entire year. If both spouses die in the same year, a joint return can be filed that includes the income of each for the period covered by his or her last return. 1/1 12/31 DOD

4 Using Medical Expenses as Income Tax Deductions A medical expense incurred by the decedent but not paid before his or her death - May be deducted under 2053(a) as a debt on the decedent's estate tax return; or - May be deducted as a medical expense on the decedent's income tax return for the year in which the medical expense was incurred pursuant to 213(c), if the expense is paid by the estate within one year of death.

5 Using Medical Expenses as Income Tax Deductions Marginal Tax Rates and Other Tax Considerations The decision to make this election to deduct medical expenses on the income tax return does not rest simply on a comparison of the estate tax bracket with the decedent's income tax bracket. Any income tax due with the decedent's income tax return is a debt that will reduce the taxable estate and, correlatively, the estate tax liability. Estate Tax Over $5,490,000 $10,98,000 Married 40% Married Jointly Over $470, % Using Medical Expenses as Income Tax Deductions Example: - An unmarried decedent dies in 2014 and has an estate that will be subject to the federal estate tax. - For the year of his death, the decedent has adjusted gross income of $100,000 and has paid medical expenses of $5,000 during his life. His executor has paid another $20,500 of medical expenses. - The decedent dies in a state that does not have an estate tax but has an income tax. - The decedent's combined federal, state, and local effective income tax rate is estimated to be 33% and the decedent's effective estate tax rate is 40%. - The entire $20,500 of medical expenses paid by the executor can be deducted for federal estate tax purposes, but only $15,500 can be deducted for federal income tax purposes. - If the medical expenses are deducted on the decedent's estate tax return, the estate tax liability will be reduced by $8,200 ($20,500 40%), compared with a potential income tax savings of $5,115 ($15,500 33%). - Although the income taxes will be $5,115 higher than they otherwise would have been, such amount is deductible on the estate tax return, thereby reducing the estate tax by another $2,046 ($5,115 40%).

6 Using Medical Expenses as Example: Income Tax Deductions A decedent dies in 2017, has an estate of $10,980,000, has medical Effect of Marital Deduction expenses of $100,000, and is Many decedents survived by spouses and survived by his second wife and his with significant estates will have estate plans children from his first marriage. that take advantage of the 2010 applicable exclusion amount (formerly the unified His estate plan provides a credit credit) and the 2056 marital deduction in shelter trust for his children and a order to eliminate any Deducted estate tax on payment marital trust Deducted for his on wife In these situations, Gross it may Estate seem $ that 10,980,000 medical The marital Gross trust Estate will $ qualify 10,980,000 for the expenses ought to be deducted on the marital deduction Net Estate and $ 10,980,000 is to receive decedent's income Debt of tax Decedent return. 100,000 the smallest Martital Share amount 5,490,000 needed to Net Estate $ 10,880,000 But the executor also must consider who result in Residaul the lowest Share estate 5,490,000 tax liability bears the burden Martital of such Share medical expense 5,390,000 after accounting for the applicable 100,000 payment. Residaul Share 5,490,000 exclusion Net Residual amount Share 5,390,000

7 Accruing Series Bond Interest A cash basis taxpayer need not report the increase in redemption value (for convenience referred to as interest) on Series E U.S. savings bonds, which are no longer issued but which may still earn interest, EE U.S. savings bond and Similar U.S. obligations received in exchange for series E bonds, e.g., series H and HH bonds, until the bond is redeemed or its year of final maturity. Accruing Series Bond Interest Example: John died early in 2014 when he had not yet earned much income. At death, John owned series bonds with $50,000 of accrued interest. The executor, by electing to have John recognize the accrued interest on his final tax return, can take advantage of John's lower marginal income tax rates and deductions that John may have had that otherwise would have been wasted.

8 Requesting Prompt Assessment and Discharge Requesting Prompt Assessment Ordinarily the assessment of a federal income tax deficiency must be made by the IRS within three years after the return is filed. Under 6501(d), however, the executor can request that the assessment of any deficiency be made within 18 months after the request is made. Thus, if the request is made when the return is filed, the statute of limitations is reduced by half

9 Requesting Prompt Assessment and Discharge Requesting Discharge from Personal Liability Under 6905 the executor can apply for release from personal liability for the decedent's income taxes by filing Form Upon receipt of such application, the IRS has nine months to notify the executor of the amount of such taxes due. The executor is discharged from liability upon payment of the amount or, if no notice is given, nine months after the IRS's receipt of the application. For this purpose, executor means the executor or administrator appointed, qualified, and acting within the United States. This provision, like 6501, does not apply unless a return has been filed. Options Affecting Fiduciary Income Taxes

10 Options Affecting Fiduciary Income Tax Selection of Fiscal Year Treatment of Administration Expenses Distribution of Property In Kind 65 Day Election

11 Estate Election of a Fiscal Year An estate may adopt a fiscal year without obtaining prior approval from the IRS The estate's first year may be for a period of less than one year. The taxable year adopted must end on the last day of the month The fiscal year is adopted by filing its first federal income tax return using that taxable year. The fiscal year can be adopted on a late filed return. The estate's first year may be for a period of less than one year. The taxable year adopted must end on the last day of the month The fiscal year is adopted by filing its first federal income tax return using that taxable year. The fiscal year can be adopted on a late filed return. DOD 1/15 1/1 3/30 4/15 12/31 1/31

12 DOD 4/20/2012 How Distributions form Estates Are Taxed Estate Ends 10/31/2015 Estate Estate Tax Year Individual Tax Year 4/20/2013 Fiscal YE 1/31/2013 1/31/2014 1/31/ /31/2015 Distribution 6/15/2014 Individual Tax Year Why Elect a Fiscal Year? Deferring Income Tax Payments Selecting a Short Year to Minimize Income Taxable to Distributees Selecting a Fiscal Year to Spread Income Evenly Over Two or More Years

13 Deferring Income Tax Payments Example: Decedent dies April 20, 2012, and the executor elects a January 31 fiscal year for the estate. During the balance of 2012, the executor distributes $50,000 to the residuary beneficiary and such distributions carry out $30,000 of DNI. Although the residuary beneficiary physically received the distributions in 2012, he is deemed to have received the DNI on the last day of the tax year of the estate, or January 31, As a result, even though the beneficiary received the distribution in 2012, the income attributable to such distribution is reported on his 2013 income tax return. DOD 4/20/2012 Estate 12/31/12 1/31/2013 Selecting a Short Fiscal Year Example: Decedent died on May 21, DOD 5/21/2012 Estate adopts a fiscal year ending May 31, 2012 During the month of May, the estate earned DNI of $1,000 and distributed $30,000 to the residuary beneficiary. By adopting a fiscal year of May 31, the distribution of $30,000 will carry out only the $1,000 of DNI to the beneficiary. 5/31/2012 Estate 12/31/12

14 Selecting a Fiscal Year to Spread Income Example: Decedent died on August 23, 2012 owning accounts receivable. The estate anticipates that the receivables will represent most of the estate income, that 50% of the receivables will be collected by October 31, 2012 The balance will be collected over the subsequent six months. As a result, the executor may wish to elect October 31 as the fiscal year to spread roughly equal amounts of income over two tax years DOD 8/23/ % 50% 12/31/12 Estate 10/31/ /31/13

15 Treatment of Administration Expenses Section 642(g) provides that amounts allowable under 2053 or 2054 as deductions in computing the taxable estate of a decedent.will not be allowed as deductions in computing the taxable income of the estate or other person unless the estate files a waiver of its rights to deduct such items on the estate tax return. From the operation of 642(g), an executor may elect to deduct certain items for income tax purposes or estate tax purposes, but the same expense may not be deducted for both purposes. Treatment of Administration Expenses Availability and Effect of Election The purpose of 642(g) is to prevent the double deduction of those items that, but for 642(g), would be deductible for both income and estate tax purposes. Generally, the expenses covered by 2053(a)(2) (administration expenses) and 2054 (losses) are subject to the rule against double deduction because these items, absent 642(g), also would be deductible for income tax purposes. Also covered by this election are expenses incurred in administering property not subject to claims.

16 Treatment of Administration Expenses Planning Considerations In deciding where to deduct administration expenses and losses, the executor must determine where the deduction is most valuable within the context of the particular facts and circumstances surrounding the estate and its beneficiaries. (a) File Waiver Only When Benefit Is Known - An executor ought to keep options open as long as possible. - To this end, an executor ought to file a waiver only when he or she reasonably has concluded that an income tax deduction is more valuable than an estate tax deduction. - Generally, such a determination can be made once the estate tax audit is near completion. Treatment of Administration Expenses Planning Considerations (b) Consider Marginal Tax Brackets of Relevant Taxpayers - The executor will need to consider the marginal estate and income tax rates for the estate. - If, because of the marital deduction, there is no estate tax liability, claiming deductions for estate Deducted tax purposes on on the will not reduce tax payments. Deducted on on the However, taking Gross such Estate deductions $ 10,980,000 Gross Estate $ 10,980,000 against the estate tax can Net reduce Estate $ the 10,980,000 amount needed to Debt satisfy of Decedent the marital deduction 100,000and, as a result, Martital reduce Share the future 5,490,000 transfer tax liability of the Net surviving Estate $ spouse. 10,880,000 Residaul Share 5,490,000 - It is also important Martital to Share determine 5,390,000 who would bear the burden of such expenses. 100,000 Residaul Share 5,490,000 Net Residual Share 5,390,000

17 Treatment of Administration Expenses Expenses Allocable to Tax Exempt Income - Where an estate has tax exempt income, a portion of the estate's expenses not directly attributable to a class of income must be allocated proportionately to such tax exempt income and - Not deducted for income tax purposes. - This nondeductible portion may be deducted on the estate tax return and this is so even though a waiver of the estate tax deduction has been filed. Treatment of Administration Expenses Cash Flow Needs of the Estate - Cash needs of the estate must be taken into account when determining where administration expenses and losses ought to be deducted. - Administration expenses can be deducted on the estate tax return before their actual payment provided that the expenses are ascertainable with reasonable certainty and will be paid. - For the estate's income tax returns, however, expenses are deductible only for the tax year in which such expenses are paid.

18 Treatment of Administration Expenses Equitable Apportionment - Although the states' principal and income acts may charge some administrative expenses against principal, if such expenses are taken as income tax deductions rather than estate tax deductions,.the income beneficiaries receive the benefit of the deductions and resulting income tax savings at the expense of the principal beneficiaries. - As a result, unless there is a contrary intent expressed in the governing instrument, the doctrine of equitable apportionment may require the benefited income account to reimburse principal for the amount of the increased estate tax caused by the election.

19 Distribution of Property In Kind General Rule Beneficiaries are taxed on amounts distributed from a trust or estate to the extent such distributions carry out the trust's or estate's DNI, and The trust or estate is allowed deduction for amounts distributed a to its beneficiaries If an discretionary in kind distribution is made: The trust or estate recognizes no gain or loss on the distribution The trust or estate s deduction is generally the adjusted basis of the property limited by DNI The beneficiary recognizes income in the same amount Distribution of Property In Kind Sec. 643(e)(3) If property other than cash is distributed, and if Sec. 643(e)(3) applies The trust or estate is treated as selling the property for its FMV The amount of DNI deemed distributed equals the FMV of the property Distributees basis = FMV of the property

20 Distribution of Property In Kind When a 643(e) Election Is Available - Section 643(e) will apply whenever a discretionary distribution of property would carry out DNI pursuant to Estate funds residuary gift with appreciated property - Trust makes a discretionary property distribution - Does not apply to simple trusts - Does not apply to specific gifts of property - Does not apply when appreciated property funds a pecuniary bequest Distribution of Property In Kind When is Sec. 643(e)(3) a good idea The trust or estate has excess capital losses Capital Loss carryovers Step Up in Basis in hand beneficiary produces a positive tax result Low DNI

21 Impact of Sec. 643 (3) Multiple Beneficiaries If no 643(e) election is made B is treated as receiving $2,500, the basis of the property distributed to him. As a result, B is treated as receiving one third of the DNI (2,500/7,500), or $1,000, while J is treated as receiving two thirds of the DNI (5,000/7,500), or $2,000. If a 643(e) election is made to recognize gain in the trust, both J and B are treated as receiving equal amounts and, hence, both will recognize ordinary income of $1,500. Also, if the election is made, the trust now recognizes $2,500 of capital gain. Thus, beneficiary J wants the trustee to make the election, but beneficiary B and the remainder beneficiaries wants the trustee not to make the election. Example 2: Trust Y has DNI of $3,000 comprised of ordinary income. The trustee, exercising its discretion, distributes $5,000 in cash to beneficiary J and distributes property with a basis of $2,500 and a fair market value of $5,000 to beneficiary B. Related Party Rules Planning Considerations If a trustee distributes appreciated property to a beneficiary and such property in the hands of the beneficiary will be subject to depreciation, any gain recognized by the trustee will be treated as ordinary income under 1239.

22 Distribution of Property In Kind Related Party Rule - Property distributed have a value below their income tax basis, the potential loss is not deductible by the trust or estate - A trustee of a trust and a beneficiary of such trust, and an executor of an estate and a beneficiary of such estate are regarded as related parties and - Neither is allowed a deduction with respect to any loss from the sale or exchange of property between such parties. Property Declines in Value Planning Considerations Where property has declined in value, the analysis for the fiduciary may be simpler. In the case of an estate or trust, whether or not the fiduciary elects to recognize loss upon a distribution of property, the tax results under 643(e) to the trust and beneficiaries will be the same. 643(e)(3) No loss on the sale; DNI deduction = FMV, DNI carry out = AB; Basis = AB No 643(e)(3) Same

23 Election is Made Election is made on the Tax Return for the Year of the Distribution Applies to All Distributions for the Year

24 65 Day Election 663(b) If within the first 65 days of the taxable year of a trust or an estate an amount is properly paid or credited If the trustee makes a proper election, the distribution is treated as having been made on the last day of the preceding taxable year for all purposes. The election is made on the back page of Form If no return is required, a statement making the election must be filed with the Internal Revenue office where a return would have been filed. 65 Day Election 663(b) The fiduciary need not make the 65 day election for all distributions made in the first 65 days, but may designate particular distributions. The election applies only to those amounts properly paid or credited within the first 65 days of the following year and which the fiduciary designates in his election. Thus, a fiduciary may make the election only as to part of a distribution.

25 Treating Trust as a Part of the Estate Decedents may elect to treat any trust revocable by the decedent as part of the decedent's estate for federal tax purposes. The election must be made by the executor and the trustee (or by the trustee only if no executor is appointed) no later than the due date of the first fiduciary income tax return for the estate, including extensions. The election is irrevocable.

26 Treating Trust as a Part of the Estate The election is effective for all taxable years of the estate but not longer than six months after the final determination of the federal estate tax liability. If no federal estate tax return is required, the election is effective for all taxable years of the estate ending before the date that is two years after the date of death. Treating Trust as a Part of the Estate Potential Benefits This election allows a trust to be treated as an estate for a limited period and take advantage of those tax rules that apply to estates but not to trusts. These would include: Using the estate's fiscal year for income tax purposes; Being entitled to the charitable set aside deduction under 642(c); Being an eligible S corporation shareholder;

27 Treating Trust as a Part of the Estate Potential Benefits Recognizing loss upon the satisfaction of a pecuniary bequest with assets that have a fair market value less than basis pursuant to 267(b)(13); Having the active participation requirements under the passive loss rules waived for tax years ending less than two years after the decedent's death pursuant to 469(i)(4); Eligibility for the deduction for medical expenses under 213(c) incurred by the decedent that are paid by the estate in the oneyear period after the decedent's death (this deduction is not available if the medical expenses are paid by the trust). Options Involving Business Interests

28 Options Involving Business Interests Elections Affecting S Elections Optional Basis Adjustment 754 Deferral of Estate Tax Special Use Valuation

29 Elections Affecting S Elections Ownership of S Corporation Stock An estate and certain trusts may own stock issued by a subchapter S corporation. The trusts that may own S corporation stock are. A grantor trust treated as owned by an individual who is a U.S. citizen or resident; A grantor trust before the death of the grantor that continues in existence after the grantor's death, but only for two years after the grantor's death; A trust to which stock is transferred either by a 645 electing trust or pursuant to the terms of a will, but only for two years after the transfer A voting trust; An electing small business trust (ESBT) A qualified subchapter S trust (QSST) Elections Affecting S Elections Estates When a decedent dies owning stock in an S corporation, the fiduciary must be concerned with having the stock held by an entity that can own such stock. In this regard, several options may be open to the fiduciary. Because an estate may own S corporation stock, the executor may keep the stock in the estate for as long as the estate properly remains open if the stock will be distributed to a person who is not a permitted shareholder.

30 Elections Affecting S Elections Estates An estate may remain open for the period needed to perform the ordinary duties of administration, such as the collection of assets and the payment of debts, taxes, and bequests. If the payment of estate taxes is deferred under 6166, the estate can remain open during the period of deferral Elections Affecting S Elections Trusts The ability of a trustee to deal with stock of an S corporation will depend on the terms of the trust. Where the terms of a trust do not allow the trust to own such stock, the trustee may consider exercising discretionary powers (assuming such powers exist) to distribute principal in order to distribute such stock to an individual. A marital deduction trust under which the surviving spouse has a right to withdraw all of the trust principal will qualify as a permitted shareholder because such trust is a grantor trust under 678 and need not make any QSST election. However, a QSST election would be needed for a QTIP trust.

31 Optional Basis Adjustment 754 Effect of the 754 Election If a proper 754 election is made, then the adjusted basis of the partnership property either is increased by: The excess of the estate's basis in its partnership interest over That partner's proportionate share of the adjusted basis of partnership property Such increase (or decrease) constitutes an adjustment of the partnership property with respect to the transferee partner only. A transferee partner's proportionate share of the adjusted basis is equal to the sum of such partner's interest in the partnership's plus his or her share of partnership liabilities.

32 Optional Basis Adjustment 754 Availability of Election An interest in a partnership owned by a decedent is valued for federal estate tax purposes like any other asset, that is, at its fair market value as of the decedent's date of death or alternate valuation date, Such value establishes the basis of the partnership interest in the hands of the person acquiring such interest from the decedent. This basis will not be the same as the basis that the partnership has in its property, which basis is unaffected by the death of a partner. Absent any adjustment by the partnership to such basis, the tax consequences to the transferee partner of the decedent's interest resulting from transactions and operations by the partnership will not take into account such transferee partner's adjusted basis. Optional Basis Adjustment 754 Availability of Election Section 754 allows the partnership to elect to make a special adjustment to the basis of its property to account for the difference between the partnership's basis in its property and the transferee partner's basis in his or her partnership interest. The election may be made in the manner provided in 743 whenever: There is a transfer of a partnership interest by sale or exchange or by reason of death of a partner or In the manner provided in 734 whenever there is a distribution of property by the partnership to a partner.

33 Optional Basis Adjustment 754 Time and Manner of Making the 754 Election The election is automatically effective if it was made before the partner's death and was not revoked. If the election was not made before the death of a partner, then the partnership makes the election by filing a statement with its return for the taxable year in which the partner's death occurred. The statement so filed must: (1) set forth the name and address of the partnership making the election; (2) contain a declaration that the partnership elects under 754 to apply the provisions of 734(b) and 743(b); and (3) be signed by any one of the partners. The election must be made with the return for the year in which the distribution or transfer occurred and the return must be timely filed. The IRS does have discretionary authority to grant an extension of time for making the 754 election. The IRS has issued private rulings allowing late 754 elections to be made. Optional Basis Adjustment 754 Revoking the 754 Election A partnership may revoke a 754 election with the approval of the IRS. A request to revoke the 754 election must be signed by a partner and must be filed no later than 30 days after the close of the partnership taxable year for which the revocation is intended to take effect.

34 Optional Basis Adjustment 754 Revoking the 754 Election The application for revocation must set forth the grounds on which the revocation is desired. Possible grounds for revocation include: A change in the nature of the partnership business; A substantial increase in the assets of the partnership; A change in the character of partnership assets; or An increased frequency of retirements or shifts of partnership interests, resulting in an increased administrative burden from the election. Optional Basis Adjustment 754 Special Rule for IRD Items Unrealized receivables paid or distributed to the estate in exchange for or in liquidation of its partnership interest are considered 736(a) payments by reason of 736(b)(2)(A). Section 753 provides, in turn, that 736(a) payments are income in respect of a decedent (IRD), and 1014(c) provides that items of IRD do not acquire a new basis upon the decedent's death. In other words, unrealized receivables (as defined in 751(c)) cannot get the benefit of the 754 election and avoid recognition of gain. This denies a step up in basis on death for partnership unrealized receivables, defined under 751(c), notwithstanding the existence of a valid 754 election.

35 Optional Basis Adjustment 754 Planning Considerations If the effect of the 754 election is to increase the estate's basis in the partnership property, the election is advantageous from the estate's viewpoint. The partnership may be reluctant to make a 754 election because of increased administration and accounting recordkeeping needs If the partnership refuses or fails to timely elect 754, that may be a factor that decreases the otherwise fair market value of the partnership interest. Optional Basis Adjustment The Section 732(d) Option If the 754 election is not in effect and is not to be made, the estate may make a 732(d) election on its own behalf without affecting the other partners. If the 732(d) election is made, any partnership property distributed to the estate within two years after the decedent's death will receive the basis such property would have received if the adjustment provided in 743(b) were in effect with respect to the estate's partnership interest. The estate makes the 732(d) election with its income tax return either: For the year of the distribution, if the distribution included depreciable, depletable, or amortizable property; or For the first year in which the basis of any distributed property is pertinent in determining the estate's income tax.

36 Optional Basis Adjustment The Section 732(d) Option The special basis rule of 732(d) applies regardless of whether the election is made and regardless of whether the distribution is within the two year period if, at the date of the partner's death: - The fair market value of all partnership property (other than money) exceeds 110% of its adjusted basis to the partnership; - An allocation of basis under 732(c) upon the liquidation of the estate's interest immediately after the date of death would have resulted in a shift of basis from property not subject to an allowance for depreciation, depletion, or amortization to property subject to such an allowance; and - A special basis adjustment under 743(b) would change the basis to the estate of the property actually distributed. Optional Basis Adjustment The Section 732(d) Option The Section 732(d) Option The special basis rule of 732(d) applies only to distributions and does not apply for purposes of computing a transferee's share of depreciation or gain or loss on a sale of partnership property by the partnership. A 732(d) election is well suited to the liquidation of the partnership interest following the partner's death. But in the case of liquidating distributions under 732(b), 732(d) will have an effect only upon how basis is allocated among the distributed properties and not on the overall basis for all such properties. The reallocation of basis among the properties will have a positive effect in terms of avoiding distortion of gains and losses on subsequent sales of such properties.

37 Deferral of Estate Tax Extending the Time for Payment of Estate Tax Under 6166 Generally, the estate tax is due nine months after the decedent's death, but where a significant value of the estate consists of interests in closely held businesses, the executor may elect to defer payment of a portion of the estate tax pursuant to Under 6166, a portion of the estate tax may be paid in up to 10 installments, with the first installment of tax deferred up to five years.

38 Deferral of Estate Tax Availability of the Election The 6166 election is available if: (a) the decedent was a citizen or resident of the United States at the time of death; and (b) the value of all interests in closely held businesses included in the decedent's gross estate exceeds 35% of the adjusted gross estate. For this purpose, the adjusted gross estate = The gross estate reduced by amounts allowable as deductions under 2053 and 2054 based on the facts and circumstances as of the earlier of the due date for filing the return or the date the return is filed. The 35% test also must be satisfied if gifts made within three years of the date of death that are included in the gross estate because of 2035(a). Deferral of Estate Tax Determining the Value of the Closely Held Business Interest In determining the value of the interest in a closely held business for purposes of 6166, only those assets used in carrying on the trade or business are considered. For example, if a business bank account contains both non business funds as well as working capital, only that part of the account that represents working capital will constitute a part of the interest in the closely held business. However, in a case where an interest in a partnership or stock of a corporation qualifies as an interest in a closely held business, the decedent's entire interest in the partnership, or the decedent's entire holding of stock in the corporation, constitutes an interest in a closely held business even though a portion of the partnership or corporate assets is used for a purpose other than the carrying on of a trade or business.

39 Deferral of Estate Tax Interest Must Be in a Closely Held Business An interest in a closely held business means an interest as proprietor, as a partner of any partnership, or as a stockholder of any corporation that carries on a trade or business. In the case of a partnership or corporation: 20% or more of the total capital interest, in the case of a partnership, or 20% or more of the value of the corporate voting stock, in the case of a corporation, must be included in the decedent's gross estate; or Deferral of Estate Tax There is no statutory definition determining what constitutes the carrying on of a trade or business. The IRS has stated that 6166 was intended to apply only with respect to a business such as a manufacturing, mercantile, or service enterprise, as distinguished from management of investment assets. But active Real Estate holdings now qualify The activities of an agent appointed to manage the affairs of the decedent are considered the activities of the decedent

40 Deferral of Estate Tax Effect of the 6166 Election If 6166 is elected properly, a portion of the estate tax liability may be paid in installments with the first tax payment deferred for up to five years. Maximum Amount that Can Be Deferred The maximum amount of estate tax that can be paid in installments = The total tax liability X The value of the qualified closely held business The value of the Adjusted Gross Estate Deductions allowable under 2053 and 2054 that the estate elects to deduct on the income tax return pursuant to 642(g) are taken into account for purposes of determining the adjusted gross estate. The maximum amount that can be deferred will be presumed unless the executor indicates a smaller amount. Deferral of Estate Tax Number of Installments The estate tax liability deferred under 6166 may be paid in two or more (but not more than 10) installments as the executor elects. If the number of installments is not indicated, 10 installments are presumed.

41 Deferral of Estate Tax Time Installments Are Due The first installment of tax deferred under 6166 is paid on the date selected by the executor that is not more than five years and nine months after the decedent's death. All future installments are then due on the anniversary of such date selected by the executor. As with the number of installments, the maximum deferral is presumed if not indicated otherwise. The executor may seek an extension of time to pay any installment for a reasonable period not in excess of 10 years by showing reasonable cause for the need of any extension pursuant to 6161(a)(2)(B). A taxpayer may file Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation Skipping Transfer) Taxes, to seek an extension of time to pay a 6166 installment payment. Deferral of Estate Tax Payment of Interest During the period of deferral, interest is paid annually. Once the tax is to be paid, interest is paid at the same time as the tax. The interest rate on the 2% portion is 2%. The 2% portion is the lesser of the following amounts: (1) The amount by which the tentative tax computed on the sum of (i) $1,000,000, adjusted for cost of living adjustments after 1998, plus (ii) the applicable exclusion amount under 2010(c), exceeds (iii) the applicable credit amount under 2010(c); or (2) The amount of the tax extended under All tax in excess of that is subject to the 2% interest rate is subject to 45% of the rate of interest in effect from time to time under 6621.

42 Deferral of Estate Tax Effect of the 6166 Election Payment of Interest The amounts are $1,520,000, $1,490,000, and $1,480,000, for 2018, 2017, and 2016, respectively. Estate Tax to which 2% applies is $596,000 The quid pro quo for the favorable 2% interest rate is that no deduction is allowed for estate or income tax purposes for any interest paid on tax extended under Deferral of Estate Tax Section 6166 and Tax Deficiencies The election, once made, will apply to any subsequent deficiency. Any deficiency is prorated to the installments and that part of the deficiency prorated to any installment not yet due is paid when that installment is due. If the election has not been made when a deficiency is assessed, the executor may, within 60 days of notice and demand for payment of such deficiency by the IRS, elect to pay the deficiency in installments in the same manner as if the election had been originally made.

43 Deferral of Estate Tax Executor Is Liable for the Estate Tax The executor is personally liable for the estate tax for the full period of deferral to the extent the executor has paid any other debts of the decedent before paying the IRS. The executor may seek a discharge from personal liability under 2204, but a bond must be furnished. The executor may be discharged by obtaining the agreement of the distributees to the imposition of a lien in accordance with 6324A.

44 Special Use Valuation Special Use Valuation 2032A Generally, property included in the gross estate is valued at its fair market value as of the date of death, or the alternate valuation date if available and elected. Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. But 2032A allows certain real property to be valued at less than fair market value. Special Use Valuation Special Use Valuation 2032A When land is actually used for farming purposes or in other closely held businesses (both before and after the decedent's death), it is inappropriate to value the land on the basis of its potential highest and best use especially since it is desirable to encourage the continued use of property for farming and other small business purposes.

45 Special Use Valuation Special Use Valuation 2032A Property that qualifies for the Sec. 2032A election will be valued at the greater of (a) its special use value, or (b) its fair market value reduced by the Sec. 2032A amount. For estates of decedents dying after 1998, the Sec. 2032A amount is $750,000* multiplied by the cost of living adjustment and rounded to the next lowest multiple of $10,000 *1,140,000 of 2018, *1,120,000 for 2017 Special Use Valuation The qualified real property must be located in the U.S. and have been used by the decedent or a member of his or her family Who was materially participating in the trade or business for at least five of the eight years preceding the date of death, disability or retirement Sec. 2032A(b)(4), at which time the decedent must have been a citizen or resident of the U.S. The adjusted value of the real or personal property must be 50% or more of the adjusted value of the gross estate. The adjusted value of the real property alone must be 25% or more of the adjusted value of the gross estate. The property also must pass from the decedent to a qualified heir defined in Secs. 2032A(e)(1) and (e)(2) as a member of the decedent's family who acquired the property from the decedent. Qualified property also may include residential buildings, related improvements, roads, and other structures "functionally related to the qualified usesec.2032a(e)(3).

46 Special Use Valuation Election and Agreement The election for special valuation is made by the executor on the estate tax return (Form 706) by checking the "yes" box on page 2, line 2 and completing Schedule A 1 "Section 2032A Valuation" on pages 6 8. The election may be made on a late filed return as long as it is made on the first estate tax return filed. Once made, the election is irrevocable. Most importantly, a properly executed notice of election and a written agreement signed by each person with an interest in the property must be attached to the Estate Tax Return Secs. 2032A(a)(1)(b) and (d)(1) and (2). Special Use Valuation Any estate taxes saved due to the Sec. 2032A election can be recaptured if, within 10 years after the decedent's death, the property is disposed of or if the qualified heir ceases to use the property for the qualified use Se.2032A(c)(1). For example, if the qualified heir sells the farm or business property to real estate developers within the 10 year period the recapture provisions would be triggered. The death of the qualified heir before the expiration of the 10 year recapture period would eliminate recapture.

47 Rollovers Rollovers by Employees Under 402(c), if any portion of a qualifying distribution is transferred to an IRA or another qualified retirement plan within 60 days of receipt, such transferred amount will not be includible in the gross income of the recipient for the taxable year in which paid. Almost any distribution to an employee of all or any portion of the balance to the credit of the employee in a qualified trust will be eligible for rollover.

48 Rollovers by Surviving Spouse If any distribution attributable to an employee is paid to the employee's spouse after the employee's death, the rules for rollover treatment applicable to the employee apply to the spouse. Rollovers by Surviving Spouse Account Holder Under 70 1/2 Rollover to own IRA Treat as an Inherited IRA Life Expectancy Method Treat as Inherited IRA 5 Year Method Lump Sum

49 Rollovers by Surviving Spouse Account Holder 70 ½ and Over Rollover to own IRA Treat as an Inherited IRA Life Expectancy Method Lump Sum Rollovers by Persons Other Than the Surviving Spouse Account Holder Under 70 1/2 Treat as an Inherited IRA Life Expectancy Method Treat as Inherited IRA 5 Year Method Lump Sum

50 Rollovers by Persons Other Than the Surviving Spouse Account Holder 70 ½ and Over Treat as an Inherited IRA Life Expectancy Method Lump Sum The End

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