RECENT DEVELOPMENTS IN FIDUCIARY INCOME TAX FIDUCIARY INCOME TAX COMMITTEE. 'W ASHINGTON, D.C. MAY 7, 2011

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1 RECENT DEVELOPMENTS IN FIDUCIARY INCOME TAX ABA SECTION OF TAXATION FIDUCIARY INCOME TAX COMMITTEE. 'W ASHINGTON, D.C. MAY 7, 2011 Judith K. Tobey K&L GATES LLP 1717 Main Street, Suite 2800 Dallas, Texas (214) judith. Rachel D. Burke FUREY, DOOLAN & ABELL LLP 8401 Connecticut Avenue, Suite 1100 Chevy Chase, Maryland (301)

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3 RECENT DEVELOPMENTS IN FIDUCIARY INCOME TAX (January 8, April 29, 2011) By Judith K. Tobey* I. Section 61 (Gross Income Defined) A. Notice of Proposed Rulemaking ,76 Federal Register 20,593 (Apr. 13, 2011) - Proposed Regulations under Section 108(a) Concerning the Exclusion of Grantor Trust Discharge of Indebtedness Income. The Treasury Department and Service have issued proposed regulations regarding the exclusion from gross income under Section 108(a) of discharge of indebtedness income of a grantor trust or disregarded entity. Section 61(a)(12) provides that income from the discharge of indebtedness is includable in gross income. However, such income may be excluded from gross income under Section 108 in certain circumstances. Sections 108(a)(1)(A) and 108(a)(1)(B) exclude from gross income any amount that would be includable in gross income by reason of the discharge of indebtedness of the taxpayer if the discharge occurs in a title 11 (bankruptcy) case or when the taxpayer is insolvent. Sections 108(a)(1)(A) and 108(a)(I)(B). Some taxpayers have taken the position that the exceptions in Sections 108(a)(1)(A) and 108(a)(1)(B) are available to a grantor trust that is under the jurisdiction of a bankruptcy court (or insolvent, as the case may be), even if the owner of the trust is not. The proposed regulations make clear that the TreasUlY Department and Service do not believe this is an appropriate application of Sections 108(a)(1 )(A) and 108(a)(1)(B). The proposed regulations provide that for purposes of applying Sections 108(a)(l)(A) and 108( a)( 1 )(B) to discharge of indebtedness income of a grantor trust, the tenn taxpayer refers to the owner or owners of the grantor trust. Prop. Treas. Reg. Section ( a). The grantor trust itself will not be considered an owner for this purpose. Prop. Treas. Reg. Section (a). Finally, the proposed regulations provide that in the case of partnerships, the owner rules apply at the partner level to the partners of the partnership to whom the discharge of indebtedness income is allocable. Prop. Treas. Reg. Section (b). If a partner is itself a grantor trust, then the applicability of Sections 108(a)(l)(A) and 108(a)(l)(B) is detennined by looking through such grantor trust to the ultimate owner or owners of such partner. Finally, the proposed regulations clarify that the bankruptcy exception is available only to the extent the owner of the grantor trust is subject to the bankruptcy court's jurisdiction, and the insolvency exception is available only to the extent the owner of the grantor trust is insolvent. Prop. Treas. Reg. Section (a). The regulations will apply to discharge of indebtedness Income occurring on or after the date final regulations are published in the Federal Register. * Judith K. Tobey 2011.

4 II. Section 67 a-percent Floor on Miscellaneous Itemized Deductions) A. Notice , I.R.B. (May 16, 2011) - Bundled Fiduciary Fees Fully Dedudible Until Final Regulations Published. Notice released April 13, 2011 provides guidance to trustees and executors concerning the deductibility of bundled fiduciary fees. On January 16,2008, the Supreme Court of the United States issued its decision in Knight v. Commissioner, 552 U.S. 181 (2008), holding that investment advisory fees incurred by a non-grantor trust or estate are generally subject to the 2% floor for miscellaneous itemized deductions under Section 67(a). Notice states that the Service and Treasury Department expect to issue Treasury Regulations under Treasury Regulation Section that are consistent with the Knight decision and that address the issue raised when a non-grantor trust or estate pays a bundled fiduciary fee that includes some costs that are subject to the 2% floor and some costs that are fully deductible without regard to the 2% n()or. However, the Notice also states that these regulations will not apply to taxable years that begin before such final regulations are published in the Federal Register. Notice extends the interim guidance regarding bundled fiduciary fees that was first provided in Notice , R.B. 593 (Feb. 27, 2008) and extended in Notices , I.R.B (Dec. 11,2008) and , I.R.B. 594 (Apr. 1,2010). Taxpayers will not be required to detern1ine the portion of a bundled fiduciary fp'p' that is sllhject to the 2% floor under Section 67 for any taxable year beginning before the date the final regulations under Treasury Regulation Section are published. The Notice provides that for those years, taxpayers may deduct the full amount of the bundled fiduciary fee without having to determine which portion of the bundled fee is attributable to costs subject to the 2% floor. However, payments by a fiduciary to third parties for expenses subject to the 2% floor are readily identifiable and must be treated separately from the otherwise bundled fiduciary fee. III. Section 663 (Special Rules Applicable to Sections 661 and 662) A. Private Letter Ruling (Apr. 15, 2011) - Trust Granted Extension of Time to Elect that Distribution be Treated as Paid in Preceding Year. Facts. Trust files its federal income tax returns on a calendar year basis. Trustee made a distribution from Trust during the first sixty-five days of the calendar year and intended to have the distribution considered to be paid on the last day of the previous year under Section 663(b). Trustee inadvertently failed to timely file the election required under Section 663(b) and requested an extension of time to make that election. Law, Analysis & Conclusions. Section 663(b) provides that the executor of an estate or the fiduciary of a trust may make an election to have any amount properly paid from or credited to such estate or trust within the first sixty-five days of any taxable year considered paid or credited on the last day of the preceding taxable year. An effective election must be made in the manner and at the time prescribed by the Secretary. Section 663(b)(2). Treasury Regulation Section 1.663(b)-2(a)(I) provides that if a trust is required to file a federal income tax return for the taxable year for which such election is made, the election shall be made in the appropriate place on such return. The election must be made no later than the time for filing such return 2

5 (including extensions) and will be irrevocable after the last day prescribed for making it. Treas. Reg. Section 1.663(b)-2(a)(I). Treasury Regulation Section (c) provides that the Commissioner may grant a reasonable extension of time to make a regulatory election. Treas. Reg. Section (c). Treasury Regulation Section (a) provides that a request for such relief will be granted when a taxpayer provides satisfactory evidence that the taxpayer acted reasonably and in good faith and the grant of relief will not prejudice the interests of the government. Treas. Reg. Section (a). Based on the facts submitted and the representations made in this instance, the Service granted Trustee a l20-day extension of time to file an election under Section 663(b). IV. Section 664 (Charitable Remainder Trusts) A. Private Letter Ruling (Apr ) - Proposed Judicial Reformation Will Not Disqualify Charitable Remainder Unitrust or Constitute Self-Dealing. Facts. Husband and Wife established a net income with makeup charitable remainder unitrust (a "NIMCRUT"). The trust agreement provided that Trustees pay the unitrust amount to Husband and Wife each year, and after the death of the first spouse to die, to the surviving spouse for the rest of his or her life. The unitrust amount was defined in the trust agreement as (l) the lesser of trust income or eight percent of the net fair market value of the trust assets (valued annually), plus (2) trust income in excess of eight percent, to the extent that the aggregate unitrust payments in prior years were less than the aggregate eight percent determined for all such prior years. Husband and Wife intended and believed that the NIMCRUT provisions would apply only so long as the trust held celiain contributed property and that once the specified property was sold, the trust would convert to an ordinary charitable remainder unitrust ("CRUT"). However, due to a scrivener's error, the trust agreement did not provide for the intended conversion. Trustees filed a petition in state court requesting a reformation of the trust agreement to provide that after the specified property was sold, the unitrust amount during the remaining unitrust period would be eight percent of the net fair market value of the trust assets. The state court granted Trustees' request and ordered that the reformation be effective on the date the Service approved the reformation. Husband and Wife submitted affidavits stating their intention and belief that the trust be drafted to convert from a NIMCRUT to an ordinary CRUT in the year following the sale of certain trust propeliy, and the drafting attorney's handwritten notes indicated that such provisions were intended. Husband and Wife also represented that no deduction under Sections 170, 2055 or 2522 had been allowed for any income interest that they had received or been entitled to receive. Trustees requested rulings from the Service that (1) the judicial reformation and amendment of the trust instrument would not violate Section 664 and that the reformed and amended trust would continue to qualify as a charitable remainder unitrust; and (2) the reformation would not be an act of self-dealing under Section Law, Analvsis & Conclusions. Section 664(d)(3) provides that a charitable remainder unitrust may require the trustee to make the following annual payments to the income beneficiary: (A) the amount of trust income, if such amount is less than the fixed percentage 3

6 unitrust amount under Section 664(d)(2)(A) plus (B) any amount of trust income that is in excess of the fixed percentage unitrust amount under Section 664(d)(2)(A), to the extent that the total of the amount of such trust income paid in prior years was less than the total of such required unitrust amounts. Section 664(d)(3). Treasury Regulation Section (a)(4) provides that a charitable remainder unitrust may not be subject to a power to invade, alter, amend or revoke for the benefit of any person other than a charitable organization described in Section 170( c). Treas. Reg. Section (a)(4). However, the Service stated in this ruling that the reformation of a charitable remainder trust will not violate Section 664 if the reformation is necessary to conform the trust instrument to the grantors' intent. Based on the evidence presented and a review of the trust agreement, the Service found that the provisions of the trust agreement as originally drafted were contrary to the intent of Husband and'wife and that the state court's reformation of the trust agreement was consistent with applicable state law. The Service concluded that the judicial reformation did not violate Section 664 and would not adversely affect the trust's qualification as a valid charitable remainder unitrust under Section 664. Section 4947(a)(2) subjects celiain split-interest trusts (such as charitable remainder trusts) to the excise taxes on acts of self-dealing that are described in Section 4941 in the same manner as if such trusts were private foundations. Section 4947(a)(2)(A) provides that the selfdealing rules of Section 4941 do not apply to any amounts payable to income beneficiaries pursuant to the terms of a split-interest trust as long as no deduction was allowed for such income interest under Section l70(f)(2)(b), 642(c), 2055(e)(2)(B) or 2522(c)(2)(B). As Husband's and Wife's affidavits stated that no such deduction was taken in this case, the Service concluded that the self-dealing rules under Section 4941 did not apply to Husband and Wife as beneficiaries of the trust. The Service also concluded that Husband and Wife did not engage in an act of self-dealing under Section 4941 in their capacity as substantial contributors to the trust because they never intended that the NIMCRUT provisions continue after the specified trust property was sold. B. Private Letter Ruling 20U (Apr ) - Deduction of Qualified Charitable Interests Allowed Following Reformation of Testamentarv Trust into CLAT and CRUT. Facts. Decedent died testate after May 1,2009. Pursuant to Decedent's will, the residue of his estate passed to Trust. Trust provided that all income be paid to Individuals A and B for their lifetimes and that each of Charity 1 and 2 receive fixed annual payments during that period. Upon the death of the survivor of Individuals A and B, Trust was to terminate and be distributed as follows: (i) various fixed dollar amounts to each of Charity 3 and 4 and to each of Individuals C, D, E, F and G; and (ii) one-third of the remaining corpus to each of Individual H, Charity 1 Foundation, and Charity 2. Before the 90th day after the last date for filing Decedent's estate tax return, Executor commenced a judicial proceeding under Section 2055(e)(3) and applicable state law. Executor proposed to reform Trust to create two new trusts: a charitable lead annuity trust (a "CLAT") and a charitable remainder unitrust (a ' CRUT"). The proposed terms of the CLAT were: (i) fixed annual payments to each of Charity 1 and 2 for a term of years corresponding to the actuarial life expectancy of Individuals A and B; 4

7 (ii) upon the expiration of the term of years, various fixed dollar payments to each ofindividuals C, D, E, F and G, with the balance passing to Individual H. The terms of the CLAT would meet the requirements for a testamentary CLAT set forth in Revenue Procedure , I.R.B. 102 (2007). The proposed terms of the CRUT were: (i) unitmst payments to Individuals A and B (or the survivor) for their lifetimes; (ii) upon the death of the survivor of Individuals A and B, fixed dollar an10unts to each of Charity 3 and 4, with the balance divided equally between Charity 1 Foundation and Charity 2. The terms of the CRUT would meet the requirements for a testamentary CRUT set forth in Revenue Procedure , I.R.B. 412 (2005). Executor asked the Service for rulings concerning the proposed reformation under Section 2055(e)(3). Law. Analysis & Conclusions. Section 2055(a) generally provides that the value of a decedent's taxable estate shall be detennined by deducting from the gross estate the amount of all bequests, legacies, devises or transfers to or for the use of charitable organizations described in Sections 2055(a)(1) through 2055(a)(4). Section 2055(a). Section 2055(e)(2) generally provides that where an interest in property passes from the decedent to or for a charitable purpose described in Section 2055(a) and an interest in the same property passes from the decedent to or for a purpose not described in Section 2055(a), no deduction shall be allowed for the interest that passes to or for the charitable purpose unless (A) such interest is an interest in a charitable remainder annuity tmst or charitable remainder unitmst described in Section 664 or a pooled income fund described in Section 642(c)(5), or (B) such interest is in the form of a guaranteed annuity or is a fixed percentage of the fair market value of the property determined and distributed yearly. Section 2055(e)(2). Section 2055(e)(3) provides for the reformation of interests passing from decedents so that such interests may comply with the requirements of Section 2055( e )(2). Section 2055( e )(3). Section 2055(e)(3)(A) provides that a deduction will be allowed under Section 2055(a) in respect of any qualified reformation. Section 2055(e)(3)(A). Section 2055(e)(3)(B) defines a qualified reformation to mean a change of a reformable interest into a qualified interest (by refonnation, amendment or construction of the governing instrument) if the following are true: (i) any difference between the actuarial value of the qualified interest (determined as of the date of the decedent's death) and the actuarial value of the reformable interest (as so determined) does not exceed five percent of the actuarial value of the reformable interest; (ii) in the case of a charitable remainder interest, the non-remainder interest terminated at the same time before and after the qualified reformation or, in the case of any other interest, the refonnable interest and the qualified interest are for the same period; and (iii) the change is effective as of the date of the decedent's death. Section 2055(e)(3)(B). Section 2055(e)(3)(C)(i) defines a refom1able interest to mean any interest for which a deduction would be allowable under Section 2055(a) at the time of the decedent's death but for Section 2055(e)(2). Section 2055(e)(3)(C)(i). In this case, the Service concluded that the charitable interests in Tmst were reformable interests under Section 2055(e)(3)(C)(i) because they were presently ascertainable and severable from the noncharitable interests. The Service also concluded that the proposed reformation satisfied all of the requirements of Section 2055(e)(3)(B). Therefore, the Service held that: (1) the proposed reformation of Tmst would be a qualified reformation under Section 2055(e)(3) 5

8 provided that the CLA T meets the requirements of a guaranteed ammity interest under Section 2055(e)(2)(B) and the CRUT meets the requirements of a charitable remainder unitrust under Section 664(d); and (2) a charitable deduction would be allowed under Section 2055(a) for the present value of the qualified interests under Treasury Regulation Sections (:f)(2)(ii) and (iv). V. Section 679 (Foreign Trusts Having One or More United States Beneficiaries) A. American Institute of Certified Public Accountants Requests Guidance on Foreign Trusts as Part of the HIRE Act of2010 (Mar. 28, 201l). On March 28, 2011, the American Institute of Certified Public Accountants ("AICPA") requested guidance from the Service regarding several provisions of the Hiring Incentives to Restore Employment Act of 2010 (Public Law No , Mar. 18, 2010, the "HIRE Act") relating to foreign trusts. Guidance was requested in three areas: (1) treatment of the use of foreign trust property as a trust distribution; (2) clarification regarding foreign trusts that are treated as having a United States beneficiary; and (3) disclosure of infoffi1ation with respect to foreign financial assets. More specifically, Section 643(i) now provides that if a trustee pennits a United States grantor, beneficiary, or relative of a grantor or beneficiary to use trust property without payment to the trust for the fair market value of the use of such property, such use will be treated as a distribution from the trust. Section 643(i). The AICPA requested that guidance be issued that would: (1) clarify who will detennine fair market value of the propeliy usage; (2) limit the rule regarding usage of property to property for which a rental market exists; (3) set forth standards to be used in determining fair market value if the preceding suggestions are not adopted; (4) provide a de minimis fair market value or minimal number of days of usage pennitted without causing a deemed distribution from the foreign trust; (5) explain how the uncompensated use of trust property should be reported when more than one U.S. person simultaneously uses the same property; and (6) clarify the reporting requirements imposed on a U.S. beneficiary with access to trust property who allows another individual to use the property. Pursuant to the HIRE Act, the scope of Section 679 was expanded so that a foreign trust is now treated as having a U.S. beneficiary if any of the following are true: (1) a U.S. beneficiary's only interest in the trust is contingent on a future event (Section 679(c)(l»; (2) any person has discretion to make trust distributions, unless the te.nns of the trust specifically identify the class of persons to whom such distributions may be made and none of those persons are U.S. persons during the taxable year (Section 679(c)(4»; (3) agreements or understandings regarding the accumulation or payment of income or corpus to a U.S. person exist between the foreign trust and a U.S. person who directly or indirectly transferred property to the foreign trust (Section 679(c)(5»; or (4) the foreign trust received transfers from a U.S. person, unless such person demonstrates that the trust does not have any U.S. beneficiaries (Section 679(d». The AICPA requested that guidance be issued that would address: (i) the treatment of foreign trusts that pennit the exercise of limited powers of appointment in favor of U.S. persons; (ii) the types of agreements or understandings between a foreign trust and a U.S. transferor that would be treated as tenns of the trust agreement; and (iii) how a U.S. transferor may demonstrate that the trust does not have any U.S. beneficiaries. 6

9 Finally, Section 6038D (added to the Intemal Revenue Code by the HIRE Act) requires disclosure of "specified foreign financial assets" held by U.S. persons if the aggregate value of all such assets exceeds $50,000. Specified foreign financial assets are defined to include interests in any foreign entity, and the term foreign entity means any entity that is not a U.S. person. Sections 6038D(b)(2)(C) and 1473(5). The AICPA requested guidance as to whether a beneficiary of a foreign trust is required to report his interest in such trust as an interest in a foreign entity under Section 1473(5), and if so, how such interest should be valued for purposes of determining whether the $50,000 reporting threshold has been met. VI. Section 691 (Recipients of Income in Respect of Decedents) A. Private Letter Ruling (Apr. 22, 2011) - Beneficiary'S Assignment of IRAs to Special Needs Trust Not a Sale, Disposition or Transfer. Fact::, Beneficiary'S father died owning two individual retirement accounts (two.~'iras") of which Beneficiary and his siblings were the designated beneficiaries. Beneficiary is a disabled person eligible to receive government benefits. Beneficiary proposed to transfer his share of the IRAs to a new IRA benefiting Special Needs Trust and its beneficiaries. Beneficiary is the sole beneficiary of Special Needs Trust during his lifetime. The terms of Special Needs Trust provided that Trustee may make discretionary distributions of income (and corpus, to the extent income and Beneficiary'S other resources are insufficient) from Special Needs Trust for Beneficiary'S benefit and welfare. Trustee may not invade the corpus of Special Needs Trust if such invasion will cause any reduction or elimination of Beneficiary'S govemment benefits. Upon Beneficiary'S death, any remaining property of Special Needs Trust will be distributed to State as reimbursement for assistance provided to Beneficiary during his lifetime, with any excess trust property passing to Beneficiary'S issue or siblings. Trustee requested rulings from the Service regarding the tax consequences of the proposed transfer of Beneficiary's share of his father's IRAs. Law, Analvsis & Conclusions. Section 691(a)(1) provides that the amount of all items of gross income in respect of a decedent ("IRD") that are not properly includible in the taxable year of the decedent's death (or a prior period) must be included in the gross income of (A) the decedent's estate (if the right to receive the amount is acquired by the decedent's estate from the decedent); (B) the person who acquires the right to receive the amount by reason of the decedent's death (if the right to receive the amount is not acquired by the decedent's estate from the decedent); or (C) the person who acquires the right to receive" the amount by bequest, devise or inheritance from the decedent (if the amount is received after a distribution by the decedent's estate of such right). Section 691(a)(1). Section 691(a)(2) provides that if a right described in Section 691 (a)(1) to receive an amount is transferred by the decedent's estate or a person who received such right by reason of the decedent's death or by bequest, devise or inheritance from the decedent, then such estate or person must include the fair market value of such right at the time of such transfer (or any consideration received for the transfer, if greater), in his, her or its gross income for the taxable period in which the transfer occurs. Section 691(a)(2). Revenue Ruling holds that a distribution to the beneficiary of a decedent's IRA equal to the amount of the balance in the IRA at the decedent's death (less any non-deductible contributions) is IRD under Section 691(a)(1) that is includable in the beneficiary's gross income for the tax year in which the distribution is received. Revenue Ruling 92-47, LR.B. 6 (1992). 7

10 Section 677(a) provides that the grantor shall be treated as the owner of any portion of a trust whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be: (1) distributed to the grantor or the grantor's spouse; (2) held or accumulated for future distribution to the grantor or the grantor's spouse; or (3) applied to the payment of premiums on policies of insmance on the life of the grantor or the grantor's spouse. Section 677(a). Finally, Revenue Ruling concludes that if a grantor is treated as the owner of a trust, he or she is considered to be the owner of the trust assets for federal income tax purposes. Revenue Ruling 85-13, LR.B. 28 (1985). Based on the facts and circumstances presented in this case, the Service concluded that Beneficiary would be treated as the owner of (at least a portion of) Special Needs Trust under Section 677(a) following the transfer of his share of the IRAs to the trust. Therefore, assuming Beneficiary's transfer of his share of the IRAs was not a gift, the Service determined that such transfer would not be a sale or disposition for federal income tax purposes or a transfer under Section 691 (a)(2). VII. Section 1014 (Basis of Property Acguired from a Decedent) A. Administration's Fiscal Year 2012 Revenue Proposals ("2011 Greenbook"). In February, the Obama Administration released its Fiscal Year 2012 Revenue Proposals (the "2011 Greenbook"). The 2011 Greenbook includes a proposal that would require consistency in values used for transfer tax and income tax purposes. Similar proposals were included in the 2009 and 2010 Greenbooks as well. More specifically, the 2011 Greenbook proposes requirements that (1) the recipient's basis in property received by reason of the transferor's death under Section 1014 be equal to the value of that property for federal estate tax purposes in the transferor's estate; (2) the recipient's basis in property received as a gift dming the donor's lifetime be equal to the donor's basis in the property under Section 1015; and (3) the recipient's basis in property received by reason of the death of a transferor to whose estate Section 1022 is applicable be the lesser of the decedent's adjusted basis or the fair market value of the property on the date of the decedent's death. The proposal would require that the recipient's basis in the property received be no greater than the value of the property as detemlined for federal estate or gift tax purposes (subject to subsequent adjustments). The proposal would also impose a new repoliing requirement on the executor of the decedent's estate and on the donor of a lifetime gift to provide necessary valuation infol111ation to the recipient of the property and the Service. Finally, the proposal would grant regulatory authority to provide detailed rules for situations in which (i) no estate or gift tax return is required; (ii) a surviving joint tenant or other recipient has better information than the executor; and (iii) there is an adjustment to reported value after the gift or estate tax return has been filed. The 2011 Greenbook indicates that these proposed changes would produce estimated revenue of $2,095,000,000 over the next ten years. 8

11 VIII. Section 1022 (Treatment of Property Acquired from a Decedent Dving After December 31, 2009) A. Notice and Request for Comments - Form 8939 (Allocation of Increase in Basis for Property Acquired From a Decedent). On March 7, 2011, the Service issued a request for comments regarding Form 8939 (Allocation of Increase in Basis for Property Acquired From a Decedent). Form 8939 is an informational return that will be used to establish basis for income tax purposes of property acquired from a person who died in Section 6018 requires that Form 8939 be filed by the executor of a decedent's estate if: (1) the fair market value of all property (other than cash) acquired from such decedent is more than $1,300,000; (2) in the case of a decedent who was a nonresident not a citizen of the United States, the total fair market value of tangible personal property situated in the United States and other property acquired from the decedent by a United States person is greater than $60,000; or (3) appreciated propeliy acquired from the decedent was acquired by the decedent by gift within three years of the decedent's death and a gift tax return was required to be filed repoliing such transfer to the decedent. Section 60 18(b). The deadline for written comments regarding Form 8939 was May 6, Fed. Reg. 12,416 (Mar. 7, 2011). Note that the Individual and Fiduciary Income Tax Committee, the Estate and Gift Tax Committee and the International Tax Planning Committee of the Real Property, Trust and Estate Law Section of the ABA and the Fiduciary Income Tax Committee of the Tax Section of the ABA submitted their comments on the draft Form 8939 to Commissioner Shulman on January 31, Robert Chapman of the Service's Forms Desk responded to those comments in a telephone conference with the Chairperson of the Individual and Fiduciary Income Tax Committee on February 3, At that time, Mr. Chapman communicated that: (1) the decedent's estate may be listed as the recipient of the decedent's property if the property has not yet been transferred to a beneficiary (and the Service may not require a report or amendment when the property is subsequently distributed to the beneficiary); (2) Form 8939 will include a place to allocate the decedent's generation-skipping transfer tax exemption so that estates need not file both FornlS 8939 and 706 (the Service may add Schedule R from Form 706 to Form 8939); (3) the mere act of filing Form 8939 may constitute an affirmative election out of the estate tax rules and into the modified carryover basis regime (rather than requiring that a box be checked on Fonn 8939); (4) final drafts of Form 8939, Instructions for Form 8939, and Publication 4895 (Tax Treatment of Property Acquired from a Decedent Dying in 2010) are expected to be released in May 2011; (5) the Service is disinclined to allow protective elections out of the estate tax rules; and (6) property sold by an estate will not qualify for the $3,000,000 spousal basis adjustment, even if the proceeds are subsequently distributed to the decedent's surviving spouse. He also noted that additional guidance regarding the following would be forthcoming: (i) the due date for Form 8939; (ii) instructions for amending and extending the due date for Form 8939; (iii) how the carryover basis rules apply to various interests in community property; (iv) whether appraisals must be attached to Form 8939, whether a de minimis exception will be available, and whether grouping will be allowed; and (v) the responsibilities of multiple fiduciaries. 9

12 B. IRS News Release IR (Mar. 31, 2011) - Deadline for Filing Form 8939 Extended Beyond April 18, On March 31, 2011, the Treasury Department and Service announced that Form 8939 (Allocation of Increase in Basis for Property Acquired From a Decedent) would not be due on April 18,2011 and that the Fon11 should not be filed with the final Form 1040 (U.S. Individual Income Tax Return) of persons who died in The News Release also stated that new guidance announcing the due date for Form 8939 would be issued at a later date and that the final version of Form 8939 would be released soon thereafter. That guidance will also provide a deadline for electing to have the estate tax rules not apply to estates of persons who died in 2010 and will explain the manner in which an executor of such an estate may make such election. Finally, the News Release assures that a reasonable period of time for preparation and filing will be given between the issuance of such guidance and the deadline for filing Form 8939 (the Service previously indicated on its website that the final Form 8939 would be released at least ninety days before it is required to be filed). The final Form: 8939 and instructions for its completion will be made available at As of April 29, 2011, the guidance and final Form 8939 have not yet been released (although a draft of Form 8939 as of December 16, 2010 is available). C. Publication 4895 (Tax Treatment ofpropeliy Acquired From a Decedent Dying in 2010) - Service Publishes Advice to Taxpayers Pending Release of Publication. In April 2011, the Service posted advice to taxpayers who acquired property from a decedent who died in The advice was released electronically at Publication 4895 as "Basis oflnherited Property Held by Decedents Who Died in 2010." The informal publication summarizes Section 301 ( c) of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law No , Dec. 17,2010), which allows the executor of the estate of any decedent who died in 2010 to elect that the estate tax rules do not apply and to have the modified carryover basis rules of Section 1022 apply to such estate instead. The Service advised that this election could impact the amount of taxes owed by persons who acquired property from such a decedent, and that the rules governing how to make this election and the effect of such an election are still under development. Once these rules have been developed, Publication 4895 (Tax Treatment of Property Acquired From a Decedent Dying in 2010) will be issued. The Service noted that as of April 18, 2011, persons who acquired property from a decedent who died in 2010 (a "Recipient") may not know whether the executor of the decedent's estate will elect to have the estate tax rules apply. Therefore, the Service counseled that a Recipient who sold propeliy in 2010 that was acquired from a 2010 decedent may need to request an extension to file his or her individual income tax return, estimate the gain or loss from such sale, and make any other estimates for the acquired property necessary to compute tax. Under these circumstances, if a Recipient owes additional tax because his or her reasonable estimates turn out to be incorrect, penalty relief will be available (although interest will accrue). 10

13 IX. Section 1361 (S Corporation Defined) A. Private Letter Ruling (Apr. 8,2011) - Permission Granted to Revoke ESBT Election and Extension Granted to File QSST Election. Facts. Trust was a shareholder of an S corporation and made an election to be treated as an Electing Small Business Trust (an "ESBT") under Section 1361(e). Trustee requested that the Service consent to revoke Trust's ESBT election and grant Trustee an extension of time to elect to treat Trust as a Qualified Subchapter S Trust (a "QSST") under Section 1361 (d). Law, Analysis & Conclusion. Treasury Regulation Section (m)(6) provides that an ESBT election may be revoked only with the consent of the Commissioner. Treas. Reg. Section (m)(6). The application for consent to revoke the election must be submitted to the Service in the form of a private letter ruling request. Treas. Reg. Section (m)(6). Treasury Regulation Section (c}.provides that the Commissioner may grant a reasonable extension of time to make a regulatory election. Treas. Reg. Section (c). Treasury Regulation Section (a) provides that a request for such relief will be granted when a taxpayer provides satisfactory evidence that the taxpayer acted reasonably and in good faith and the grant of relief will not prejudice the interests of the government. Treas. Reg. Section (a). Based on the facts submitted and the representations made in this instance, the Service (1) allowed Trustee to revoke the ESBT election; (2) determined that the requirements of Treasury Regulation Section had been satisfied; and (3) granted Trustee an 120-day extension of time to file a QSST election for Trust effective as of the date the ESBT election was revoked. B. Private Letter Ruling (Apr. 22,2011) - Failure to File QSST Election Caused Inadvertent Termination of S Corporation Status. Facts. Grantor was the sole shareholder of Corporation when Corporation initially elected to be treated as an S corporation. Grantor later transferred all of his shares of Corporation to a revocable trust that was treated as owned by Grantor under the grantor trust rules of Sections 671 through 679. Grantor died, and following a reasonable period of administration after his death, the shares of Corporation were distributed to Trust Two and Trust Three for the benefit of Grantor's Wife. Each of Trust Two and Trust Three were intended to be a Qualified Subchapter S Trust (a "QSST"). During Wife's lifetime, she was the sole beneficiary of Trust Two and Trust Three, and both Trusts distributed all of their income to Wife. Trust Two was eligible to be a QSST, but Wife inadvertently failed to make a timely QSST election under Section 1361(d)(2). Trust Three would have been eligible to be a QSST, except that Wife had a lifetime limited power of appointment over the trust property. Wife disclaimed her power of appointment, but also failed to make a timely QSST election as to Trust Three. Upon Wife's death, the shares of Corporation were distributed from Trust Two and Trust Three to an individual who was then an eligible S corporation shareholder. As a result of the transfer of shares to Trust Two and Trust Three, Corporation's S corporation election was terminated. Corporation represented that the presence of ineligible shareholders and the termination of its S corporation election were inadvertent and not motivated by tax avoidance. In addition, Corporation and its shareholders agreed to make any adjustments 11

14 required by the Secretary consistent with the treatment of Corporation as an S corporation. Corporation requested a ruling that the termination of its S corporation status was an inadvelient termination within the meaning of Section 1362(f) and that the Corporation be treated as continuing to be an S corporation from the date of its initial election and thereafter. Law. Analysis & Conclusions. An S corporation, with respect to any taxable year is a small business corporation for which an election under Section 1362(a) is in effect for such year. Section 1361(a)(1). A small business corporation is a domestic corporation that is not an ineligible corporation under Section 1361(b)(2) and does not have (A) more than 100 shareholders; (B) a shareholder (other than an estate, a trust described in Section 1361(c)(2), or an organization described in Section 1361 (c)(6» that is not an individual; (C) a shareholder who is a nonresident alien; or (D) more than one class of stock. Section 1361(b)(1). Section 1361(c)(2)(A)(i) states that a trust all of which is treated for federal income tax purposes as owned by an individual who is a citizen or resident of the United States may be a shareholder in an S corporation. Section 1361(c)(2)(A)(i). Section 1361(c)(2)(A)(ii) states that a trust that was described in Section 1361 (c)(2)(a)(i) immediately before the death of the deemed owner and that continues in existence after such death may be a shareholder in an S corporation for the two-year period begilming on the date of the deemed owner's death. Section 1361 (c)(2)(a)(ii). Section 1361(d)(1) provides that in the case of a QSST with respect to which a beneficiary makes an election under Section 1361(d)(2), (A) such trust will be treated as a trust described in Section 1361(c)(2)(A)(i), and (B) for purposes of Section 678(a), the beneficiary of such trust will be treated as the owner of that poliion of the trust's S corporation stock to which the QSST election applies. Section 1361 (d)(1). Section 1362(f) provides that if (1) an election under Section 1362(a) by any corporation was terminated by such corporation ceasing to be a small business corporation; (2) the Secretary determines that the circumstances resulting in such termination were inadvertent; (3) no later than a reasonable period of time after the discovery of such circumstances steps were taken so that the corporation is a small business corporation; and (4) the corporation and each shareholder agree to make such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary, then such corporation shall be treated as an S corporation during the period specified by the Secretary. Section 1362(f). Based on the facts submitted and the representations made, the Service concluded that (1) Grantor's revocable trust was a pennitted shareholder from the date it first received shares of Corporation until the date of Grantor's death under Section 1361 (c)(2)(a)(i); (2) Grantor's revocable trust was a permitted shareholder from the date of Grantor's death until the date the shares were distributed to Trust Two and Trust Three under Section 1361 (c )(2 )(A)(ii); (3) the termination of Corporation's S corporation election upon the transfer of shares to Trust Two and Trust Three was inadvertent within the meaning of Section 1362(f); (4) Corporation would be treated as an S corporation from the date shares were transferred to Trust Two and Trust Three and thereafter, assuming Corporation's S corporation election was not otherwise terminated under Section 1362(d); (5) Trust Two would be treated as a QSST from the date it first received shares of Corporation and thereafter; and (6) Trust Three would be treated as a QSST from the date Wife disclaimed her limited power of appointment over Trust Three and thereafter. The relief granted was contingent upon a QSST election being filed for Trust Two and Trust Three 12

15 within 120 days and Wife being treated as the shareholder of the Corporation stock during the period such stock was held by Trust Two and Trust Three. X. Section 2053 (Expenses, Indebtedness, and Taxes) A. Estate of Bernard Shapiro v. United States, 634 F.3d 1055 (9th Cir. 2011) - Value of Palimony Suit May Be Deductible from Decedent's Gross Estate. Facts. Decedent and Girlfriend lived together for twenty-two years but never married. During that time, Girlfriend cooked, cleaned and managed the joint household, but she contributed no financial assets. After discovering that Decedent was involved with another woman, Girlfriend sued Decedent in state court claiming that she and Decedent had agreed to pool their resources and share in each other's assets. She alleged breach of contract, breach of fiduciary duty and quantum meruit. Decedent died while that action was pending. Girlfriend eventually settled her palimony claim (and a will contest) with Decedent's estate for approximately $1,000,000. After the claims were settled, Co-Executors filed an amended federal estate tax return seeking to deduct $8,000,000 from the value of Decedent's taxable estate under Section 2053(a)(3) for Girlfriend's palimony claim. The Service disallowed the deduction of the value of Girlfriend's palimony claim, and Co-Executors brought suit in federal district court seeking a refund of estate taxes paid. Estate of Bernard Shapiro v. United States, 2008 WL (D. Nev.), U.S.T.e. ~ 60,313 (Sept. 24,2008). Decedent's estate and the United States filed cross-motions for summary judgment, and the U.S. District COUli for the District of Nevada ruled in favor of the United States. Co-Executors appealed the judgment to the U.S. Court of Appeals for the Ninth Circuit. Law. Analysis & Conclusions. Section 2053(a)(3) provides that the value of a decedent's taxable estate is determined by deducting from the value of the gross estate the amount of any claims against the estate that are allowable by the laws of the jurisdiction in which the estate is being administered. Section 2053(a)(3). Section 2053(c)(1)(A) provides that a claim founded on a promise or agreement is deductible only to the extent it was "contracted bona fide and for an adequate and full consideration in money or money's worth." Section 2053(c)(1)(A). The District Court stated that if Girlfriend's claim were "rooted in a legal obligation, such as contract or quantum meruit, then the claim would be deductible." However, the District COUli concluded that Girlfriend's contributions of love, support and management of Decedent's household were not sufficient consideration to support a contractual agreement between her and Decedent. Therefore, the District Court concluded that Girlfriend's claim did not qualify as a deduction under Section 2053 because there was no legal obligation or contract between Decedent and Girlfriend. The U.S. Court of Appeals for the Ninth Circuit disagreed, stating that the District Court had erred in concluding that Girlfriend did not have a valid contract claim under state law and that love, support and homemaking services could indeed provide sufficient consideration to support a contractual agreement between cohabitants. The Court of Appeals held that homemaking services such as those provided by Girlfriend can be quantified and have a non-zero value attached to them. Because the value of such services and the value of Girlfriend's claim were questions of fact precluding summary judgment, the Court of Appeals reversed the grant of 13

16 summary judgment and remanded the case to the District COUli to determine the value of Girlfriend's services and the value of her claim against Decedent's estate. B. Estate o[sylvia Riese v. Commissioner, 101 T.C.M. (CCH) 1269 (Mar. 15,2011) - Accrued Rent Owed to QPR T Remainder Beneficiaries Deductible Despite Absence of Lease Agreement. Facts. Decedent established a three-year qualified personal residence trust (a "QPRT"), transferred her residence to the QPRT, and reported the transfer on her federal gift tax retum. The QPRT agreement provided that if Decedent survived the three-year term, the QPRT would terminate and the balance of the trust property would pass in equal shares to separate trusts for Decedent's daughters. Before Decedent executed the QPRT agreement, her attomey explained (orally and in writing) that Decedent would no longer own her residence after transferring it to the QPRT and that she would have to pay rent to her daughters' trusts if she remained in the residence upon termination of the three-year term.,... Following the expiration of the three-year term, Decedent continued to live in the residence until her unexpected death six months later. During those six months, Decedent continued to pay all of the property taxes, insurance, upkeep and maintenance on the residence. She did not pay rent or execute a written lease or rental agreement with her daughters' trusts. After Decedent's death, her estate assumed responsibility for and paid all property taxes, insurance, upkeep and maintenance costs associated with the residence until it was sold nearly one year later. The co-executors of Decedent's estate filed a federal estate tax return and did not include the value of the residence in the calculation of Decedent's gross estate. The co-executors claimed as a deduction under Section 2053 debts in the amount of (1) the net fair market rent payable to the daughters' trusts from the date the QPRT terminated until the date of Decedent's death; and (2) the net fair market rent payable to the daughters' trusts for approximately six months following Decedent's death. The Service examined Decedent's federal estate tax retum, included the value of the residence in Decedent's gross estate, and denied the deductions for predeath and post-death payments of rent. Law, Analysis & Conclusions. Section 2036(a)(1) provides, in pertinent part, that the value of a decedent's gross estate includes the value of all property transferred by the decedent, in trust or otherwise, in which the decedent has retained possession or enjoyment for his or her lifetime (or for any period that does not in fact end before his or her death). Section 2036(a)(l). Treasury Regulation Section (c)(l)(i) explains that "an interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred." Treas. Reg. Section (c)(1)(i). Although the Service argued that "nothing changed after the QPRT expired," the Tax Court found that Decedent did not retain a life estate in the QPRT residence and that there was no understanding, express or implied, at the time of the transfer to the QPR T that the Decedent could occupy the residence rent-free beyond the three-year term. Therefore, the Tax Court found that the value of the residence was properly excluded from the value of Decedent's gross estate. 14