Recent Developments in the Estate and Gift Tax Area. Annual Business Plan and the Proposed Regulations under Section 2642

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1 DID YOU GET YOUR BADGE SCANNED? Gift & Estate Tax Recent Developments in the Estate and Gift Tax Area Annual Business Plan and the Proposed Regulations under Section 2642 #TaxLaw #FBA Username: taxlaw Password: taxlaw18

2 The Revenue Reconciliation Act of 2017 Increased the Applicable Exclusion Amount and the Generation - Skipping Transfer Exemption No Repeal of the Estate and Generation Skipping Transfer Tax Change to the Indexing of the Applicable Exclusion Amount and the Generation - Skipping Transfer Tax Exemption 2

3 Treasury-IRS Priority Guidance Plan The Guidance Plan is now divided into 5 parts: Part 1 of the Plan centers on initial implementation of Tax Cuts and Jobs Act. Part 2 of the Plan centers on eight regulations that were identified as a result of Executive Order Part 3 of the Plan includes projects that have been identified as burden reducing and that can be completed in the remaining months of the plan year, which runs to June 30, Part 4 of the Plan includes guidance relating to the new statutory partnership audit regime. Part 5 of the Plan describes additional projects that the Treasury Department and the IRS will focus on 3

4 Part 1 of the Guidance Plan Provided the Treasury Department and the IRS with the authority to issue regulations to appropriately consider the computation of estate and gift taxes to reflect changes in the basic exclusion amount. Added to the Priority Guidance Plan Announced on February 7, Guidance on computation of Estate and Gift Taxes to reflect changes in Basis Exclusion Amount. This is the Claw back Issue. 4

5 Part 2 of the Guidance Plan Treasury withdraws the proposed regulations under Section 2704 April 21, 2017, Executive Order was issued which instructed the Treasury Department to review significant tax regulations. July 8, 2017, the IRS issued Notice , which indicated that 105 temporary, proposed, or final regulations met at least one of the criteria described in the Executive Order. October 2, 2017, the Treasury Department announced that it would withdraw. The project was officially withdrawn on October 20, 2017 (82 Fed. Reg ). 5

6 Part 3 Near-Term Burden Reduction 1. Regulations under Sections 1014(f) and 6035 regarding basis consistency between estate and a person receiving property from a decedent. a. The requirement to provide estate tax values to beneficiaries 30 days after the estate tax return is filed. This frequently before an executor will know which beneficiaries will receive which assets. b. A requirement that succeeding transferors provide those estate tax values to recipients of gifts and other transferees in transactions that involve carryover basis. c. Zero basis for after discovered or omitted property. 6

7 Part 3 Near-Term Burden Reduction (continued) 2. Regulations under Section 2642(g) This project is a result of the addition of section 2642(g) to the Code in the 2001 Tax Act which directs the Treasury Department to issue regulations detailing the situations under which extensions of time will be granted to make allocations of GST exemption. Before the 2001 Tax Act, if a timely allocation was not made relief was not available. Subsequently, the IRS issued Notice , which provided that relief under section 2642(g) would be granted by seeking an extension under section of the Procedure and Administration regulations. Proposed Regulation was issued on April 16, These proposed regulations resemble the regulations under section above. Final regulations under this section will describe the circumstances in which relief will be granted to allocate GST exemptions. 7

8 Part 4 Partnership Audits Plan deals with the implementation of the 2015 legislation pertaining to partnership audit regulations. 8

9 Part 5 General Guidance 1. Basis of Grantor Trust Assets at Death The project will consider whether the assets held in a grantor trust will receive a step up in basis under section 1014 in situations in which an individual is considered the owner of the trust for income tax purposes but the same assets are not includible in the individual s gross estate at his or her death. 2. Final Regulations under Section 2032(a) Proposed Regulations were issued on April 25, The proposed regulations provided that the election to use the alternate valuation method under section 2032 is available to estates that experience a reduction in the value of the gross estate during the alternate valuation period, but only to the extent that the reduction in value is due to market conditions and not to other post-death events that occurred during the alternate valuation period. 9

10 Part 4 General Guidance (continued) New proposed regulations were issued on November 18, The new proposed regulations identify transactions that constitute distributions, sales, exchanges or dispositions of property. If an estate s property is subject to such a transaction during the alternate valuation period, the estate must value the property on the transaction date. The value included in the gross estate is the fair market value of that property on the date of and immediately prior to the transaction. 3. Guidance under Section 2053 It is expected that the project will address issues pertaining to personal guarantees and the application of present value concepts in determining the deductible amount of expenses and claims against the estate. 10

11 Items no longer on the Priority Guidance Plan Spousal Support Trusts Valuation of Promissory Notes Defined Value Formula Clauses Split Interest Charitable Trusts Gifts and Bequests from certain expatriates

12 Litigation Developments 1. Estate of Powell v. Commissioner, 148 TC No. 18 (May 18, 2017) The decedent, Nancy Powell, was in very poor health when her son, acting under a power of attorney, transferred approximately $10 million of cash and securities from her revocable trust to a family limited partnership (NHP) in exchange for a 99% limited partner interest. The decedent s two sons contributed unsecured notes for a 1% general partnership interest. The interest was valued based on a 25% discount for lack of control and marketability. On the same day the assets were transferred to the family limited partnership, son, acting under the power of attorney, transferred decedent s 99% interest to a charitable lead annuity trust (CLAT). The terms of the CLAT called for an annuity payment to a charitable organization for the remainder of decedent s life with the corpus of the trust divided between her two sons upon her death. The power of attorney only authorized gifts to the decedent s issue up to the annual exclusionary amount for federal gift tax purposes. Mrs. Powell died approximately one week after the transfer. 12

13 Estate of Powell v. Commissioner (continued) IRS argued that the $10 million in assets contributed to the FLP should be included in the decedent s gross estate without a valuation discount on three different grounds: First, the decedent retained at her death the possession, enjoyment, or right to the income from property she transferred to NHP or the right either alone or in conjunction with any person to designate the persons who shall possess the property transferred and thus is includible under Sec. 2036(a). Second, decedent retained, at her death, the power to alter, amend, revoke, or terminate the property transferred to the partnership and, thus, is includible under Sec. 2038(a). Third, decedent retained, at her death, a power to change the enjoyment of the 99% limited partnership interest in NHP through the exercise of a power by the decedent alone or in conjunction with any other person to alter, amend, revoke, or terminate the interest and, thus, is includible under Sec

14 Estate of Powell v. Commissioner (continued) In this case, the decedent could control distributions through her son acting as the general partner and as her agent. In addition, the only owners of the partnership other than the decedent were members of the family and the partnership did not conduct a business. The Tax Court had no trouble concluding that the value of the cash and securities transferred to the limited partnership should be included in the decedent s gross estate under Sec. 2036(a)(2). The court also determined that the son with power of attorney lacked authority to transfer the decedent s limited partnership interest to the CLAT and as a result, the 99% limited partnership interest was includible in the estate under Sec or Sec. 2038(a). Finally, the stated that even if the interest had been validly transferred to the CLAT, Sec. 2035(a) would have recaptured the assets for inclusion because the transfers occurred less than three years before the decedent s death. 14

15 2. Estate of Sommers v. Commissioner, 149 T.C. No. 8 (August 22, 2017) During his life, the decedent made transfers of art to an LLC and made gifts of LLC interests to his nieces under a net gift arrangement. When a donee agrees to pay the gift tax on the gift, the full amount of the property transferred is not treated as a taxable gift. Instead, the taxable gift is determined algebraically and is the difference between the total value of the property transferred and the gift on the net gift. After making the gifts, the decedent remarried his former wife and commenced a state court action against the nieces claiming there had been no effective transfer or gift of the artwork to the LLC or of LLC units to the nieces. An arbitrator in an Indiana action and a subsequent state court in New Jersey held that the gift transfers were effective. The decedent died shortly thereafter and following his death, the estate with his widow serving as executrix filed a Federal estate tax return claiming that the decedent had retained the power to alter, amend, revoke or terminate the gifts within the meaning of Sec so that the LLC units were includable in his gross estate (and arguably would pass in a manner that would qualify for the marital deduction). On audit, the IRS: 15

16 Estate of Sommers v. Commissioner (continued) 1) Reduced the amount of the LLC interest the executor had included in the estate under Sec. 2038, 2) Reduced the corresponding marital deduction, 3) Under Sec. 2035(b), included the value of the gift tax attributable to the gifts The Tax Court determined that the gift tax paid by the nieces was includible in the value of his gross estate. The parties, however, did not agree on whether that inclusion was offset by a deduction allowable in the same amount under Sec. 2053(a) since the gift tax liability was not paid until after the individual s death. 16

17 Estate of Sommers v. Commissioner (continued) The Tax Court rejected the estate s argument that denying a deduction for the estate s gift tax liability conflicted with the rationale for including the gift tax in the value of decedent s gross estate under Sec. 2035(b). In this case, the two state court actions determined that the transfer of the LLC interests was complete and could not be considered revocable transfers. Thus, the amount of the gift tax was includible in the decedent s estate. The court pointed out that if the gross-up were offset by a deduction of the same amount, there would be a complete exemption from gift tax that would frustrate the purpose of Sec. 2035(b). The estate was also unsuccessful in its attempt to apportion part of the estate tax liability to the nieces. The court ruled that New Jersey law only allows apportionment to individuals who received property included in the gross estate. Because the LLC units that held the artwork had already been transferred as gifts to the nieces prior to decedent s death, the LLC units were not included in the decedent s estate, and therefore, apportionment was not proper. 17

18 Estate of Sower v. Commissioner, 149 T.C. No. 11 September 11, 2017) Husband predeceased wife in 2012 and his estate had decrease unused exclusion amount (DSUE). Husband s estate elected portability for the DSUE, and when wife died in 2013, her estate claimed the husband s DSUE. IRS examined the husband s estate tax return as part of its examination into wife s estate tax return and determined there was a deficiency in wife s estate based on the return submitted by husband s estate (available DSUE was reduced by unreported taxable gifts). The wife s estate argued that IRS was not entitled to examine husband s estate tax return due to the statute of limitations and the letter accepting husband s estate tax return represented a closing agreement that barred IRS from examining his estate s return in the context of her estate s liability. The Tax Court held that the statute of limitations does not bar IRS from examining a deceased spouse s estate tax return to determine the DSUE amount available to the surviving spouse s estate under Sec. 2010(c)(2)(B). The Tax Court also held that a letter from IRS accepting a spouse s estate tax return is not a closing agreement and does not restrict an examination of the other spouse s estate tax return. This USNT Analysis addresses issues that are especially significant for clients in the PCS service line. 18

19 Green v. United States, - Appeal from Western District Oklahoma DC No. 5i 13 CV (10 th Circuit, January 12, 2018) The district court originally granted a motion for partial summary judgment in favor of the trust and found the trust statutorily entitle to deduct the fair market value (FMV) of properties at the time of the donation. The taxpayer donated real estate that had appreciated to various charities. The 10 th Circuit Court of Appeals held that the charitable deduction under Section 642(c) is limited to the adjusted base of property and not the FMV. The IRS argued on appeal that the trust never sold of exchanged properties, and therefore it never realized gains associated with their increases in market value, and was never subject to tax on those gains. 19

20 Revenue Procedure IRB 1282 Relief Procedure for Extension of time to Elect Portability This Revenue Procedure provides permanent relief for estate s to elect portability when the election has not been made on a timely filed estate tax return. Section 2010(c)(5)(A) requires that the portability election to be made on the estate tax return of decedent whose unused exclusion amount will be conveyed to his or her surviving spouse. A number of estates failed to meet the filing requirement. Under the Revenue Procedure, a late election is available if: 1. The decedent: a) Was survived by spouse, b) Died after 2010, c) Was a citizen or resident of the United States 20

21 Revenue Procedure Relief Procedure for Extension of time to Elect Portability (continued) 2. The executor was not required to file an estate tax return because it was under the threshold prescribed in section 6018(a). 3. The executor did not timely file an estate tax return. 4. The election is made on a complete and properly prepared Form A statement on the top of the Form 706 FILED PURSUANT TO REV. PROC TO ELECT PORTABILITY UNDER SECTION 2010(c)(5)(A). 6. Must be filed within two years of the decedent s date of death. If the estate fails to file under the revenue procedure within two years, it may still a private letter ruling request under section

22 Notice , I.R.B. 783 Relief for Same-Sex Couples The Notice acknowledges the decision in United States v. Windsor, 133 S. Ct. 2665, and hence forward, valid same sex marriages will be recognized for federal tax purposes. The Notice provides that same-sex couples who were validly married under state law at the time of a gift from one spouse to another can claim the gift tax marital deduction and the estate tax marital deduction for transfers at death. The deduction can be claimed even after the statute of limitations has run on the transfer. As a result, the transferor spouse can recover applicable exclusion amount and deceased unused exclusion amount. The transferor may need to file for relief under section to make a QTIP or QDOT election. 22 Generation-skipping transfer tax exemption allocated because the marital status was not recognized may be voided and recalculated even if the statute of limitations has run.

23 CCA Purchase of a GRAT remainder interest Grantor created three trusts. The first trust was an irrevocable trust for the benefit of the grantors first spouse and issue. Grantor s first spouse predeceased him. Grantor established two additional trusts, each of which were grantor retained annuity trusts. Grantor received the annuity payments, and the remainder was to be paid under the terms of the first trust. The day before the Grantor died he/she purchased the remainder interest, and the grantor retained annuity trusts for a promissory note. The CCA concludes that the deathbed purchase of the remainder interests did not replenish the Grantor s taxable estate. Therefore, the purchase wasn t for adequate and full consideration in money or money s worth. The remainder interest in this case would have been includible in the Grantor s estate, in any event under section 2036(a). Adequate and full consideration must be reducible to money value, and the grantor should receive something in return to make the grantor whole. The CCA also concludes that the notes were not deductible by the estate under section 2053(a) because it was a mere cloak for the gift. 23

24 Section 2642(g)(1)(A) - Some history Added to the Internal Revenue Code by the Economic Growth and Tax Relief Reconciliation Act of 2001(EGTRRA). Before (and after) EGTRRA, donors could make: 1) Timely allocation of Generation-skipping transfer (GST) tax exemption to a transfer. The value of the amount necessary to reduce the amount of the inclusion to zero was the value of the transfer on the date of the transfer. A timely allocation is one that was made on a timely filed gift tax return (Form 709) Section (b)(4)(ii). 2) Late Allocation of GST exemption. An allocation to a trust made on a Form 709 filed after the due date of the return is effective on the date the return is filed. Thus, if the value of the gift had appreciated, the amount of GST exemption necessary to reduce the inclusion ratio of the gift to zero had to be allocated to the trust. 24

25 Section 2642(g)(1)(A) - Some history (continued) 3) Issues. Many practitioners failed to understand the importance of making a timely allocation of GST exemption to a transfer to a trust. Sometimes the failure to allocate was discovered when the value of the property had significantly appreciated in value such that the inclusion ratio of the trust could not be reduced to zero. Think about the exploding value of the stock market in the 90s and that the GST tax was applied at a rate of 55 percent. 4) Amendment to the statue. EGTRRA added: The Deemed Allocation Rules in Section 2632(c) and Relief from late elections in section 2642(g) which allowed the IRS to issue regulations providing relief to taxpayers that had not timely allocated GST exemption. 25

26 Section 2642(g)(1)(A) Authorizes the Treasury Department to issue regulations prescribing the circumstances and procedures under which extensions of time will be granted to make an allocation of the GST exemption described in: I. Section 2642(b)(1) and (2) II. or to make an election under section 2632 (b)(3) and (c)(5) 26

27 Notice , C.B. 189 IRS announced that relief under section 2642(g) would be granted under section of the Procedure and Administration Regulations. This section provides standards the IRS applies to determine whether to grant an extension of time to make an election, when the due date is not expressly in the statute. 27

28 Section of the Procedure and Administration Regulations Relief is usually granted when a taxpayer can show the IRS that it acted: Reasonably, In good faith, and Granting relief will not prejudice the interest of the government. 28

29 Section of the Proposed Generation-skipping Transfer Tax Regulations Describe the factors that the IRS will consider when a transferor seeks an extension of time to: 1. Timely allocate GST exemption, and /or 2. Elect under section 2632 (b)(3) or (C)(5). Factors are similar to those found in section Transferor must establish that he acted reasonably and in good faith, and the government will not be prejudiced. 29

30 Proposed Regulations under (continued) Reasonableness and Good Faith Include 1. The transferor s intent to make a timely allocation or election as evidenced by the trust or transfer instrument or contemporaneous documents. 2. The occurrence of intervening events beyond the transferor s or executor s control that caused the failure. 3. The transferor s or executor s lack of awareness of the need to allocate or make the election after exercising reasonable diligence taking into account the transferor s or executor s experience and the GST tax issue s complexity. 4. Evidence of the transferor s consistency in making or not making the allocation or election. 5. The transferor s or executor s reasonable reliance on a qualified tax professional s advice. 30

31 Proposed Regulations under (continued) Prejudice to interest of the government I. The interests of the Government would be prejudiced to the extent to which the request for relief is an effort to benefit from hindsight. A factor relevant to this determination is whether the grant of the requested relief would permit an economic advantage or other benefit that would not have been available if the allocation or election had been timely made. II. The timing of the request for relief will be considered in determining whether the interests of the Government would be prejudiced by granting relief. III. The occurrence and effect of an intervening taxable termination or taxable distribution will be considered in determining whether the interests of the Government would be prejudiced by granting relief. The interests may be prejudiced if a taxable termination or taxable distribution occurred between the time for making a timely allocation or a timely election, and the time at which the request for relief was filed. 31

32 Proposed Regulations under (continued) Situations in which the standard of reasonableness, good faith, and lack of prejudice to the interests of the government has not been met 1. Timely allocations and elections. Relief will not be granted under this section to decrease or revoke a timely allocation of GST exemption. 2. Timing. Relief will not be granted if the transferor or executor delayed the filing of the request for relief with the intent to deprive the IRS of sufficient time to challenge the claimed identity of the transferor or the valuation of the transferred property for Federal gift or estate tax purposes. 3. Failure after being accurately informed. Relief will not be granted under this section if the decision made by the transferor or the executor of the transferor s estate (who had been accurately informed in all material respects by a qualified tax professional retained or employed by either (or both) of them with regard to the allocation of GST exemption or an election.) 4. Hindsight. Relief under this section will not be granted if the IRS determines that the requested relief is an attempt to benefit from hindsight rather than an attempt to achieve the result the transferor or the executor of the transferor s estate intended when the transfer was made. 32

33 Revenue Procedure , I.R.B. 142 This revenue procedure applies only to a taxpayer who satisfies the following requirements; 1. On or before December 31, 2000, the taxpayer made or was deemed to have made a transfer by gift to a trust from which a GST may be made; 2. At the time the taxpayer files the request for relief under this revenue procedure, no taxable distributions have been made and no taxable terminations have occurred. 3. The transfer qualified for the annual exclusion under section 2503(b), and the amount of the transfer, when added to the value of all other gifts by the transferor to that donee in the same year, was equal to or less that the amount of the applicable annual exclusion for the year of the transfer. 4. No GST exemption was allocated to the transfer, whether or not a Form 709 was filed: 5. At the time the taxpayer files a request for relief under this revenue procedures, the taxpayer has unused GST exemption available to allocate the transfer. 33

34 Revenue Procedure , C.B A valid QTIP election under section 2056 (b) (7) was made for the property or trust on the federal estate tax return (Form 706) for the transferor. 2. The reverse QTIP election under section was not made because the taxpayer relied on a qualified tax professional and that qualified tax professional failed to advise the taxpayer of the need, advisability, or proper method to make a reverse QTIP election. 3. The decedent has sufficient GST exemption after the automatic allocation under section 2632(e) to result in a zero inclusion ratio of the reverse QTIP trust or property. 4. The estate is not eligible for the automatic six-month extension under section (b), of the Procedure and Administration Regulations. 5. The surviving spouse has not made a lifetime disposition of all or any part of the qualifying income interest for life in the QTIP trust or property. 6. The surviving spouse is alive or no more than six months has passed since the death of the surviving spouse, and 7. Relief is requested by the executor in accordance with the procedure provided in Rev. Proc

35 35 The opinions and analyses expressed herein are subject to change at any time. Any suggestions contained herein are general, and do not take into account an individual s or entity s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. No warranty or representation, express or implied, is made by Andersen Tax, nor does Andersen Tax accept any liability with respect to the information and data set forth herein. Distribution hereof does not constitute legal, tax, accounting, investment or other professional advice. Recipients should consult their professional advisors prior to acting on the information set forth herein Andersen Tax LLC. All rights reserved.