Editor's Note: This is the final of three parts on the impact of the 2024 Green Book on trust and estate planning. Read Part 1. Read Part 2.
On March 9, the Biden administration released its proposed budget calling for an increase of trillions in federal spending along with his proposed offsetting revenue raisers in General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals (the 2024 Green Book.) The 2024 Green Book contains a number of changes that impact estate-planning strategies, as discussed in Parts 1 and 2. In addition, it contains proposals affecting valuation clauses and discounts and increased reporting about trusts, among other changes.
Valuation Clauses and Discounts
The estate, gift, and GST tax regimes (collectively “transfer taxes”) are taxes that are computed on the fair market value (FMV) of property transferred. Given the importance of the valuation of property, certain valuation and planning techniques have come under fire by the IRS. The 2024 Green Book contains three proposals related to valuations for transfer tax purposes.
To ensure a desired transfer tax outcome, estate planners have employed what’s referred to as a “defined value formula clause,” in which the amount transferred in a gift or bequest is based on a value as finally determined for transfer tax purposes. Formula clauses have long been used and accepted as part of testamentary estate planning, for example: a credit shelter trust is funded with the greatest amount possible without exceeding the decedent’s remaining exemption with the balance passing to a beneficiary that qualifies for the marital or charitable deduction. Similar approaches have been taken during lifetime gifting, especially with respect to hard to value assets, when the gift isn’t defined by the nature of the property transferred, but instead by a set dollar amount’s worth of such property as determined for gift tax purposes, including adjustments on audit. Such clauses have gained acceptance by the courts over the years, most notably in Wandry.
The government has consistently challenged the use of these defined valuation formula clauses on various policy grounds, such as disincentivizing audits because no tax liability would result from adjustments, incentivizing the undervaluation of property by taxpayers (implying there’s no downside risk to the taxpayer) and creating ambiguity in the actual ownership of property at the time of the transfer given the potential for adjustments. However, these policy arguments have been unpersuasive to the courts, with the U.S. Court of Appeals for the 9th Circuit even inviting the government to amend the Treasury regulations if it disagreed with judicial acceptance of such clauses. During the later years of the Obama administration, the Treasury Department did add a regulatory project to its Priority Guidance Plan on the subject, but the project was dropped after President Trump took office and hasn’t made a return. The 2024 Green Book proposes that starting next year “if a gift or bequest uses a defined value formula clause that determines value based on the result of involvement of the IRS, then the value of such gift or bequest will be deemed to be the value as reported on the corresponding gift or estate tax return.” The proposal includes only two exceptions for when a defined value clause will be allowed for transfer tax purposes. First, if the value is to be determined by someone other than the IRS (such as an appraiser) within a reasonably short period of time after the date of transfer. Second, if the clause is being used for estate tax purposes to define a “marital or exemption equivalent bequest…”
The second proposal seeks to disallow valuation discounts for the transfer of certain closely held entities. As the valuation of property is based on a FMV standard, the value of a transfer in partial or fractional interests in property isn’t necessarily the proportionate value of the underlying property, but instead considers factors hypothetical buyers and sellers would consider, such as discounts for lack of control and lack of marketability. The 2024 Green Book provides a synopsis of the government’s concern about a transfer of a partial or fractional interest as it “offers opportunities for tax avoidance when those interests are transferred intrafamily… they are not appropriate when families are acting in concert to maximize their economic benefits… artificially reducing the amount of transfer tax due.” The IRS proposed regulations under IRC Section 2704 in 2016 in an effort to address its concern, but the proposed regulations were ultimately withdrawn. The 2024 Green Book would amend Section 2704(b) to apply a new valuation rule to any intrafamily transfers in which the family collectively owns 25% or more of the transferred property. Under this proposal, discounts would be curbed for minority interests by making the value for transfer tax purposes be the pro-rata share of the FMV for the property collectively owned by the family. Discounts could still be applied to the family’s collective interest, if appropriate, but only to the extent attributable to a trade or business. Passive assets (that is, assets not actively used in the conduct of a trade or business), even if held in a trust or business, would be segregated and valued as if held directly by a sole individual.
The final proposal is a carryover from last year’s Green Book addressing the valuation of certain promissory notes. The specific type of transaction of concern that gave rise to the proposal is one in which a taxpayer provides assets to a related party (such as a family member but more often a trust for the benefit of a family member), in exchange for a promissory note that has the minimum interest rate required for the loan to not be treated as a below market loan under the Tax Code. For gift tax purposes, the promissory note is valued at face value, meaning that the transfer isn’t treated as a gift. However, when that promissory note is later gifted or included in a decedent’s gross estate, some taxpayers take the position that the FMV is worth less than the face value given various factors such as a low interest rate or lack of security. The 2024 Greenbook states that if the promissory note was originally treated as having a sufficient interest rate to avoid having any forgone interest treated as income or any part of the transaction treated as a gift, then for valuation purposes the interest rate from the loan will be the greater of: (1) the stated interest rate in the promissory note, or (2) the applicable IRS published rate at the date of valuation. In addition, the loan would be assumed to be short term to further avoid the application of discounts. This attempt to bring consistency of valuation standards related to promissory notes was previously raised for regulatory action in prior versions of the Treasury Department’s Priority Guidance Plan, before a statutory change was first proposed in last year’s Green Book.
Increased Reporting for Trusts
Last year’s Green Book introduced a provision requiring many trusts to report additional information on their tax returns. This proposal returns this year requiring all trusts (domestic and foreign if administered in the United States) with an estimated value over $300,000 at the end of a taxable year or $10,000 of income (in each case, indexed for inflation) to report information about its grantor, trustees and “general information with regard to the nature and estimated total value of the trust’s assets as the Secretary may prescribe.” Given the broad delegation to the IRS, no one can be certain how burdensome the reporting would be pending regulatory action. Regardless, with such low thresholds of value and income that would trigger the reporting obligation, this will be painful for all trusts and potentially cost prohibitive for some.
The 2024 Green Book adds GST tax reporting obligations on the annual fiduciary income tax return. Under the new provisions of this proposal, a return would need to report the GST inclusion ratio at the time of any distribution to a non-skip person. Further, the return must report any trust modification or transaction with another trust during the year. The proposal states that this is to provide the IRS “with current information necessary to verify the GST effect of any trust contribution or distribution…” This proposed reporting would likely require greater participation by the attorney in the preparation of the fiduciary income tax return.
Other Changes
There are three other proposals that carried forward from last year that estate planners might find interest in and aren’t going to capture any headlines. One would expand the application of the definition of “executor” under IRC Section 2203. Section 2203 applies when there’s no fiduciary appointed and acting in the United States, in which case, any person in actual or constructive possession of property in the decedent’s gross estate will be treated as the executor for estate tax purposes. The limitation to only estate taxes can be problematic as it doesn’t allow a party to represent the estate regarding income taxes, gift taxes and other filing obligations without a court appointed fiduciary. The provision can also be confusing in practice as multiple people could be an executor under Section 2203 by virtue of possessing even trivial amounts of the decedent’s property. Like last year, the 2024 Green Book proposes that the definition of “executor” apply for all taxes and grants the Treasury Department regulatory authority to establish a priority order when multiple parties meet the definition.
The second proposal would extend the special estate tax lien under IRC Section 6324 to continue during any deferral or installment payment period for estate taxes. Under current law, the lien ends after 10 years even if the liability hasn’t been paid.
The third proposal increases the cap on valuation decreases for special use property. The FMV of property for estate tax purposes is generally determined at the property’s highest and best use, but there’s an election that can be made under IRC Section 2032A allowing qualified real property or personal property to have its value reduced to reflect its actual use. Under current law, the reduction in value is capped at $1.31 million for decedents dying in 2023. The proposal would increase this cap to $13 million effective for those dying on or after the election date.
Advising Clients
As demonstrated by the number of repeat proposals, the Biden administration had little success in enacting any of its prior proposals. With a Republican-controlled House of Representatives, the administration’s chances of success only decreased when the new Congress took their seats. Nevertheless, it is important to keep track of all the proposals covered here because first, with the headlines about taxing HNW to pay for trillions in spending, advisors can be an informed resource for their clients by understanding the details; and second, these proposals could one day become law if political fortunes change, so understanding them helps identify current opportunities and potential future risks that could affect your clients. Third, it provides some insight into what the administration thinks requires statutory change versus regulatory guidance.