Significant coverage was devoted at the recently concluded 51st Annual Heckerling Institute on Estate Planning in Orlando, Fla. to the Internal Revenue Service’s proposed regulations (proposed regs) concerning basis consistency and reporting for property acquired from a decedent. The governing rules, as well as the statutory background for these rules, are explained below.
The Highway Act
On July 31, 2015, then President Obama signed into law the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the Highway Act”). The Highway Act, among other things, added new provisions to Internal Revenue Code Sections 1014(f) and 6035 concerning basis consistency and reporting for property acquired from a decedent. These new provisions apply to federal estate tax returns filed after July 31, 2015 and have two primary components: (1) a substantive rule requiring basis consistency that’s set forth in IRC Section 1014(f); and (2) reporting requirements imposed upon executors and certain other persons under IRC Section 6035. The Highway Act also enacted related penalty provisions under IRC Sections 6662, 6721 and 6722. Congress left it to the U.S. Department of Treasury and the IRS to figure out how to implement these rules.
On March 4, 2016 the IRS published proposed regs under IRC Sections 1014(f) and 6035, which are summarized below.
Consistency of Basis with Estate Tax Return
Proposed Treasury Regulations Section 1.1014-10(a)(1) provides that a taxpayer’s initial basis in certain property acquired from a decedent may not exceed the “final value” of the property as that term is defined in Treas. Regs. Section 1.1014-10(c). This limitation applies to the property whenever the taxpayer reports to the IRS a taxable event with respect to the property (for example, depreciation or amortization) and continues to apply until the property is sold, exchanged or otherwise disposed of in one or more transactions that result in the recognition of gain or loss for federal income tax purposes. The property for this purpose includes any other property the basis of which is determined in whole or in part by reference to the basis of the property acquired from the estate or as a result of the death of the decedent (for example, as a result of a like-kind exchange or involuntary conversion).
Property that Increases Estate Tax Liability
The consistent basis requirement of Section 1014(f)(1) applies only to property the inclusion of which in the decedent’s gross estate for federal estate tax purposes increases the federal estate tax liability payable by the decedent’s estate. Proposed Section 1.1014-10(b) defines this property as property includible in the gross estate under IRC Section 2031, as well as property subject to tax under IRC Section 2106, which generates a federal estate tax liability in excess of allowable credits. The proposed regs specifically exclude all property reported on a federal estate tax return required to be filed by IRC Section 6018 if no federal estate tax is imposed on the estate due to allowable credits (other than a credit for a prepayment of that tax). In cases in which federal estate tax is imposed on the estate, the proposed regs exclude property that qualifies for a charitable or marital deduction under IRC Sections 2055, 2056 or 2056A because this property doesn’t increase the federal estate tax liability. In addition, the proposed regs exclude any tangible personal property for which an appraisal isn’t required under Treas. Regs. Section 20.2031-6(b) (relating to the valuation of certain household and personal effects) because of its value (generally there’s a $ 3,000 cutoff). Thus, if any federal estate tax liability is incurred, all of the property in the gross estate (other than that described in the preceding two sentences) is deemed to increase the federal estate tax liability and is subject to the consistency requirement of Section 1014(f).
Final Value of Property Acquired From a Decedent
Section 1014(f)(3) provides that, for purposes of Section 1014(f)(1), the “final value” of property has been determined for federal estate tax purposes if the value: (1) is reported on a federal estate tax return filed with the IRS and isn’t contested by the IRS before the period of limitation on assessment expires; (2) is specified by the IRS and isn’t timely contested by the executor of the estate; or (3) is determined by a court or pursuant to a settlement agreement with the IRS.
Proposed Section 1.1014-10(c)(1) defines the “final value” of property that’s reported on a federal estate tax return filed with the IRS. That value is the value reported on the federal estate tax return once the period of limitations on assessment for adjusting or contesting that value has expired. If the IRS determines a value different from the value reported, the final value is the value determined by the IRS once the estate can no longer contest that value. If the value determined or specified by the IRS is timely contested by the estate, the final value is the value determined in an agreement that’s binding on all parties or the value determined by a court once the court’s determination is final.
Proposed Section 1.1014-10(c)(2) provides that the recipient of property to which the consistency requirement applies may not claim a basis in excess of the value reported on the statement required to be furnished under Section 6035(a) (the value shown on the federal estate tax return) if the taxpayer’s basis in the property is relevant for any purpose under the IRC before the final value of that property has been determined under proposed Section 1.1014-10(c)(1). However, under Section 1014(f)(1), basis can’t exceed the property’s final value. Therefore, proposed Section 1.1014-10(c)(2) provides that if the final value is determined before the period of limitation on assessment expires for any federal income tax return of the recipient on which the taxpayer’s basis is relevant and the final value differs from the initial basis claimed with respect to that return, a deficiency and an underpayment may result.
After-Discovered or Omitted Property
The proposed regs clarify how the consistent basis requirement applies to property that’s discovered after the filing of the federal estate tax return or is otherwise omitted from that return. If this property would have generated a federal estate tax liability if it had been reported on the federal estate tax return that was filed with the IRS, proposed Section 1.1014-10(c)(3)(i) provides two different results based on whether the period of limitation on assessment has expired for the federal estate tax imposed on the estate. Proposed Section 1.1014-10(c)(3)(i)(A) provides that, if the executor reports the after-discovered or omitted property on an estate tax return filed before the expiration of the period of limitation on assessment of the estate tax, the final value of the property is determined under proposed Section 1.1014-10(c)(1) or (2), as described above. Alternatively, proposed Section 1.1014-10(c)(3)(i)(B) provides that, if the after-discovered or omitted property isn’t reported before the period of limitation on assessment expires, the final value of the after-discovered or omitted property is zero.
Finally, to address situations in which no federal estate tax return was filed, proposed Section 1.1014-10(c)(3)(ii) provides that the final value of all property includible in the gross estate subject to the consistent basis requirement is zero until the final value is determined under proposed Section 1.1014-10(c)(1) or (2).
Definition of Executor for Purposes of IRC Sections 1014(f) and 6035
The proposed regs adopt the definition of the term “executor” found in IRC Section 2203 applicable for federal estate tax purposes and expand it to include a person required to file a return under Section 6018(b).
Information Return and Statement(s) under Section 6035
The proposed regs define the term “Information Return” as the Form 8971, “Information Regarding Beneficiaries Acquiring Property from a Decedent,” including the “Statement” (Schedule A) to be provided to each person who’s received or will receive property from the estate or by reason of the decedent’s death.
Proposed Section 1.6035-1(a)(1) provides that an executor who’s required to file a federal estate tax return also is required to file the Form 8971 with the IRS to report the final value of certain property, the recipient of that property and other information prescribed by the Form 8971 and the related instructions. The executor also is required to furnish a Schedule A to each beneficiary who’s acquired (or will acquire) property from the decedent or by reason of the death of the decedent to report the property the beneficiary has acquired (or will acquire) and the final value of that property.
When No Form 8971 or Schedule A is Required Under Section 6035
The proposed regs provide that the filing requirements of Section 6035 don’t apply when the executor isn’t required to file an estate tax return by Section 6018. Thus, proposed Section 1.6035-1(a)(2) clarifies that the Form 8971 doesn’t have to be filed when an estate tax return is filed solely to make a portability election under IRC Section 2010(c)(5) or a generation-skipping transfer tax election or exemption allocation, when a federal estate tax return isn’t otherwise required to be filed under Section 6018.
Property to be Reported on the Form 8971 and Schedule A
Proposed Section 1.6035-1(b) defines the property to be reported on the Form 8971 and Schedule A as all property included in the gross estate for federal estate tax purposes with four exceptions:
- Cash (other than coins or papers bills with numismatic value);
- Income in respect of a decedent (for example, qualified retirement plans and individual retirement accounts);
- Those items of tangible personal property for which an appraisal isn’t required under Treas. Regs. Section 20.2031-6(b); and
- Property that’s sold or otherwise disposed of by the estate (and therefore not distributed to a beneficiary) in a transaction in which capital gain or loss is recognized. An open question here is what happens if property is sold at a fair market value (FMV) that’s precisely equal to basis so that no gain or loss results. This could very easily occur if property is sold soon after the decedent’s death because of the step-up in basis to FMV on death. In my view, the proposed regs should be modified to extend the fourth exception to cover this situation as well.
Beneficiaries
Proposed Section 1.6035-1(c)(1) provides that each beneficiary (including a beneficiary who’s also the executor of the estate) who receives property to be reported on the estate’s Form 8971 must receive a copy of the Schedule A reporting the property distributable to that beneficiary. Proposed Section 1.6035-1(c)(2) provides that, if the beneficiary is a trust, estate or business entity instead of an individual, the executor is to furnish the entity’s Schedule A to the trustee, executor or to the business entity itself, and not to the beneficiaries of the trust or estate or the owners of the business entity.
Commenters to an earlier IRS Notice requested guidance on how to comply with the Section 6035 reporting requirements when the executor can’t determine the exact distribution of the estate’s property and thus the beneficiary of each property by the due date of the Form 8971 and the related Schedule A’s. This situation can arise, for example, when tangible personal property defined in Treas. Regs. Section 20.2031-6 is to be distributed among a group of beneficiaries as that group determines, the residuary estate is distributable to multiple beneficiaries or when multiple residuary trusts are to be funded. In response, proposed Section 1.6035-1(c)(3) provides that, if by the due date the executor doesn’t yet know what property will be used to satisfy the interest of each beneficiary, the executor is required to report on the Schedule A for each beneficiary all of the property that could be used to satisfy that beneficiary’s interest. This results in the duplicate reporting of those assets on multiple Schedule A’s, but each beneficiary will have been advised of the final value of each property that may be received by that beneficiary and therefore will be able to comply with the basis consistency requirement, if applicable. Once the exact distribution has been determined, the executor may, but isn’t required to, file and furnish a supplemental Form 8971 and Schedule A.
Proposed Section 1.6035-1(c)(4) provides that, if the executor is unable to locate a beneficiary by the due date of the Form 8971, the executor is required to report that on that Form 8971 and explain the efforts taken to locate the beneficiary. If the executor subsequently locates the beneficiary, the executor is required to furnish the beneficiary with a Schedule A and file a supplemental Form 8971 with the IRS within 30 days of locating the beneficiary. If the executor is unable to locate a beneficiary and distributes the property to a different beneficiary who wasn’t identified in the Form 8971 as the recipient of that property, the executor is required to file a supplemental Form 8971 with the IRS and furnish the successor beneficiary with a Schedule A within 30 days after distributing the property.
Due Date for Information Return and Statements
Proposed Section 1.6035-1(d)(1) provides that the executor is required to file the Form 8971 with the IRS and to furnish each beneficiary with that beneficiary’s Schedule A, on or before the earlier of the date that’s 30 days after the due date of the federal estate tax return (including extensions actually granted, if any), or the date that’s 30 days after the date on which that return is filed with the IRS. Proposed Section 1.6035-1(d)(2) provides a transition rule for any federal estate tax return that was due on or before July 31, 2015, but that’s filed after July 31, 2015. In that case, the due date of the Form 8971 and all Schedule As is 30 days after the date on which the estate tax return is filed.
Supplemental Form 8971s and Schedule As
Proposed Section 1.6035-1(e)(1) and (2) generally requires a supplemental Form 8971 and corresponding supplemental Schedule A on a change to the information required to be reported on the Form 8971 or the Schedule A that causes the information as reported to be incorrect or incomplete. Such changes include, for example:
- the discovery of property that should have been, but wasn’t, reported on the federal estate tax return;
- a change in the value of property pursuant to an examination or litigation; or
- except as provided in proposed Section 1.6035-1(e)(3)(B), a change in the identity of the beneficiary to whom the property is to be distributed (for example, as a result of death, disclaimer, bankruptcy or otherwise).
Proposed Section 1.6035-1(e)(3) provides that a supplemental Form 8971 and Schedule A may be filed—although they aren’t required—to correct an inconsequential error or omission within the meaning of Treas. Regs. Section 301.6722-1(b) or to specify the actual distribution of assets previously reported as being available to satisfy the interests of multiple beneficiaries in the situation described in proposed Section 1.6035-1(c)(3), as described above.
Proposed Section 1.6035-1(e)(4) provides that the due date for the supplemental Form 8971 and each supplemental Schedule A is 30 days after:
- The final value (within the meaning of proposed Section 1.1014-10(c)(1)) of property is determined;
- The executor discovers that the information reported on the Form 8971 or Schedule A is otherwise incorrect or incomplete; or
- A supplemental Federal estate tax return is filed.
However, if these events occur prior to the distribution to the beneficiary of probate property or of the property of a revocable trust, a supplemental Form 8971 or Schedule A isn’t due until 30 days after the property is distributed. The preamble to the proposed regs expresses the belief that this is likely to be approximately the same time when the executor would provide the beneficiary with information as to changes, if any, to the basis of the property that have occurred since the decedent’s death and prior to the distribution. Because that basis adjustment isn’t part of what’s required to be reported under Section 6035, however, if the executor chooses to provide that basis adjustment information on the Schedule A provided to the beneficiary, the basis adjustment information must be shown separately from the final value required to be reported on the beneficiary’s Schedule A.
Subsequent Transfers
Section 6035(a)(2) imposes a reporting requirement on the executor of the decedent’s estate and on any other person required to file an estate tax return under Section 6018. The purpose of this reporting is to enable the IRS to monitor whether the basis claimed by an owner of the property is properly based on the final value of that property for estate tax purposes. According to the preamble to the proposed regs, the Treasury Department and the IRS are concerned that opportunities may exist in some circumstances for the recipient of such reporting to circumvent the purpose of the statute. The preamble cites as an example the making of a gift of the property to a complex trust for the benefit of the transferor’s family.
Relying on the regulatory authority granted to Treasury by Section 6035(b)(2), the proposed regs require additional information reporting by certain subsequent transferors in limited circumstances. Specifically, proposed Section 1.6035-1(f) provides that, with regard to property that previously was reported or is required to be reported on a Schedule A furnished to a recipient, when the recipient distributes or transfers (by gift or otherwise) all or any portion of that property to a related transferee, whether directly or indirectly, in a transaction in which the transferee’s basis for federal income tax purposes is determined in whole or in part with reference to the transferor’s basis, the transferor is required to file and furnish with the IRS and the transferee, respectively, a supplemental Schedule A documenting the new ownership of this property. This proposed reporting requirement is imposed on each such recipient of the property. For purposes of this provision, a related transferee means any member of the transferor’s family as defined in IRC Section 2704(c)(2), any controlled entity (meaning a corporation or any other entity in which the transferor and members of the transferor’s family, whether directly or indirectly, have control within the meaning of IRC Section 2701(b)(2)(A) or (B) and any trust of which the transferor is a deemed owner for income tax purposes. This last prong would appear to apply to a transfer by a transferor to his revocable living trust that’s an incomplete gift for gift tax purposes. In my view, the proposed regs should be modified to exclude a transfer to a trust of which the transferor is a deemed owner for income tax purposes where such transfer is an incomplete gift for gift tax purposes.
In the event such transfer occurs before a final value is determined within the meaning of proposed Section 1.1014-10(c), the transferor must provide the executor with a copy of the supplemental Schedule A filed with the IRS and furnished to the transferee reporting the new ownership of the property. When a final value is determined, the executor will then provide a supplemental Schedule A to the new transferee instead of to the transferor. The supplemental Schedule A is due no later than 30 days after the transferor distributes or transfers all or a portion of the property to the transferee.
Proposed Effective / Applicability Date
Once the proposed regs are finalized, they’ll apply to property acquired from a decedent or by reason of the death of a decedent whose estate tax return required by Section 6018 is filed after July 31, 2015. Taxpayers may rely upon these rules before the date of publication of the Treasury Decision adopting these rules as final in the Federal Register.
Kevin Matz is a Partner at the law firm of Stroock & Stroock & Lavan LLP in New York City