• Tax Court upholds review of return for portability of DSUE—In Estate of Sower v. Commissioner (149 T.C. No 11. (Sept. 11, 2017)), the Tax Court ruled against an estate and held that the Internal Revenue Service was able to review the return of a decedent’s deceased spouse for purposes of adjusting the deceased spousal unused exclusion (DSUE) applicable to the decedent’s return.
After Frank Sower’s death, his estate filed an estate tax return but didn’t use his entire basic exclusion amount. His return showed the remaining amount (the DSUE) to be over $1.2 million. After submitting the return, Frank’s estate received a letter from the IRS stating that the estate tax return was accepted as filed.
Frank’s wife, Minnie, survived him. On her death, her estate filed an estate tax return using Frank’s DSUE of over $1.2 million. However, as part of its examination of Minnie’s return, the IRS reviewed the calculation of the DSUE on Frank’s estate tax return. It determined that the DSUE wasn’t calculated properly because taxable gifts were omitted from the calculation. After reducing the amount of the DSUE available for Minnie’s estate to just over $282,000, the IRS found that estate tax was due, and it issued a notice of deficiency to her estate for $788,165.
Minnie’s estate filed a petition disputing the deficiency. First, the estate argued that the letter from the IRS to Frank’s estate should be treated as a closing agreement that binds the IRS. However, the court held that only particular IRS forms qualify as closing agreements. In the absence of the proper form, courts have held certain agreements reached between the IRS and an estate have bound the IRS as closing agreements but only when reached through a process of negotiation. In this case, the “accepted as filed” letter sent to Frank’s estate was neither one of the requisite forms nor an agreement obtained after negotiations.
In addition, Minnie’s estate argued that reviewing Frank’s estate tax return for the calculation of the DSUE was an improper second examination. However, the court again disagreed. First, it held there was no examination because an “examination” means a request for further facts. The IRS didn’t request any additional information from Frank’s estate, it just reviewed the returns already filed and in its possession. Second, if there were any such second examination, it was of Frank’s estate tax return, not Minnie’s. Minnie’s estate couldn’t use a purported second examination of Frank’s estate tax return to its own advantage.
The estate made several other unconvincing arguments based on statutory interpretation. It argued that the effective date of the statute didn’t allow the IRS to adjust the DSUE for gifts made before 2010. Lastly, it suggested that when the IRS applied the portability statute, it overrode the statute of limitations on assessment under Internal Revenue Code Section 6501, which violated due process. The court ruled against the estate on both claims.
This case is a reminder that if your clients use the DSUE, the IRS may review and examine the deceased spouse’s return with respect to the calculation of the DSUE when the surviving spouse files his gift or estate tax return, regardless of the statute of limitations under IRC Section 6501. However, under temporary regulations, the IRS may only assess additional tax on the deceased spouse’s estate within the statute of limitations period.
• Treasury to withdraw IRC Section 2704 proposed regulations—On Oct. 2, 2017, the Treasury issued a report (the October report) to implement President Executive Order 13789, which directed the Treasury to identify proposed, temporary and final regulations for withdrawal, revocation or modification because they are unnecessary, unduly complex or excessively burdensome or fail to provide clarity and useful guidance.
The October report recommends that the proposed regulations under Section 2704 be withdrawn, finding them to be a “web of dense rules and definitions” that are “unworkable.” The proposed regulations were an attempt to counteract state statutes and case law that, over time, have reduced the ability of Section 2704 to curtail artificial valuation discounts for interests in family controlled entities. The proposed regulations required an interest in an entity to be valued as if certain restrictions on withdrawal or liquidation didn’t exist, either in the entity’s governing documents or state law, without exception for active or operating businesses. Commenters noted that it wasn’t feasible to value an entity in a vacuum, as if there were no restrictions on liquidation or withdrawal. The Treasury agrees, and it plans to publish a withdrawal of the proposed regulations shortly.
• New revenue procedure governing private foundations’ grants to foreign charities—Revenue Procedure 2017-53 updates the procedure that private foundations (PFs) follow to make good faith determinations that a foreign grant recipient qualifies as a public charity.
Generally, PFs are restricted to making grants to charitable organizations. However, if a PF plans to make a grant to a foreign organization that doesn’t have U.S. charitable status, it may assess whether that grant recipient is the equivalent of a public charity. If it makes a good faith determination that the organization is the equivalent of a public charity, then distributions to that foreign organization won’t require “expenditure responsibility” under IRC Section 4945, and the grant may count as a “qualifying distribution” under IRC Section 4942. This determination by the PF is often referred to as an “equivalency determination.”
In 2015, regulations regarding equivalency determinations were finalized. These 2015 regulations provide that a PF’s determination will be considered made in good faith if it’s based on written advice that’s current and from a qualified tax practitioner concluding that the grant recipient is a qualifying public charity.
This new standard, which is elaborated under Rev. Proc. 2017-53, makes several changes to the rules under prior regulations. First, it broadens the class of qualified tax practitioners who can prepare the written advice. Second, it eliminates the special prior rule that allowed a PF to rely solely on grantee affidavits. Third, it now provides a rule for the period during which the PF can rely on that written advice.
Under the Rev. Proc., the written advice qualifies as “current” if the law relating to the advice hasn’t changed, and the factual information on which the advice is based is from the current or prior taxable year. As a result, written advice can remain current for two years.
A “qualified tax practitioner” is an attorney, CPA or enrolled agent. A PF may reasonably rely on the written advice in good faith. The standard isn’t met if the PF knows or should know that a qualified tax practitioner lacks knowledge of U.S. tax law relating to charities, or the practitioner wasn’t fully informed as to relevant facts or is otherwise relying on incorrect assumptions.
To meet the standard, written advice should show that the foreign grant recipient meets the general standards of a U.S. charity by including (among others):
• The grant recipient organization’s articles of organization, bylaws or other organizing document;
• The tax-exempt purposes of the organization;
• Confirmation that if the organization terminates or dissolves, its assets will be distributed to another charitable organization;
• Confirmation that the organization has no shareholders or members who have an ownership interest in its assets or income;
• Confirmation that the organization doesn’t attempt to lobby or influence legislation;
• A description of the past current and future activities of the organization;
• Confirmation that the organization hasn’t been designated as a terrorist organization; and
• Financial information and demonstration that the organization satisfies any applicable financial/support test.