The Obama administration proposed its final budget, and the Treasury Department in turn released the accompanying Treasury Department’s General Explanation of the Administration's Fiscal Year 2017 Revenue Proposals (the 2017 Greenbook).1 While there are notable proposals for other parts of the Internal Revenue Code, the gift and estate tax section will be very familiar to those who’ve followed past proposals.2 In last year’s Greenbook, there were nine proposals related to the transfer tax system, which included the proposal to “Reform the Taxation of Capital Income” to close what the administration inexplicably claimed was the “trust fund loophole.” Out of the nine proposals from last year, eight of them didn’t make it into the statute book, but they did make it into this year’s Greenbook unchanged. The final proposal, to require consistency in the value for transfer tax purposes and income tax purposes, did make it into law, and the 2017 Greenbook seeks to expand what’s been enacted. Here’s a brief summary of the new consistency in value proposal, a summary of the eight other proposals that are consistent with last year and a recap on the Obama Administration's record in office on transfer tax provisions.
In each of the Obama administration’s Greenbooks, the administration proposed amending the basis rules related to gifted and inherited property. The concern was that there was a loophole in which a lower basis might be reported by an estate in an effort to minimize transfer taxes, while the transferee would take the position that the value at the time of death was higher to claim a higher basis under the step-up in basis rule under IRC Section 1014 to reduce the transferee's income tax liability. Under prior law, the value of property as reported for estate tax purposes was only presumptive and not conclusive for purposes of the transferee’s new basis under IRC Section 1014.3 This allowed for a beneficiary, who wasn't the fiduciary of the estate, to potentially claim a higher basis.4 Only in situations in which the transferee was a fiduciary or took some other action showing the transferee agreed to the estate tax value did the Internal Revenue Service have the ability to prevent an inconsistent position being taken by the estate and beneficiary.5
Past Greenbook proposals called for the estate of a decedent or the donor who made a gift to provide information to the transferee and barred the transferee from using a basis higher than that which was reported. On July 31, 2015, the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the 2015 Act) was enacted, which added Section 1014(f) and Section 6035 to the IRC. Section 1014(f) imposes the requirement that the basis reported by a beneficiary of an estate “shall not exceed” the value reported on the estate tax return. Thus, the rule isn’t necessarily about consistency, as it leaves the IRS in a position to challenge the basis reported by a beneficiary that’s no greater than the estate tax value. It merely ensures that any inconsistency would be in the government’s favor. Section 1014(f)(2) provides an important exception to the consistency rule in that it doesn’t apply to property that qualifies for the marital deduction or the charitable deduction.
Section 6035 imposes a reporting requirement on estates that are required to file an estate tax return to send statements to beneficiaries receiving property. The IRS recently released Form 8971, the form’s accompanying Schedule A and instructions for both. A critique of these documents could be an article unto itself. For purposes of this article, let’s just note that the reporting requirement is burdensome. Further, there are still uncertainties regarding the new provisions, which have repeatedly delayed the implementation of the reporting requirement of Section 6035 while the IRS continues to work on proposed regulations.6
The 2017 Greenbook proposal notes that the perceived abuse that was raised in prior Greenbooks was only partially addressed because the 2015 Act didn’t cover property: (1) transferred by gift (as Section 1014(f) has no bearing on the carry over basis rules of Section 1015), (2) that qualifies for the marital or charitable deduction because of the exception in Section 1014(f)(2), and (3) transferred by non-taxable estates (a point which some commentators have asked prior to the issuance of the 2017 Greenbook for regulatory guidance confirming).
To address the outstanding concerns of the administration, the 2017 Greenbook proposes two changes to expand the consistent basis-reporting requirement: First, it proposes that the donor will need to provide basis information to the beneficiary in situations in which the transfer must be reported on a federal gift tax return. This new requirement will create many of the same administrative headaches and increased professional fees for donors that the 2015 Act created for estates. Second, it proposes that the consistency requirement apply to property that qualifies for the marital deduction if the estate was required to file an estate tax return under Section 6018. This change should create no additional work for estates given that the current statutory regime and IRS forms require that this information be reported to beneficiary (whether it be the surviving spouse or a trust which qualifies for the marital deduction).
The eight remaining estate and gift tax proposals in the 2017 Greenbook continue the Obama administration’s theme of consistency by repeating prior proposals almost verbatim. They are:
- Bringing back 2009 rates and exemptions. Consistent with each Greenbook issued since the enactment of the American Taxpayer Relief Act of 2012 (ATRA), the 2017 Greenbook proposes rolling back the estate and generation-skipping transfer tax exemptions to $3.5 million and rolling back the gift tax exemption to $1 million, without indexing either for inflation. If enacted into law, the proposal would be effective for estates of decedents dying and for transfers made after Dec. 31, 2016. Gifts in excess of the decreased exemption made prior to Dec. 31, 2016 would enjoy grandfathered status.
- Limiting GRATs and sales to grantor trusts. This Greenbook proposal seeks to coordinate income and transfer tax rules by treating assets sold or otherwise exchanged with a grantor trust as includible in the grantor’s estate on death, or as a taxable gift on either the termination of grantor trust status or a distribution of the transferred assets during the grantor’s life. With respect to grantor retained annuity trusts (GRATs), the proposal prohibits a grantor from engaging in any tax-free exchange of assets with a GRAT. The proposal also requires GRAT transactions to come at a significant cost by imposing a minimum remainder (generally equal to the greater of 25 percent of the assets contributed to the GRAT or $500,000) and by imposing a minimum 10-year term on new GRATs.
- Tackling the “trust fund loophole.” Last year, President Obama’s State of the Union Address touted his proposal to plug the curiously-dubbed “trust fund loophole” by abrogating the carry-over basis rules and requiring a donor or decedent to recognize gain on a gift or bequest of appreciated property. That proposal makes an encore appearance in the 2017 Greenbook, together with its various caveats and carve outs. In addition to raising the capital gains rate to 24.2 percent and generally requiring the recognition of gain on gift or bequest, the proposal provides for two new income tax exclusions for gain recognized at death: first, a blanket exclusion for the first $100,000 of capital gain recognized; and second, an additional $250,000 exclusion for gain recognized with respect to any residence. Both exclusions would be portable to a decedent’s surviving spouse, although the portability mechanism is unclear. Transfers of tangible personal property (excluding collectibles), transfers to spouses, transfers to charity and transfers of qualified small business stock would also be exempt from recognition. Lastly, for family-owned businesses and other illiquid assets transferred at death, the proposal graciously provides a 15-year fixed-rate payment plan to families unable to marshal the liquidity needed to pay the tax.
- Limit duration of GST tax exemption. This proposal seeks to eliminate dynasty trusts, which the Obama administration considers “transfer tax shields.” While the Greenbook proposal doesn’t flatly prohibit such trusts, it does limit a trust’s GST exclusion to a period of no longer than 90 years, effectively subjecting multi-generational trusts to transfer tax approximately once every lifetime.
- Extending estate tax liens on closely held businesses. Under current law, an estate may avoid the forced sale of a family business by electing to defer the payment of estate tax for up to 14 years. The government’s lien on that business, however, only extends for 10 years. Because this mismatch has generated some collection headaches for the IRS, the Greenbook proposal seeks to unify these concepts by extending the estate tax lien throughout the 14-year deferral period.
- Turning up the heat on HEETs. This proposal takes aim at the health and education exclusion trust (HEET), a multi-generational trust that leverages the gift and GST tax exemptions for payments made for the education or medical care of another. Despite the good intentions of such trusts – protecting families from excessive education and medical costs for several generations – the Greenbook proposal would limit the exclusion from GST tax to payments made by a donor directly to a provider of medical care or to a school in payment of tuition. Notably, the President’s budget indicates that no revenue will be generated by this change in the near term.
- A Crummey crackdown. In response to perceived abuses by practitioners who’ve leveraged the annual exclusion by creating Crummey trusts with large classes of beneficiaries, many of whom are exceedingly unlikely to exercise the withdrawal power granted to them or to ever benefit from trust assets, the Obama administration has proposed eliminating the present interest requirement from the gift tax annual exclusion and limiting the application of the current gift tax annual exclusion to transfers to individuals or to trusts for the exclusive benefit of the donee, which are includible in the donee’s taxable estate (that is, IRC Section 2503(c) trusts). The proposal further limits a donor’s annual tax-free gifts to an aggregate value of $50,000.
- Expanding the definition of “Executor.” Under current law, the term “executor” only applies for estate tax purposes, raising a technical concern that an executor isn’t authorized to act on behalf of a decedent with respect to income or gift tax matters. This limitation is particularly salient in the context of estates attempting to disclose a decedent’s foreign assets through the Offshore Voluntary Disclosure Program and other income tax related matters. The Greenbook proposes a clarifying amendment, expanding the definition of “executor” to encompass all tax matters and granting the IRS regulatory authority to issue rules to resolve conflicts among multiple persons satisfying the definition.
Take Advantage of Planning Opportunities While Still Viable
Unfortunately for the Obama administration, it seems likely that its theme of consistency will extend to Congress, where the President’s ambitious attempts to generate new revenue from successful individuals has met with resistance from a Republican congressional majority. If the President and Congress should decide that gift and estate tax reform is the area in 2016 where they might work together and, in the President's words, “surprise the cynics again,” the President’s proposal to further amend the basis provisions of IRC Section 1014 and his plan to confront GRATs and sales to grantor trusts may be areas for development. In light of the Obama administration’s willingness to stay the course with regard to its gift and estate tax proposals (even in the face of significant opposition from Congress and from practitioners), successful individuals and their advisors should continue to be mindful of the legislative landscape and should take advantage of valuable planning opportunities while they remain viable.
1. Office of Management and Budget, Executive Office of the President, Budget of the United States Government, Fiscal Year 2017 (2016); Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals (Greenbook) (Feb. 2016)
2. See James I. Dougherty & Eric Fischer, “President Obama ‘Steps Up’ Attacks on Estate Planning Techniques,” WealthManagement.com (Feb. 11, 2015), http://wealthmanagement.com/print/estate-planning/president-obama-steps-attack-estate-planning-techniques; Edward A. Renn & James I. Dougherty, “Seven Old Ideas, a New Idea and a Crummey Idea,” WealthManagement.com (March. 11, 2015), http://wealthmanagement.com/estate-planning/seven-old-ideas-new-idea-and-crummey-idea.
3. Augustus v. Commissioner, 40 B.T.A. 1201 (1939); Rev. Rul. 54-97, 1954-1.
4. Technical Advice Memorandum 199933001.
5. See Janus v. Comm’r, T.C. Memo 2004-117, aff'd, 461 F.3d 1080 (9th Cir. 2006).
6. See Rev. Notice 2016-19; Rev. Notice 2015-57.