Basis consistency: how to kill a fly with a bazooka.

• Author: Scott, Mark
• Position: Tax Law

Close to two years ago, large estates became subject to a new set of federal tax rules that impose additional, and sometimes onerous, reporting requirements on fiduciaries and force beneficiaries to take tax positions consistent with that reporting. The rules were intended to close an alleged income tax loophole for those who inherit property. The government estimates that the new rules will increase tax revenues by $1.54 billion over 10 years. (1) However, many tax practitioners think that this figure is grossly exaggerated; they question whether the loophole was meaningfully exploited in the first place. Moreover, the additional burden and cost to estates and beneficiaries of complying with the rules may outweigh any additional tax revenues. The Treasury Department and Internal Revenue Service have attempted to clarify the rules by releasing temporary and proposed regulations (2) and tax forms with two sets of instructions. (3) The guidance has been helpful, but there are still many unanswered questions.

Background

To understand the purpose and impact of the new regime, it is necessary to have a basic understanding of the income tax rules applicable to inherited property. When a beneficiary inherits property, that beneficiary generally is required to take an initial income tax basis in the property equal to its fair market value on the date of the decedent's death. (4) Then, if and when the beneficiary sells the property, the taxable gain or loss is determined using that basis (taking into account any applicable adjustments for depreciation, improvements, etc., between the dates of inheritance and sale). Traditionally, if a federal estate tax return was filed for an estate, the value reported on the return was presumed to be the fair market value on the date of the decedent's death. (5) The beneficiary could rebut the presumption with clear and convincing evidence. (6) In most cases, the value reported on the estate tax return was required to be used by the beneficiary as the initial basis.

The government feared that beneficiaries were ignoring the values reported on estate tax returns and overstating their basis in inherited property, leading to excessive depreciation deductions and smaller gains (or larger losses) on subsequent sales of the property. To combat the perceived abuse, Congress added two new sections to the Internal Revenue Code--[section] 6035, which requires fiduciaries of certain estates to report asset values to the estate's beneficiaries; and [section] 1014(f), which provides generally that a beneficiary's initial basis in inherited property may not exceed the value as finally determined for estate tax purposes. (7) These sections apply to each estate that files an estate tax return after July 31, 2015, provided the estate was required to file a return. (8) The due date of the estate tax return is irrelevant; if the return was due on or before July 31, 2015, but is filed after July 31, 2015, the estate will nevertheless be subject to the new rules.

The Reporting Requirement

As noted above, if an estate fiduciary (or other person) files an estate tax return--Form 706 for a U.S. citizen or domiciliary, or Form 706NA for a noncitizen nonresident--after July 31, 2015, and the return was required to be filed under [section] [section] 6018(a) and 6018 (b), then the fiduciary must comply with the new basis reporting requirements. (9) In 2017, an estate tax return is required to be filed whenever a U.S. domiciliary or citizen's gross estate, plus taxable gifts, exceeds the $5,490,000 applicable exclusion. (10) An estate tax return is required to be filed for a noncitizen, nonresident whose gross U.S.-situs property exceeds $60,000. (11)

To facilitate the new reporting regime, the IRS issued Form 8971, information regarding beneficiaries acquiring property from a decedent. In addition to filing Form 8971 with the IRS, the fiduciary must furnish to the person inheriting the property and to the IRS a statement that identifies the property received, including the value as finally determined, as prescribed by the Treasury secretary. The IRS prescribed statement is now in the form of Schedule A, an attachment to Form 8971.

Form 8971 and Schedule(s) A generally must be filed with the IRS no later than the earlier of 1) the date that is 30 days after the date on which Form 706 or 706-NA is required to be filed (including extensions); or 2) the date that is 30 days after the date that the Form 706 or 706-NA is actually filed. However, if the estate tax return is filed late, then the Form 8971 and Schedule(s) A are due 30 days after the filing date. In addition, the fiduciary must certify on Form 8971 the date (using the same time requirements) on which Schedule A was sent to each beneficiary.

However, no Form 8971 or Schedule A is required to be filed when 1) the Form 706 is filed solely to elect portability of the deceased spousal exclusion amount; 2) the gross estate plus adjusted taxable gifts is less than the basic exclusion amount; 3) the Form 706 was filed only for an allocation or election respecting the generation-skipping transfer tax exemption; or 4) estate tax-related compliance, such as Forms 706-QDT, 706-CE, and 706-GS(D), is filed. (12)

Form 8971, with attached Schedule(s) A, is a separate filing requirement from the Form...