Helpful Suggestions for Improving Compliance With Information Regarding Beneficiaries Acquiring Property from a Decedent (form 8971) and the Associated Basis Consistency Requirements

• Publication year: 2018
• Author: By Dennis I. Leonard and Alison B. Arnold

Helpful Suggestions for Improving Compliance with Information Regarding Beneficiaries Acquiring Property from a Decedent (Form 8971) and the Associated Basis Consistency Requirements1

By Dennis I. Leonard and Alison B. Arnold²

EXECUTIVE SUMMARY3

The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the "2015 Act")⁴ requires: (1) that the income tax basis of certain property acquired from a decedent's estate be consistent with its finally determined value for federal estate tax purposes; and (2) that the executor of a decedent's estate (and certain subsequent transferees of estate assets) disclose specific information regarding estate assets to both the Internal Revenue Service (the "Service") and any persons acquiring certain assets from the decedent's estate.⁵

Information regarding certain estate assets must be reported using Form 8971 (Information Regarding Beneficiaries Acquiring Property From a Decedent) and Schedule A thereto.⁶ Any person required to file a Form 8971 or Schedule A—including any person with an ongoing duty to supplement such forms, or any person involved in certain subsequent transfers of affected assets—is subject to penalties for: (i) failure to timely file; (ii) failure to file a corrected supplement; (iii) omission of required information; and/or (iv) inclusion of incorrect information.⁷ Beneficiaries who receive affected assets are similarly subject to penalties, plus the possibility of "zero basis" in those assets.⁸ Lastly, inaccurate compliance by an executor (or anyone with a duty to report) may rise to the level of a breach of fiduciary duty under applicable state law.⁹

These risks raise three primary concerns. First, the "basis consistency rules" were designed to raise $1.5 billion of revenue.¹⁰ Thus, examinations of the Form 8971—either as part of the estate tax return, and/or future income tax/fiduciary income tax returns involving property subject to basis consistency reporting—is likely. Second, there are certain ambiguities and open questions regarding Form 8971, Schedule A, their instructions, and the current and proposed regulations under Internal Revenue Code §§ 1014 and 6035, which impede optimal compliance. Third, the basis consistency rules impose continuing reporting obligations on successor fiduciaries, certain recipients of affected assets, and certain future transferees of such assets.¹¹ Those affected in the future may not be privy to the initial compliance (or may not even born yet), which creates the risk of undue burden and unfair penalties being imposed on such persons.

The Service deserves timely, accurate compliance both on the "frontend" (i.e., with respect to Form 8971 and Schedule A) and on the "backend" (i.e., with respect to supplemental informational reporting and income tax/fiduciary income tax compliance involving assets subject to basis consistency). Thus, it is good policy for Form 8971, Schedule A thereto, the applicable instructions, and governing regulations to be clear and easy to follow. This should reduce the time, expense, and risk for associated compliance, and result in more complete reporting to the Service.

This paper details some of the open issues affecting basis consistency reporting. There are currently risks and burdens for the Service, those tasked with "frontend" compliance, those tasked with ongoing reporting obligations, and those subject to basis consistency rules in connection with "backend" income tax/fiduciary income tax compliance. The risks to all could be mitigated through modest adjustments to Form 8971, Schedule A, and the accompanying instructions. Moreover, the authors understand that there is a current project to update and finalize certain proposed regulations affecting the basis consistency rules. Thus, we hope that this paper assists in the creation of additional guidance that is to the mutual benefit of the Service and taxpayers alike.

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I. DISCUSSION

A. Background 1. Summary of Relevant Provisions of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015

On July 31, 2015, President Barack Obama signed the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the "2015 Act") into law.¹² In relevant part, the 2015 Act imposes new reporting requirements with respect to both federal estate and income taxes.¹³ More specifically, it requires that executors of estates disclose to the Internal Revenue Service (the "Service"), and to certain persons acquiring interests in the decedent's estate, specific information about property acquired from a decedent, including the value of each property interest received.¹⁴ The purpose of this requirement is to ensure that the income tax basis of any property acquired from a decedent is consistent with the value of such property as finally determined for federal estate tax purposes.¹⁵

2. Basis Consistency Reporting Requirements

As a general rule, Internal Revenue Code ("IRC") § 1014(a) provides that the basis of property in the hands of a beneficiary of assets passing at death is the fair market value of the property at the date of the decedent's death. IRC § 1014(f)(1) provides that the basis of such property may not exceed its final value for estate tax purposes (subject to normal post-death basis adjustments). Where the final value has not been determined for estate tax purposes, the basis is the property's value as identified pursuant to the reporting requirements of IRC § 6035(a). IRC § 6035(a) works in conjunction with the basis consistency requirements of IRC § 1014(f)(1), requiring that the executor, and certain other persons acquiring any interest in the decedent's estate, furnish a statement to the Service (and other required persons) identifying the value of each property interest received from the decedent.

Form 8971 (Information Regarding Beneficiaries Acquiring Property From a Decedent) and Schedule A thereto are the means to report all required information to both the Service and certain recipients of assets from the decedent's estate.¹⁶ A fiduciary must include on Form 8971 and Schedule A certain property reported on the estate tax return that increases the value of the gross estate.¹⁷ Form 8971 and Schedule A are also used to report subsequent transfers of property previously reported (or required to be reported) with a basis determined in whole or in part by reference to the value of the property in the gross estate (e.g., a gift, like-kind exchange, involuntary conversion, or sale that is disregarded for income tax purposes).¹⁸ The proposed regulations include only four asset classes that are exempt from these general reporting requirements, namely: (i) cash (other than a coin collection or other coins or bills with numismatic value); (ii) income in respect of a decedent (as defined in IRC § 691); (iii) tangible personal property for which an appraisal is not required under Treas. Reg. § 20.2031-6(b); and (iv) property that has been sold, exchanged, or otherwise disposed of (and therefore not distributed to a beneficiary) by the estate in a transaction in which capital gain or loss is recognized.¹⁹

However, as written, Form 8971 and its accompanying instructions leave open several important questions that may expose executors (and other persons required to report) to potential penalties and liability for breach of fiduciary duties. There has been considerable commentary and speculation regarding: (i) to whom, and how, corrections and supplements to Form 8971 and/or Schedule A should be submitted; (ii) how penalties for filing errors are calculated; and (iii) when the duty to file exists.²⁰

Many of these lingering open questions have caused both executors and practitioners to reevaluate how fiduciaries, beneficiaries, and transferees can both: (i) manage their exposure to penalties under the 2015 Act; and (ii) assist the Service with clear and accurate compliance. Importantly, there is no statute of limitations for the Service to examine a previously filed Form 8971.²¹ Further, any adverse income tax consequences may not arise for many years, leaving fiduciaries exposed for prolonged periods of time, and affecting beneficiaries who might currently be minors, or might not even be born yet. With several questions left unaddressed by the form or its instructions, and potentially lingering exposure for fiduciaries and beneficiaries alike, additional guidance would be helpful.

II. OPEN QUESTIONS WITH RESPECT TO FORM 8971 AND ITS INSTRUCTIONS

Form 8971 was intended to better ensure consistent basis reporting for income and estate tax purposes.²² More specifically, the form provides beneficiaries and certain subsequent transferees with reported values of various assets from a decedent's estate tax return, which assists the Service in enforcing consistent reporting of such values on subsequent income tax returns.²³ However, as written, Form 8971 and its accompanying instructions leave open several important questions that may expose executors and other persons to potentially steep penalties and lingering liability. Eleven of these open questions are discussed in more detail below, together with suggested proposals on how best to address them.

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A. Open Questions 1. How Should Property Subject to a Decedent's General Power of Appointment Be Reported on Schedule A to Form 8971?

The basis consistency rules seem to clearly apply to assets over which a decedent possessed a general power of appointment.²⁴ This is logical because a general power of appointment is reported on Schedule H of Form 706 and increases the decedent's gross estate in a way that can directly increase transfer tax liability.²⁵ Thus, anyone in receipt of assets subject to the decedent's general power of appointment would be obligated to use a consistent basis r income tax purposes.²⁶

However, from a Form 8971 reporting perspective, assets subject to a general power of appointment do not always fit neatly within the...