Recent developments in estate planning.

• Author: Ransome, Justin P.
• Position: Part 2

This article is Part II of a two-part article that examines developments 1 in estate planning and compliance between June 2011 and May 2012. Part I, in the September issue, discussed developments regarding gift tax and trusts, an outlook on estate tax reform, and annual inflation adjustments for 2011 relevant to estate, gift, and generation-skipping transfer (GST) tax. This article covers developments in estate tax.

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Portability of Exemption

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (1) permits for the first time portability of the estate tax exemption between spouses so that a surviving spouse may use the unused estate tax exemption of the first-to-die spouse. If made permanent, this provision would eliminate the need for spouses to retitle property and create trusts solely to take full advantage of each spouse's estate tax exemption. Currently, this provision is effective if the first spouse dies after Dec. 31, 2010, and the second spouse makes gifts or dies before Jan. 1, 2013.

For a surviving spouse to use the deceased spouse's unused estate tax exemption, Sec. 2010(c)(5)(A) provides that the executor of the deceased spouse must file an estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return) that computes the unused estate tax exemption and makes the portability election. Notice 2011-82 (2) provides guidance on making the election.

Because it is assumed that married couples will want to make the portability election, Notice 2011-82 provides that by timely filing a properly prepared and complete Form 706, an estate is considered to have made the portability election without the need to make an affirmative statement, check a box, or otherwise affirmatively elect. If the estate does not want to make the portability election, it can do so by not filing Form 706. However, if an estate is obligated or chooses to file Form 706, the instructions for Form 706 provide that the executor can either attach a statement to Form 706 indicating that the decedent's estate is not making the election under Sec. 2010(c)(5) or enter "No Election under Section 2010(c) (5)" across the top of the first page of Form 706.

Note: On June 18, 2012, temporary (T.D. 9593) and identical proposed (REG-141832-11) regulations were issued superseding the notice and providing guidance on the portability of the deceased spouse's unused exemption (DSUE) amount. These regulations address various aspects of making the portability election and of using the DSUE amount by the surviving spouse.

Valuation

Generally the value of property includible in a decedent's gross estate is its fair market value (FMV) on the date of the decedent's death. Two special valuation provisions may be elected--under Sec. 2032, to value the property on the alternate valuation date (AVD), and under Sec. 2032A, to value real estate used in farming or another business based on its special use, rather than its highest and best use. Reproposed regulations were issued to limit the availability of the alternate valuation date provision, and a district court declared invalid a provision of the special use valuation regulations.

Alternate Valuation Date

A decedent's estate may elect to use the AVD if that date results in a valuation of the decedent's estate that is lower than its date-of-death valuation and results in a combined estate and generation-skipping transfer (GST) tax liability that would have been less than such liability on the decedent's date of death. For property that is distributed, sold, or otherwise exchanged within six months of a decedent's date of death, the AVD is the date of the distribution, sale, or exchange (the transaction date). For all other property includible in a decedent's gross estate, the AVD is the date that is six months after the decedent's date of death (the six-month date).

In 2008, the IRS issued proposed regulations (3) under Sec. 2032 in an attempt to change the result in situations similar to Kohler, (4) in which the Tax Court held that valuation discounts attributable to restrictions imposed on closely held stock pursuant to a post-death reorganization of the closely held company should be taken into consideration in valuing the stock on the AVD. On Nov. 18, 2011, these regulations were withdrawn and reproposed. (5)

The reproposed regulations would amend Regs. Sec. 2032-1 (c) to identify transactions that require the use of the transaction date for purposes of Sec. 2032 (nine types of transactions are listed). If an estate's property is subject to such a transaction during the alternate valuation period, the estate must value that property on the transaction date. The value included in the gross estate is the FMV of the property on the date of and immediately before the transaction.

Two exceptions to this general rule would allow the estate to use the six-month rule. One exception is for exchanges of interests in the same or different entities provided the FMVs of the interests before and after the exchange are deemed to be equal. The other exception is for distributions from a business entity, bank account, or retirement account in which the decedent held an interest at death provided the FMV of the interest immediately before the distribution equals its FMV immediately after plus the amount of the distribution.

Special Use Valuation

One of the statutory requirements to qualify for the special use valuation is contained in Sec. 2032A (b)(1) (B), which provides that 25% of the estate must consist of real property used in farming or another trade or business. Regs. Sec. 20.2032A-8 (a)(2) provides that while a Sec. 2032A election need not be made for all property that qualifies for the election, the property for which the election is made must meet the 25% threshold requirement in Sec. 2032A (b)(1)(B). In Finfrock, (6) more than 25% of the total value of the gross estate consisted of real estate used in a farming business, but the estate chose to make the special use valuation election for only one piece of farmland that, by itself, represented 15% of the total value of the gross estate. The issue before the district court was whether the regulation is a valid interpretation of the statute.

The district court applied the Chevron (7) test to determine whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, both the court and the agency must give effect to the expressed intent of Congress. If the statute is silent or ambiguous about the particular issue, a court must then determine whether the agency's interpretation is based on a permissible construction of the statute.

The district court noted that Sec. 2032A does not require that the election be made for real property constituting 25% or more of the value of the gross estate. The 25%-or-more requirement is only a threshold requirement in order to be able to make the election. Once the threshold is met, the only other requirement to qualify the property for the election is to designate the property in a tax recapture agreement. The court concluded that Congress did not require that the designation be of all or a certain percentage of the real property that otherwise meets the requirements of Sec. 2032A, so the statute unambiguously provides that an estate can elect the special use valuation for any portion of the property that qualifies. Noting that Regs. Sec. 20.2032A-8(a) (2) imposes an additional requirement to make an election under Sec. 2032A that is not included in the statute, the court ruled that the regulation was invalid.

Inclusion of Gift Tax

Sec. 2035 (b) includes in a decedent's gross estate for estate tax purposes the amount of gift tax paid by the decedent or the decedent's estate on any gift made by the decedent or the decedent's spouse during the three years prior to the decedent's death. In Estate of Morgens, (8) the Ninth Circuit affirmed the Tax Court's decision that gift tax paid within three years of the decedent's death on transfers of her interests in a qualified terminable interest property (QTIP) trust established upon the death of her husband was includible in her gross estate under Sec. 2035.

When the decedent's husband died, an election was made under Sec. 2056(b) (7) to treat the trust created at his death as a QTIP trust. Thus, an estate tax marital deduction on the husband's estate tax return was allowed for the property passing to the trust, and, when the wife died, the value of the trust would be includible in the wife's gross estate under Sec. 2044. Inclusion in the transfer tax base of the surviving spouse is the quid pro quo for allowing the marital deduction to the estate of the first spouse to die. If the surviving spouse attempts to terminate a QTIP trust during his or her life by giving away the income interest, the value of the income interest is subject to gift tax under Sec. 2511. In addition, Sec. 2519 provides that the surviving spouse is considered to make a gift of the remainder interest in the property. Sec. 2207A authorizes the surviving spouse to recover from the person who receives the remainder interest in the trust the amount of gift tax attributable to the deemed transfer of the remainder interest.

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