Recent developments in estate panning.

• Author: Ransome, Justin
• Position: Part 1

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This is the first in a two-part article examining developments in estate, gift, and generation-skipping transfer (GST) tax and trust income tax between June 2015 and May 2016. Part 1 discusses legislative and gift and estate tax developments, and Part 2 will discuss GST tax and trust tax developments as well as President Barack Obama's budget proposals and inflation adjustments for 2016.

Legislation

Surface Transportation and Veterans Health Care Choice Improvement Act of 2015

On July 31, 2015, the president signed the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (1) (the Transportation Act) into law. It contains certain estate and trust provisions.

Basis consistency: In general, Sec. 1014 provides that the basis of property received from a decedent is equal to its fair market value (FMV) as of the decedent's date of death. Despite this clear language, taxpayers have used Rev. Rul. 54-97 to argue that their basis upon the sale of inherited property is something other than FMV and have had some limited success in the courts. The revenue ruling holds that when determining a property's basis, the value of the property as determined for estate tax purposes is deemed to be its FMV at the time of inheritance, but it also permits a taxpayer to rebut this value by clear and convincing evidence unless the taxpayer is estopped by his or her previous actions or statements.

Congress enacted Secs. 1014(f) and 6035 to silence this argument by requiring the basis reflected on an estate tax return to be the same as the basis a person who inherits property from the estate uses to determine gain when it is sold.

Sec. 1014(f) provides that the basis of certain property acquired from a decedent, as determined under Sec. 1014, may not exceed the value of the property as finally determined for estate tax purposes, or if not finally determined, the value of that property as reported on a statement made under Sec. 6035. However, this section only applies to property whose inclusion in the decedent's estate increased the estate's estate tax liability.

Sec. 6035 imposes new reporting requirements for the value of property included in a decedent's gross estate for estate tax purposes. Sec. 6035(a) provides that the executor of any estate required to file an estate tax return must furnish the IRS and the person inheriting any interest in property included in the decedent's gross estate, a statement identifying the value of each interest in that property as reported on the return and any other information the IRS prescribes. The statement is required to be furnished at such time as prescribed by the IRS, but in no case at a time later than the earlier of (1) 30 days after the estate tax return was required to be filed (including extensions, if any); or (2) 30 days after the date the estate tax return is filed. Sec. 6035(b) authorizes the IRS to prescribe regulations, including regulations on property for which no estate tax return is required to be filed and for situations in which the surviving joint tenant or other recipient may have better information than the executor regarding the property's basis or FMV.

To enforce these provisions, the law enacted penalties. The Sec. 6724(d)(1) list of information returns subject to penalty for failure to file has been expanded to include the new Sec. 6035 income tax basis information returns. Sec. 6662 (accuracy-related penalty on underpayments) now imposes understatement penalties on "any inconsistent estate basis," which is defined in Sec. 6662(k) as existing "if the basis of property claimed on a return exceeds the basis as determined under [Sec.] 1014(f)."

These provisions apply to estate tax returns filed after July 31, 2015, the date of enactment. Thus, regardless of the decedent's date of death, an estate tax return filed after July 31,2015, is required to follow these new rules. The proposed regulations for these provisions are discussed in the "Estate Tax" section in this article.

The basis consistency provisions have long been on the list of revenue raisers in the president's annual budget. They bring into harmony the conflicting objectives of executors of estates and their beneficiaries. Executors seek to minimize estate taxes by valuing property as low as allowable under the estate tax valuation rules, which lowers the basis for beneficiaries when they sell the asset. These consistency provisions should enhance communication between estates and beneficiaries. A beneficiary who knows he or she will soon be selling inherited property will have an interest in ensuring that the executor reports the FMV as accurately as possible on the estate tax return.

Extended filing due dates: The Transportation Act also directs Treasury and the IRS to extend the maximum filing due dates for a variety of returns--including the following trust returns:

* Form 1041, U. S. Income Tax Return for Estates and Trusts: 5%-month extension ending on Sept. 30 for calendar-year trusts. The current extension date is five months ending on Sept. 15.

* Form 5227, Split-Interest Trust Information Return-. Six-month extension beginning on the original due date. The current extension is three months.

* Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner. The 15th day of the third month after the close of the trust's tax year and a maximum six-month extension beginning on the original due date, which is already in the regulations.

* Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts: April 15 with a maximum extension for a six-month period ending on Oct. 15 (for calendar filers). Previously, the only way to extend Form 3520 was with the taxpayer's income tax return.

These changes apply to returns for tax years beginning after Dec. 31, 2015.

Protecting Americans From Tax Hikes Act

The Protecting Americans From Tax Hikes (PATH) Act of 2015, (2) enacted on Dec. 18,2015, retroactively extends to the beginning of 2015 a number of expired provisions and makes these extensions permanent; it also retroactively extended other provisions for 2015 and 2016. The PATH Act also included a couple of relevant amendments.

Charitable remainder trusts: The PATH Act amended Sec. 664(e) to provide a valuation rule for the early termination of a net income only charitable remainder unitrust (NICRUT) and a net income charitable remainder unitrust with a makeup provision (NIMCRUT). The valuation rule helps determine the amount of the grantor's income tax charitable contribution deduction for the tax year of trust termination by valuing the remainder interest passing to charity as equal to 5% of the net FMV of the trust assets (or a greater amount, if stated under the terms of the trust instrument) to be distributed each year, disregarding any net income limit.

In several private letter rulings, (3) the IRS had stated that the net income limit of NICRUTs and NIMCRUTs was required to be taken into account when valuing the remainder interest and then provided that a reasonable method of valuation would be to use the Sec. 7520 tables but disregarding Sec. 664(e), which provides an assumption that the trust's stated payout percentage is to be paid out each year. Instead, the IRS stated that the taxpayer should assume the payout percentage should be a fixed percentage that is equal to the lesser of the trust's stated payout percentage or the Sec. 7520 rate for the month of termination. The amendment to Sec. 664(e) makes it clear that the rule applies regardless of when the remainder interest is valued, not just at trust creation.

Gifts to Sec. 501(c)(4) organizations: The PATH Act also amended Sec. 2501(a), adding a new Sec. 2501(a) (6), which exempts from gift tax transfers to Sec. 501(c)(4) social welfare organizations, Sec. 501(c)(5) labor, agricultural, or horticultural organizations, and Sec. 501(c)(6) business leagues if the organizations are exempt from income tax under Sec. 501(a) and the transfer is "for the use of" the organizations.

A few years ago, the IRS was examining whether Sec. 501(c)(4) organizations were exempt from gift tax because these organizations had become a popular way to fund political campaigns and were therefore receiving enormous contributions. In September 2013, the IRS stated that it was looking at the issue but would not consider contributions to Sec. 501(c)(4) organizations subject to gift tax until it had made a final determination. (4) The IRS also invited Congress to settle the matter--which it has with the enactment of Sec. 2501(a)(6).

Gift Tax

Gifts/Bequests From Covered Expatriates

On Sept. 9, 2015, the IRS issued proposed regulations (5) on the tax on gifts or bequests from certain individuals who relinquished their U.S. citizenship or ceased to be lawful permanent residents of the United States (referred to as "expatriates") on or after June 17,2008.

The Heroes Earnings Assistance and Relief Tax Act of 2008 (6) added Sec. 2801, imposing a tax on covered gifts and covered bequests received by a U.S. citizen or resident from a covered expatriate. It applies regardless of whether the covered expatriate acquired the transferred property before or after expatriation.

Sec. 2801 defines "covered expatriate" by reference to Sec. 877A(g)(1): an individual who expatriates on or after June 17,2008, if on the expatriation date: (1) the individual's average annual net income tax liability is greater than $124,000 (indexed for inflation, $160,000 for 2015) for the previous five tax years; (2) the individual's net worth is at least $2 million (not indexed for inflation); or (3) the individual fails to certify under penalty of perjury that he or she has complied with all U.S. tax obligations for the five preceding tax years.

A U.S. citizen or resident who receives a covered gift or bequest must pay the tax. A domestic trust or a foreign trust (electing to be treated as a...