This is the first in a two-part article examining developments in estate, gift, and generation-skipping transfer (GST) tax and fiduciary income tax between June 2017 and May 2018. Part 1 discusses legislative, gift, and estate tax developments. Part 2 will discuss GST tax and trust tax developments as well as inflation adjustments for 2018.
Tax Cuts and Jobs Act
Although the title of P.L. 115-97 was stripped from the legislation due to a procedural move in Congress, it has been commonly referred to as the Tax Cuts and Jobs Act (TCJA). While the TCJA made sweeping changes to the income tax chapter of the Internal Revenue Code, it left the gift, estate, and GST tax sections of the Code relatively untouched.
Trusts and estates
Many of the changes to the income tax provisions for individuals (generally effective for tax years 2018 through 2025) also affect trusts and estates, which are generally treated as individuals unless otherwise provided in Subchapter J.
The maximum income tax rate for trusts and estates is now 37% and is reached when the trust has taxable income over $12,500 in 2018. (1)
The deduction under Sec. 67(a) for miscellaneous itemized deductions has been suspended. (2) However, in Notice 2018-61, Treasury and the IRS announced their intention to issue regulations clarifying that estates and nongrantor trusts may continue to deduct expenses described in Sec. 67(e) paid or incurred in the administration of an estate or a trust (that would not have been incurred if the property had not been held in the estate or trust), as well as deductions allowable under Secs. 642(b) (regarding the personal exemption) and 651 and 661 (both regarding distribution deductions). There had been some confusion as to whether the suspension of miscellaneous itemized deductions also suspended deductions provided for trusts and estates in Sec. 67(e). The notice (released July 13, 2018) puts to rest this uncertainty.
Also under the TCJA for the applicable period, the deduction under Secs. 164(a)(1)-(3) for state and local, personal property, and foreign taxes is limited to $10,000, and foreign real property taxes may not be deducted unless paid or accrued in carrying on a trade or business or for the production of income. (3)
Trusts and estates are eligible for the 20% deduction for qualified business income under new Sec. 199A. According to the Joint Explanatory Statement of the Committee of Conference, rules similar to (now repealed) Sec. 199 apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property under the limitation based on W-2 wages and capital. (4)
Estate, gift, and GST taxes
Although many predicted that the estate, gift, and GST tax regimes would be repealed in the tax reform effort, the TCJA does very little to these regimes except to exempt a number of taxpayers from them due to the size of their estates. Under the TCJA, for decedents dying, or gifts made, after Dec. 31, 2017, and before Jan. 1, 2026, the basic exclusion amount was increased from $5 million to $10 million, indexed for inflation occurring after 2011. For 2018, the basic exclusion amount is $11,180,000.
The TCJA also addresses the possible "clawback" issue in case a taxpayer uses up his or her applicable exclusion amount during life, the TCJA sunsets, and the basic exclusion amount returns to $5 million, indexed for inflation. Readers may remember that this same issue arose when the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act) (5) temporarily increased the applicable exclusion amount through 2012 to $5 million and, but for this provision being made permanent by the American Taxpayer Relief Act of 2012, (6) would have sunset, returning the applicable exclusion amount to $1 million. While the TCJA does not resolve the clawback issue, newly added Sec. 2001(g)(2) directs Treasury to issue regulations to address any difference between the applicable basic exclusion amount in effect at the time of the decedent's death and with respect to any gifts made by the decedent.
Surprisingly, the TCJA does not change the top estate tax rate of 40%, continues to allow "portability" of a deceased spousal unused exclusion (DSUE) amount, and does not change the basis step-up rules in Sec. 1014--all provisions that seemed likely to change under early blueprints put forth by Congress and the president. As previously stated, the change in the basic exclusion amount will exempt more estates from paying estate tax. However, for taxpayers who will still have taxable estates, estate planning will continue much in the same way it always has, with the exception that more modest estates subject to the estate tax might focus more on maximizing the income tax benefits that may come from the increase in the applicable exclusion amount, such as having assets transferred to someone in an older generation to get a step-up in basis without causing an estate tax liability to the older generation.
Purchase of remainder interest in trust
In Chief Counsel Advice (CCA) 201745012, the IRS Office of Chief Counsel determined that a donor's purchase of the remainder interests of two trusts constituted gifts and did not increase the decedent's gross estate for estate tax purposes because the donor retained an interest in the trusts under Sec. 2036.
The donor formed an irrevocable discretionary trust for the benefit of his spouse and issue. The trust was to terminate on the later of the death of the donor or that of his first spouse, when the principal and any accumulated income were to be distributed outright to the donor's issue per stirpes. The donor's first spouse predeceased him.
The donor then formed two grantor retained annuity trusts (GRATs), both of which were for the benefit of the donor and his issue. An annuity from both GRATs was payable to the donor for the term of each trust, with the remainder payable under the terms of the discretionary trust. The donor purchased the remainder interest of the GRATs from the trustees of the discretionary trust with two unsecured promissory notes. The next day, the donor died.
The donor's gift tax return reported the purchase of the remainder interests in the GRATs as nongifts, asserting that the donor received adequate and full consideration in money or money's worth. The donor's estate tax return deducted the value of the outstanding promissory notes payable to the trustees of the discretionary trust as claims against the estate.
The advice considered two issues: (1) whether the donor's deathbed purchase of the remainder interests constituted adequate and full consideration in money or money's worth for gift tax purposes, and (2) whether the notes given for the remainder interests were debt deductible by the estate for estate tax purposes.
Regarding the first issue, the IRS noted that under Sec. 2512(b), property transferred for less than an adequate and full consideration in money or money's worth is a gift to the extent the value of the property exceeds the value of the consideration. In Wemyss, (7) the Supreme Court determined that adequate and full consideration for gift tax purposes is that which replenishes or augments the donor's taxable estate. The IRS determined in the CCA that adequate and full consideration was not provided. The donor's gross estate was not increased by the purchase of the remainder interests because the remainder interests were already includible in the donor's gross estate under Sec. 2036 (which includes in a decedent's gross estate transfers in which the decedent retained a life estate). Thus, the remainder interests were not received in exchange for full and adequate consideration. The IRS concluded that the notes were a depletion of the donor's estate without a corresponding accretion and, thus, the notes were gifts to the discretionary trust.
Regarding the second issue, the IRS noted that Sec. 2053(c)(1)(A) allows a deceased's estate a deduction for claims against the estate, unpaid mortgages, or any indebtedness, when founded on a promise or agreement, to the extent that they were contracted in a bona fide transaction for an adequate and full consideration in money or money's worth. The companion case to Wemyss, Merrill v. Fahs, (8) determined that the gift tax and estate tax should be considered "harmoniously," and, thus, "adequate and full consideration" should have the same meaning for estate tax as for gift tax. Therefore, the Supreme Court determined, adequate and full consideration for estate tax purposes is that which replenishes or augments the donor's taxable estate. The IRS in the CCA determined that the debt was not the result of a bona fide transaction for full and adequate consideration because the property acquired with the notes did not increase the decedent's gross estate. As a result, the notes were not deductible on the decedent's estate tax return under Sec. 2053.
Rev. Rul. 98-8 reached a similar conclusion regarding a surviving spouse's purchase of a remainder interest in a qualified terminable interest property trust. In that ruling, the transaction was considered a gift of the remainder interest, under two separate theories: First, the commutation of the trust by dividing the trust property between the remainderman and life beneficiary was a taxable disposition by the spouse of the qualifying income interest, resulting in a gift under Sec. 2519 equal to the value of the remainder interest. Second, because the spouse acquired an asset (the remainder interest) that would have been included in the spouse's gross estate in any event under Sec. 2044, the receipt of the remainder interest did not constitute adequate and full consideration for gift and estate tax purposes.
Part gift, part sale
In Fiscalini, (9) the Tax Court held that a taxpayer had gain only to the extent of discharged liabilities on the sale of his home to his parents because the...