Recent developments in estate planning.

• Author: Ransome, Justin

This article is the first installment of an annual update on recent developments in trust, estate, and gift taxation. The second and third installments will appear in the December and January issues, respectively. In this first installment, the topics include estate tax closing letters, the basic exclusion amount, estate debts and expenses, and extending the time to elect portability. The period covered is from July 2021 through July 2022.

Estate tax closing letters

On Sept. 22, 2021, Treasury and the IRS issued final regulations (1) establishing a new $67 user fee for estates to receive an estate tax closing letter.

Prior to June 2015, the IRS generally issued an estate tax closing letter for every estate tax return filed. The IRS changed its practice for estates of decedents dying on or after June 1, 2015, and now offers an estate tax closing letter only upon the request of an authorized person. The reasons for this change were: (1) the volume of estate tax returns filing increased due to the enactment in December 2010 of the portability of a deceased spouse's unused applicable exclusion amount for the benefit of the surviving spouse; and (2) the IRS recognized that an account transcript with a transaction code and explanation of "421 --Closed examination of tax return" is available as an alternative to an estate tax closing letter.

The final regulations adopting the $67 user tee do not establish a procedure for requesting an estate tax closing letter and paying the user fee. Instead, as the preamble to the regulations notes, the procedure for requesting, and paying the fee for, the estate closing letter is found on the Pay.gov website (see also FAQs available on IRS.gov).

While the proposed regulations had defined the person liable for the fee to include a person authorized under Sec. 6103 to receive an estate tax closing letter, the final regulations remove the reference to Sec. 6103, explaining that the section governs the disclosure of return information but does not necessarily govern who would be liable for the payment of the user fee.

Basic exclusion amount

On April 27, 2022, Treasury and the IRS issued proposed regulations (2) amending estate tax regulations on the basic exclusion amount (BEA) used in computing federal estate and gift taxes. The proposed regulations would affect estates of decedents dying after a reduction in the BEA (currently set to occur on Jan. 1, 2026) who made certain types of gifts before the BEA was reduced.

Background

The 2017 law known as the Tax Cuts and Jobs Act (TCJA) (3) increased the BEA from $5 million, adjusted for inflation after 2011, to $10 million, also adjusted for inflation, for decedents dying, and gifts made, in calendar years 2018 through 2025. Under current law, the BEA will revert to $5 million, adjusted for inflation, on Jan. 1, 2026.

In addition to increasing the BEA, (4) the TCJA added new Sec. 2001(g)(2), authorizing the Treasury secretary to issue regulations addressing the tax consequences for an estate whose decedent makes gifts between $5 million and $10 million during calendars years 2018 through 2025, when the BEA is $10 million, but dies after 2025, when the BEA decreases to $5 million.

In late 2019, the IRS and Treasury issued final regulations (T.D. 9884) under Sec. 2010 to address this situation. The final regulations adopted a special rule for the purpose of ensuring that the donor's estate is not taxed on completed gifts on which no gift tax was imposed due to the increased BEA. The special rule allows the estate to compute its estate tax credit using the higher of: (1) the BEA applicable on the decedent's date of death, or (2) the BEA applicable to gifts made during the decedent's life (Sec. 2001(b)).

The preamble to T.D. 9884 noted that further consideration would be given to the issue of whether gifts that are not true inter vivos transfers but rather are includible in a decedent's gross estate should be excepted from the special rule. The new proposed regulations address this question.

Rationale for the proposed exception

The preamble to the proposed regulations explains that the special rule currently does not distinguish between completed gifts that are treated as: (1) adjusted taxable gifts for estate tax purposes and not included in the donor's gross estate; and (2) testamentary transfers for estate tax purposes and included in the donor's gross estate. The Code, however, distinguishes between these two types of transfers. (5) The proposed regulations generally would deny the benefit of the special rule to "includible gifts" by maintaining the Code's distinction between completed gifts treated as adjusted taxable gifts and those treated as testamentary transfers. In either case, the Code ensures that the gift is treated consistently with respect to credits allowable in the year in which the gift was made.

As the preamble goes on to discuss, the estate tax on the transfer of a decedent's taxable estate at death is calculated in a five-step computation under Secs. 2001 and 2010, applying the same rate schedule used lor gift tax purposes: (6)

1. Determine a tentative tax on the sum of the taxable estate and the adjusted taxable gifts; (7)

2. Determine a hypothetical gift tax on all post-1976 taxable gifts; (8)

3. Determine the net tentative estate tax by subtracting the gift tax payable determined in Step 2 from the tentative tax determined in Step 1; (9)

4. Determine a credit amount (which may not exceed the net tentative estate tax) equal to the tentative tax on the applicable exclusion amount in effect on the date of death; (10) and

5. Subtract the credit amount determined in Step 4 from the net tentative estate tax determined in Step 3. (11)

   The preamble notes that the exclusion from adjusted taxable gifts of transfers includible in the gross estate does not affect Step 2, and gift tax is payable on all post-1976 taxable gifts, regardless of whether they are included in the gross estate. Because both the hypothetical gift tax and the credit amounts are computed using the gift tax rates in effect at the date of death, when computing estate tax, a credit is provided for all credits provided on includible gifts in the year the gifts were made. This includes credit amounts attributable to the $10 million BEA.

   More about the proposed exception

   The new proposed regulations would provide an exception to the special rule for includible gifts. This exception was adopted in response to a public comment received on the 2018 proposed regulations that preceded T.D. 9884. The commenter had asked whether a special rule should apply to taxable gifts made during the increased BEA period if the gifts are essentially testamentary and thus included in the gross estate rather than in adjusted taxable gifts.

   The preamble to the new proposed regulations explains that the special rule is designed to ensure that bona fide inter vivos property transfers are consistently treated as gifts for purposes of gift and estate tax. The preamble points to a subset of includible gifts--gifts made during the increased BEA period that are essentially testamentary but are deductible for gift tax purposes due to the charitable or marital deduction--to which the special rule does not apply. Inconsistent gift or estate tax treatment will not occur with these gifts because no credits allocable to the gifts would be attributable to the BEA when computing gift tax payable under Sec. 2001(b)(2). With no BEA applicable to the deductible gifts, the increase or decrease of the BEA is of no consequence.

   Given that the Code treats certain transfers as testamentary transfers rather than adjusted taxable gifts, the preamble states that it would be inappropriate to apply the special rule to includible gifts, particularly if the transferor retained some right to the transferred property. To prevent this result, the proposed regulations provide an exception to the special rule.

   Specifically, Prop. Regs. Sec. 20.2010-l(c)(3) would provide an exception to the special rule for transfers that are includible in the gross estate or treated as includible in the gross estate for Sec. 2001(b) purposes, including:

1. Transfers subject to a life estate or other powers or interests described in Secs. 2035 through 2038 and 2042, regardless of whether the transfer was deductible under Sec. 2522 or 2523;

2. Transfers made by an enforceable promise to pay, to the extent the promise remains unsatisfied at the date of death;

3. Transfers that were subject to Secs. 2701 (regarding special valuation rules of certain transfers of interests in partnerships and corporations) and 2702 (regarding the transfer of income interests in a trust); and

4. Transfers that would have been included in 1, 2, or 3 but for the elimination of that transfer from the gross estate within 18 months of the death of the transferor.

   When published in final form, the regulations will apply to estates of decedents dying on or after April 27, 2022, the date the proposed regulations were published in the Federal Register. If the BEA decreases before final regulations are issued, the exception to the special rule contained in the proposed regulations will apply to estates of decedents dying on or after April 27,2022.

   The proposed regulations should not negatively affect a completed gift that does not involve a retained interest. If, however, a donor has made gifts of assets that may have some potential estate tax exposure (e.g., interests in family limited partnerships or a limited liability company under Sec. 2036), the proposed regulations could present a risk of the estate's receiving the benefit of only the lower BEA at death.

   Estate debts and expenses

   On June 24, 2022, Treasury and the IRS released proposed regulations (12) under Sec. 2053 that provide guidance on the proper use of present-value principles in determining the amount an estate may deduct for funeral expenses, administration expenses, and certain claims against...