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March 8, 2016
2016-0469

IRS issues temporary and proposed regulations on consistent basis reporting between estate and beneficiary

The IRS has issued proposed regulations (REG-127923-15) that provide guidance on: (1) the requirement for a recipient's basis in certain property acquired from a decedent to be consistent with the value of the property as finally determined for federal estate tax purposes; and (2) the reporting requirements for executors or other persons required to file federal estate tax returns. Simultaneously the Service issued temporary regulations (TD 9757) providing transition rules stating that executors and others required to file or furnish a statement under Section 6035(a)(1) or (a)(2) before March 31, 2016, may do so until March 31, 2016.

Background

The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, signed into law in mid-2015, added to the code: (1) Section 6035, generally requiring the executor of an estate that files its estate tax return after July 31, 2015, to provide a statement identifying the value of property reported on the return to both the IRS and the beneficiaries acquiring any interest in the property; and (2) Section 1014(f), providing that the basis of any property acquired from a decedent to which Section 1014(a) applies may not exceed the final estate tax value of the property or, if the final value has not yet been determined, the value reported on a statement furnished under new Section 6035.

Section 6662(b)(8) imposes an accuracy-related penalty on the portion of any underpayment of tax required to be shown on a return that is attributable to inconsistent estate basis. Section 6662(k) provides that an inconsistent estate basis arises if the basis of property claimed on a return exceeds its final value as determined under Section 1014(f). (See Tax Alert 2015-1532.)

Shortly after Sections 6035 and 1014 were added to the code, the IRS issued Notice 2015-57, delaying until February 29, 2016, the due date for executors of estates and others required under Section 6035 to file statements regarding the value of certain property.

In February 2016, the IRS published Notice 2016-19, delaying until March 31, 2016 the due date for executors of estates and others required under new Section 6035 to file statements with respect to the value of certain property. Notice 2016-19 is effective February 11, 2016.

Temporary and proposed regulations

The temporary regulations simply "reiterate that executors or other persons required to file or furnish a statement under [S]ection 6035(a)(1) or (a)(2) before March 31, 2016, need not do so until March 31, 2016."

The preamble to the proposed regulations outlines the statutory framework under Section 1014(f), requiring the basis of certain inherited property and the value of that property for federal estate tax purposes to be consistent and, under Section 6035, requiring the value of property included on an estate tax return to be reported to the IRS and the beneficiary. The preamble emphasizes that Sections 1014(f) and 6035 apply only if including the property in the decedent's gross estate increases the estate's federal estate tax liability.

Basis consistency requirements under Section 1014(F)

Prop. Reg. Section 1.1014-10(a)(1) provides that a taxpayer's initial basis in property subject to the consistent basis rules of Section 1014(f) may not exceed the property's final value, which is the value as finally determined for estate tax purposes.

Property subject to the consistent basis rules of Section 1014(f). Because the consistent basis requirement of Section 1014(f)(1) applies only if including the property at issue in the decedent's gross estate increases the estate's estate tax liability, the proposed regulations would expressly exclude from the consistent basis requirement all property reported on a federal estate tax return if, after application of all available credits (other than a credit for prepayment of tax), no federal estate tax is due. If estate tax were payable, all property included in the gross estate would be subject to the consistent basis requirement except: (1) property qualifying for the estate tax charitable or marital deduction under Sections 2055, 2056, or 2056A, and (2) tangible personal property for which an appraisal is not required under Reg. Section 20.2031-6(b).

Final value of inherited property. For purposes of the consistent basis rules under Section 1014(f), the final value of property has been determined if: (1) the value is reported on a federal estate tax return filed with the IRS and the IRS does not adjust or contest the amount before the statute of limitations closes; (2) the value is not reported on a federal estate tax return, the IRS determines or specifies the value, and the executor does not contest it before the statute of limitations closes; or (3) the value is determined by a court or under an agreement.

Further, the proposed regulations provide that a deficiency and underpayment may result if a taxpayer claims an initial basis in property consistent with the amount reported on the statement furnished to the taxpayer under Section 6035(a) and the subsequently determined final value of property differs from that initial basis claimed. Prop. Reg. Section 1.6662-8 seems to indicate that penalties may be imposed in this type of situation as well. A subsequently determined estate tax value that is less than the amount reported on the estate tax return and the Section 6035(a) information statement, however, is relatively rare.

Effect of other code provisions governing basis.In response to public comments, Prop. Reg. Sections 1.1014-10(a)(2) and 1.6662-8(b) would clarify that Sections 1014(f) and 6662(k) "do not prohibit adjustments to the basis of property as a result of post-death events that are allowed under other" code sections, according to the preamble. Under the proposed regulations, a beneficiary's initial basis in inherited property could not exceed the final value of the property for federal estate tax purposes, and adjustments to the basis permitted under other code sections due to post-death events (e.g., depreciation, sale, exchange or disposition of the property) would not cause the taxpayer's basis in the property on the date of a taxable event to exceed the final value of the property. Examples provided in the proposed regulations illustrate how the final value of a partnership interest with nonrecourse debt will be the value of the partnership interest as finally determined for estate tax purposes, and that any subsequent adjustments to basis to account for the debt are permitted.

After-discovered or omitted property.The proposed regulations provide guidance for situations in which property subject to Section 1014(f) was omitted from the estate tax return or is discovered after the estate tax return was filed. If an estate tax return was already filed: (1) the final value will be determined as discussed previously if the executor files, before the statute of limitations closes, an initial or supplemental estate tax return to report this property; and (2) the final value of the property will be zero if the executor does not report the property on an initial or supplemental estate tax return before the statute of limitations closes. If no federal estate tax return was filed, the final value of all property includible in the gross estate that would have generated or increased the estate's estate tax liability is zero until the final value is determined under the previously discussed rules.

Definition of executor. The proposed regulations would adopt the definition of "executor" from Section 2203 but would expand it to include any person who is required to file a federal estate tax return under Section 6018(b).

Section 6035 requirement to provide information return and statement

Prop. Reg. Section 1.6035-1(a)(1) would requires an executor who is required to file a federal estate tax return to file an information return with the IRS, and provide a statement to the estate's beneficiaries, detailing certain property included on the estate tax return and its final value.

Information return. The proposed regulations define the "information return" required under Section 6035 as Form 8971, Information Regarding Beneficiaries Acquiring Property from a Decedent, which includes a Schedule A for each person who has received or will receive certain property from the estate or as a result of the decedent's death.

Exceptions to filing. The proposed regulations provide that the Section 6035 filing requirements do not apply to estates filing estate tax returns solely to make the Section 2010(c)(5) portability election or a generation-skipping transfer tax election or exemption allocation.

Property reported on information returns and statements. Prop. Reg. Section 1.6035-1(b) explains that all property reported or required to be reported on the federal estate tax return must be reported on Form 8971, with four exceptions: (1) cash, (2) income in respect of a decedent, (3) items of tangible personal property for which an appraisal is not required under Reg. Section 20.2031-6(b), and (4) property sold or otherwise disposed of by the estate in a transaction in which capital gain or loss is recognized. The proposed regulations state that property for which basis is determined in whole or in part by reference to property reported or required to be reported on the estate tax return, such as property acquired in a like-kind exchange or involuntary conversion, for these purposes is treated as property reported or required to be reported on an estate tax return. In the case of a decedent who was not a US citizen or resident, only property subject to US estate tax would have to be reported.

Beneficiaries. If, by the due date of Form 8971, the executor has not determined how the estate's property will be distributed, Prop. Reg. Section 1.6035-1(c)(3) would require the executor to report on each beneficiary's Schedule A all of the property that could be used to satisfy the beneficiary's interest. The preamble notes that "this results in the duplicate reporting of those assets on multiple [Schedules A], but each beneficiary will have been advised of the final value of each property that may be received by that beneficiary and therefore will be able to comply with the basis consistency requirement, if applicable."

If a beneficiary were a trust, estate or business, the executor would have to furnish the beneficiary's statement to the trustee, executor or business entity itself, rather than to the beneficiaries of the trust or estate or owners of the business (Prop. Reg. Section 1.6035-1(c)(2)).

If the executor were unable to locate a beneficiary by the time the information return is due, the executor would have to explain on the information return the efforts taken to find the beneficiary. If the beneficiary were ultimately found, the executor would have to provide the beneficiary with a statement and file a supplemental information return with the IRS within 30 days.

Due date for information return and statements.The proposed regulations would require the executor to file Form 8971 (including all Schedules A) with the IRS and provide Schedule A to beneficiaries within 30 days after the due date for the federal estate tax return, including extensions. The proposed regulations provide a transition rule applicable to any federal estate tax return due on or before July 31, 2015, but filed after July 31, 2015. For these returns, the due date for Form 8971 and Schedule A would be 30 days after the date the estate tax return is filed.The due date for a supplemental information return or statement would be 30 days after: (1) the final value of the property is determined; (2) the executor discovers that incorrect information was reported on the information return or statement; or (3) a supplemental federal estate tax return is filed. For probate property or property held in the decedent's revocable trust, if these events occur before the property has been distributed to the beneficiary, a supplemental information return or statement would not be due until 30 days after the property is distributed to the beneficiary.

Subsequent transfers.Beneficiaries or subsequent transferees who subsequently transfer property that was reported to them on Schedule A would be required to file a supplemental Form 8971 and provide Schedule A to the transferee if the transferee were related (as defined under Section 2704(c)(2), or a grantor trust of which the transferor is the owner) and would determine its basis by reference to the beneficiary's basis in the property.

Implications

Overall, the regulations are helpful in determining whether Section 1014(f) or Section 6035 applies, to whom these provisions apply, to what assets they apply, what information needs to be reported and when it needs to be reported. There are, however, a couple of surprises.

First, the addition of the requirement regarding subsequent transfers is somewhat of a surprise as it would require persons other than "executors" to comply with Section 6035 if they transfer inherited assets to another in which gain or loss was not recognized. The statute does not specifically impose a filing requirement upon them. The preamble cites as the reason for the requirement Treasury's and the IRS's concern that "opportunities may exist in some circumstances for the recipient of such reporting to circumvent the purpose of the statute (for example, by making a gift of the property to a complex trust for the benefit of the transferor's family)."

It is also important to note that there is no time limit on the subsequent transfer rule. A subsequent transfer could occur within days of receipt by the beneficiary (likely the situation that concerned the IRS); because there is no time limit, there will be a Form 8971 filing requirement if the property is transferred from an estate's beneficiary to a controlled corporation/partnership or family member — for example, 37 years after the decedent's death.

Second, the provision assigning a zero basis to property for which basis should have been reported on an estate tax return, but was not, is a surprise. Specifically, property of a decedent discovered after the estate tax return has become final (i.e., after the statute of limitations has run for a filed tax return) has a basis of zero. This provision would seem to conflict with Section 1014(a), which has no such requirement. The general rule in Section 1014(a)(1), providing that the fair market value of property is the value of the property on the decedent's death, has more or less been the rule since the 1930 Supreme Court decision in Brewster v. Gage, 280 U.S. 327 (1930). If Congress had intended to modify an 85-year-old Supreme Court decision by tying basis to the listing of property on a return, it would seem logical that it would have either amended Section 1014(a) when adding Section 1014(f) or specifically addressed that outcome in the associated legislative history.

Interestingly, because Section 1014(f) only applies to property that would increase the tax, the "zero-basis rule" does not apply to unknown property of decedents with estates under the filing thresholds, or first-to-die spouses with full marital deduction plans in place. Therefore, it creates a dichotomy between heirs of taxable estates and those who are not.

Finally, the zero-basis rule could be viewed as functionally eliminating the statute of limitations on the tax assessment process. Even though estate taxation of property omitted from the estate would be barred by the statute of limitations after a period of time, the rule functionally replaces the estate tax with an income tax that lives in perpetuity. It has similarities with the carryover basis regime advanced several times in US income tax history, but goes one step further by eliminating the decedent's basis altogether.

Estates with estate tax returns filed after July 31, 2015 and before March 1, 2016, must file Form 8971 and provide Schedules A to beneficiaries by March 31, 2016. This is a very short time in which to compile all of the necessary information and complete the form. Although commentators have suggested extending this deadline, it is unclear whether the IRS will agree to an extension. Therefore, executors should proceed under the assumption that no additional extensions will be granted.

It is important to note that the property subject to basis consistency differs from the property needed to be reported on the Form 8971. The Form 8971 filing requirement applies to property transferred to a spouse and charity. Therefore, a Form 8971 is likely required in estates in which the marital and charitable deductions fully eliminate the tax.

Notably, although the proposed regulations would not require the executor to report each beneficiary's social security number (SSN), individual taxpayer identification number (ITIN) or employer identification number (EIN) to the IRS on Form 8971 or Schedule A, the instructions to Form 8971 state that this information is required, and reporting "none," "unknown," or similar language, or leaving this field blank will cause the form to be treated as incomplete and may subject the estate to penalties. This is of particular concern to estates with foreign beneficiaries who may not have US tax identification numbers, as it can take several months for a non-US resident to obtain an ITIN. Recall that Reg. Section 301.6109-1(b)(2) provides a list of situations in which foreign persons are required to obtain tax information numbers. Strangely, the receipt of property from an estate is not listed, and this set of proposed regulations would not amend the Section 6109 regulations to include such a situation. Of course, the foreign estate beneficiary is also subject to the subsequent transferor rule.

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Contact Information
For additional information concerning this Alert, please contact:
 
Private Client Services
David H. Kirk(202) 327-7189
Justin Ransome(202) 327-7043
Jennifer Einziger(202) 327-6216