July 14, 2022
Proposed regulations address deductibility of certain estate expenses
In proposed regulations (REG-130975-08) under IRC Section 2053, the IRS provides guidance on the proper use of present-value principals in determining the amount an estate may deduct for funeral expenses, administration expenses and certain claims. The proposed regulations also provide guidance on the deductibility of (1) interest expense accruing on tax and penalties the estate owes; (2) interest expense accrued on certain loan obligations the estate incurs; and (3) amounts paid under a decedent's personal guarantee.
The value of a decedent's gross estate, less deductions under IRC Sections 2053–2058, is generally taxable under IRC Section 2051. Final regulations (TD 9468) issued under IRC Section 2053 in October 2009 (2009 Final Regulations) generally limit an estate's deduction for claims and expenses to the amount actually paid to settle a debt or other claim.
A section of the 2009 Final Regulations (Reg. Section 20.2053-1(d)(6)) was reserved for future guidance on how present-day value principles should be applied in determining the amount the estate may deduct under IRC Section 2053 — the new proposed regulations represent that guidance. The proposed regulations also provide or clarify rules under IRC Section 2053 on:
Applying present-value principles to deductible amounts
The 2009 Final Regulations implemented the "present value" accounting principle in determining the amount that an estate may deduct for certain claims and expenses. They generally limit the IRC Section 2053 deduction to the amount actually paid to settle or satisfy a claim or expense and clarify that events occurring after death are considered in determining the allowable IRC Section 2053 deduction. To more accurately measure the amounts not passing to heirs and legatees, the IRS has determined that the deductible amount should be limited "to the present value of the amounts paid after an extended post-death period."
Proposed regulations (REG-143316-03; 2007 Proposed Regulations) that preceded the 2009 Final Regulations permitted deductions for a decedent's noncontingent recurring obligations if the present value of future payments under the obligation were computed. In contrast, a decedent's contingent recurring obligations were deductible only as the estate paid amounts to satisfy the claims and computing the present value of the amounts was not necessary. Responding to commenters who argued the proposed regulations "produced an inconsistent and inequitable result," the IRS clarified in the 2009 Final Regulations that the amount payable under a decedent's noncontingent recurring obligation is deemed ascertainable with reasonable certainty and therefore may be deducted in advance; the amount payable under a contingent recurring obligation, however, cannot be determined with reasonable certainty and thus is deductible only as paid. The final regulations also removed the language making the present-value limitation applicable only to noncontingent recurring obligations and reserved the issue for future guidance.
The new proposed regulations generally would apply present-value principles consistently to expenses and claims without regard to whether they are contingent. (Only unpaid mortgages and indebtedness excluded under Reg. Section 20.2053-7 would be excluded.) Acknowledging that estates "often cannot pay every deductible claim and expense within a short time after the decedent's death," the IRS has concluded that a three-year grace period following the decedent's death should be provided to allow the estate to pay deductible debts. Therefore, the proposed regulations would require an estate to calculate the present value of a deductible claim or expense that is not paid, or to be paid, by the third anniversary of the decedent's death. A general formula in the new regulations determines the present value of these not-yet-paid amounts by applying a discount rate equal to the applicable federal rate determined under IRC Section 1274(d) for the month of the decedent's death, compounded annually for the length of time between the date of death and the anticipated date of payment. The proposed regulations would allow "any reasonable assumptions or methodology in regard to time period measurements [to] be used in calculating the present value" and require the estate to submit a supporting statement on Form 706 showing how present value was calculated.
Reg. Section 20.2053-1(d)(6) completes the 2009 revisions to the regulations under IRC Section 2053 that set forth the use of post-death events in determining the amount deductible for expenses and claims the against the estate. Before the 2009 revisions to the regulations, the courts were split as to whether post-death events had to be taken into account when determining the amount deductible on an estate tax return. This section sets forth the use of present value concepts in determining the amount of the deduction for expenses and claims against the estate depending on when those expenses and claims will be paid by the estate. The regulations provide a three-year grace period for payment of the expenses and claims before these present value rules would have to be used. As with the general implications of the 2009 revisions, the deductible amount of expenses and claims against the estate may be lower than their values on the date of the decedent's death due to post-death events.
Deducting interest expense as estate administration expense
Provisions relevant to the deductibility of interest as an IRC Section 2053(a)(2) administration expense include:
Interest on unpaid tax and penalties
An estate generally must pay interest at the IRC Section 6621 underpayment rate on any unpaid federal tax and additions to tax (IRC Section 6621 interest). In contrast, interest payable under IRC Section 6601 on unpaid estate tax deferred under IRC Section 6166 (Section 6166 interest) receives a more favorable interest rate under IRC Section 6601(j) and is not deductible.
The Preamble to the proposed regulations notes that non-IRC Section 6166 interest may accrue on or after the date of death on unpaid estate tax in connection with an IRC Section 6161 extension, which is granted by showing reasonable cause for extending the time for payment. According to the Preamble, the IRS considers an IRC Section 6163 deferral to be appropriate if the value of a reversionary or remainder interest is includible in the estate but is not immediately available to pay the estate tax. The IRS has "determined that interest payable under [IRC Section] 6601 on unpaid estate tax in connection with an extension under [IRC Section] 6601 or a deferral under [IRC Section] 6163 is necessarily incurred in the administration of the estate."
Although non-IRC Section 6166 interest and the underlying underpayment of tax or deficiency is often attributable to an executor's reasonable exercise of his/her fiduciary duties — and thus incurred in the administration of the estate — the Preamble notes that this is not always the case. Therefore, the proposed regulations would not consider any non-IRC Section 6166 interest accruing on an unpaid tax or penalty attributable to an executor's negligence, disregard of the rules or regulations, or fraud with the intent to evade tax to be (1) actually or necessarily incurred in the administration of the estate or (2) essential to the proper settlement of the estate.
Interest on certain estate loan obligation
Parallel issues apply to interest accrued on bona fide loan obligations that the estate incurs. The proposed regulations would permit the estate to deduct interest expense only if:
The proposed regulations provide a nonexclusive list of factors to consider in determining whether interest payable under an estate's loan obligation satisfies Reg. Sections 20.2053-1(b)(2) and 20.2053-3(a) and thus are reasonable and comparable to an arm's-length loan.
Although applicable to estate loans, these proposed regulations appear designed to curtail the use of what the estate planning area generally calls "Graegin loans," referring to Estate of Graegin v. Commissioner, T.C. Memo. 1988-477 (Sept. 28, 1988). In Graegin, the estate was able to deduct on its estate tax return all the interest due on the estate loan as an administration expense under IRC Section 2053.
While the election under IRC Section 6166 allows estates to defer the payment of estate tax up to 14 years, it has two potential disadvantages: (1) it does not generally apply to a decedent's entire estate (just closely held businesses), and (2) the interest charged on the deferred amount of estate tax is not deductible as an expense under IRC Section 2053. Graegin loans have neither of these disadvantages: (1) they may apply to the entire estate-tax obligation, and (2) the interest is a deductible expense. A Graegin loan is only required to be bona fide and "actually and necessarily" incurred. In recent cases, the IRS has successfully argued that the Graegin loans were not "actually and necessarily" incurred with regard to liquid assets or family investment partnerships (see, e.g., Estate of Koons v. Commissioner, T.C. Memo. 2013-94 (Apr. 8, 2013); Estate of Black v. Commissioner, 133 T.C. 340 (Dec. 15, 2009). These proposed regulations provide guidance as to when Treasury and the IRS will respect estate loan obligations.
Substantiating certain valuations
Although an estate generally may deduct only amounts it actually pays to satisfy a claim, certain exceptions exist. For example, deductions are permitted for the value of (1) claims and counterclaims in a related matter (Reg. Section 20.2053-4(b)), and (2) unpaid claims totaling $500k or less (Reg. Section 20.2053-4(c)). For both exceptions, the value of the claim must be determined from a qualified appraisal performed by a qualified appraiser, as defined under IRC Section 170. Noting that qualified appraisals characterized under IRC Section 170 pertain to charitable contribution deductions, the Preamble explains that the proposed regulations would replace this requirement with new requirements.
Specifically, the proposed regulations would require a written appraisal adequately reflecting the current value of the claim when Form 706 is being completed. The written appraisal should:
The apparent reasons for these proposed regulations is two-fold: (1) the realization that the definition of qualified appraiser and qualified appraisal under IRC Section 170 pertain to charitable contributions of property and not to claims against the estate (and, therefore, are not entirely compatible) and (2) the requirement that the appraiser consider, and the appraisal reflect, post-death events in determining the amount deductible as a claim against the estate.
Deducting amounts paid pursuant to a decedent's personal guarantee
A commenter on the 2007 Proposed Regulations suggested the final regulations confirm that payments made based on a decedent's personal guarantee are deductible in the same vein as payments made to satisfy any other deductible claim against the estate. For a claim that is based on a decedent's guarantee to meet the adequate-and-full-consideration-in-money-or-money's-worth requirement, the Preamble notes that the guarantee must have provided the decedent with "a benefit reducible to money value."
The proposed regulations provide guidance on whether, for IRC Section 2053 purposes, a guarantor agreement is contracted for adequate and full consideration in money or money's worth. For instance, the regulations would require a claim based on the decedent's personal guarantee of another's debt to satisfy the applicable requirements in IRC Section 2053(c)(1)(A) and Reg. Section 20.2053-4(d)(5).
A bright-line rule would deem a decedent's guarantee of a bona fide debt of an entity that the decedent controlled (under IRC Section 2701(b)(2)) when the guarantee was made to satisfy the adequate-and-full-consideration requirement. The requirement would also be met if, when the guarantee is given, the decedent's maximum liability under the guarantee did not exceed the fair market value of the decedent's interest in the entity. To the extent that the estate had a right of contribution or reimbursement for the decedent's guarantee, the deductible amount would be reduced under Reg. Section 20.2053-1(d)(3).
These proposed regulations provide guidance as to whether a decedent's personal guarantee is deductible as a claim against the estate. The main requirement is that it be bona fide and the decedent receive adequate and full consideration in money or money's worth — e.g., the decedent receives a guarantee fee for his or her personal guarantee. In many instances involving personal guarantees among family members or related parties, the guarantor is uncompensated for his or her personal guarantee. If that is true, the decedent's estate would not be able to deduct the claim associated with the personal guarantee even if the decedent's estate had to pay the claim.
Comment period and applicability date
The IRS is requesting comments be received by September 26, 2022. A public hearing is scheduled for October 12, 2022.
The new regulations are proposed to apply to estates of decedents who die on or after publication of the final regulations in the Federal Register.