National Association of Estate Planners and Councils

September, 2011 Newsletter
Provided by Leimberg Information Services

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Steve Akers: Carryover Basis Guidance in Notice 2011-66 & Revenue Procedure 2011-41

The IRS issued Notice 2011-66 and Revenue Procedure 2011-41 on August 5, 2011, and LISI has provided members with significant commentary by the country’s best and brightest minds on all of the issues raised. Now, Steve Akers weighs-in with his thorough and detailed analysis.

Steve R. Akers is a managing director at Bessemer Trust, where he directs the family estate and legacy planning practice for the Southwest Region.  Steve has lectured on a variety of estate planning, estate administration, and family business planning topics at national meetings of the American College of Trust and Estate Counsel; American Bar Association Real Property, Probate and Trust Law Annual CLE Meetings; the U.S.C. Tax Institute; the University of Miami Philip E. Heckerling Institute on Estate Planning; the Annual Notre Dame Tax and Estate Planning Institute and the Southern Federal Tax Conference – among many others.

Here is Steve’s commentary:

EXECUTIVE SUMMARY:

A summary on the IRS website provides that “[t]he IRS expects to issue Form 8939 and the related instructions early this fall.” Notice 2011-66 generally provides the procedures for electing into carryover basis and for making GST exemption allocations and electing out of automatic allocation. Revenue Procedure 2011-41 generally provides guidance regarding the meaning of terms in Section 1022 and how the carryover basis provisions apply.

IRS Releases in February and March, 2011 indicated that the Form 8939, instructions to the Form 8939, and Publication 4895, “Treatment of Property Acquired from a Decedent Dying in 2010” would be issued.  So far, none of those have been issued. The IRS announcement of the issuance of Notice 2011-66 and Revenue Procedure 2011-41 stated that the Form 8939 and instructions to Form 8939 will be issued in the “early this fall,” but makes no mention of whether it is still in the process of issuing Publication 4895.  

COMMENT:

The Tax Relief … Act of 2010 retroactively imposes the estate tax for decedents dying after January 1, 2010, but provides that an executor may instead elect for the carryover basis provisions of §1022 to apply.  This is referred to as the “Section 1022 Election.”

If the Section 1022 Election is made, all “property acquired from the decedent” will have a basis equal to the lesser of the decedent’s basis or fair market value. The executor can allocate several adjustments to increase the basis of assets received by recipients that are both “property acquired from the decedent” and “property owned by the decedent,” as those terms are defined in §1022.  The amount of increased basis from these allocations is referred to as the “Basis Increase.”

Notice 2011-66

1.                 How to elect into carryover basis.

2.                 How to elect out of GST automatic allocation to direct skips in 2010.

3.                 The due dates of returns for GST purposes to report a generation skipping transfer, to allocate GST exemption, or to opt out of automatic allocation.

4.                 The application of the GST tax to testamentary transfers in 2010.

5.                 Collateral issues, such as no necessity of transfer certificates for nonresident aliens and the "applicable period” for purposes of § 645 if the carryover basis election is made.

Section 1022 Election and Filing Requirements.

Section 1022 Election.

Form 8939.  The election is made by filing Form 8939. Observation: If the executor previously filed something else to make the election, the Form 8939 still must be filed to make the Section 1022 Election.

Irrevocable. The election is irrevocable, except as described below.

Form 706 and Form 8939 for Same Estate. If the IRS receives a Form 706 and Form 8939 for the same estate, it will send a letter to the filers. They must collectively file either a restated Form 706 or Form 8939 within 90 days. If they fail to do so, the IRS will determine whether the carryover basis election has been made.  The IRS “will consider all relevant facts and circumstances disclosed to the IRS, including without limitation the relative total fair market values of the decedent’s property in the possession of the executors and the nature and significance of the economic impact of the Section 1022 Election (or its loss) on the beneficial owners of the property held by each executor.”

Observation: The Notice seems to contemplate Forms 706 and 8939 being filed by multiple persons. Does this procedure also apply if both forms are filed by the same person? What if the executor or (or multiple persons) purposefully file Form 706 and Form 8939 to provide additional time for making the election decision?

Method to Allocate Basis.

Executor.  Basis adjustments are allocated by the executor. The term “executor” is construed in accordance with § 2203 of the Internal Revenue Code. If there is no court-appointed executor, the term refers to any person in actual or constructive possession of property acquired from a decedent.

Appointed Executor. If there is a court-appointed executor, the IRS will only accept a Form 8939 filed by the appointed executor.

Observation: As noted below, the executor is required to list all “property acquired from the decedent” [other than cash or IRD assets], even if those assets are non-probate assets.

Statutory Executor. If there is no court-appointed executor, any person in actual or constructive possession of property acquired from the decedent may file a Form 8939 of the property he or she actually or constructively possesses. If multiple Forms 8939 that collectively purport to allocate more Basis Increase than is available to the estate, the IRS will send a letter to filers of the Forms. They must collectively file one restated Form 8939 within 90 days. If they do not do so, the IRS can allocate the Basis Increase in its discretion. It “might be made on a pro-rata basis, based on the amount of unrecognized appreciation … or in any other manner deemed appropriate.”

Observation: The Notice does not address the situation of there being no court appointed executor and only some but not all persons in possession of property filing a Form 8939. Is the Section 1022 Election made (which would apply to all property acquired from the decedent, including property in the possession of those who did not file a Form 8939) or not? If the Election is made, are those persons in possession of property who did not choose to file Form 8939 liable for penalties under § 6716(a) [$10,000 for each failure] for failing to file the Form 8939 with respect to property in that person’s possession?

Statute of Limitations Remains Open. The IRS may contest the basis of a particular property (including the amount of Basis Increase allocated to the property) with respect to any tax return reporting a value dependent on the property’s basis, such as depreciation or gain or loss recognition on a sale or disposition of the asset.

Reporting Requirements for Form 8939.

Information Required. The Notice summarizes the property that “the executor must report” on the Form 8939 (as required by § 6018(c)). The property includes:

·        All property acquired from the decedent (other than cash or income in respect of a decedent property)

·        Gifts to the decedent within the last three years (other than gifts from the decedent’s spouse, unless the spouse had also acquired the property by gift within that three-year period.)

·        For non-resident alien decedents, any property “acquired from the decedent” that passes to a U.S. person, as well as tangible property located in the U.S. that passes to others.

Supporting Documentation. Supporting documentation should be included as provided in the instructions to the Form 8939 (which are not yet available). As discussed below, Section 4.04(1) of Rev. Proc. 2011-41 requires attaching “appraisals required under section 2031.”

Observation: Apparently, that includes appraisals that must be attached to estate tax returns pursuant to regulations and the Form 706 instructions. See the discussion below of Rev. Proc. 2011-41 for a discussion of what appraisals that appears to require.

Providing Information to Recipients. Within 30 days after filing the Form 8939 the executor must provide information to each recipient acquiring property that is reported on the form, regardless whether Basis Increase is allocated to the property.

Observation: The information to be provided to each recipient is listed in 6018(c):

·        Name and TIN of the recipient

·        Accurate description of the property

·        Adjusted basis of the property in the hands of the decedent and fair market value at the date of death

·        Decedent’s holding period of the property

·        Information to determine whether gain on sale of the property would be ordinary income

·        Amount of Basis Increase allocated to the property, and

·        Any other information that may be required by regulations.

Time for Filing Form 8939: In General.

Nov. 15, 2011 Due Date and Amendments. The Form 8939 is due November 15, 2011. The Form may be amended or revoked before the due date, and if that is done, the last Form 8939 that is filed before the due date controls. No executor’s Form 8939 will have any effect on a Form 8939 filed by another executor, however, if the multiple Forms filed by different “statutory executors” allocate more than the allowed Basis Increase, they will be contacted to file a collective restated Form 8939, see above.

Observation: An IRS release on February 16, 2011 said that the due date of Form 8939 would be no earlier than 90 days after it was issued. The IRS later backed away from that commitment in a March 31 release, instead stating that there would be “a reasonable period of time for preparation and filing.” To meet a 90-day period, the Form 8939 would have to be issued by August 17, 2011.

Observation: November 15 is a “drop dead” date that is fast looming. Many difficult decisions must be made between now and then. See below for a discussion of some of the complexities that must be resolved by November 15. Part of the critical importance of this “drop dead” date is that the relief exception that specifically addresses Basis Increase allocations prohibits reducing any allocation that has already been made, perhaps suggesting that no reduction of Basis Increase allocated to any particular property will be permitted under any of the exceptions. If all of the available Basis Increase is allocated on Form 8939, this effectively means that no changes in the Basis Increase allocations are possible after November 15.

Observation:  As a practical matter, unless the estate is absolutely sure that it will make the Section 1022 Election, it will need to file a request for extension of time to file the Form 706 (which is extended to September 19 for decedents who died in 2010 before Dec. 17, 2010). Interestingly, the IRS has not officially confirmed that the automatic 6-month extension applies to the extended September 19 due date.  Presumably it does, but the Tax Relief … Act of 2010 did not explicitly amend § 6075(a) and Reg. §20.6081-1(b) says the automatic 6-month extension applies “beyond the date prescribed in section 6075(a).”  The draft Instructions to the 2010 Form 706, issued on August 3, 2011, merely say to file Form 4768 “to apply for an automatic 6-month extension of time to file” and do not suggest any special  restriction that applies to the extended September 19 due date.

No Extensions!! “The IRS will not grant extensions of time to file a Form 8939 and will not accept a Form 8939 or an amended Form 8939 filed after the due date ….” However, amended Form 8939s are allowed (i) if a Form 706 and Form 8939 are filed for the same decedent and the IRS notifies the filers to file either a restated From 706 or Form 8939 [described above], (ii) if multiple Form 8939s are filed allocating more than the allowed Basis Increase and the filers are notified to file a restated single Form 8939 [described above], and (iii) to report the allocation of Spousal Property Basis Increase to property within 90 days after that property has been distributed to the surviving spouse [described, below]. Also, there are three relief provisions to file an amended or supplemental Form 8939 or to file a late Form 8939 under several “9100 relief” exceptions described below.

No Protective Elections. “[A] taxpayer may not file an estate tax return as well as a conditional Form 8939 that would take effect only if an estate tax audit results in an increase in the gross estate above the applicable exclusion amount.” If an executor files a conditional Form 8939, apparently that sentence means the estate will be treated as not having made the Section 1022 Election.

Observation: This statement of a rule prohibiting protective elections does not explicitly cover the more common situation of an estate that is less than $5 million and is therefore not required to file a Form 706, but the executor files a Form 8939 electing into the carryover basis regime if the gross estate is over $x million. However, the IRS’s intent is clear that such protective elections on Form 8939 are not allowed and will not be recognized as making a Section 1022 Election even if the stated conditions occur.

Exceptions for Postponement of Due Date Under §§ 7508, 7508A or 692.  The due date for Form 8939 is postponed as provided in § 7508 (service in or in support of Armed Forces in a combat zone or contingency operation) and § 7508A (presidentially declared disaster or terroristic or military actions). A Form 8939 filed late under those sections should write “Filed Pursuant to Section 7508 [or 7508A if appropriate]” at the top of the Form.

Observation: As discussed above, the IRS generally will not even accept a late filed Form 8939. The handwritten notation notifies the IRS of the reason for the late filing so that it is not rejected out of hand. Decedents qualifying for relief under § 692, providing that income taxes for the year of death and years after serving in a combat zone do not apply to an individual who dies while in active service in the Armed Forces in a combat zone, or as a result of wounds incurred while so serving, must still file Form 8939 to make the carryover basis election. The Notice does not specifically say that the Form 8939 must be timely filed in that circumstance, but that appears to be the intent.

Relief Provisions. There are four situations in which an amended (or in the fourth situation, an initial) Form 8939 is permitted. The last three all involve “9100 relief” provisions.

Allocating Spousal Property Basis Increase Following Distribution to Spouse.  An amended Form 8939 may be filed to allocate Spousal Property Basis Increase to property distributed to a spouse if two requirements are met: (1) there was a timely-filed complete Form 8939 (other than allocation of the full amount of Spousal Property Basis Increase), and (2) such amended Form 8939 is filed within 90 days after distribution of property to the spouse to which such Basis Increase is allocated.

File Amended Form 8939 under Automatic Six-Month Extension Per Regulation § 301.9100-2. If the executor timely filed a Form 8939, the executor may file an amended Form 8939 under the provisions of Reg. § 301.9100-2(b), except to make or revoke a Section 1022 Election. The executor must write “Filed Pursuant to Section 301.9100-2” at the top of the amended Form 8939.

Observation: Reg. § 301.9100-2 allows an automatic six-month extension to make regulatory or statutory elections whose due dates are the due date of the return or due date including extensions, provided the taxpayer timely filed its return for the year the election should have been made and the taxpayer takes corrective action within the six-month period. Corrective action “includes filing an original or amended return for the year the regulatory or statutory election should have been made and attaching the appropriate form or statement for making the election.” No request for letter ruling is required to obtain an automatic extension, and user fees do not apply to taxpayers taking corrective action to obtain an automatic extension under § 301.9100-2.

Observation: This is a seemingly important exception to the general rule that amended Forms 8939 are not permitted after the due date. An amended Form 8939 can be filed within the first six months after November 15, 2011, and no letter ruling or user fees apply. Allowing the amendment under Reg. § 301.9100-2 is helpful, in that no letter ruling or user fee is required.  However, allowing this amendment under Reg. § 301.9100-2 is confusing in that the regulation applies to an automatic six-month extension “to make regulatory or statutory elections,” but Notice 2011-66 says that the amended

Form 8939 cannot “make or revoke a Section 1022 Election.” What other “regulatory or statutory election” is made on the Form 8939? Seemingly, the only other possibility would be the allocation of Basis Increase, but neither the statute nor the Notice refers to the allocation of Basis Increase as an “election.” Furthermore, the third relief exception, discussed immediately below, specifically deals with Basis Increase adjustments, which are allowed in only very limited situations, with the additional requirement of a formal letter ruling and payment of a user fee. The third relief exception, with its severe restrictions, might seem to be meaningless if Basis Increase adjustments could be made under this second very easy-to-satisfy relief provision.

Perhaps these two exceptions can be harmonized by allowing Basis Increase adjustments under this second relief exception, which only applies from November 15, 2011 to May 15, 2012, and allowing Basis Increase adjustments after May 15, 2012 only pursuant to the more restrictive provisions of the third relief exception. If that is intended, what is the policy reason for allowing additional Basis Increase allocations in the first six months by merely filing an amended Form 8939 under this second relief exception, but imposing severe restrictions after that six-month period? As to any of the information on the Form 8939 other than Basis Increase allocations, this exception apparently allows changes to any of that information such as listing property passing to particular recipients, descriptions of property, fair market values of property, etc.  However, none of those changes seem to be a “regulatory or statutory election” coming within the technical constructs of Reg. § 301.9100-2.

Supplement a Form 8939 Under Reg. § 301.9100-3 to Allocate Additional Basis Increase If There Is After-Discovered Property or If IRS Adjusts Fair Market Value of Property. If a Form 8939 has been timely filed, the executor may request relief to supplement the Form under Reg. § 301.9100-3 for the sole purpose of allocating any Basis Increase that has not previously been validly allocated. However, relief can be granted only in two situations: (1) the executor discovers additional property after filing Form 8939, and/or (2) the fair market value of property reported on the Form 8939 is adjusted in an IRS examination.

The supplemental Form cannot reduce an allocation of Basis Increase made on the timely filed Form 8939 — it can only allocate additional Basis Increase that was not previously allocated.  Observation: Query, does the prohibition on reducing a previously made Basis Increase allocation under this relief provision that specifically addresses changes to Basis Increase allocations reflect that the IRS intends that no reductions in Basis Increase previously allocated to a particular property will ever be allowed under any of the relief provisions?

Observation: Reg. § 301.9100-3 permits extensions of time for regulatory elections that do not meet the requirements for “9100-2 automatic extension relief.” Extensions are granted only if the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good faith and the grant of relief will not prejudice the interests of the Government. Reasonable action and good faith include failing to make an election “because of intervening events beyond the taxpayer’s control.” Reg. § 301.9100-3(b)(1)(ii).

The two situations described in this third relief exception seem to fall within the “intervening events” circumstance. An extension request under Reg. § 301.9100-3 is a request for a letter ruling and requires applicable user fee. The request must be accompanied by an affidavit and declaration from the taxpayer describing “events that led to the failure to make a valid regulatory election and to the discovery of the failure.” In addition, there must also be affidavits from individuals having knowledge about events that led to the failure to make a valid regulatory election, including the taxpayer’s return preparer or other tax advisor who advised the taxpayer with regard to the election. Reg. § 301.9100-3 allows the IRS to grant an extension of time for making “regulatory elections.” Apparently, the IRS is treating the Basis Increase allocation as a “regulatory election.”

Observation: Forcing taxpayers to go through the complicated process of a ruling request, with the required accompanying affidavits, and with the required stout user fee of $14,000 (unless the taxpayer qualifies for a reduced fee, which can apply for decedents with gross income under $1 million), see Rev. Proc. 2001-1, Appendix A (A)(3)(c), in order to allocate additional Basis Increase in these two non-abusive situations seems quite unfortunate.

Observation: The severe limits on being able to make changes to the Basis Increase allocations suggested in this relief exception emphasizes the critical importance of making the decision of how the allowable Basis Increase will be allocated on the Form 8939 by November 15. These decisions can be quite difficult and complex, both in determining the tax effects of the allocations as well as the fiduciary issues of treating beneficiaries fairly. There may be considerable difficulty in even determining the amount of allowable Basis Increase, in light of the fact that the $1.3 million General Basis Increase is increased by the amount of unrealized losses, which obviously depends upon date of death valuations.

Furthermore, deciding how to allocate Basis Increases by November 15 may be very difficult. There are the obvious situations of conflicts of interests and fights among beneficiaries, with the executor caught in the middle. There may also be situations in harmonious family situations where the optimal allocation depends on future events.  For example, Ron Aucutt (Tysons Corner, Virginia) poses the scenario of a will that bequeaths a highly appreciated ranch to a spouse and also provides that the spouse will receive one-half of the residuary estate consisting of highly appreciated stock and bonds with no significant appreciation. Does the executor allocate any of the Spousal Property Basis Increase to the ranch?  If the executor ultimately decides to distribute the highly appreciated stock to the spouse in satisfaction of his or her part of the residuary estate, allocating the Spousal Property Basis Increase to the stock may be preferable to allocating it to the ranch, because the spouse may be much more likely to sell the stock than the ranch during the spouse’s lifetime.

Observation: This exception makes clear that the executor will not be able to reduce the allocation of Basis Increase to any recipient. What if the executor incorrectly determines and overstates the amount of unrealized losses, and therefore overstates the amount of available General Basis Increase, and therefore over allocates Basis Increase? In that situation, there would have to be a reduction of the Basis Increase allocations. How will they be made?

Relief Exception for Extension to File Form 8939 Under Reg. § 301.9100-3.  An executor may request an extension of time “to file the Form 8939 (thus, making the Section 1022 Election and the allocation of Basis Increase)” pursuant to Reg. § 301.9100-3.  The Notice suggests that the IRS will apply a strict standard in determining whether relief will be granted:

“Taxpayers should be aware, however, that, in this context, the amount of time that has elapsed since the decedent's death may constitute a lack of reasonableness and good faith and/or prejudice to the interests of the government (for example, the use of hindsight to achieve a more favorable tax result and/or the lack of records available to establish what property was or was not owned by the decedent and death), which would prevent the grant of the requested relief.”

Observation: This is a broad sweeping relief exception, allowing the late filing for making the election itself and for allocating Basis Increases, that the IRS will apparently apply a strict standard before allowing relief under this exception. If relief is granted under this section, this is another situation (in addition to the third relief exception discussed above) in which Basis Increase allocations could be made after November 15 if they have not been fully allocated by November 15.

An example of a situation in which this relief might be granted is if the executor thinks that the estate is under $5 million and decides not to file Form 8939 by Nov. 15, 2011 making the Section 1022 Election, but subsequently discovers additional assets that makes the estate larger than $5 million, and therefore subject to estate taxation. In that situation, the estate may prefer to make the Section 1022 Election.  Obviously, the good faith activities and due diligence of the executor would be critical factor in the IRS’s consideration of the matter.

GST Tax in 2010: With Respect to Decedents Who Died in 2010.

Inclusion Ratio is Not Zero. For 2010, the GST tax rate is zero. Because the GST tax equals the inclusion ratio times the maximum estate tax rate, and because the maximum estate tax rate is 35%, one might argue that the inclusion ratio must therefore be zero. The Notice confirms, as expected, that the inclusion ratio is not zero. Rather, the maximum federal estate tax rate is deemed to be zero for this purpose.

If Section 1022 Election is Made, Allocate GST Exemption on Schedule R to Form 8939. For estates that make the Section 1022 Election, GST exemption is allocated by attaching the Schedule R of Form 8939 to the Form 8939. If the Form 8939 is timely filed, this allocation would be considered a timely allocation of the decedent's GST exemption.

Observation: This sentence seems somewhat redundant. The IRS will not accept an initial Form 8939 filed after the due date. If an extension is granted under § 301.9100-3 for filing Form 8939, the Form would then be timely filed if filed within the extended period. Query whether a GST exemption allocation on a Form 8939 for which an extension has been granted under Reg. § 301.9100-3 will be treated as a timely allocation of GST exemption?

Observation: The Notice does not address how an estate would make an intentionally late GST exemption allocation if the estate makes the Section 1022 Election by timely filing a Form 8939.  If a Schedule R is not attached to the Form 8939 (to avoid making a timely allocation), there is no discussion of filing an amended Form 8939 specifically for the purpose of later attaching a Schedule R making a late allocation.  Presumably, that would be permitted under the second relief exception allowing an amended return within the first 6 months under Reg. § 301.9100-2(b) (which does not require a letter ruling or payment of a user fee).

Observation: The Notice also does not specifically address how to elect out of automatic allocation for testamentary direct skips for an estate that makes the Section 1022 Election. Presumably that would be done by filing Schedule R and specifically describing an election out of automatic allocation.

Inter Vivos Direct Skips. A donor will typically want to elect out of automatic GST exemption allocation for direct skip gifts in 2010, because the GST tax is zero even without any exemption allocation. That may not be the case for a direct skip gift to a trust, the oldest beneficiary of which is at the grandchildren level, for example, if the donor anticipates that the trust will last for the lives of grandchildren and ultimately pass to more remote generations. Election out of automatic allocation can be made in two ways:

·        Timely Filed Form 709 Describing Election Out. A timely filed Form 709 could specifically describe the extent to which automatic allocation will not apply.

·        Timely Filed Form 709 Reporting Direct Skip Not in Trust.  The Notice observes that a donor would never want to allocate GST exemption to a 2010 direct skip gift not in trust. Regulation § 26.2632-1(b)(1)(i) provides that “a timely-filed Form 709 accompanied by payment of the GST tax (as shown on the return with respect to the direct skip) is sufficient to prevent an automatic allocation of GST exemption with respect to the transferred property.” To come within this regulation, the IRS will treat the reporting of any direct skip gift not in trust in 2010 as constituting the payment of tax (at a 0% rate), and therefore an election out of automatic allocation of GST exemption to that direct skip.

Filing Deadlines for Reporting GST Transfers and for Making GST Exemption Allocations.

GST Transfers. The Tax Relief … Act of 2010 provides that returns reporting GST transfers that occurred before December 17, 2010 are not due until September 19, 2011. Accordingly, the due date for reporting direct skips, taxable terminations or taxable distributions that occurred in 2010 before December 17, 2010 is September 19, 2011. However, if the executor files Form 8939, the due date for filing the GST report is extended to November 15, 2011.

Observation: What is the statutory authority for extending the due date for reporting GST transfers in 2010 beyond September 19, regardless of whether the estate makes the Section 1022 Election? Section 2662 provides that a direct skip must be reported by the date on which an estate or gift tax return is required to be filed with respect to the transfer. For a testamentary direct skip in 2010, since no estate tax return is required if the Section 1022 Election is made, that ambiguity presumably authorizes the IRS to provide a time period appropriate for replacing the due date of the estate tax return, which obviously would not be relevant to the estate. However, for inter vivos direct skips, taxable terminations or taxable distributions, there does not appear to be statutory authority for extending the due date.

Indirect Skip or GST Transfer After December 16, 2010.  For indirect skips (i.e., transfers to trusts from which there may be distributions to second-generation beneficiaries at some point in the future) and for GST transfers occurring after December 16, 2010, there is no extension of the time for filing GST returns. Therefore, the returns were due April 18, 2011 (or October 17, 2011 if the gift tax return was extended).  If the gift tax return was timely filed but the GST exemption allocation was not made, an automatic six-month extension for making GST exemption may be allowed under Reg. § 301.9100-2 (b) (without requesting a letter ruling or paying a user fee).

Chapter 13 Applies to Testamentary Transfers in 2010 Even If Section 2011 Election is Made.  The Notice reiterates provisions in the Tax Relief… Act of 2010 making clear that Chapter 13 applies to 2010 decedents even if the Section 1022 Election is made. Without this provision in the Tax Relief… Act of 2010, arguably there would be no “transferor” for purposes of the GST tax, because the decedent would not be subject to the estate tax.

Collateral Provisions Regarding Nonresident Aliens and Section 645 Elections.

Transfer Certificates for Nonresident Aliens. For the estate of a nonresident alien who died in 2010, a transfer certificate permitting the transfer of property without liability for estate tax is not necessary if the estate makes the Section 1022 Election, and the IRS will not issue such transfer certificates.

“Applicable Date” For Trusts Making Section 645 Election. An estate and revocable trust may make an election under § 645 for the trust to be treated as part of the estate for income tax purposes from the date of the decedent's death until the “applicable date.”  If the executor makes the Section 1022 Election, no estate tax return is required to be filed, and the “applicable date” will be two years after the date of death.

Miscellaneous.

IRS Will Issue Regulations. The “effective date” section of the Notice states that the Treasury Department and the IRS intends to issue regulations to confirm the guidance in the Notice. Observation: It is somewhat surprising that the Treasury Department and IRS will go through the formal process of issuing regulations, given that the carryover basis provisions apply only to decedents who died in 2010 for which the estate makes the Section 1022 Election.

Separate Schedules for Each Recipient. Section 6018(e) requires the executor to give carryover basis information to each recipient within 30 days after filing the Form 8939. The Notice contemplates that the executor will attach separate schedules to the Form 8939 for each recipient detailing property distributed to that recipient, and will send each recipient's statement to the recipient to meet the information reporting requirement.

Anticipated Number of Returns.  The IRS anticipates that 7000 estates of decedents who died in 2010 will file Form 8939. Even though only large estates (over $5 million) will likely file the Form 8939, the IRS estimates that executors will need only approximately 10 hours “to comply with [the Form 8939] filing requirements” (presumably including compiling all of the carryover basis information, making Basis Increase decisions among estate recipients, and describing the assets, basis information, and Basis Increase allocations on the report). Interestingly, Revenue Procedure 2011-41 estimates that executors who file the Form 8939 will need approximately eight hours “to prepare the documentation.” Of the 7000 estates that file Form 8939, the IRS anticipates that approximately 6000 of those estates will also file Schedule R to report GST transfers, GST exemption allocations, or elections out of automatic allocation.

Retain Books and Records. “Books or records relating to collections of information must be retained as long as their contents may become material in the administration of any internal of a new law.” (Emphasis added.) This time period would presumably last until all estate assets have been sold by the recipients, and the statute of limitations has run on income tax returns reporting the gain transactions, and throughout the useful life of any assets being depreciated as a result of Basis Increases allocated to those assets.

Revenue Procedure 2011-41

Overview. Rev. Proc. 2011-41 purports to provide “optional safe harbor guidance” regarding § 1022. However, Revenue Procedure 2011-41 offers few (if any) “safe harbors,” but provides substantive information regarding the meaning of various definitions and the application of provisions in § 1022. The only “safe harbor” even mentioned in the substantive discussion of Rev. Proc. 2011-41 is that revocable trusts and trusts that would be includable in the estate under §§ 2036, 2037 and 2038 [if the estate tax applied] qualify for the special rule that gain recognition can result from funding pecuniary distributions only with respect to post-death appreciation (see below).) That is not really a safe harbor, because the statute specifically contemplates that trusts may be covered by that special rule, to the extent provided in regulations.

Observation: Planners have been hoping that some true “safe harbor” situations would be addressed by the IRS. For example:

·        De minimis rules — Is there a need to allocate basis adjustment to the piano, for example, or should there be de minimis rules?

·        If an asset clearly has a value in excess of basis adjustment being allocated to the asset, is a “full-fledged” appraisal necessary, or might a statement that the value far exceeds the possible basis adjustments suffice?

Observation: Perhaps the Rev. Proc. references “safe harbors” because the IRS cannot issue retroactive interpretive regulations more than 18 months after the enactment of the statute under § 7805.  Because the Rev. Proc. merely purports to provide safe harbors rather than providing substantive guidance of the meaning of provisions in § 1022, taxpayers may conceivably take contrary positions, knowing that they merely do not fall within a “safe harbor” that has been recognized by the IRS. However, much of the Rev. Proc. reads as substantive interpretation of the statute rather than as providing for safe harbors.

Section 4.01 — Application of Section 1022.

Section 1022 Applies Regardless When Property is Sold. Section 1022 applies to determine a recipient’s basis in property acquired from a decedent “regardless of the year in which the property is sold or distributed.”  Rev. Proc. 2011-41, § 4.01(1).

Property Not Subject to Section 1022. Section 1022 (a) provides that the basis of “property acquired from a decedent” is the lesser of the adjusted basis of the decedent or fair market value of the property at the date of the decedent's death. Examples of property not subject to 1022 are income in respect of a decedent items, annuities subject to income tax under § 72, and the decedent’s interest in QTIP trust property.  For those types of assets, “[t]he recipient’s basis in property that is not subject to section 1022 is determined under other applicable sections of the Code.” Rev. Proc. 2011-41, § 4.01(2).

Observation: If the Section 1022 Election is made, the basis would not be determined under § 1014.  The Tax Relief … Act of 2010 provides that if the Section 1022 Election is made, the provisions of subtitle A or E of title V of the Economic Growth and Tax Relief Reconciliation Act of 2001 are not “repealed.” Subtitle E included section 542, which added § 1014 (f) providing that § 1014 would not apply to decedents dying after 2009.  Therefore, the asset would retain its basis, not being subject to a “step up” or “step down” in basis under § 1014, and not being subject to a “step down” in basis under § 1022(a) (because it limits the basis to the lesser of the decedent’s basis or fair market value at the date of death.

“Property Acquired From the Decedent,” Which Is Therefore Subject to Modified Carryover Basis Under § 1022(a).  Rev. Proc. 2011-41, § 4.01(3).

Bequeathed Assets; Revocable Trust Assets.  Property acquired by bequest, devise or inheritance or by the decedent’s estate from the decedent as well as property in a qualified revocable trust, whether or not the election under § 645 is made for that trust, constitutes “property acquired from the decedent.”

Trusts Includable Under §§ 2036(a)(2) or 2038; Retained Reversionary Interest or Power of Appointment. Property acquired from a decedent includes a trust with respect to which the decedent reserved the right to make any change in enjoyment through the exercise of the power to alter, amend, or terminate the trust, including trusts in which the decedent retained a reversionary interest or retained a power of appointment.

As an example, a QPRT, for which the decedent does not have a reversionary interest if the decedent dies during the term of the QPRT, is not “property acquired from a decedent.” However, if the grantor has a retained reversionary interest if the grantor dies before the end of the QPRT term (which is typical), it is “property acquired from a decedent,” and therefore subject to § 1022. In addition, as described below, it is also treated as “owned by the decedent” and therefore qualifies to receive Basis Increase allocations.

Not Trusts Includible Under § 2036(a)(1). Trusts in which the decedent has retained a beneficial interest, and that would be includable in the gross estate under § 2036 (a) (1), are not “property acquired from a decedent” and are not subject to § 1022.  This is confirmed by Example 14 in Rev. Proc. 2011-41.

Observation: As an example, assets in a GRAT would not be subject to § 1022 (assuming the grantor has not retained a power that would cause estate inclusion under §§ 2036(a)(2) or 2038).  Therefore, even if the grantor dies during the term of the GRAT, such that the GRAT assets would ordinarily be included in the grantor’s estate under§ 2036(a)(1) if the estate tax applied, the basis of GRAT assets will not be “stepped down” to fair market value if there are depreciated assets, and the GRAT assets are not eligible to receive Basis Increase allocations.

Observation: The rationale for the difference in treatment of § 2036(a)(1) assets (assets with retained enjoyment) versus the treatment of §§ 2036(a)(2) or 2038 assets (for which the decedent can designate who can enjoy the assets including by altering, amending or terminating the trust) seems to be based on control.  Because of the decedent’s greater ability to control the assets in the §§ 2036(a)(2) or 2038 situation, the assets are deemed to be acquired from the decedent.  Because the decedent can merely enjoy but not control the disposition of assets subject to inclusion under §§ 2036(a)(1), recipients of those assets are not deemed to have acquired them from the decedent.

Surviving Spouse’s One-Half Interest in Community Property. The surviving spouse’s one-half of community property is subject to § 1022 (and the basis of the surviving spouse’s one-half is therefore subject to being “stepped down” to fair market value at the date of death).

General Power of Appointment. Property over which the decedent held a general power of appointment is “acquired from the decedent” and subject to § 1022. However, as discussed below, such property is not eligible to receive Basis Increase allocations.

Not QTIP Property. The decedent’s interest in a QTIP trust that was created by the decedent’s spouse for the decedent’s benefit is not “property acquired from a decedent” and is not subject to § 1022.

Observation: Consider a situation in which a QTIP trust is the major asset that would be in the gross estate if the estate tax applied, and assume the gross estate would be under $5 million. One ordinarily assumes that an estate of under $5 million would prefer to be in the estate tax regime rather than making the Section 1022 Election. However, if the QTIP assets are depreciated and if the estate tax regime applies, there would be a “step down” in basis of the QTIP assets to the date of death value.  If the Section 1022 Election is made, § 1014 does not apply to step down the basis of the assets, and the QTIP assets are not subject to the rule in § 1022(a) limiting basis to the lesser of the carryover basis or fair market value.  The estate may strategically decide that it would prefer to make the Section 1022 Election.

“Property Owned by the Decedent” to Which Basis Increases May be Allocated. The $1.3 million “Aggregate Basis Increase”(together with the “Carryover/Unrealized Losses Increase”) and the $3.0 million “Spousal Property Basis Increase” can only be allocated to property that is both “acquired from the decedent” and “owned by the decedent.” Rev. Proc. 2011-41, § 4.01(4).

Examples of Assets That Constitute “Property Owned by the Decedent” That Can Receive Basis Increase Allocations.  Examples of assets that qualify as “property owned by the decedent” include (i) assets legally titled to the decedent (unless held in a legal representative capacity), (ii) certain jointly owned property, whether as tenants in common or with right of survivorship, (iii) assets in a qualified revocable trust, and (iv) both halves of community property.

Not Property Subject to Any Power of Appointment. Property over which the decedent holds any power of appointment is not considered owned by the decedent at death.

Observation: “General power of appointment property is “property acquired from a decedent” and therefore subject to the modified carryover basis rule of § 1022(a), but is not “property owned by the decedent” and therefore Basis Increase cannot be allocated to it.

Not Trusts Includable Under §§ 2036(a)(1), 2036(a)(2) or 2038 Unless Retained Reversionary Interest. A trust with respect to which the decedent had a beneficial interest or reserved the right to make any change in enjoyment through the exercise of the power to alter, amend, or terminate the trust is not “property owned by the decedent,” unless the decedent retained a reversionary interest, as discussed below.

Not Section 679 Trusts. Property in a foreign trust treated as owned by the grantor for income tax purposes under § 679 is not considered to be owned by the decedent at the grantor's death for purposes of receiving Basis Increase allocations.  Observation: Presumably, the same result would apply to property that is treated as owned by a trust beneficiary for income tax purposes under § 678.

Decedent Held Reversionary Interest; Does Constitute “Owned by Decedent.”  For the various trusts described above that are not treated is “owned by the decedent,” if the terms of the trust required that the trust property reverted back to the decedent upon his or her death, the property is deemed to be “owned by the decedent” (and therefore can receive allocations of Basis Increase).

Not QTIP. An interest in a QTIP trust for the benefit of the decedent is not “owned by the decedent.”

Other Assets Not Eligible For Basis Increase Allocations.

Property Acquired by Gift within Three Years of Death. Property acquired by the decedent by gift within three years of death is not treated as “owned by the decedent” unless the property was acquired by gift from the decedent's spouse (except where the spouse also received the property by gift within the three-year period).  I.R.C. § 1022 (d) (1) (C).

Certain Foreign Entities. Stock in certain foreign entities, including a foreign personal holding company, DISC, foreign investment company, are not eligible for Basis Increase allocations.

Section 4.02 — Amount of Basis Increase That May be Allocated to Appreciated Assets. The total basis increase that can be allocated on Form 8939 to property owned by the decedent is referred to as the “Basis Increase.”

Observation:  The Revenue Procedure makes clear that the permissible Basis Increase amounts may be allocated to appropriate assets, even if post-death depreciation in the assets would result in the recipient being able to take a loss on the sale of the assets. See, e.g., Rev. Proc. 2011-41, § 4.02(3) Ex. 4.

Overview and Nomenclature.  An algebraic statement of the allowable Basis Increase, using definitions described in Rev. Proc. 2011-41, is as follows:

·        Basis Increase = General Basis Increase + Spousal Property Basis Increase

·        Where General Basis Increase = Aggregate Basis Increase ($1.3 million) + Carryovers/Unrealized Losses Increase

·        General Basis Increase.  The General Basis Increase consists of the sum of the “Aggregate Basis Increase” (which is $1.3 million) plus the “Carryovers/Unrealized Losses Increase.”

Aggregate Basis Increase. Section 1022(b)(2)(B) says that the Aggregate Basis Increase is $1.3 million.

Carryovers/Unrealized Losses Increase.  The $1.3 million Aggregate Basis Increase is increased by the sum of capital loss carryovers, net operating loss carryovers, and unrealized losses. Rev. Proc. 2011-41, § 4.02(2)(b). The carryovers include capital loss carryovers under § 1212 (b) and net operating loss carryovers under § 172 that would be carried over from the decedent's last taxable year to a later taxable year (but for the decedent's death). If the spouses file a joint return, only the decedent’s share of the loss carryovers may be added to the General Basis Increase. As discussed below regarding community property, only the decedent’s one half of loss carryovers may be added to the General Basis Increase, and the surviving spouse would retain his or her one half of the loss carryovers to report on future income tax returns.

Unrealized losses that may be added to the $1.3 million Aggregate Basis Increase include all losses described in §§ 165 (c)(1) (losses incurred in a trade or business), 165(c)(2) (losses incurred in any transaction entered into for profit though not connected with a trade or business — which would include typical capital assets, but would not include personal use assets such as autos) from all property acquired from the decedent that would have been allowable as a deduction if the property had been sold at fair market value immediately before the decedent's death. (Losses described in § 165(c)(3) (losses from fire, storm, shipwreck, or other casualty or from theft) would by their nature have been incurred prior to death and would be reported on the decedent’s final income tax return and are not included in the Carryovers/Unrealized Losses Increase.

The full amount of such unrealized losses may be added in determining the General Basis Increase, and the capital loss limitations in §§ 1211 and 1212 (and referred to in § 165(f)) are ignored for this purpose. Accordingly, the $3,000 annual limitation on losses, to the extent that losses cannot be offset by gains, is not applicable, and the full amount of unrealized losses can be used.

Spousal Property Basis Increase.  The executor can allocate $3 million of basis increase to property (i) passing outright to the surviving spouse, or (ii) that is QTIP property (even though there is obviously no QTIP election in light of the fact that an estate tax return is not filed for the estate). (For simplicity, “QTIP property” will subsequently be referred to in this summary as a QTIP trust, since that is the most common type of QTIP property.) This is referred to as the “Spousal Property Basis Increase.” Rev. Proc. 2011-41, § 4.02(3).

Allocation Only to Assets Transferred to Spouse or QTIP Trust. The executor can allocate Spousal Property Basis Increase on Form 8939 only to property that is transferred outright to the surviving spouse or a QTIP trust. Spousal Property Basis Increase may be allocated to qualified spousal property that has already been distributed.

Observation: The Revenue Procedure does not specifically address the allocation of Spousal Property Basis Increase on the Form 8939 to property that is bequeathed or otherwise specified to pass to the surviving spouse or to a QTIP trust, but presumably that is allowed.  However, it is not clear whether that can be done for property that may pass to the surviving spouse, where the executor has discretion in selecting assets to fund a pecuniary, fractional, or residuary bequest to the spouse, but the property has not been transferred to the spouse or QTIP trust at the time of the allocation. Notice 2011-66 allows filing an amended Form 8936 to allocate Spousal Property Basis Increase to property that is distributed to a spouse or QTIP trust after the Form 8939 is filed, and perhaps the discretionary funding situation is one of the circumstances contemplated where the executor would have to use the amended Form 8939 procedure to allocate Spousal Property Basis Increase to a particular asset that is ultimately distributed to the spouse or a QTIP trust.

Allocation to Property Where Net Sales Proceeds Will be Distributed to Spouse or QTIP Trust. The executor can also allocate Spousal Property Basis Increase to property that is sold by the estate before the property is distributed, where the net proceeds from the sale will be distributed to the spouse or a QTIP trust IF:

·        the executor certifies on Form 8939 that the net proceeds from the sale of the property will be distributed to or for the benefit of the spouse or a QTIP trust, AND

·        each document providing for a bequest to the spouse or QTIP trust is attached to the Form 8939.

If a portion of the net proceeds from the sale of assets are used to pay administration expenses, Spousal Property Basis Increase can be allocated only to the surviving spouse’s portion of the unrealized appreciation in the asset. Examples 4-6 of Rev. Proc. 2011-41 illustrate this computation.

Observation: This is excellent news for estates that have already sold assets, where the executor intends to distribute the net sales proceeds to the surviving spouse.  If this procedure is not followed with respect to a particular asset, but the executor later decides to sell that asset, the proceeds of which will be distributed to the surviving spouse, there is no clear way under the Revenue Procedure for the executor to allocate Spousal Property Basis Increase to that asset to decrease the amount of gain recognized by the estate on the sale. Executors must carefully consider before November 15 whether any assets will be sold by the estate, the net sale proceeds of which will later be distributed to the surviving spouse.

The Revenue Procedure addresses how to deal with a situation in which an asset is sold and used partly to pay administration expenses with the balance being distributed to the surviving spouse. What if, instead of using some net proceeds to pay administration expenses, the executor uses some of the net proceeds to fund bequests passing the beneficiaries other than the surviving spouse? Is it possible to allocate Spousal Property Basis Increase to the asset in an amount equal to the portion of the unrealized appreciation at death that is proportionate to the net sales proceeds that will be received by the surviving spouse?

Allocation to Charitable Remainder Trust with Spouse as Sole Beneficiary. Assets distributed to a charitable remainder trust also qualify for the Spousal Property Basis Increase if the spouse is the sole beneficiary of the trust.

Nonresident Alien Decedents. For nonresident alien decedents, the General Basis Increase is limited to $60,000. However, the full amount of the $3 million Spousal Property Basis Increase can be allocated to property to property passing to a spouse or QTIP trust. Rev.

Section 4.03 — General Rules for Allocating Basis Increase. Rev. Proc. 2011-41, § 4.03.

Property by Property. The allocations are made on a property-by-property basis, but the basis of each such property, after the allocation, cannot exceed the fair market value of the property at the decedent's death.

Interest in Property. Basis Increase can be allocated to each “interest” in a property. For example, Basis Increase could be allocated to some but not all shares of stock in a particular company, or to a life estate or remainder interest owned by the decedent. However, it cannot be allocated separately to separate interests that are created by reason of the decedent’s death that are not undivided portions or fractional interests of each and every interest in the property that was owned by the decedent. For example, if the decedent’s will creates a life estate and remainder interest in property, the basis allocation could not be made separately to those separate interests. However, if the decedent bequeathed undivided fractional interests in the property to various recipients, the Basis Increase could be allocated to the fractional interests distributed to certain recipients and not others.

Observation: The draft Form 8939 available on the IRS website requires listing property acquired from the decedent by each recipient.  Instructions have not been issued. It is not clear whether, or how the executor might be able to allocate any of the General Basis Increase to an interest in a property that will be distributed to one recipient but not interests in that same property that will be distributed to other recipients.

Observation: The Notice does not address the very common situation of real property consisting of a building and land. Will the building and land be treated as separate interests, such that Basis Increase could be allocated just to the building [which can be depreciated] and not the land [which cannot be depreciated]?

Section 4.04 — Determination of Fair Market Value.

Significance. Determination of each property’s value at the date of death is important because (i) the basis of the property will be the lesser of the decedent’s basis or fair market value, and (ii) Basis Increase can be allocated to a property only to the extent that the resulting basis does not exceed the property’s fair market value at the date of death.

General Estate Tax Valuation Principles; Appraisals. Estate tax valuation principles apply, and the provisions in regulations to § 2031 regarding required appraisals also apply for determining the fair market value of any property acquired from the decedent for purposes of § 1022. “The executor must attach any appraisals required under section 2031 to the Form 8939.”

Observation: Assuming the reference to “appraisals required under section 2031” includes appraisals that are required to be attached to a Form 706 (for estates subject to the estate tax) in either the regulations or the instructions to Form 706, the following would be required: Real estate (Instructions for Schedule A on 2009 Form 706 and Draft of 2010 Form 706 Instructions). “[A]attach copies of any appraisals.” Therefore, the instructions do not require obtaining appraisals of real estate to attach to the Form 706, but they do require attaching any appraisals that are obtained.

Stocks and bonds (Form 706 instructions). The instructions applicable to Schedule B do not require attaching appraisals of closely held companies, but requires sending “complete financial and other data used to determine value.” The required information includes balance sheets and statements of net earnings and dividends paid for each of the five years preceding the valuation date.

Partnerships or unincorporated businesses (Form 706 instructions). The instructions do not require attaching appraisals, but require attaching statements of assets and liabilities as well as statements of earnings, both for the year of death and each of the preceding five years.

Household and personal effects (Reg. § 20.2031-6(a)-(b)). Reg. § 20.2031-6(a) requires an itemization of each item of household furnishings or personal effects, except that items in the same room may be grouped as long as no individual item exceeds $100.  In lieu of an itemized list, a written statement may be attached “setting forth the aggregate value as appraised by a competent appraiser or appraisers of recognized standing and ability, or by a dealer or dealers in the class of personality involved.”

Reg. § 20.2031-6(b) requires that there be an appraisal of any household or personal effects article “having marked artistic or intrinsic value  … in excess of $3,000.”

The instructions for Schedule F on the 2009 Form 706 requires an appraisal of “any one work of art or item with

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