IRS Issues Final Regulations on Portability
The Treasury and the IRS have released the final regulations on portability of a Deceased Spouse’s Unused Exclusion Amount (“DSUE amount”). These regulations modify the Temporary Regulations issued on June 18, 2012. The final regulations became effective June 12, 2015. Several issues in connection with extensions of the deadline to elect portability are addressed. First, no extension of time to elect portability will be granted under Reg. §301.9100-3 because the portability requirement is statutory and not regulatory. However, under circumstances addressed in Rev. Proc. 2014-18, in some cases a taxpayer may obtain a discretionary extension of time in which to file an estate tax return for the purpose of electing portability without the need to obtain a Private Letter Ruling. One such case would be the situation in which the taxpayer is not required to file an estate tax return by reason of the value of the gross estate and adjusted taxable gifts, without regard to portability.
The final regulations also clarify which individuals may elect portability. The Internal Revenue Code requires that the election be made by the decedent’s “executor.” The final regulations clarify that although an individual may be deemed to be an executor if in possession of estate assets, an appointed executor has the right to make the portability election. The final regulations do not address whether a surviving spouse who is not an executor to make the portability election. Treasury affirmed its position that the IRS has broad authority under IRC § 2010(c) to examine the correctness of any estate return to determine the allowable DSUE amount without regard to the period of limitations on the return of the decedent. Whether an estate tax return is complete and properly prepared would be determined on a case-by-case basis by applying standards as prescribed in current law. Applicability of portability to a surviving spouse that becomes a U.S. citizen subsequent to the death of a spouse is addressed by the final regulations in favorable manner. The final regulations allow a surviving spouse to take into account the DSUE amount of the deceased spouse as of the date he or she becomes a U.S. citizen. Thus, the spouse would benefit from the DSUE for any subsequent lifetime transfers made. Of course, the estate of the deceased spouse must have made a portability election.
The Surface Transportation and Veterans Health Care Improvement Act of 2015
The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (enacted July 31, 2015) created new Code §§ 6035 and 1014(f). IRC § 6035 provides that an executor required to file an estate tax return file a valuation statement with the IRS and with beneficiaries within thirty days of the earlier of (i) the date on which the estate tax return was required to be filed, or (ii) the date on which the estate tax return was actually filed. Only those estates that are required to file an estate tax return must file valuation statements. Executors that file an estate tax return to elect portability are not required to file valuation statements.
Valuation statements must identify the value reported on the decedent’s estate tax return for each property interest. A supplemental statement reporting any later adjustment in the value of the property must be filed no later than thirty days after the adjustment. For the purpose of penalties, the statement filed with the IRS is an information return, while the statement filed with beneficiaries is a “payee statement.” IRC § 1014(f) introduces the “consistent valuation rule.” Subsection (f) states that the basis of property acquired from a decedent shall not exceed the value determined for estate tax purposes or, for property the value of which has not been determined for federal estate tax purposes, the value identified in a valuation statement filed pursuant to IRC § 6035.
The purpose of Section 1014(f) is to prevent taxpayers from using a lower value for an asset in order to reduce estate tax while at the same time using a higher value to reduce gain for income tax purposes. The IRS made proposals similar to the consistent basis rule in its General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals. The Joint Committee on Taxation estimated that Section 2014(f) will raise $1.54 billion in revenues for the ten year period 2015 through 2025.
New Rulings and Procedures
The IRS made additions to the “no-rulings” list in Rev. Proc. 2015-37. With respect to all ruling requests received after June 15, 2015, the IRS will no longer rule on whether the assets in a grantor trust will receive a Section 1014 basis adjustment if they are not includible in the gross estate of the owner at death. This is an issue which has elicited a fair amount of commentary by tax attorneys. The prevailing and preferred view is that assets in a grantor trust not includible in the gross estate would not receive a basis step up.
In PLR 201544005, the IRS agreed with the taxpayer, and found that amending an irrevocable trust to correct scrivener’s error retroactively created a completed gift, which resulted in the avoidance estate taxation. Here, a husband and wife created an irrevocable trust for the benefit of their two children. They intended that transfers to the trust be completed gifts that would not be included in their gross estates. Gift tax returns were filed reporting the transfers as gifts. The settlors later discovered that transfers to the trust were not completed gifts, because they had retained the power to amend the trust to change the beneficial interests. At the request of the settlors, a local court amended the trust language to correct the error. The IRS respected the amendment because it effectuated the intent of the settlors.
Two recent rulings, PLRs 201507008 and 201516056 address the time at which contributions to a trust will be deemed as completed gifts subject to federal gift tax. In PLR 201507008, the IRS examined an irrevocable trust and the effect of settlor’s powers over distributions. The Service concluded that the settlor’s contributions were not completed gifts, reasoning that the settlor had retained lifetime and testamentary powers of appointment, as well as the power to veto distributions. The IRS further determined that a distribution of income or principal by a “distribution adviser” to a beneficiary that was not the settlor was a completed gift. Upon the settlor’s death, the fair market value of the property remaining in the trust (less distributions made to beneficiaries) would be included in the settlor’s gross estate for estate tax purposes.
In PLR 201516056, the taxpayer’s proposed disclaimers of securities gifted by his wife prior to her death constituted qualified disclaimers. The disclaimers involved securities held in two accounts. With respect to the first account, securities transferred by the wife were a completed gift at the time of transfer. With respect to the second account, the wife added her husband as a joint owner with right of survivorship. That transfer became complete only upon the death of the wife. The disclaimers would be qualified with respect to the completed gift in the first account since the disclaimer occurred within nine months of the date of transfer of securities; and would be qualified with respect to the second account because the disclaimer was made within nine months of the date of death.
Treasury General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals
Treasury proposed changes in connection with estate tax procedures. The first involves broadening the term “executor,” thereby giving that person the authority to act on behalf of the decedent with respect to all tax matters, rather than only estate tax matters. The second would be that the special lien imposed under IRC § 6324(a)(1) for taxes deferred under IRC § 6166 be extended from ten years to fifteen years. Treasury General Explanations of the Administration’s Fiscal Year 2016 (the “Green Book”) proposed various changes involving capital gains: First, the capital gains tax would increase to 24.2 percent; second, the basis step up upon death would be eliminated; and third, gratuitous transfers of appreciated property (either by gift or at death) would be treated as a sale for income tax purposes, with the donor or decedent realizing capital gain at the time of the gift or death.
The following exceptions would apply to the somewhat draconian proposed third change:
(i) Taxes imposed on gains deemed realized at death would be deductible on any estate tax return of the decedent’s estate;
(ii) Capital gains on a gift or bequest to a spouse would not be realized until the spouse disposes of the asset or dies;
(iii) Each decedent would have a $100,000 exclusion for capital gains recognized by reason of death, portable to the decedent’s surviving spouse;
(iv) Gifts or bequests to a spouse or charity would carry out the basis of the donor or decedent;
(v) Appreciated property given or bequeathed to charity would be exempt from capital gains tax;
(vi) The final income tax return of a decedent may utilize unlimited capital losses and carry-forwards against ordinary income;
(vii) There would be no capital gain tax imposed on tangible personal property;
(viii) The $250,000 per person exclusion for capital gain on a principal residence would apply to all residences, portable to the decedent’s surviving spouse; and
(ix) A deduction would be available for the full cost of appraisals of appreciated assets.
Sales of assets to grantor trusts have also attracted the attention of Treasury, which proposed that the gross estate of a decedent deemed to own a trust under the grantor trust rules would include that portion of the trust attributable to a sale, exchange, or “comparable transaction” between the grantor and the trust, if that transaction was disregarded for income tax purposes. The gross estate would include any income, appreciation and reinvestments (net the amount of consideration received by the grantor) therefrom. These amounts would also be subject to gift tax at any time during the life of the deemed owner if grantor trust treatment terminated, or to the extent any distribution were made to another person.
New York State Matters
Determining Residency for Income Tax Purposes Where Property Straddles a Boundary Line
The NYS Department of Taxation and Finance (“DTF”) recently advised whether married taxpayers were residents of New York City for income tax purposes where their residence was located on both sides of the border separating the Bronx (a borough of New York City) and Yonkers. The taxpayers do not work in New York City or hold any other property located in New York City. New York (Tax Law § 605(b)), New York City (N.Y.C. Administrative Code § 11-1705(b)(1)(A)) and Yonkers (Yonkers Income Tax surcharge § 15-99) all define residence as the place where an individual is domiciled and maintains a permanent place of abode. The tax law defines “domicile” as “the place which an individual intends to be such individual’s permanent home.” (20 NYCRR 105.20(d)(1)). “Permanent place of abode” is defined as “a dwelling place of a permanent nature maintained by the taxpayer.” (20 NYCRR § 105.20(e)(1)).
TSB-A(15(8)I advised that a house meets the definition of “permanent place of abode” and that its location determines the residency of the taxpayers. Since the portion of the property located in the Bronx consisted entirely of vacant land, while the house itself was located in Yonkers, the taxpayers were domiciled in Yonkers rather than New York City. Although the TSB provides some clarity in this particular situation, questions still remain. DTF did not opine as to whether taxpayers would be treated as residents of either or both locations where a house straddles two different jurisdictions.
Interests in Disregarded Single Member LLCs are Tangible Property for New York Estate Tax Purposes
A recent advisory opinion (TSB-A-15(1)M) stated that a membership interest in a single-member LLC disregarded for income tax purposes is not intangible property for New York State estate tax purposes. However, this result would not obtain if a single member LLC elected to be treated as a corporation. The New York resident intended to transfer real property with a situs in New York to a non-New York LLC prior to moving permanently to another state. New York imposes estate tax on real property and tangible personal property that is physically located in New York. However, New York imposes no estate tax on a nonresident’s intangible property since such property is considered to be located at the domicile of the owner. New York regulations state that a single member LLC disregarded for Federal income tax purposes is treated as owned by the individual owner. Activities of the LLC are treated as activities of the owner. Thus, the New York real property held by a single member LLC that is disregarded for income tax purposes would be treated as real property held by the taxpayer for New York estate tax purposes.
There is a question as to the Constitutionality of the conclusion reached in this TSB since the New York Constitution prohibits the imposition of an estate tax on the intangible property of a nonresident, even if such property is located within New York State. While it is true that single member LLCs are ignored for federal income tax purposes, they are not ignored for other federal (or state) legal purposes. Therefore, it arguably an unjustified logistical jump to conclude that because the entity is ignored for federal income tax purposes, it should also be ignored for purposes of the New York State Constitution.
DTF Explains 2015 Legislative Amendments to Estate Tax Provisions Enacted in 2014
The year 2015 saw significant changes in New York estate tax. On April 13, 2015, the legislature enacted technical amendments which provided some clarity. DTF then issued a technical memorandum on July 24, 2015 explaining the amendments. (TSB-M-15(3)M). Some amendments clarify certain issues relating to the new three year “add-back” rule. The add-back rule provides that any gifts made within three years of death that are taxable for federal gift tax purposes will be added back to the New York taxable estate. The first amendment to the add-back rule provides that the rule will not apply to estates of decedents dying on or after January 1, 2019. A second specifically excludes from the scope of the rule any gifts of real or tangible personal property located outside of New York at the time the gift was made.Estate Tax § 960(b) was amended to disallow deductions related to intangible personal property for non-resident decedents otherwise available for federal estate tax purposes. The amendment is logical since intangible personal property is excluded from the taxable estate of a non-resident.
Another amendment made to the estate tax law in 2015 corrects a drafting error which would have resulted in the estate tax expiring on March 31, 2015. There was no tax rate schedule applicable after that date. The tax tables have now been made permanent.
Neither the amendments nor the technical memo address a significant change to New York estate tax made effective in 2014. That change related to the exemption amount. Prior to 2014, an estate was only subject to estate tax to the extent that it exceeded the exemption amount. For the first time, estates considered too large could not benefit from the tax exemption at all. Under current law, if an estate exceeds 105 percent of the basic exclusion amount, the entire estate becomes subject to New York estate tax, rather than just the amount which exceeds the exemption amount. Those estates between 100 percent and 105 percent of the exemption amount are subject to a phase-out of the estate tax exemption. With the law remaining unchanged, marginal changes in the size of the New York estate may cause disproportionate differences in the amount of estate tax imposed. One means of easing the resulting burden would be to extend the phase-out of the exemption to apply to larger estates. A Senate budget proposal would have extended the phase-out of the exemption to those estates between 100 percent and 110 percent of the exemption amount. The proposal was not enacted.
Decanting Bill Passes Both Houses
EPTL §10-6.6 allows trustees to decant or transfer trust property from an existing irrevocable trust to another existing irrevocable trust or a new irrevocable trust. The statute provides that a trust decanting becomes effective within thirty days of notifying interested persons. Although current law allows interested parties to object to a decanting, it does not provide any mechanism for a trustee amendable to the objection from preventing the decanting from becoming effective by operation of law after thirty days. A bill passed by both houses would allow a trustee to void a proposed decanting in response to objections by interested persons. However, the bill would not grant interested parties any power to compel the trustee to void the decanting. Governor Cuomo has not signed the bill.