Tax Law Update: Trusts & Estates
• New law enacts consistent basis reporting rules and new reporting obligations for executors
—President Obama recently signed what’s known as the “Highway Bill” (Surface Transportation and Veterans Health Care Choice Improvement Act of 2015) into law. This law requires beneficiaries of estates to use the finally determined estate tax value of any property they receive as their income tax basis and imposes a reporting obligation on executors to provide such values to the Internal Revenue Service and the beneficiaries.
The new law amends Internal Revenue Code Section 1014(f) and adds IRC Section 6035(a), which requires an executor to send a statement to the IRS and to each beneficiary providing the value of the property received by that beneficiary as reported on the Form 706; the beneficiary is then obligated to use that value as his basis. However, there are two exemptions: (1) the executor is only subject to this reporting requirement if the estate is required to file a Form 706, and (2) a beneficiary is only subject to these rules if the property he received increases the estate tax due (that is, not property that qualifies for the marital or charitable deduction).
Assuming the executor (or, if the executor doesn’t have enough information to do so, such other person who’s in possession of the property) sends a statement of value to the beneficiary, the value of the property reported on the Form 706 and this statement must be used as the beneficiary’s basis in the property. If an audit or litigation occurs that later adjusts the value, the executor must send a supplemental statement reflecting the finally determined value.
The executor must provide the statement within 30 days after the return is required to be filed or, if earlier, actually filed. This filing is almost certainly going to be difficult for the executor because it’s common for the executor not to know exactly what property each beneficiary is receiving at the time that the Form 706 is filed. The new law applies to all returns required to be filed after July 31, 2015, provided, however, that Notice 2015-57 (Aug. 21, 2015) delays the due date until Feb. 29, 2016 for any statement required to be filed with the IRS or provided to a beneficiary prior to Feb. 29, 2016. The delayed due date is intended to give the IRS time to issue guidance.
• Colorado Court of Appeals denies grantor’s attempt to substitute promissory note for value of trust property
—In In re the Matter of The Mark Vance Condiotti Irrevocable GST Trust (unpublished opinion, Colorado Court of Appeals No. 14C0969, July 9, 2015), Mark Condiotti, the grantor of an irrevocable trust for the benefit of his minor son, notified the trustees of the trust that he’d decided to exercise his substitution power by exchanging the property of the trust for a promissory note in the principal amount of the full value of the trust property, which was about $9.5 million. The opinion doesn’t describe the terms of the note regarding interest or repayment. The trust instrument included a provision that allowed the grantor to reacquire trust assets by substituting property of equivalent value, a power commonly included in trust instruments to cause a trust to be a grantor trust for income tax purposes.
However, the trust instrument also prohibited any person from borrowing the principal or income of the trust, directly or indirectly, without adequate interest or security. The trustees denied Mark’s request to substitute the note for the trust assets, arguing that he was attempting to borrow the trust property (presumably without adequate interest or security, but this wasn’t expressly mentioned in the opinion) and sought instructions from the Probate Court.
The Probate Court agreed with the trustees, and the Colorado Court of Appeals affirmed. It held that the trustees were obligated to determine whether Mark was attempting to borrow the trust property or exercise his substitution power and agreed with the Probate Court that the transaction was an attempt to take a loan from the trust. It noted that a prior revenue ruling and case indicated that receipt of the entire corpus of the trust in exchange for an unsecured promissory note constitutes an indirect borrowing of the trust corpus. As the transaction was a loan, the trustees had discretionary authority to reject it.
Because the court agreed that the transaction was a loan, it didn’t reach the issue of whether, if it were instead a substitution, the promissory note would have been of equivalent value to the entire trust corpus (it did indicate that the Probate Court had held that the note wasn’t of equivalent value).
This case serves as a warning that advisors must be cautious when substituting promissory notes for trust property under a grantor’s substitution power. Drafting attorneys could consider permitting loans to a grantor without adequate security (which also may cause grantor trust status) but even then, depending on interest rates and the other terms of the loan, the trustees could still determine that the loan to the grantor isn’t in the best interests of the beneficiaries.
• Field Attorney Advice concludes that inadequate disclosure of gift of partnership interests on gift tax return kept the statute of limitations from running
—In FAA 20152201F, the IRS held that the taxpayer’s disclosure on a gift tax return was inadequate and, as a result, didn’t cause the statute of limitations to run. The taxpayer had made two gifts of partnership interests. On the Form 709, he noted the percentage interest given, the name of the partnerships and their employer identification numbers (EINs). He attached a short supplemental paragraph to the gift tax return titled “Valuation of Gifts.” The supplement stated that the partnerships held farm land that was appraised by a certified appraiser and that an overall discount was applied for minority interests and lack of marketability. The taxpayer’s attorney noted in correspondence with the IRS that the taxpayer had provided the appraisals of real estate, appraisals of discounts and partnership agreements to the IRS.
The IRS held that the disclosure wasn’t adequate. Treasury Regulations Section 301.6501(c) provides the rules on what constitutes adequate disclosure on a gift tax return that will start the statute of limitations running. These rules require, among other items, a description of the property transferred. The partnership names were abbreviated on the Form 709, and both EINs were missing one digit. The description didn’t include the type of interests transferred (general or limited partnership interests or limited liability company interests). While these more formalistic errors were certainly problematic, the IRS also explained that the Treasury regulations require “a detailed description of the method used to determine the fair market value of the property transferred.” The appraisal valued the farm land but not the partnership interests. The valuation description attached to the Form 709 didn’t describe the valuation method used to value the farm land, identify any restrictions that were considered in valuing the partnership interests or break down the type of discount and the basis for each.
This FAA shows the importance of obtaining a complete appraisal that meets the requirements of the adequate disclosure regulations. Providing basic facts, generic conclusions and the partnership agreements may not be enough: The IRS wants to see the methodology and reasoning behind the valuation.