Estate Tax Changes Past, Present and Future
I. INTRODUCTION –
This outline is a selective and evolving review of the history of the modern federal estate tax. It originated during the attempts to repeal the estate tax in President Clinton’s second term and accelerated with the one-year (2010) “repeal” enacted in 2001. A discussion of current developments begins with Part XVII.D on page 106, and a discussion of currently pending and proposed developments begins with Part XVIII on page 116.
II. PAST REMINISCENCES –
A. The World War I Era –
1. In the Revenue Act of September 8, 1916, as the United States was on the brink of entering World War I, Congress enacted the current estate tax, imposed at rates of 1 percent to 10 percent on taxable estates over $50,000. In the Act of March 3, 1917, the rates were generally increased by half, to levels of 1½ percent to 15 percent. In explaining the Senate bill, which would have doubled rates to 2 percent-20 percent, the Finance Committee said…
Please see full newsletter below for more information.
Estate Tax Changes Past, Present and Future
Charting the rates,
Planning for mates,
Watching the states,
Handling the waits,
And predicting the fates
Of the effective dates.
Ronald D. Aucutt
Tysons Corner, Virginia; Washington, D. C.
(Outline updated through March 30, 2016)
© Copyright 2016 by McGuireWoods LLP. All Rights Reserved.
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Estate Tax Changes Past, Present and Future
Table of Contents
I. Introduction ……………………………………………………………………………………………………..1
II. Past Reminiscences …………………………………………………………………………………………..1
A. The World War I Era …………………………………………………………………………………. 1
B. The Kennedy-Johnson Studies and the Nixon Administration …………………………. 1
C. The Ford Administration…………………………………………………………………………….. 2
D. The Reagan Administration ………………………………………………………………………… 3
E. The Clinton Administration ………………………………………………………………………… 4
III. The Turbulence Created by the 2001 Tax Act ………………………………………………………6
A. The Phase In and Out of the 2001 Tax Act ……………………………………………………. 6
B. The Gift Tax ……………………………………………………………………………………………… 7
C. The State Death Tax Credit…………………………………………………………………………. 7
D. Carryover Basis …………………………………………………………………………………………. 8
E. Three Shall Nots and One Had Never Been ………………………………………………….. 8
IV. Republican-Led Efforts to Repeal or Reform (2001-2006) …………………………………..10
A. Early Efforts After 2001 To Make Repeal Permanent …………………………………… 10
B. Reports of Compromise Efforts …………………………………………………………………. 11
C. The 2004 Election ……………………………………………………………………………………. 11
D. The Final Push for Repeal or Compromise………………………………………………….. 12
E. PETRA …………………………………………………………………………………………………… 13
F. ETETRA ………………………………………………………………………………………………… 14
G. Adjournment …………………………………………………………………………………………… 15
H. What Might Have Been ……………………………………………………………………………. 15
V. “Options” Presented by the Joint Committee Staff (2005) ……………………………………16
A. Perpetual Dynasty Trusts ………………………………………………………………………….. 16
B. Valuation Discounts …………………………………………………………………………………. 17
C. Lapsing Crummey Powers ………………………………………………………………………… 18
D. Consistent Basis ………………………………………………………………………………………. 19
E. 529 Plans ………………………………………………………………………………………………… 19
VI. “Middle Class” Focus Under Democratic Leadership (2007-2008) ……………………….19
A. The Fiscal 2008 Congressional Budget Resolution (March 2007) ………………….. 19
B. The Fiscal 2009 Congressional Budget Resolution (March 2008) ………………….. 23
C. Finance Committee Hearings …………………………………………………………………….. 24
VII. The One-Hundred-Eleventh Congress (2009-2010) …………………………………………….25
A. The First Pomeroy Bill (H.R. 436) …………………………………………………………….. 25
B. The Arithmetic of the Estate Tax ……………………………………………………………….. 26
C. The Obama Administration’s Fiscal 2010 Budget Proposal…………………………… 27
D. The Fiscal 2010 Congressional Budget Resolution ………………………………………. 28
E. The First Baucus Bill (S. 722) …………………………………………………………………… 29
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F. The McDermott Bill (H.R. 2023) ………………………………………………………………. 29
G. Ways and Means Committee Engagement and the Second Pomeroy Bill ……….. 30
H. Senate Refusal To Act in 2009 ………………………………………………………………….. 31
I. The “Responsible Estate Tax Act” …………………………………………………………….. 32
J. The Second “Baucus Bill” ………………………………………………………………………… 33
K. The Deal Between the President and Some Congressional Leaders ………………… 34
L. The 2010 Tax Act ……………………………………………………………………………………. 34
VIII. The Clarified and Modified 2010-2012 Law ………………………………………………………35
A. The Sunset in General ………………………………………………………………………………. 35
B. The Estate Tax Exemption and Rate …………………………………………………………… 36
C. The Election out of the Estate Tax into Carryover Basis for 2010 Estates……….. 36
D. Indexing for Inflation ……………………………………………………………………………….. 48
E. The GST Tax…………………………………………………………………………………………… 49
F. Extension of Time for Performing Certain Acts …………………………………………… 52
G. The Gift Tax (and “Clawback”) …………………………………………………………………. 53
H. Portability ……………………………………………………………………………………………….. 59
I. Comment ………………………………………………………………………………………………… 64
IX. The One-Hundred-Twelfth Congress (2011-2012) ……………………………………………..64
A. Another McDermott Bill …………………………………………………………………………… 64
B. More Death Tax Repeal Permanency Bills ………………………………………………….. 66
C. Senate and House Leadership Bills…………………………………………………………….. 66
X. The Climate After the 2012 Election …………………………………………………………………67
A. The 113th Congress (2013-2014) ………………………………………………………………. 67
B. The “Fiscal Cliff” …………………………………………………………………………………….. 67
C. Factors That Affected the Ability to Compromise ……………………………………….. 68
D. Residual Discomfort with a High Estate Tax ………………………………………………. 68
E. Simple Math ……………………………………………………………………………………………. 69
XI. The American Taxpayer Relief Act of 2012 ……………………………………………………….70
A. Enactment ………………………………………………………………………………………………. 70
B. “Fiscal Cliff” Issues in General …………………………………………………………………. 70
C. Estate Tax Provisions ……………………………………………………………………………….. 71
XII. Following up Those 2012 Gifts ………………………………………………………………………..72
A. Renouncing, Refocusing, Reversing, Rescinding, Reforming, Refinancing …….. 72
B. Perfection and Implementation ………………………………………………………………….. 74
C. 2012 Gift Tax Returns ……………………………………………………………………………… 74
D. Uses of 2012 Grantor Trusts ……………………………………………………………………… 75
E. Calibrating the Overall Estate Plan to the 2012 Gifts ……………………………………. 76
F. Other Special Follow-Up of Gifts ………………………………………………………………. 76
XIII. Otherwise Adjusting to a Permanent High-Exemption World ………………………………77
A. Considerations in Making Post-2012 Taxable Gifts ……………………………………… 77
B. Portability ……………………………………………………………………………………………….. 78
C. Important Areas of Practice Besides Transfer Tax Planning ………………………….. 85
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XIV. What We Learned from Those 2012 Gifts ………………………………………………………….86
A. Forgiveness of Past Loans ………………………………………………………………………… 86
B. Life Insurance Transactions ………………………………………………………………………. 86
C. Qualified Personal Residence Trusts (QPRTs) …………………………………………….. 87
D. Spousal Lifetime Access Trusts (SLATs)……………………………………………………. 87
E. Using Defined Value Transfers …………………………………………………………………. 88
XV. The 3.8 Percent Medicare Tax on Trusts and Estates …………………………………………..93
XVI. Further 2013-2014 Developments …………………………………………………………………….96
A. The Deal That Reopened the Federal Government October 16, 2013 ……………… 96
B. The December 2013 Budget Deal ………………………………………………………………. 96
C. Reintroduction of the McDermott Bill ………………………………………………………… 97
D. Talk of “Tax Reform” in General ………………………………………………………………. 97
XVII. The 114th Congress (2015-2016) ……………………………………………………………………..99
A. Another Death Tax Repeal Act ………………………………………………………………….. 99
B. Other House-Passed Legislation ………………………………………………………………. 105
C. The “Sensible Estate Tax Act of 2015” …………………………………………………….. 106
D. Consistent Basis Reporting Enacted in the “Highway Act” …………………………. 106
E. Protecting Americans from Tax Hikes (“PATH”) Act of 2015 (Dec. 18, 2015) 114
XVIII. The Administration’s Revenue Proposals …………………………………………………………116
A. “Restore the Estate, Gift, and Generation-Skipping Transfer Tax Parameters
in Effect in 2009” …………………………………………………………………………………… 117
B. “Expand Requirement of Consistency in Value for Transfer and Income Tax
Purposes” ……………………………………………………………………………………………… 118
C. “Modify Transfer Tax Rules for Grantor Retained Annuity Trusts (GRATs)
and Other Grantor Trusts” ………………………………………………………………………. 119
D. “Limit Duration of Generation-Skipping Transfer (GST) Tax Exemption” …… 129
E. “Extend the Lien on Estate Tax Deferrals Provided Under Section 6166” …….. 130
F. “Modify Generation-Skipping Transfer (GST) Tax Treatment of Health and
Education Exclusion Trusts (HEETs)” ……………………………………………………… 130
G. “Simplify Gift Tax Exclusion for Annual Gifts” ………………………………………… 132
H. “Expand Applicability of Definition of Executor” ……………………………………… 133
I. Another Topic: Taxation of Appreciation at Death …………………………………….. 134
J. Omitted: “Modify Rules on Valuation Discounts” ……………………………………… 136
XIX. Treasury-IRS Priority Guidance Plan ………………………………………………………………139
A. Gifts and Estates and Trusts …………………………………………………………………….. 139
B. Omissions ……………………………………………………………………………………………… 162
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Estate Tax Changes Past, Present and Future
Ronald D. Aucutt
This outline is a selective and evolving review of the history of the modern federal estate
tax. It originated during the attempts to repeal the estate tax in President Clinton’s second
term and accelerated with the one-year (2010) “repeal” enacted in 2001. A discussion of
current developments begins with Part XVII.D on page 106, and a discussion of
currently pending and proposed developments begins with Part XVIII on page 116.
(State estate and inheritance taxes are tabulated at http://www.mcguirewoods.com/news-
II. PAST REMINISCENCES
A. The World War I Era
1. In the Revenue Act of September 8, 1916, as the United States was on the brink of
entering World War I, Congress enacted the current estate tax, imposed at rates of
1 percent to 10 percent on taxable estates over $50,000. In the Act of March 3,
1917, the rates were generally increased by half, to levels of 1½ percent to 15
percent. In explaining the Senate bill, which would have doubled rates to 2
percent-20 percent, the Finance Committee said:
Such a tax, when used as an emergency measure, is necessarily unequal in
operation. Only if continued at the same rate for many years – the period of a
generation – does it become equal for all persons in like situation. If levied as a
war tax, that is, as a temporary emergency measure, it falls only upon the estates
of those who happen to die during the period of the emergency. Particularly is it
to be remembered that perhaps a majority of those dying during the war and
leaving estates to be taxed will be soldiers and sailors dying in defense of our
country. On the other hand, as a permanent measure, such a tax, even at the
rates already fixed by existing law, trenches in considerable degree on a sphere
which should be reserved to the States.
S. REP. NO. 103, 65TH CONG., 1ST SESS. 14 (1917) (emphasis added).
2. In its version of the Revenue Act of 1926, when the gross rates ranged from 1
percent to 20 percent, the House of Representatives raised the state death tax
credit to 80 percent of the basic tax, while the Senate version would have repealed
the estate tax. In support of repeal, the Finance Committee quoted the excerpts
from its 1917 report that are italicized above. S. REP. NO. 52, 69TH CONG., 1ST
SESS. 8 (1926). In short, the Finance Committee of 1917 and 1926 seems to have
cited the same arguments in support of doubling the tax and in support of
repealing the tax! The 1926 House-Senate conference, of course, accepted the
B. The Kennedy-Johnson Studies and the Nixon Administration
On February 5, 1969, less than two weeks after the inauguration of President Nixon,
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Congress published a multi-volume Treasury Department work entitled “Tax Reform
Studies and Proposals,” reflecting work that had been overseen by Assistant Secretary
of the Treasury for Tax Policy Stanley Surrey during the Kennedy and Johnson
Administrations. It included a number of estate and gift tax proposals. The following
list of the estate and gift tax proposals gives the date each proposal was eventually
enacted in some form:
1. Taxation of appreciation at death or at the time of gifts (carryover basis enacted in
1976, repealed in 1980, and enacted again in 2001, effective only for 2010).
2. Unification of the gift and estate taxes.
a. Same rates (1976).
b. Same base – tax-inclusive (1976, for gifts within three years of death).
c. Single exemption (1976 – until 2004).
d. Abolition of the “gifts in contemplation of death” rule (1976).
3. Unlimited marital deduction, including income interests (1981).
4. Repeal of the exclusion of interests in qualified retirement plans (1984).
5. More explicit rules governing disclaimers (1976).
6. An “orphan exclusion” equal to the amount of the gift tax annual exclusion
multiplied by the number of years by which the orphan is under 21 (roughly in
1976 – repealed in 1981).
7. Tightening of the deduction rules for transfers to charity (1969).
8. More rational allocation of deductions between estate tax and income tax returns
(in part by the “Hubert regulations,” Reg. §§20.2013-4(b)(3), 20.2055-3(b) &
20.2056(b)-4(d), in 1999).
9. Tax on generation-skipping transfers (1976 and 1986).
10. Liberalized extended payment of estate taxes (section 6166) (1976).
11. Discontinuance of “flower bonds” redeemable at par to pay estate tax (last issued
1971, last matured 1998).
C. The Ford Administration
“Blueprints for Basic Tax Reform” was published by the Treasury Department
January 17, 1977, during the last week of the Ford Administration. In the context of
proposing a comprehensive model of income taxation that depended on a dramatically
(and at points esoterically) broader tax base, “Blueprints” assumed that transfers by
gift or at death would be recognition events. Such capital gains, whether by gift, at
death, or otherwise, would be fully taxed at ordinary income rates, with adjustments to
the basis of corporate stock for retained earnings and to the basis of all assets for
general price inflation. Pre-enactment gain would be excluded, following the
precedent of the “carryover basis at death” rules that were enacted in 1976.
“Blueprints” was not embraced by the incoming Carter Administration.
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D. The Reagan Administration
1. “Tax Reform for Fairness, Simplicity, and Economic Growth” (“Treasury I”) was
published by Treasury on November 27, 1984, just three weeks after President
Reagan’s landslide reelection. See http://www.treasury.gov/resource-center/tax-
policy/Documents/tres84v1All.pdf and http://www.treasury.gov/resource-
center/tax-policy/Documents/tres84v2All.pdf. Treasury I included the following
(at vol. 2, pp. 373-405):
a. Imposition of gift tax, like the estate tax, on a “tax-inclusive” basis.
b. Imposition of tax only once, when beneficial enjoyment ceases, ignoring
retained powers (a proposal that kindled an “easy to complete”/“hard to
c. Treatment of all powers of appointment as general powers of appointment if
the holder could benefit from them, without regard to complicating concepts
such as “ascertainable standards” and “adverse interests.”
d. Valuation of fractional interests in an asset at their pro rata share of the value
of the asset owned or previously transferred by the transferor or the
e. A simplified GST tax (compared to the GST tax enacted in 1976) with a $1
million exemption and a flat rate (in this proposal equal to 80 percent of the
top estate tax rate).
f. Elimination of the phase-out of the credit for tax on prior transfers from a
member of the same or a younger generation.
g. Expansion of section 6166 deferral of the payment of estate tax to all cases
where the estate lacks sufficient cash or marketable assets, whether or not it
holds an interest in a business. Liquidity would be reevaluated annually on
an “if you have it send it in” basis (or at least send in 75 percent of it).
h. Conversion of the IRD deduction under section 691(c) to a basis adjustment.
i. Replacement of the separate rate schedule for calculating the maximum state
death tax credit with a maximum credit equal to a flat 5 percent of the taxable
estate. This would have resulted in a substantially smaller state death tax
credit in most cases.
j. Repeal of section 303, which provides for exchange treatment of stock
redemptions to pay certain taxes and funeral and administration expenses.
2. “The President’s Tax Proposals to the Congress for Fairness, Growth, and
Simplicity” was published by the White House on May 29, 1985. It was
popularly called “Treasury II” or “White House I” or sometimes “Regan II” in
reference to the fact that Donald T. Regan was the Secretary of the Treasury who
signed the transmittal letter for “Treasury I” and had become the White House
chief of staff by May 1985. Based generally on Treasury I, it was the rough
model for the Tax Reform Act of 1986. It contained no transfer tax proposals.
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a. Ultimately, the Tax Reform Act of 1986 (Public Law 99-514) did enact a
supposedly simpler GST tax (but at a rate equal to 100 percent, not 80
percent, of the top estate tax rate).
b. In the Omnibus Budget Reconciliation Act of 1987 (“OBRA”) (Public Law
100-203), the House of Representatives added a repeal of the state death tax
credit, a rule valuing interests in family-owned entities at their pro rata share
of the total value of all interests in the entity of the same class, and rules
regarding “disproportionate” transfers of appreciation in estate freeze
transactions. H.R. REP. NO. 100-391, 100TH CONG., 1ST SESS. 1041-44. The
House-Senate conference retained only the estate freeze rules, as section
2036(c) (which in turn was repealed in 1990 and replaced with the
supposedly more workable rules of chapter 14).
c. The other transfer tax suggestions of Treasury I have not been enacted.
E. The Clinton Administration
1. The Clinton Administration’s budget proposals for fiscal 1999 included a
proposal to “eliminate non-business valuation discounts,” described as follows:
The proposal would eliminate valuation discounts except as they apply to
active businesses. Interests in entities would be required to be valued for transfer
tax purposes at a proportional share of the net asset value of the entity to the
extent that the entity holds readily marketable assets (including cash, cash
equivalents, foreign currency, publicly traded securities, real property, annuities,
royalty-producing assets, non-income producing property such as art or
collectibles, commodities, options and swaps) at the time of the gift or death. To
the extent the entity conducts an active business, the reasonable working capital
needs of the business would be treated as part of the active business (i.e., not
subject to the limits on valuation discounts). No inference is intended as to the
propriety of these discounts under present law.
General Explanations of the Administration’s Revenue Proposals (Feb. 1998) at
a. The Clinton Administration’s budget proposals for fiscal 2000 and fiscal
2001 repeated this proposal, except that “readily marketable assets” was
changed to “non-business assets” and “the propriety of these discounts under
present law” was changed to “whether these discounts are allowable under
b. This proposal was reduced to legislative language in section 276 of H.R.
3874, 106th Cong., 2d Sess., introduced on March 9, 2000, by the Ranking
Democrat on the House Ways and Means Committee, Rep. Charles Rangel of
New York. This bill would have added a new section 2031(d) to the Code,
the general rule of which read as follows:
(d) VALUATION RULES FOR CERTAIN TRANSFERS OF NONBUSINESS
ASSETS—For purposes of this chapter and chapter 12—
(1) IN GENERAL—In the case of the transfer of any interest in an entity
other than an interest which is actively traded (within the meaning of
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section 1092), the value of such interest shall be determined by taking
(A) the value of such interest’s proportionate share of the
nonbusiness assets of such entity (and no valuation discount shall be
allowed with respect to such nonbusiness assets ), plus
(B) the value of such entity determined without regard to the value
taken into account under subparagraph (A).
c. A slightly different articulation of this rule appeared in section 303 of H.R.
1264, 107th Cong., 1st Sess., which Rep. Rangel introduced on March 26,
2001, partly as an alternative to the Republican proposals that became the
2001 Tax Act:
(d) VALUATION RULES FOR CERTAIN TRANSFERS OF NONBUSINESS
ASSETS—For purposes of this chapter and chapter 12—
(1) IN GENERAL—In the case of the transfer of any interest in an entity
other than an interest which is actively traded (within the meaning of
(A) the value of any nonbusiness assets held by the entity shall be
determined as if the transferor had transferred such assets directly to
the transferee (and no valuation discount shall be allowed with
respect to such nonbusiness assets ), and
(B) the nonbusiness assets shall not be taken into account in
determining the value of the interest in the entity.
Rep. Rangel’s 2001 bill would also have added a new section 2031(e) to the
Code, to read as follows:
(e) LIMITATION ON MINORITY DISCOUNTS—For purposes of this chapter and
chapter 12, in the case of the transfer of any interest in an entity other than an
interest which is actively traded (within the meaning of section 1092), no
discount shall be allowed by reason of the fact that the transferee does not
have control of such entity if the transferee and members of the family (as
defined in section 2032A(e)(2)) of the transferee have control of such entity.
Identical statutory language for new sections 2031(d) and (e) appeared in
H.R. 5008, 107th Cong., 2d Sess. §3 (introduced June 24, 2002, by Rep. Earl
Pomeroy (D-ND)), H.R. 1577, 109th Cong., 1st Sess. §4 (introduced April
12, 2005, by Rep. Pomeroy), and H.R. 4242, 110th Cong., 1st Sess. §4
(introduced November 15, 2007, by Rep. Pomeroy).
d. Clinton Administration proposals inevitably experienced a bit of a revival
after Democrats took control of the Congress and White House. Democratic
staff members publicly referred to them as a possible model for legislative
drafting. This is perhaps reflected in H.R. 436, the 2009 version of Rep.
Pomeroy’s bill, discussed in Part VII.A on page 25.
e. The same Clinton Administration’s proposed budgets also recommended the
repeal of the personal residence exception from section 2702.
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2. The “Death Tax Elimination Act of 2000” (H.R. 8) was passed in 2000 by large
majorities in Congress, including 59 Senators, but it was vetoed by President
Clinton. H.R. 8 would have –
a. reduced the top rate from 55 percent to 40.5 percent in nine annual steps from
2001 through 2009,
b. converted the “unified credit” to an exemption, thereby allowing the
exemption to be applied to the top marginal rate rather than to the lower rates
as the credit is,
c. eliminated the 5 percent surtax that resulted in the 60 percent “bubble” for
taxable estates larger than $10 million,
d. repealed the estate tax, gift tax, and generation-skipping transfer tax (GST
tax), beginning in 2010, and
e. replaced the estate, gift, and GST taxes with a carryover basis regime,
beginning in 2010.
III. THE TURBULENCE CREATED BY THE 2001 TAX ACT
A. The Phase In and Out of the 2001 Tax Act
The changes to the estate, gift, and GST taxes made by the Economic Growth and Tax
Relief Reconciliation Act of 2001 (the “2001 Tax Act”) are summarized as follows:
Year-by-Year Summary of the Changes Made by the 2001 Tax Act
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Exclusion $675,000 $1 million $1.5 million $2 million $3.5m
Lowest rate 37% 41% 45%
Top rate 55% 50% 49% 48% 47%
5% bubble Yes No
QFOBI Yes No
State tax credit 100% 75% 50% 25% None. State taxes are deductible.
Exemption $1.06 million
mil. $1.5 million $2 million
Rate 55% 50% 49% 48% 47% 46% 45%
Exclusion $675,000 $1 million
Lowest rate 37% 41%
Top rate 55% 50% 49% 48% 47% 46% 45%
5% bubble Yes No
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B. The Gift Tax
1. The gift tax was not repealed, but was left in place, reportedly to discourage
indiscriminate transfers of income-producing or appreciated assets from one
taxpayer to another to avoid or reduce income tax liabilities.
2. Consistent with that objective, the gift tax rate in 2010 was reduced to 35 percent,
which was the top long-term income tax rate enacted by the 2001 Tax Act, but the
gift tax exemption was capped at $1 million, which was thought to better serve
the income tax objectives of the gift tax in a post-estate tax world.
C. The State Death Tax Credit
1. The federal credit for state death taxes was repealed, and that has produced
dramatically different results from state-to-state, depending on the existence and
structure of state estate taxes. In a strictly “coupled” state, where the state tax is
tied to whatever the federal credit is from time to time, there is no state tax
because there is no federal credit.
2. In a “decoupled” state, where the state tax typically is tied to the federal credit in
effect at some point before 2002, there is a state tax. Section 2058 allows a
deduction for the state tax in calculating the taxable estate, which generally
resulted in an iterative (or algebraic) calculation. In some of those states,
however, the state law does not allow a deduction for the state tax in calculating
the state tax itself. This avoids the iterative calculation, but it changes the
effective state and federal tax rates. Federal Form 706 now accommodates the
calculation of tax in such a state by providing a separate line 3a on page 1 for
calculating a “tentative taxable estate” net of all deductions except state death
taxes. The “tentative taxable estate” in effect is the taxable estate for calculating
the state tax (but not the federal tax) in such a state.
3. The following table shows the resulting marginal rates on the largest estates,
including the results under the 2010 Tax Act and the American Taxpayer Relief
Act of 2012, discussed below):
Top Marginal Estate Tax Rates
Federal State Total
“Coupled” State 45% 0 45%
“Decoupled” State with Deduction 38.8% 13.8% 52.6%
“Decoupled” State, No Deduction 37.8% 16% 53.8%
“Coupled” State 35% 0 35%
“Decoupled” State with Deduction 30.2% 13.8% 44.0%
“Decoupled” State, No Deduction 29.4% 16% 45.4%
2013 and Beyond
“Coupled” State 40% 0 40%
“Decoupled” State with Deduction 34.5% 13.8% 48.3%
“Decoupled” State, No Deduction 33.6% 16% 49.6%
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4. The landscape is further complicated by other departures from the federal model
in various jurisdictions, such as jurisdictions that decoupled their tax systems after
2001 not only from the federal credit for state death taxes but also from the
phased increases in the federal unified credit, so that the state exemption is less
than the federal exemption. In January 2012, only Delaware, Hawaii, and North
Carolina had exemptions and filing thresholds equal to the federal exclusion
amount, but that has changed as other states do their best to conform.
5. See the compilation of state laws maintained on the McGuireWoods website at
D. Carryover Basis
1. For 2010, the 2001 Tax Act added carryover basis rules that would change the
way executors and beneficiaries determine the income tax basis of property
acquired from a decedent, which is used to calculate gain or loss upon sale of the
property and in some cases to calculate depreciation deductions. Instead of a
basis equal to the value on the date of death (or “alternate valuation date,”
generally six months after death), the basis was to be the value on the date of
death or the decedent’s basis in the property, whichever is less.
2. As somewhat of a substitute for the estate tax exemption, each decedent’s estate
was allowed $1.3 million of basis increase (increased by the decedent’s capital
loss and net operating loss carryovers and by the capital loss that would have been
recognized if the decedent’s loss assets had been sold for their fair market value
immediately before the decedent’s death), which the executor may allocate to
individual assets to eliminate up to $1.3 million of that unrealized appreciation.
The executor was able to allocate an additional $3 million of basis increase to any
assets passing to a surviving spouse, either outright or in certain kinds of trusts.
E. Three Shall Nots and One Had Never Been
1. Not Really Repeal
a. Section 2210(a) stated that “this [estate tax] chapter shall not apply to the
estates of decedents dying after December 31, 2009.”
b. Section 1014(f) stated that “[t]his section [providing for a stepped-up basis at
death for appreciated assets] shall not apply with respect to decedents dying
after December 31, 2009.”
c. Section 2664 stated that “[t]his [GST tax] chapter shall not apply to
generation-skipping transfers after December 31, 2009.” It was the entire
chapter that did not apply, not just the tax. All definitions, exemptions, rules,
etc. were inapplicable. But the GST tax chapter was inapplicable only in the
case of generation-skipping transfers.
2. Watching a Byrd at Sunset
a. It was well known that the “repeal” of the federal estate tax took effect in
2010, for only one year. In 2011, the 2001 Tax Act was to “sunset” and the
estate tax law return to where it would have been without the enactment of
– 9 –
the 2001 Tax Act – namely the former 55 percent rate (with a 60 percent
“bubble”), a credit for state death taxes, and the $1 million exemption that
would have been reached in 2006 under the phased in changes made by the
Taxpayer Relief Act of 1997.
b. Specifically, section 901(a) of the 2001 Tax Act stated:
SEC. 901. SUNSET OF PROVISIONS OF ACT.
(a) IN GENERAL.—All provisions of, and amendments made by, this Act
shall not apply—
(1) to taxable, plan, or limitation years beginning after December
31, 2010, or
(2) in the case of title V, to estates of decedents dying, gifts made,
or generation-skipping transfers, after December 31, 2010.
(b) APPLICATION OF CERTAIN LAWS.—The Internal Revenue Code of
1986 and the Employee Retirement Income Security Act of 1974 shall be
applied and administered to years, estates, gifts, and transfers described in
subsection (a) as if the provisions and amendments described in subsection
(a) had never been enacted.
c. Section 901 was the only section in the ninth and last title of the 2001 Tax
Act, entitled “Compliance with Congressional Budget Act.”
i. The Congressional Budget Act of 1974 (2 U.S.C. §621 et seq.)
prescribes the procedures by which Congress adopts spending and tax
priorities in a budget resolution and implements those priorities in a
streamlined process of budget reconciliation. In a rule added in 1985
and amended in 1990, sponsored by the late Senator Robert Byrd (D-
WV) (and hence known as the “Byrd Rule”), section 313 of the Budget
Act (2 U.S.C. §644) makes “extraneous” provisions in budget
reconciliation subject to a point of order in the Senate. “Extraneous” is
defined to include the reduction of net revenues in years beyond the
period provided for in the budget resolution. Since the 2001 budget
resolution generally covered 10 years, a net reduction of taxes beyond
the tenth year would have been ruled out of order.
ii. A point of order under the Byrd Rule can be waived by a vote of 60
Senators (just as a Senate filibuster against general legislation can be
broken by a vote of 60 Senators). H.R. 1836, which became the 2001
Tax Act, originally passed the Senate, on May 23, 2001, by a vote of 62-
38 (while the conference report on the 2001 Tax Act passed the Senate
on May 26, 2001, by a vote of only 58-33). H.R. 1836, however,
garnered 62 votes only with a “sunset” provision in it. The Senate was
not asked to vote on a non-sunsetting repeal, and presumably the votes
were just not there. In the Senate consideration of H.R. 1836,
amendments to eliminate the estate tax repeal were defeated by votes of
43-56 and 42-57. Even an amendment to preserve the estate tax only for
estates greater than $100 million was defeated by a vote of 48-51.
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d. The “as if … had never been enacted” language of section 901(b) of the 2001
Tax Act attracted a lot of attention and created a lot of speculation and
exasperation. This was particularly true in the context of the GST tax. It is
safe to surmise that members of Congress in 2001 did not think about how
this language might affect estate planning in 2010 and 2011. Indeed, it is
unlikely that they expected the 2001 Tax Act changes to still be in effect
without modification and permanence by 2010. It is certain that the “had
never been enacted” language was not cobbled together just to torment estate
planners nine years later. Indeed, as of 2001, it was not unprecedented
repeal, override, or sunset language.
i. Similar language had been used, ironically, in the 1980 repeal of the
original 1976 carryover basis regime. Section 401(b) of the Crude Oil
Windfall Profit Tax Act of 1980 (Public Law 96-223) stated:
Except to the extent necessary to carry out subsection (d) [which
allowed executors of decedents dying from January 1, 1977, to
November 6, 1978, to elect the 1976 carryover basis regime, despite its
repeal], the Internal Revenue Code of 1954 shall be applied and
administered as if the provisions repealed by subsection (a), and the
amendments made by those provisions, had not been enacted.
ii. In a different context, the words “if the Revenue Act of 1948 had not
been enacted” appear in section 1014(b)(7) itself.
IV. REPUBLICAN-LED EFFORTS TO REPEAL OR REFORM (2001-2006)
A. Early Efforts After 2001 To Make Repeal Permanent
1. In the consideration of H.R. 2646, the Farm Security and Rural Investment Act of
2002, which President Bush signed on May 13, 2002, the Senate added an
expression of the “sense of the Senate” that the estate tax repeal should be made
permanent. Even though such an expression had no statutory or other binding
effect whatsoever, it garnered only 56 votes, with 42 votes opposed, although the
two Senators not voting (Senators Bennett of Utah and Domenici of New Mexico)
were Republicans who had supported the repeal of the estate tax in the past.
2. As part of an agreement reached to facilitate consideration of certain tax
provisions of the 2002 energy bill (H.R. 4), the leadership of the Senate agreed to
allow consideration of a proposal to remove the “sunset” feature of the estate and
GST tax repeal, so that the repeal scheduled under the 2001 Tax Act to take effect
in 2010 would no longer be scheduled to sunset on January 1, 2011 – making the
repeal, in effect, permanent. The vote was promised by the end of June 2002.
a. The repeal measure the Republican leadership agreed to consider would only
make the repeal of the estate and GST taxes in 2010 permanent for the years
2011 and beyond. Until 2010, the rates would fall and the unified credit
would rise, on the schedule enacted in 2001. The gift tax unified credit
would continue to be limited, so as to shelter gifts only up to $1 million, and
after 2009 the gift tax would continue in effect, with a 35 percent rate. The
state death tax credit would be phased out by 2005, and carryover basis
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would be enacted as a permanent replacement for the estate tax, beginning in
b. This permanent repeal measure involved a suspension of the budget
reconciliation rules under which the 2001 Tax Act was crafted, and therefore
it required the vote of 60 Senators – the same 60-vote requirement that
contributed prominently to the odd results in the 2001 Tax Act in the first
c. The vote was held on June 12, 2002. The vote was 54-44, and the measure
therefore failed. (The two Senators not voting supported repeal.)
d. Before voting on permanent repeal, the Senate took up alternatives offered by
Democratic Senators, including accelerated increases in the unified credit
(which failed by a vote of 38-60) and expansion of qualified family-owned
business interest (QFOBI) relief (which failed by a vote of 44-54).
B. Reports of Compromise Efforts
1. The October 22, 2003, Washington Post reported that Senator Jon Kyl (R-AZ), an
important member of the Senate Committee on Finance who had been a major
player in actively advocating permanent repeal of the estate tax, was at that time
considering abandoning that position in exchange for an increase in the estate tax
exemption to $15 million per person and a decrease in the estate tax rate, above
that exemption, to 15 percent, the current income tax rate on capital gains.
2. The Post report was silent as to what, if anything, Senator Kyl would do about the
gift and GST taxes, about adjustment of basis at death, and about state death
taxes. The Post also reported that Senator Kyl’s proposal had gained the interest
of several Democratic Senators and the support of several important lobbyists.
The article implied that the impetus for Senator Kyl’s proposal was the growth of
the deficit and the risk that if a Democrat were elected President in 2004
permanent repeal or substantial reduction of the estate tax would be a dead letter.
3. Then, on October 23, 2003, one day after the Post report, Senator Kyl repudiated
the article. As if to leave no doubt, on the same day Senator Kyl introduced S.J.
Res. 20, to express “the sense of the Congress that the number of years during
which the death tax … is repealed [that is, 2010] should be extended, pending the
permanent repeal of the death tax.”
C. The 2004 Election
1. On the day after his reelection in 2004, President Bush referred to the “political
capital” that he had earned and intended to “spend.” He also made it clear that
one of the centerpieces of his domestic agenda was to make permanent the tax
cuts enacted in 2001 and 2003, including the repeal of the estate and GST taxes.
2. Also in the 2004 election, the Republicans maintained control of the House and
gained four seats in the Senate. Fifty-five was more Republicans than there had
been in the Senate since Herbert Hoover was President. This gain in the Senate
immediately triggered a lot of speculation about the new votes that might be
available for permanent repeal of the estate tax.
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3. Extrapolating from the 59 Senate votes for H.R. 8 (which President Clinton
vetoed) in 2000, the 58 votes for the 2001 Tax Act, and especially the 54 votes for
the up-or-down repeal vote in June 2002 (with two absent Senators expressing
support for repeal), some observers attempted to predict the likely votes for repeal
in light of the intervening personnel changes. See, e.g., M.A. Sullivan, “60-Vote
Majority at Hand for Estate Tax Repeal,” TAX NOTES, Nov. 29, 2004, at 1174.
4. Some also cited the intangible effect of the “Daschle factor” – the likelihood that
Democrats in “red states” carried by President Bush, especially those up for
reelection in 2006, would have second thoughts about opposing the supposedly
popular repeal of the estate tax. Id.
5. It is harder still to evaluate the intangible factor of weighing votes rather than
counting them. A vote in 2000 for a measure everyone knew President Clinton
would veto, a vote in 2001 for a repeal for only one year nine years in the future,
and a vote in 2002 where the counting had already been done were not necessarily
indicative of how lawmakers would vote on a measure with a realistic chance of
success, when it is actually necessary for them to take responsibility for their
actions (as the 2006 votes were to show).
D. The Final Push for Repeal or Compromise
1. The permanent repeal of the federal estate tax was placed before the Senate when,
by a more or less bipartisan vote of 272-162 on April 13, 2005, the House passed
the 109th Congress’s version of H.R. 8 (the “Death Tax Repeal Permanency Act
of 2005”) to eliminate the 2011 “sunset” that limits repeal to just the year 2010.
2. At the end of July 2005, just before the August recess, Senate Majority Leader
Bill Frist of Tennessee filed a motion of “cloture” on H.R. 8, basically the Senate
form of “calling the question,” which requires approval of 60 Senators. When the
Senate was scheduled to reconvene on September 6, the day after Labor Day,
there was only one matter that might have been ahead of that cloture motion, a
cloture motion on the “Native Hawaiian Government Reorganization Act of
3. Meanwhile, with full repeal lacking 60 votes, compromise efforts continued. The
idea of a 15 percent rate, mentioned in the October 22, 2003, Washington Post,
although quite a departure from the top 55 percent rate of just a few years ago and
even the 45 percent top rate achieved in 2007 under present law, had proved
remarkably durable, and it remained the target rate openly discussed by Senator
Kyl and others as the compromise discussions reached a public crescendo. In
contrast, the $15 million exemption level reported in October 2003 was elusive.
Following the 2004 elections, the most often mentioned aspiration was an
exemption of $10 million. In mid-July (2005), $8 million was mentioned in the
press, and by the end of July it was $3.5 million.
4. By Labor Day, the pressures of dealing with Hurricane Katrina had become too
much for the Senate, and the estate tax vote was postponed.
a. Opponents of repeal of the estate tax asked how Congress could possibly
consider huge tax cuts for the nation’s wealthiest families when multitudes on
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the Gulf Coast had been left with nothing.
b. Supporters of repeal asserted that more than ever the economy needed
stability in tax policy, especially regarding the taxation of saving and
investment that would be so important in the Gulf Coast rebuilding effort.
5. On May 2, 2006, a “Summit for Permanent Death Tax Repeal” convened at the
National Press Club in Washington. It was sponsored by the Family Business
Estate Tax Coalition, and participants included Senator Kyl, Ways and Means
Committee Member Congressman Kenny Hulshof (R-MO) (who retired from
Congress and ran, unsuccessfully, for Governor of Missouri in 2008), and Al
Hubbard, Assistant to the President for Economic Policy and Director of the
National Economic Council. The consensus at the Summit was to support a
compromise of a 15 percent rate, a $5 million exemption (indexed for inflation),
and continued stepped-up basis for appreciated assets, all effective January 1,
6. On June 8, 2006, the Senate considered a cloture motion to take up H.R. 8, which
the House had passed in April 2005, thus returning the debate to the posture that
had been expected before the hurricanes of late August 2005. The motion was
only to take up H.R. 8, not necessarily to approve it but possibly to amend it with
something like Senator Kyl’s 15 percent/$5 million proposal.
a. Prior to the vote, however, Senator Kyl had floated the suggestion that he
would agree to a second rate of, say, 30 percent, imposed on taxable estates
over, say, $30 million. That made it unlikely that the last few necessary
Democratic votes would support a 15 percent rate that did not include a 30
b. The vote was 57-41 in favor of cloture, three votes short of the necessary 60.
(The two Senators who did not vote would have voted no.)
On June 22, 2006, by a vote of 269-156, the House of Representatives passed a new
bill, H.R. 5638, called the “Permanent Estate Tax Relief Act of 2006” (“PETRA”).
1. PETRA, effective January 1, 2010, would have provided
a. a $5 million exemption equivalent (indexed for inflation after 2010),
b. an initial rate tied to the top income tax rate on general capital gains under
section 1(h)(1)(C) (currently 15 percent, but returning to 20 percent in 2011 if
Congress does not act),
c. a rate equal to double that rate on taxable estates over $25 million (not
d. gift tax exemptions and rates re-conformed to the estate tax (rather than a
special exemption of $1 million and a special rate of 35 percent as in 2010
under current law),
e. repeal of the deduction for state death taxes (which itself replaced the phased-
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out credit for state death taxes in 2005),
f. retention of a stepped-up basis at death for appreciated assets, and
g. repeal of the 2011 “sunset” for the other transfer tax provisions of the 2001
2. PETRA would also have provided a mechanism for a surviving spouse’s estate
and gift (but not GST) exemptions to be increased (but no more than doubled) by
the amount of the exemption that was not used by that spouse’s predeceased
a. This in effect would have allowed a surviving spouse an exemption of up to
$10 million (in 2010 and thereafter), indexed for inflation, if the first spouse
to die did not use any exemption – if, for example, the estate of the first
spouse to die were left entirely to the surviving spouse.
b. This treatment would have to be elected on a timely estate tax return of the
first spouse to die, and the Internal Revenue Service would have been
authorized to reexamine that return at the time the surviving spouse died, no
matter how much time had passed, for the purpose of determining the
exemption available to the surviving spouse (but not for the purpose of
changing the tax with respect to the first return).
c. The $25 million level for the higher rate would not have been transferable
3. In addition, PETRA included a relief provision for the timber industry, widely
viewed as an effort to attract the votes of Senators from timber-growing states.
4. The Bush Administration, despite its official commitment to full and permanent
repeal of the estate tax, announced on June 22 that it supported PETRA “as a
constructive step toward full repeal of the death tax.”
5. On June 27, Senator Frist announced that PETRA would not be brought to the
Senate floor before the Fourth of July recess.
On July 29, 2006, by a somewhat less enthusiastic and less bipartisan vote of 230-180,
the House of Representatives passed still another bill, H.R. 5970, called the “Estate
Tax and Extension of Tax Relief Act of 2006” (“ETETRA”).
1. ETETRA modified PETRA by
a. phasing in the $5 million exemption equivalent in $250,000 annual
increments from $3.75 million in 2010 (up from $3.5 million in 2009) to $5
million in 2015,
b. delinking the top estate tax rate (but not the initial 15 percent rate) from the
capital gains tax rate,
c. phasing in the top 30 percent rate in 2 percent annual increments from 40
percent in 2010 (down from 45 percent in 2009) to 30 percent in 2015,
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d. extending the indexing for inflation (after 2015) to the $25 million bracket
e. removing the “miscellaneous” provisions of the 2001 Tax Act from the repeal
of the sunset, meaning that they again would be scheduled to expire in 2011.
2. In addition to the estate tax provisions and the timber relief provision, ETETRA
included two-year “extenders” of the research credit and other expiring
provisions, an increase in the minimum wage to $7.25 per hour by June 1, 2009,
and a number of other tax changes not related to the estate tax. The estate tax
provisions, extenders, and minimum wage increase were popularly referred to as
3. On August 3, the Senate cloture motion to take up consideration of H.R. 5970
failed by a vote of 56-42. Senator Frist changed his vote to no only to preserve
his right to request reconsideration later in the year, and Senator Baucus (D-MT),
who was expected to vote yes, was absent because of the recent death of his
nephew in Iraq, thus suggesting that the total votes for cloture might have been
58. The only Senator to change from his June 8 vote was Senator Byrd (D-WV).
1. After recessing for the November 7 elections and returning for a “lame duck”
session, the 109th Congress adjourned without enacting ETETRA-like changes or
any other significant changes to the estate, gift, and GST taxes.
2. Congress did, however, enact a number of the extenders that had been in
ETETRA, but without estate tax changes, without an increase in the minimum
wage (which was postponed to 2007), and without even the relief provisions for
the timber industry that had originated in PETRA.
H. What Might Have Been
1. We will probably never know how the Senate would have voted just after Labor
Day in 2005, if Katrina had not intervened. But it is clear that even before
Republicans lost control of Congress to the Democrats in the 2006 election,
the effort for total repeal had simply lost too much traction to have a meaningful
chance of recovery. Consider the following:
2. In October 2003, Senator Kyl was publicly insisting on full and permanent repeal
and denying rumors of compromise, but by the end of 2004 his push for a 15
percent rate instead of full repeal was a matter of general knowledge. Even
before the June 8 cloture vote, it was understood in the Senate that Senator Kyl
would accept a 30 percent rate for the largest estates – an understanding that later
was reflected in PETRA and ETETRA. Once willingness to compromise in this
way is conceded, it is very hard to credibly reassert a “purist” position.
3. As late as April 21, 2005, a letter from Majority Leader Frist called on his
Republican colleagues to “end the death tax forever,” but by summer he was
leading the effort to bring ETETRA to a vote, with its 15 percent and 30 percent
4. The Bush Administration’s official position had been to favor full and permanent
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repeal, but the White House called PETRA “a constructive step toward full repeal
of the death tax.” Again, once a compromise effort is dignified in that way, it can
become, in effect, the new agenda.
5. The opposition to repeal – indeed even the opposition to substantial reduction –
has been resolute and deep, as indicated by the failure of the ETETRA
“sweeteners” to change more than one Senator’s vote.
6. Meanwhile, the support for total repeal was diluted both by years of frustrations
and by the realization that carryover basis would be a very unwelcome substitute.
7. Unlike 2001, when large budget surpluses were forecast, a climate of large budget
deficits fuels the unease of politicians and voters with “tax cuts for the rich.”
V. “OPTIONS” PRESENTED BY THE JOINT COMMITTEE STAFF (2005)
On January 27, 2005, the Staff of the Joint Committee on Taxation published a 430-page
Report entitled OPTIONS TO IMPROVE TAX COMPLIANCE AND REFORM TAX EXPENDITURES
(JCS-02-05), as requested in February 2004 by Chairman Grassley and Ranking Member
Baucus of the Senate Finance Committee. The Report may be viewed at
http://www.house.gov/jct/s-2-05.pdf. Under the heading of Estate and Gift Taxation, it
presented five proposals estimated to raise revenue by $4.2-4.7 billion over 10 years.
A. Perpetual Dynasty Trusts
1. The first proposal is labeled “Limit Perpetual Dynasty Trusts (secs. 2631 and
2632).” The purpose of this proposal is described as follows:
Perpetual dynasty trusts are inconsistent with the uniform structure of the estate
and gift taxes to impose a transfer tax once every generation. In addition, perpetual
dynasty trusts deny equal treatment of all taxpayers because such trusts can only be
established in the States that have repealed the mandatory rule against perpetuities.
2. The proposal would prohibit the allocation of GST exemption to a “perpetual
dynasty trust” that is subject either to no rule against perpetuities or a significantly
relaxed rule against perpetuities. If an exempt trust were moved to a state that had
repealed the rule against perpetuities, the inclusion ratio of the trust would be
changed to one. (Presumably this latter rule would apply only if the relocation of
the trust produced a change in the governing law, and a similar rule would also
apply if the situs state changed its governing law.)
3. The details, not disclosed in the Report, would have been important.
a. For example, the proposal states that it would apply in a state that relaxes its
rule against perpetuities to permit the creation of interests for individuals
more than three generations younger than the transferor. Presumably, the
statutory language would not be harsher than a classical rule against
perpetuities, which easily allows transfers to great-great-grandchildren.
b. Likewise, rather than an outright prohibition on allocation of GST exemption,
as the proposal says, it seems more appropriate to simply limit allocation of
the transferor’s GST exemption to a one-time use (permitting a tax-free
transfer to grandchildren) and then allow the allocation of GST exemption,
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again for one-time use, by members of each successive generation also.
c. An overall objective of tax-neutrality among jurisdictions would be salutary,
B. Valuation Discounts
1. The second proposal is labeled “Determine Certain Valuation Discounts More
Accurately for Federal Estate and Gift Tax Purposes (secs. 2031, 2512, and
2624).” The purpose of this proposal is described as follows:
The proposal responds to the frequent use of family limited partnerships
(“FLPs”) and LLCs to create minority and marketability discounts. … The
proposal seeks to curb the use of this strategy frequently employed to
manufacture discounts that do not reflect the economics of the transfers during
life and after death.
2. The proposal would determine valuation discounts for transfers of interests in
entities by applying aggregation rules and a look-through rule. The aggregation
rules are what the Report calls a “basic aggregation rule” and a “transferee
a. The basic aggregation rule would value a transferred interest at its pro rata
share of the value of the entire interest owned by the transferor before the
transfer. For example, a transferred 20 percent interest would be valued at
one-fourth the value of an 80 percent interest if the transferor owned an 80
percent interest and at one-half the value of a 40 percent interest if the
transferor owned a 40 percent interest.
b. The transferee aggregation rule would take into account the interest already
owned by the transferee before the transfer, if the transferor does not own a
controlling interest. For example, if a person who owns an 80 percent
interest transfers a 40 percent interest by gift and the other 40 percent interest
at death to the same transferee, the gifted 40 percent interest would be valued
at one-half the value of the 80 percent interest originally owned by the donor
and the bequeathed 40 percent interest would be valued at one-half of the
value of the 80 percent interest ultimately owned by the donee/legatee.
c. Interests of spouses would be aggregated with the interests of transferors and
transferees. The proposal explicitly (and wisely) rejects any broader family
attribution rule “because it is not correct to assume that individuals always
will cooperate with one another merely because they are related.”
3. The look-through rule would require the portion of an interest in an entity
represented by marketable assets to be valued at its pro rata share of the value of
the marketable assets, if those marketable assets represent at least one-third of the
value of the assets of the entity.
4. The proposal takes a measured approach which appears designed to avoid the
uncertain and overbroad reach of previous legislative proposals. Nevertheless, the
successive focus on what the transferor originally owned and on what the
transferee ends up with – in contrast, for example, to the simple aggregation with
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the transferor’s previous transfers – could produce some curious results.
a. Transferors with multiple transferees – e.g., parents with two or more
children – would apparently have more opportunities to use valuation
discounts than transferors with only one transferee.
b. Transfers over time could apparently be treated more leniently than transfers
at one time.
c. The results illustrated in the examples, based on the assumption that a
majority (i.e., more than 50 percent) represents control, would apparently be
easier to avoid in an entity like a limited partnership or LLC, where a 99
percent interest is often a noncontrolling interest.
d. Testing valuation discounts ultimately against what the transferee ends up
with would encourage successive transfers (retransfers) or transfers split, for
example, between a child and a trust for that child’s descendants.
C. Lapsing Crummey Powers
1. The third proposal is labeled “Curtail the Use of Lapsing Trust Powers to Inflate
the Gift Tax Annual Exclusion Amount (sec. 2503).” The purpose of this
proposal is described as follows:
Recent arrangements involving Crummey powers [i.e., lapsing powers of
withdrawal from a trust] have extended the “present interest” concept far beyond
what the Congress likely contemplated in enacting the gift tax annual exclusion,
resulting in significant erosion of the transfer-tax base.
2. The proposal offers three options for curbing the use of lapsing Crummey powers.
a. Limit Crummey powers to “direct, noncontingent beneficiar[ies] of the trust.”
This would repudiate the broad use of Crummey powers sustained in
Cristofani v. Commissioner, 97 T.C. 74 (1991).
b. Limit Crummey powers to powers that never lapse. As the proposal
acknowledges, “[t]his option effectively eliminates Crummey powers as a tax
c. Limit Crummey powers to cases where “(1) there is no arrangement or
understanding to the effect that the powers will not be exercised; and (2)
there exists at the time of the creation of such powers a meaningful
possibility that they will be exercised. This option requires a facts-and-
circumstances analysis of every Crummey power.”
3. Again curiously, the proposal does not explore the possibility of making “tax-
vesting” (includibility in the powerholder’s gross estate), rather than actual non-
lapsing, the test, even though a tax-vesting test is already used for trusts for
minors under section 2503(c) and for all GST tax purposes under section
4. Indeed, if lapsing Crummey powers were ever eliminated, Congress might at the
same time recognize the desirability of allowing section 2503(c) trusts to extend
beyond age 21, even for life, subject to a tax-vesting requirement patterned after
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5. The proposal is silent about its possible application to lapsing rights of withdrawal
at age 21 to qualify a trust under section 2503(c), although the principles seem to
be the same.
D. Consistent Basis
1. The fourth proposal is labeled “Provide Reporting for a Consistent Basis Between
the Estate Tax Valuation and the Basis in the Hands of the Heir (sec. 1014).” The
idea is that an heir will be required to use as the income tax basis the same value
that is used for estate tax purposes, with the rather noncontroversial objective of
consistency. To implement this rule, the executor would be required to report the
basis to each recipient of property and to the IRS.
2. Consideration might be given to a vehicle analogous to Form 8082 (by which
beneficiaries of an estate can report an income tax position that is inconsistent
with the Form K-1 received from the executor) to permit the use of a different
basis by the heir if the inconsistency is disclosed and explained to the IRS.
E. 529 Plans
1. The fifth and final proposal is labeled “Modify Transfer Tax Provisions
Applicable to Section 529 Qualified Tuition Accounts (sec. 529).” This proposal
would essentially subject 529 plans to the transfer tax rules that are generally
2. An exception is the special rule allowing the use of five annual gift tax exclusions
for a single transfer, which apparently would not be changed.
VI. “MIDDLE CLASS” FOCUS UNDER DEMOCRATIC LEADERSHIP (2007-2008)
A. The Fiscal 2008 Congressional Budget Resolution (March 2007)
1. On March 21, 2007, in the context of finalizing the fiscal 2008 budget resolution
(S. Con. Res. 21), the Senate, by a vote of 97-1 (with only Senator Feingold (D-
WI) opposed), approved an amendment offered by Senator Baucus (joined by
Senators Mary Landrieu (D-LA), Mark Pryor (D-AR), Evan Bayh (D-IN), and
Bill Nelson (D-FL)) that in effect would make the $132 billion surplus projected
for 2012 available to offset tax cuts in both 2011 and 2012, including selective
extension of the tax cuts enacted in 2001 and 2003.
2. Senator Baucus stated that under this amendment “the Senate’s highest priority
for any surplus should be American families.” 153 CONG. REC. S3469 (daily ed.
March 21, 2007). Accordingly, the first priority Senator Baucus cited was
improving children’s health care coverage under the State Children’s Health
Insurance Program (SCHIP). Senator Baucus continued:
Then our amendment takes the rest of the surplus and returns it to the hard-
working American families who created it. Our amendment devotes the rest of
the surplus to the extension and enhancement of tax relief for hard-working
Here are the types of tax relief about which we are talking. We are talking
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about making the 10-percent [income] tax bracket permanent.…
We are talking about extending the child tax credit.…
We are also talking about continuing the marriage penalty relief….
We are also talking about enhancing the dependent care credit.…
We are talking about improving the adoption credit.…
We are talking about [taking] combat pay [into account] under the earned-
income tax credit, otherwise known as the EITC.…
We are talking about reforming the estate tax. We want to try to give
American families certainty. We want to support America’s small farmers
and ranchers, and in this amendment, we have allowed room for estate tax
reform that will do that.
And we talk about returning surplus revenues to hard-working American
3. Senator Kent Conrad (D-ND), the Chairman of the Senate Budget Committee
(and a former North Dakota Tax Commissioner), responded:
Madam President, I thank very much Senator Baucus for his leadership on
this very important amendment. This amendment is to reassure all those who
have benefited from the middle-class tax cuts that those tax cuts will go forward,
that those children who are not now currently covered under the SCHIP
legislation will have the opportunity to be covered.
The Senator has also provided for small business because we have a number
of provisions that are critically important to small business and, of course, to
prevent the estate tax from having this bizarre outcome, which is now in the law,
where the exemption would go down to $1 million from $3.5 million just two
years before. That makes no sense. So the Senator provides for room in this
amendment to deal with estate tax reform.
The precise contours of that will be up to, obviously, the Finance Committee.
4. In response to the ensuing discussion of several of the points he had made,
Senator Baucus subsequently said (id. at S3470):
There is an underlying answer to all these questions; namely, these are
questions the Finance Committee is going to address and find the appropriate
offsets and deal with the pay-go when it comes up at that time.
5. After being asked specifically about the estate tax, Senator Baucus stated that the
amendment “contemplates extending the estate tax provisions that are in effect in
a. In the context of this budget resolution, of course, “permanently” meant only
through 2012 (or perhaps only through 2011, since the tax from 2011 estates
would generally be payable in fiscal 2012, which begins October 1, 2012).
b. The prospect of extending 2009 law through 2011 or 2012 was intriguing. It
reflected some thoughtful attention to the concerns about the instability of the
estate tax law, especially as 2010 approached.
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c. Moreover, by eliminating the repeal year of 2010, an extension actually
picked up some revenue to offset the revenue lost in 2011 and 2012. The
revenue loss in 2011 and 2012, when the exemption would increase from $1
million (under current law) to $3.5 million, would be complicated by the fact
that the top federal rate would go from 39 percent (net of the state death tax
credit) under current law to something like 37.8 percent, 38.8 percent, or 45
percent (as in the table on page 6).
d. Since the revenue gain from 2010 would have been a one-time gain, it would
not have been available again to mitigate revenue losses, meaning that
permanent estate tax reduction would become even more expensive if this
extension were enacted.
6. On March 23, 2007, the Senate rejected a variation of Senator Kyl’s proposal to
direct the tax-writing committees to report an estate tax exemption of $5 million
(indexed for inflation) and a top rate no higher than 35 percent. The vote was 48-
51. The vote was severely partisan; no Democrat voted for it, and only one
Republican (Senator Voinovich) voted against it. The four Senators who voted
for cloture on H.R. 8 in June 2006 but not for Senator Kyl’s March 2007
amendment were Senators Baucus, Lincoln (D-AR), Bill Nelson (D-FL), and Ben
7. On the same day, by a vote of 25-74, the Senate rejected an amendment offered
by Senator Ben Nelson that he described as follows (id. at S3667 (March 23,
Like the Kyl amendment, our amendment will allow us to accommodate the
Landrieu proposal of a $5 million [exemption] and 35 percent [rate] with a
surcharge for the largest estates. Unlike the Kyl amendment, this amendment is
fiscally responsible and deficit neutral [that is, it will be paid for].
Only four Republicans (Senators Susan Collins and Olympia Snowe of Maine,
Richard Lugar of Indiana, and George Voinovich of Ohio) voted for Senator
8. Thus, with only Senators Collins, Lugar, and Snowe voting for both the Kyl
amendment and the Nelson amendment, it might be said that 70 Senators voted on
March 23 for an exemption of $5 million and a top rate no greater than 35 percent
(at least if it can be “paid for” and depending on what Senators Nelson and
Landrieu meant by “a surcharge for the largest estates”).
9. The Senate approved the overall budget resolution on March 23 by a largely
partisan vote of 52-47.
10. On May 9, 2007, when the Senate was considering the appointment of Senators to
the House-Senate conference on the budget resolution, Senator Kyl offered the
following motion (id. at S5838 (May 9, 2007)):
That the conferees on the part of the Senate on the disagreeing votes of the two
Houses on the concurrent resolution S. Con. Res. 21 (the concurrent resolution
on the budget for fiscal year 2008) be instructed to insist that the final conference
report include the Senate position to provide for a reduction in revenues,
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sufficient to accommodate legislation to provide for permanent death tax relief,
with a top marginal rate of no higher than 35%, a lower rate for smaller estates,
and with a meaningful exemption that shields smaller estates from having to file
estate tax returns, and to permanently extend other family tax relief, so that
American families, including farmers and small business owners, can continue to
enjoy higher after-tax levels of income, increasing standards of living, and a
growing economy, as contained in the recommended levels and amounts of Title
I of S. Con. Res. 21, as passed by the Senate.
a. In explaining the motion, Senator Kyl said: “While the motion does not
specify that amount, an exemption of $5 million per estate indexed for
inflation is what is contemplated.” Id. at S5839.
b. Senator Conrad opposed the motion, on the grounds that it was not paid for
and that the subject was already covered by the Baucus amendment in the
Senate resolution, which he as a Senate conferee would be committed to
c. Nevertheless, Senator Kyl’s motion passed by a vote of 54-41, with eight
Democrats in favor and no Republicans opposed.
d. The binding effect of such a motion to “instruct” conferees was unclear.
Even provisions “sufficient to accommodate” the desired legislation would
still leave the implementation up to the tax-writing committees.
11. On May 17, 2007, the House and Senate approved the budget resolution with
intriguing references to the estate tax.
a. The provisions of the budget resolution applicable to the House of
Representatives (section 303(b)(2)) permit
one or more bills, joint resolutions, amendments, motions, or conference
reports that provide for tax relief for middle-income families and taxpayers
and enhanced economic equity, such as extension of the child tax credit,
extension of marriage penalty relief, extension of the 10 percent individual
income tax bracket, modification of the Alternative Minimum Tax,
elimination of estate taxes on all but a minute fraction of estates by
reforming and substantially increasing the unified credit, extension of the
research and experimentation tax credit, extension of the deduction for State
and local sales taxes, and a tax credit for school construction bonds …
provided that such legislation would not increase the deficit or decrease the
surplus for the total over the period of fiscal years 2007 through 2012 or the
period of fiscal years 2007 through 2017.
H.R. REP. NO. 110-153, 110TH CONG., 1ST SESS. 27 (2007).
b. With respect to the corresponding language of the budget resolution
applicable to the Senate (section 303(a)), an overview prepared by the staff of
the Senate Budget Committee stated:
The Conference Agreement supports middle-class tax relief, including
extending marriage penalty relief, the child tax credit, and the 10 percent
bracket subject to the pay-as-you-go rule. It also supports reform of the
estate tax to protect small businesses and family farms. House provisions
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include additional procedural protections to help ensure fiscal responsibility.
c. The proviso that the contemplated tax relief “not increase the deficit or
decrease the surplus for the total over the period of fiscal years 2007 through
2012 or the period of fiscal years 2007 through 2017” – what the Senate
Budget Committee’s overview refers to as “procedural protections to help
ensure fiscal responsibility” – could fairly be interpreted to mean that under
the budget resolution the Ways and Means Committee would not include any
tax relief provisions that were not “paid for” through increases of other taxes
or projected budget surpluses. That would have been an especially hard
standard to meet in view of the deficits that budgets needed to overcome and
the commitment of Ways and Means Committee Chairman Charles Rangel
(D-NY) and other Members of Congress to give priority to the very
expensive task of fixing the individual alternative minimum tax (which in the
2012 Tax Act may actually have been accomplished).
B. The Fiscal 2009 Congressional Budget Resolution (March 2008)
1. In the consideration of the fiscal 2009 budget resolution (S. Con. Res. 70) on
March 11, 2008, Senator Baucus again proposed an amendment that would make
projected surpluses available for middle-class tax relief. He said, at 154 CONG.
REC. S1840 (daily ed. March 11, 2008):
This amendment would take the surplus in the budget resolution and give it back
to the hard-working American families who earned it. It would make permanent
the 10-percent tax bracket. It would make permanent the child tax credit. It
would make permanent the marriage penalty relief. And it would make
permanent the changes to the dependent care credit. Further, it would make
changes to the tax law to honor the sacrifices our men and women in uniform
make for us every day. We lower the estate tax to 2009 levels. And it would
allow middle-income taxpayers who do not itemize their deductions to
nonetheless take a deduction for property taxes.
2. Once again, Senator Conrad chimed in:
Mr. President, I thank the chairman of the Finance Committee, Senator
Baucus, for this excellent amendment. This will extend the middle-class tax cuts,
the 10-percent bracket, the childcare credit, and the marriage penalty relief
provisions. All those tax cuts will be extended.
In addition, as I understand it, the chairman of the Finance Committee has
crafted an amendment that will include significant estate tax reform because we
are now in this unusual situation of where, under current law, the estate tax will
go from a $3.5-million exemption per person in 2009 to no estate tax in 2010,
and then in 2011, the estate tax comes back with only $1 million exemption per
person. The amendment of the Senator from Montana would make certain it
stays at $3.5 million and is allowed to rise with inflation.
3. And again, Senator Baucus’s amendment was approved with only Senator
Feingold opposed. The vote was 99-1.
4. On the following day, as he had in 2007, Senator Kyl offered an amendment that
would provide a $5 million estate tax exemption (indexed for inflation) and a top
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rate of 35 percent. Id. at S1922 (daily ed. March 12, 2008). An alternative, “paid
for,” amendment offered by Senator Salazar (D-CO) was defeated by a vote of
38-62. Id. at S2044. Senator Kyl’s amendment was then defeated by a vote of
a. Vice President Cheney had been in the presiding officer’s chair and
recognized Senators Salazar and Kyl just before the vote on Senator Salazar’s
amendment (id.), but he was no longer in the Senate chamber to break the tie
after the vote on Senator Kyl’s amendment
b. During the debate, Senator Kyl complained (id. at S1923-24):
The American people need to understand what is really going on. Each
year we pass a budget that, theoretically, allows for a reform of the estate
tax, but then we don’t do anything about it. And the budget itself isn’t law.
The budget is merely a goal, a blueprint of where we want to go for the year.
If you don’t follow it up with a bill, you haven’t done anything. But
Members here pat themselves on the back and go back home and tell their
constituents that they voted to cut the estate tax. Oh, that is wonderful,
people say. But it is never followed up with an actual bill.
So the chairman of the Finance Committee said: Well, he would have
the goal of marking up a bill this spring. He has since advised me he has no
plans whatsoever for a real bill on estate tax, and said: It won’t happen.
5. Democratic Senators Landrieu and Lincoln voted for Senator Kyl’s amendment,
while Republican Senator Voinovich voted against it. Republican Senators
Collins, Snowe, and Voinovich joined 35 Democrats, including Senators Landrieu
and Lincoln, to vote for Senator Salazar’s amendment. Thus, only four Senators
(Collins, Landrieu, Lincoln, and Snowe) voted for both amendments, meaning
that 84 Senators (including Senators Obama, Biden, and Clinton) voted for
substantial estate tax relief, albeit in what were essentially “free” votes.
C. Finance Committee Hearings
On October 4, 2007, while the Senate Finance Committee was considering the tax
features of an energy, conservation, and agriculture tax package entitled the Heartland,
Habitat, Harvest, and Horticulture Act of 2007, Senator Kyl proposed an amendment
that would set the estate tax exemption at $5 million indexed for inflation, tie the
estate tax rate above $5 million to the capital gains tax income tax rate (currently 15
percent), and add a 30 percent bracket beginning at $25 million. (This is essentially
the same as ETETRA.) Senator Kyl withdrew the amendment after Chairman Baucus
promised to hold a hearing on estate tax reform “later in the year,” with the goal of
marking up a bill in the spring of 2008.
1. The Finance Committee held that hearing on November 14, 2007. A
manufacturer from Iowa and a rancher from Nevada advocated repeal of the estate
tax or at least a substantial increase in the exemption. Warren Buffett of
Berkshire Hathaway supported a progressive estate tax (with an exemption of
perhaps $4 million) as necessary to prevent “plutocracy.” Practitioner Conrad
Teitell of Stamford, Connecticut, pointed out the caprice of current law and the
complexities and uncertainties faced in estate planning. Both Chairman Baucus
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and Ranking Member Grassley complained about the estate tax, expressed their
preference for repeal, but offered a commitment to serious reform as an
achievable alternative. Chairman Baucus promised more extensive hearings in
2008 with a goal of major changes in the 111th Congress (2009-2010). See
2. A second hearing was held on March 12, 2008. Three professors discussed
alternatives to the estate tax system, largely donee-based taxes such as inheritance
taxes and inclusion of inheritances in income, as well as income taxes on gains
imposed at the donor level. It was clear that the Senators in attendance (three
Democrats and three Republicans at various times) were not inclined to replace
the estate tax with another regime, although they obviously were aware of the
coming anomaly in 2010 and 2011 and seemed interested in finding some way to
avoid it. Both Democrats and Republicans expressed concern for the liquidity
problems of family-owned farms and businesses. One of the witnesses was New
York University School of Law Professor Lily Batchelder, who, it was announced
May 17, 2010, has been appointed the Chief Tax Counsel for the Committee. See
3. A third hearing was held on April 3, 2008. Witnesses were invited to discuss
a. the need to clarify, modernize, simplify, and otherwise improve the rules for
deferred payment of estate tax under section 6166,
b. the “portability” of transfer tax exemptions (and exemption equivalents
represented by the unified credit) from deceased spouses to surviving
c. reunifying the estate and gift tax unified credits, and
d. the effect of the estate tax on charitable giving.
The topics provide clues about the “targeted” relief to look for in any legislation
(tied to family farms and other family businesses which have been a vocal
concern of Senators, especially Democrats like Senator Lincoln). See
VII. THE ONE-HUNDRED-ELEVENTH CONGRESS (2009-2010)
A. The First Pomeroy Bill (H.R. 436)
1. On January 9, 2009, Rep. Earl Pomeroy (D-ND) introduced H.R. 436, called the
“Certain Estate Tax Relief Act of 2009.” It received a great deal of attention, but
the attention was probably overdone (not surprising in the atmosphere of
anticipation that prevailed in January 2009). H.R. 436 was not even featured on
Rep. Pomeroy’s own website.
2. H.R. 436 would freeze 2009 estate tax law – a $3.5 million exemption equivalent
(with no indexing) and a 45 percent rate.
3. H.R. 436 would also revive, effective January 1, 2010, the “phaseout of graduated
rates and unified credit” of pre-2002 law, expressed as a 5 percent surtax.
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a. The pre-2002 surtax applied only to taxable estates between $10,000,000 and
$17,184,000. Because of the increase in the unified credit to match a $3.5
million exemption, the surtax under H.R. 436 would apply to taxable estates
from $10 million all the way up to $41.5 million.
b. In other words, the marginal rate between $10 million and $41.5 million
would be 50 percent (45 percent plus 5 percent), and the ultimate tax on a
taxable estate of $41.5 million, calculated with the 2009 unified credit of
$1,455,800, plus the 5 percent surtax on $31.5 million (the excess over $10
million), would be $18,675,000 – exactly 45 percent of $41.5 million.
c. At least the old 5 percent surtax used to work that way when there was a
federal credit and no deduction for state death taxes. Today, it would still
work that way in “coupled” states where in effect there is no state death tax.
Once again, the repeal of the state death tax credit makes the math more
complicated in “decoupled” states that impose their own tax. In those states,
the actual numbers will depend on the structure of the state tax, but in general
the combined federal and state marginal rates for taxable estates between
$10.1 million and $41.5 million will be 56.9 percent in states that conform to
the federal deduction for their own state taxes and 58.0 percent in states that
have decoupled even from that federal deduction.
d. Regardless of the stature or future of H.R. 436 in general, the revival of the
surtax idea might gain traction in a revenue-minded and middle-class-focused
congressional environment. No idea ever fades away completely.
e. If a surtax like this were enacted, it would be one more reason to be careful in
providing blanket general powers of appointment in trusts subject to the GST
tax, because at least the GST tax is imposed at a flat 45 percent rate.
4. H.R. 436 would add a new section 2031(d), generally valuing transfers of
nontradeable interests in entities holding nonbusiness assets as if the transferor
had transferred a proportionate share of the assets themselves. If the entity holds
both business and nonbusiness assets, the nonbusiness assets would be valued
under this special rule and would not be taken into account in valuing the
transferred interest in the entity. Meanwhile, new section 2031(e) would deny a
minority discount (or discount for lack of control) in the case of any nontradeable
entity controlled by the transferor and the transferor’s ancestors, spouse,
descendants, descendants of a spouse or parent, and spouses of any such
descendants. The statutory language is identical to the bills introduced by Rep.
Rangel in 2001 and Rep. Pomeroy in 2002, 2005, and 2007, discussed in Part
II.E.1.c on page 5. These rules would apply for both gift and estate tax purposes
and would be effective on the date of enactment.
B. The Arithmetic of the Estate Tax
1. Although the estate tax was not prominent in the 2008 presidential campaign,
President Obama’s campaign embraced making permanent the 2009 estate tax
law, with a $3.5 million exemption and 45 percent rate.
2. Freezing the federal estate tax at its 2009 level would have increased federal
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revenues for fiscal 2011 – the 12 months that began October 1, 2010 – because
that is when the tax would have been due with respect to decedents dying in 2010.
3. After 2010, reversing the 2001 Tax Act “sunset” and “reducing” the federal estate
tax to its 2009 level would of course have reduced federal revenues (relative to
what the pre-2002 law would produce in 2011). But that reduction of federal
revenue would have been of less magnitude and different composition than might
sometimes be assumed, because, if the 2001 Tax Act sunset were allowed to run
its course and pre-2002 law, including the credit for state death taxes, returned
in 2011, the net federal rate on the largest estates would not increase very much.
4. If pre-2002 law returned, at the level of a taxable estate of $3.5 million (the 2009
exemption), the net federal marginal rate would be 45.4 percent, as it was before
2002. At a taxable estate of $3.6 million, it would drop to 44.6 percent, and
never again would be above 45 percent, the current federal rate in states with no
deductible state death tax. At a taxable estate just under $10 million, the net
federal marginal rate would be 39.8 percent. Because of the 5 percent surtax
under old section 2001(c)(2), the net marginal rate would become 44.8 percent at
$10 million and then 44 percent over $10.1 million. At a little over $17 million,
the net marginal rate would fall to 39 percent, the net rate on all taxable estates
above that level. These rates compare to the 2009 net federal marginal rate on the
largest estates of 45 percent in “coupled” states, 38.8 percent in ordinary
“decoupled” states, and 37.8 percent in “decoupled” states where the state tax
itself is not allowed as a deduction in computing the state tax.
5. Putting it another way, the following table shows the net federal tax paid, if
Congress had not changed the law, on a small and large taxable estate (with no
adjusted taxable gifts or other complexities, and no state estate tax):
Federal Estate Tax Owed
Taxable Estate 2009 2011 (before 2010 Tax Act) Change
$5 million $675,000 $1,653,400 +145%
$50 million $20.9 million $19.7 million -6%
6. The upshot of all this is that a return to pre-2001 law in 2011, compared to 2009
law, would have collected more federal revenue, but mostly from estates at the
low end of the range of taxable estates. The very largest estates would actually
get a federal tax cut in many states. It is a bit of an oversimplification to ignore
state taxes and other factors, but the prima facie effect of raising substantial
revenue from the smallest taxable estates and reducing the net federal marginal
rates and even the net federal tax on the estates of the richest decedents would not
have fit well with popular notions of “tax cuts for the rich” versus “middle class
C. The Obama Administration’s Fiscal 2010 Budget Proposal
1. The ambitious document announcing the Administration’s proposed budget, “A
New Era of Responsibility: Renewing America’s Promise,” was published
February 26, 2009. In a summary of the adjustments to baseline projections to
reflect selective (targeted) continuation of the 2001 and 2003 tax cuts, a footnote
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(footnote 1 to Table S-5) stated that “the estate tax is maintained at its 2009
parameters.” Apparently the gift tax exemption was assumed to remain $1
million, and the exemptions were not indexed for inflation or portable between
2. On June 11, 2009, revenue estimates from the Joint Committee on Taxation
scored the 10-year cost of the Administration proposal at about 43 percent of
D. The Fiscal 2010 Congressional Budget Resolution
1. The House and Senate versions of the budget resolution, H. Con. Res. 85 and S.
Con. Res. 13, both as proposed by the respective Budget Committees and as
passed by the House and Senate respectively, allowed for 2009 estate tax law to
be made permanent.
2. On April 2, 2009, the Senate, by a vote of 51-48, approved an amendment offered
by Senator Blanche Lincoln (D-AR) and cosponsored by Senators Jon Kyl (R-
AZ), Ben Nelson (D-NE), Chuck Grassley (R-IA), Mark Pryor (D-AR), Pat
Roberts (R-KS), Mary Landrieu (D-LA), Michael Enzi (R-WY), Susan Collins
(R-ME), and John Thune (R-SD). The precise wording of Senator Lincoln’s
The Chairman of the Senate Committee on the Budget may revise the allocations
of a committee or committees, aggregates, and other appropriate levels and limits
in this resolution for one or more bills, joint resolutions, amendments, motions,
or conference reports that would provide for estate tax reform legislation
(1) an estate tax exemption level of $5,000,000, indexed for inflation,
(2) a maximum estate tax rate of 35 percent,
(3) a reunification of the estate and gift credits, and
(4) portability of exemption between spouses, and
provided that such legislation would not increase the deficit over either the period
of the total of fiscal years 2009 through 2014 or the period of the total of fiscal
years 2009 through 2019.
3. In short, Senator Lincoln’s 2009 amendment had about the same effect as would
have the amendment proposed by her cosponsor Senator Nelson in 2007 (see Part
VI.A.7 on page 21) and by Senator Salazar in 2008 (see Part VI.B.4 on page 23) –
that is, in Senator Nelson’s words, “[l]ike the Kyl amendment, [but] fiscally
responsible and deficit neutral.” In an environment of extreme fiscal challenges,
that effect could be very small.
4. As if to leave no doubt about the aspirational nature of this amendment, the
Senate then immediately approved, by a vote of 56-43, an amendment offered by
Assistant Majority Leader Richard Durbin (D-IL), providing that “[i]n the Senate,
it shall not be in order to consider any bill, joint resolution, amendment, motion,
or conference report that would provide estate tax relief beyond $3,500,000 per
person ($7,000,000 per married couple) and a graduated rate ending at less than
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45 percent unless an equal amount of tax relief is provided to Americans earning
less than $100,000 per year and that such relief is in addition to the amounts
assumed in this budget resolution.” Senator Kyl mildly opposed the Durbin
amendment, but Senators Lincoln, Nelson, and Pryor themselves voted for it.
5. On April 29, 2009, the conference report on the budget resolution was passed by
votes of 233-193 in the House and 53-43 in the Senate. The Lincoln amendment
was not included.
E. The First Baucus Bill (S. 722)
1. Meanwhile, on March 26, 2009, Chairman Max Baucus (D-MT) of the Senate
Finance Committee had introduced the “Taxpayer Certainty and Relief Act of
2009” (S. 722), including Title III captioned “Permanent Estate Tax Relief.”
2. Consistent with the Obama Administration’s budget proposal, S. 722 would make
permanent the current $3.5 million estate tax applicable exclusion amount and 45
percent rate. It would again fully unify the gift tax with the estate tax by
providing a single exclusion amount of $3.5 million, and it would also make the
cap on the reduction of value under the special use valuation provisions of section
2032A equal to the applicable exclusion amount. Beginning in 2011, it would
index the applicable exclusion amount for inflation.
3. S. 722 would also make permanent the other transfer tax changes made by the
2001 Tax Act, including the rules affecting the allocation of GST exemption.
And it would provide for the “portability” of the unused gift and estate tax unified
credit of a deceased spouse to the surviving spouse and the surviving spouse’s
4. The portability provisions of S. 722 are identical to those in the 2006 House-
passed bills, except that the iterative portability of the unified credit to spouses of
spouses is prohibited.
a. In other words, if Husband 1 dies after 2009 without using his full exclusion
amount, and his widow, Wife, marries Husband 2 and then dies, Wife’s estate
could use her own exclusion amount plus whatever amount of Husband 1’s
exclusion amount was not used. Husband 2’s estate could use his own
exclusion amount plus whatever amount of Wife’s basic exclusion amount
was not used. But Husband 2’s estate could not use any of Husband 1’s
unused exclusion amount transmitted through Wife’s estate. Some
commentators describe this as requiring privity between the spouses.
b. Husband 2’s estate could still use the unused exclusion amount of any
number of his predeceased wives (and S. 722 would make that explicit),
subject only to the overall limitation that the survivor’s exclusion amount
could be no more than doubled.
F. The McDermott Bill (H.R. 2023)
1. On April 22, 2009, Rep. Jim McDermott (D-WA), the fourth most senior
Democrat on the Ways and Means Committee, introduced H.R. 2023, called the
“Sensible Estate Tax Act of 2009.” Virtually identical to H.R. 6499, which he
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had introduced in 2008, H.R. 2023, effective January 1, 2010, would provide
a. a $2 million exemption equivalent, indexed for inflation after 2010,
b. an initial rate of 45 percent (over $1.5 million in the tax table), a rate of 50
percent over $5 million, and a rate of 55 percent over $10 million (with these
amounts also indexed for inflation after 2010),
c. restoration of the credit for state death taxes and repeal of the deduction for
state death taxes,
d. gift tax exemptions and rates re-conformed to the estate tax,
e. retention of a stepped-up basis at death for appreciated assets,
f. repeal of the 2011 “sunset” for other transfer tax provisions of the 2001 Tax
g. portability of the unified credit between spouses (as in PETRA and ETETRA,
not requiring “privity” between spouses as in S. 722).
2. The staff of the Joint Committee on Taxation estimated that H.R. 2023 would cost
$202 billion over 10 years, or about 37 percent of current-law revenue estimates
(compared to 43 percent of current-law estimates for the cost of the
Administration proposal to make 2009 estate tax law permanent).
G. Ways and Means Committee Engagement and the Second Pomeroy Bill
1. On October 22, 2009, Ways and Means Committee members Shelley Berkley (D-
NV), Kevin Brady (R-TX), Artur Davis (D-AL), and Devin Nunes (R-CA)
introduced H.R. 3905, called the “Estate Tax Relief Act of 2009.”
a. Under H.R. 3905, in each of the 10 years from 2010 through 2019, the estate
tax applicable exclusion amount would increase by $150,000 and the top rate
would decrease by 1 percent. Thus, by 2019 the exemption and rate would
be $5 million and 35 percent, the levels embraced aspirationally by a majority
of Senators while considering the fiscal 2010 budget resolution (see part
VII.D, beginning on page 28). The $5 million exemption would be indexed
for inflation after 2019.
b. In addition, the deduction for state death taxes would be reduced 10 percent
per year through 2019, when it would be eliminated entirely.
c. H.R. 3905 would abandon carryover basis and make permanent the other
2001 transfer tax changes, including the several helpful rules regarding
allocation of the GST exemption. But it would not reunify the gift and estate
tax exemptions or make the exemption portable between spouses.
2. Meanwhile, on November 4, the House Small Business Committee held a hearing
entitled “Small Businesses and the Estate Tax: Identifying Reforms to Meet the
Needs of Small Firms and Family Farmers.” Three family business owners and a
think tank scholar argued that if the estate tax cannot be abolished, at least there
should be greater relief for family businesses and farms. The statements of
Chairwoman Nydia Valazquez (D-NY) and the witnesses are available at
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3. On November 18, 2009, the Democratic members of the Ways and Means
Committee reportedly agreed to go forward with only a one-year extension of the
2009 estate tax law but had second thoughts when Majority Leader Steny Hoyer
(D-MD) reconvened them and urged them to embrace a permanent solution.
4. Then on the following day (November 19), Congressman Earl Pomeroy (D-ND),
the Ways and Means Committee member whom Chairman Rangel had tapped to
put the permanent statutory language together, introduced H.R. 4154, a very
simple bill that would only freeze 2009 law, including the estate tax exemption of
$3.5 million, the gift tax exemption of $1 million, the top rate of 45 percent, a
stepped-up basis at death for appreciated assets, a deduction (and no credit) for
state death taxes, and the special rules for conservation easements, section 6166,
and allocation of GST exemption enacted in 2001.
5. On December 3, 2009, the House passed H.R. 4154 by a vote of 225-200.
Twenty-six Democrats voted against the bill. No Republican voted for it.
a. The supporters of the bill in the floor debate focused on the need for
predictability in planning and the unfairness of carryover basis.
b. Those voting no presumably did so mainly because they would have
preferred to see the estate tax permanently repealed or more significantly
reduced – the House of Representatives then included over 170 members who
were among the 272 votes for permanent repeal the last time that issue had
come before the House in April 2005. Indeed, the opposition in the floor
debate before the vote supported the Berkley-Brady bill (H.R. 3905), which
would have phased in a $5 million exemption and 35 percent rate by 2019
and indexed the exemption for inflation after that. A few voting no, however,
were Democrats who have expressed a preference for a higher tax, including,
for example, a reduction of the exemption to $2 million and a return to a top
rate of 55 percent. Other Democrats of that view voted yes.
H. Senate Refusal To Act in 2009
1. H.R. 4154 reached the Senate when the Senators were preoccupied with health
care reform. On December 16, 2009, Finance Committee Chairman Max Baucus
(D-MT) asked the Senate for unanimous consent to bring H.R. 4154 to the floor,
approve an amendment to extend 2009 law for only two months (not
permanently), and approve the bill as amended.
2. In response, the Republican Leader, Senator Mitch McConnell (R-KY), asked
Senator Baucus to agree to consideration of an amendment reflecting, as Senator
McConnell described it, “a permanent, portable, and unified $5 million exemption
that is indexed for inflation, and a 35-percent top rate.”
a. By use of the word “permanent,” of course, Senator McConnell was
advocating legislation that would eliminate not just all or part of the 2010
repeal year, but also the return to a higher tax in 2011.
b. By “portable,” he was affirming the ability of a surviving spouse to use any
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estate tax exemption available to but not used by the first spouse to die.
c. By “unified,” Senator McConnell was supporting the increase of the $1
million gift tax exemption to be equal to the estate tax exemption, as it had
been before 2004.
d. By “indexed for inflation,” he was embracing annual increases in the unified
exemption with reference to increases in the consumer price index, as the
GST exemption was indexed from 1999 through 2003 (and will be indexed
again in 2011 unless Congress changes the law).
3. Portability, unification, and indexing had been approved in two bills passed by the
House of Representatives in 2006 and included in S. 722 introduced by Chairman
Baucus in March 2009. A $5 million exemption and 35 percent top rate, along
with unification, indexing, and portability, had been part of the amendment,
sponsored by Senator Blanche Lincoln (D-AR), that received 51 votes in the
consideration of the fiscal 2010 Congressional Budget Resolution in April 2009.
And it was the measure that 84 Senators (including then Senators Obama, Biden,
Clinton, and Salazar) voted for, albeit in two separate votes, in the consideration
of the fiscal 2009 budget resolution (S. Con. Res. 70) on March 11, 2008
(described in Part VI.B.5 on page 24).
4. Senator Baucus objected to Senator McConnell’s request, whereupon Senator
McConnell objected to Senator Baucus’s request, and all practical hopes of
transfer tax legislation in 2009 died.
5. In the course of the debate, Senator Baucus stated:
Mr. President, clearly, the right public policy is to achieve continuity with respect
to the estate tax. If we do not get the estate tax extended, even for a very short
period of time, say, 3 months, we would clearly work to do this retroactively so
when the law is changed, however it is changed, or if it is extended next year, it
will have retroactive application.
I. The “Responsible Estate Tax Act”
1. On June 24, 2010, a bill dubbed “the liberals’ bill,” the “Responsible Estate Tax
Act” (S. 3533), was introduced by Senators Sanders (I-VT), Whitehouse (D-RI),
Harkin (D-IA), Brown (D-OH), and Franken (D-MN). A companion bill, H.R.
5764, was introduced in the House by Rep. Linda Sanchez (D-CA) on July 15,
2. These bills would have restored a unified credit equivalent to a $3.5 million
exemption effective January 1, 2010, with a flat 39 percent rate used to calculate
the pre-unified credit tax on the amount of the taxable estate from $750,000 to
$3.5 million. The tax would then be imposed at rates of 45 percent over $3.5
million, 50 percent over $10 million, 55 percent over $50 million, and 65 percent
over $500 million.
a. The 65 percent rate is cast as a 10 percent “surtax,” but it has the same effect
as a 65 percent rate, and it has no ceiling. It replaces the former 5 percent
surtax on taxable estates over $10 million.
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b. Like the former 5 percent surtax, the 10 percent surtax would not affect the
GST tax rate, which would be 55 percent as it was before 2002.
c. There was a typo in section 3(a)(2) of S. 3533 and H.R. 5764 as introduced.
This “surtax” is said to replace section 2011(c)(2). The correct reference
would be section 2001(c)(2).
3. These bills would abandon carryover basis, restore the credit for state death taxes,
and make permanent the other 2001 transfer tax changes, including the rules
regarding allocation of the GST exemption. But they would not reconform the
gift and estate tax exemptions, index the exemption or brackets for inflation, or
make the exemption portable between spouses.
4. These bills would increase the cap on the reduction in value under the special use
valuation rules of section 2032A (then $1 million) to $3 million (indexed for
inflation as it has been since 1998). And they would increase the maximum
exclusion from the gross estate under section 2031(c) by reason of a conservation
easement from the lesser of $500,000 or 40 percent of the net value of the land to
the lesser of $2 million or 60 percent of the net value of the land.
5. Finally, S. 3533 and H.R. 5764 include the same valuation discount provisions
included in the first Pomeroy bill, H.R. 436 (see Part VII.A.4 on page 26 and Part
II.E.1.c on page 5), and statutory language implementing the Administration’s
revenue proposals regarding basis and GRATs.
J. The Second “Baucus Bill”
1. On December 2, 2010, in a “lame duck” session, Senator Max Baucus (D-MT),
the chairman of the Senate Finance Committee, introduced an amendment to
pending tax legislation entitled the “Middle Class Tax Cut Act of 2010” and
widely known as the “Baucus Bill.”
2. As with Senator Baucus’s previous proposals, such as S. 722 he had introduced
on March 26, 2009 (Part VII.E beginning on page 29), the amendment would
permanently reinstate 2009 estate tax law, with a 45 percent rate and $3.5 million
exemption, effective January 1, 2010, indexed for inflation beginning in 2011.
Executors of decedents who died in 2010 would be able to elect out of the estate
tax into the carryover basis regime that had been 2010 law. In a result viewed by
many as “too good to be true” and thus possibly an oversight, the Baucus Bill
apparently would have left a testamentary trust completely free of GST tax
forever if that election were made.
3. The December 2010 Baucus Bill also revived the idea of the “portability” of the
unified credit, or “exclusion amount” or “exemption,” by making the portion of
the exemption not used by the last predeceased spouse available to the surviving
4. The December 2010 Baucus Bill would have provided substantial estate tax relief
targeted to real estate.
a. The value of family farmland that met certain qualifications and passed to a
“qualified heir” would not be subject to estate tax until it was disposed of by
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a qualified heir.
b. The cap on the special use valuation reduction under section 2032A – then $1
million, the statutory cap of $750,000 indexed for inflation since 1999 –
would be tied to the applicable exclusion amount ($3.5 million in the Baucus
Bill) and would be indexed for inflation beginning in 2011.
c. The treatment of a disposition or severance of standing timber on qualified
woodland as a recapture event under section 2032A(c)(2)(E) would be made
inapplicable to a disposition or severance pursuant to a forest stewardship
plan developed under the Cooperative Forestry Assistance Act of 1978, 16
d. Certain contributions and sales of qualified conservation easements would
likewise not result in recapture under section 2032A.
e. The limitation on the exclusion from the gross estate by reason of a qualified
conservation easement under section 2031(c) would be increased from
$500,000 to $5 million.
5. Finally, the December 2010 Baucus Bill also included the requirement for
consistency in basis reporting and a minimum 10-year term for GRATs that were
proposed in the 2009 and 2010 Administration budget proposals.
K. The Deal Between the President and Some Congressional Leaders
1. On Monday, December 6, 2010, President Obama announced on national
television that he and certain congressional leaders had agreed on “the framework
of a deal” to permit the 2001 and 2003 income tax cuts – the so-called “Bush tax
cuts” – to be extended for two years. The President reported that the agreement
included a one-year 2 percent payroll tax reduction, a 13-month extension of
employment benefits desired by many Democrats, and an extension of the estate
tax for two years – presumably 2011 and 2012 – with a $5 million exemption and
a 35 percent rate (an exemption and rate that then Senator Obama himself had
voted for in the consideration of the fiscal 2009 budget resolution on March 11,
2008, described in Part VI.B.5 on page 24).
2. It appears that the congressional leaders the President reached this agreement with
were mostly Republicans, and the initial reactions of Republicans were
supportive, even if not enthusiastic, while surprised Democrats originally reacted
with skepticism or even hostility. As the days passed, Republican criticisms also
emerged while more Democratic support began to be heard. In the House of
Representatives in particular, the Democratic resistance was directed largely at
the estate tax proposal, believed by many to be both overly generous and
extraneous to the core elements of the compromise.
L. The 2010 Tax Act
1. On December 9, 2010, the Senate released the text of an amendment (S. Amdt.
4753) to implement the agreement announced by President Obama. The
amendment, offered by the Senate leaders, Senators Harry Reid (D-NV) and
Mitch McConnell (R-KY), to an Airport and Airway Trust Fund funding measure
– 35 –
(H.R. 4853), was entitled the “Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of 2010.” It provided
a. a postponement of the 2001 Tax Act sunset for two years, until December 31,
b. an estate tax exemption of $5 million and estate tax top rate of 35 percent,
beginning January 1, 2010,
c. an opportunity for executors of 2010 estates to elect out of the estate tax into
the 2010 carryover basis rules,
d. a GST exemption of $5 million beginning January 1, 2010,
e. a GST tax rate of zero in 2010 and 35 percent beginning January 1, 2011,
f. a gift tax exemption of $5 million and a gift tax top rate of 35 percent,
beginning January 1, 2011,
g. indexing of the $5 million exemption for inflation, beginning in 2012, and
h. portability of the unified credit (“exemption”) from a deceased spouse to the
surviving spouse, as in the December 2010 Baucus Bill, but
i. nothing addressing GRATs, consistent basis, targeted relief for real estate, or
valuation discounts, and
j. nothing to permanently remove the shadows of “sunset” from the other
changes made by the 2001 Tax Act, affecting the GST exemption (expanded
deemed allocations and elections, retroactive allocations, qualified
severances, determinations of value, and relief from late allocations),
conservation easements, and section 6166. (All those provisions are only
extended for two years.)
2. On December 15, 2010, the Senate approved the Reid-McConnell Amendment by
a vote of 81-19.
3. On December 16, 2010, by a vote of 194-233, the House of Representatives
defeated an amendment to replace the estate, gift, and GST tax changes of the bill,
generally with 2009 law with an election out for 2010 estates.
4. Early on December 17, 2010, the House approved the Tax Relief, Unemployment
Insurance Reauthorization, and Job Creation Act of 2010 by a vote of 277-148.
5. On December 17, 2010, President Obama signed the Act, which became Public
VIII. THE CLARIFIED AND MODIFIED 2010-2012 LAW
A. The Sunset in General
1. Section 101(a) of the Tax Relief, Unemployment Insurance Reauthorization, and
Job Creation Act of 2010, Public Law 111-312 (“the 2010 Tax Act”) simply
extended the sunset in the oft-discussed section 901 of the 2001 Tax Act for two
years by replacing “December 31, 2010” with “December 31, 2012.” As a result,
everything that was expected to expire at the end of 2010 was rescheduled to
– 36 –
expire at the end of 2012 instead.
2. This included the “Bush” income tax cuts that were scheduled to expire at the end
of 2010 and were the main engine that drove the extraordinarily intense
discussions that led to consideration of the Reid-McConnell Amendment. But,
read together with section 304 of the 2010 Tax Act, it also included the new
estate, gift, and GST tax provisions introduced by the 2010 Tax Act.
B. The Estate Tax Exemption and Rate
1. Title III of the 2010 Tax Act, under the heading of “Temporary Estate Tax
Relief,” gave special attention to the estate, gift, and GST taxes, because of the
unique disruption of those taxes in 2010. Section 301 reinstated the estate tax and
repealed carryover basis for 2010. Section 302(a) established an estate tax
applicable exclusion amount, or “exemption,” of $5 million and a top estate tax
rate of 35 percent, effective January 1, 2010. It also indexed that $5 million
exemption for inflation, beginning in 2012, and, being found in the context of the
two-year extension, also ending in 2012.
2. The 35 percent rate, like the 2010 gift tax rate, took effect at a level of $500,000.
In other words, the “progressive” rates, or “run up the brackets,” occurred only
below $500,000. The tax value of that run is only $19,200 (35 percent of
$500,000 less the stated tax on $500,000 of $155,800).
3. The $5 million exemption and 35 percent rate, effective even for 2010, were a bit
of a surprise, and it is understandable that they attracted special attention,
especially in the attempted House amendment. While the rest of the measures
extending the 2001 tax cuts simply maintained the 2010 status quo through 2011
and 2012, the estate tax component of the compromise was different in two
a. First, unlike the income tax compromises, which prevented, in effect, a tax
increase on January 1, 2011, the estate tax deal was a tax increase compared
to former 2010 law but represented a tax cut when compared to 2009.
b. Second, this tax cut was effective not just in 2011 and 2012, but also, in large
part, retroactively in 2010.
C. The Election out of the Estate Tax into Carryover Basis for 2010 Estates
a. One complication of the attempted repeal of the estate tax in 2001 (to take
effect in 2010) and the manner in which it became a reality in 2010 was the
abrupt introduction of the modified carryover basis regime of section 1022,
without technical corrections, without regulations or other guidance, without
forms or instructions, and without much serious study at all. Discomfort with
the impending carryover basis regime was a principal argument cited in 2009
by congressional supporters of legislation to make the 2009 law permanent
and prevent the 2010 law enacted in 2001 from taking effect. See Part
VII.G.5.a on page 31. Because Congress did not act in 2009, however, the
modified carryover basis regime appeared to apply to property passing from a
– 37 –
decedent who died in 2010. Ultimately it did apply to such property if the
executor elected that the estate tax not apply.
b. Under pre-2010 and post-2010 law, and under 2010 law without an election
out of estate tax, a decedent’s beneficiaries inherit assets with a basis for
computing depreciation and capital gains equal to the fair market value of the
assets on the date of the decedent’s death. This basis adjustment is typically
referred to as a “basis step-up,” because it is assumed that one’s basis in
assets is lower than the fair market value of assets on the date of death.
However, the adjustment actually works in both directions, and if the fair
market value of an asset on the date of death is lower than the decedent’s
basis, the asset’s basis is stepped down for all purposes, so that the
beneficiaries inherit the property with a lower basis. One historical reason
for the basis adjustment rules is apparently the perceived unfairness of
imposing a double tax on a beneficiary who inherited assets – first an estate
tax and then a capital gains tax when the executor or beneficiary
subsequently sold the asset, especially if the sale was necessary to raise
money to pay the estate tax. This reasoning would not fully apply in the
absence of an estate tax.
2. The Elective 2010 Carryover Basis Regime
a. The basic rule in 2010 under section 1022 was that a decedent’s basis in
appreciated property remained equal to the decedent’s basis in the property if
the fair market value of the property on the date of death was greater than the
decedent’s basis. If the fair market value of an asset on the date of death was
less than the decedent’s basis, the basis was stepped down to the fair market
value on the date of death, just as it would have been under former law. This
rule applied separately to each item of property.
b. Under section 1022(a), carryover basis applied to “property acquired from a
decedent,” which is defined in section 1022(e). The definition does not cover
all property the value of which would have been included in a decedent’s
gross estate, such as property that would have been included in the gross
estate of a surviving spouse by reason of a QTIP election under section
2056(b)(7) at the first spouse’s death and property that would be included in a
decedent’s gross estate under section 2036 solely because the decedent had
been the grantor and beneficiary of a grantor retained annuity trust (”GRAT”)
or a qualified personal residence trust (“QPRT”).
i. Section 4.01(3)(i) of Rev. Proc. 2011-41, 2011-35 I.R.B. 188, clarified
that property subject to a general power of appointment defined in
section 2041 (if it applied) was subject to carryover basis.
ii. In the case of a GRAT or QPRT, the basis of the assets is likely to be the
decedent’s basis anyway. Example 1 of Rev. Proc. 2011-41 illustrated
that carryover basis would not apply to the assets of a QPRT if the
grantor died during the QPRT term and those assets passed to the
grantor’s child. But if in that case those assets passed to the grantor’s
– 38 –
estate (which is common because it results in a lower taxable gift),
Example 2 of Rev. Proc. 2011-41 stated that then those assets were
subject to carryover basis. Presumably the rule for a GRAT would be
the same (except that a reversion to the grantor’s estate would not be as
c. Section 6018, as applicable to the estate of a decedent who died in 2010 and
whose executor elected out of the estate tax, required reporting to the IRS and
to recipients of property from the decedent, if the fair market value of all
property except cash acquired from the decedent exceeds $1.3 million.
i. Before the enactment of the 2010 Tax Act, the IRS released a draft Form
8939 for this purpose. But the draft indicated that the form would be
heavily dependent on the instructions, and the IRS had not yet released
ii. Section 6075(a), as applicable to the estate of a decedent who died in
2010 and whose executor elected out of the estate tax, appears to require
the report to the IRS (Form 8939) to be “filed with the return of the tax
imposed by chapter 1 for the decedent’s last taxable year [that is, the
decedent’s final 1040 due April 18, 2011] or such later date specified in
d. In Notice 2011-66, 2011-35 I.R.B. 184, released on August 5, 2011, the IRS
provided the first substantive guidance regarding carryover basis and the
election. Notice 2011-76, 2011-40 I.R.B. 479, released on September 13,
2011, amplified and modified that guidance. Confirmations and clarifications
provided by those Notices include the following.
i. Form 8939, Allocation of Increase in Basis for Property Acquired From
a Decedent, was to be used to make what Notice 2011-66 called “the
Section 1022 Election” out of the estate tax, as well as to report the value
and basis of property as required by section 6018 and to allocate the
basis increases discussed below.
ii. Form 8939 was to have been filed on or before January 17, 2012.
iii. Notice 2011-66 had originally said November 15, 2011.
iv. Curiously, even Notice 2011-76, which announced the January 17 due
date, stated that “the Treasury Department and IRS intend to confirm in
regulations … that Form 8939 is due on or before November 15, 2011.”
v. Perhaps even more curiously, proposed regulations released on May 8,
2015 (REG-107595-11), will make conforming references to section
1022 in many places throughout the income tax regulations, but say
nothing about the due date of Form 8939.
vi. The statute (section 301(c) of the 2010 Tax Act), however, does not
prescribe a due date for the Section 1022 Election and states only that the
election “shall be made at such time and in such manner as the Secretary
of the Treasury or the Secretary’s delegate shall provide.”
– 39 –
e. Ordinarily Form 8939 would have been filed by the executor appointed by
the appropriate probate court.
i. Sometimes, however, there is no such executor, such as when all of the
decedent’s property is held jointly or held in trust. In that case, a Form
8939, or multiple Forms 8939 as the case may be, would have been filed
by the trustees or others in possession of that property (often called
“statutory executors” after the definition in section 2203). Notice 2011-
66 stated that if those statutory executors did not agree regarding the
election, or attempted in the aggregate to allocate more basis increase
than the law allowed, the IRS would notify those statutory executors that
they have 90 days to resolve their differences. If the executors failed to
resolve their differences within 90 days, the IRS, after considering all
relevant facts and circumstances disclosed to it, would determine
whether the election has been made and how the allocations should be
made. As with most “facts and circumstances” judgments, it was
impossible to know how the IRS might make those decisions.
ii. In support of that regime, the 2010 estate tax return (Form 706) posted
on the IRS website on September 3, 2011 (the Saturday before Labor
Day), and the Form 8939 posted on October 6, 2011, both included the
following sentence in the declaration above the signature line: “I
(executor) understand that if any other person files a Form 8939 or Form
706 (or Form 706-NA) with respect to this decedent or estate, that [sic]
my name and address will be shared with such person, and I (executor)
also hereby request [that] the IRS share with me the name and address of
any other person who files a Form 8939 or Form 706 (or Form 706-NA)
with respect to this decedent or estate.”
f. The IRS indicated that in general it would not grant extensions of time to file
Form 8939 and would not accept a Form 8939 filed late, and that, once made,
the Section 1022 Election and basis increase allocations would be
irrevocable. There were four explicit exceptions, which Notice 2011-66
called “relief provisions”:
i. The executor could file supplemental Forms 8939 to make additional
allocations of Spousal Property Basis Increase as additional property is
distributed to the surviving spouse. Each such supplemental Form 8939
must have been filed no later than 90 days after such distribution.
ii. The executor could make other changes to a timely filed Form 8939,
except making or revoking a Section 1022 Election, on or before July 17,
2012 (six months after January 17). The reasons for such an amendment
could have included the following:
(A) Property subject to carryover basis or eligible for basis
increases had been more accurately identified. For example,
property acquired by a decedent within three years before death by
gift from anyone other than the decedent’s spouse did not qualify
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for the basis increases. Likewise, property subject to a general
power of appointment was subject to carryover basis but not
eligible for basis increases. Property in a QTIP trust for the benefit
of a 2010 decedent was not subject to carryover basis at all. These
results departed significantly from the estate tax rules with which
return preparers had been familiar.
(B) Historical bases and date-of-death values had been more
accurately determined. As expected, many executors had
difficulty reconstructing the decedent’s bases in assets. Even the
familiar estate tax concept of date-of-death fair market value may
have been a challenge in the 2010 economy. Many executors and
their advisors got a late start in a climate of rumors that Congress
might change the rules.
(C) The decedent’s tax profile had been more thoroughly studied.
For example, before 2010 many taxpayers may have had little
reason to distinguish between capital assets and other assets,
especially when those assets, if sold, would have produced a loss
and not a gain. Even some taxpayers with loss carryovers may
have had little reason to keep strict track of them. Death in 2010
may have made such tax accounting notions relevant for the first
(D) Equitable treatment of respective beneficiaries had been more
appropriately determined. Because the burdens of the estate tax
and the income tax might not affect all beneficiaries the same way,
some executors may have found it difficult both to allocate assets
among beneficiaries and to allocate basis increases among assets.
After January 17, more equitable approaches may have been
crafted, disagreements among beneficiaries may have been
addressed, or necessary court approvals may have been obtained.
iii. The IRS may grant “9100 relief” allowing an executor to amend or
supplement a Form 8939 “to allocate any Basis Increase that has not
previously been validly allocated,” if additional assets are discovered or
if assets are revalued in what Notice 2011-66 refers to as “an IRS
examination or inquiry” after Form 8939 was filed. Such an audit could
occur when an asset is sold many years or even decades after the Form
8939 was filed, which means that most “formula” allocations would have
been ill-advised (and in any event there could have been no “protective”
iv. The IRS also retained the discretion, under “9100 relief” procedures, to
allow an executor to amend or supplement a Form 8939 or even to file a
Form 8939 (and thus make the Section 1022 Election) late.
(A) The IRS indicated in Notice 2011-66 that its standards for this
relief are likely to be strict, especially when a long time has passed
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since January 17, 2012.
(B) But this anticipated strictness may need to be balanced against one
of the apparent purposes of the Section 1022 Election, which was
to relieve concern for a constitutional challenge to what would
otherwise have been a retroactive reinstatement of the estate tax.
(C) The first such ruling to be published, Letter Ruling 201231003
(April 16, 2012), cited no facts other than “Decedent died in 2010.
The executrix for Decedent’s estate retained a qualified tax
professional to prepare the Form 8939.” The ruling request was
filed January 27, 2012 (only 10 days after the missed due date),
and the ruling was issued 80 days later.
(D) Subsequent rulings have been similar.
g. The executor must furnish the required information to each recipient, using a
Schedule A to Form 8939, no more than 30 days after the original Form 8939
or any amended or supplemental Form 8939 is filed (basically, by February
16, 2012). Assets not distributed are treated as received by the executor, and
the executor must furnish the required information to each recipient as
distributions in kind are made.
h. Notice 2011-76 confirmed other helpful relief:
i. An automatic six-month extension of time to file an estate tax return for
a 2010 decedent could have been obtained by timely filing a Form 4768,
Application for Extension of Time to File a Return and/or Pay U.S.
Estate (and Generation-Skipping Transfer) Taxes. This was true whether
the decedent died before December 17, 2010 (the date of enactment of
the 2010 Tax Act), or on or after that date.
ii. In a break from normal procedure, a six-month extension of time to pay
the estate tax was also automatic; Notice 2011-76 stated that the executor
“is not required to substantiate … the reason.” It is not clear why the
Notice used the word “substantiate” and did not just say it is not
necessary even to state a reason.
iii. But the Notice went on to state:
The IRS will not impose late filing and late payment penalties
under section 6651(a)(1) or (2) on estates of decedents who died after
December 31, 2009, and before December 17, 2010, if the estate timely
files Form 4768 and then files Form 706 or Form 706-NA and pays the
estate tax by March 19, 2012. The IRS also will not impose late filing
or late payment penalties under section 6651(a)(1) or (2) on estates of
decedents who died after December 16, 2010, and before January 1,
2011, if the estate timely files Form 4768 and then files Form 706 or
Form 706-NA and pays the estate tax within 15 months after the
decedent’s date of death.
Section 6651(a)(1) relates to the failure to file, and section 6651(a)(2)
relates to the failure to pay. So not only did this statement make it clear
– 42 –
that estates of decedents who died before December 17 and on or after
that date would be treated the same, but it also addressed filing and
paying with the same language. This confirms that the standard for
“substantiating,” or even stating, a reason for an extension of time to pay
the tax was a very low standard indeed. But a timely Form 4768 had to
iv. Notice 2011-76 confirmed that tax that is paid late under such an
automatic six-month extension would still, of course, bear interest.
v. Finally, Notice 2011-76 provided that if the Section 1022 Election was
made and the income tax liability of someone who sold property in 2010
that had been received from the decedent was thereby increased,
“reasonable cause and good faith will be presumed” and no penalty
under section 6651(a)(2) or 6662(a) will be imposed. Such a taxpayer
was advised to write “IR Notice 2011-76” across the top of the amended
return that was required to report consistently with the Section 1022
Election. The Notice refers only to property “disposed of” and does not
apply by its terms to adjustments to depreciation (although an argument
for relief based on Notice 2011-76 would appear to be compelling).
i. Rev. Proc. 2011-41, 2011-35 I.R.B. 188, also released on August 5, 2011,
elaborated the rules governing the allocation of the basis increases discussed
below and provided a number of other clarifications, including the following:
i. Section 4.06(1) of Rev. Proc. 2011-41 provided that the heir’s holding
period of property subject to the carryover basis rules includes the
decedent’s holding period (whether or not the executor allocates any
basis increase to the property).
ii. Section 4.06(2) provided that such property generally retained the
character it had in the hands of the decedent.
iii. Section 4.06(3) provided that the depreciation of property in the hands of
the recipient is determined in the same way it was in the hands of the
decedent, using the same depreciation method, recovery period, and
convention. For example, if the decedent had been depreciating an asset
over a 20-year period and died after eight years, the executor or other
recipient will continue to depreciate that asset on the same schedule over
the next 12 years.
iv. Section 4.06(4) clarified that a suspended loss under the passive activity
loss rules was added to basis (as in a gift, not deductible as at death)
immediately before death. The explanation seems to assume that a
deduction and an addition to basis are more or less equivalent, but by
denying a deduction that could have been taken against ordinary income,
this rule could, in effect, convert capital gain to ordinary income.
v. Section 4.06(5) clarified that if appreciated property were distributed to
satisfy a pecuniary bequest, the gain recognized would be limited by
section 1040 to post-death appreciation (just as in other years), even if
– 43 –
basis was less than the date-of-death value (unlike other years).
vi. Section 4.06(6) provided that if section 684 applies, so as to impose sale
or exchange treatment on a transfers to a nonresident alien, the allocation
of basis increases under section 1022 were deemed to occur before the
application of section 684.
vii. Section 4.07 clarified that a testamentary trust that otherwise qualified as
a charitable remainder trust under section 664 would still qualify if the
executor made a Section 1022 Election, even though the election out of
the estate tax would mean that no estate tax deduction under section
2055 was allowable, which would appear to have disqualified the trust
under Reg. §1.664-1(a)(1)(iii)(a).
j. Curiously, Rev. Proc. 2011-41 began by stating that “[t]his revenue
procedure provides optional safe harbor guidance under section 1022…,” but
many observers commented that it did not provide what are typically viewed
as safe harbors. The instructions to Form 8939 included the following:
If the executor makes the Section 1022 Election and follows the provisions
of section 4 of Revenue Procedure 2011-41, and takes no return position
contrary to any provisions of section 4, the IRS will not challenge the
taxpayer’s ability to rely on the provisions of section 4 on either Form
8939 or any other return of tax.
k. Section 7 of Rev. Proc. 2011-41 stated that the IRS expected 7,000 executors
to file Form 8939.
l. Publication 4895 generally addressed the same topics as Notices 2011-66 and
2011-76 and Rev. Proc. 2011-41, without adding much that was new.
3. Two Statutory Basis Increases
a. Two modifications in section 1022 lessened the harshness of the 2010
carryover basis regime.
b. The first modification, provided by section 1022(b), was called simply a
“basis increase” in the statute, but was called the “General Basis Increase” in
Rev. Proc. 2011-41.
c. The second modification, provided by section 1022(c), was an additional $3
million increase in basis for property passing to the surviving spouse, called
the “Spousal Property Basis Increase.”
4. The General Basis Increase
a. The General Basis Increase was the sum of the “Aggregate Basis Increase,”
which was $1.3 million, and the “Carryovers/Unrealized Losses Increase.”
The Carryovers/Unrealized Losses Increase in turn had two components:
i. the amount of a decedent’s unused capital loss carryovers and net
operating loss carryovers and
ii. “the sum of the amount of any losses that would have been allowable
– 44 –
under section 165 if the property acquired from the decedent had been
sold at fair market value immediately before the decedent’s death”
(section 1022(b)(2)(C)(ii)). Section 4.02(2)(b) and Example 3 of Rev.
Proc. 2011-41 made it clear that this second component of the
Carryovers/Unrealized Losses Increase included all unrealized losses in
capital assets at the moment of the decedent’s death, without regard to
the limitations on immediate deductibility that would apply for income
tax purposes in the event of an actual sale. Thus, the amount of those
unrealized losses, in effect, was available to increase the basis of
appreciated assets (up to their fair market value at death).
b. The basis increases could not increase the basis of any asset in excess of the
fair market value of that asset as of the date of the decedent’s death.
c. Section 4.04(2) of Rev. Proc. 2011-41 provided that the fair market value of
an undivided portion of property for this purpose was a proportionate share of
the fair market value of the decedent’s entire interest in that property at death.
This provision applied to determine both the fair market value cap on the
allocation of basis increase and, in the case of temporal or successive
interests, the allocation of the basis increase itself.
i. For example, if real estate with a value of $600,000 and a basis of
$300,000 was devised to three recipients in undivided one-third shares,
each share was allocated $100,000 of the decedent’s basis, and the
executor could allocate up to $100,000 of basis increase to each one-
third share – or to just one or two of those shares. This was true even
though the resulting basis of $200,000 for an undivided one-third interest
could have exceeded its fair market value as an undivided interest.
ii. But if the real estate had been devised to one person for life and then to a
second person, this provision would require, in effect, an allocation of up
to $300,000 of basis increase to the real estate itself, not separately to the
life estate or the remainder, and the respective bases of the temporal
interests would be determined under the uniform basis principles set out
in Reg. §§1.1014-4 & -5. (This focus of the allocation rule on temporal
interests was confirmed by the focus on temporal interests on page 8 of
the instructions to Form 8939, which were posted on the IRS website on
October 7, 2011.)
d. Section 1022(d)(1)(B)(ii) provided that some property interests that were not
held through simple outright ownership qualified for the General Basis
Increase, including a portion of joint tenancy property, the decedent’s half of
community property, the surviving spouse’s half of community property if
the deceased spouse owned at least half of the whole community property
interest, and property held in trusts that were revocable by the grantor.
e. The General Basis Increase could not be applied to some property the value
of which would have been included in the decedent’s gross estate if the
election out of estate tax had not been made. As noted above (Part VIII.C.2.b
– 45 –
on page 37), carryover basis did not apply to a QTIP trust of which the
decedent was the beneficiary and may or may not have applied to a GRAT or
a QPRT of which the decedent was the grantor. If carryover basis applied,
then the General Basis Increase might apply. For example, carryover basis
would apply to a QPRT in which the grantor had a reversion in the event of
death during the QPRT term, and Example 2 of Rev. Proc. 2011-41
confirmed that the General Basis Increase would also apply. In the case of
property subject to the decedent’s general power of appointment, section
4.01(3)(i) of Rev. Proc. 2011-41 clarified that carryover basis applied, but
Code section 1022(d)(1)(B)(iii) provided that the General Basis Increase may
not be allocated to that property.
f. Property acquired by a decedent by gift within three years of the decedent’s
date of death from anyone other than the decedent’s spouse also did not
qualify for the General Basis Increase, under section 1022(d)(1)(C).
g. A frequent question since carryover basis was enacted in 2001, and especially
after it became effective at the beginning of 2010, was whether an executor
may allocate basis increases to property that has already been distributed or
sold. Section 4.03 of Rev. Proc. 2011-41 said yes. Example 4 of Rev. Proc.
2011-41 even acknowledged that the basis of property that had declined in
value after the decedent’s death and was then sold may be increased by
allocation of basis increases up to date-of-death value, thus generating a loss
on the sale.
5. The Spousal Property Basis Increase
a. The basis of property eligible for the General Basis Increase could have been
increased by an additional $3 million Spousal Property Basis Increase, but
not in excess of the fair market value of the property as of the date of the
decedent’s death, if and only if such property was transferred to the surviving
spouse, outright or as “qualified terminable interest property” for the
exclusive benefit of the surviving spouse.
b. Section 1022 provided its own definition of “qualified terminable interest
property” and did not simply refer to the definition of “qualified terminable
interest property” contained in the estate tax marital deduction provision of
section 2056. Because the QTIP election in section 2056(b)(7)(B)(i)(III) was
omitted from section 1022(c)(5)(A), a so-called Clayton QTIP trust (Estate of
Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992); see Reg.
§20.2056(b)-7(d)(3)(i) as amended in 1998), in which the spouse’s
mandatory income interest is conditioned on the executor’s QTIP election,
was not eligible for the Spousal Property Basis Increase. A general power of
appointment marital trust that would qualify for the marital deduction for
estate tax purposes would have satisfied the requirements for the Spousal
Property Basis Increase, because, as under the estate tax rules, it would not
have been a “terminable” interest at all.
c. As noted above, the three-year rule did not apply to property acquired by the
– 46 –
decedent from the decedent’s spouse unless, during the three-year period, the
transferor spouse acquired the property by gift or inter vivos transfer. The
law when the estate tax applies (section 1014(e)) limits death-bed transfers to
a spouse in order to obtain a step-up in basis when the transferred property
was given back to the surviving spouse. The limitations in the carryover
basis rules excluded spouses. Property transferred from a healthy spouse to a
terminally ill spouse that passed back to the healthy spouse in 2010 was
eligible for both the $1.3 million General Basis Increase and the $3 million
Spousal Property Basis Increase.
d. Also as noted above (part VIII.C.4.g on page 45), section 4.03 of Rev. Proc.
2011-41 confirmed that an executor could allocate the basis increases to
property that had already been distributed or sold. With regard to the Spousal
Property Basis Increase, section 4.02(3) of Rev. Proc. 2011-41 actually
contemplated allocations to property already distributed to the surviving
spouse as those distributions are made. (Notice 2011-66 allowed the filing of
additional Forms 8939 for that purpose.) Section 4.02(3) of Rev. Proc. 2011-
41 also allowed allocation of the Spousal Property Basis Increase to property
that the executor had sold, but only to the extent that the applicable Form
8939 included documentation that the sale proceeds were appropriately
earmarked for the surviving spouse.
6. The Election for 2010 Estates
a. As many expected, the 2010 Tax Act dealt with the “retroactivity” of the
2010 estate tax provisions by permitting an executor to elect out of the estate
tax back into the carryover basis regime enacted for 2010 in the 2001 Tax
Act. Section 301(c) of the 2010 Tax Act provided that “[s]uch election shall
be made at such time and in such manner as the Secretary of the Treasury or
the Secretary’s delegate shall provide. Such an election once made shall be
revocable only with the consent of the Secretary of the Treasury or the
Secretary’s delegate.” It had been hoped that Form 8939 would include an
opportunity to make that election or, better, that the filing of Form 8939 itself
would be treated as the election. Notice 2011-66 confirmed that.
b. The vast majority of executors did not need or want such an election, because
they were perfectly satisfied with the reinstated estate tax and a stepped-up
basis for appreciated assets.
i. That included executors of most estates that would not pay estate tax
anyway, such as estates under $5 million (at least in states without a state
estate tax), estates that passed largely to charity, and some estates that
passed largely to a surviving spouse.
ii. But if the “estate” consisted, for example, of a QTIP trust of which the
decedent was the beneficiary as surviving spouse and in which the assets
had declined in value, plus cash and modest other assets (less than $1.3
million), then the election might have been considered in order to
preserve the higher basis of the assets in the QTIP trust (because that
– 47 –
basis would be “stepped-down” under section 1014 if the estate tax
applied). In any event, in the case of any election where the decedent
was the beneficiary of a QTIP trust, the executor was well-advised not to
overlook the need to allocate the decedent’s GST exemption to the QTIP
trust on Schedule R of Form 8939, if appropriate.
iii. Executors facing only a modest estate tax might also have forgone the
election, to get the benefit of the stepped-up basis.
iv. Even executors for whom the estate tax burden would have been
substantial may still have considered the estate tax superior to carryover
basis if basis presented unusual challenges, such as in the estate of a real
v. Still other executors may have elected out of the estate tax to avoid estate
tax controversy or uncertainty – for example, to avoid the revaluation of
assets, or an assertion that the value of assets transferred during life
would be taxed under section 2036, or an assertion that a limited power
of appointment held by the decedent was a general power.
c. In most estates significantly larger than $5 million, the election out of the
estate tax and into carryover basis was a clear choice, because it avoided an
estate tax paid sooner and at a presumably higher rate than the additional
income tax that was thereby incurred on the sale of appreciated assets. This
was a small percentage of 2010 estates, and therefore it was appropriate that
the default outcome in the absence of an election was that the reinstated
estate tax applied. As noted above, section 7 of Rev. Proc. 2011-41 stated
that the IRS expected 7,000 executors to file Form 8939.
7. Factors Influencing the Election
In any event, the following factors were among those that should have been
considered in making the election between the estate tax and the carryover basis
a. Calculation and apportionment of estate tax burden.
b. Impact of state death taxes, particularly in states with an exemption below $5
c. Likelihood that the asset will be sold before the recipient’s death.
d. Anticipated date of sale of each asset.
e. Decedent’s basis in each asset.
f. Ability to allocate basis increases.
g. Date of death value of each asset.
h. Projected future value of each asset.
i. Projected earnings from each asset.
j. Tax character of any future gains or earnings on assets.
– 48 –
k. Identity of the beneficiaries.
l. Revenue needs of the beneficiaries.
m. Future tax rates.
n. Domicile of beneficiaries and personal income tax profiles.
o. Availability of asset-specific deductions and credits, including depreciation.
p. Impact of election on formula clauses.
q. Potential for disagreement among beneficiaries concerning the allocation of
r. Conflicts of interest in making the election and allocating basis.
s. Aggressiveness of positions that would have been taken if an estate tax return
had been filed.
t. Aggressiveness of positions taken and valuation discounts claimed on the
decedent’s previously filed gift tax returns and those gift tax returns of the
decedent that would have been filed contemporaneously with the estate tax
u. Whether “adequate disclosures” were made on the decedent’s previously
filed gift tax returns.
v. Comparison of the expense and aggravation associated with filing the estate
tax return and filing the Form 8939.
w. The availability of binding consents or court approval.
x. Whether a compensating equitable adjustment was appropriate, and whether
it should be approved by a court.
D. Indexing for Inflation
1. The indexing of the applicable exclusion amount in 2012 will follow the normal
indexing rules that have been applicable to income tax brackets since 1993 and in
various transfer tax contexts – such as the $10,000 gift tax annual exclusion, the
maximum decrease in value attributable to special-use valuation under section
2032A, the amount of value on which estate tax deferred under section 6166 is
payable at a special interest rate, and the former $1 million GST exemption –
2. The inflation adjustment is computed by comparing the average consumer price
index (CPI) for the 12-month period ending on August 31 of the preceding year
with the corresponding CPI for 2010. Thus, the inflation adjustment to the
applicable exclusion amount in 2012 will be computed by dividing the CPI for the
12 months ending August 31, 2011, by the CPI for the 12 months ending August
3. Indexing will occur in $10,000 increments, so the amount applicable in any year
will be a relatively round number.
– 49 –
a. But, unlike the typical inflation adjustments on which the indexing is
patterned, the result of the calculation will not be rounded down to the next
lowest multiple of $10,000. It will be rounded to the nearest multiple of
$10,000 and thus possibly rounded up. If enacted, this will not make a huge
difference in practice – obviously not more than $10,000 in any year.
b. It will also need to be remembered that the calculation will be repeated every
year with reference to the CPI for the 12 months ending August 31, 2010.
Because of the rounding rule, it will be a mistake to assume that the
applicable exclusion amount for any particular year will simply be inflation-
adjusted for the following year. All annual calculations will be redone with
reference to the 2010 baseline and then rounded to the nearest multiple of
4. The indexed applicable exclusion amount was $5,120,000 in 2012. Rev. Proc.
2011-52, §3.29, 2011-45 I.R.B. 701.
E. The GST Tax
1. The GST tax exemption and rate remain tied to the estate tax applicable exclusion
amount and top rate, just as they have been since 2004. As a result, beginning in
2011 the estate tax applicable exclusion amount, gift tax applicable exclusion
amount, and GST exemption have been the same for the first time ever.
2. The reinstatement of the estate tax for 2010 meant that once again there was an
applicable exclusion amount and therefore a GST exemption for inter vivos
transfers in 2010. In fact, it was $5 million.
3. For any taxable distribution or taxable termination with respect to a trust or a
“direct skip” gift in 2010, section 302(c) of the 2010 Tax Act set the 2010 GST
tax rate at zero, regardless of inclusion ratios or any other calculations.
a. This was hugely significant, addressing a number of questions that the 2001
Tax Act created for 2010 and 2011 by providing in section 2664 of the Code
that the GST tax chapter “shall not apply to generation-skipping transfers
after December 31, 2009” and providing in section 901(b) of the 2001 Tax
Act, in relevant part, that “[t]he Internal Revenue Code of 1986 … shall be
applied and administered to … [generation-skipping transfers after December
31, 2010] as if [Code section 2664] had never been enacted.” For example –
i. Would it have been possible to allocate GST exemption to 2010
ii. Would the “move down” rule of section 2653 have applied to “direct
skip” transfers in trust in 2010?
iii. Could a “reverse QTIP” election under section 2652(a)(3) have been
made for a transfer in 2010?
iv. Would GST exemption allocated to transfers before 2010 still have
affected the inclusion ratio even to the extent that that GST exemption
exceeded the indexed GST exemption that would have been available if
– 50 –
the 2001 Tax Act “had never been enacted”?
v. Would deemed allocations of GST exemption provided for by section
2632(c), which was added by the 2001 Tax Act, still have been effective
vi. Would elections in and out of automatic allocations, provided for by
section 2632(c)(5), which was added by the 2001 Tax Act, still have
been effective after 2010?
vii. Would retroactive allocations of GST exemption in the case of the death
of a non-skip person, provided for by section 2632(d), which was added
by the 2001 Tax Act, still have been effective after 2010?
viii. Would late allocations of GST exemption pursuant to “9100 relief”
allowed by section 2642(g), which was added by the 2001 Tax Act, still
have been valid after 2010?
ix. Would qualified severances under section 2642(a)(3), which was added
by the 2001 Tax Act, have been respected after 2010?
b. The technical key for answering all these questions was to allow the GST tax
chapter to “apply” without actually resulting in a GST tax. Setting the GST
tax rate at zero was the elegantly simple way to accomplish that.
c. Because inter vivos transfers in 2010 to trusts that were “direct skips” – for
example, where only grandchildren and not children of the donor are
beneficiaries – qualified for the “move down” rule of section 2653, so that
future distributions to grandchildren when the GST tax rate is not zero will
not be taxed, it may be important to have affirmatively elected on the 2010
gift tax return not to permit a deemed allocation of GST exemption under
section 2632(b) or (c). This was not always be desirable, however, because
the “move down” permits the tax-free skip of only a generation or two, while
the allocation of GST exemption would cause a long-term trust to be exempt
as long as it lasts.
d. But if the 2010 direct skip gift was made outright to a skip person, there were
no future GST tax characteristics to protect and no conceivable reason to
want GST exemption to be allocated. The IRS acknowledged this in section
II.B of Notice 2011-66, which stated:
[Reg. §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.” Because it is
clear that a 2010 transfer not in trust to a skip person is a direct skip to
which the donor would never want to allocate GST exemption, the IRS will
interpret the reporting of an inter vivos direct skip not in trust occurring in
2010 on a timely filed Form 709 as constituting the payment of tax (at the
rate of zero percent) and therefore as an election out of the automatic
allocation of GST exemption to that direct skip. This interpretation also
applies to a direct skip not in trust occurring at the close of an estate tax
– 51 –
inclusion period (ETIP) in 2010 other than by reason of the donor’s death.
The “payment of tax (at the rate of zero percent)” is certainly an odd notion,
but again, like the zero rate itself, it produced the right result.
e. The 2010 gift tax return (Form 709) that the IRS posted on its website on
March 18, 2011, was consistent with this approach. In Part 3 of Schedule C,
the “applicable rate” in column G was filled in as “0,” and column H, which
instructed “multiply col. B by col. G,” was also filled in with “0.” Similarly,
in the 2010 estate tax return (Form 706) posted on the IRS website on
September 3, 2011, line 8 of Part 2 of Schedule R, line 8 of Part 3 of
Schedule R, and line 6 of Schedule R-1 all provided for the calculation of
“GST tax due” by multiplying the previous line by zero. Meanwhile, the
second page of Schedule R-1 (page 26 of the entire return) included the usual
comprehensive instructions for trustees about the payment of the (zero) tax.
f. Although the huge uncertainties about 2010 were eliminated, it is still a good
idea to review all past transfers with generation-skipping potential and use
the next gift tax return as an opportunity to affirm, clarify, modify, or make
any allocations or elections with respect to the GST exemption.
4. It was once thought that a testamentary generation-skipping trust created by
reason of a decedent’s death in 2010 might escape GST tax forever, because the
property in the trust would not have been subject to estate tax, and therefore there
would be no “transferor” under section 2652(a)(1)(A) and no “skip person” under
section 2613(a)(1). That result was reversed by the 2010 Tax Act.
a. In the majority of estates for which no election back into carryover basis was
made, the GST tax worked fine. The tax rate on direct skips was zero and the
GST exemption allocable to trusts created at death was $5 million. If the
estate was smaller than $5 million and no estate tax return was filed, the
deemed allocation under section 2632(e) ordinarily worked just fine. Only
when there were two or more potentially generation-skipping trusts and the
total value of all such trusts was greater than the available GST exemption
and it was undesirable to permit section 2632(e) to allocate that GST
exemption pro rate among those trusts would an affirmative allocation have
b. If the executor elected out of the estate tax into carryover basis, which
probably occurred in the largest estates that are likely to include generation-
skipping trusts, the result is the same, but the analysis is more complicated.
A sentence added to the end of section 301(c) of the Reid-McConnell
Amendment, which became the 2010 Tax Act, that had not appeared in the
Baucus Bill makes it clear that such an election does not affect the treatment
of property placed in a generation-skipping trust as “subject to the tax
imposed by chapter 11” for purposes of section 2652(a)(1)(A). Therefore,
the decedent is still the “transferor,” “skip persons” are still defined with
reference to that transferor under section 2613, and that will govern the
taxation of the trust in the future.
– 52 –
c. There is no specific reference to the other important way that the GST tax
rules are linked to the estate tax rules, which is the definition of the GST
exemption in section 2631(c) by reference to the estate tax applicable
exclusion amount in section 2010(c). But in section 302(c) the Section 1022
Election is explicitly stated to apply “with respect to chapter 11 of such Code
and with respect to property acquired or passing from such decedent (within
the meaning of section 1014(b) of such Code)” – in other words, with respect
to the suspension of the estate tax and the imposition of carryover basis, not
with respect to chapter 13 – meaning that for purposes of section 2631(c)
(part of chapter 13) the $5 million applicable exclusion amount in section
2010(c) remained available.
i. This analysis was confirmed by the Joint Committee staff’s explanation
of the Reid-McConnell Amendment, which stated that “[t]he $5 million
generation skipping transfer tax exemption is available in 2010
regardless of whether the executor of an estate of a decedent who dies in
2010 makes the election … to apply the 2010 Tax Act estate tax rules
and section 1022 basis rules.” STAFF OF THE JOINT COMMITTEE ON
TAXATION, TECHNICAL EXPLANATION OF THE REVENUE PROVISIONS
CONTAINED IN THE “TAX RELIEF, UNEMPLOYMENT INSURANCE
REAUTHORIZATION, AND JOB CREATION ACT OF 2010” SCHEDULED FOR
CONSIDERATION BY THE UNITED STATES SENATE (JCX-55-10) at 50 n.53
(Dec. 10, 2010).
ii. This result was again confirmed in section II.D of Notice 2011-66, which
stated that “references to chapter 11 in [chapter 13] will be construed as
if the decedent was subject to chapter 11 even if the decedent’s executor
made the Section 1022 Election.”
iii. Notice 2011-66, as amplified by Notice 2011-76, also confirmed that
GST exemption in the case of an election out of the estate tax would be
allocated on Schedule R or R-1 of Form 8939, Allocation of Increase in
Basis for Property Acquired From a Decedent. The automatic allocation
rules applied if the executor did not make, or timely revoked, a Section
1022 Election, or filed a Form 8939 without attaching a Schedule R or
R-1. (Not surprisingly, these Schedules R and R-1 are very similar to the
Schedules R and R-1 that accompany Form 706.)
5. Because the GST exemption is tied to the estate tax, it also will be indexed for
inflation, beginning in 2012. For 2012 it is $5,120,000. Rev. Proc. 2011-52,
§3.29, 2011-45 I.R.B. 701.
F. Extension of Time for Performing Certain Acts
Section 301(d) of the 2010 Tax Act provided that the due date for certain acts was no
earlier than nine months after the date of enactment, which was September 17, 2011.
Because that was a Saturday, those acts were due no earlier than Monday, September
19, 2011 (although care in this regard is always warranted, especially in the case of
disclaimers, which are not returns required to be filed with the IRS and therefore are
– 53 –
not clearly covered by sections 7502 and 7503, but are addressed only to the extent
Reg. §25.2518-2(c)(2) applies). The acts that were extended are
1. filing an estate tax return with respect to the estate of a decedent who died after
December 31, 2009, and before December 17, 2010,
2. making any election on the estate tax return of a decedent who died after
December 31, 2009, and before December 17, 2010,
3. paying any estate tax with respect to the estate of a decedent who died after
December 31, 2009, and before December 17, 2010,
4. making any disclaimer of an interest in property passing by reason of the death of
a decedent who died after December 31, 2009, and before December 17, 2010
(but care will still be required to ensure that the disclaimer is permitted under state
law, or, if not, that section 2518(c)(3) can provide a workaround),
5. filing a return reporting any generation-skipping transfer after December 31,
2009, and before December 17, 2010, and
6. making any election required to be made on a return reporting any generation-
skipping transfer after December 31, 2009, and before December 17, 2010.
G. The Gift Tax (and “Clawback”)
1. The gift tax was not changed for 2010. The exemption remained $1 million, and
the rate remained 35 percent.
2. Beginning January 1, 2011, the gift tax chapter no longer has its own unified
credit (“determined as if the applicable exclusion amount were $1,000,000,” as
section 2505(a)(1) provided for gifts from 2002 through 2009) or its own rate
schedule. It is once again the same as the estate tax unified credit and rates.
a. This is introduced in section 302(b)(1) of the 2010 Tax Act under the heading
“Restoration of unified credit against gift tax.” It is awkward to refer to a
“unified” credit since 2004, when the estate tax exemption increased to $1.5
million but the gift tax exemption remained at $1 million, although the credits
were still “unified” in the sense that the credit used affected the credit
available both for future gifts and for estate tax purposes.
b. Under the 2010 Tax Act, the estate and gift tax calculations will again be
identical and, in that sense, once again “unified.”
c. Beginning in 2012, the gift tax exemption is therefore indexed for inflation,
because it will be identical to the indexed estate tax exemption.
3. There was a surge in gift-giving in 2011 and 2012.
a. For many donors, a $5.12 million lifetime exemption in 2012, $10.24 million
for a married couple, was enough to accomplish estate planning objectives
with simple gifts, outright or, more likely for larger gifts, in trust. Because
the GST exemption was also $5.12 million, those trusts could be generation-
skipping or even perpetual, without any gift or GST tax paid.
b. In other cases, more creative use of the gift tax exemption was desirable. Just
– 54 –
as the former $1 million dollar exemption could be leveraged, so can the $5
million indexed exemption, except there is five times as much of it. The
basic techniques for leveraging the gift tax exemption have not changed and
include life insurance, installment sales, AFR loans (including forgiveness),
GRATs, QPRTs, and the use of entity-based valuation discounts as in closely
held businesses and family limited partnerships.
c. In all of these cases, growth in the value of asset following the gift would
escape estate tax. And any gift tax paid escapes estate tax if the donor
survives for three years after the gift, which reduced the 35 percent gift tax
rate to an estate-tax-equivalent rate (or “net gift” or “tax-exclusive” rate) of
about 26 percent (0.35 ÷ 1.35). (The tax-exclusive rate corresponding to a 40
percent rate is 28.57 percent (0.4 ÷ 1.4).
d. The interest in making gifts in 2012, of course, was fueled by the concern
that the large gift tax exemption might not survive into future years, either
because Congress would not act and it fell to a $1 million level on January 1,
2012, or because Congress might choose to “deunify” the estate and gift tax
exemption again. Married donors could resolve the tension between the
desire to use the gift tax exemption while it is available and the desire to save
it for future use by forgoing gift-splitting, using the high 2012 exemption of
the donor spouse and saving even $1 million of the exemption for future use
by the non-donor spouse.
4. The possibility of a surge in gifts followed by a return to a $1 million applicable
exclusion amount in 2013 (e.g., if Congress had not acted) also created concerns
that some of the current gift tax saving would be “recaptured” or “clawed back”
by an increased estate tax at death. This concern about “clawback” arose from the
provision of former section 2001(b)(2) (which was scheduled to be revived in
2013) that after calculating a tentative tax on the sum of the taxable estate and
adjusted taxable gifts there is subtracted “the aggregate amount of tax which
would have been payable under chapter 12 [i.e., gift tax] with respect to gifts
made by the decedent after December 31, 1976, if the provisions of subsection (c)
(as in effect at the decedent’s death) [which deals only with tax rates] had been
applicable at the time of such gifts.”
a. For a gift in 2011 and death in 2013, for example (if there had been no
change in law), this amount would have tended to be greater than the gift tax
actually paid, because it would have been calculated on the higher rates in
effect in 2013.
b. But this amount would have tended to be smaller than the amount of the
tentative tax attributable to the adjusted taxable gifts, because it appears that
it would have been calculated using the larger unified credit resulting from
using the 2011 applicable exclusion amount. Section 2001(b)(2) expressly
requires a substitution only of the current rates in section 2001(c) in
reconstructing the hypothetical gift tax payable, not a substitution of the
current applicable exclusion amount in section 2010(c).
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c. Because the adjustment under section 2001(b)(2) is a reduction of the estate
tax, a reduction of that reduction by using the 2011 applicable exclusion
amount will result in an increase in the resulting estate tax. The estate tax
(plus the gift tax paid, if any) would ordinarily not be as high as it would
have been if the gift had not been made, but it could result in an effective tax
on the taxable estate greater than 55 percent.
5. The clawback can be illustrated this way:
a. Assume an unmarried individual who has never before made a taxable gift
makes a $5,000,000 taxable gift in 2011. The “tentative tax” under sections
2502(a)(1) and 2001(c) would be $155,800 plus 35 percent of the excess of
the taxable gift over $500,000, or $1,730,800. The unified credit under
sections 2505(a) and 2010(c) would be the same ($1,730,800), and the tax
payable would be zero.
b. Assume that the applicable exclusion amount had returned to $1 million in
2013 and the individual dies in 2013 with a taxable estate of $5,000,000 and,
of course, “adjusted taxable gifts” (the 2011 taxable gift) of $5,000,000. The
“tentative [estate] tax” computed under section 2001(b)(1) on the sum of
those two amounts would be $1,290,800 plus 55 percent of the excess (of
$10,000,000) over $3,000,000, or $5,140,800.
c. The estate tax unified credit would return to its pre-2002 level of $345,800.
d. In calculating the hypothetical gift tax to subtract under section 2001(b)(2),
the “tentative [gift] tax” that would have been computed under sections
2502(a)(1) and 2001(c) in 2011 using 2013 rates would likewise be
$1,290,800 plus 55 percent of the excess (of $5,000,000 in this case) over
$3,000,000, or $2,390,800.
i. If the net estate tax were computed without regard to the unified credit in
either 2011 or 2013, it would be $5,140,800 (¶b) less $2,390,800 (¶d), or
$2,750,000. Because $2,750,000 is exactly 55 percent (the 2013
marginal rate) of $5,000,000 (the taxable estate), this is intuitively the
ii. But using the 2011 unified credit of $1,730,800, the section 2001(b)(2)
reduction would be $2,390,800-$1,730,800 or $660,000, and the estate
tax would be $5,140,800-$660,000-$345,800 (unified credit) or
iii. If the 2011 unified credit were recalculated using 2013 rates (but the
2011 applicable exclusion amount), it would also be $1,290,800 plus 55
percent of the excess (of $5,000,000) over $3,000,000, or $2,390,800.
The section 2001(b)(2) reduction would be zero, and the estate tax would
be $5,140,800-$345,800 (unified credit) or $4,795,000. (Thus, the cost
of clawback would be $4,795,000-$2,750,000, or $2,045,000.)
iv. If the 2011 unified credit were recalculated using both 2013 rates and the
2013 applicable exclusion amount of $1,000,000, it would be $345,800.
– 56 –
In that case, the section 2001(b)(2) reduction would be $2,390,800-
$345,800 or $2,045,000, and the estate tax would be $5,140,800-
$2,045,000-$345,800 (unified credit) or $2,750,000.
e. If the gift had not been made, and the estate tax were computed only on a
taxable estate of $10,000,000, it would be $5,140,800-$345,800 (unified
credit) or $4,795,000 (the same as in clause iii above). On the other hand, if
the 2011 taxable gift of $5,000,000 had been made under 2013 (or 2001) law,
a gift tax of $2,045,000 would actually have been paid, and, together with the
estate tax (computed under clause iv above) of $2,750,000, the total taxes
would also be $4,795,000, confirming that in a static tax structure the
computation works right (although if the donor survived for three years the
total tax would be reduced by excluding the gift tax paid from the taxable
f. But if the estate tax were simply 55 percent of the taxable estate of
$5,000,000, which is intuitively what it ought to be to preserve the benefit of
the lower tax at the time of the gift, the estate tax would be $2,750,000.
Indeed, if the donor died in 2012 instead of 2013, the “tentative [estate] tax”
computed on $10,000,000 would be $155,800 plus 35 percent of the excess
of $10,000,000 over $500,000, or $3,480,800; there would be no reduction
for gift tax paid, and after the unified credit of $1,730,800 the estate tax
would be $1,750,000, which is simply 35 percent of $5,000,000.
g. This intuitively correct estate tax of $2,750,000 is less than the amount
computed in clause iii above (which is the clawback), but identical to the
amount computed in clause iv, suggesting that the solution to the clawback
problem might be to simply take the approach illustrated in clause iv.
h. This intuitive view of the estate tax (and thus the approach illustrated in
clause iv) are supported by legislative history. The wording of section
2001(b)(2) was intended “to prevent the change in rates from having a
retroactive effect to gifts made prior to” the phase-in of the lower rates
enacted by the Economic Recovery Tax Act of 1981. H.R. REP. NO. 97-201,
97TH CONG., 1ST SESS. 156 (1981). This wording was occasioned by the
phased lowering of rates in 1981; it was not needed for the phased increase in
the unified credit in 1976, because the increased unified credit is applied after
the section 2001(b) calculation, and therefore such increases would take care
of themselves. The objective of the calculation was to tax the taxable estate
consistently in the proper rate bracket – in other words, to ensure that, as in
the gift tax calculation, “previous taxable gifts only affect the starting point in
determining the applicable rate.” H.R. REP. NO. 94-1380, 94TH CONG., 2D
SESS. 13 (1976). In 1976, the gift tax structure was specifically designed to
provide that “the reduction for taxes previously paid is to be based upon the
new unified rate schedule even though the gift tax imposed under present
[i.e., pre-1977] law may have been less than this amount.” Id. (emphasis
added). There is no reason to doubt that Congress would intend the same
policy judgment again if the gift tax “may have been less” than a future estate
– 57 –
tax and therefore no reason to suspect that Congress would have intended the
“clawback” that is now causing speculation and concern.
i. That policy judgment would have been a justification for Treasury and
the IRS (in forms and instructions under section 7805(c), for example) to
apply the same treatment to the applicable exclusion amount in section
2010(c) as to the rates in section 2001(c); the technical justification
would have been that rates and exemptions (unified credits) have always
been treated together in defining the burden of the tax and therefore in
determining whether a “change in rates” would have “a retroactive
ii. Put another way, because the rates in section 2001(c) cannot be
completely understood or applied apart from the brackets, applicable
credit amount, and applicable exclusion amount that define their
operation, regulations or other guidance (including forms and
instructions) could reach this result by simply construing the reference in
section 2001(b)(2) to the rates of subsection (c).
6. Section 302(d) of the 2010 Tax Act added a new section 2001(g) to the Code
intended to conform the deduction for tax attributed to adjusted taxable gifts in
the calculation of the estate tax to the new gift and estate tax applicable exclusion
amount and rates. Section 2001(g) reads as follows:
(g) MODIFICATIONS TO GIFT TAX PAYABLE TO REFLECT DIFFERENT TAX
RATES.—For purposes of applying subsection (b)(2) with respect to 1 or more
gifts, the rates of tax under subsection (c) in effect at the decedent’s death shall,
in lieu of the rates of tax in effect at the time of such gifts, be used both to
(1) the tax imposed by chapter 12 with respect to such gifts, and
(2) the credit allowed against such tax under section 2505, including in
(A) the applicable credit amount under section 2505(a)(1), and
(B) the sum of the amounts allowed as a credit for all preceding
periods under section 2505(a)(2).
a. Section 2001(g) is not completely clear, in the absence of implementing
forms and instructions. It appears to be well-meaning and likely intended,
among other things, to prevent any untoward “recapture” or “clawback” of a
gift tax exemption in the form of an increased estate tax, including the
increased estate tax that could take effect in 2013 if Congress does not act.
But section 2011(g) has two limitations:
i. Like the previous wording of section 2001(b)(2), section 2001(g)
expressly requires a substitution only of the current rates in section
2001(c) in reconstructing the hypothetical gift tax payable, not a
substitution of the current applicable exclusion amount in section
– 58 –
ii. Besides, section 2001(g) itself is scheduled to sunset in 2013 when it
might most be needed.
b. Thus, until there were forms, instructions, or other published guidance from
the Internal Revenue Service on this subject, there would always have been a
certain risk in making gifts in 2011 and 2012. Of course, this became
academic when the indexed applicable exclusion amount in the 2010 Tax Act
was made permanent by the 2012 Tax Act.
c. A similar addition was made to section 2505(a), relating to the treatment of
previous gifts in calculating the tax on current gifts, which restores the full
cumulative exemption of $1 million for 2010 in most cases.
7. The “Sensible Estate Tax Act of 2011,” H.R. 3467, introduced on November 17,
2011, by Congressman Jim McDermott (D-WA), would have reduced the
exemption to $1 million (indexed for inflation since 2001) and restore the top 55
percent rate (for taxable estates over $10 million), thus presenting the potential for
clawback. But section 2(c) of H.R. 3467 would have eliminated the estate tax
clawback by providing that the applicable exclusion amount used to calculate the
hypothetical gift tax to subtract under section 2001(b)(2) may never exceed the
estate applicable exclusion amount used to compute the tentative estate tax.
8. In what was called a “conforming amendment,” section 302(e) of the 2010 Tax
Act would have repealed section 2511(c), which had treated certain transfers in
trust as a gift if the trust was not a grantor trust.
9. There was a glitch in the description of the effective date of the $5 million gift tax
a. The $5 million gift tax exemption was provided for in two ways.
i. Section 302(b)(1)(A) of the 2010 Tax Act deleted “(determined as if the
applicable exclusion amount were $1,000,000)” from section 2505(a)(1)
of the Code. Section 302(b)(1)(B) stated that “[t]he amendment made by
this paragraph shall apply to gifts made after December 31, 2010.”
ii. Section 302(b)(2) of the 2010 Tax Act stated that “[o]n and after January
1, 2011, subsection (a) of section 2502 is amended to read as such
subsection would read if section 511(d) of the Economic Growth and
Tax Relief Reconciliation Act of 2001 had never been enacted.”
b. While those references to an effective date of January 1, 2011, are clear
enough standing alone, section 302(f) of the 2010 Tax Act states that
“[e]xcept as otherwise provided in this subsection, the amendments made by
this section shall apply to estates of decedents dying, generation-skipping
transfers, and gifts made, after December 31, 2009.” Obviously, the words
“this subsection” (which are meaningless, because nothing else is provided in
subsection (f)) should be “this section” (which would ratify the January 1,
2011, effective dates in section 302(b). And no one would seriously argue
that the general effective date language in section 302(f) should override the
specific effective date language in section 302(b).
– 59 –
c. The other reference to a specific effective date in section 302 of the 2010 Tax
Act (the provision for inflation adjustments “in a calendar year after 2011”) is
hardwired into section 2010(c)(2)(B) of the Code itself and is not affected by
d. A similar, but more consequential, glitch appeared in section 304 of the
original Reid-McConnell Amendment, which provided, nonsensically, that
“[s]ection 901 of the Economic Growth and Tax Relief Reconciliation Act of
2001 shall apply to the amendments made by this section.” Before Senate
action, the word “section” was changed to “title” by unanimous consent,
thereby clarifying that the estate, gift, and GST tax amendments would sunset
at the end of 2012 as contemplated.
1. Section 303 of the 2010 Tax Act included provisions for the portability of the
unified credit between spouses that were identical to those in the Baucus Bill,
conformed to the exclusion amount ($5 million) and effective date (January 1,
2011) of the 2010 Tax Act.
2. Under section 2010(c)(5)(A), portability is not allowed “unless the executor of the
estate of the deceased spouse files an estate tax return on which such amount is
computed and makes an election on such return that such amount may be so taken
into account. Such election, once made, shall be irrevocable. No election may be
made under this subparagraph if such return is filed after the time prescribed by
law (including extensions) for filing such return.”
a. Such an election will keep the statute of limitations on that estate tax return
open forever, but only for the purpose of determining the amount of unused
exemption, not to make adjustments to that return itself. (The regular statute
of limitations will prevent any adjustments to the predeceased spouse’s return
b. It is not clear why this election is required for the surviving spouse to use the
unused exemption of the predeceased spouse. But such an election was in
every legislative version of portability since 2006, despite criticisms. It is
possible that Congress thought an election by the predeceased spouse’s
executor was necessary in order to keep the return open even for such a
limited purpose. See also the explanation in the preamble to the June 2012
temporary regulations in paragraph XIII.B.2.a.i on page 78 below.
c. The IRS’s August 25, 2011, draft of the 2011 estate tax return (Form 706)
said nothing about portability, which fueled speculation that the “election” of
portability required by section 2010(c)(5)(A) would be presumed in the case
of any return for a married decedent that provides the information necessary
to determine the exclusion amount that was available and the exclusion
amount that was used, and therefore the amount of “deceased spousal unused
exclusion amount” contemplated by section 2010(c)(4). Arguably part 4 of
the August 25 draft did that, because it asked for the customary information
about beneficiaries other than charity and the surviving spouse (line 5), as
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well as all federal gift tax returns (line 7a). (Information about taxable gifts
was also collected, as usual, on lines 4 and 7 of the tax computation in Part
d. Sure enough, the updated draft of the instructions for the 2011 return (dated
September 2, 2011, but not released until a few days later) ended the
speculation and, in the instructions to line 4 of Part 4 (on page 13), provided
the much-anticipated, albeit labored, reassurance that “[t]he executor is
considered to have elected to allow the surviving spouse to use the decedent’s
unused exclusion amount by filing a timely and complete Form 706.” The
final instructions posted on the IRS website on September 28, 2011, were the
same. Those instructions went on to specify that an executor who did not
wish to make the election may (1) attach a statement to that effect to the
return, (2) write “No Election under Section 2010(c)(5)” across the top of the
return, or (3) simply file no return, if a return is not otherwise required.
Notice 2011-82, 2011-42 I.R.B. 516, released on September 29, 2011,
confirmed all this.
e. Without knowing whether portability would be made permanent, it was
prudent to assume that it would be and therefore to consider an election every
time a married person died (unless that person used the entire exemption or it
was very unlikely that the spouse’s total estate would exceed the exemption).
i. To the extent that the smallest estates may have the most unused
exemption to pass on and therefore need the election the most, it might
be hard to see portability as a simplification, especially as long as a
return that is not required for estate tax purposes is still required to make
the portability election.
ii. In contrast, if the couple’s combined estate is well under the exemption,
there may be no reason to get involved with portability at all.
3. Each iteration of the legislative portability proposal was more restrictive in its
treatment of the vexing issue of the surviving spouse who may have succeeded to
unused exemptions from more than one predeceased spouse.
a. The House-passed “Permanent Estate Tax Relief Act of 2006” (“PETRA”)
(Part IV.E.2 on page 14) and “Estate Tax and Extension of Tax Relief Act of
2006” (“ETETRA”) (Part IV.F on page 14) avoided complex tracing and
anti-abuse rules by simply limiting any decedent’s use of exemptions from
previous spouses to the amount of that decedent’s own exemption. In other
words, no one could more than double the available exemption by
accumulating multiple unused exemptions from previous spouses.
b. S. 722 in March 2009 (Part VII.E.4 on page 29) restricted portability still
further by limiting the source of unused exemption to a spouse or spouses to
whom the decedent had personally been married. Thus, if Husband 1 died
without using his full exemption, and his widow, Wife, married Husband 2
and then died, Wife’s estate could use her own exemption plus whatever
amount of Husband 1’s exemption had not been not used. Ultimately,
– 61 –
Husband 2’s estate could use his own exemption plus whatever amount of
Wife’s own exemption had not been used. But Husband 2’s estate could not
use any of Husband 1’s unused exemption transmitted through Wife’s estate.
Some commentators describe this as requiring “privity” between the spouses.
c. The December 2010 “Baucus Bill” amendment (Part VII.J.3 on page 33)
went still further by limiting portability to just one predeceased spouse, the
“last such” deceased spouse. The 2010 Tax Act followed the December 2010
Baucus Bill in this respect.
4. These limitations – the surviving spouse’s own exemption can be no more than
doubled and the increase is limited to the unused exemption from just one
predeceased spouse – seem redundant (except in the case where the exemption
might be reduced in the future). But the wording of the new limitation to just one
predeceased spouse appeared to produce a result that was not intended.
a. The Joint Committee Staff’s Explanation included the following three
examples, which did a good job of illustrating what was apparently intended:
Example 1. − Assume that Husband 1 dies in 2011, having made taxable
transfers of $3 million and having no taxable estate. An election is made on
Husband 1’s estate tax return to permit Wife to use Husband 1’s deceased
spousal unused exclusion amount. As of Husband 1’s death, Wife has made
no taxable gifts. Thereafter, Wife’s applicable exclusion amount is $7 million
(her $5 million basic exclusion amount plus $2 million deceased spousal
unused exclusion amount from Husband 1), which she may use for lifetime
gifts or for transfers at death.
Example 2. − Assume the same facts as in Example 1, except that Wife
subsequently marries Husband 2. Husband 2 also predeceases Wife, having
made $4 million in taxable transfers and having no taxable estate. An
election is made on Husband 2’s estate tax return to permit Wife to use
Husband 2’s deceased spousal unused exclusion amount. Although the
combined amount of unused exclusion of Husband 1 and Husband 2 is $3
million ($2 million for Husband 1 and $1 million for Husband 2), only
Husband 2’s $1 million unused exclusion is available for use by Wife,
because the deceased spousal unused exclusion amount is limited to the
lesser of the basic exclusion amount ($5 million) or the unused exclusion of
the last deceased spouse of the surviving spouse (here, Husband 2’s $1
million unused exclusion). Thereafter, Wife’s applicable exclusion amount is
$6 million (her $5 million basic exclusion amount plus $1 million deceased
spousal unused exclusion amount from Husband 2), which she may use for
lifetime gifts or for transfers at death.
Example 3. − Assume the same facts as in Examples 1 and 2, except that
Wife predeceases Husband 2. Following Husband 1’s death, Wife’s
applicable exclusion amount is $7 million (her $5 million basic exclusion
amount plus $2 million deceased spousal unused exclusion amount from
Husband 1). Wife made no taxable transfers and has a taxable estate of $3
million. An election is made on Wife’s estate tax return to permit Husband 2
to use Wife’s deceased spousal unused exclusion amount, which is $4 million
(Wife’s $7 million applicable exclusion amount less her $3 million taxable
– 62 –
estate). Under the provision, Husband 2’s applicable exclusion amount is
increased by $4 million, i.e., the amount of deceased spousal unused
exclusion amount of Wife.
TECHNICAL EXPLANATION, supra, at 52-53 (emphasis to Example 3 added).
b. The problem with Example 3 is that under section 2010(c)(4)(B) the
“deceased spousal unused exclusion amount” that is portable from Wife to
Husband 2 is the excess of Wife’s “basic exclusion amount” (which is $5
million) over the amount with respect to which Wife’s tentative tax is
determined under section 2001(b)(1) (which is Wife’s taxable estate of $3
million). The excess of $5 million over $3 million is $2 million, not $4
million as in Example 3.
c. Even if Wife tried to “use” Husband 1’s deceased spousal unused exclusion
amount by making $2 million of taxable gifts and left a taxable estate of only
$1 million, the amount with respect to which Wife’s tentative tax is
determined under section 2001(b)(1) would still be $3 million (a $1 million
taxable estate plus $2 million of adjusted taxable gifts), and her deceased
spousal unused exclusion amount would still be only $2 million.
d. The discrepancy occurred because section 2010(c)(4)(B)(i) used her $5
million basic exclusion amount, while Example 3 used Wife’s $7 million
applicable exclusion amount.
e. The result in Example 3 was probably intended. When the staff of the Joint
Committee on Taxation prepared its GENERAL EXPLANATION OF TAX
LEGISLATION ENACTED IN THE 111TH CONGRESS (JCS-2-11, March 2011), it
repeated Example 3 unchanged. Id. at 555.
f. On March 23, 2011, the Joint Committee staff published an “Errata” for the
General Explanation (JCX-20-11), including just two items – 24 pages of
revised budget effect estimates and the following:
On page 555, add the following footnote 1582A to the word “amount” in the
next to last sentence in example 3:
The provision adds new section 2010(c)(4), which generally defines
“deceased spousal unused exclusion amount” of a surviving spouse as
the lesser of (a) the basic exclusion amount, or (b) the excess of (i) the
basic exclusion amount of the last deceased spouse of such surviving
spouse, over (ii) the amount with respect to which the tentative tax is
determined under section 2001(b)(1) on the estate of such deceased
spouse. A technical correction may be necessary to replace the reference
to the basic exclusion amount of the last deceased spouse of the
surviving spouse with a reference to the applicable exclusion amount of
such last deceased spouse, so that the statute reflects intent. Applicable
exclusion amount is defined in section 2010(c)(2), as amended by the
Section 2(d) of the “Sensible Estate Tax Act of 2011,” H.R. 3467, introduced
on November 17, 2011, by Congressman Jim McDermott (D-WA), would
have made that change.
– 63 –
5. Although the last sentence of Examples 1 and 2 confirmed that portability was
intended to be available for lifetime gifts as well as transfers at death, when the
exclusion amount defined by the portability rules is translated into the unified
credit, its use for lifetime gifts is limited by the reduction under section 2505(a)(2)
by “the sum of the amounts allowable as a credit … for all preceding calendar
periods.” As an expansion of Examples 1 and 2, assume Wife used the entire $7
million of applicable exclusion amount she had after Example 1 to make gifts
(whether before or after marrying Husband 2), and then Husband 2 died and she
had an applicable exclusion amount of $6 million as in Example 2. If she then
made more gifts, her allowable credit under sections 2505(a) and 2010(c)(1)
would be the tentative tax on $6 million (section 2505(a)(1)) reduced by the
tentative tax on the $7 million previously used (section 2010(a)(2)). In other
words, she would have no allowable unified credit (except to the extent that future
inflation adjustments of the exclusion amount overtake that $1 million
difference). She would still have $6 million of applicable exclusion amount
available at death, although its impact would be diminished by the inclusion of
her $7 million gifts in “adjusted taxable gifts” under section 2001(b)(1)(B).
6. In any event, Treasury was given broad authority to flesh out the portability rules
7. Notice 2011-82, 2011-42 I.R.B. 516, released on September 29, 2011,
recapitulated the statutory rules regarding portability
The Treasury Department and the Service anticipate that, as a general rule,
married couples will want to ensure that the unused basic exclusion amount of
the first spouse to die will be available to the surviving spouse and, thus, that the
estates of most (if not all) married decedents dying after December 31, 2010, will
want to make the portability election. As indicated above, because the election is
to be made on a timely-filed Form 706, the Treasury Department and the Service
anticipate a significant increase in the number of Forms 706 that will be filed by
the estates of decedents dying after December 31, 2010, and that many of those
returns will be filed by the estates of decedents whose gross estates have a value
below the applicable exclusion amount.
As a result, the Treasury Department and the Service believe that the
procedure for making the portability election on the Form 706 should be as
straightforward and uncomplicated as possible to reduce the risk of inadvertently
missed elections. To that end, the Treasury Department and the Service have
determined that the timely filing of a Form 706, prepared in accordance with the
instructions for that form, will constitute the making of a portability election by
the estate of a decedent dying after December 31, 2010.
Of course, some might have wondered if the preparation of a Form 706 in
accordance with its instructions is really “straightforward and uncomplicated.”
8. Notice 2012-21, 2012-10 I.R.B. 450, released on February 17, 2012, granted a
six-month extension of time to file a federal estate tax return (Form 706) to make
the portability election in the case of married decedents who died in the first six
months of 2011 with gross estates no greater than $5 million.
– 64 –
a. Thus, the first extended returns for decedents who died January 1, 2011, and
the first unextended returns for decedents who died July 1, 2011, were both
due April 2, 2012 (because April 1 was a Sunday).
b. Notice 2012-21 contained no substantive rules, but it reported that “Treasury
and the Service have received comments on a variety of issues.”
9. Temporary regulations and identical proposed regulations were released on June
15, 2012, and very similar final regulations were released on June 12, 2015. See
the discussion of the portability regulations and the use of portability in Part
XIII.B, beginning on page 78.
1. On December 16, 2009, when Senator Baucus asked unanimous consent that the
Senate pause from its consideration of health care reform and approve an
extension of 2009 transfer tax law for just two or three months, Senator
McConnell asked Senator Baucus to agree to consideration of an amendment
reflecting, as Senator McConnell described it, “a permanent, portable, and unified
$5 million exemption that is indexed for inflation, and a 35-percent top rate.” See
Part VII.H.2 on page 31. Senator Baucus objected to Senator McConnell’s
request, whereupon Senator McConnell objected to Senator Baucus’s request, and
all hopes of transfer tax legislation in 2009 died.
2. Except for permanence, the 2010 Tax Act fulfilled Senator McConnell’s request.
3. But lack of permanence was important.
a. Many observers, including the author of this outline, had long thought that
the true congressional consensus in a stand-alone estate bill would arrive at a
rate less than 45 percent and an exemption greater than $3.5 million, possibly
not going quite as far as 35 percent and $5 million (although 51 Senators did
in April 2009), possibly phased in to make it cost less, and possibly
accompanied by some revenue raisers to make it look as if they tried to
control the cost.
b. But to do it all it once, without a phase-in (indeed to do it retroactively to
January 1, 2010, for estate and GST tax purposes), to not even pretend to pay
for it, to link it to the income tax cuts; to link the income tax cuts in turn to a
bad economy, to insist on indexing and portability and “unification” at the
same time, and to sunset it all in two years – just teed it up for two more
years of contention.
4. Permanence eventually was achieved, of course, in the 2012 Tax Act. See Part
X.E.3, beginning on page 69.
IX. THE ONE-HUNDRED-TWELFTH CONGRESS (2011-2012)
A. Another McDermott Bill
1. The “Sensible Estate Tax Act of 2011,” H.R. 3467, introduced on November 17,
2011, by Congressman Jim McDermott (D-WA), would have reduced the estate
and gift tax exemptions to $1 million, effective in 2012. Quixotically, it would
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have indexed that amount for inflation since 2001, but would appear to begin that
indexing in 2013, not 2012, with the result that the 2011 exemption of $5,000,000
would apparently have dropped to $1,000,000 in 2012 and then jump to about
$1,340,000 in 2013 (assuming 2011 inflation rates). If indexing began in 2012,
which is the likely intent, the 2012 exemption would have been about $1,310,000.
2. H.R. 3467 would also have restored the top 55 percent rate, but for taxable estates
over $10 million, and after 2012 all the rate bracket amounts would also have
been indexed for inflation, which would make the 55 percent rate effective for
taxable estates over about $13,430,000.
3. As a significant tax increase, H.R. 3467 had no future in the Republican-led
House of Representatives. But it was of foremost significance for its attention to
a number of subsidiary technical issues and its careful and effective drafting to
address those issues.
a. Section 2(c) of H.R. 3467 would have prevented the notorious “clawback”
that might otherwise operate to recapture some or all of the benefit of today’s
large gift tax exemption if the donor dies when the estate tax exemption is
lower. It would have done that by providing that the applicable exclusion
amount used to calculate the hypothetical gift tax to subtract under section
2001(b)(2) may never exceed the applicable exclusion amount used to
compute the tentative estate tax.
b. Section 2(d) of H.R. 3467 would have corrected a divergence between the
statutory “portability” language and the legislative history, by confirming that
the legislative history reflected true congressional intent.
c. Section 5 of H.R. 3467 would have fleshed out the statutory language
implementing an Administration proposal to require the estate tax value (not
the heir’s after-the-fact opinion of date-of-death value) to be used as the
heir’s basis for income tax purposes. Specifically,
i. new sections 1014(f)(1) and 1015(f)(1) would have required the value
used to determine basis in the hands of the recipient for all income tax
purposes generally to be no greater than the value “as finally
determined” for estate or gift tax purposes,
ii. a new section 6035 would have required each executor or donor required
to file an estate or gift tax return to report to the Service and to each
person receiving any interest in property from a decedent or donor the
value of all such interests as reported on the estate or gift tax return “and
such other information with respect to such interest as the Secretary may
iii. new sections 1014(f)(2) and 1015(f)(2) would have required the value
used to determine basis to be no greater than the value reported on that
statement if “the final value … has not been determined,”
iv. new sections 1014(f)(3) and 1015(f)(3) would have authorized Treasury
by regulations to “provide exceptions” to the application of these rules,
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v. new section 6035(c) would have authorized Treasury to prescribe
implementing regulations, including the application of these rules to
situations where no estate or gift tax return is required and “situations in
which the surviving joint tenant or other recipient may have better
information than the executor regarding the basis or fair market value of
the property,” and
vi. both the failure to report under section 6035 and the failure to use a
consistent basis under section 1014(f) or 1015(f) would have been
subject to penalties.
The references in proposed sections 1014(f)(1) and 1015(f)(1) to the value
“as finally determined” for estate or gift tax purposes allay concerns raised by
a publication in September 2009 by the staff of the Joint Committee on
Taxation that income tax basis might be limited to the value reported on an
estate tax return, even if that value is increased in an estate tax audit. The
exception in proposed sections 1014(f)(2) and 1015(f)(2) when “the final
value … has not been determined” seems to be a necessary compromise,
although it would inevitably influence the liquidation decisions of executors
d. This attention to technical issues at the staff level was a source of relief and
reassurance about any estate tax legislation Congress might entertain.
B. More Death Tax Repeal Permanency Bills
1. The “Death Tax Repeal Permanency Act of 2011” (H.R. 1259) was introduced
March 30, 2011, by Congressman Kevin Brady (R-TX). It had over 220 co-
sponsors. The “Death Tax Repeal Permanency Act of 2012” (S. 2242), was
introduced March 28, 2012, by Senator John Thune (R-SD). It had over 35
cosponsors, all Republican.
2. H.R. 1259 and S. 2242 would have repealed the estate and GST taxes again,
effective as of the date of enactment. But they would have left the “stepped up”
basis provisions of section 1014 intact without reviving carryover basis.
3. These bills would have left the gift tax at its 2011-2012 rate (35 percent) with a $5
million lifetime exemption (non-indexed and non-portable). They would also
have restored the 2001 Tax Act’s enigmatic section 2511(c), providing that
“except as provided in regulations, a transfer in trust shall be treated as a taxable
gift under section 2503, unless the trust is treated as wholly owned by the donor
or the donor’s spouse under subpart E of part I of subchapter J of chapter 1.”
C. Senate and House Leadership Bills
1. The “Middle Class Tax Cut Act,” S. 3393, introduced on July 17, 2012, by
Majority Leader Harry Reid (D-NV), would have returned the estate, gift, and
GST tax law generally to 2009 levels, with a $3.5 million exemption, portable but
not indexed, and a top 45 percent rate. Section 201(b) of S. 3393 included
provisions apparently intended to deal with the “clawback issue,” but in a manner
that is more complicated and less clear than section 2(c) of H.R. 3467.
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2. The same language appeared in a draft of S. 3412, Senator Reid’s “Middle Class
Tax Cut Act” that passed the Senate by a partisan vote of 51-48 on July 25, but,
reportedly to focus more on “middle class tax relief,” the estate tax provisions
were deleted from the final version of S. 3412 that was introduced on July 19. A
virtually identical bill, H.R. 15, was introduced in the House on July 30 by the
ranking member of the Ways and Means Committee, Rep. Sander Levin (D-MI).
3. Meanwhile, the “Tax Hike Prevention Act of 2012,” S. 3413, introduced on July
19 by Finance Committee Ranking Member Orrin Hatch (R-UT) and Minority
Leader Mitch McConnell (R-KY) would simply extend 2012 law, including
indexing and portability, through 2013. In this case, similar provisions appeared
in the “Job Protection and Recession Prevention Act of 2012,” title I of H.R. 8,
which was introduced by Ways and Means Committee Chairman Dave Camp (R-
MI) on July 24 and passed by the House of Representatives by a largely partisan
vote of 256-171 on August 1. (H.R. 8 was destined to become the “American
Taxpayer Relief Act of 2012, after a Senate amendment and House concurrence
on January 1, 2013.)
X. THE CLIMATE AFTER THE 2012 ELECTION
A. The 113th Congress (2013-2014)
1. The House of Representatives: 234 Republicans (a loss of 8) and 202 Democrats.
2. The Senate: 53 Democrats (a gain of 2), 2 Independents who caucus with the
Democrats, and 45 Republicans.
B. The “Fiscal Cliff”
1. Expiration of the 2001 and 2003 “Bush Tax Cuts” on January 1, 2013.
a. The 10 percent income tax bracket eliminated.
b. The top rate raised to 39.6 percent.
c. The rate on qualified dividends raised from 15 percent to 39.6 percent – 43.4
percent with the 3.8 percent Medicare tax on net investment income under
section 1411 if adjusted gross income, without regard to the foreign earned
income exclusion, exceeds $200,000 ($250,000 in the case of a joint return
and $125,000 in the case of a married person filing separately).
d. The rate on long-term capital gains raised from 15 percent to 20 percent (23.8
percent with the 3.8 percent Medicare tax).
e. Itemized deductions and personal exemptions again subject to phaseouts.
f. The “marriage penalty” returned.
g. The child tax credit cut from $1,000 to $500.
h. The estate, gift, and GST taxes returned to 2001 levels.
2. Perhaps 25 million or more individual taxpayers added to the alternative
minimum tax roles as of January 1, 2012.
3. More than 60 business and individual “extenders” expired as of January 1, 2012.
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4. End of the 2 percent payroll tax reduction.
5. Expiration of the extension of unemployment benefits.
6. “Sequestration” under the Budget Control Act of 2011 (enacted in August 2011).
a. Spending cuts of $1.2 trillion over 10 years, beginning January 1, 2013.
b. Equally divided between defense and non-defense spending.
7. All subject to change by Congress.
C. Factors That Affected the Ability to Compromise
1. The bitterness of the election versus the enormous pressures of the fiscal cliff, the
debt ceiling, and the economy.
2. The focus on “high-income” taxpayers versus the fragility of the economy
(especially for the “small businesses” represented by self-employed, sole
proprietorships, partnerships, and S corporations).
3. The convenience of targeted relief (e.g., for job-creating small businesses) versus
the burden of additional complexity in the tax law.
4. The pressure to enact a temporary extension versus the need for certainty and the
eventual challenge of split-year rules for 2013 returns.
5. The pressures of the 2013 filing season (2012 returns, tables, and instructions) and
the 2013 withholding tables versus the clock and the calendar.
6. The unlikelihood of a constitutional challenge to any retroactive tax reduction in
2013 versus the oft-forgotten predicament of the majority of states that would
have seen their state estate taxes (tied to the federal state death tax credit) return
on January 1, 2013, and then disappear again.
D. Residual Discomfort with a High Estate Tax
1. In the House of Representatives, 207 Members of the 113th Congress are among
the 272 who voted for the “Death Tax Repeal Permanency Act of 2005” (H.R. 8)
in 2005 (see Part IV.D.1 on page 12) or the 222 cosponsors of the “Death Tax
Repeal Permanency Act of 2011” (H.R. 1259). Adding 47 other new Republicans
(since 2005) results in 254 Members with possible no-tax or low-tax leanings.
2. Sixty Senators in the 113th Congress are among the 84 who voted for a 35 percent
rate and $5 million exemption during consideration of the Fiscal 2009 budget
resolution in 2008 (see Part VI.B.5 on page 24) or the 38 cosponsors of the
“Death Tax Repeal Permanency Act of 2012” (S. 2242) (see Part IX.B.1 on page
66). Adding five other new Republicans (since 2008) results in 65 Senators with
possible no-tax or low-tax leanings.
3. During the night of March 22-23, 2013, in consideration of its version of a fiscal
2014 budget resolution, the Senate somewhat reprised its 2007 and 2008 votes.
An amendment offered by Senator John Thune (R-SD) allowing repeal of the
estate tax in a deficit-neutral way was defeated on a 46-53 vote after an
amendment offered by Senator Mark Warner (D-VA) allowing repeal or reduction
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of the estate tax in a revenue-neutral way was approved on a 80-19 vote.
a. The difference, of course, is that Senator Thune’s deficit-neutral repeal could
be offset by reduced spending, not necessarily by increased revenue as in
Senator Warner’s revenue-neutral proposal – a big difference between
Republicans and Democrats these days.
b. Senator Warner’s amendment was strange, because he spoke in favor of the
estate tax while appearing to propose its repeal, stating that “I personally
believe the current estate tax—with a very generous $5 million-per-person
exemption, and $10 million per family; an estate tax that only applies to
3,800 families per year—is a fair part of our Tax Code.” 159 CONG. REC.
S2285-86 (daily ed. March 22, 2013). But he concluded by stating that “I
urge my colleagues, if we want to repeal the estate tax and pay for it, to vote
for the Warner amendment.” Id. (emphasis added). And when he was
Governor of Virginia he vetoed the General Assembly’s first effort to repeal
Virginia’s estate tax by “coupling” it to the repealed state death tax credit. It
fell to his successor, Governor Tim Kaine, another Democrat and now also in
the Senate, to eventually sign the Virginia repeal into law. Apparently,
Senator Warner’s amendment was a simple attempt at preemption – basically
to make a statement that the estate tax should not be repealed, or, by
extension, further relaxed, unless it is paid for with revenue offsets.
c. But it is likely that some of the 79 Senators who voted with Senator Warner,
including all or most of the 46 Senators who voted for Senator Thune’s
amendment, meant to express for the record their dissatisfaction with the
E. Simple Math
1. Return to 2001 law would have resulted in a 55 percent rate that might have been
unacceptable to many. But a net marginal federal rate on the largest estates of 39
percent (55 percent less the top 16 percent state death tax credit) would represent
an increase of only 4 percent that might not have been worth the trouble to others.
(The largest revenue pick-up might have come from the smallest taxable estates.)
2. The 45 percent rate and $3.5 million exemption of 2009 law supported by the
Administration, which once might have looked like a compromise (for example,
between 2001 law and 2012 law), was beginning to look like the high-tax
position. The 35 percent rate and $5 million indexed and unified exemption
looked like the new compromise (for example, between 2009 law and repeal).
3. Ironically, the “Death Tax Elimination Act of 2000” (H.R. 8), passed in 2000 by
large majorities in Congress but vetoed by President Clinton (see Part II.E.2 on
page 6), would have reduced the top rate from 55 percent to 40.5 percent in nine
annual steps from 2001 through 2009. (It would also have repealed the estate,
gift, and GST taxes in 2010.)
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XI. THE AMERICAN TAXPAYER RELIEF ACT OF 2012
1. After weeks of public and private discussions, notably between the President and
the Speaker of the House, then between the Majority and Minority Leaders of the
Senate, and finally between the Vice President and the Senate Minority Leader, an
amendment to H.R. 8 (which had been originally passed by the House on August
1, 2012 – see Part IX.C.3 on page 67), formally entitled the “American Taxpayer
Relief Act of 2012,” was introduced in the Senate by Senators Reid and
McConnell. The Senate debated it on New Year’s Eve and passed it in the wee
hours of New Year’s Day by a bipartisan vote of 89-8.
2. After a New Year’s Day of suspense, the House concurred in the Senate
amendment late in the day. The vote was 257-167, with about twice as many
Democrats as Republicans supporting it.
3. President Obama signed the “American Taxpayer Relief Act of 2012,” Public
Law 112-240 (“ATRA” or just the “2012 Tax Act”), into law on January 2, 2013.
B. “Fiscal Cliff” Issues in General
1. Compare to Part X.A.1 on page 67.
2. Under the 2012 Tax Act, the 10 percent income tax bracket was permanently
3. The top rate was permanently raised from 35 percent to 39.6 percent, but only for
taxable incomes over $450,000 for joint filers and $400,000 for single individuals.
a. With the 3.8 percent “Medicare tax” on net investment income under section
1411, applicable if adjusted gross income, without regard to the foreign
earned income exclusion, exceeds $200,000 ($250,000 in the case of a joint
return and $125,000 in the case of a married person filing separately), the top
federal rate on investment income is essentially 43.4 percent.
b. On earned income, the net investment income tax is 0.9 percent, making the
top federal rate 40.5 percent.
4. The top rate on long-term capital gains was permanently raised from 15 percent to
20 percent (23.8 percent with the 3.8 percent Medicare tax).
5. The top rate on qualified dividends was also permanently raised from 15 percent
to 20 percent (not 39.6 percent) (also 23.8 percent with the 3.8 percent Medicare
6. Itemized deductions and personal exemptions are again subject to phaseouts, but
with the threshold reset to $300,000 for joint filers and $250,000 for single
individuals. (Under normal indexing the 2013 thresholds would have been about
$180,000 in the case of itemized deductions and about $270,000 for joint filers
and $180,000 for single individuals in the case of the personal exemption.)
7. The annual individual alternative minimum tax “patch” was made permanent, by
indexing the AMT exemption, beginning in 2012.
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8. Most of the business and individual “extenders” were extended for two years,
2012 and 2013. The biggest business extenders involve the research credit under
section 41, accelerated cost recovery (depreciation) under section 168, expensing
under section 179, and the active financing income exception from the current
taxation of income of a controlled foreign corporation under section 953(e).
9. Some popular credits – the American Opportunity Tax Credit, the Child Tax
Credit, and the Earned Income Tax Credit – were extended for five years.
10. The 2 percent payroll tax reduction was allowed to expire.
11. Unemployment benefits were extended another year.
12. Modest spending cuts were agreed to, but the issue of “sequestration” in general
was postponed for two months. (The IRS, for example, announced “furlough
days,” originally May 24, June 14, July 5 and 22, and August 30. IR-2013-51
(May 15, 2013).)
C. Estate Tax Provisions
1. The compromise in the federal estate tax was to make 2011 and 2012 law
generally permanent, but with a compromise rate of 40 percent (the midpoint
between the 2012 rate of 35 percent and the 2009 rate of 45 percent).
a. A 40 percent rate produces a “tax-exclusive” gift tax rate of about 28.57
percent, if the donor survives three years after the gift.
b. State death taxes are still deductible. As a result, the top marginal combined
federal and state estate tax rate is about 48.3 percent in a state with an estate
tax that follows the federal deduction under section 2058 for the state tax
itself, about 49.6 percent in a state with an estate tax that does not follow that
federal deduction, and of course 40 percent in a state with no state estate tax.
See the table on page 7. (Some states have very different tax structures.)
2. The 2012 Tax Act makes the technical correction to the portability provisions,
proposed by the staff of the Joint Committee on Taxation (see Part VIII.H.4.f on
page 62), changing “basic exclusion amount” to “applicable exclusion amount” in
3. Everything else about 2012 law is made permanent. All “sunsets” are removed.
There no longer are any “as if … had never been enacted” provisions.
4. In particular, the “exemption” – technically the applicable exclusion amount for
estate and gift tax purposes and the GST exemption for GST tax purposes – is $5
million, permanently indexed from 2011, permanently unified (the same for gift
tax purposes), and permanently portable for gift and estate (not GST) tax
purposes. That made the 2012 exemption $5.12 million, the 2013 exemption
$5.25 million, the 2014 exemption $5.34 million, and the 2015 exemption $5.43
million. The 2016 exemption is $5.45 million. Rev. Proc. 2015-53, 2015-47
5. There is no “clawback.” This is addressed for gift tax purposes in the flush
language to section 2505(a)(2) and to some extent for estate tax purposes in
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section 2001(g) (both of which are no longer sunsetted). But the real answer to
the feared estate tax clawback is that the applicable exclusion amount will not go
down – at least not without further congressional action that presumably would
include specific provisions to prevent clawback.
6. Estimated revenue loss over 10 years: $369 billion.
XII. FOLLOWING UP THOSE 2012 GIFTS
In 2012, the gift tax lifetime exemption was $5.12 million. Before 2011, it was $1 million
(decoupled from the estate tax exemption). Thus, even donors who had historically
“maxed out” their use of the gift tax exemption, or even paid some gift tax, still had $4 or
$4.12 million of available gift tax exemption in 2012. But on January 1, 2013, that
exemption was scheduled to return to $1 million, unless Congress acted. (Congress did
act, but not until January 1, 2013.) This created a “use it or lose it” attitude toward the
exemption in 2012 and a surge of gifts, often hasty, ranging from $4 or $4.12 million up to
$5.12 million (or $10.24 million for a married couple).
A. Renouncing, Refocusing, Reversing, Rescinding, Reforming, Refinancing
a. Some gifts in 2012, especially at the end of the year, were structured with
explicit provisions for a disclaimer, with a redirection in the instrument of the
property in the event of a disclaimer. Such disclaimers could be used within
nine months after the gift (thus, in some cases, as late as September 2013) to
determine the effect of a gift otherwise completed for gift tax purposes in
b. A disclaimer or renunciation of an outright gift might cause the property to
revert to the would-be donor and be treated as if the gift had never been
made. But the applicable state disclaimer law needed to be consulted to see
i. if it even applies to inter vivos gifts and
ii. if it is broad enough in that case to direct that the gift passes to the
children or other “heirs” of the donee (as if the donee had died).
c. A disclaimer by a trustee was more controversial and more doubtful,
although broad authority (or even direction) in the instrument creating the
trust (and, thus, the instrument creating the office of the trustee) might help.
2. QTIP trusts.
a. Some trusts created in 2012 were designed to qualify as inter vivos QTIP
trusts, with the non-donor spouse entitled to all the trust income for life
within the meaning of section 2523(f)(2)(B). In some cases, the expectation
was that the donor could wait to see if the 2012 gift tax exemption really was
reduced in 2013, by congressional action or inaction, and then, if the
exemption was reduced, simply forgo the QTIP election and make use of the
donor’s now-lost 2012 exemption.
b. If the donor chose to use gift tax exemption for the 2012 trust and forwent the
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QTIP election, the donor’s spouse, and thereby the donor’s household, could
have retained the income for the spouse’s life, which might have been one of
the objectives of making the spouse a beneficiary. Alternatively, the spouse
could have disclaimed all or part of the income interest and thereby permit
the trust to accumulate income and continue more efficiently as a generation-
skipping trust for descendants. If the spouse disclaimed a mandatory income
interest and still retained a right to income or principal in the trustee’s
discretion, the disclaimer is still a qualified disclaimer under the explicit
exception for spouses in section 2518(b)(4)(A). But under section 2518(b)(4)
and Reg. §25.2518-2(e)(2) the disclaiming spouse was not permitted to retain
a testamentary power of appointment (or any power of appointment not
limited by an ascertainable standard).
c. In any event, a QTIP election for a 2012 gift had to have been made by April
15, 2013, or, if the due date of the gift tax return was extended, by October
3. Rescission or judicial construction or reformation.
a. Much discussion of rescission of gifts that are subsequently regretted
revolves around the concepts of “mistakes” of fact or law and the recent, oft-
cited case of Breakiron v. Gudonis, 106 A.F.T.R. 2d 2010-5999 (D. Mass.
2010). There the taxpayer and his sister were the two beneficiaries of
qualified personal residence trusts (QPRTs) created by their parents,
following the 10-year QPRT term. The taxpayer sought to disclaim his
interest, so the remainder would pass solely to his sister, and was incorrectly
advised by his attorney that he could do so within nine months of the
expiration of the QPRT term. Once he had made the disclaimer, he learned
that it was untimely and therefore was treated as his taxable gift, resulting in
a gift tax of about $2.3 million. The court likened this case to those in which
courts had held that “the original transfer was defective ab initio because the
original instrument contained a mistake.” It therefore allowed a rescission of
the disclaimer nunc pro tunc, stating that “[t]he rescission binds all parties to
this action and is conclusive for federal tax purposes.” (The suit was
originally brought in a Massachusetts state court, naming the United States as
a party. The Justice Department appeared and removed the case to the
b. But it would be a stretch to compare Breakiron’s attorney’s erroneous advice
about what the deadline for a qualified disclaimer was to the inability of
advisors in 2012 to know for sure what the gift tax exemption after 2012
would be. And the actual appearance of the Government in the Breakiron
litigation was perhaps a fluke and in any event could not be assured in any
current rescission action.
4. Exchange of assets.
a. It may be possible to fine-tune a 2012 gift if the grantor can exchange assets
into the trust, such as non-income-producing assets in exchange for assets
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that produce income the grantor now may wish to have to live on. Such an
exchange can be pursuant to a reserved power to substitute assets of
equivalent value under section 675(4)(C), or can be a simple exchange with
the trustee even in the absence of such a reserved power. If the trust is not a
grantor trust, however, the income tax on the capital gain needs to be taken
b. There is no deadline for such exchanges.
c. In the most serious cases of the donor’s insecurity following the gift, the
exchange might even be for the grantor’s promissory note. But see Part
XII.D.2.c.ii on page 76.
B. Perfection and Implementation
1. Recording, obtaining transfer agents’ acknowledgments, making book entries,
adjusting capital accounts, etc.
2. Opening and maintaining accounts, obtaining taxpayer identification numbers (or
using the grantor’s Social Security number), etc.
3. Establishing and maintaining a businesslike administration. (Many of these trusts
will be the first trusts those clients have created.)
4. Communicating, as appropriate, with beneficiaries.
5. Assembling and maintaining a professional team: investment advice, property
management, accounting, etc.
C. 2012 Gift Tax Returns
1. In general.
a. The surge of gifts made in 2012 resulted in a surge of gift tax returns filed in
2013, which might suggest that IRS audit resources will be spread thin.
b. On the other hand, a Joint Committee on Taxation publication published
November 9, 2012, reported that in 2008, there were 38,374 estate tax returns
filed, of which 17,172 showed tax due (totaling about $25 billion). STAFF OF
THE JOINT COMMITTEE ON TAXATION, MODELING THE FEDERAL REVENUE
EFFECTS OF CHANGES IN ESTATE AND GIFT TAXATION (JCX-76-12) at 15,
Table 3 (Nov. 9, 2012). (Gift tax returns in 2008 numbered 257,485, with
9,553 taxable, and $2.843 billion total gift tax. Id. at 16, Table 4.)
Projections of the results if 2012 law were made permanent estimated that in
2013, there would be 9,200 estate tax returns filed, of which 3,600 would
show tax due (totaling about $11 or $12 billion, say $13 billion to reflect the
higher 40 percent rate). Id. at 40, Table A3. This 79 percent drop-off in
taxable estate tax returns may well free up resources to audit gift tax returns
c. Besides, just as techniques for gift-giving in 2012 were interesting, 2012 gift
tax returns are likely to be interesting and to attract attention.
2. Special issues with defined value gifts.
a. It is likely that many late-2012 gifts followed the template in Wandry v.
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Commissioner, T.C. Memo 2012-88, nonacq., 2012-46 I.R.B., of assigning “a
sufficient number of my Units [in an LLC] so that the fair market value of
such Units for federal gift tax purposes shall be [stated dollar amounts].”
b. The Government appealed Wandry, but dropped the appeal. The IRS issued
a nonacquiescence, possibly signaling that it is waiting for cases with “better”
facts (“better” for the IRS, “bad” facts for taxpayers). But Wandry itself
included some facts that could have been viewed that way, and which should
be avoided in 2013 is possible, including
i. a 19-month delay for obtaining the appraisal,
ii. a description of the gifts on the gift tax returns as straightforward
percentage interests without reference to the defined value formulas, and
iii. adjustments to capital accounts rather than percentage interests as the
prescribed response to changes in valuation.
c. Defined value transfers are discussed in Part XIV.E, beginning on page 88.
D. Uses of 2012 Grantor Trusts
1. The use of the assets in the grantor trust to further leverage additional installment
sales and similar transactions.
a. Such sales proceed under the rather tentative but unquestioned authority of
Rev. Rul. 85-13, 1985-1 C.B. 184, and Letter Ruling 9535026, and use notes
with section 7872 interest rates with the approval of Frazee v. Commissioner,
98 T.C. 554 (1992), and Estate of True v. Commissioner, T.C. Memo 2001-
167, aff’d on other grounds, 390 F.3d 1210 (10th Cir. 2004).
b. If an advisor follows the convention of providing at least 10 percent “equity”
in the structure (see Mulligan, “Sale to a Defective Grantor Trust: An
Alternative to a GRAT,” 23 Est. Plan. 3, 8 (Jan. 1996)), gifts by a married
couple of $10.24 million in 2012, $260,000 in 2013, and $180,000 in 2014
and 2015 will have provided a $10.86 million fund that can support a
purchase of property with a value of $97.74 million, for a total transfer of
2. The grantor’s exchange of assets with 2012 grantor trusts, whether before or after
such an installment sale.
a. Short-term benefits.
i. Complete the strategic funding of a grantor trust funded in haste with
cash or marketable securities.
ii. Regain liquidity.
iii. Mitigate a reluctant 2012 transfer (discussed above).
b. Long-term benefits.
i. React to changes in value, “harvest” appreciation.
ii. Include appreciated assets in the grantor’s estate, where they will receive
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a stepped-up basis.
ii. Verifications by the trustee “that the properties acquired and substituted
by the grantor are in fact of equivalent value, and … that the substitution
power cannot be exercised in a manner that can shift benefits among the
trust beneficiaries.” See Rev. Rul. 2008-22, 2008-16 I.R.B. 796. This
standard might well require appraisals, even, for example, of promissory
notes, for which face value is typically taken for granted if an interest
rate prescribed by section 7872 is used. That conformity with section
7872 does not preclude a fair market value inquiry is highlighted by the
last sentence of the Frazee opinion, in which Judge Hamblen stated that
“[w]e find it anomalous that respondent urges as her primary position the
application of section 7872, which is more favorable to the taxpayer than
the traditional fair market value approach, but we heartily welcome the
concept.” Frazee v. Commissioner, 98 T.C. 554, 590 (1992).
3. The grantor’s termination of grantor trust status by relinquishing the feature that
confers grantor trust status.
E. Calibrating the Overall Estate Plan to the 2012 Gifts
1. Because the 2012 gift-giving was probably the most recent opportunity to fine-
tune the donor’s estate planning objectives – identification of beneficiaries,
selection and succession of trustees, standards for distributions, ages and events
for mandatory distributions (if any), duration, powers of appointment, and so forth
– the decisions made in designing trusts in 2012 might also be incorporated into
the donor’s will, revocable trust, and other estate planning vehicles. There is
nothing like irrevocability to sharpen one’s focus.
2. In any event, long-term estate planning documents should be reviewed to make
sure that their formulas still produce a desirable result despite the hit the credit-
shelter disposition took from the 2012 gift, and that those formulas will work
properly in a world of significant annual inflation adjustments – so far $120,000
in 2012, $130,000 in 2013, $90,000 in 2014 and 2015, and $20,000 in 2016.
F. Other Special Follow-Up of Gifts
1. Qualified personal residence trusts (QPRTs): Calendar the time for working out
the post-QPRT term lease; monitor the grantor’s occupancy.
2. Domestic asset protection trusts (DAPTs): Observe formalities.
3. Spousal lifetime access trusts: If “mutual,” administer differently.
4. “Donative promise gifts”: Doesn’t matter?
5. 2010 gifts too: Direct skip trusts (for grandchildren or great-grandchildren only):
Resist “adding” children as beneficiaries, especially if unnecessary.
– 77 –
XIII. OTHERWISE ADJUSTING TO A PERMANENT HIGH-EXEMPTION WORLD
A. Considerations in Making Post-2012 Taxable Gifts
a. The basis of property for purposes of determining gain is the donor’s basis if
the property is acquired by gift, but the date-of-death (or alternate valuation
date) value if the property passes at death. For low basis assets, it has always
been necessary to compare the estate tax saved with the additional income tax
on capital gain that may be incurred.
b. The estate tax rate is still likely to be higher than the capital gain tax rate in
the typical case, but lower estate tax rates and higher capital gains tax rates
have made the spread smaller. In the 2012 Tax Act, for example, the top
federal estate tax rate was increased by 14.3 percent (from 35 percent to 40
percent) while the top federal general income tax rate on capital gains was
increased by 33.3 percent (from 15 percent to 20 percent). As a result, there
may be less priority for making leveraged transfers of appreciated assets
likely to be sold soon after death.
c. For assets subject to depreciation, this observation may be even more true,
because depreciation will typically reduce taxes at ordinary, not capital gains,
d. In addition, when gift tax is paid, the gift tax is removed from the gross estate
if the donor survives for three years after the date of the gift, which saves the
estate tax on that tax, effectively turning the 40 percent “tax-inclusive” rate
into a 28.57 percent “tax-exclusive” rate.
i. But the payment of the gift tax might also reduce the opportunity for
more post-gift growth in the assets sold to pay the gift tax or into which
the cash used to pay the gift tax could have been invested.
ii. On the other hand, under section 1015(d)(6), the amount of the gift tax
paid is itself added to the basis of the asset given, in proportion to the
appreciation in that asset.
e. In any event, the weight given to basis must be evaluated in light of the
likelihood that the asset will be sold. If the trust or other recipients are
unlikely to ever sell it (like a “legacy” asset), or if it is likely to be sold
during the grantor’s life (like a marketable security in a managed portfolio),
the basis will generally not make any difference.
f. If the gift is made in trust, the basis can be managed during the donor’s life
by swapping assets in and out of the trust, perhaps pursuant to a reserved
substitution power. Another person can be authorized to exercise that
substitution power under a durable power of attorney. But it must be
remembered that there may not be an opportunity to exercise such a power.
– 78 –
2. Making gifts within the gift tax exemption, now permanently unified, is often
both easier and more beneficial than paying gift tax.
a. And the exemption is increasing by reason of inflation every year – by
$130,000 in 2013 and $90,000 in 2014 and 2015, but by only $20,000 in
b. Some techniques, like GRATs, use little exemption.
3. Some valuation discounts may be more appropriate in a gift tax setting. See, e.g.,
Rev. Rul. 93-12, 1993-1 C.B. 202.
4. Some gifting tools, such as GRATs, valuation discounts, and grantor trusts, might
be lost or limited in the future.
5. Some gifts can be sheltered by the annual exclusion – increased to $14,000 in
2013 – or, like direct payments of tuition and medical expenses, are exempt
without regard to the annual exclusion.
6. And it is important not to overlook the GST exemption. If a gift tax or a capital
gain tax must be paid if a gift is made, that short-term downside might be offset
by the permanent, or very long-term, benefit of an allocation of GST exemption.
This is especially pertinent in cases where prior gifts to children have used gift tax
exemption, leaving the available GST exemption greater than the gift tax
1. The 2012 Tax Act made portability permanent.
2. Temporary regulations (T.D. 9593, 77 FED. REG. 36150 (June 18, 2012)) and
identical proposed regulations (REG-141832-11, id. at 36229) were released on
Friday, June 15, 2012, just barely 18 months after the enactment of the 2010 Tax
Act and therefore permitted by section 7805(b)(2) to be retroactive to January 1,
2011. Public comments on the proposed regulations were invited by September
17, 2012, and a public hearing, if requested, was scheduled for October 18, 2012,
but no one asked for a hearing and the hearing was cancelled. Final regulations,
very similar to the temporary and proposed regulations, were released on June 12,
2015. T.D. 9725, 80 FED. REG. 34279 (June 16, 2015). (Under section
7805(e)(2), the temporary regulations would have expired after three years, on
June 15, 2015.)
a. Reg. §20.2010-2(a)(1) through (4) confirm that the portability election must
be made on a timely filed estate tax return of the predeceased spouse, that
timeliness is determined in the usual way whether or not a return is otherwise
required for estate tax purposes, that the election is deemed made by the
filing of a return unless it is affirmatively repudiated, and that the election is
i. With regard to the due date even when a return is not required for estate
tax purposes, the preamble to the temporary and proposed regulations
explained simply that a return required in order to elect portability is a
– 79 –
required return for purposes of the due date. The preamble went on to
explain that “[t]his rule will benefit the IRS as well as taxpayers
choosing the benefit of portability because the records required to
compute and verify the DSUE amount [which is what the regulations call
the deceased spousal unused exclusion amount] are more likely to be
available at the time of the death of the first deceased spouse than at the
time of a subsequent transfer by the surviving spouse by gift or at death,
which could occur many years later.” But the regulations do not indicate
how, if at all, such a return might be “audited.”
ii. While additional relaxation of the due date might be appropriate, it is
clear that such relief must come from Congress.
b. Reg. §20.2010-2(a)(6) confirms that the election may be made by an
appointed executor or administrator or, if there is none, “any person in actual
or constructive possession of any property of the decedent.” This reflects the
notion of what is often called a “statutory executor,” after the definition in
section 2203. Such a “non-appointed executor” could (and often will) be the
surviving spouse himself or herself. The regulation adds that a portability
election made by a non-appointed executor “cannot be superseded by a
contrary election made by another non-appointed executor.”
c. In what is perhaps the most significant and welcome provision of the
regulations, Reg. §20.2010-2(a)(7)(ii) provides special rules for reporting the
value of property on an estate tax return filed to elect portability but not
otherwise required for estate tax purposes (most notably a return for an estate
with a value less than the basic exclusion amount).
i. Under Reg. §20.2010-2(a)(7)(ii)(B), the value of property qualifying for
a marital or charitable deduction (which does not use any unified credit
anyway) need not be stated, if the executor “exercises due diligence to
estimate the fair market value of the gross estate.” Pending the
publication of instructions to the estate tax return, the temporary and
proposed regulations provided that this due diligence could be shown by
provision of “the executor’s best estimate, rounded to the nearest
$250,000,” of that value. When the instructions were published in
October 2012, they included a “Table of Estimated Values” modifying
this “nearest $250,000” convention only by requiring that the rounding
always be up to the next higher multiple of $250,000, except for a total
value greater than $5 million and less than or equal to $5.12 million (the
2012 applicable exclusion amount), which was rounded to $5.12 million.
The current (August 2014) instructions are similar, adjusted for the 2014
exclusion amount of $5.34 million. The final regulations affirm the
reliance on the instructions for Form 706.
ii. More rigorous valuation of marital or charitable deduction property is
still needed in the case of formula bequests, partial disclaimers, partial
QTIP elections, split-interest transfers, and eligibility for tax treatment
that is affected by such values. As examples of such tax treatment, Reg.
– 80 –
§20.2010-2(a)(7)(ii)(A)(2) cites sections 2032 and 2032A, but explicitly
excludes section 1014 (under which, the preamble acknowledges, the
value of all assets have an impact).
iii. Reg. §20.2010-2(a)(7)(ii)(A) requires the reporting of “only the
description, ownership, and/or beneficiary of such property, along with
all other information necessary to establish the right of the estate” to the
marital or charitable deduction. As examples of this last requirement,
Reg. §20.2010-2(a)(7)(ii)(C), Example 1, cites “evidence to verify the
title of each jointly held asset, to confirm that [the surviving spouse] is
the sole beneficiary of [a] life insurance policy and [a] survivor annuity,
and to verify that the annuity is exclusively for [the surviving spouse’s]
life.” It is possible that such evidence will actually be more in some
cases than the information normally provided with an estate tax return.
iv. But it is clear that in the paradigm case of a married couple with a home,
modest tangible personal property, bank account, and perhaps an
investment account – all possibly jointly owned – and life insurance and
retirement benefits payable to the survivor, the requirements for
completing an estate tax return to elect portability have been made
relatively manageable, especially considering that the surviving spouse is
likely to be the “non-appointed executor” with respect to all the property.
d. Reg. §§20.2010-2(d), 20.2010-3(d), and 25.2505-2(e) reiterate, without
elaboration or example, the authority of the IRS to examine returns of a
decedent, after the period of limitations on assessment has run, for the limited
purpose of determining the decedent’s DSUE amount, if the portability
election has been made. For this purpose, Reg. §20.2010-3(d) confirms that
“the surviving spouse is considered to have a material interest that is affected
by the return information of the deceased spouse within the meaning of
section 6103(e)(3).” That means the IRS is authorized to disclose the
deceased spouse’s estate tax return information to the surviving spouse.
e. In response to several comments, Reg. §20.2010-2(c)(2) provides that the
computation of a predeceased spouse’s DSUE amount will disregard amounts
on which gift taxes were paid by the decedent because taxable gifts in that
year exceeded the applicable exclusion amount but the larger estate tax
applicable exclusion amount on the date of death exceeded the total adjusted
f. Reg. §§20.2010-3(a) and 25.2505-2(a) confirm that the DSUE amount of the
last deceased spouse dying after 2010 is available both to the surviving
spouse for gift tax purposes and to the surviving spouse’s estate for estate tax
purposes. Neither remarriage nor divorce will affect that availability, but the
death of a subsequent spouse will terminate the availability of the DSUE
amount from the previous last deceased spouse. This is true no matter how
much DSUE amount, if any, of the previous last deceased spouse is still
unused, and whether or not the new last deceased spouse has any DSUE
amount or whether or not the executor of the new last deceased spouse even
– 81 –
made a portability election.
g. Reg. §25.2505-2(b) creates an ordering rule providing that when the
surviving spouse makes a taxable gift, the DSUE amount of the last deceased
spouse (at that time) is applied to the surviving spouse’s taxable gifts before
the surviving spouse’s own basic exclusion amount. Reg. §§25.2505-2(c)
and 20.2010-3(b) provide rules that retain the DSUE amounts of a previous
last deceased spouse that the surviving spouse has used for previous gifts in
the future calculations of either gift tax or estate tax, in order to accommodate
the cumulative nature of those tax calculations. The effect of these rules is to
permit a surviving spouse, by making gifts, to benefit from the DSUE
amounts of more than one predeceased spouse.
h. Reg. §20.2010-3(c)(3) provides, in general, that when property of the last
deceased spouse has passed to a qualified domestic trust (QDOT) for the
surviving spouse, the surviving spouse will not be able to use any of the
deceased spouse’s DSUE amount until the final QDOT distribution or the
termination of the QDOT, typically upon the surviving spouse’s death. This
rule will usually prevent the surviving spouse from using any of the DSUE
amount by gift. But Reg. §20.2010-3(c)(2) clarifies that the DSUE amount
becomes available if and when the surviving spouse becomes a U.S. citizen.
i. Reg. §§20.2010-3(e) and 25.2505-2(f) clarify that the estate of a nonresident
who is not a U.S. citizen may not use the DSUE amount of a predeceased
spouse, except to the extent allowed under a treaty.
j. Reg. §20.2010-2(c)(3), added in the final regulations after being “reserved”
in the temporary and proposed regulations, provides that eligibility for other
credits, such as the credit for gift tax (section 2012), the credit for tax on prior
transfers (section 2013), the credit for foreign death taxes (section 2014), and
the credit for death taxes on remainders (section 2015), does not affect the
computation of the DSUE amount. In other words, those credits will not help
to protect the DSUE amount from being used.
3. The 2012 Form 706 was released on October 4, 2012, after a draft had been
released in August 2012. The instructions were released as a draft in September
2012 and finalized on October 12, 2012. As finalized, Form 706 includes:
a. Part 2, Line 9b, to add the DSUE amount to the basic exclusion amount.
b. Part 4, line 3b, asking for the identification of all prior spouses and whether
the marriage ended by annulment, divorce, or death.
c. Part 5, lines 10 and 23, for reporting the “[e]stimated value of assets subject
to the special rule of Reg. section 20.2010-2T(a)(7)(ii).” See paragraph 2.c
above. Each schedule of the return used for reporting assets (A through I), as
well as Schedules M and O used for reporting transfers that qualify for the
marital or charitable deduction, includes a Note referring to this special rule.
(As stated above, a “Table of Estimated Values” on page 16 of the
instructions modifies the “nearest $250,000” convention of the regulations
only by requiring that the rounding always be up to the next higher multiple
– 82 –
of $250,000, except for a total value greater than $5 million and less than or
equal to $5.12 million (the 2012 applicable exclusion amount), which is
rounded to $5.12 million.)
d. Part 6, Section A, providing that the portability election is made “by
completing and timely-filing this return” and providing a box to check to opt
out of electing portability. (The instructions, on page 17, state simply that
“[i]f an estate files a Form 706 but does not wish to make the portability
election, the executor can opt out of the portability election by checking the
box indicated in Section A of [Part 6]. If no return is required under section
6018(a), not filing Form 706 will avoid making the election.”)
e. Part 6, Section B, asking if any assets are transferred to a QDOT and advising
that, if so, any DSUE calculation is only preliminary. See paragraph 2.h
f. Part 6, Section C, providing for the calculation of the amount portable to the
g. Part 6, Section D, entitled “DSUE Amount Received from Predeceased
Spouse(s),” in two parts:
i. Part 1, for DSUE received from the last deceased spouse.
ii. Part 2, for DSUE received from other predeceased spouse(s) and “used”
by the decedent – i.e., when the surviving spouse makes taxable gift(s)
before the last deceased spouse has died. See paragraphs 2.f and 2.g
4. A new gift tax return, Form 709, was released on November 20, 2012, after a
draft had been released in September 2012. It is also consistent with the
regulations, as well as the estate tax return and instructions. It includes a new
Schedule C, with two parts, like Part 6, Section D, of the estate tax return, for
DSUE received from the last deceased spouse and DSUE received from other
predeceased spouse(s) and “Applied by Donor to Lifetime Gifts.” Instructions for
the gift tax return, dated November 19, 2012, were released November 29, 2012.
5. On January 27, 2014, the Internal Revenue Service published Rev. Proc. 2014-18,
2014-7 I.R.B. 513, providing a simplified method to obtain an extension of time
to make the “portability” election with respect to the estate of a decedent who
died in 2011, 2012, or 2013 survived by a spouse.
a. Noting that the IRS had granted extensions of time to make the portability
election under Reg. §301.9100-3 (“9100 relief”) in several letter rulings, Rev.
Proc. 2014-18 provided that an executor of such a decedent who was not
required to file an estate tax return for estate tax purposes and who in fact did
not file an estate tax return could simply file the otherwise late estate tax
return, prepared in accordance with Reg. §20.2010-2T(a)(7), on or before
December 31, 2014, and state at the top of the return “FILED PURSUANT
TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER
– 83 –
b. Rev. Proc. 2014-18 noted that executors who could benefit from this relief
include executors of decedents who were legally married to same-sex
spouses. Those executors could not have known that portability would be
available for same-sex married couples until the Supreme Court decided
United States v. Windsor, 570 U.S. ___, 133 S. Ct. 2675 (2013), on June 26,
2013, and the Service issued Rev. Rul. 2013-17, 2013-38 I.R.B. 201, on
August 29, 2013. The relief provided by Rev. Rul. 2014-18, however,
applied to all married persons who died in 2011, 2012, and 2013 for whom an
estate tax return was not required, not just to same-sex married couples.
c. Revenue Procedure 2014-18 provides no relief with respect to decedents who
die in 2014 or later. The executors of such decedents have until at least
October 1, 2014, to file estate tax returns (or claim automatic extensions) and
make the portability election. If they fail to do so, Rev. Proc. 2014-18
confirms that they may continue to seek 9100 relief.
6. A credit shelter trust will still offer advantages over portability, especially in the
largest estates, including
a. professional management and asset protection for the surviving spouse,
b. protection of the expectancy of children from diversion by the surviving
spouse, especially in cases of second marriages and blended families, as well
as remarriage of the surviving spouse,
c. sheltering intervening appreciation and accumulated income from estate tax,
d. preservation of the predeceased spouse’s exemption even if the surviving
spouse remarries, the exemption is reduced, or portability sunsets,
e. use of the predeceased spouse’s GST exemption, because portability applies
only to the gift and estate taxes (although portability will apparently also be
available if the first estate is placed in a QTIP trust for which a reverse-QTIP
election is made, if a QTIP election in that case is not disregarded under Rev.
Proc. 2001-38, 2001-24 I.R.B. 1335, discussed below),
f. avoiding the filing of an estate tax return for the predeceased spouse’s estate,
if the estate is not so large as to otherwise require a return, and
g. prevention of disclosure of the predeceased spouse’s estate tax return
information to the surviving spouse and the surviving spouse’s
representatives (see paragraph 2.d on page 80).
7. On the other hand, for many couples, portability will offer advantages, including
a. simplicity, including relief of any concern about the titling of assets,
b. convenience, in the case of assets like retirement benefits that are awkward in
c. greater perceived security for the surviving spouse by accommodating an
outright bequest that confers complete control over the entire estate, without
the intervention of a trust,
– 84 –
d. avoidance of state estate tax on the first estate in states with an estate tax and
no state-only QTIP election.
e. a second step-up in basis for appreciated assets at the surviving spouse’s
death (which, if the protection of a trust is still desired, could be in a QTIP-
style trust, again if a QTIP election in that case is not disregarded under Rev.
Proc. 2001-38), and
f. facilitating proactive planning by the surviving spouse.
8. About QTIP trusts and Rev. Proc. 2001-38.
a. Rev. Proc. 2001-38, 2001-24 I.R.B. 1335, announced circumstances in which
the IRS “will disregard [a QTIP] election and treat it as null and void” if “the
election was not necessary to reduce the estate tax liability to zero, based on
values as finally determined for federal estate tax purposes.” The procedure
states that it “does not apply in situations where a partial QTIP election was
required with respect to a trust to reduce the estate tax liability and the
executor made the election with respect to more trust property than was
necessary to reduce the estate tax liability to zero.” The procedure states that
it “also does not apply to elections that are stated in terms of a formula
designed to reduce the estate tax to zero.”
i. Thus, the paradigm case to which the procedure applies is the case where
the taxable estate would have been less than the applicable exclusion
amount anyway, so the estate would not be subject to federal estate tax,
but the executor listed some or all of the trust property on Schedule M to
the estate tax return and thus made a redundant QTIP election.
ii. Rev. Proc. 2001-38 is a relief measure. The transitional sentence
between the summary of the background law and the explanation of the
problem states that “[t]he Internal Revenue Service has received requests
for relief in situations where an estate made an unnecessary QTIP
iii. Letter Ruling 201338003 (June 19, 2013) is a recent routine example of
a letter ruling in which the IRS granted relief under Rev. Proc. 2001-38.
b. The question is whether a QTIP election made only to support a reverse-
QTIP election for GST tax purposes or to gain a second basis step-up at the
death of the surviving spouse might be treated as an election that “was not
necessary to reduce the estate tax liability to zero” and therefore as “null and
i. The revenue procedure goes on to state that “[t]o establish that an
election is within the scope of this revenue procedure, the taxpayer must
produce sufficient evidence to that effect. For example, the taxpayer [the
surviving spouse or the surviving spouse’s executor] may produce a copy
of the estate tax return filed by the predeceased spouse’s estate
establishing that the election was not necessary to reduce the estate tax
liability to zero.”
– 85 –
ii. That statement, the “relief” origin of Rev. Proc. 2001-38, the likelihood
that a revenue procedure announcing the Service’s administrative
forbearance cannot negate an election clearly authorized by statute, and
the unseemliness of denying the benefits of a QTIP election to smaller
estates while allowing it to larger estates all suggest that a QTIP election
will be respected in such a case. This view is reinforced by the explicit
reference in Reg. §20.2010-2(a)(7)(ii)(A)(4) to QTIP elections in returns
filed to elect portability but not otherwise required for estate tax
purposes (see paragraph 2.c.ii on page 79).
iii. It may be that this approach could appear, in effect, to make the
consequences of a QTIP election elective on the basis of what could be
very long hindsight. With respect to the second basis step-up, that
actually seems to have been a potential result ever since Rev. Rul. 2001-
38 was published; it is not really changed by portability.
iv. Obviously, clarification would be helpful and is promised in a new item
on the 2013-2014 Treasury-IRS Priority Guidance Plan. See part
XIX.A.4 beginning on page 143.
c. There might be other approaches to address at least the basis issue, including
outright distributions to the surviving spouse and “springing” or discretionary
general powers of appointment. All such approaches have their own
strengths and weaknesses, including the possible loss of protection of the
predeceased spouse’s beneficiaries, especially in the case of a second
C. Important Areas of Practice Besides Transfer Tax Planning
(The author acknowledges with appreciation his former partner Lou Mezzullo’s contribution to this list.)
1. Identifying guardians for minor children, if and when needed.
2. Planning for the disposition of the client’s assets upon death.
3. Asset protection planning.
4. Planning for marital and other dissolutions.
5. Planning for physical disability.
6. Planning for legal incapacity.
7. Business succession planning (without the estate tax to blame for failure of a
8. Using business entities to accomplish non-tax objectives.
9. Income tax planning.
10. Charitable giving (for its own sake, and also because income tax considerations
are still relevant and techniques such as lifetime charitable remainder trusts to
facilitate diversification are not affected at all).
11. Retirement planning.
– 86 –
12. Planning for life insurance protection.
13. Trust administration.
14. Fiduciary litigation (perhaps more so if there is more to fight over).
15. Planning to pay state death taxes (in many states).
16. Planning for clients with property in more than one state, including ownership,
asset protection, state taxation, and probate issues (in addition to state estate tax).
17. Planning for children with disabilities.
18. Planning for spendthrift children.
19. Planning for clients who are U.S. citizens or resident aliens who own property in
20. Planning for nonresident aliens with assets in the United States or who plan to
move to the United States.
21. Planning for clients who intend to change their citizenship.
22. Planning to live with non-tax regulatory regimes, including Sarbanes-Oxley, the
Patriot Act, HIPAA, and charitable governance reform.
23. Planning for possible increases in the estate, gift, and GST taxes.
XIV. WHAT WE LEARNED FROM THOSE 2012 GIFTS
A. Forgiveness of Past Loans
1. This is a very simple and surprisingly popular technique, despite its perceived
lack of “leverage.” Often it simply confers on a prior transfer the gift treatment
that would have been chosen at that time if the gift tax exemption had not been
smaller. It does not even require the commitment of any assets, although
sometimes a gift of cash followed by repayment in cash, while circular, is more
consistent with and supportive of the bona fides of the original characterization as
2. Forgiveness of loans followed by new loans (at a lower interest rate) may be an
option, if not over-done.
3. The “loan” that is forgiven, in whole or in part, could be the “loan” imbedded in a
previous installment sale to a grantor trust.
B. Life Insurance Transactions
1. Life insurance is an asset that historically has most strained the limits of gift tax
exclusions and exemptions, in order to provide post-death liquidity. A $5.12 gift
tax exemption can enable the creation of life insurance trusts to procure new life
insurance, or to acquire policies from the grantor or the grantor’s spouse.
2. But many life insurance policies are not kept in force until death, and the use of
gift and GST exemptions with respect to a policy that is abandoned or cashed in
can be a waste of those exemptions.
– 87 –
3. If a life insurance policy happens to be in trust and subject to inclusion in the
gross estate under section 2035(a)(2) if the insured dies within three years of the
transfer and the insured becomes terminally ill,
a. the policy-holder might be entitled to withdraw accelerated death benefits,
reducing the value of the policy that is subject to section 2035(a)(2), while
the withdrawn cash is not subject to section 2035(a)(2), or
b. alternatively, the insured’s spouse, if possible, can purchase that policy from
i. The fair market value price of a policy if the insured is close to death is
likely to be close to the face amount of the policy. The spouse’s estate is
not increased by the receipt of the proceeds, because that simply restores
the purchase price the spouse paid. Meanwhile, the price paid becomes
the corpus of the long-term trust, but is no longer subject to section
2035(a)(2). Assuming the trust is a grantor trust as to the purchaser’s
spouse, there is no gain recognized (section 1041(a)(1)) and no change in
basis (section 1041(b)(2)), and therefore the transfer for value rule of
section 101(a)(2) does not apply (section 101(a)(2)(A)).
ii. If the spouse cannot afford to do this, using a promissory note can work
if done carefully.
C. Qualified Personal Residence Trusts (QPRTs)
1. It is well known that qualified personal residence trusts (QPRTs) are more
effective when the section 7520 rate is high. These days the rate is very low.
2. But, unlike a GRAT, a QPRT cannot be “zeroed-out.” The unavoidable
remainder (gift) value in the case of very valuable houses can be transferred in a
QPRT more easily when the gift tax exemption is high.
3. Transferring undivided interests can have the double benefit of reducing the
discounted value transferred and providing a type of hedge against the mortality
risk by using QPRTs of different terms.
D. Spousal Lifetime Access Trusts (SLATs)
1. A frequent secondary objective in making large gifts is retaining access to the
transferred funds, either because the gift is a substantial part of the donor’s estate
or, even in the case of very wealthy donors, … “just in case.”
2. For married couples, giving access to a spouse is often tantamount to retaining
access for oneself, although there are obvious risks implicit in that assumption.
3. It is often said that the “reciprocal trust doctrine” can be avoided, even when each
spouse creates a trust in which the other spouse has an interest, by making the
trusts different. See Estate of Levy v. Commissioner, T.C. Memo 1983-453
(reciprocal trust doctrine did not apply to trusts created by spouses that benefited
each other because the wife had a broad lifetime limited power to appoint trust
assets to anyone other than herself, her creditors, her estate, or the creditors of her
estate, while the husband had no such power).
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4. But it is hard to deny that the safest way to avoid the reciprocal trust risk is for
only one spouse to create such a trust. (This was especially true when there was
not much time left in 2012 for the creation of two trusts to be separated by much
5. Gift-splitting, if the non-donor spouse has an interest in the trust, is complicated.
A right to distributions subject to an ascertainable standard might be ignored if it
is unlikely to be exercised, but that is factual and subjective. A 5% withdrawal
right might be valued like a unitrust right, significantly reducing the amount of the
trust that is eligible for gift-splitting. An independent trustee’s unlimited
discretion would be a problem without an easy solution or limitation. See Reg.
§25.2513-1(b)(4); Rev. Rul. 56-439, 1956-2 C.B. 605; Robertson v.
Commissioner, 26 T.C. 246 (1956), acq., 1956-2 C.B. 8; Falk v. Commissioner,
T.C. Memo 1965-22; Wang v. Commissioner, T.C. Memo 1972-143.
E. Using Defined Value Transfers
1. The use of “defined value clauses” or “value definition formulas” received both
attention and an arguable boost from the 2012 Tax Court decision in Wandry v.
Commissioner, T.C. Memo 2012-88, nonacq., 2012-46 I.R.B.
a. Just as in the days when one could drive into a gas station and ask for “five
dollars’ worth of regular,” without specifying the number of gallons, there is
an intuitive notion that a donor ought to be able to make a gift of any stated
amount expressed in the form of “such interest in X Partnership … as has a
fair market value of $13,000,” which the IRS approved in Technical Advice
Memorandum 8611004 (Nov. 15, 1985).
b. In Knight v. Commissioner, 115 T.C. 506 (2000), the Tax Court disregarded
the use of such a technique to transfer “that number of limited partnership
units in [a partnership] which is equal in value, on the effective date of this
transfer, to $600,000.” As a result, the court redetermined the value subject
to gift tax. It was generally believed, however, that the result in Knight could
have been avoided if the taxpayers had acted more consistently and carefully.
Despite the apparent attempt to make a defined value gift, the gifts shown on
the gift tax return were stated merely as percentage interests in the
partnership (two 22.3% interests on each return). Moreover, the taxpayers
contended in court that such interests were actually worth less than the
c. Field Service Advice 200122011 (Feb. 20, 2001) addressed, negatively, the
facts generally known to be those at issue in McCord v. Commissioner, 120
T.C. 358 (2003), in which the taxpayers had given limited partnership
interests in amounts equal to the donors’ remaining GST exemption to GST-
exempt trusts for their sons, a fixed dollar amount in excess of those GST
exemptions to their sons directly, and any remaining value to two charities.
The IRS refused to respect the valuation clauses, citing Commissioner v.
Procter, 142 F.2d 824 (4th Cir. 1944), a case with unusual facts in which the
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court found a provision in a document of transfer that “the excess property
hereby transferred which is deemed by [a] court to be subject to gift tax …
shall automatically be deemed not to be included in the conveyance” to be
contrary to public policy because it would discourage the collection of tax,
would require the courts to rule on a moot issue, and would seek to allow
what in effect would be an impermissible declaratory judgment. The IRS
acknowledged that the approach in question was not identical to the valuation
clause in Procter, because it used a “formula” clause that defined how much
was given to each donee, while Procter involved a so-called “savings” clause
that required a gift to be “unwound” in the event it was found to be taxable.
Nevertheless, the IRS believed the principles of Procter were applicable,
because both types of clauses would recharacterize the transaction in a
manner that would render any adjustment nontaxable.
d. Technical Advice Memoranda 200245053 (July 31, 2002) and 200337012
(May 6, 2003) took the IRS discomfort with defined value clauses to the next
e. When McCord itself was decided by the Tax Court, the court essentially
avoided the formula issue by dwelling on the fact that the assignment
document had used only the term “fair market value” not “fair market value
as determined for federal gift tax purposes.”
f. In Succession of McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006), the
Court of Appeals for the Fifth Circuit reversed the Tax Court totally, scolded
the Tax Court majority soundly, and remanded the case to the Tax Court to
enter judgment for the taxpayers. The court said that “although the
Commissioner relied on several theories before the Tax Court, including …
violation-of-public policy [the Procter attack], … he has not advanced any of
those theories on appeal. Accordingly, the Commissioner has waived them.”
But, in the view of many, the Fifth Circuit said other things that are hard to
understand unless the court was comfortable with the use of defined value
clauses in that case.
g. Estate of Christiansen v. Commissioner, 130 T.C. 1 (2008) (reviewed by the
court), addressed the use of value formulas in the different context of a
disclaimer of a testamentary transfer. The decedent’s will left her entire
estate to her daughter, with the proviso that anything her daughter disclaimed
would pass to a charitable lead trust and a charitable foundation. The
daughter disclaimed a fractional portion of the estate, with reference to values
“finally determined for federal estate tax purposes.” Noting that phrase, the
Tax Court, without dissent, rejected the Service’s Procter argument and
upheld the disclaimer to the extent of the portion that passed to the
foundation. (The court found an unrelated technical problem with the
disclaimer to the extent of the portion that passed to the charitable lead trust.)
In a pithy eight-page opinion, the Eighth Circuit affirmed. 586 F.3d 1061
(8th Cir. 2009).
h. In Estate of Petter v. Commissioner, T.C. Memo 2009-280, the Tax Court
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upheld gifts and sales to grantor trusts, both defined by dollar amounts “as
finally determined for federal gift tax purposes,” with the excess directed to
two charitable community foundations. Elaborating on its Christiansen
decision, the court stated that “[t]he distinction is between a donor who gives
away a fixed set of rights with uncertain value—that’s Christiansen—and a
donor who tries to take property back—that’s Procter. … A shorthand for
this distinction is that savings clauses are void, but formula clauses are fine.”
The court also noted that the Code and Regulations explicitly allow valuation
formula clauses, for example to define the payout from a charitable
remainder annuity trust or a grantor retained annuity trust, to define marital
deduction or credit shelter bequests, and to allocate GST exemption. The
court expressed disbelief that Congress and Treasury would allow such
valuation formulas if there were a well-established public policy against
them. On appeal, the Government did not press the “public policy” Procter
argument, and the Ninth Circuit affirmed the taxpayer-friendly decision. 653
F.3d 1012 (9th Cir. 2011).
i. Hendrix v. Commissioner, T.C. Memo 2011-133, was the fourth case to
approve the use of a defined value clause, with the excess going to charity.
The court emphasized the size and sophistication of the charity, the early
participation of the charity and its counsel in crafting the transaction, and the
charity’s engagement of its own independent appraiser. Hendrix was
appealable to the Fifth Circuit, and the court also relied heavily on McCord.
3. In Wandry v. Commissioner, T.C. Memo 2012-88, the donors, husband and wife,
each defined their gifts as follows:
I hereby assign and transfer as gifts, effective as of January 1, 2004,
a sufficient number of my Units as a Member of Norseman Capital, LLC, a
Colorado limited liability company, so that the fair market value of such
Units for federal gift tax purposes shall be as follows: [Here each donor
listed children and grandchildren with corresponding dollar amounts.]
Although the number of Units gifted is fixed on the date of the gift,
that number is based on the fair market value of the gifted Units, which
cannot be known on the date of the gift but must be determined after such
date based on all relevant information as of that date.…
4. The court stressed the now familiar “distinction between a ‘savings clause’, which
a taxpayer may not use to avoid the tax imposed by section 2501, and a ‘formula
clause’, which is valid. … A savings clause is void because it creates a donor that
tries ‘to take property back’. … On the other hand, a ‘formula clause’ is valid
because it merely transfers a ‘fixed set of rights with uncertain value’.”
5. The Tax Court then compared the Wandrys’ gifts with the facts in Petter and
determined that the Wandrys’ gifts complied. Most interesting, the court said
It is inconsequential that the adjustment clause reallocates
membership units among petitioners and the donees rather than a charitable
organization because the reallocations do not alter the transfers. On January
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1, 2004, each donee was entitled to a predefined Norseman percentage
interest expressed through a formula. The gift documents do not allow for
petitioners to “take property back”. Rather, the gift documents correct the
allocation of Norseman membership units among petitioners and the donees
because the [appraisal] report understated Norseman’s value. The clauses at
issue are valid formula clauses.
6. This is a fascinating comparison, because it equates the rights of the charitable
foundations in Petter that were the “pourover” recipients of any value in excess of
the stated values with the rights of the children and grandchildren in Wandry who
were the primary recipients of the stated values themselves. In a way, the facts of
Wandry were the reverse of the facts in Petter.
a. The effect of the increased value in Petter was an increase in what the
charitable foundations received, whereas the effect of the increased value in
Wandry was a decrease in what the donees received. The analogs in Wandry
to the charitable foundations in Petter were the donors themselves, who
experienced an increase in what they retained as a result of the increases in
value on audit.
b. It is also telling that in the court’s words the effect of the language in the gift
documents was to “correct the allocation of Norseman membership units
among petitioners and the donees because the [appraisal] report understated
Norseman’s value.” Until Wandry, many observers had believed that the
courts had approved not “formula transfers” but “formula allocations” of a
clearly fixed transfer. In fact, the Wandry court used a variation of the word
“allocate” five times to describe the determination of what was transferred
and what was retained. But the “allocation” was between the donees and the
original donors. “Allocation” to the donors looks a lot like retention by the
donors, if not a way to “take property back,” and thus the court might be
suggesting that the time-honored distinction between “formula transfers” and
“formula allocations” might not be so crucial after all. But it is a cause for
concern that the court did not acknowledge that tension, but continued to use
“allocation” language to justify what in economic effect defined what was
transferred by the donors, not merely how the transferred property was
allocated among donees. Again, though, the overall context and thrust of the
court’s analysis was that the donors had not sought “to take property back,”
but had merely defined what was given on the date of the gift.
7. Thus, there is now a taxpayer victory in a case that does not involve a “pourover”
to charity of any excess value. The court concluded by again acknowledging the
absence of a charity and saying that “[i]n Estate of Petter we cited Congress’
overall policy of encouraging gifts to charitable organizations. This factor
contributed to our conclusion, but it was not determinative.” Thus, Wandry
appears to bless a simpler fact pattern that more closely conforms to the common
sense “five dollars’ worth of regular” approach that many observers, apparently
even the IRS in 1985, have thought should work.
8. The IRS issued a nonacquiescence in Wandry on November 9, 2012. AOD 2012-
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004, 2012-46 I.R.B.
a. The Action on Decision took the view that “on the date of the gift the
taxpayers relinquished all dominion and control over the fixed percentage
interests” because “[t]he final determination of value for federal gift tax
purposes is an occurrence beyond the taxpayers’ control.” It went on to say
that “[i]n Petter, there was no possibility that the transferred property would
return to the donor, and thus, the court had no need to consider the extent to
which the gift was complete.”
b. Although the nonacquiescence could signal that the IRS is waiting for cases
with “better” facts (“better” for the IRS, “bad” facts for taxpayers), Wandry
itself included some facts that could have been viewed that way, including a
19-month delay for obtaining the appraisal, a description of the gifts on the
gift tax returns as straightforward percentage interests without reference to
the defined value formulas, and adjustments to capital accounts rather than
percentage interests as the prescribed response to changes in valuation.
9. The fairest summary of Wandry is that it is undeniably significant for extending
the scope of the decided cases beyond the context of a charitable pourover. But
unlike the charitable cases, where the weight of case law has now accumulated
behind defined value clauses with a “pourover” to a charity that has actively
monitored and participated in the transaction, Wandry does not represent a
consistent body of Tax Court and appellate court jurisprudence, and, as even the
charitable cases show, the IRS does not approve of the defined value technique.
Because it is also fair to speculate that many year-end 2012 gifts followed the
pattern of a “Wandry formula,” we should not be surprised to see future cases
involving Wandry types of defined value transfers.
10. In Estate of Marion Woelbing v. Commissioner (Tax Court Docket No. 30260-13,
petition filed Dec. 26, 2013) and Estate of Donald Woelbing v. Commissioner
(Tax Court Docket No. 30261-13, petition filed Dec. 26, 2013), the Tax Court has
been asked to consider a sale by Donald Woelbing, who owned the majority of
the voting and nonvoting stock of Carma Laboratories, Inc., of Franklin,
Wisconsin, the maker of Carmex skin care products.
a. In 2006 Mr. Woelbing sold his nonvoting stock for a promissory note with a
principal amount of $59 million (the appraised value of the stock) and
interest at the applicable federal rate (AFR). The purchaser was a trust that
owned insurance policies under a split-dollar arrangement with the company
Two of Mr. Woelbing’s sons, who were beneficiaries of the trust, gave their
personal guarantees, apparently for 10 percent of the purchase price.
b. The sale agreement provided for the number of shares sold to be adjusted if
the IRS or a court revalued the stock.
c. In its notice of deficiency, the IRS basically ignored the note, treating it as
subject to section 2702, essentially treating it as equity rather than debt. The
IRS also doubled the value of the stock to about $117 million. These changes
produced substantial gift tax deficiencies.
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d. The IRS ignored the note for estate tax purposes too, but included the value
of the stock, then asserted to be about $162 million, in Mr. Woelbing’s gross
estate under sections 2036 and 2038.
e. The IRS also asserted gift and estate tax negligence and substantial
f. The case was settled, and stipulated decisions were filed on March 25 and 28,
2016, finding no additional gift taxes due with respect to either Mr. or Mrs.
Woelbing and no additional estate tax due with respect to Mr. Woelbing’s
estate. It has been informally reported that an agreed upward valuation
adjustment in the settlement was reflected in an agreed downward adjustment
in the number of shares Mr. Woelbing transferred in the 2006 sale, much as
the defined value clause contemplated. In that case, the value of those shares
would have been included in his gross estate, would have qualified for a
marital deduction, and thus presumably would increase the size of Mrs.
Woelbing’s gross estate and increase the amount of estate tax owed by her
estate. The settlement with the IRS probably included her executors’
agreement to make or accept those changes to her estate tax return..
XV. THE 3.8 PERCENT MEDICARE TAX ON TRUSTS AND ESTATES
1. Under section 1411(a)(2), the 3.8 percent tax on net investment income
(sometimes called the “Medicare Tax” or “Medicare Surtax”), enacted by the
Health Care and Education Reconciliation Act of 2010 (Public Law 111-152) in
connection with the Patient Protection and Affordable Care Act (Public Law 111-
148), is imposed on the undistributed net investment income of an estate or trust,
or, if lesser, on the adjusted gross income of the estate or trust less the amount at
which the highest (39.6 percent) income tax bracket begins – $11,950 for 2013,
$12,150 for 2014, $12,300 for 2015, and $12,400 for 2016. This effectively
makes the total income tax rate on such income 43.4 percent, beginning at that
level. And all or virtually all income of a trust will be investment income.
2. Because this new tax took effect for taxable years beginning after December 31,
2012, executors of the estates of decedents who died before the end of 2012 could
have elected a fiscal year ending November 30, thereby exempting the income in
the first 11 months of 2013 from the new tax. Those executors and the trustees of
qualified revocable trusts could have also elected under section 645 to treat the
trust as a part of the estate for federal income tax purposes.
3. Investment income does not include income derived from a trade or business that
is not a “passive activity” under section 469 (and is not trading in financial
instruments or in commodities within the meaning of section 475(e)(2)).
Therefore, the new tax provides an additional reason to avoid the treatment of a
business as a “passive activity.”
a. Section 469(c)(1) defines “passive activity” as “the conduct of any trade or
business … in which the taxpayer does not materially participate.” Section
469(h)(1) defines material participation as involvement in the operations of
the activity on a “regular, continuous, and substantial” basis.
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b. There are no regulations specifically applying the “passive activity” rules to
the unique circumstances of estates and trusts.
i. Reg. §1.469-8 is entitled “Application of section 469 to trust, estates, and
their beneficiaries” but is “reserved.” Similarly, Reg. §1.469-5T(g) is
entitled “Material participation of trusts and estates” and is also
ii. Since section 469 was added by the Tax Reform Act of 1986, the details
of application of that section to trusts and estates, as a practical matter
and out of necessity, have been developed largely by the accountants
who prepare returns and financial statements.
iii. Before 2012, this ad hoc approach generally mattered only for activities
that produced losses that section 469 made nondeductible (along with
other narrow rules that incorporate “passive activity” status as a test or
trigger, such as the special amortization rules involved in Technical
Advice Memorandum 201317010, discussed below).
c. In Mattie K. Carter Trust v. United States, 256 F. Supp. 2d 536 (N.D. Tex.
2003), a federal district judge held that “common sense” and the notion of the
“trust” as the “taxpayer” dictate that “material participation” in the context of
a trust be determined with reference to the individuals who conduct the
business of the trust on behalf of the trust, not just the trustee as the IRS had
argued, although, alternatively, the court also found that the activities of the
trustee alone were sufficiently “regular, continuous, and substantial.”
d. In Technical Advice Memorandum 200733023 (date not given, released
August 17, 2007), the IRS rejected the reasoning of the Mattie K. Carter
court and, citing a 1986 committee report, reasoned that it was appropriate to
look only to the activities of the trust’s fiduciaries, not its employees. The
IRS also concluded that “special trustees,” who performed a number of tasks
related to the trust’s business but were powerless to commit the trust to a
course of action without the approval of the trustees, were not “fiduciaries”
for this purpose.
e. The IRS took a similar view in Technical Advice Memorandum 201317010
(Jan. 18, 2013). The IRS agreed that a “special trustee” was a fiduciary of
the trust, but only as to his insubstantial time spent in voting the stock of two
S corporations or in considering sales of stock of those corporations
(although one could question what else a trustee does with stock), not as to
his presumably regular, continuous, and substantial time spent as president of
one of the corporations. The technical advice memorandum referred to him
as “an employee” of the company and did not identify circumstances in
which his fiduciary duties to the other trust beneficiaries as special trustee (or
even if he had been a regular trustee) would cause his services as president of
the company to be performed in his role as trustee with serious regard to
those fiduciary duties.
f. There are no rulings yet that apply directly to the 3.8 percent tax.
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g. Final regulations addressing many issues under section 1411 were issued on
November 26, 2013, but did not address the issue of material participation in
the context of trusts. The Preamble candidly acknowledged Treasury’s
sympathy with the problems of material participation and the difficulty of
dealing with those problems.
h. In Frank Aragona Trust, Paul Aragona, Executive Trustee v. Commissioner,
142 T.C. No. 9 (March 27, 2014), the Tax Court (Judge Morrison) rejected an
IRS argument that for purposes of the passive loss rules of section 469 itself a
trust in effect could never materially participate in a trade or business.
i. The court held that a trust operating a real estate business could avoid the
per se characterization of a real estate business as passive under section
469(c)(2), as could a natural person, if, as provided in section
469(c)(7)(B), “(i) more than one-half of the personal services performed
in trades or businesses by the taxpayer during such taxable year are
performed in real property trades or businesses in which the taxpayer
materially participates, and (ii) such taxpayer performs more than 750
hours of services during the taxable year in real property trades or
businesses in which the taxpayer materially participates.” The court also
held that the trust in this case materially participated in the business
because some of its co-trustees materially participated to the extent
required by section 469(c)(7)(B). Therefore, the trust could fully deduct
its expenses, including trustee fees.
ii. The IRS had argued that the activities of trustees who were also
employees of the business could be treated only as the activities of
employees and not the activities of trustees. The court rejected that
notion in part because “[t]he trustees were required by Michigan
statutory law to administer the trust solely in the interests of the trust
beneficiaries, because trustees have a duty to act as a prudent person
would in dealing with the property of another, i.e., a beneficiary.”
iii. Because section 1411 refers to section 469, this decision should shed
light on the determination of “material participation” with respect to
trusts for purposes of the 3.8% net investment income tax.
i. “Guidance regarding material participation by trusts and estates for purposes
of §469” was placed on the Treasury-IRS 2014-2015 Priority Guidance Plan,
published August 26, 2014, under the heading of “General Tax Issues.”
4. The new 3.8 percent tax is imposed on trusts at an income level of $11,950 for
2013, $12,150 for 2014, $12,300 in 2015, and $12,400 on 2016, but it is imposed
on individuals only at an income level over $200,000 ($250,000 for a joint return
and $125,000 for a married person filing separately), and the top regular income
tax rate of 39.6 percent, also applicable to trusts on taxable income over $12,400
in 2016 for example, is otherwise not reached for individuals until an income
level of $466,950 for joint filers and $415,050 for single individuals. As a result,
the difference between the trust’s marginal rate and the marginal rate of its
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beneficiaries can range from 4.6 percent to 33.4 percent, with the highest
difference occurring at the lowest income levels of the beneficiaries. (State
income taxes might increase this effect somewhat.) Therefore, because the
undistributed net income and adjusted gross income of a trust are both reduced by
distributions under sections 651 and 661, it will sometimes be possible to reduce
the overall income tax by making such distributions.
a. Of course, a trustee will have to be satisfied that the applicable distribution
standard (such as “support”) justifies a distribution solely for the purpose of
minimizing overall income tax liability.
b. In addition, a trustee may have to balance that income tax benefit against
purposes of the trust that dictate that income be accumulated for future needs
or future generations.
c. Drafting can determine the extent to which distributions for tax reasons are
encouraged or even permitted.
XVI. FURTHER 2013-2014 DEVELOPMENTS
A. The Deal That Reopened the Federal Government October 16, 2013
1. Funded the federal government by a continuing resolution through January 15,
a. A “continuing resolution” meant that the “sequestration” cuts that took effect
in January 2013 would continue.
b. The January 15, 2014, deadline coincided with the next scheduled round of
$21 billion of “sequestration” cuts, including Medicare cuts.
2. Postponed enforcement of any debt limit until February 7, 2014.
a. Until February 7, 2014, the debt limit could be raised by presidential action,
unless Congress disapproved. Meanwhile, the Secretary of the Treasury was
authorized to use “extraordinary measures” to meet obligations.
b. A “clean” one-year extension was approved in February 2014.
3. Required a House-Senate budget conference to report by December 13, 2013.
4. Required verification that individuals receiving subsidies for health insurance
purchased on exchanges under the Patient Protection and Affordable Care Act
meet the prescribed income limits.
a. The Secretary of Health and Human Services was required to report to
Congress on verification measures by January 1, 2014. (She did so on
December 31, 2013.)
b. In addition, the Inspector General of the Department of Health and Human
Services was required to report to Congress on the effectiveness of measures
to prevent fraud under the Patient Protection and Affordable Care Act.
B. The December 2013 Budget Deal
1. The “regular order” budget conference mandated by the October 2013 deal was
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chaired by Congressman Ryan and Senator Murray. The deal they achieved (H.J.
Res. 59) was approved by the House on December 12 and by the Senate on
December 18, and President Obama signed it on December 26.
2. Spending was set at $1.012 trillion for fiscal 2014 (splitting the difference
between the Democratic goal of $1.058 trillion and the Republican goal of $967
billion) and $1.014 trillion for fiscal 2015.
3. To raise revenue, part of the sequester cuts were extended into 2022 and 2023,
including cuts for Medicare providers, and various fees, including airline security
fees, were increased over the next 10 years. Other savings come from reduced
contributions to federal pensions, divided equally between military retirees and
civilian workers hired after 2013.
4. The deal did not include any significant tax provisions, but it created a relatively
peaceful environment in which to possibly make some progress behind the scenes
on tax reform or other initiatives in 2014 and 2015.
C. Reintroduction of the McDermott Bill
On February 14, 2014, Congressman Jim McDermott (D-WA) introduced the
“Sensible Estate Tax Act of 2014” (H.R. 4061), similar to H.R. 3467 that he had
introduced in 2011. See Part IX.A beginning on page 64.
D. Talk of “Tax Reform” in General
1. While talk of “tax reform” or sometimes “fundamental tax reform” never really
ceases, the possibilities for 2014 originally seemed to be a bit more serious than
a. This optimism was encouraged by the well-known commitment and
cooperation of Senate Finance Committee Chairman Max Baucus (D-MT)
and House Ways and Means Committee Chairman Dave Camp (R-MI).
Senator Baucus released three working drafts during the week of November
18, 2013, addressing the subjects of international taxation, tax administration
and enforcement, and accounting and cost recovery.
b. But in December 2013 President Obama announced his intention to nominate
Senator Baucus as the Ambassador to China; he was succeeded as Finance
Committee Chairman (now Ranking Member) by Senator Ron Wyden of
Oregon). Congressman Camp was in his third and, under House Republican
rules, final term as Ways and Means Committee Chairman, and on March 31,
2014, he announced that he would retire from Congress at the end of that
term. His successor as Chairman was Congressman Paul Ryan of Wisconsin.
2. Meanwhile, on February 26, 2014, Chairman Camp released a “Discussion Draft”
that would create just three individual income tax rates – 10, 25, and 35 percent –
and would phase in a reduced top corporate income tax rate of 25 percent by
2019. The draft includes the elimination or reduction of many deductions and
other tax breaks, including limitations on the charitable deduction and mortgage
interest deduction and elimination of the deduction for personal state and local
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income, property, and sales taxes. Probably because of its treatment of many tax
breaks, Camp’s draft was not immediately embraced with great enthusiasm.
Nevertheless, it remains a source from which reform measures may be drawn in
the foreseeable future. Selected items from the draft include:
a. Examples of changes affecting businesses:
i. Top income tax rate (currently 25% from $50,000 to $75,000, 34% over
$75,000, and 35% over $10 million, with all lower rates phased out at
$18⅓ million) reduced from 35% to 25% in 2% annual increments from
2015 through 2019.
ii. Most special accelerated depreciation rules repealed in favor of straight-
line depreciation over more realistic economic lives.
iii. Percentage depletion (which permits only extractive industries to recover
more than their investments) repealed.
iv. Passive activity exception for working interests in oil and gas properties
v. Like-kind exchanges repealed.
vi. Research credit trimmed down and made permanent, and many other
special credits repealed.
vii. Multiple rules for determining eligibility to use the cash method of
accounting replaced (except for farming businesses and sole
proprietorships) with a single test of no more than $10 million of average
annual gross receipts.
viii. Last-in, first-out (LIFO) inventory method prohibited.
ix. Exceptions from the rule for transfers for value of life insurance policies
repealed if the transferee has no “substantial family, business, or
financial relationship” with the insured.
b. Examples of changes affecting individuals:
i. Mortgage interest limit reduced from $1,000,000 to $500,000 in four
ii. Charitable contributions made deductible if made by April 15 of the
following year (the due date of the income tax return).
iii. Adjusted gross income (AGI) limitations “harmonized” at 40% for
public charities (currently 50% for cash and 30% for capital gain
property) and 25% for most non-operating private foundations (currently
30% for cash and 20% for capital gain property).
iv. Contributions deductible only to the extent they exceed a floor of 2% of
v. “Pease” overall limitation on itemized deductions (actually a rate
increase on high incomes) repealed.
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vi. Alternative minimum tax repealed.
vii. Special temporary rules for contributions of conservation easements,
including special rules for farmers, made permanent.
viii. But no charitable deduction for land reasonably expected to be used as a
ix. 2% floor on “miscellaneous itemized deductions” repealed.
c. Examples of changes affecting charitable organizations:
i. Unrelated Business Taxable Income computed separately for each
ii. Single 1% tax on investment income of private foundations (currently
2% in general and 1% only when certain distribution standards are met).
[This was also in H.R. 644, the “America Gives More Act of 2015,”
which the House of Representatives passed on February 12, 2015.]
iii. 2.5% self-dealing excise tax (10% in cases involving the payment of
compensation) on private foundations themselves.
iv. Donor advised funds required to distribute contributions within five
years of receipt.
v. Private operating foundations made subject to distribution requirements.
vi. Type II and Type III supporting organizations eliminated.
vii. Qualification simplified for social welfare (501(c)(4)) organizations –
notice to IRS required, no Form 1024 needed, and information typically
included on Form 1024 included on first Form 990 instead.
viii. Disclosure of donors of $5,000 or more limited to officers, directors, and
highest compensated employees.
ix. One-year moratorium on changing 501(c)(4) standards.
d. The estate, gift, and GST taxes are not addressed at all.
XVII. THE 114TH CONGRESS (2015-2016)
A. Another Death Tax Repeal Act
1. On April 16, 2015, by a largely party-line vote of 240-179 (with seven Democrats
voting yes and three Republicans voting no), the House of Representatives passed
the “Death Tax Repeal Act of 2015” (H.R. 1105). It had been introduced by
Congressman Kevin Brady (D-TX) (now the chair of the Ways and Means
Committee), and like previous bills he had introduced (e.g., H.R. 1259 in 2011,
see Part IX.B on page 66), it would completely and permanently repeal the estate
and GST taxes and would retain the gift tax at its 2011-2012 level, with a 35
percent rate (for cumulative gifts over $500,000) and an exemption of $5 million.
Unlike the 2011 bill, however, H.R. 1105 would index the exemption for
inflation, so that the 2015 exemption would have remained $5.43 million.
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2. As in 2011, the House-passed bill would retain a carryover basis for gifts and a
date-of-death-value basis for transfers at death (despite the absence of an estate
3. It would also restore the 2001 Tax Act’s enigmatic section 2511(c), providing that
“[n]otwithstanding any other provision of this section and except as provided in
regulations, a transfer in trust shall be treated as a taxable gift under section 2503,
unless the trust is treated as wholly owned by the donor or the donor’s spouse
under subpart E of part I of subchapter J of chapter 1.” (It ignores the 2002
amendment, which changed “taxable gift” to “transfer of property by gift.”) This
provision appears to perpetuate the 2001 lore that the retention of the gift tax is
needed to back-stop the income tax by subjecting to gift tax any transfer that
would be “income-shifting,” but, as in 2001, it is hard to be sure or to fully
understand such a policy.
4. The Ways and Means Committee Report (H.R. Rep. No. 114-52 of April 6, 2015)
While the Committee continues actively to pursue comprehensive tax reform
as a critical means of promoting economic growth and job creation, the
Committee also believes it is important to provide family businesses and farms
with immediate tax relief to help encourage economic growth and job creation.
By repealing the estate tax and the generation skipping transfer tax, families no
longer will be threatened with the loss of a business due to the untimely death of
a family member. Families also will be free to focus their attention on expanding
their businesses and creating jobs rather than wasting critical resources on estate
planning. A family business or farm facing an estate tax bill could be forced to
sell critical assets such as land and inventory, and the business also could face
years of lower capital investment, limiting growth opportunities. In addition, the
Committee believes that the estate tax imposes a double or, in some cases, triple
tax on assets. Repeal of the estate tax eliminates this unfair tax burden.
The Committee believes the Federal estate and generation-skipping transfer
taxes harm taxpayers and the economy and therefore should be repealed. A tax
on capital, such as the estate tax, motivates wealth holders to reduce savings and
increase spending during life, rather than passing it to the next generation,
ultimately increasing the consumption gap between the wealthy and poor. A tax
on capital also causes investors to provide less capital to workers, thereby
reducing wages in the long run.
5. The Committee Democrats replied:
Committee Democrats oppose H.R. 1105. The estate tax has been an
important component of our tax code that promotes fairness and reduces
economic inequality. Repeal of the estate tax would increase the deficit by more
than a quarter of a trillion dollars to provide tax cuts to the wealthiest estates in
Estate taxes promote fairness by providing an essential counterweight to the
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extraordinary benefits conferred on inherited wealth under our income tax
system, and work to mitigate the impacts of wealth inequality. This legislation
would further exacerbate the growing wealth and income inequality in the United
States. The wealth gap is a problem for the economic health of the country as
studies have consistently found that significant disparities in wealth correlate
with poor economic performance. The share of total wealth owned by the top
0.1% in the U.S. grew from 7% in 1978 to 22% in 2012, according to the
National Bureau of Economic Research. In 2013, the median wealth of upper
income families ($639,400) was nearly seven times the median wealth of middle
income families ($96,500), the widest wealth gap since the Federal Reserve
began collecting data 30 years ago. The Congress must not accelerate our
country’s growing wealth inequality by conferring extraordinary tax benefits on
the small number of ultra-wealthy taxpayers.
Under present law, estates valued at less than $5.43 million ($10.86 million
jointly) are exempt from the estate tax, with this exemption increasing annually
for inflation. The reach of the estate tax has been significantly reduced over the
past decade as the exemption amounts have increased so significantly over time
such that 99.85 percent of estates are not subject to any estate tax. While the
majority argues that the estate tax burdens all Americans, the fact is that only the
estates of the wealthiest 0.15 percent pay any estate tax at all. Analysis from the
Joint Committee on Taxation shows that H.R. 1105 would provide an average tax
cut of over $22 million to each estate valued at over $50 million.
These tax cuts for the wealthiest of estates would come at a cost of nearly
$270 billion over the 10-year window. This is more than the budgets for the
Centers for Disease Control and Prevention, the Food and Drug Administration,
and the Environmental Protection Agency combined. In past years, the
Republican Congress has battled over spending the dollars required to provide
adequate funding for National Institutes for Health, which has an annual budget
of $30.9 billion. Misguided Republican priorities have led to consistent
underfunding of important research and public health institutions, while draining
the fisc to deliver hundreds of billions of tax cuts for the nation’s wealthiest.
Furthermore, the Republican budget does not include repeal of the estate tax,
which, if passed, would put their own budget out of balance. Indeed, the
Republican Tax Reform plan that was released last year recognized the
significant cost of repeal, both in terms of the revenue raised by the tax and by
distribution, and retained the estate tax.
The issue of the estate tax affecting small businesses and family farms has
been used as a justification for outright repeal of the estate tax. In general, a
small percentage of taxable estates contain farm or business assets. According to
recent Internal Revenue Service and U.S. Department of Agriculture data,
roughly 0.6 percent of all farm operator estates owed any estate tax, with 97.3
percent of all farm operator estates falling below the current exemption.
Committee Democrats do not disagree with the importance of maintaining
protections for small businesses and family farms. Congress has recognized their
importance and has included exemptions and special provisions to address
perceived burdens in existing law. If those protections are inadequate, the
Congress can act to ensure that working family farms and active small businesses
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are not harmed without eviscerating the wealth transfer tax regime.
6. The arguments in the committee report reflect inputs received from four witnesses
in a hearing of the Subcommittee on Select Revenue Measures on March 18,
2015. The following are excerpts:
When my wife’s grandmother passed in 1988, my father-in-law, who had farmed
the land his entire life, was faced with a huge estate tax. The farm at the time
was a little over 600 acres. Land values were booming and the value of the farm
had doubled over the previous 10 years. John ended up having to sell 120 acres
of land to pay estate taxes. This may not sound like much of a sacrifice since it
left him with 483 acres to farm, but it completely changed the farm business. The
land was lost to development and having houses so close to our fields made it
impossible for us to continue raising cattle.
Brandon Whitt, a seventh-generation farmer from Murfeesboro, Tennessee
Some in Washington may see the death tax as a minor inconvenience for the
wealthy, something that does not deserve attention. The truth is, when the death
tax lands on your doorstep, it is a very big deal. The death tax impacts more than
just the family, it affects the employees of the impacted business and the other
local businesses who are losing customers. The death tax has a ripple effect that
impacts local economies for many years and many times the damage cannot be
undone. This is not a tax on the wealthy elite in America. It’s a death warrant
for far too many family businesses.
Bobby McKnight, a seventh-generation cattleman from Fort Davis, Texas
Over the last few years, my dad has spent countless hours and entirely too much
money trying to figure out how his company can outlive him. Instead of
focusing on growing his business so he can open more branches and employ
more people, he has had to strategize about how to pass his company on to his
kids without having to dismantle it. Most of our strategic management decisions,
whether they are about day-to-day operations or opportunities to expand, involve
consideration of the estate tax in one way or another. We have opted to maintain
a large cash reserve as a precaution. Other companies choose to protect
themselves by purchasing insurance. Either way, money that could be used to
grow and create jobs is sitting on the sidelines.
Karen Madonia, next-generation CFO of a Chicago-area HVAC distributor
The estate tax promotes fairness by providing an essential counterweight to
the extraordinary benefits conferred on inherited wealth under our income tax
system. [Yes, the Minority report borrowed that sentence.] Our current income
tax system favors inherited wealth in two significant ways:
First, inherited wealth is entirely excluded from income taxes. No matter
how much wealth an individual inherits, whether it is $100, $100,000 or $100
million, she is treated the same for income tax purposes as a person who inherits
nothing. [footnote omitted] The failure to tax inherited wealth is particularly
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glaring in comparison to the taxes imposed on wages of working Americans, who
are subject to income taxes of up to 39.6% and payroll taxes of up to 15.3%.
Second, those with inherited wealth enjoy special benefits with respect to
taxation from sales of property. Normally, when an individual sells property, she
is subject to tax on the difference between the amount she receives from the sale
and the purchase price (called “basis”). If the property is passed on by gift, the
recipient has the same basis in the property that the donor had (thus passing on
any built-in gains to the recipient.) However, there is a special basis rule that
applies to property passed on at death: in that case, the heir receives the property
with a basis equal to the fair market value of the property at the time of the
decedent’s death (called “stepped–‐up basis.”) The effect of stepped-up basis is
that an heir can sell inherited property and pay no capital gains taxes, even if the
decedent had significant untaxed built-in gains at the time of death.
The strongest rhetorical argument in favor of repealing the estate tax is its
potential impact on family farms and businesses. As a society, we value the idea
of businesses staying within families. If the estate tax were to significantly limit
that ability, then that could be a strong argument in favor of a legislative fix.
However, despite the rhetorical appeal of the family farm and business
argument, it ultimately does not support estate tax repeal because (1) given the
large exemption amount currently in effect (combined with the ability of spouses
to combine their unified credit exemptions), the vast majority of family farms
and businesses will fall within the exemption amount and therefore not be subject
to the estate tax at all; (2) to the extent that a family farm or business is not
covered by the $5/$10 million exemption there are statutory provisions designed
to mitigate the impact of the estate tax; and (3) if Congress is still concerned
about the potential impact of the estate tax on a family’s ability to pass a family
business on to the next generation, it need not repeal the estate tax, but rather
could easily carve out a targeted exception that would exempt family farms and
businesses from the estate tax.
Repealing the estate tax would impose considerable burdens on society that
go well beyond the loss of revenue that the estate tax raises. In particular: (1)
repeal of the estate tax would cause even greater concentration of wealth among
the wealthiest Americans, resulting in an aristocracy of wealth that threatens our
most cherished democratic ideals and harms our economy; and (2) repeal of the
estate tax could result in a significant reduction in charitable giving which would
in turn have a devastating effect on the charitable sector and the people it serves.
Professor Ray D. Madoff, Boston College Law School (invited by the Minority)
7. Along the lines of the suggestion that Congress could “carve out a targeted
exception that would exempt family farms and businesses from the estate tax,” on
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January 20, 2011, Rep. Mike Thompson (D-CA), a Democrat on the Select
Revenue Measures Subcommittee, had introduced the “Family Farm Preservation
and Conservation Estate Tax Act” (H.R. 390, 112th Congress), which would
exclude from the gross estate the value of property used by a decedent and the
decedent’s family as a farm and impose a recapture tax if such farmland is sold
outside the decedent’s family or is no longer used for farming purposes. It
attracted three Democratic cosponsors and one Republican cosponsor, but the
Ways and Means Committee did not take it up.
8. In a Statement of Administration Policy issued April 14, 2015 (see
r_20150414.pdf), the White House added:
The Administration strongly opposes H.R. 1105, which would add hundreds
of billions of dollars to the deficit to provide large tax cuts exclusively to the very
Repealing the estate tax exclusively benefits just the wealthiest one or two
estates out of every thousand—which would receive a tax cut averaging more
than $3 million each—because current law already exempts more than $5 million
of wealth for individuals and more than $10 million of wealth for couples from
the tax. Given these large exemptions, well over 99 percent of Americans,
including virtually all small businesses and family farms, do not pay any estate
tax. H.R. 1105 would also shift a greater share of the tax burden onto working
Americans at a time when the top one percent already holds more than 40 percent
of the Nation’s wealth and wealth disparities have risen to levels not seen since
H.R. 1105 is fiscally irresponsible and, if enacted, would add $269 billion to
the deficit over ten years, according to the Joint Committee on Taxation. The bill
would worsen the Nation’s long-term fiscal challenges, jeopardizing programs
and investments important to the middle class and national security. In addition,
H.R. 1105, which was reported by the House Ways and Means Committee on
March 25, is inconsistent with the budget resolution passed by the House of
Representatives that same day, which depends on current law estate tax revenues
to meet its purported fiscal goals.
H.R. 1105 is even more extreme than the temporary estate tax repeal enacted
in 2001. That legislation provided for a “carryover basis” regime to prevent large
amounts of accumulated wealth from escaping both income and estate tax. H.R.
1105 contains no such provision. Instead, it leaves in place the largest capital
gains loophole in the tax code by retaining “stepped-up basis” rules that exempt
capital gains on assets held until death from income taxes. The wealthiest
Americans can often afford to hold onto assets until death, which lets them use
the stepped-up basis loophole to avoid ever having to pay income tax on capital
gains. By retaining stepped-up basis even after repealing the estate tax,
enactment of H.R. 1105 would not only add hundreds of billions of dollars to the
deficit to provide huge tax cuts to the most fortunate, it would endorse the
principle that the wealthiest Americans should not have to pay tax on certain
forms of income at all. By contrast, the President’s Budget would repeal the
stepped-up basis loophole.
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The Administration has consistently supported tax relief for middle-class and
working families. The President’s FY 2016 Budget proposes tax credits that
allow paychecks to go further in covering the cost of child care, college, and a
secure retirement, and would create and expand tax credits that support and
reward work. In addition, it would invest in accelerating and sharing economic
growth through education, research, infrastructure, and help for working families.
The President’s proposals are fully paid for, primarily by closing tax loopholes
for the highest-income Americans. The Administration wants to work with the
Congress on fiscally responsible tax relief for middle-class and working
Americans. However, H.R. 1105 represents the wrong approach to the Nation’s
fiscal and economic challenges. If the President were presented with H.R. 1105,
his senior advisors would recommend that he veto the bill.
B. Other House-Passed Legislation
1. At the same time as it passed H.R. 1105, the House passed the “State and Local
Sales Tax Deduction Fairness Act of 2015” (H.R. 622) to make permanent the
section 164(b)(5) election for federal income tax purposes to deduct state and
local sales taxes in lieu of state and local income taxes, which had been a
temporary provision since 2004 and had expired again for 2015. The vote was
somewhat less partisan (272-152, with 34 Democrats voting yes and one
Republican voting no), but it was accompanied by similar partisan rhetoric and a
veto threat. (Eventually this provision was made permanent in the PATH Act of
December 18, 2015. See Part XVII.E.1.c on page 115.)
2. On April 15, 2015, the House had passed seven stand-alone bills by voice vote
under suspension of the rules.
a. The “Prevent Targeting at the IRS Act” (H.R. 709), to permit the firing of
any IRS employee for performing, delaying, or failing to perform (or
threatening to perform, delay, or fail to perform) any official action
(including any audit) with respect to a taxpayer for purpose of extracting
personal gain or benefit or for a political purpose.
b. Authority for the IRS to disclose to taxpayers who complain of alleged illegal
conduct by IRS employees, including unauthorized disclosure or inspection
of tax information, the existence, outcome, and consequences of any internal
investigation based on such complaints (H.R. 1026).
c. Another “Taxpayer Bill of Rights” (H.R. 1058), to ensure that IRS employees
are familiar with and act in accordance with taxpayer rights, including the
rights to be informed, to be assisted, to be heard, to pay no more than the
correct amount of tax, to an appeal, to certainty, to privacy, to confidentiality,
to representation, and to a fair and just tax system.
d. Deduction for gift tax purposes of gifts to organizations described in sections
501(c)(4), (5), and (6) (H.R. 1104).
e. Prohibition of use of personal email accounts for official business by IRS
employees (H.R. 1152).
f. Changes in determining exempt status under section 501(c)(4), requiring a
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social welfare organization that intends to operate as a tax-exempt entity to
notify the IRS of its identity and purpose within 60 days after it is
established, and allowing such an organization to seek a declaratory judgment
concerning its initial or continuing classification as a tax-exempt
organization. (H.R. 1295).
g. Requiring regulations allowing a tax-exempt organization to request an
administrative appeal to the IRS Office of Appeals of an adverse
determination, made on or after May 19, 2014, with respect to the initial or
continuing qualification of such organization as tax-exempt or the initial or
continuing classification of such organization as a private foundation or a
private operating foundation (H.R. 1314).
C. The “Sensible Estate Tax Act of 2015”
1. On March 23, 2015, Congressman Jim McDermott (D-WA) introduced H.R.
1544, the “Sensible Estate Tax Act of 2015,” similar to H.R. 3467 he had
introduced in 2011 (see Part IX.A beginning on page 64) and H.R. 4061 he had
introduced in 2014 (see Part XVI.C on page 97). Effective January 1, 2016, it
would reduce the estate and gift tax exemptions to $1 million, increase the rates to
41 percent over $1 million, 43 percent over $1.25 million, 45 percent over $1.5
million, 50 percent over $5 million, and a top rate of 55 percent over $10 million.
Those numbers would be indexed for inflation after 2016 (thus avoiding the
quirky 2000 inflation base in previous bills).
2. Section 2(c) of H.R. 1544 would provide wording to prevent the “clawback”
effect if lifetime gifts exceed the estate tax exemption, and section 3 would restore
the credit for state death taxes.
3. H.R. 1544 also contains statutory language to reflect, at least roughly, revenue-
raising measures that the Obama Administration has proposed in its annual budget
proposals (discussed in the following Part XVII.D.11), including valuation rules
for nonbusiness assets (section 4), consistency of basis reporting with estate tax
values (section 5), a minimum 10-year term for GRATs (section 6), and a 90-year
limit on the effectiveness of the allocation of GST exemption (section 7).
D. Consistent Basis Reporting Enacted in the “Highway Act”
1. On July 31, 2015, the day that funding for the Highway Trust Fund was scheduled
to expire, President Obama signed into law the Surface Transportation and
Veterans Health Care Choice Improvement Act (Public Law 114-41), extending
that infrastructure funding for three months, with the $8 billion cost funded by
various tax compliance measures. One of those is section 2004 of the Act,
labelled “Consistent Basis Reporting Between Estate and Person Acquiring
Property from Decedent.” The provision adds new provisions to the Code.
a. New section 1014(f) requires in general that the basis of property received
from a decedent may not exceed the value as finally determined for estate tax
purposes, or, if there is no final determination (as in the case of property sold
while an estate tax audit is still in progress or, within the statutory period for
assessments, has not begun) the value reported on the estate tax return.
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b. New section 6035 requires every executor (or person in possession of
property with the statutory duties of an executor) who is required to file an
estate tax return – that is, in general, if the gross estate plus adjusted taxable
gifts exceeds the applicable filing threshold – to furnish to the IRS and to the
recipients of property interests included in the decedent’s gross estate a
statement setting forth the value of those property interests reported on the
estate tax return. This statement is due 30 days after the estate tax return is
filed or, if the return is filed after its due date (including extensions), 30 days
after that due date. Every such statement must be supplemented if a value is
adjusted, for example on audit.
c. There are also penalties for failure to file a required statement and for
reporting basis inconsistently with such a statement.
2. Previously (and still the law unless an estate tax return was or is filed after July
31, 2015), under section 1014(a)(1), the basis of property acquired from a
decedent is simply “the fair market value of the property at the date of the
decedent’s death,” with appropriate adjustments in section 1014 for the alternate
valuation date and so forth. It is possible for the recipient of property from a
decedent to claim, for income tax purposes, that the executor somehow just got
the estate tax value too low, and that the heir’s basis should be greater than the
estate tax value. Usually, of course, such claims are made after the statute of
limitations has run on the estate tax return. Such claims can be accompanied by
elaborate appraisals and other evidence of the “real” date-of-death value that, long
after death, is hard to refute. Invoking principles of “privity,” the Service is able
to insist on using the lower estate tax value when the recipient was one of the
executors who signed the estate tax return, but otherwise it has had no tool to
enforce such consistency.
3. Van Alen v. Commissioner, T.C. Memo 2013-235, however, created confusion
about the role of a duty of consistency in determining the basis of heirs.
a. In Van Alen a brother and sister had inherited a cattle ranch from their father
in 1994, with a low “special use” estate tax value under section 2032A. They
were not executors; their stepmother was. The heirs sold a conservation
easement on the land in 2007 and argued that their basis for determining
capital gain should be higher than the estate tax value. The court held their
basis to the low estate tax value.
b. A key to the outcome was that section 1014(a)(3) describes the basis of
property acquired from a decedent as “in the case of an election under section
2032A, its value determined under such section.” This is in contrast to the
general rule of section 1014(a)(1), which describes the basis as merely “the
fair market value of the property at the date of the decedent’s death,” which
arguably opens up the opportunity for a non-executor heir to argue that the
value “determined” for estate tax purposes was simply too low. In addition,
the court pointed to the special use valuation agreement, which the two heirs
(one, a minor, by his mother as his guardian ad litem) had signed.
Consistently with this rationale for its holding, the court cited Rev. Rul. 54-
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97, 1954-1 C.B. 113 (“the value of the property as determined for the purpose
of the Federal estate tax … is not conclusive but is a presumptive value
which may be rebutted by clear and convincing evidence”), and observed that
“it might be reasonable for taxpayers to rely on this revenue ruling if they
were calculating their basis under section 1014(a)(1).”
c. Surprisingly, however, the court also seemed to view heirs who were not
executors as bound by a “duty of consistency” to use the value determined for
estate tax purposes as their basis for income tax purposes. The court spoke of
a “sufficient identity of interests” between the heirs and the executor and
concluded that “[w]e rest our holding on the unequivocal language of section
1014(a)(3).… And we rest it as well on a duty of consistency that is by now
a background principle of tax law.”
d. While “consistency” is superficially an appealing objective, the notion that it
might apply generally to the basis of an heir who was not an executor may be
more novel and more troubling than the court assumed. The court
acknowledged that “[t]here are lots of cases that hold that the duty of
consistency binds an estate’s beneficiary to a representation made on an
estate-tax return if that beneficiary was a fiduciary of the estate.” But the
court then went on to say: “But the cases don’t limit us to that situation and
instead say that the question of whether there is sufficient identity of interests
between the parties making the first and second representation depends on the
facts and circumstances of each case.” The problem is that the court cited the
same three cases for both propositions, and all three cases involved the basis
of an heir who was a co-executor. Thus, Van Alen appears to stand alone for
applying a duty of consistency to the basis of an heir who was not an
executor, although the Van Alen holding does have the alternative ground of
the word “determined” in section 1014(a)(3), applicable only in special use
4. In the Obama Administration, the Treasury Department’s annual “General
Explanations” of revenue proposals associated with the President’s budget
proposals (popularly called the “Greenbook”) included a provision, last found on
pages 195-96 in the 2015 Greenbook (see http://www.treasury.gov/resource-
center/tax-policy/Documents/General-Explanations-FY2016.pdf) to require the
income tax basis of property received from a decedent or donor to be equal to the
estate tax value or the donor’s basis. The Greenbooks have provided that the
executor or donor would be required to report the necessary information to both
the recipient and the Service.
a. The Greenbook proposal would have been effective for transfers (by death or
by gift) after the year of enactment.
b. Statutory language for this proposal first appeared in 2010 in section 6 of the
Responsible Estate Tax Act, S. 3533 and H.R. 5764. See Part VII.I
beginning on page 32. Revised statutory language appeared in section 5 of
the “Sensible Estate Tax Act of 2011,” H.R. 3467, introduced on November
17, 2011, by Congressman Jim McDermott (D-WA), and, applicable only to
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estate tax values, in section 1422 of Ways and Means Committee Chairman
Dave Camp’s Discussion Draft released February 26, 2014, in section 5 of
the “Sensible Estate Tax Act of 2015,” H.R. 1544, introduced on March 23,
2015, by Congressman McDermott, and then as a “pay-for” in the “Highway
and Transportation Funding Act of 2015, Part II” endorsed by Ways and
Means Committee Chairman Ryan on July 13, 2015, which became the
Surface Transportation and Veterans Health Care Choice Improvement Act
(with a 10-year revenue estimate of $1.542 billion).
5. Compared to the Greenbook proposals, new subsection (f) of section 1014
includes some twists.
a. Like the Camp draft and the current “Sensible Estate Tax Act of 2011” (H.R.
1544), it applies only to property acquired from a decedent, not to gifts.
b. Under section 1014(f)(2), it “shall only apply to any property whose
inclusion in the decedent’s estate increased the liability for the tax imposed
by chapter 11 (reduced by credits allowable against such tax) on such estate.”
In other words, these new rules apparently do not apply to property that
passes to a surviving spouse or to charity, or to property that does not pass to
the surviving spouse but is reported on an estate tax return filed only to elect
portability. (Oddly, there is no such exception to the reporting
requirement of section 6035.)
c. While the Greenbook versions would have been effective for transfers – that
is, for gifts made and decedents dying – after the year of enactment, section
1014(f) (as in H.R. 1544) is applicable to property with respect to which an
estate tax return is filed after the date of enactment – that is, on or after
August 1, 2015. This produces a significant acceleration of the application of
the statute. A return filed after the date of enactment might have been due,
and filed, on August 1, 2015, making the statement due August 31, 2015.
6. In response to that accelerated application, Notice 2015-57, 2015-36 I.R.B. 294,
released on August 21, 2015, extended to February 29, 2016, the due date of any
statements required by section 6035 that otherwise would be due before February
29, 2016. The Notice cited section 6081(a), which allows extensions of time only
for up to six months except in the case of taxpayers who are abroad. February 29,
2016, is the closest date the calendar allows to six months after August 31, 2015.
So the Notice signaled that it was the only extension there will be.
a. Notice 2015-57 also stated that “[t]he Treasury Department and the IRS
expect to issue additional guidance to assist taxpayers with complying with
sections 1014(f) and 6035.” Presumably, they must have thought, by
February 29, 2016.
b. Notice 2016-19, 2016-9 I.R.B. 362, released on February 11, 2016, provided:
“Statements required under sections 6035(a)(1) and (a)(2) to be filed with the
IRS or furnished to a beneficiary before March 31, 2016, need not be filed
with the IRS and furnished to a beneficiary until March 31, 2016.” In other
words the “due date” is not “extended” (confirming the implication of Notice
– 110 –
2015-57), but executors “need not” comply with any due date earlier than
March 31, 2016.
c. Notice 2016-19 added that “[t]he Treasury Department and IRS recommend
that executors and other persons required to file a return under section 6018
wait to prepare the statements required by section 6035(a)(1) and (a)(2) until
the issuance of proposed regulations by the Treasury Department and the IRS
addressing the requirements of section 6035” and that “[t]he Treasury
Department and the IRS expect to issue proposed regulations under sections
1014(f) and 6035 very shortly.”
d. Notice 2016-27, 2016-15 I.R.B. ___, released on March 23, 2016, extended
the same relief through June 30, 2016. The somewhat curious stated
rationale was that “[t]he Treasury Department and the IRS have received
numerous comments that executors and other persons have not had sufficient
time to adopt the systemic changes that would enable the filing of an accurate
and complete Form 8971 and Schedule A.”
7. Meanwhile, the IRS developed Form 8971 (January 2016) for reporting the
information for which the due date was originally August 31, 2015, and then was
February 29, 2016, which “need not” be observed before March 31, 2016. Form
8971 itself is to be filed only with the IRS. It includes a Schedule A that is to be
given to each respective beneficiary (like a K-1), as well as to the IRS.
a. With respect to one of the biggest problems with the reporting deadline –
namely, that executors, especially of estates large enough to be required to
file an estate tax return – the Instructions to Form 8971 candidly state
All property acquired (or expected to be acquired) by a beneficiary must be
listed on that beneficiary’s Schedule A. If the executor has not determined
which beneficiary is to receive an item of property as of the due date of the
Form 8971 and Schedule(s) A, the executor must list all items of property
that could be used, in whole or in part, to fund the beneficiary’s distribution
on that beneficiary’s Schedule A. (This means that the same property may
be reflected on more than one Schedule A.) A supplemental Form 8971 and
corresponding Schedule(s) A should be filed once the distribution to each
such beneficiary has been made.
b. Schedule A of Form 8971 states (emphasis in original):
Notice to Beneficiaries
You have received this schedule to inform you of the value of property you
received from the estate of the decedent named above. Retain this schedule
for tax reporting purposes. If the property increased the estate tax liability,
Internal Revenue Code section 1014(f) applies, requiring the consistent
reporting of basis information. For more information on determining basis,
see IRC section 1014 and/or consult a tax professional.
c. It is striking that the Instructions refer to property “expected to be acquired”
while Schedule A refers to “property you received.” This interchangeability
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of “acquired” and “received” could have been the basis for regulations that
construed the requirement to file Form 8971 to apply only when property had
been distributed by the estate or other “received.” See paragraph 9.b.iii
8. Certain regulations were explicitly contemplated and authorized by the statute.
a. Section 1014(f)(4) states that “[t]he Secretary may by regulations provide
exceptions to the application of this subsection.”
b. Section 6035(b) states that “[t]he Secretary shall prescribe such regulations as
necessary to carry out this section, including regulations relating to (1) the
application of this section to property with regard to which no estate tax
return is required to be filed, and (2) situations in which the surviving joint
tenant or other recipient may have better information than the executor
regarding the basis or fair market value of the property.”
9. Proposed regulations were released on March 2, 2016. Proposed Reg. §§1.1014-
10 & 1.6035-1 (REG-127923-15).
a. The proposed regulations provide some welcome clarifications.
i. Only the “initial” basis of property received from a decedent is subject to
these rules. Proposed Reg. §1.1014-10(a)(1). Subsequent authorized
adjustments are not precluded. Proposed Reg. §§1.1014-10(a)(2) &
ii. The consistency rules do not apply to tangible personal property for
which an appraisal is not required under Reg. §20.2031-6(b) – generally
household and personal effects other than “articles having marked
artistic or intrinsic value of a total value in excess of $3,000.” Proposed
iii. In addition to such tangible personal property, cash (other than a coin
collection or other coins or bills with numismatic value), income in
respect of a decedent, and property that is sold (and therefore not
distributed to a beneficiary) in a transaction in which capital gain or loss
is recognized are exempt from the reporting requirement and do not have
to be included on Form 8971. Proposed Reg. §1.6035-1(b)(1).
iv. The term “executor” is given its usual expanded meaning in section
2203. Proposed Reg. §1.1014-10(d).
v. Form 8971 is not required if the estate tax return was not required for
estate tax purposes and was filed solely to make a portability election
(“notwithstanding §20.2010-2(a)(1)”) or a GST tax election or
exemption allocation. Proposed Reg. §1.6035-1(a)(2).
vi. If a beneficiary is a trust, estate, or business entity, Form 8971 is to be
furnished only to the entity and not to its beneficiaries or owners.
Proposed Reg. §1.6035-1(c)(2).
vii. An executor may state on Form 8971 that a beneficiary cannot be
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located, although the executor must also state the efforts taken to locate
the beneficiary. Proposed Reg. §1.6035-1(c)(4).
viii. A supplemental Form 8971 to report a change in value or otherwise
correct or complete information on an original Form 8971 is not required
to be filed until 30 days after the property is distributed. Proposed Reg.
§1.6035-1(e)(4)(ii). (That, of course, should have been acknowledged as
the appropriate occasion for any reporting under section 6035. See
paragraph b.iii below.)
ix. Indeed, a supplemental Form 8971 is not needed at all merely to report a
distribution of property if a previous Form 8971 included that property
as property that might be used to satisfy the beneficiary’s interest.
Proposed Reg. §1.6035-1(e)(3)(i)(B) & (ii), Examples 1 & 2.
b. The proposed regulations also include some surprising or disappointing
i. After-discovered and omitted property that is not reported on an (initial
or supplemental) estate tax return before the estate tax statute of
limitations runs (thus including all property and omissions discovered
after the estate tax statute of limitations runs) is given a value, and
therefore an initial basis, of zero. Proposed Reg. §1.1014-10(c)(3)(i)(B).
Moreover, if the after-discovered or omitted property would have
increased the gross estate enough to cause an estate tax return to be
required, but no estate tax return was filed, the estate tax value of all
property subject to the consistency rule is considered to be zero.
Proposed Reg. §10.1014-10(c)(3)(ii). The statutory support for these
zero basis rules is very questionable, because such property appears to be
neither “property the final value of which has been determined for
purposes of the [estate] tax” within the meaning of section 1014(f)(1)(A)
nor property “with respect to which a statement has been furnished under
section 6035(a)” within the meaning of section 1014(f)(1)(B).
ii. The consistency rule can apply to a sale of property by a beneficiary if,
after the sale, the estate tax value of the property is decreased. Proposed
Reg. §10.1014-10(e), Example 4.
iii. Echoing the Instructions, Proposed Reg. §1.6035-1(c)(3) states:
If, by the due date [of Form 8971], the executor has not
determined what property will be used to satisfy the interest of
each beneficiary, the executor must report on the Statement for
each such beneficiary all of the property that the executor could
use to satisfy that beneficiary’s interest. Once the exact
distribution has been determined, the executor may, but is not
required to, file and furnish a supplemental Information Return
This is asserted even though a beneficiary who has not yet received (and
may never receive) the property has no use for basis information and
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providing such information serves no discernable purpose of section
1014(f), and even though, like the Instructions, the preamble to the
proposed regulations refers to “each beneficiary who has acquired (or
will acquire) property from the decedent” and the statutory requirement
of section 6035(a)(1) itself attaches only “to each person acquiring any
interest in property.” It seems that the regulations could have carried
that linguistic comparison to its logical conclusion by requiring Form
8971 and Schedule A only with respect to property that is distributed –
that is, “received” – that is, “acquired.” In that case, section 6035(a)(3)
would be construed to not require such reporting for property passing
upon death or distributed before the estate tax return is filed and its value
is reported until 30 days after the return is filed, whereas property
distributed after the estate tax return is filed is reported on a
supplemented Form 8971 and Schedule A within 30 days after the
distribution – a much more workable rule.
iv. The Greenbook proposals since 2009 have explicitly contemplated a
grant of regulatory authority “for situations in which the surviving joint
tenant or other recipient may have better information than the executor.”
Congress seems to have captured that notion in section 6035(b)(2).
Some observers read this as authorizing Treasury to relieve the tension
between an executor and beneficiaries that a strict consistency rule might
otherwise create by permitting beneficiaries to prove a higher value in
some cases. In the preamble to the proposed regulations, Treasury
recites that regulatory authority in section 6035(b)(2), but construes it in
effect to apply only to a person with a legal or beneficial interest in
property who is required to file an estate tax return under section 6018(b)
in some cases.
v. In addition, the preamble to the proposed regulations states:
One commenter requested the creation of a process to allow an
estate beneficiary to challenge the value reported by the
executor. There is no such process under the Federal law
regarding returns described in section 6018. The beneficiary’s
rights with regard to the estate tax valuation of property are
governed by applicable state law. Accordingly, the proposed
regulations do not create a new Federal process for challenging
the value reported by the executor.
In other words, the preamble not only confirms the potential for these
rules to create tension within families (see paragraph 10 below), it
documents Treasury’s indifference to it.
vi. Proposed Reg. §1.6035-1(f) imposes a seemingly open-ended
requirement on the recipient of a Schedule A to in turn file a Form 8971
and Schedule(s) A upon gifts or other retransfers of the property that
result in a carryover basis in whole or in part for the transferee. The
preamble again cites the regulatory authority granted in section
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6035(b)(2) and also a concern “that opportunities may exist in some
circumstances for the recipient of such reporting to circumvent the
purpose of the statute (for example, by making a gift of the property to a
complex trust for the benefit of the transferor’s family).” While such
property does indeed continue to have a basis determined in part with
reference to the value at the time of someone’s death in the past, section
6035 purports to impose the reporting requirement only on the
“executor,” and section 1014(a) itself purports to apply only to property
acquired “from a decedent,” creating great doubt about the statutory
authority for Proposed Reg. §1.6035-1(f), especially when one of the
explicit changes Congress made to Treasury’s Greenbook proposal was
to apply it only to transfer at death, not to lifetime gifts.
10. But no administrative guidance will or can address what many observers consider
the fundamental flaw of the statute – it has the potential, especially when an estate
tax return is audited, to pit family members and other beneficiaries against each
other in an intolerable tension.
a. The Van Alen opinion itself, discussed in paragraph 3 above reveals how
mischievous a “consistency” requirement might be in this context.
b. The court describes how the audit “went back and forth” and the low value of
the ranch could have been a trade for higher values of three other properties.
Indeed, the court said: “The bottom line was that the IRS got an increase in
the total taxable value of the estate … and an increase in the estate tax”
(although later the court said, with specific reference to the ranch, that
“[b]oth Shana and Brett [the heirs], and their father’s estate, benefited from a
reduced estate tax.”
c. If the heirs benefited from the special use valuation, it was a coincidental
detail that is affected by tax apportionment rules and other factors and may
not be present in every estate. And, as Van Alen illustrates, executors often
settle estate tax audits by trade-offs and for strategic reasons that could have
nothing to do with an effort to find the “true” “fair market value” for
purposes of section 1014(a)(1).
d. To bind heirs who do not participate in that audit seems quite unfair, and to
give the heirs a role in the audit would be monstrously impractical. Yet,
enchanted by the Siren Song of “consistency” – not to mention the temptation
of a conjectural revenue gain – Congress seems not to have thought this
11. The 2016 Greenbook renews the proposal of past Greenbooks to also apply the
consistency rules to gifts reportable on a gift tax return and to property qualifying
for an estate tax marital deduction. See Part XVIII.B on page 118.
E. Protecting Americans from Tax Hikes (“PATH”) Act of 2015 (Dec. 18, 2015)
1. The “Tax Hikes” in view were for the most part the tax hikes Congress faces at
the end of nearly every year as various “extender” provisions are about to expire
or, most of the time, have already expired at the beginning of the year and need to
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be retroactively restored. Indeed, 56 (out of 127) sections of the PATH Act deal
with such “extenders,” and 22 of those sections make certain “extenders”
a. Middle-class relief like the child tax credit (Act §101 and Code §24);
American Opportunity Tax Credit (Act §102 and Code §25); and earned
income credit (Act §103 and Code §32).
b. Business provisions like the research and development tax credit (Act §121
and Code §41) and the reduction from ten to five years of the period in which
a newly converted S corporation’s built-in gains are subject to a corporate-
level tax (Act §127 and Code §1374).
c. General provisions like the option to claim an itemized deduction for state
and local sales taxes rather than income taxes (Act §106 and Code
d. Charitable provisions like allowing distributions from IRAs of individuals
over 70½, up to $100,000 per year, without including those amounts in gross
income (Act §112 and Code §408(d)(8)); favorable rules for contributions of
real property for conservation purposes, especially for farmers and ranchers
and Alaska Native Corporations (Act §111 and Code §170(b)); favorable
rules for certain contributions of food inventory (Act §113 and Code
§170(e)(3)(C)); and not reducing the basis in an S corporation shareholder’s
stock by the unrealized appreciation in property contributed to charity by the
S corporation (Act §115 and Code §1367(a)(2)).
2. A subtitle labelled “Internal Revenue Service Reforms” reflects the wary view of
the IRS held by congressional leadership, including:
a. Provisions related to tax-exempt organizations like a streamlined recognition
process for section 501(c)(4) social welfare organizations (Act §405 and
Code §506); a requirement that the IRS allow administrative appeals of
adverse exemption determinations to the Office of Appeals (Act §404 and
Code §7123); extension of declaratory judgment relief under section 7428 to
all organizations described in section 501(c) (not just section 501(c)(3) and
explicitly including section 501(c)(4)) (Act §406 and Code §7428); and
exemption from gift tax of gifts to section 501(c)(4), (5), and (6) (social
welfare, labor, agricultural, horticultural, business league, etc.) organizations
(Act §408 and Code §2501(a)).
b. Provisions of more general application like the codification of a “taxpayer
bill of rights” (Act §401 and Code §7803(a)(3)); the prohibition of IRS
employees from using a personal email account to conduct government
business (Act §402); a provision for taxpayers who have been victimized by
the IRS, such as by unauthorized disclosure of private tax information, to
learn the IRS’s reaction, such as whether the case is being investigated or
referred to the Justice Department for prosecution (Act §403 and Code
§6103(e)(11)); and a requirement that an IRS employee who performs,
delays, or fails to take any official action for personal gain or political
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purposes be terminated (Act §407).
XVIII. THE ADMINISTRATION’S REVENUE PROPOSALS
The Treasury Department’s “General Explanations of the Administration’s Fiscal
Year 2010 Revenue Proposals” (popularly called the “Greenbook”) was released on May
11, 2009. See http://www.treas.gov/resource-center/tax-policy/Documents/grnbk09.pdf.
An Appendix, on page 125, confirmed that “[e]state and gift taxes are assumed to be
extended at parameters in effect for calendar year 2009 (a top rate of 45 percent and an
exemption amount of $3.5 million).” On pages 119-23, as revenue raisers dedicated to
health care reform, three revenue-raising proposals were described under the heading
“Modify Estate and Gift Tax Valuation Discounts and Make Other Reforms,” requiring
consistency in value for transfer and income tax purposes, modifying rules on valuation
discounts, and requiring a minimum term for GRATs. On page 112, under the heading
“Insurance Companies and Products,” the Greenbook proposed to “modify the transfer-
for-value rule [applicable to life insurance policies] to ensure that exceptions to that rule
would not apply to buyers of polices” in life settlement transactions.
The “General Explanations of the Administration’s Fiscal Year 2011 Revenue
Proposals” was released on February 1, 2010. See http://www.treas.gov/resource-
center/tax-policy/Documents/greenbk10.pdf. Again, an Appendix, on page 147, stated
that “[e]state and gift and GST taxes are assumed to be extended at parameters in effect
for calendar year 2009 (a top rate of 45 percent and an exemption amount of $3.5
million).” (The words “and GST” are added in the 2010 Greenbook.) In footnotes on
pages 124 and 126, the 2010 Greenbook stated:
The Administration’s baseline assumes that the laws governing the estate, gift and
generation-skipping taxes as in effect during 2009 are extended permanently.
Consequently, the discussion of Current Law set forth above reflects the applicable law
as in effect during 2009.
The 2010 Greenbook included the same estate and gift tax proposals (pages 122-
26), except that they were under the overall heading of “Reduce the Tax Gap and Make
Reforms” and not tied to health care reform. The 2010 proposals were identical to the
2009 proposals, except in one detail related to GRATs described below, and on page 69
there was the same life insurance proposal as in the 2009 Greenbook.
The “General Explanations of the Administration’s Fiscal Year 2012 Revenue
Proposals” was released on February 14, 2011. See http://www.treas.gov/resource-
center/tax-policy/Documents/Final%20Greenbook%20Feb%202012.pdf. In a footnote to
the table of contents, the 2011 Greenbook stated, among other things, that “[t]he
Administration’s policy proposals reflect changes from a tax baseline that modifies the
Budget Enforcement Act baseline by … freezing the estate tax at 2009 levels.” The 2011
Greenbook included the life insurance proposal (page 51) and the same three estate and
gift tax proposals (pages 125-28). In addition, on pages 123-24, the 2011 Greenbook
includes a proposal to make permanent the portability of unused exemption between
spouses and, on pages 129-30, a proposal to generally terminate an allocation of GST
exemption to a trust after 90 years.
The “General Explanations of the Administration’s Fiscal Year 2013 Revenue
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Proposals” was released on February 13, 2012 (see http://www.treasury.gov/resource-
center/tax-policy/Documents/General-Explanations-FY2013.pdf). The 2012 Greenbook
repeated the proposals of the previous Greenbooks (pages 75-82) and added two, a
surprisingly broad proposal to apparently subject all grantor trusts to gift or estate tax
(page 83) and a noncontroversial proposal to extend the lien on estate tax deferrals under
section 6166 (page 84).
The “General Explanations of the Administration’s Fiscal Year 2014 Revenue
Proposals” was released on April 10, 2013 (see http://www.treasury.gov/resource-
center/tax-policy/Documents/General-Explanations-FY2014.pdf), about two months later
than usual. Seven proposals under the heading “Modify Estate and Gift Tax Provisions”
(pages 138-48) changed the grantor trust proposal, omitted the valuation discount
proposal, and added one new proposal dealing with the GST tax treatment of “health and
education exclusion trusts.”
The “General Explanations of the Administration’s Fiscal Year 2015 Revenue
Proposals” was released on March 4, 2014 (see http://www.treasury.gov/resource-
center/tax-policy/Documents/General-Explanations-FY2015.pdf). Nine proposals under
the heading “Modify Estate and Gift Tax Provisions” (pages 158-72) included without
significant change the seven proposals from 2013, plus two new proposals dealing with
the annual gift tax exclusion and the definition of “executor.”
The “General Explanations of the Administration’s Fiscal Year 2016 Revenue
Proposals” was released on February 2, 2015 (see http://www.treasury.gov/resource-
center/tax-policy/Documents/General-Explanations-FY2016.pdf). The following eight
proposals under the heading “Modify Estate and Gift Tax Provisions” (pages 193-206)
are the same as the nine proposals from the 2014 Greenbook, with the proposal on
GRATs combined with the proposal on grantor trusts and, in the process, substantially
The “General Explanations of the Administration’s Fiscal Year 2017 Revenue
Proposals” was released on February 9, 2016 (see https://www.treasury.gov/resource-
center/tax-policy/Documents/General-Explanations-FY2017.pdf). The following eight
proposals under the heading “Modify Estate and Gift Tax Provisions” (pages 179-89) are
the same as the nine proposals from the 2015 Greenbook, except that the proposal
regarding consistent basis is now a reprise of certain features and applications that
Congress eliminated from the 2015 legislation.
A. “Restore the Estate, Gift, and Generation-Skipping Transfer Tax Parameters in
Effect in 2009”
1. In spite of the “permanent” legislation enacted in the 2012 Tax Act (ATRA) but
generally consistently with the Administration’s previous budget proposals, the
2013 Greenbook (pages 138-39) revived the proposal to return the estate, gift, and
GST taxes to their 2009 levels, including a top 45 percent rate and non-indexed
exemptions of $3.5 million for the estate and GST taxes and $1 million for the gift
tax, which, as in past years, the Greenbook quixotically calls “parameters.”
a. The twist in the 2013 Greenbook was that it called for this return to 2009
levels to happen in 2018. No explanation was given for the four-year delay.
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The 2014 Greenbook (pages 158-59) was the same.
b. The 2015 Greenbook (pages 193-94) returns to a more traditional effective
date of January 1, 2016. The first higher tax payments would be due October
3, 2016, barely four weeks before the 2016 presidential election.
2. Like the 2013, 2014, and 2015 Greenbooks, the 2016 Greenbook (page 178)
states that “ATRA retained a substantial portion of the tax cut provided to the
most affluent taxpayers under [the 2010 Tax Act] that we cannot afford to
continue. The United States needs an estate tax law that is fair and raises an
appropriate amount of revenue.”
a. Even so, there is little indication that Congress is eager to revisit what it just
made permanent in January 2013.
b. If anything, the larger number of Republicans in Congress makes it more
likely that Congress will want to permanently repeal the estate tax, although
there is no indication that they would be willing to trade anything significant
enough to overcome President Obama’s disposition to veto it.
3. The proposal is estimated to raise revenue by $201.754 billion over fiscal years
2017 through 2026.
4. The 2013, 2014, 2015, and 2016 Greenbooks also call for permanent retention of
portability and mitigation of the potential “clawback” that could occur when the
unified credit for estate tax purposes is lower than the unified credit in effect
when lifetime gifts were made. See Part VIII.G beginning on page 53.
B. “Expand Requirement of Consistency in Value for Transfer and Income Tax
1. A version of the proposal in previous Greenbooks was enacted in the Surface
Transportation and Veterans Health Care Choice Improvement Act of 2015,
signed into law on July 31, 2015. See Part XVII.D, beginning on page 106.
2. What Congress enacted in 2015 departed from the Administration’s proposals in a
number of respects, including its effective date provisions, but also including the
limitation of the rules to transfers at death (not by gift) and only to property
transferred at death “whose inclusion in the decedent’s estate increased the
liability for the tax imposed by chapter 11 (reduced by credits allowable against
such tax) on such estate.”
3. In reaction to those changes, the 2016 Greenbook (page 179) renews the proposal
to apply the consistency rules to gifts reportable on a gift tax return and to
property qualifying for an estate tax marital deduction (but not the charitable
deduction). The Greenbook explains:
Reasons for Change
Because the consistency requirement enacted in 2015 applies only to the
particular items of property that generate a federal estate tax, the requirement
does not apply to property transferred by gift, or to property that qualifies for the
estate tax marital or charitable deduction, or to any property of an estate with a
– 119 –
total value that does not exceed the applicable exclusion amount ($5,450,000 for
2016). Although the exclusion of property given on death to charities (tax-
exempt organizations) has only a minimal impact for income tax purposes, there
is a possible effect on the annual excise tax imposed on certain such
organizations. However, the exclusion from the application of the consistency
requirement of property qualifying for the estate tax marital deduction is
significant because an unlimited amount of property may qualify for the estate
tax marital deduction in a decedent’s estate tax proceeding. Although it is true
that the value of such property passing to the decedent’s surviving spouse may be
increased without incurring any federal estate tax, and a high estate tax value
provides a high cap on the recipient’s permissible basis, current law contains
provisions to prevent an inaccurately high estate tax valuation. Specifically, the
executor certifies to the accuracy of the information on the estate tax return under
penalties of perjury, and significant underpayment penalties are imposed on the
understatement of capital gains and thus income tax that would result from an
overstatement of basis.
The proposal would expand the property subject to the consistency requirement
imposed under section 1014(f) to also include (1) property qualifying for the
estate tax marital deduction, provided a return is required to be filed under
section 6018, even though that property does not increase the estate’s federal
estate tax liability, and (2) property transferred by gift, provided that the gift is
required to be reported on a federal gift tax return.
4. Like past Greenbook proposals, and unlike the 2015 legislation, these Treasury
proposals would be effective for transfers after the year of enactment.
5. The 2015 Greenbook estimated the 10-year revenue gain from its original
proposal as $3.237 billion, while the 2016 Greenbook estimates the 10-year
revenue gain of its two changes as $1.693 billion. In other words, the Treasury
revenue estimators think Congress got only about half of the job done.
C. “Modify Transfer Tax Rules for Grantor Retained Annuity Trusts (GRATs) and
Other Grantor Trusts”
1. The GRAT Proposal, 2009-2014
a. After reciting the history of section 2702 and the use of GRATs, the
Greenbooks, prior to 2015 (page 162 in the 2014 Greenbook) noted that
“[t]axpayers have become adept at maximizing the benefit of this technique,
often by minimizing the term of the GRAT (thus reducing the risk of the
grantor’s death during the term), in many cases to two years, and by retaining
annuity interests significant enough to reduce the gift tax value of the
remainder interest to zero or to a number small enough to generate only a
minimal gift tax liability.”
b. While rumors had occasionally been heard of congressional plans to limit the
attractiveness of GRATs by imposing a minimum gift tax value for the
remainder (such as 10 percent), the Greenbooks instead proposed to increase
the mortality risk of GRATs by requiring a minimum 10-year term.
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i. Both the Greenbooks and the September 8, 2009, Joint Committee staff’s
publication focused on the effect of the proposal in increasing the
mortality risk of a GRAT, not necessarily its effect in diminishing the
upside from volatility.
ii. The JCT staff publication noted that even a 10-year GRAT could be used
“as a gift tax avoidance tool” and that a 10-year minimum term might
encourage the use of GRATs by younger taxpayers. As an alternative
way of achieving more accurate valuation, the JCT staff publication
suggested valuation of the remainder interest for gift tax purposes at the
end of the GRAT term when the remainder is distributed – embracing the
“hard to complete” approach floated by the Reagan Administration’s
“Treasury I” (Part II.D.1.b on page 3).
c. Before 2015, the Greenbook discussions actually ratified the use of “zeroed-
out” GRATs, within the constraint of a minimum 10-year term.
i. In the single substantive change from the 2009 Greenbook, the 2010 and
2011 Greenbooks added that “[t]he proposal would also include a
requirement that the remainder interest have a value greater than zero
and would prohibit any decrease in the annuity during the GRAT term.”
The 2012 Greenbook clarified that the requirement is “that the remainder
interest have a value greater than zero at the time the interest is created”
ii. Nevertheless, the 2010, 2011, 2012, 2013, and 2014 Greenbooks went on
to say, like the 2009 Greenbook, that “a minimum term would not
prevent ‘zeroing-out’ the gift tax value of the remainder interest.”
Obviously near-zeroing-out is what is meant.
d. The 2012 Greenbook added an additional requirement of a maximum term
equal to the life expectancy of the annuitant plus 10 years. That would limit
the use of very long-term “Walton-style” GRATs with a low annual payout
that would result in a reduced inclusion in the gross estate under Reg.
e. The 2013 and 2014 Greenbooks made no change from the 2012 Greenbook.
f. The proposal would apply to GRATs created after the date of enactment.
g. The proposal was estimated to raise revenue over 10 years by $3¼ billion in
the 2009 Greenbook, $2.959 billion in the 2010 and 2011 Greenbooks, $3⅓
billion in the 2012 Greenbook, $3.894 in the 2013 Greenbook, and $5.711 in
the 2014 Greenbook. (The June 11, 2009, Joint Committee on Taxation
estimates scored the 10-year revenue gain from the Administration proposal
at $2.28 billion.)
h. These limitations on GRATs were included in section 307 of the “Small
Business and Infrastructure Jobs Tax Act of 2010” (H.R. 4849), which the
Democratically-controlled House of Representatives passed by a vote of 246-
178 on March 25, 2010. The vote was partisan; only four Republicans voted
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for the bill and only seven Democrats voted against it. Reminiscent both of
the Greenbooks’ explanations and of the 1990 legislative history of section
2702 itself, the House Ways and Means Committee offered the following
“Reasons for Change”:
The valuation rates and tables prescribed by section 7520 often produce
relative values of the annuity and remainder interests in a GRAT that are not
consistent with actual returns on trust assets. As a result, under present law,
taxpayers can use GRATs to make gifts of property with little or no transfer
tax consequences, so long as the investment return on assets in the trust is
greater than the rate of return assumed under section 7520 for purposes of
valuing the lead and remainder interests. The Committee believes that such
uses of GRATs for gift tax avoidance are inappropriate.
In some cases, for example, taxpayers “zero out” a GRAT by structuring
the trust so that the assumed value of the annuity interest under the actuarial
tables equals (or nearly equals) the entire value of the property transferred to
the trust. Under this strategy, the value of the remainder interest is deemed
to be equal to or near zero, and little or no gift tax is paid. In reality,
however, a remainder interest in a GRAT often has real and substantial
value, because taxpayers may achieve returns on trust assets substantially in
excess of the returns assumed under section 7520. Any such excess
appreciation passes to the remainder beneficiaries without further transfer tax
In addition, grantors often structure GRATs with relatively short terms,
such as two years, to minimize the risk that the grantor will die during the
trust term, causing all or part of the trust assets to be included in the grantor’s
estate for estate tax purposes. Because GRATs carry little down-side risk,
grantors frequently maintain multiple short-term, zeroed-out GRATs funded
with different asset portfolios to improve the grantor’s odds that at least one
trust will outperform significantly the section 7520 rate assumptions and
thereby allow the grantor to achieve a transfer to the remainder beneficiaries
at little or no gift tax cost.
The provision is designed to introduce additional downside risk to the
use of GRATs by imposing a requirement that GRATs have a minimum term
of 10 years. Relative to shorter-term (e.g., two-year) GRATs, a GRAT with
a 10-year term carries greater risk that the grantor will die during the trust
term and that the trust assets will be included in the grantor’s estate for estate
tax purposes. The provision limits opportunities to inappropriately achieve
gift tax-free transfers to family members in situations where gifts of
remainder interests in fact have substantial value.
H.R. REP. NO. 111-447, 111TH CONG., 2D SESS. 55-56. (2010) (footnote
i. The GRAT limitations contained in H.R. 4849, like the Administration’s
recommendations, were to apply to transfers made after the date of the
enactment – that is, after the date the President signs it into law.
j. The same provisions appeared in
i. section 531 of the “Small Business Jobs Tax Relief Act of 2010” (H.R.
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5486), which the House of Representatives passed by a vote of 247-170
(with five Republicans in favor and eight Democrats against) on June 15,
ii. the supplemental appropriations bill (H.R. 4899) that the House
approved on July 1, 2010,
iii. section 8 of the “Responsible Estate Tax Act” (S. 3533 and H.R. 5764),
introduced by Senator Sanders on June 24, 2010, and Rep. Linda
Sanchez on July 15, 2010 (see Part VII.I.5 on page 33), and
iv. section 308 of the December 2010 “Baucus Bill” (see Part VII.J.5 on
k. These provisions appeared again in section 301 of the “Trade Adjustment
Assistance Extension Act of 2011,” (S. 1286), introduced on June 28, 2011,
by Senators Casey (D-PA) and Brown (D-OH), neither of whom was a
member of the Finance Committee. Unlike the other bills, this provision, as
introduced, would have applied to GRATs funded after December 31, 2010.
There seems to be little or no chance that Congress would pass such
l. If a minimum 10-year term for GRATs is required, it will be harder to realize
one of the chief benefits of a GRAT, which is capturing upside volatility in
the GRAT for the benefit of the next generation. (The Greenbooks and the
JCT staff publication focused on the effect of the proposal in increasing the
mortality risk of a GRAT, not necessarily its effect in diminishing the upside
i. With current values that are still depressed in some industries, difficulty
in predicting the timing of recovery, and relatively low interest rates
under section 7520, many clients have recently been opting for GRATs
with terms longer than the typical two years anyway.
ii. But requiring a minimum 10-year term (at least before the 2015
proposal) would encourage more customizing of the terms of a GRAT,
including greater use of level GRATs or GRATs in which the annuity
increases in some years but not others or increases at different rates in
different years. For example, the typical 20 percent increase in the
annuity payment each year would produce a payment in the tenth year
equal to about 5.16 times the payment in the first year.
iii. A 10-year GRAT might also demand greater monitoring and active
management. For example, if the asset originally contributed to the
GRAT achieves its anticipated upside early in the 10-year term (maybe
in the first year or two as is hoped for with a two-year GRAT), the
grantor can withdraw that asset and substitute another asset of equivalent
value with upside potential. If the grantor holds that withdrawn
appreciated asset until death, this will also permit the asset to receive a
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iv. A longer term for the GRAT will also permit a lower payout rate, which
could make it easier to fund the annuity payments with cash (as with S
corporation stock where the corporation distributes cash to equip its
shareholders to pay income tax) and thereby avoid an annual appraisal.
v. A lower payout rate could result in a smaller amount includible in the
grantor’s gross estate under section 2036 if the grantor dies during the
10-year term. Under Reg. §20.2036-1(c)(2)(i) (promulgated in April
2008) that includible amount is the amount needed to sustain the retained
annuity interest without invasion of principal – that is, in perpetuity.
Thus, for example, a 10-year GRAT with a level payout created when
the section 7520 rate is 2.0 percent (as it was in February 2015) will
require a payout equal to about 11.1 percent of the initial value. If the
section 7520 rate when the grantor dies is 5.0 percent (as it was as
recently as December 2007), the amount included in the grantor’s gross
estate will be 222 percent of the initial value. That would represent a lot
of appreciation, but often that is exactly what is hoped for when a GRAT
is created. In that case, any appreciation in excess of 122 percent will
pass tax-free to the next generation, even if the grantor dies during the
10-year term (unless the GRAT instrument provides for a reversion to
the grantor, a general power of appointment, or a similar feature that
would result in total inclusion of the date-of-death value in the gross
m. Planners who don’t mind monitoring the requirements of two sets of tax rules
in the same transaction will be intrigued by the possibility of placing a
preferred (frozen) interest in a partnership (or LLC) that meets the
requirements of section 2701 into a GRAT that meets the requirements of
i. This technique is described in Angkatavanich & Yates, “The Preferred
Partnership GRAT—A Way Around the ETIP Issue,” 35 ACTEC
JOURNAL 289 (2009). In the paradigm addressed in this thoughtful
article, the partnership (or LLC) is formed by the prospective grantor’s
capital contribution in exchange for the preferred interest and a capital
contribution by a GST-tax-exempt generation-skipping trust in exchange
for the growth interest in the partnership. The payouts on the preferred
interest are structured to be “qualified payments” within the meaning of
ii. Even if the grantor dies during the GRAT term, the underlying
appreciation in the partnership growth interest will still escape estate tax.
iii. Moreover, all the appreciation in the partnership growth interest will be
captured in a generation-skipping trust, unlike the typical GRAT.
2. The Grantor Trust Proposal, 2012-2014
a. Most of the rules treating a grantor as the “owner” of a trust were crafted in
the 1930s and 1940s to curb the shifting of taxable income to taxpayers in
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lower income tax brackets, even to the spouses of grantors in common law
states before 1948 when joint income tax returns were introduced.
b. At least since the promulgation of Rev. Rul. 85-13, 1985-1 C.B. 184, in
which the Service held that an apparent sale between a grantor trust and its
grantor would not be regarded as a sale for income tax purposes, the
disconnect between the grantor trust rules and the gift and estate tax rules has
inspired considerable effective planning with so-called “defective” grantor
c. It is hard to argue that the grantor’s payment of income tax on someone else’s
income is not economically equivalent to a gift, but, because the tax is the
grantor’s own obligation under the grantor trust rules, it escapes gift tax. And
sales to grantor trusts are often viewed as economically equivalent – or
superior – to GRATs, but without the policing of sections 2702 and 2036 or
the “ETIP” restrictions of section 2642(f) on allocating GST exemption.
d. Relatively recent developments have seemed to actually ratify and validate
the widespread use of grantor trusts in estate planning, including
i. Rev. Rul. 2004-64, 2004-2 C.B. 7, addressing the estate tax
consequences of provisions regarding the reimbursement of the grantor
for income tax on the grantor trust’s income,
ii. Rev. Rul. 2007-13, 2007-11 I.R.B. 684, holding that the transfer of life
insurance contracts between two grantor trusts treated as owned by the
same grantor is not a transfer for valuable consideration for purposes of
iii. Rev. Rul. 2008-22, 2008-16 I.R.B. 796, providing reassurance regarding
the estate tax consequences under sections 2036 and 2038 of the
grantor’s retention of a section 675(4)(C) power, exercisable in a
nonfiduciary capacity, to acquire property held in trust by substituting
property of equivalent value,
iv. Rev. Rul. 2011-28, 2011-49 I.R.B. 830, extending that reassurance to
section 2042 and cases where the trust property includes policies of
insurance on the grantor’s life, and
v. Rev. Proc. 2008-45, 2008-30 I.R.B. 224, promulgating sample inter
vivos charitable lead unitrust forms, including forms for both nongrantor
and grantor CLUTs, where the feature used to confer grantor trust status
is such a substitution power in a person other than the grantor.
e. Nevertheless, there has long been interest in closing the gap between the two
sets of tax rules. The Greenbook proposal, new in 2012, would simply
include the date-of-death value of all grantor trusts in the grantor’s gross
estate and subject that value to estate tax. Specifically, the 2012 Greenbook
(page 83) stated:
To the extent that the income tax rules treat a grantor of a trust as an owner
of the trust, the proposal would (1) include the assets of that trust in the gross
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estate of that grantor for estate tax purposes, (2) subject to gift tax any
distribution from the trust to one or more beneficiaries during the grantor’s
life, and (3) subject to gift tax the remaining trust assets at any time during
the grantor’s life if the grantor ceases to be treated as an owner of the trust
for income tax purposes. In addition, the proposal would apply to any non-
grantor who is deemed to be an owner of the trust and who engages in a sale,
exchange, or comparable transaction with the trust that would have been
subject to capital gains tax if the person had not been a deemed owner of the
trust. In such a case, the proposal would subject to transfer tax the portion of
the trust attributable to the property received by the trust in that transaction,
including all retained income therefrom, appreciation thereon, and
reinvestments thereof, net of the amount of the consideration received by the
person in that transaction. The proposal would reduce the amount subject to
transfer tax by the value of any taxable gift made to the trust by the deemed
owner. The transfer tax imposed by this proposal would be payable from the
f. That proposal was very broad and vague, and many observers assumed that it
would be revised. Sure enough, in the 2013 Greenbook (page 145) and the
2014 Greenbook (page 166), the proposal was reworded as follows:
If a person who is a deemed owner under the grantor trust rules of all or a
portion of a trust engages in a transaction with that trust that constitutes a
sale, exchange, or comparable transaction that is disregarded for income tax
purposes by reason of the person’s treatment as a deemed owner of the trust,
then the portion of the trust attributable to the property received by the trust
in that transaction (including all retained income therefrom, appreciation
thereon, and reinvestments thereof, net of the amount of the consideration
received by the person in that transaction) will be subject to estate tax as part
of the gross estate of the deemed owner, will be subject to gift tax at any time
during the deemed owner’s life when his or her treatment as a deemed owner
of the trust is terminated, and will be treated as a gift by the deemed owner to
the extent any distribution is made to another person (except in discharge of
the deemed owner’s obligation to the distributee) during the life of the
deemed owner. The proposal would reduce the amount subject to transfer
tax by any portion of that amount that was treated as a prior taxable gift by
the deemed owner. The transfer tax imposed by this proposal would be
payable from the trust.
g. In comparison to the 2012 Greenbook, the 2013 and 2014 Greenbooks
referred more to “a deemed owner” and less to “the grantor.”
i. The classic paradigm trust deemed owned by a beneficiary for income
tax purposes under section 678(a) would likely be included in the
beneficiary’s gross estate anyway, because the power described in
section 678(a) would essentially be a general power of appointment.
Therefore, the changes in this Greenbook from references to “the
grantor” to “a deemed owner” may indicate that more sophisticated
beneficiary-owned trusts are in view.
ii. It is no secret that the Service is concerned about such trusts and is
watching the developments that might affect such trusts. Rev. Proc.
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2013-3, 2013-1 I.R.B. 113, §4.01(48) included “[w]hether trust assets are
includible in a trust beneficiary’s gross estate under §§ 2035, 2036, 2037,
2038, or 2042 if the beneficiary sells property (including insurance
policies) to the trust or dies within 3 years of selling such property to the
trust, and (i) the beneficiary has a power to withdraw the trust property
(or had such power prior to a release or modification, but retains other
powers which would cause that person to be the owner if the person were
the grantor), other than a power which would constitute a general power
of appointment within the meaning of § 2041, (ii) the trust purchases the
property with a note, and (iii) the value of the assets with which the trust
was funded by the grantor is nominal compared to the value of the
property purchased” among what Rev. Proc. 2013-3 described as “areas
in which rulings or determination letters will not ordinarily be issued.”
That fact pattern was also included as a no-rule area for purposes of
deemed owner status (§4.01(43)), completed gift treatment (§4.01(55)),
and the application of section 2702 (§4.01(63)). That IRS position is
maintained in Rev. Proc. 2016-3, 2016-1 I.R.B. 126, §4.01(44) (deemed
owner status), (49) (estate inclusion), (52) (completed gift treatment) and
(60) (application of section 2702).
h. Like the 2012 Greenbook, the 2013 Greenbook also stated:
The proposal would not change the treatment of any trust that is already
includable in the grantor’s gross estate under existing provisions of the
Internal Revenue Code, including without limitation the following: grantor
retained income trusts; grantor retained annuity trusts; personal residence
trusts; and qualified personal residence trusts.
That is an odd concession.
i. The implication is that the treatment of GRATs, for example, does not
have to be changed because GRATs already are treated consistently with
the Greenbook proposal. In fact, while it is assumed that all or most
GRATs are grantor trusts (which can facilitate payment of the annuity in
kind without capital gain), the value of the assets in a long-term GRAT
might not be fully included in the grantor’s gross estate, and the
termination of a GRAT’s grantor trust status, which may or may not
occur at the end of the GRAT term, is not treated as a taxable gift.
ii. In any event, the trusts cited in the Greenbook – GRITs, GRATs, PRTs,
and QPRTs – ordinarily do not acquire assets from the grantor by
purchase, so there is no reason to think that they would be affected by
this proposal anyway.
i. The Greenbooks say nothing about adjustments to basis, under either section
1015(d)6) with respect to gift tax or section 1014(b)(9) with respect to estate
j. The reference to GRITs, GRATs, PRTs, and QPRTs was followed in the
2012 Greenbook by a description of the proposed effective date,
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accompanied by a reference to “[r]egulatory authority …, including the
ability to create transition relief for certain types of automatic, periodic
contributions to existing grantor trusts,” fueling the speculation that the
proposal was aimed at life insurance trusts, where the periodic payment of
premiums, while not exactly “automatic,” is typically done under the terms of
a preexisting insurance contract.
k. In contrast, the reference to GRITs, GRATs, PRTs, and QPRTs in the 2013
Greenbook was followed by disclaimers that the proposal “would not apply
to any trust having the exclusive purpose of paying deferred compensation
under a nonqualified deferred compensation plan if the assets of such trust
are available to satisfy claims of general creditors of the grantor” (possibly a
reference to a “rabbi trust”) or “to any trust that is a grantor trust solely by
reason of section 677(a)(3)” (evidently a reference to life insurance trusts).
i. The passes given to these trusts were no doubt meant to be helpful, and
they were helpful, but they only highlighted the tension that remains
inherent in the proposal.
ii. For example, life insurance trusts sometimes can and do acquire assets
from the grantor by purchase, including life insurance policies, and those
policies are certainly expected to increase in value. The fact that they
nevertheless are not covered by the clarified proposal still leaves us
wondering what policy lies behind the proposal or what characteristics of
estate planning techniques actually offend that policy.
iii. And the implication that a life insurance trust that purchases a policy
from the grantor is covered by the proposal if it has some other grantor
trust feature, like a substitution power under section 675(4)(C), even
though the economics might be identical, was just as baffling. Probably
in response to that, the 2014 Greenbook revised this reference to state:
“The proposal … would not apply to any irrevocable trust whose only
assets typically consist of one or more life insurance policies on the life
of the grantor and/or the grantor’s spouse.”
iv. The staff of the Joint Committee on Taxation has expressed some of the
same concerns. See Staff of the Joint Comm. on Taxation, Description
of Certain Revenue Provisions Contained in the President’s Fiscal Year
2014 Budget Proposal 104-05 (Dec. 2013).
l. Moreover, while the last sentence of the 2013 and 2014 Greenbook
descriptions, like the 2012 Greenbook, proposed regulatory authority, the
stated example was “the ability to create exceptions to this provision.”
i. This may be the most important feature of the proposal, because, without
it, while narrower than last year’s proposal, the proposal is still very
ii. In particular, the proposal appears to apply to all sales, no matter how
leveraged, no matter what the interest rate is on any promissory note, no
matter what the other terms of the note are, and no matter whether the
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note is still outstanding at the seller’s death. A GRAT, for example, has
clear regulatory safe harbors for all those features and “works” for estate
tax purposes if it falls within those safe harbors. It would be odd if a
simple installment sale to a grantor trust, which is a sale and not a gift, is
subjected to harsher gift (and estate) tax treatment than the funding of a
GRAT, which actually is a gift.
iii. But these are complex issues. And for that reason, it may be best, or
even crucial, that they be addressed in regulations. So viewed, the
changes to this proposal reflected in the 2013 Greenbook, and
particularly the implicit promise of workable regulations, should be
iv. Nevertheless, except in the extraordinary event that Treasury and the IRS
release an indication of what will be in such regulations before the
legislation is enacted, there might still be a gap between enactment and
such a release in which a popular and effective estate planning technique
will have been chilled.
m. The proposal would apply with respect to transactions (possibly including
even the substitution of assets by the grantor, whether under a section
675(4)(C) reserved power or otherwise) engaged in on or after the date of
n. In the 2012 Greenbook, the almost unlimited proposal was estimated to raise
revenues by $910 million over 10 years. In the 2013 Greenbook, the
ostensibly narrower proposal was estimated by Treasury to raise revenues by
$1.087 billion over 10 years. In 2014, an essentially unchanged proposal is
estimated by Treasury to raise revenues by $1.644 billion over 10 years. The
staff of the Joint Committee on Taxation estimated that the 2013 proposal
would raise revenues by $3.227 billion over 10 years. STAFF OF THE JOINT
COMM. ON TAXATION, DESCRIPTION OF CERTAIN REVENUE PROVISIONS
CONTAINED IN THE PRESIDENT’S FISCAL YEAR 2014 BUDGET PROPOSAL 206
3. The 2015 and 2016 Combined GRAT and Grantor Trust Proposal
a. The 2015 Greenbook combined the GRAT and grantor trust proposals into
b. The GRAT proposal added “a requirement that the remainder interest in the
GRAT at the time the interest is created must have a minimum value equal to
the greater of 25 percent of the value of the assets contributed to the GRAT
or $500,000 (but not more than the value of the assets contributed).”
i. While a minimum gift tax value as such is not a surprise, the 25 percent
level is surprisingly high. For example, 10 percent is the minimum
remainder value required for the IRS to consider ruling that an interest in
a GRAT is a qualified annuity interest under section 2702. Rev. Proc.
2016-3, 2016-1 I.R.B. 126, §4.01(58). In the context of an installment
sale to a grantor trust, it is well known that the IRS required the
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applicants for Letter Ruling 9535026 (May 31, 1995) to commit to
“equity” of at least 10 percent of the purchase price. And 10 percent is
the equity floor, the minimum value of the common stock of a
corporation or “junior equity interest” in a partnership, under section
2701(a)(4), which was enacted at the same time as section 2702.
ii. The alternative minimum remainder value of $500,000 means that 25
percent is not enough for GRATs funded with less than $2 million. It is
possible that one of the targets of that provision is a $100,000 GRAT that
appreciates miraculously before the first annuity payment is due. In any
event, this rule would require a substantial invasion of the grantor’s
lifetime gift tax exemption, or even the payment of gift tax, to create a
c. The 2015 Greenbook also added that “the proposal … would prohibit the
grantor from engaging in a tax-free exchange of any asset held in the trust.”
That would diminish the availability of some of the proactive techniques
described in Part XVIII.C.1.l beginning on page 122.
d. The 2015 grantor trust proposal was substantively the same as in 2013 and
e. The combined and revised proposal in the 2015 Greenbook was estimated to
raise revenue by $18.354 billion over 10 years, compared to a total of $7.355
billion for both proposals in the 2014 Greenbook.
f. The 2016 Greenbook proposal (pages 180-82) is the same as the 2015
proposal, with a 10-year revenue estimate of $19.149 billion.
D. “Limit Duration of Generation-Skipping Transfer (GST) Tax Exemption”
1. This proposal, which first appeared in the 2011 Greenbook, is essentially
unchanged in the 2016 Greenbook (pages 183-84). It is reminiscent of an option
presented by the staff of the Joint Committee on Taxation in January 2005. See
Part V.A beginning on page 16.
a. Unlike the 2005 option, which would have in effect limited an allocation of
GST exemption to one generation, the Greenbook proposal would limit the
duration of GST exemption to 90 years, requiring the inclusion ratio of a trust
to reset to zero on the ninetieth anniversary of the creation of the trust.
b. Like the 2005 option, the Greenbooks cites the repeal or limitation of the
Rule Against Perpetuities in many states as the occasion for this proposal.
The 2005 option would have been harsher than present law under a classical
rule against perpetuities, which easily allows transfers to great-great-
grandchildren. The current proposal could also be harsher than present law
under a classical rule against perpetuities, which would permit some trusts to
last longer than 90 years, but it would not be nearly as uneven or arbitrary in
c. The Greenbook proposal arguably is more tailored to the structure of chapter
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2. If enacted, the proposal would presumably prompt a lot of distributions to young
beneficiaries in 90 years. It is hard to know how to plan for that now (other than
to provide trustees with discretion); the entire estate tax is barely 90 years old.
3. The proposal would apply to trusts created after the date of enactment and to
additions to trusts made after the date of enactment.
4. Understandably, the proposal to subject all trusts to tax after 90 years is estimated
to have only a negligible effect on revenues over the next 10 fiscal years.
E. “Extend the Lien on Estate Tax Deferrals Provided Under Section 6166”
1. Although it would make no change to substantive tax rules, this proposal (page
185 in the 2016 Greenbook), new in 2012, to extend the 10-year estate tax lien
under section 6324(a)(1) to cover the last four years and nine months of the
potential deferral period under section 6166 will be very important as a practical
matter to some successors to family businesses.
2. The 2015 Greenbook made no substantive change, but it corrected the calculation
of the due date of the last installment payment under section 6166 to 14 years and
nine months. It had been 15 years and three months, which inappropriately took
into account a possible six-month extension of time to file the estate tax return
(but not to pay the tax).
3. As proposed, this change would apply both to the estates of decedents dying on or
after the date of enactment and the estates of decedents who died before the date
of enactment if the 10-year lien under section 6324(a)(1) had not expired before
the date of enactment. Probably for that reason, this proposal is estimated in the
2016 Greenbook to increase revenue over 10 years by $260 million (up from $213
million in 2014 and $248 million in 2015).
F. “Modify Generation-Skipping Transfer (GST) Tax Treatment of Health and
Education Exclusion Trusts (HEETs)”
1. A “health and education exclusion trust” (“HEET”) builds on the rule of section
2611(b)(1) that distributions from a trust directly for a beneficiary’s school tuition
or medical care or insurance are not generation-skipping transfers, no matter what
generation the beneficiary is in. Sometimes, by including charities, or section
501(c)(4) social welfare organizations, as permissible beneficiaries with interests
that are vague enough to avoid being treated as separate shares, the designers of
such trusts hope that a non-skip person (the charity) will always have an interest
in the trust within the meaning of section 2612(a)(1)(A), and thereby the trust will
avoid a GST tax on the taxable termination that would otherwise occur as
interests in trusts pass from one generation to another.
2. The Greenbook proposal, new in 2013 (page 148), would limit the exemption of
direct payments of tuition and medical expenses from GST tax to payments made
by individuals, not distributions from trusts.
a. The Greenbook justifies this proposal by stating that “[t]he intent of section
2611(b)(1) is to exempt from GST tax only those payments that are not
subject to gift tax, that is, payments made by a living donor directly to the
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provider of medical care for another person or directly to a school for another
person’s tuition.” But section 2611(b)(1) exempts from the definition of a
“generation-skipping transfer” “any transfer which, if made inter vivos by an
individual, would not be treated as a taxable gift by reason of section
2503(e)….” Certainly that wording was an odd way for Congress to express
an intent to limit the exception only to transfers actually made by living
individuals (which already are exempt under section 2642(c)(3)(B) anyway).
b. Moreover, in contrast with other proposals, the Greenbook proposes that this
change would be effective when the bill proposing it is introduced and would
apply both to trusts created after that date and to transfers after that date to
pre-existing trusts. Such an effective date, used more often in the past, is
today rather unusual.
c. The extraordinary interpretation of congressional intent and the urgent
effective date reveal a really intense reaction to HEETs.
d. But, curiously, the proposal would not address the use in any trust of
charitable interests to avoid taxable terminations, which arguably could be
viewed as abusive and could explain such an intense reaction. Under section
2652(c)(2), however, the IRS already has the authority to disregard any
interest used primarily to postpone or avoid GST tax. Without offering any
specifics, Reg. §2612-1(e)(2)(ii) states that “[a]n interest is considered as
used primarily to postpone or avoid the GST tax if a significant purpose for
the creation of the interest is to postpone or avoid the tax.” See STAFF OF THE
JOINT COMM. ON TAXATION, DESCRIPTION OF CERTAIN REVENUE PROVISIONS
CONTAINED IN THE PRESIDENT’S FISCAL YEAR 2014 BUDGET PROPOSAL 109-
10 (Dec. 2013) (pointing out some of the same anomalies in this Greenbook
e. Meanwhile, a trustee of a trust with broad discretion over distributions could
get around this limitation by making a distribution to a non-skip person (and
generally there will always be a beneficiary who in effect is a non-skip
person under section 2653, leaving aside a charitable or other interest that
prevent taxable terminations), who could in turn make the educational or
medical payment free of gift tax under section 2503(e) itself. Ironically, the
trustee of a more old-fashioned trust with distributions limited, for example,
to support, maintenance, and health, might have a harder time doing that.
f. Surprisingly, the 2014 Greenbook (page 169) made no change, except to
change “clarify” to “provide” in describing the proposal and to change
“CLARIFY” to “MODIFY” in the heading. The 2015 Greenbook (page 203)
made no substantive change, and neither does the 2016 Greenbook (page
g. The Greenbooks have appeared to estimate that this proposal would lose
revenue ($247 million over 10 years in the 2016 Greenbook), but there is no
explanation of that.
– 132 –
G. “Simplify Gift Tax Exclusion for Annual Gifts”
1. This proposal appeared for the first time, at least since similar Clinton
Administration proposals in 1998 and 2000, in the 2014 Greenbook (pages 170-
71). The Greenbook cited Crummey v. Commissioner, 397 F.2d 82 (9th Cir.
1968), and pointed out that the use of “Crummey powers” has resulted in
significant compliance costs, including the costs of giving notices, keeping
records, and making retroactive changes to the donor’s gift tax profile if an annual
exclusion is disallowed. The Greenbook added that the cost to the IRS of
enforcing the rules is significant too.
2. The 2014 Greenbook also acknowledged an IRS concern with the proliferation of
Crummey powers, especially in the hands of persons not likely to ever receive a
distribution from the trust, and lamented the IRS’s lack of success in combating
such proliferation (citing Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991);
Kohlsaat v. Commissioner, T.C. Memo 1997-212).
3. The 2015 Greenbook (pages 204-05) dropped the citation of Crummey, but
continued to refer to “Crummey powers” and the challenges they create.
4. The 2014 Greenbook offered the following explanation of the proposal:
The proposal would eliminate the present interest requirement for gifts
that qualify for the gift tax annual exclusion. Instead, the proposal would
define a new category of transfers (without regard to the existence of any
withdrawal or put rights), and would impose an annual limit of $50,000
per donor on the donor’s transfers of property within this new category
that will qualify for the gift tax annual exclusion. Thus, a donor’s
transfers in the new category in a single year in excess of a total amount
of $50,000 would be taxable, even if the total gifts to each individual
donee did not exceed $14,000. The new category would include
transfers in trust (other than to a trust described in section 2642(c)(2)),
transfers of interests in passthrough entities, transfers of interests subject
to a prohibition on sale, and other transfers of property that, without
regard to withdrawal, put, or other such rights in the donee, cannot
immediately be liquidated by the donee.
5. As to interests in passthrough entities, see the IRS successes in Hackl v.
Commissioner, 118 T.C. 279 (2002), aff’d, 335 F.3d 664 (7th Cir. 2003) (interests
in an LLC engaged in tree farming); Price v. Commissioner, T.C. Memo 2010-2
(interests in a limited partnership holding marketable stock and commercial real
estate); Fisher v. United States, 105 AFTR 2d 2010-1347 (D. Ind. 2010) (interests
in an LLC owning undeveloped land on Lake Michigan).
6. So this is what apparently would be left as excludable gifts:
a. Unlimited gifts directly for tuition or medical expenses under section
b. Up to $50,000 of annual exclusion for transfers that otherwise might be
impermissible, suspect, or at least controversial. There apparently wouldn’t
even have to be an arguable basis for the annual exclusion under current law.
– 133 –
(The Greenbook provides the simple example of “transfers in trust.”)
i. Some were inclined to interpret the 2014 proposal as proposing that the
“new category of transfers” would be allowed, up to $50,000 per donor
per year, without tapping into the donor’s $14,000-per-donee annual
exclusions. Others were inclined to view the proposal only as allowing
up to $50,000 of annual exclusion gifts (also subject to the $14,000-per-
donee limit) to avoid the tightened outright-or-tax-vested requirement.
In fact, that interpretation was quickly confirmed informally to have
been the intention of the drafters. The 2015 Greenbook removed all
doubt by adding a new sentence: “This new $50,000 per-donor limit
would not provide an exclusion in addition to the annual per-donee
exclusion; rather, it would be a further limit on those amounts that
otherwise would qualify for the annual per-donee exclusion.”
ii. So limited, the proposal is less of a simplification. For example, for the
“new category of transfers” up the $50,000 per year, it apparently would
then still be necessary to identify the donees, the very function of
Crummey powers that the IRS has viewed as complicating and
iii. The 2015 Greenbook also added that the proposed limit of $50,000
would be indexed for inflation.
c. Gifts up to $14,000 (currently) per donee per year, or $28,000 if split,
i. simple outright gifts (other than gifts of interests in passthrough entities,
property subject to a prohibition on sale, assets that, without regard to
withdrawal, put, or other such rights in the donee, cannot immediately be
liquidated, etc.) and
ii. gifts to trusts described in section 2642(c)(2) – that is, “tax-vested” trusts
exempt from GST tax. This latter provision would effectively permit
“2503(c) trusts” to any age (not just 21).
7. The 2016 Greenbook (pages 187-88) makes no change.
8. The proposal would be effective for gifts made after the year of enactment. It is
estimated to raise revenues by $3.68 billion over 10 years.
H. “Expand Applicability of Definition of Executor”
1. The 2014 Greenbook (page 172) noted that “[b]ecause the tax code’s definition of
executor currently applies only for purposes of the estate tax, no one (including
the decedent’s surviving spouse who filed a joint income tax return) has the
authority to act on behalf of the decedent with regard to a tax liability that arose
prior to the decedent’s death. Thus, there is no one with authority to extend the
statute of limitations, claim a refund, agree to a compromise or assessment, or
pursue judicial relief in connection with the decedent’s share of a tax liability.”
[Section 2203 provides a meaning of “the term ‘executor’ wherever it is used in
this title in connection with the estate tax imposed by this chapter.”]
– 134 –
2. Interestingly, the Greenbook added that “[t]his problem has started to arise with
more frequency, as reporting obligations, particularly with regard to an interest in
a foreign asset or account, have increased, and survivors have attempted to
resolve a decedent’s failure to comply.”
3. The proposal in the 2014 Greenbook would “expressly make the tax code’s
definition of executor applicable for all tax purposes, and authorize such executor
to do anything on behalf of the decedent in connection with the decedent’s pre-
death tax liabilities or obligations that the decedent could have done if still living.
In addition, the proposal would grant regulatory authority to adopt rules to resolve
conflicts among multiple executors authorized by this provision.”
4. The 2015 Greenbook was identical, except that it added a clarification that the
executor, as defined, would be empowered to deal with all tax liabilities “whether
arising before, upon, or after death.” The 2016 Greenbook (page 189) makes no
5. The proposal would apply upon enactment, regardless of a decedent’s date of
death, and would have a negligible revenue effect.
I. Another Topic: Taxation of Appreciation at Death
1. Elsewhere in the 2015 Greenbook (pages 156-57) and the 2016 Greenbook (pages
155-56), under the general heading of “Reforms to Capital Gains Taxation,
Upper-Income Tax Benefits, and the Taxation of Financial Institutions,” there is a
proposal labeled simply “Reform the Taxation of Capital Income.”
2. In describing current law, the proposal points out that capital gains are subject to a
top income tax rate of 20 percent, plus the 3.8 percent tax on net investment
income, while appreciation during the life of someone who dies holding the asset
escapes income tax because the decedent’s heir receives a new basis equal to the
fair market value of the asset at the decedent’s death.
3. Believing that “[p]referential tax rates on long-term capital gains and qualified
dividends disproportionately benefit high-income taxpayers,” the Greenbook
Because the person who inherits an appreciated asset receives a basis in
that asset equal to the asset’s fair market value on the decedent’s death,
the appreciation that accrued during the decedent’s life is never subjected
to income tax. In contrast, less-wealthy individuals who must spend
down their assets during retirement must pay income tax on their realized
capital gains. This increases the inequity in the tax treatment of capital
gains [the “equity” argument]. In addition, the preferential treatment for
assets held until death produces an incentive for taxpayers to inefficiently
lock in portfolios of assets and hold them primarily for the purpose of
avoiding capital gains tax on the appreciation, rather than reinvesting the
capital in more economically productive investments [the “lock-in”
4. The proposal would increase the top rate on capital gains and qualified dividends
to 24.2 percent, which, with the 3.8 percent tax on net investment income, would
– 135 –
produce a rate of 28 percent. It would also treat a gift or bequest of appreciated
property as a realization event, subjecting the appreciation to capital gains tax.
a. Gifts or bequests to a spouse or charity would not be taxed, but the spouse or
charity would take a carryover basis in the asset.
b. Gain on tangible personal property such as household furnishings and
personal effects would be exempt, but gains on “collectibles” are explicitly
removed from that exception and thus taxed.
c. Each person would be allowed an additional exclusion of capital gains at
death of up to $100,000 (indexed for inflation after 2016), and each person’s
$250,000 exclusion of capital gain on a principal residence would be
extended to all residences. Both of these exclusions would be portable to the
decedent’s surviving spouse “under the same rules that apply to portability
for estate and gift tax purposes.” The exclusion under section 1202 for
capital gain on certain small business stock would also apply.
d. Taxation of the appreciation in the value of certain small family-owned and
operated businesses (no further details given) would be deferred until the
business is sold or ceases to be family-owned and operated.
e. A “15-year fixed-rate payment plan” would be allowed for the tax on
appreciated illiquid assets transferred at death, perhaps comparable to the
deferral of estate tax under section 6166.
f. The Greenbooks clarify that the income tax on capital gains deemed realized
at death would be deductible for estate tax purposes.
5. The proposal is estimated to raise revenues by $235.208 billion over 10 years.
6. This proposal was featured in President Obama’s State of the Union Address on
January 20, 2015, and previewed in a White House “Fact Sheet” (see
hments/356770/FactSheet.pdf) released on Saturday, January 17, 2015.
a. The first page of the Fact Sheet highlighted three bullet points:
• “Close the trust fund loophole – the single largest capital gains
tax loophole – to ensure the wealthiest Americans pay their fair
share on inherited assets. Hundreds of billions of dollars escape
capital gains taxation each year because of the ‘stepped-up’ basis
loophole that lets the wealthy pass appreciated assets onto their heirs
• “Raise the top capital gains and dividend rate back to the rate
under President Reagan. The President’s plan would increase the
total capital gains and dividends rates for high-income households to
• “Reform financial sector taxation to make it more costly for the
biggest financial firms to finance their activities with excessive
borrowing. The President will propose a fee on large, highly-
leveraged financial institutions to discourage excessive borrowing.
– 136 –
b. The label of “trust fund loophole” is an odd way to describe the stepped-up
basis for appreciated assets at death, when assets in typical ancestral trusts are
not subject to estate tax and do not get a stepped-up basis. And the idea that
“[h]undreds of billions of dollars escape capital gains taxation each year” is
hard to reconcile with the overall 10-year revenue estimate of $208 billion,
especially as the Fact Sheet noted that “99 percent of the impact of the
President’s capital gains reform proposal (including eliminating stepped-up
basis and raising the capital gains rate) would be on the top 1 percent, and
more than 80 percent on the top 0.1 percent (those with incomes over $2
million),” who would likely be paying the top 28 percent rate.
c. The Fact Sheet also mentions the equity argument and lock-in argument that
are recapitulated in the Greenbook.
d. The “financial sector” proposal (Greenbook page 160), by the way, would
impose on any financial firm with assets over $50 billion a fee equal to 7
basis points applied to the firm’s liabilities. It would become effective
January 1, 2016, and is estimated to raise revenue by an astonishing $111.814
billion over 10 years.
7. Generally, the Greenbook articulation of the proposal avoids the anomalies of the
White House Fact Sheet and presents a clearer picture. Showing appreciation for
the complexities involved, the Greenbook adds the following:
The proposal also would include other legislative changes designed to
facilitate and implement this proposal, including without limitation: the
allowance of a deduction for the full cost of appraisals of appreciated
assets; the imposition of liens; the waiver of penalty for underpayment of
estimated tax if the underpayment is attributable to unrealized gains at
death; the grant of a right of recovery of the tax on unrealized gains;
rules to determine who has the right to select the return filed; the
achievement of consistency in valuation for transfer and income tax
purposes; and a broad grant of regulatory authority to provide
To facilitate the transition to taxing gains at death and gift, the Secretary
would be granted authority to issue any regulations necessary or
appropriate to implement the proposal, including rules and safe harbors
for determining the basis of assets in cases where complete records are
J. Omitted: “Modify Rules on Valuation Discounts”
1. The Obama Administration’s first four Greenbooks called for Congress to give
Treasury greater regulatory authority to create more durable rules for disregarding
restrictions under section 2704(b) in valuing nonmarketable interests in
corporations, partnerships, LLCs, and other entities.
2. The Greenbooks recalled that sections 2701-2704 were enacted to curb techniques
designed to reduce transfer tax value but not the economic benefit to the
– 137 –
a. Specifically, the Greenbooks pointed out that section 2704(b) provides that
certain “applicable restrictions” that would otherwise justify valuation
discounts are ignored in intra-family transfers of interests in family-
controlled corporations and partnerships, but added that “[j]udicial decisions
and the enactment of new statutes in most states, in effect, have made section
2704(b) inapplicable in many situations.”
b. The Greenbooks also stated that “the Internal Revenue Service has identified
other arrangements designed to circumvent the application of section 2704.”
c. Section 2704(b) applies to an “applicable restriction,” which section
2704(b)(2) defines as “any restriction (A) which effectively limits the ability
of the corporation or partnership to liquidate, and (B) with respect to which
either … (i) [t]he restriction lapses, in whole or in part, after the transfer …
[or] (ii) [t]he transferor or any member of the transferor’s family, either alone
or collectively, has the right after such transfer to remove, in whole or in part,
the restriction.” Section 2704(b)(3) provides exceptions for “(A) any
commercially reasonable restriction which arises as part of any financing by
the corporation or partnership with a person who is not related to the
transferor or transferee, or a member of the family of either, or (B) any
restriction imposed, or required to be imposed, by any Federal or State law.”
d. Under section 2704(b)(4), Treasury has the authority to “provide that other
restrictions shall be disregarded in determining the value of the transfer of
any interest in a corporation or partnership to a member of the transferor’s
family if such restriction has the effect of reducing the value of the
transferred interest for purposes of this subtitle but does not ultimately reduce
the value of such interest to the transferee.” Since 2003, a guidance project
under section 2704 has been on the Treasury-IRS Priority Guidance Plan.
See Part XIX.A.11 on page 153.
3. Using section 2704(b) as a framework, the Greenbook proposal would create a
more durable category of “disregarded restrictions.”
a. Disregarded restrictions would “include” restrictions on liquidation of an
interest that are measured against standards prescribed in Treasury
regulations, not against default state law.
b. Although the Greenbooks did not say so, it is possible that the “disregarded
restrictions” in view, which “include” certain limitations on liquidation (the
current scope of section 2704(b)(2)(A)), may also include other restrictions,
such as restrictions on management, distributions, access to information, and
transferability. If so, it might call for reconsideration of the famous
disclaimer in the 1990 conference report that “[t]hese rules do not affect
minority discounts or other discounts available under present law.” H.R.
REP. NO. 101-964, 101ST CONG., 2D SESS. 1137 (1990). After all, even the
regulation authority under section 2704(b)(4) extends to “other restrictions.”
c. On the other hand, the September 8, 2009, Joint Committee staff’s
publication stated that “because the proposal targets only marketability
– 138 –
discounts, it would not directly address minority discounts that do not
accurately reflect the economics of a transfer.” The JCT staff pointed out
that other possible approaches include the “look through” rules of the Clinton
Administration’s budget proposals (Part II.E.1 on page 4) and the JCT staff’s
own 2005 proposals (Part V.B beginning on page 17) and the aggregation
rules of the 2005 proposals and the Reagan Administration’s “Tax Reform
for Fairness, Simplicity, and Economic Growth” (“Treasury I”) published by
Treasury on November 27, 1984 (Part II.D.1.d on page 3).
d. Disregarded restrictions would also include limitations on a transferee’s
ability to be admitted as a full partner or other holder of an equity interest,
thus apparently denying the opportunity to value a transferred interest as a
“mere” “assignee” interest.
e. Treasury could by regulations treat certain interests owned by charities or
unspecified “others” as if they were owned by the transferor’s family.
f. In any event, the Greenbooks were careful to cast their references in terms of
“entities,” not just corporations and partnerships.
4. The Greenbooks included some other references that could be significant.
a. Regulations could “create safe harbors to permit taxpayers to draft the
governing documents of a family-controlled entity so as to avoid the
application of section 2704 if certain standards are met.” While no details
were given, it is hard to imagine regulations that prescribe “safe harbor”
discounts, and it is particularly odd that a proposal to limit opportunities to
“circumvent” section 2704 would contemplate that section 2704 could be
avoided simply by the way governing documents are drafted. But perhaps
this authority could be used to protect actual family operating businesses or
to protect the holder of a restricted noncontrolling interest received from
others (including ancestors) if that holder did not create those restrictions and
never had a meaningful opportunity to remove those restrictions.
b. The Greenbooks promised to “make conforming clarifications with regard to
the interaction of this proposal with the transfer tax marital and charitable
deductions.” This could override the harsh “reverse-Chenoweth” result seen
in Technical Advice Memoranda 9050004 (Aug. 31, 1990) and 9403005
(Oct. 14, 1993) (all stock owned by the decedent valued as a control block in
the gross estate, but the marital bequest valued separately for purposes of the
marital deduction), relying on Estate of Chenoweth v. Commissioner, 88 T.C.
1577 (1987) (estate of a decedent who owned all the stock of a corporation
entitled to prove a control premium for a 51-percent block bequeathed to the
surviving spouse for purposes of the marital deduction), and Ahmanson
Foundation v. United States, 674 F.2d 761 (9th Cir. 1981). Such a result
would reinforce the fairness of the proposal and would be very welcome.
5. The proposal would have applied to transfers – gifts and deaths – after the date of
enactment. Consistent with section 2704 itself, the proposal would not have
applied to restrictions created on or before October 8, 1990. Under section
– 139 –
7805(b)(2), regulations issued within 18 months of the date of enactment could be
retroactive to the date of enactment.
6. The proposal was estimated to raise revenue over 10 years by $19.038 billion in
the 2009 Greenbook, $18.667 billion in the 2010 Greenbook, $18.166 billion in
the 2011 Greenbook, and $18.079 billion in the 2012 Greenbook. (The June 11,
2009, Joint Committee on Taxation revenue estimates skipped this proposal,
because of its lack of specificity – a “failure to score” that diminishes the
proposal’s revenue-raising appeal in Congress.)
7. When the “Responsible Estate Tax Act” (S. 3533 and H.R. 5764 of 2010, see Part
VII.I.5 on page 33) and Congressman McDermott’s “Sensible Estate Tax Act of
2011” (H.R. 3467) included statutory language for the other Greenbook
proposals, they did not implement this proposal (possibly because its revenue
effect would be so hard to estimate), but merely reproduced valuation discount
provisions from previous bills.
8. The 2013, 2014, 2015, and 2016 Greenbooks omit this proposal. But many have
thought that section 2704(b)(4) already gives Treasury that authority. See
paragraph 2.d on page 137. And when the 2013-2014 Priority Guidance Plan was
released on August 9, 2013, it included the same reference to regulations under
section 2704 that previous Plans had since 2003 (Part XIX.A.11 on page 153).
XIX. TREASURY-IRS PRIORITY GUIDANCE PLAN
The Treasury-IRS Priority Guidance Plan for the 12 months beginning July 1, 2015, was
released on July 31, 2015. See http://www.irs.gov/pub/irs-utl/2015-2016_pgp_initial.pdf.
It contains 277 projects (down from 317 in 2014) described as “priorities for allocation of
the resources of our offices during the twelve-month period from July 2015 through June
2016 (the plan year). The plan represents projects we intend to work on actively during the
plan year and does not place any deadline on completion of projects.”
A. Gifts and Estates and Trusts
The Plan lists the following 12 projects under the heading of “Gifts and Estates and
Trusts” (up from 10 last year). Four of them (an ambitious number) are new in 2015.
1. Guidance on qualified contingencies of charitable remainder annuity trusts under
a. This project is new in 2015.
b. Qualified contingencies are contingencies that, if they occur, would permit
the early termination of a charitable remainder trust and acceleration of the
charitable remainder interest. They are allowed by section 664(f), which was
added to the Code by the same section of the Deficit Reduction Act of 1984
(Public Law 98-369) that permanently provided for port-mortem reformation
of split-interest trusts under section 2055(e)(3) to qualify for the estate tax
charitable deduction. Even though a qualified contingency may permit the
early termination of a charitable remainder trust, under section 644(f)(2) that
possibility is disregarded in determining the amount of the charitable
– 140 –
c. This project now replaces the section 1014 project that was completed on
August 12, 2015 (see the following paragraph 2), as a pending change
affecting charitable remainder trusts. Unlike the section 1014 project,
however, it is not clear what the objective of this guidance project is.
2. Final regulations under §1014 regarding uniform basis of charitable remainder
trusts. Proposed regulations were published on January 17, 2014.
a. This project first appeared in the 2008-09 Plan, where, as in the 2009-10
Plan, it was described as “Guidance under §643 regarding uniform basis rules
b. Reg. §§1.1014-4 & -5 provide that the basis of property held in trust or
otherwise shared by holders of term and remainder interests is apportioned
among the beneficial interests in proportion to the actuarial value of the
interests. Section 1001(e) and Reg. §1.1001-1(f) provide that when an
interest in property for life or a term of years or an income interest in
property in a trust is sold, its basis is generally disregarded, unless the sale is
a part of a transaction in which the entire interest in property is transferred.
c. Notice 2008-99, 2008-47 I.R.B. 1194, effective October 31, 2008, described
a transaction in which a grantor contributes appreciated assets to a charitable
remainder trust, the trustee sells the assets and reinvests the proceeds, and the
income and remainder beneficiaries then sell their respective interests to a
third party in a coordinated sale (which arguably could avoid both the
disregarded basis rules of section 1001(e) and Reg. §1.1001-1(f) and the rules
governing commutation of CRT interests). The grantor recognizes no gain
from the trust’s sale of the appreciated assets. When the grantor and the
charity sell their respective interests in the trust, they take the position that
they have sold the entire interest in the trust within the meaning of section
1001(e)(3), so section 1001(e)(1), which otherwise would disregard the term
holder’s basis in the case of a sale of a term interest, does not apply. The
grantor also takes the position that under section 1001(a) the gain on the sale
of the term interest is computed by taking into account the grantor’s actuarial
share of the new uniform basis derived from the high cost basis of the
reinvestment, which makes the sale essentially tax free to the grantor, who
started out with appreciated assets. The sale has produced a pool of capital
gain that is carried out to the grantor only to the extent of the prorated
distribution with respect to the grantor’s term interest, but if this all happens
very quickly, as it would if it were all prearranged, that distribution and thus
that portion of the gain is small. And, especially if the grantor is relatively
young, the charity receives something for its trouble (and the grantor gets a
corresponding income tax deduction), but the grantor receives most of the
d. The Notice stated that “the IRS and Treasury Department are concerned
about the manipulation of the uniform basis rules to avoid tax on the sale or
other disposition of appreciated assets.” Accordingly, the Notice identified
this type of transaction as a reportable “transaction of interest” for purposes
– 141 –
of sections 6111 and 6112 and Reg. §1.6011-4(b)(6).
e. In Rev. Proc. 2010-3, 2010-1 I.R.B. 110, §§4.01(39), (42), and (43), the
Service identified “[w]hether the termination of a charitable remainder trust
before the end of the trust term as defined in the trust’s governing instrument,
in a transaction in which the trust beneficiaries receive their actuarial shares
of the value of the trust assets, causes the trust to have ceased to qualify as a
charitable remainder trust within the meaning of § 664” or “is treated as a
sale or other disposition by the beneficiaries of their interests in the trust” or
“is treated as a sale or exchange of a capital asset by the beneficiaries” as
areas “in which rulings or determination letters will not ordinarily be issued.”
In Rev. Proc. 2015-3, 2015-1 I.R.B. 129, perhaps reflecting the publication of
the proposed regulations (described in the following paragraph) almost a year
earlier, these items were moved from section 4.01 to section 3.01
(§§3.01(68), (82) & (87)), changing them simply to areas “in which rulings or
determination letters will not be issued” – in effect dropping the word
“ordinarily.” Rev. Proc. 2016-3, 2016-1 I.R.B. 126, §§3.01(71), (86), and
(91) are the same.
f. On January 14, 2014, the IRS issued a Notice of Proposed Rulemaking
(REG-154890-03), acknowledging three supportive comments in response to
Notice 2008-99 and proposing the addition of a new paragraph (c) to Reg.
§1.1014-5 and the addition of new Examples 7 and 8 to redesignated Reg.
§1.1014-5(d). New paragraph (c) would provide that in any joint sale by the
holder of the term interest and the charitable remainder beneficiary of their
respective interests in a CRT, the taxable beneficiary’s actuarially allocated
basis must be reduced by a portion of the trust’s undistributed net ordinary
income and undistributed net capital gains for the current and prior taxable
years, allocated to the taxable beneficiary on the same actuarial basis. In
effect, that would restore the grantor’s original low basis in the contributed
appreciated assets, and the grantor’s actuarial portion of the gain will be fully
g. The regulations were finalized without change by T.D. 9729 on August 12,
2015, with a January 16, 2014, effective date.
3. Guidance on basis of grantor trust assets at death under §1014.
a. This project is new in 2015.
b. In Letter Ruling 200434012 (April 23, 2004), involving a sale from one
grantor trust to another, the Service included the caveat that “when either
Trust 1 or Trust 2 ceases to be treated as a trust owned by A under § 671 by
reason of A’s death or the waiver or release of any power under § 675, no
opinion is expressed or implied concerning whether the termination of such
grantor trust treatment results in a sale or disposition of any property within
the meaning of § 1001(a), a change in the basis of any property under § 1012
or § 1014, or any deductible administration expense under § 2053.”
c. An installment note received by the grantor from a grantor trust in connection
– 142 –
with the popular technique of a sale to a grantor trust receives a new basis –
presumably a stepped-up basis – under section 1014 when the grantor dies.
The note is not an item of income in respect of a decedent (“IRD”) under
section 691, which would be excluded from the operation of section 1014 by
section 1014(c), because the fact, amount, and character of IRD are all
determined in the same manner as if “the decedent had lived and received
such amount” (section 691(a)(3); cf. section 691(a)(1)), and the decedent
would not have realized any income in that case, as confirmed by Rev. Rul.
85-13, 1985-1 C.B. 184). See the discussion of the Administration’s
legislative proposal beginning on page 123 and the analysis in Manning &
Hesch, “Deferred Payment Sales to Grantor Trusts, GRATs, and Net Gifts:
Income and Transfer Tax Elements,” 24 Tax Mgmt. Est., Gifts & Tr. J. 3
d. Chief Counsel Advice 200923024 (Dec. 31, 2008) opined that “the Service
should not take the position that the mere conversion of a nongrantor trust to
a grantor trust [by reason of the replacement of an independent trustee with a
related or subordinate party] results in taxable income to the grantor.” After
citing and discussing Madorin v. Commissioner, 84 T.C. 667 (1985), and
Rev. Rul. 77-402, 1977-2 C.B. 222 (which addressed the reverse conversion
to nongrantor trust status), the Chief Counsel’s office noted (emphasis added)
that “the rule set forth in these authorities is narrow, insofar as it only affects
inter vivos lapses of grantor trust status, not that caused by the death of the
owner which is generally not treated as an income tax event.” Because of the
interrelationship with certain partnership transactions and section 754 basis
elections, however, the Chief Counsel’s office viewed the overall transaction
as “abusive” and wanted to explore other ways to challenge it. But it
nevertheless believed that “asserting that the conversion of a nongrantor trust
to a grantor trust results in taxable income to the grantor would have an
impact on non-abusive situations.”
e. This new proposal may somehow be related to the analytical gymnastics
found in these authorities.
f. On the other hand, this proposal may simply be aimed at a clarification of the
rules for foreign trusts.
i. Rev. Proc. 2015-37, 2015-26 I.R.B. 1196, added “[w]hether the assets in
a grantor trust receive a section 1014 basis adjustment at the death of the
deemed owner of the trust for income tax purposes when those assets are
not includible in the gross estate of that owner under chapter 11 of
subtitle B of the Internal Revenue Code” to the list of “areas under study
in which rulings or determination letters will not be issued until the
Service resolves the issue through publication of a revenue ruling, a
revenue procedure, regulations, or otherwise.” That designation was
continued in section 5.01(12) of Rev. Proc. 2016-3, 2016-1 I.R.B. 126.
ii. Meanwhile, Letter Ruling 201544002 (June 30, 2015), held that assets in
a revocable trust created by foreign grantors for their U.S. citizen
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children would receive a stepped-up basis under section 1014(b)(2) at the
grantors’ deaths. The ruling acknowledged the no-rule policy of Rev.
Proc. 2015-37, but avoided it on the ground that the ruling request had
been submitted before the no-rule policy was announced.
iii. Is it a coincidence that Rev. Proc. 2015-37 was published in the Internal
Revenue Bulletin on June 29, 2015, the day before Letter Ruling
201544002 was issued? If not, and those two contemporaneous events
are related, then the no-rule position of Rev. Procs. 2015-37 and 2016-3
might be aimed only at foreign trusts, and so might this new proposal in
the Priority Guidance Plan.
4. Revenue Procedure under §2010(c) regarding the validity of a QTIP election on
an estate tax return filed only to elect portability.
a. This was the only new item in the 2013-2014 Plan.
b. Rev. Proc. 2001-38, 2001-24 I.R.B. 1335, announced circumstances in which
the IRS “will disregard [a QTIP] election and treat it as null and void” if “the
election was not necessary to reduce the estate tax liability to zero, based on
values as finally determined for federal estate tax purposes.” The procedure
states that it “does not apply in situations where a partial QTIP election was
required with respect to a trust to reduce the estate tax liability and the
executor made the election with respect to more trust property than was
necessary to reduce the estate tax liability to zero.” The procedure states that
it “also does not apply to elections that are stated in terms of a formula
designed to reduce the estate tax to zero.”
i. Thus, the paradigm case to which the procedure applies is the case where
the taxable estate would have been less than the applicable exclusion
amount anyway, so the estate would not be subject to federal estate tax,
but the executor listed some or all of the trust property on Schedule M to
the estate tax return and thus made a redundant QTIP election.
ii. Rev. Proc. 2001-38 is a relief measure. The transitional sentence
between the summary of the background law and the explanation of the
problem is: “The Internal Revenue Service has received requests for
relief in situations where an estate made an unnecessary QTIP election.”
c. With portability made permanent in the 2012 Tax Act (see Part XIII.B
beginning on page 78), an estate tax return to elect portability might be filed
that is not necessary for estate tax purposes because the value of the estate is
below the filing requirement. For such a return, the question arises whether a
QTIP election made only to support a reverse-QTIP election for GST tax
purposes or to gain a second basis step-up at the death of the surviving
spouse might be treated as an election that “was not necessary to reduce the
estate tax liability to zero” and therefore as “null and void.”
d. Rev. Proc. 2001-38 goes on to state that “[t]o establish that an election is
within the scope of this revenue procedure, the taxpayer must produce
sufficient evidence to that effect. For example, the taxpayer [the surviving
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spouse or the surviving spouse’s executor] may produce a copy of the estate
tax return filed by the predeceased spouse’s estate establishing that the
election was not necessary to reduce the estate tax liability to zero.”
i. That statement, the “relief” origin of Rev. Proc. 2001-38, the likelihood
that a revenue procedure announcing the Service’s administrative
forbearance cannot negate an election clearly authorized by statute, and
the unseemliness of denying the benefits of a QTIP election to smaller
estates while allowing it to larger estates all suggest that a QTIP election
will be respected in such a case.
ii. This view is reinforced by the explicit reference in Temporary Reg.
§20.2010-2(a)(7)(ii)(A)(4) to QTIP elections in returns filed to elect
portability but not otherwise required for estate tax purposes.
e. Clarifying that result is evidently what this new item on the Priority Guidance
Plan is about.
i. It would be astonishing if QTIP elections on portability-only returns
were in jeopardy.
ii. What might be in jeopardy is the very broad and open-ended ability
under Rev. Proc. 2001-38 to repudiate a QTIP election that was made on
a timely estate tax return, perhaps decades later by the surviving spouse’s
executor, in an environment where high transfer tax exemptions and
heightened interest in income tax basis have possibly altered the strategic
significance of the QTIP election in the first place.
5. Guidance on the valuation of promissory notes for transfer tax purposes under
§§2031, 2033, 2512, and 7872.
a. This project is new in 2015.
b. It is well known that the Tax Court has held that section 7872 is the
applicable provision for valuing an intra-family promissory note –
specifically for determining that a note carrying the section 7872 rate may be
valued at its face amount. See Frazee v. Commissioner, 98 T.C. 554 (1992).
See also Estate of True v. Commissioner, T.C. Memo 2001-167, aff’d on
other grounds, 390 F.3d 1210 (10th Cir. 2004).
i. But Judge Hamblen concluded his opinion in Frazee by stating: “We
find it anomalous that respondent urges as her primary position the
application of section 7872, which is more favorable to the taxpayer than
the traditional fair market value approach, but we heartily welcome the
concept.” 98 T.C. at 590.
ii. And at times the Service has seemed to embrace a market interest rate
standard. See Letter Ruling 200147028 (Aug. 9, 2001).
iii. Section 7872(d)(2) provides that in a gift context (which includes a
transfer to a grantor trust) the gift tax consequences of a term loan are
analyzed under section 7872(b)(1). Section 7872(b)(1) treats as a
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transfer from the lender (the grantor/seller) to the borrower (the trust) an
amount equal to the excess of the amount lent (the value of the property
transferred, less any down payment) over the present value of the
payments to be made under the terms of the loan. Section 7872(f)(1)
defines “present value” with reference to the “applicable Federal rate.”
Section 7872(f)(2)(A) defines the “applicable Federal rate” for a term
c. Meanwhile, although the note is included in the decedent’s gross estate, it is
possible that it could be valued for estate tax purposes at less than its face
amount, under general valuation principles, because section 7872 is not an
estate tax valuation rule. That would be especially true if interest rates rise
between the date of the sale and the date of death.
i. Section 7872(i)(2) states that “[u]nder regulations prescribed by the
Secretary [of the Treasury], any loan which is made with donative intent
and which is a term loan shall be taken into account for purposes of
chapter 11 [the estate tax chapter] in a manner consistent with the
provisions of subsection (b) [providing for the income and gift tax
treatment of below-market loans].” Regardless of what Congress had in
mind, Congress said “[u]nder regulations prescribed by the Secretary”
and did not write a self-executing rule.
ii. Proposed Reg. §20.7872-1 (proposed in 1985) provides that a “gift term
loan” shall be valued for estate tax purposes at no less than (a) its unpaid
stated principal plus accrued interest or (b) the present value of all the
future payments under the note using the applicable federal rate in effect
at the time of death.
iii. The estate planner’s answers to the proposed regulation would include
the arguments that (1) the proposed regulation is not effective unless and
until it is finalized, (2) the loan represented by the installment note is not
a “gift term loan” because it uses an interest rate calculated to avoid
below-market treatment under section 7872(e), and (3) with respect to
section 7872(i)(2) itself, the loan is not made “with donative intent”
because the transaction is a sale.
iv. Under section 7805, the proposed regulations could probably be
expanded even beyond the strict mandate of section 7872(i)(2), and,
under section 7805(b)(1)(B) such expanded final regulations might even
be made effective retroactively to the publication date of the proposed
regulations in 1985. But, unless and until that happens, most estate
planners have seen no reason why the estate tax value should not be fair
market value, which, after all, is the general rule, subject to Reg.
§20.2031-4, which states that “[t]he fair market value of notes, secured
or unsecured, is presumed to be the amount of unpaid principal, plus
interest accrued to the date of death, unless the executor establishes that
the value is lower or that the notes are worthless. However, items of
interest shall be separately stated on the estate tax return. If not returned
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at face value, plus accrued interest, satisfactory evidence must be
submitted that the note is worth less than the unpaid amount (because of
the interest rate, date of maturity, or other cause), or that the note is
uncollectible, either in whole or in part (by reason of the insolvency of
the party or parties liable, or for other cause), and that any property
pledged or mortgaged as security is insufficient to satisfy the obligation.”
d. It is not clear that this guidance project is related to these developments. It
does not cite Proposed Reg. §20.7872-1. It is clear that there has been a lot
of interest in the valuation of promissory notes, especially after the docketing
of Estate of Davidson v. Commissioner, T.C. Docket No. 13748-13, in which
the IRS asserted $2.8 billion in estate, gift and generation-skipping taxes
owed. On July 6, 2015, the case was settled for just over $550 million.
Addressing Mr. Davidson’s sales both in Chief Counsel Advice 201330033
(Feb. 24, 2012) and in its answer in the Tax Court, the IRS argued the notes
should be valued, not under section 7520, but under a willing buyer-willing
seller standard that took account of Mr. Davidson’s health. See also Estate of
Kite v. Commissioner, T.C. Memo 2013-43.
6. Final regulations under §2032(a) regarding imposition of restrictions on estate
assets during the six month alternate valuation period. Proposed regulations were
published on November 18, 2011.
a. This first appeared in the 2007-08 Plan.
b. Proposed Reg. §20.2032-1(f) (REG-112196-07) was published on April 25,
2008. The preamble appears to view these regulations as the resolution of
“[t]wo judicial decisions [that] have interpreted the language of section 2032
and its legislative history differently in determining whether post-death
events other than market conditions may be taken into account under the
alternate valuation method.”
c. In the first of these cases, Flanders v. United States, 347 F. Supp. 95 (N.D.
Calif. 1972), after a decedent’s death in 1968, but before the alternate
valuation date, the trustee of the decedent’s (formerly) revocable trust, which
held a one-half interest in a California ranch, entered into a land conservation
agreement pursuant to California law.
i. The conservation agreement reduced the value of the ranch by 88
percent. Since that reduced value was the value of the ranch at the
alternate valuation date (which until 1971 was one year after death), the
executor elected alternate valuation and reported the ranch at that value.
ii. Citing the Depression-era legislative history to the effect that alternate
valuation was intended to protect decedents’ estates against “many of the
hardships which were experienced after 1929 when market values
decreased very materially between the period from the date of death and
the date of distribution to the beneficiaries,” the court held that “the
value reducing result of the post mortem act of the surviving trustee”
may not be considered in applying alternate valuation.
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d. The second of these cases was Kohler v. Commissioner, T.C. Memo 2006-
152, nonacq., 2008-9 I.R.B. 481, involving the estate of a shareholder of the
well-known family-owned plumbing fixture manufacturer. The executor had
received stock in a tax-free corporate reorganization that had been under
consideration for about two years before the decedent’s death but was not
completed until about two months after the decedent’s death.
i. The court rejected the Service’s attempt to base the estate tax on the
value of the stock surrendered in the reorganization (which had been
subject to fewer restrictions on transferability), on the ground that Reg.
§20.2032-1(c)(1) prevents that result by specifically refusing to treat
stock surrendered in a tax-free reorganization as “otherwise disposed of”
for purposes of section 2032(a)(1).
ii. The court also noted that the exchange of stock must have been for equal
value or the reorganization would not have been tax-free as the parties
had stipulated (although, ironically, the executor’s own appraiser had
determined a value of the pre-reorganization shares of $50.115 million
and a value of the post-reorganization shares of $47.010 million – a
difference of about 6.2 percent). The court distinguished Flanders,
where the post-death transaction itself reduced the value by 88 percent.
iii. The Tax Court in Kohler viewed the 1935 legislative history relied on in
Flanders as irrelevant, because Reg. §20.2032-1(c)(1) (promulgated in
1958) was clear and unambiguous and because “the legislative history
describes the general purpose of the statute, not the specific meaning of
‘otherwise disposed of’ in the context of tax-free reorganizations.”
e. The 2008 proposed regulations made no change to Reg. §20.2032-1(c)(1), on
which the Kohler court relied. But they invoked “the general purpose of the
statute” that was articulated in 1935, relied on in Flanders, and bypassed in
Kohler to beef up Reg. §20.2032-1(f), to clarify and emphasize, with both
text and examples, that the benefits of alternate valuation are limited to
changes in value due to “market conditions.” The 2008 proposed regulations
would specifically add “post-death events other than market conditions” to
changes in value resulting from the “mere lapse of time,” which are ignored
in applying alternate valuation under section 2032(a)(3).
f. New proposed regulations (REG-112196-07) were published on November
18, 2011. In contrast to the 2008 approach of ignoring certain intervening
events – and thereby potentially valuing assets six months after death on a
hypothetical basis – the new approach is to expand the description of
intervening events that are regarding as dispositions, triggering alternate
valuation as of that date. The expanded list, in Proposed Reg. §20.2032-
1(c)(1)(i), includes distributions, exchanges (whether taxable or not), and
contributions to capital or other changes to the capital structure or ownership
of an entity, including “[t]he dilution of the decedent’s ownership interest in
the entity due to the issuance of additional ownership interests in the entity.”
Proposed Reg. §20.2032-1(c)(1)(i)(I)(1). But under Proposed Reg. §20.2032-
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1(c)(1)(ii), an exchange of interests in a corporation, partnership, or other
entity is not counted if the fair market values of the interests before and after
the exchange differ by no more than 5 percent (in contrast to the 6.2 percent
difference in Kohler).
i. If the interest involved is only a fraction of the decedent’s total interest,
an aggregation rule in Proposed Reg. §20.2032-1(c)(1)(iv) values such
interests at a pro rata share of the decedent’s total interest.
ii. The proposed regulations also include special rules for coordinating with
annuities and similar payments (§20.2032-1(c)(1)(iii)(B)) and excepting
qualified conservation easements (§20.2032-1(c)(4)), and also greatly
expanded lists of examples.
g. While the 2008 proposed regulations were referred to as the “anti-Kohler
regulations,” the most significant impact of these proposed regulations may
be felt by efforts to bootstrap an estate into a valuation discount by
distributing or otherwise disposing of a minority or other noncontrolling
interest within the six-month period after death (valuing it as a minority
interest under section 2032(a)(1)) and leaving another minority or
noncontrolling interest to be valued six months after death (also valued as a
minority interest under section 2032(a)(2)).
i. Examples 7 and 8 of Proposed Reg. §20.2032-1(c)(5) specifically
address the discount-bootstrap technique – Example 8 in the context of a
limited liability company and Example 7 in the context of real estate –
and leave no doubt that changes in value due to “market conditions” do
not include the valuation discounts that might appear to be created by
ii. Example 1 reaches the same result with respect to the post-death
formation of a limited partnership.
h. The 2008 proposed regulations were to be effective April 25, 2008, the date
the proposed regulations were published. The new proposed regulations,
more traditionally, state that they will be effective when published as final
7. Guidance under §2053 regarding personal guarantees and the application of
present value concepts in determining the deductible amount of expenses and
claims against the estate.
a. This project first appeared in the 2008-09 Plan. It is an outgrowth of the
project that led to the final amendments of the section 2053 regulations in
b. The part of this project relating to “present value concepts” is evidently
aimed at the leveraged benefit obtained when a claim or expense is paid long
after the due date of the estate tax, but the additional estate tax reduction is
credited as of, and earns interest from, that due date.
i. If this project results in a deduction of only the present value of the
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payment, as of the due date of the tax, and the discount rate used in the
calculation of the present value is the same as the rate of interest on the
tax refund, and the interest is not subject to income tax (or the discount
rate is also reduced by the income tax rate), then the invocation of
“present value concepts” might make very little difference on paper. But
it might require legislation to accomplish all these things.
ii. Since claims or expenses are rarely paid exactly on the due date of the
tax, the precise application of such principles might be exceedingly
complicated. Presumably that is not intended.
iii. Graegin loans (see Estate of Graegin v. Commissioner, T.C. Memo
1988-477) are an obvious target of the present value proposal.
8. Guidance on the gift tax effect of defined value formula clauses under §§2512 and
a. This project is also new in 2015.
b. Defined value clauses have an interesting history. See, for example,
Technical Advice Memorandum 8611004 (Nov. 15, 1985) (approving a
transfer of “such interest in X Partnership … as has a fair market value of
$13,000”); Knight v. Commissioner, 115 T.C. 506 (2000) (disregarding the
use of such a technique to transfer “that number of limited partnership units
in [the partnership] which is equal in value, on the effective date of this
transfer, to $600,000”); Succession of McCord v. Commissioner, 461 F.3d
614 (5th Cir. 2006), rev’g 120 T.C. 358 (2003) (approving a defined value
clause, with the excess going to charity); Estate of Christiansen v.
Commissioner, 130 T.C. 1 (2008) (reviewed by the Court), aff’d, 586 F.3d
1061 (8th Cir. 2009) (approving a formula disclaimer in favor of charity);
Estate of Petter v. Commissioner, T.C. Memo 2009-280, aff’d, 653 F.3d 1012
(9th Cir. 2011) (approving a defined value clause, with the excess going to
charity); Hendrix v. Commissioner, T.C. Memo 2011-133 (approving a
defined value clause, with the excess going to charity); Wandry v.
Commissioner, T.C. Memo 2012-88, nonacq., AOD 2012-004, 2012-46
I.R.B. (approving a type of defined value clause, with the excess remaining
with the transferor); Estate of Donald Woelbing v. Commissioner (Tax Court
Docket No. 30261-13, petition filed Dec. 26, 2013) and Estate of Marion
Woelbing v. Commissioner (Tax Court Docket No. 30260-13, petition filed
Dec. 26, 2013).
c. In affirming the Tax Court in Petter, albeit in the context of a rather narrow
subpoint of a condition precedent within the meaning of Reg. §25.2522(c)-
3(b)(1), the Court of Appeals for the Ninth Circuit concluded its opinion by
“[W]e expressly invite[ ] the Treasury Department to “amend its
regulations” if troubled by the consequences of our resolution of th[is]
case.” Mayo Found. for Med. Educ. & Research v. United States, 131
S. Ct. 704, 713 (2011) (quoting United Dominion Indus., Inc. v. United
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States, 532 U.S. 822, 838 (2001)).
Maybe, in this guidance project, Treasury is accepting the invitation.
9. Regulations under §2642 regarding available GST exemption and the allocation
of GST exemption to a pour-over trust at the end of an ETIP.
a. This project first appeared in the 2012-2013 Plan.
b. Some context might be derived from a request for guidance from the AICPA,
first made in a letter to the IRS dated June 26, 2007, which stated:
The issues presented here are best illustrated by considering the following
Taxpayer creates an irrevocable trust, Trust Z, in which a qualified
annuity interest (as defined in section 2702(b)) is payable to the
taxpayer or his estate for 10 years. Upon the termination of the
annuity interest, Trust Z is to be separated into two trusts, Trust A
and Trust B. Trust A is for the exclusive benefit of Taxpayer’s
children and grandchildren. Trust B is for the exclusive benefit of
Taxpayer’s children. Trust A is to receive from Trust Z so much
of the Trust Z’s assets as is equal to Taxpayer’s remaining GST
exemption, if any. Trust B is to receive from Trust Z the balance of
Trust Z’s assets, if any, after funding Trust A. The taxpayer is
alive at the end of the 10 years.
Presumably, the transfer to Trust Z is an indirect skip to which GST
exemption will be automatically allocated at the end of the ETIP. Will the
automatic allocation rules apply to all the assets remaining in Trust Z at that
time? If so and if the taxpayer wants to allocate GST exemption only to the
assets going to Trust A, the taxpayer should timely elect out of the automatic
allocation rules of section 2632(c), and then affirmatively allocate GST
exemption only to the assets going into Trust A at the end of the ETIP. Is
In the alternative, the automatic allocation rules may apply only to the
transfer going into Trust A because Trust B is not by definition a GST trust.
Because of the application of the ETIP rules, the transfer from the taxpayer
for GST purposes would occur only at the time that the assets are funded into
Trust A. If that is the case, then the taxpayer does not need to do anything
affirmatively to ensure that GST exemption is allocated to Trust A and not
Trust B as he or she desires.
It has been our experience that many trusts are structured in a manner similar
to the above referenced fact pattern. By letter dated November 10, 2004, the
AICPA submitted comments on the proposed regulations on electing out of
deemed allocations of GST exemption under section 2632(c). In that letter,
guidance was requested on these issues. The preamble to the final
regulations (T.D. 9208) acknowledged this request for the inclusion in the
regulations of an example addressing the application of the automatic
allocation rules for indirect skips in a situation in which a trust subject to an
ETIP terminates upon the expiration of the ETIP, at which time the trust
assets are distributed to other trusts that may be GST trusts. According to the
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preamble, the Treasury Department and the Internal Revenue Service
believed that this issue was outside the scope of the regulation project and
would consider whether to address these issues in separate guidance.
10. Final regulations under §2642(g) regarding extensions of time to make allocations
of the generation-skipping transfer tax exemption. Proposed regulations were
published on April 17, 2008.
a. This first appeared in the 2007-08 Plan.
b. The background of this project is section 564(a) of the 2001 Tax Act, which
added subsection (g)(1) to section 2642, directing Treasury to publish
regulations providing for extensions of time to allocate GST exemption or to
elect out of statutory allocations of GST exemption (when those actions are
missed on the applicable return or a return is not filed).
i. Before the 2001 Tax Act, similar extensions of time under Reg.
§301.9100-3 (so-called “9100 relief”) were not available, because the
deadlines for taking such actions were prescribed by the Code, not by the
regulations. The legislative history of the 2001 Tax Act stated that “[n]o
inference is intended with respect to the availability of relief from late
elections prior to the effective date of [section 2642(g)(1)],” and section
2642(g)(1)(A) itself directs that the regulations published thereunder
“shall include procedures for requesting comparable relief with respect
to transfers made before the date of the enactment of [section
2642(g)(1)].” Section 2642(g)(1)(B) adds:
In determining whether to grant relief under this paragraph, the
Secretary shall take into account all relevant circumstances, including
evidence of intent contained in the trust instrument or instrument of
transfer and such other factors as the Secretary deems relevant. For
purposes of determining whether to grant relief under this paragraph,
the time for making the allocation (or election) shall be treated as if not
expressly prescribed by statute.
ii. Shortly after the enactment of the 2001 Tax Act, Notice 2001-50, 2001-2
C.B. 189, acknowledged section 2642(g)(1) and stated that taxpayers
may seek extensions of time to take those actions under Reg. §301.9100-
3. The Service has received and granted several requests for such relief
over the years since the publication of Notice 2001-50.
c. In addition, Rev. Proc. 2004-46, 2004-2 C.B. 142, provides a simplified
method of dealing with pre-2001 gifts that meet the requirements of the
annual gift tax exclusion under section 2503(b) but not the special “tax-
vesting” requirements applicable for GST tax purposes to gifts in trust under
i. Gifts subject to Crummey powers are an example.
ii. In such cases, GST exemption may be allocated on a Form 709 labeled
“FILED PURSUANT TO REV. PROC. 2004-46,” whether or not a
Form 709 had previously been filed for that year.
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iii. Post-2000 gifts are addressed by the expanded deemed allocation rules of
section 2632(c), enacted by the 2001 Tax Act.
d. Proposed Reg. §26.2642-7 (REG-147775-06) was released on April 16, 2008.
When finalized, it will oust Reg. §301.9100-3 in GST exemption cases and
become the exclusive basis for seeking the extensions of time Congress
mandated in section 2642(g)(1) (except that the simplified procedure for
dealing with pre-2001 annual exclusion gifts under Rev. Proc. 2004-46 will
e. The proposed regulations resemble Reg. §301.9100-3, but with some
important differences. Under Proposed Reg. §26.2642-7(d)(1), the general
standard is still “that the transferor or the executor of the transferor’s estate
acted reasonably and in good faith, and that the grant of relief will not
prejudice the interests of the Government.” Proposed Reg. §26.2642-7(d)(2)
sets forth a “nonexclusive list of factors” to determine whether the transferor
or the executor of the transferor’s estate acted reasonably and in good faith,
including (i) the intent of the transferor to make a timely allocation or
election, (ii) intervening events beyond the control of the transferor or the
executor, (iii) lack of awareness of the need to allocate GST exemption to the
transfer, despite the exercise of reasonable diligence, (iv) consistency by the
transferor, and (v) reasonable reliance on the advice of a qualified tax
professional. Proposed Reg. §26.2642-7(d)(3) sets forth a “nonexclusive list
of factors” to determine whether the interests of the Government are
prejudiced, including (i) the extent to which the request for relief is an effort
to benefit from hindsight, (ii) the timing of the request for relief, and (iii) any
intervening taxable termination or taxable distribution. Noticeably, the
proposed regulations seem to invite more deliberate weighing of all these
factors than the identification of one or two dispositive factors as under Reg.
f. “Hindsight,” which could be both a form of bad faith and a way the interests
of the Government are prejudiced, seems to be a focus of the proposed
regulations. This is probably explained by the obvious distinctive feature of
the GST tax – its effects are felt for generations, in contrast to most “9100
relief” elections that affect only a current year. There simply is more
opportunity for “hindsight” over such a long term. Thus, the greater rigor
required by the proposed regulations seems to be justified by the nature of the
GST tax and consistent with the mandate of section 2642(g)(1)(B) to “take
into account all relevant circumstances … and such other factors as the
Secretary deems relevant.”
g. Proposed Reg. §26.2642-7(h)(3)(i)(D) requires a request for relief to be
accompanied by “detailed affidavits” from “[e]ach tax professional who
advised or was consulted by the transferor or the executor of the transferor’s
estate with regard to any aspect of the transfer, the trust, the allocation of
GST exemption, and/or the election under section 2632(b)(3) or (c)(5).” The
references to “any aspect of the transfer” and “the trust” appear to go beyond
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the procedural requirement of Reg. §301.9100-3(e)(3) for “detailed affidavits
from the individuals having knowledge or information about the events that
led to the failure to make a valid regulatory election and to the discovery of
the failure.” Presumably, a professional who advised only with respect to
“the transfer” or “the trust” would have nothing relevant to contribute other
than a representation that they did not advise the transferor to make the
election, a fact that the transferor’s own affidavit could establish. Out of
concern about returning to the supercharged “fall on your sword” days before
the reformation of the 9100 rules reflected in Rev. Proc. 92-85, 1992-2 C.B.
490, the author of this outline recommended the relaxation of that
requirement in a comment letter dated July 3, 2008.
h. Section 2642(g)(1), having been enacted by the 2001 Tax Act, was once
scheduled to “sunset” on January 1, 2011, then on January 1, 2013, and is
11. Regulations under §2704 regarding restrictions on the liquidation of an interest in
certain corporations and partnerships.
a. This item first appeared in the 2003-04 Plan.
b. It is apparently intended to address section 2704(b)(4), which states, in the
context of corporate or partnership restrictions that are disregarded:
The Secretary may by regulations provide that other restrictions shall be
disregarded in determining the value of the transfer of any interest in a
corporation or partnership to a member of the transferor’s family if such
restriction has the effect of reducing the value of the transferred interest for
purposes of this subtitle but does not ultimately reduce the value of such
interest to the transferee.
c. From May 2009 until April 2013, the status of this regulation project had to
be evaluated in light of the Administration’s related revenue proposal
described in Part XVIII.J beginning on page 136. The 2013, 2014, 2015, and
2016 Greenbooks omit that proposal.
d. Using the pre-2013 Greenbooks as a general guide, the following are markers
or factors to help us guess what the proposed regulations might contain:
i. First, Eliminate $4.5 Billion of Discounts Per Year. The 10-year
revenue estimates in the 2009-2012 Greenbooks – $19.038 billion,
$18.667 billion, $18.166 billion, and $18.079 billion – trending
downward to, say, $18 billion, represent a revenue gain of about $1.8 per
year. At today’s 40 percent estate and gift tax rate, an annual recovery of
$4.5 billion of value otherwise lost to discounts would raise $1.8 billion
per year. This is a grossly simplified model that ignores income tax
effects, opportunity costs, and doubtless a host of other factors that
Treasury’s revenue estimators use. But it is all we have.
ii. Second, Consider the Composition of the Assets. Perhaps the most
obvious badge of aggressive discount planning is the justification of
those discounts only by features of the entity holding the assets, not
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features of the assets themselves. The entity holding only cash or
publicly-traded securities is the easiest target.
iii. Third, Forget Those “Nontax Reasons.” The application of a
“legitimate and significant nontax reason” test to family entities in Estate
of Bongard v. Commissioner, 124 T.C. 95 (2005) (reviewed by the
Court), was welcomed by some as a relaxation or at least a clarification
of a narrower “business purpose” test. Indeed, Judge Laro, joined by
Judge Marvel, wrote a concurring opinion stating: “I disagree with the
use of the majority’s ‘legitimate and significant nontax reason’ test. … I
would apply the longstanding and well-known business purpose test of
Gregory v. Helvering, 293 U.S. 465 (1935).” Ironically, the underlying
assets in Bongard were an operating business, and even Judges Laro and
Marvel concurred in the result. Judge Halpern found “a legitimate and
significant nontax reason” to be “an inappropriate motive test” and
dissented in part, while Judges Chiechi, Wells, and Foley, citing United
State v. Byrum, 408 U.S. 125 (1972), questioned the need for “any
significant nontax reason” and would have gone even farther in the
taxpayer’s favor than the majority. The Bongard test is used in applying
the “bona fide sale for an adequate and full consideration in money or
money’s worth” exception of sections 2036(a) and 2038(a)(1), not for
determining the effect on value of an entity-level restriction as such, but
it has been applied in 20-some cases and has become a staple of the
family entity planning vocabulary. But we should not count on a nontax
reason exception in the anticipated proposed regulations. The
regulations might conclude that if holding assets in a family entity like a
limited partnership or LLC has nontax benefits such as keeping legacy
investments in the family, permitting centralized and more efficient
investing, facilitating transfers of interests in real estate, and protecting
assets from claimants and spendthrifts, those benefits may actually
enhance value for the family, as section 2704(b)(4) contemplates, which
is an odd justification for reducing the transfer tax value through
discounts. This will be an uncomfortable notion for many, but it is hard
to deny the economics.
iv. Fourth, Leave Operating Businesses Alone. In contrast, the operation
of a genuine business, such as the business at the core of the Bongard
case, would be a very poor target for these regulations. The valuation of
an operating business is complicated. A net asset value method of
valuation, which “courts are overwhelmingly inclined to use … for
holding companies whose assets are marketable securities” (Estate of
Richmond v. Commissioner, T.C. Memo 2014-26), is rarely as useful for
valuing an interest in an operating business, and, even when it is used, it
is normally attended by many adjustments to the otherwise unhelpful
concept of “book value.” Business valuation entails judgments in
selecting and weighting valuation approaches, judgments in selecting
and weighting comparable businesses, judgments in making adjustments
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to financial statements, judgments about the economic context and
outlook, judgments about the specific opportunities and risks of the
business in question, judgments about the relevant interest rates and
similar data to be used, and countless other judgments trained and
experienced appraisers make, not just judgments about various discounts
applied after the appropriate base of value has been determined but still
inseparable from the unique overall process of business valuation.
Applying any mechanical constraints on that last part of a unified
process would be an imprudent and unworkable idea. In addition,
applying such rules to operating businesses would unnecessarily burden
a category of entities – small businesses and family-owned businesses –
that transfer tax law has historically, even if somewhat haltingly, sought
to aid, evidenced in policy judgments at least since the Small Business
Tax Revision Act of 1958 added section 6166 to the Code. (Subchapter
S was added at the same time.) It is understandable that those in the IRS
and Treasury who are charged with interpreting and administering
transfer tax laws may find it frustrating when a family limited
partnership, for example, claims nontax purposes or the right to be
valued like a “business,” especially when value seems to disappear for
transfer tax purposes but reappear in the hands of the transferees, as
section 2704(b)(4) contemplates. But it is also frustrating to tax
professionals when tax enforcement seems to overreact by treating real
operating businesses like FLPs. These regulations should not make that
mistake. Admittedly, that would probably require measures to prevent
circumvention of the rules by “stuffing” nonbusiness assets, especially
liquid assets, into family-owned businesses beyond the reasonable needs
of the business for working capital. But that is already true in other
contexts, including section 6166. And while the treatment of that issue
in section 6166 is not necessarily pretty, some thoughtful effort to that
end is necessary and could reap a dividend in public acceptance that
these regulations are likely to need.
v. Fifth, Consider Who Created the Restriction. Again in the interest of
public acceptance, the proposed regulations must consider the origin of
any targeted restriction. A transferor who self-creates and self-imposes a
restriction should be the target. The holder who receives a restricted
noncontrolling interest from others (including ancestors) and who never
had a meaningful opportunity to remove those restrictions should not be
a target. If that seems arbitrary or sounds like a “loophole,” consider that
the most flagrant scenario that fuels this regulation project may be the
scenario in which the family finds a way to remove, mitigate, or ignore a
restriction shortly after the estate tax statute of limitations has run on a
valuation that was substantially depressed by that restriction. Exempting
ancestral restrictions not created by the transferor would not ordinarily
permit that scenario. Attribution among family members, except
between spouses, would have no place. The Greenbooks provided that
“[r]egulatory authority would be granted, including the ability to create
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safe harbors to permit taxpayers to draft the governing documents of a
family-controlled entity so as to avoid the application of section 2704 if
certain standards are met.” No details were given. (As an aside, it is odd
that a proposal to limit opportunities to “circumvent” section 2704 would
contemplate that section 2704 could be avoided simply by the way
governing documents are drafted.) But perhaps this authority would be
used in the proposed regulations to protect actual family operating
businesses or to protect the holder of a restricted noncontrolling interest
received from others. In other words, there may be room within the
Greenbooks’ offer of regulatory safe harbors to support and confirm
these fourth and fifth factors.
vi. Sixth, Consider Who Can Remove the Restriction. The Greenbooks
stated that “[f]or purposes of determining whether a restriction may be
removed by member(s) of the family after the transfer, certain interests
(to be identified in regulations) held by charities or others who are not
family members of the transferor would be deemed to be held by the
family.” Presumably, for example, the relatively small interest held by
the University of Texas in Kerr v. Commissioner, 292 F.3d 490 (5th Cir.
2002), aff’g 113 T.C. 449, 472-74 (1999), would be treated as held by
the Kerr family under this provision, despite the Fifth Circuit’s ruling
that it was enough to prevent section 2704(b) from applying. Whether
viewed as a de minimis rule or something else, this is another element to
expect in the proposed regulations. Under the Greenbooks, disregarded
restrictions would also include limitations on a transferee’s ability to be
admitted as a full partner or other holder of an equity interest, thus
apparently denying the opportunity to value a transferred interest as a
“mere” “assignee” interest. Although it is not clear that that makes much
practical difference, such a rule should be expected in the proposed
vii. Seventh, Expect a More Holistic Approach Than Case Law Can
Provide. The Greenbooks promised to “make conforming clarifications
with regard to the interaction of this proposal with the transfer tax
marital and charitable deductions.” This could override the harsh
“reverse-Chenoweth” result seen in Technical Advice Memoranda
9050004 (Aug. 31, 1990) and 9403005 (Oct. 14, 1993) (all stock owned
by the decedent valued as a control block in the gross estate, but the
marital bequest valued separately for purposes of the marital deduction),
relying on Estate of Chenoweth v. Commissioner, 88 T.C. 1577 (1987)
(estate of a decedent who owned all the stock of a corporation entitled to
a control premium for a 51-percent block bequeathed to the surviving
spouse for purposes of the marital deduction), and Ahmanson
Foundation v. United States, 674 F.2d 761 (9th Cir. 1981). Put another
way, it could ensure that a large estate left in three equal shares to three
public charities would be entitled to charitable deductions that equaled
the whole gross estate, rather than three charitable deductions calculated
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as minority interests that left a portion of the value of the estate subject
to tax. Such a result in the proposed regulations would also reinforce the
fairness of the proposal and promote public acceptance. Because judges
are limited to the cases before them, case law could never achieve such a
viii. Eighth, Without Statutory Cover, Walk It Back a Bit. Assuming that
Treasury was right in desiring strengthened statutory authority, it is
reasonable to assume that in the absence of such statutory authority it
might, in caution, back off some of its original expectations. Maybe that
would result in dropping the attribution to the family of small interests
held by charity or other non-family members. Maybe it would cause
reconsideration of the treatment of “assignee” interests. Maybe
something else. There really is no way to tell.
e. Effective Date.
i. There are two elements of the effective date – when? and what? The
date the regulations are proposed and the date they are finalized are the
likely possibilities for when.
ii. But perhaps an even more significant factor is what event is measured
against the effective date. If that event is the creation of a restriction, as
in section 2704 itself, then post-enactment transfers from an entity
already created and funded would not be subject to the new rules. But if
the critical event is the transfer of restricted interests, then it is not
enough to have the entity in place before the effective date. The
necessary transfers, presumably to younger generations or trusts for their
benefit, must have been completed. For some that possibility could
encourage an acceleration of taxable gifts, rather than waiting until
iii. Somehow effectiveness of the new rules immediately upon their
publication in proposed form, especially if they are applicable to all
transfers even of interests in entities already formed subject to
restrictions already imposed, seems ambitious for regulations under a 25-
year-old statute and a 12-year-old Priority Guidance Plan project.
Perhaps such an aggressive effective date is the main reason Treasury
sought statutory cover from Congress for four years. If so, then we
should expect that either the application of the proposed rules is
postponed until they are finalized, or they are proposed to be
immediately effective but that goal is eventually watered down or
abandoned in the face of the intense and voluminous public criticism that
is bound to come.
iv. Even so, while it might be wrong to push to completion an entity-based
estate planning transaction that has no compelling “nontax reason,” the
pending regulations do encourage us to get off our desks whatever
projects are sitting there, if feasible. Of course, despite some signals in
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2015 that the proposed regulations might be imminent, readers will
remember that they have been hearing these “urgent” warnings for 12
12. Guidance under §2801 regarding the tax imposed on U.S. citizens and residents
who receive gifts or bequests from certain expatriates.
a. The Heroes Earnings Assistance and Relief Tax Act of 2008 (the “HEART”
Act) enacted a new income tax “mark to market” rule when someone
expatriates on or after June 17, 2008, and a new succession tax on the receipt
of certain gifts or bequests from someone who expatriated on or after June
17, 2008. The new succession tax is provided for in section 2801,
comprising all of new chapter 15.
b. Referring to the guidance contemplated by this project, Announcement 2009-
57, 2009-29 I.R.B. 158 (released July 16, 2009), stated:
The Internal Revenue Service intends to issue guidance under section 2801,
as well as a new Form 708 on which to report the receipt of gifts and
bequests subject to section 2801. The due date for reporting, and for paying
any tax imposed on, the receipt of such gifts or bequests has not yet been
determined. The due date will be contained in the guidance, and the
guidance will provide a reasonable period of time between the date of
issuance of the guidance and the date prescribed for the filing of the return
and the payment of the tax.
c. This project first appeared on the 2009-2010 Plan. It has consistently been
referred to by Treasury and IRS personnel as a top priority, but the
implementation of what amounts to a transfer tax on transferees, not
transferors or their estates, is quite complicated and challenging.
d. Proposed regulations (§§28.2801-1 through -7 and related procedural
sections, REG-112997-10) were published on September 10, 2015. They are
about 18,000 words long and were accompanied by a preamble of about
8,600 words. The preamble included the estimate that there would be 1,000
e. Proposed Reg. §28.6011-1(a) provides that “covered” gifts and bequests must
be reported by the recipient on Form 708, “United States Return of Tax for
Gifts and Bequests from Covered Expatriates.”
i. Under Proposed Reg. §28.6071-1(a)(1), Form 708 is generally due on
the 15th day of the 18th month following the close of the calendar year in
which the transfer was received. Thus, a Form 708 reporting a 2015
transfer would be due June 15, 2017. But, fulfilling the promise of
Announcement 2009-57, Proposed Reg. §28.6071-1(d) states that no
Form 708 will be due before the date specified in the final regulations.
ii. Under Proposed Reg. §28.2801-3(c)(1) and (2), if a gift or bequest is
reported by the expatriate donor or executor of the expatriate decedent
on a Form 709 or 706, and gift or estate tax is paid, it is not a covered
gift or bequest and need not be reported on Form 708.
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f. Proposed Reg. §28.2801-3(b) confirms that covered bequests include the
receipt of assets the value of which would be included in a U.S. citizen’s
gross estate under section 2036, 2037, 2038, 2040, 2042, or 2044.
g. There are some oddities and surprises in the calculation of the tax.
i. Under Proposed Reg. §28.2801-4(b)(2), the sum of both covered gifts
and covered bequests is reduced by the annual exclusion amount
provided for gift tax purposes under section 2503(b) (currently $14,000).
But only one such reduction is allowed, regardless of the number of
donors. In the case of a gift to a spouse who is not a U.S. citizen, that
amount is determined under section 2523(i) (see Proposed Reg.
§28.2801-3(c)(4) and -3(f), Example 1) and is 10 times the unrounded
amount determined under section 2503(b) (currently $147,000).
ii. Under section 2801(b), the tax is an obligation of the recipient.
Nevertheless, under the calculation rules in Proposed Reg. §28.2801-
4(b), the gift tax the recipient pays is not deducted from the amount
subject to tax, as it would be in the case of a typical “net gift.” The
section 2801 tax, whether on a gift or a bequest, is “tax-inclusive.”
iii. Proposed Reg. §28.2801-4(a)(2)(iii) provides rules for computing the tax
in the case of a covered transfer to a charitable remainder trust. The
value of the transferred property is allocated between the noncharitable
interest and the charitable remainder interest in the usual way and the tax
is calculated on the noncharitable portion. Although the payment of the
tax by the trust does not reduce the value of the gift for purposes of the
calculation of the section 2801 tax (see paragraph ii above), it does
reduce the true value of the charitable remainder and therefore might
actually increase the value of the covered gift.
iv. Under Proposed Reg. §28.2801-6(a), the recipient’s payment of the tax
does not increase the basis of the transferred property.
h. One of the most vexing issues regarding the section 2801 tax has been
figuring out how the recipient will know when a gift or bequest is a
“covered” gift or bequest from a “covered” expatriate. Gifts and bequests
normally have no tax consequences to the recipient.
i. Proposed Reg. §28.2801-7(a) provides this ominous and exasperating,
but probably unavoidable, confirmation:
(a) Responsibility of recipients of gifts and bequests from expatriates.
It is the responsibility of the taxpayer (in this case, the U.S. citizen or
resident receiving a gift or bequest from an expatriate or a distribution
from a foreign trust funded at least in part by an expatriate) to ascertain
the taxpayer’s obligations under section 2801, which includes making
the determination of whether the transferor is a covered expatriate and
whether the transfer is a covered gift or covered bequest.
ii. Doing the best it can to be helpful, Proposed Reg. §28.2801-7(b) adds:
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(b) Disclosure of return and return information—(1) In general. In
certain circumstances, the Internal Revenue Service (IRS) may be
permitted, upon request of a U.S. citizen or resident in receipt of a gift
or bequest from an expatriate, to disclose to the U.S. citizen or resident
return or return information of the donor or decedent expatriate that
may assist the U.S. citizen or resident in determining whether the
donor or decedent was a covered expatriate and whether the transfer
was a covered gift or covered bequest. The U.S. citizen or resident
may not rely upon this information, however, if the U.S. citizen or
resident knows, or has reason to know, that the information received
from the IRS is incorrect. The circumstances under which such
information may be disclosed to a U.S. citizen or resident, and the
procedures for requesting such information from the IRS, will be as
provided by publication in the Internal Revenue Bulletin (see
(2) Rebuttable presumption. Unless a living donor expatriate authorizes
the disclosure of his or her relevant return or return information to the
U.S. citizen or resident receiving the gift, there is a rebuttable
presumption that the donor is a covered expatriate and that the gift is a
covered gift. A taxpayer who reasonably concludes that a gift or
bequest is not subject to section 2801 may file a protective Form 708 in
accordance with §28.6011-1(b) to start the period for the assessment of
any section 2801 tax.
iii. The preamble further explains:
Section 28.2801-7 provides guidance on the responsibility of a U.S.
recipient, as defined in §28.2801-2(e), to determine if tax under section
2801 is due. The Treasury Department and the IRS realize that,
because the tax imposed by this section is imposed on the U.S. citizen
or resident receiving a covered gift or covered bequest, rather than on
the donor or decedent covered expatriate making the gift or bequest,
U.S. taxpayers may have difficulty determining whether they are liable
for any tax under section 2801. Nevertheless, the same standard of due
diligence that applies to any other taxpayer to determine whether the
taxpayer has a tax liability or a filing requirement also applies to U.S.
citizens and residents under this section. Accordingly, it is the
responsibility of each U.S. citizen or resident receiving a gift or
bequest, whether directly or indirectly, from an expatriate (as defined
in section 877A(g)(2)) to determine its tax obligations under section
2801. Thus, the burden is on that U.S. citizen or resident to determine
whether the expatriate was a covered expatriate (as defined in section
877A(g)(1)) and, if so, whether the gift or bequest was a covered gift
or covered bequest.
iv. In other words, if a family member expatriates, life will be tougher for
other family members (or any objects of the expatriate’s bounty) who do
v. Proposed Reg. 28.6011-1(b)(i) does provide that a recipient who
reasonably concludes that a gift or bequest is not a “covered” gift or
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bequest may file a protective Form 708, and that such a filing will start
the period for assessment of tax with respect to any transfer reported on
i. Section 2801(e)(1) provides that a “covered gift or bequest” includes any
property acquired “directly or indirectly.” Section 2801(e)(4)(A) provides
that a covered transfer includes a transfer to a U.S. domestic trust. Section
2801(e)(4)(B)(i) provides that in the case of a covered gift or bequest to a
foreign trust, the tax is imposed on distributions from the trust “attributable to
such gift or bequest.”
i. Proposed Reg. §28.2801-5(c)(1)(i) provides that the amount of any
distribution attributable to covered gifts and bequests is determined by
applying a “section 2801 ratio” to the value of the distribution. Tracing
of particular trust assets is not allowed.
ii. Under Proposed Reg. §28.2801-5(c)(1)(ii), the “section 2801 ratio,”
representing the portion of the trust and of each distribution that is
deemed to be attributable to covered transfers, is redetermined after each
contribution to the trust, in a manner resembling the calculation of the
inclusion ratio for GST tax purposes.
iii. Proposed Reg. §28.2801-5(c)(3) provides:
If the trustee of the foreign trust does not have sufficient books and
records to calculate the section 2801 ratio, or if the U.S. recipient is
unable to obtain the necessary information with regard to the foreign
trust, the U.S. recipient must proceed upon the assumption that the
entire distribution for purposes of section 2801 is attributable to a
covered gift or covered bequest.
This encourages the expatriate transferor to cooperate with transferees.
iv. Proposed Reg. §28.2801-5(d) permits a foreign trust to elect to be treated
as a U.S. domestic trust.
(A) Thereby the section 2801 tax is imposed on the value of the
trust multiplied by the section 2801 ratio and on all current
and future transfers to the trust from covered expatriates, but
not on future distributions from the trust.
(B) The trustee of an electing foreign trust must designate and
authorize a U.S. agent solely for purposes of section 2801.
Proposed Reg. §28.2801-5(d)(3)(iv) states:
By designating a U.S. agent, the trustee of the foreign
trust agrees to provide the agent with all information
necessary to comply with any information request or
summons issued by the Secretary. Such information
may include, without limitation, copies of the books
and records of the trust, financial statements, and
appraisals of trust property. … Acting as an agent for
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the trust for purposes of section 2801 includes serving
as the electing foreign trust’s agent for purposes of
section 7602 (“Examination of books and witnesses”),
section 7603 (“Service of summons”), and section
7604 (“Enforcement of summons”) with respect to
[a]ny request by the Secretary to examine records or
produce testimony related to the proper identification
or treatment of covered gifts or covered bequests
contributed to the electing foreign trust and
distributions attributable to such contributions; and
[a]ny summons by the Secretary for records or
testimony related to the proper identification or
treatment of covered gifts or covered bequests
contributed to the electing foreign trust and
distributions attributable to such contributions.
a. The 2011-2012 Priority Guidance Plan included, as item 13, “Notice on
decanting of trusts under §§2501 and 2601.” This project was new in 2011-
2012, but it had been anticipated for some time, at least since the publication
at the beginning of 2011 of Rev. Proc. 2011-3, 2011-1 I.R.B. 111, in which
new sections 5.09, 5.16, and 5.17 included decanting among the “areas under
study in which rulings or determination letters will not be issued until the
Service resolves the issue through publication of a revenue ruling, revenue
procedure, regulations or otherwise.” Rev. Proc. 2016-3, 2016-1 I.R.B. 126,
§§5.01(11), (16) & (17) continues this designation.
b. On December 20, 2011, the IRS published Notice 2011-101, 2011-52 I.R.B.
932. Notice 2011-101 asked for comments from the public by April 25,
2012, on the tax consequences of decanting transactions – the transfer by a
trustee of trust principal from an irrevocable “Distributing Trust” to another
“Receiving Trust.” Notice 2011-101 asked for comments on the relevance
and effect of the following 13 facts and circumstances (as well as the
identification of any other factors that might affect the tax consequences):
i. A beneficiary’s right to or interest in trust principal or income is changed
(including the right or interest of a charitable beneficiary);
ii. Trust principal and/or income may be used to benefit new (additional)
iii. A beneficial interest (including any power to appoint income or corpus,
whether general or limited, or other power) is added, deleted, or
iv. The transfer takes place from a trust treated as partially or wholly owned
by a person under §§671 through 678 of the Internal Revenue Code (a
“grantor trust”) to one which is not a grantor trust, or vice versa;
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v. The situs or governing law of the Receiving Trust differs from that of the
Distributing Trust, resulting in a termination date of the Receiving Trust
that is subsequent to the termination date of the Distributing Trust;
vi. A court order and/or approval of the state Attorney General is required
for the transfer by the terms of the Distributing Trust and/or applicable
vii. The beneficiaries are required to consent to the transfer by the terms of
the Distributing Trust and/or applicable local law;
viii. The beneficiaries are not required to consent to the transfer by the terms
of the Distributing Trust and/or applicable local law;
ix. Consent of the beneficiaries and/or a court order (or approval of the state
Attorney General) is not required but is obtained;
x. The effect of state law or the silence of state law on any of the above
xi. A change in the identity of a donor or transferor for gift and/or GST tax
xii. The Distributing Trust is exempt from GST tax under §26.2601-1, has an
inclusion ratio of zero under §2632, or is exempt from GST under
xiii. None of the changes described above are made, but a future power to
make any such changes is created.
c. Notice 2011-101 also “encourage[d] the public to suggest a definition for the
type of transfer (‘decanting’) this guidance is intended to address” and
encouraged responses to consider the contexts of domestic trusts, the
domestication of foreign trusts, and transfers to foreign trusts.
d. Meanwhile, Notice 2011-101 said that the IRS “generally will continue to
issue PLRs with respect to such transfers that do not result in a change to any
beneficial interests and do not result in a change in the applicable rule against
e. There were extensive public comments, and there is no doubt that Treasury
and the IRS are continuing to study decanting. But decanting was omitted
from the 2012-2013 Plan and has been omitted again from the 2013-2014,
2014-2015, and 2015-2016 Plans.
f. A new Uniform Trust Decanting Act (UTDA) was approved by the National
Conference of Commissioners on Uniform State Laws at its annual
conference in Williamsburg, Virginia, in July 2015. The Act, available at
t.pdf, generally allows decanting whenever the trustee has discretion to make
principal distributions, or even if the trustee does not have such discretion if
it is appropriate to decant into a special-needs trust.
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i. Generally decanting may not add beneficiaries, and Section 19 of UTDA
includes extensive explicit safeguards, called “tax-related limitations,” to
prevent decanting from jeopardizing any intended beneficial tax
characteristics of the trust. The beneficial tax characteristics explicitly
addressed are the marital deduction, the charitable deduction, the annual
gift tax exclusion, the eligibility of the trust to hold S corporation stock,
an inclusion ratio of zero for GST tax purposes, preservation of the use
of the trust beneficiary’s life expectancy in determining minimum
required distributions from a retirement plan or IRA, and the
preservation, creation, or termination of grantor trust status as the
circumstances might warrant.
ii. UTDA in effect now provides the “definition” Notice 2011-101 asked
for, and its publication should now pave the way for the long-awaited tax
guidance for decantings done under UTDA or substantially identical
statutes. And because of the care to avoid tax problems that UTDA
exhibits, that guidance should not be as hard to complete or as harsh in
its application as many might have feared.
2. Charitable remainder trust forms
a. Every Plan since the 2008-09 Plan had included an item described as
“Guidance concerning adjustments to sample charitable remainder trust
forms under §664.” (The 2011-12 Plan added the word “remainder,” but that
had been implied by the reference to section 664 anyway.) When it
published sample charitable lead unitrust forms in Rev. Proc. 2008-45, 2008-
30 I.R.B. 224, and Rev. Proc. 2008-46, 2008-30 I.R.B. 238, the Service
completed a round of sample forms for various split-interest trusts. At that
time the Service apparently intended to go over its work again, to reflect
updates in the law, practice, and thinking, at least with respect to charitable
b. That project is omitted from the 2014-2015 Plan. But, as with decanting, it is
likely that split-interest trust forms will continue to get attention.
3. Private trust companies
a. Privately owned and operated trust companies are becoming an option that
families with large trusts are turning to in increasing numbers, and state law
authority for such private trust companies is being continually refined. Every
Priority Guidance Plan since the 2004-2005 Plan had included an item
referring to private trust companies.
i. When this project first appeared, in the 2004-05 Plan, it was described as
“Guidance regarding family trust companies.”
ii. In the 2005-06, 2006-07, and 2007-08 Plans, it was described as
“Guidance regarding the consequences under various estate, gift, and
generation-skipping transfer tax provisions of using a family-owned
company as the trustee of a trust.” The omission of income tax issues
from that formulation was a source of concern, because income tax
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issues have frequently been addressed in the relevant letter rulings.
Indeed, in the first such letter rulings, Letter Rulings 9841014 and
9842007 (July 2, 1998), the only issue was whether a family-owned trust
company was a “related or subordinate party” with respect to the living
grantors of various trusts, within the meaning of section 672(c), an
income tax rule.
iii. In the 2008-09 and 2009-10 Plans, the description was a more
comprehensive “Revenue ruling regarding the consequences under
various income, estate, gift, and generation-skipping transfer tax
provisions of using a family owned company as a trustee of a trust.”
iv. That reassurance of comprehensive treatment was maintained in the most
recent Plans by describing the project as “Guidance concerning private
trust companies under §§671, 2036, 2038, 2041, 2042, 2511, and 2601.”
v. By dropping the reference to a revenue ruling, the 2010-2011 Plan
suggested that Treasury and the IRS might be reviewing the basic
approach of the proposed revenue ruling, which attracted a large number
of diverse public comments. But a revenue ruling as the vehicle for the
guidance would be much easier to finalize than would, for example,
amendment of the many regulations that would have to be amended.
vi. Following the first appearance of this project on the 2004-2005 Plan, the
IRS identified the treatment of private trust companies for estate tax
purposes under sections 2036, 2038, and 2041 as “areas under study in
which rulings or determination letters will not be issued until the Service
resolves the issue through publication of a revenue ruling, revenue
procedure, regulations or otherwise.” Rev. Proc. 2005-3, 2005-1 C.B.
118, §§5.07, 5.08 & 5.09. This designation has continued to the present.
Rev. Proc. 2016-3, 2016-1 I.R.B. 126, §§5.01(13), (14) & (15).
b. The proposed revenue ruling was released with Notice 2008-63 on July 11,
2008, and published at 2008-31 I.R.B. 261 (2008-2 C.B. 261) on August 4,
2008. The Notice solicited comments on the proposed revenue ruling, which
affirmed favorable conclusions with respect to five tax issues faced by trusts
of which a private trust company serves as trustee:
i. Inclusion of the value of trust assets in a grantor’s gross estate by reason
of a retained power or interest under section 2036 or 2038.
ii. Inclusion of the value of trust assets in a beneficiary’s gross estate by
reason of a general power of appointment under section 2041.
iii. Treatment of transfers to a trust as completed gifts.
iv. Effect on a trust’s status under the GST tax either as a “grandfathered”
trust or as a trust to which GST exemption has been allocated.
v. Treatment of a grantor or beneficiary as the owner of a trust for income
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While these are not the only issues that the use of private trust companies can
present, these are the most common issues. It was especially encouraging to
see grantor trust treatment addressed, in view of the omission of income tax
from the formulation of this project on the then current Plan.
c. The proposed revenue ruling posited several trusts, illustrating both the
introduction of a private trust company as the trustee of a preexisting trust
and the creation of new trusts with a private trust company as the trustee.
The trusts had the following features:
i. The trustee has broad discretionary authority over distributions of both
income and principal.
ii. Each successive primary beneficiary has a broad testamentary power of
appointment (although not as broad as a power to appoint to anyone
other than the beneficiary’s estate, creditors, and creditors of the estate).
iii. The grantor or primary beneficiary may unilaterally appoint (but not
remove) trustees, with no restrictions other than on the ability to appoint
d. The proposed revenue ruling presented two situations – Situation 1, in which
the private trust company is formed under a state statute with certain
limitations, and Situation 2, in which the private trust company is formed in a
state without such a statute but comparable limitations are included in the
governing documents of the private trust company itself.
e. The basic premise of the proposed revenue ruling, as stated in the second
paragraph of Notice 2008-63, was:
The IRS and the Treasury Department intend that the revenue ruling, once
issued, will confirm certain tax consequences of the use of a private trust
company that are not more restrictive than the consequences that could have
been achieved by a taxpayer directly, but without permitting a taxpayer to
achieve tax consequences through the use of a private trust company that
could not have been achieved had the taxpayer acted directly. Comments
are specifically requested as to whether or not the draft revenue ruling will
achieve that intended result.
f. Consistently with this basic premise, the proposed revenue ruling provided
that the hypothetical private trust companies it addressed would generally
avoid tax problems by the use of certain “firewall” techniques. For example:
i. A “Discretionary Distribution Committee” (“DDC”) with exclusive
authority to make all decisions regarding discretionary distributions.
Anyone may serve on the DDC, but no member of the DDC may
participate in the activities of the DDC with respect to a trust of which
that DDC member or his or her spouse is a grantor or beneficiary, or of
which the beneficiary is a person to whom that DDC member or his or
her spouse owes an obligation of support.
ii. In Situation 2, an “Amendment Committee” with exclusive authority to
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amend the relevant sensitive limitations in the private company’s
governing documents (which are imposed by statute in Situation 1). A
majority of the members of the Amendment Committee must be
individuals who are neither members of the relevant family nor persons
related or subordinate (within the meaning of section 672(c)) to any
shareholder of the company.
g. A paragraph near the end of the proposed revenue ruling identified three
factual details that were not material to the favorable tax conclusions,
explicitly confirming that the conclusions would not change if those details
changed. No doubt the list of immaterial factual details could be expanded.
Some likely examples (not exhaustive):
i. The designation of a “primary beneficiary” of each preexisting trust,
possibly excluding so-called “pot” or “sprinkle” trusts.
ii. The assumed requirement of an independent “Discretionary Distribution
Committee” for each trust administered by the private trust company,
possibly excluding a differently conceived body with a similar effect, a
different committee for different trusts, and any exception for trusts for
customers other than family members administered by family-owned
trust companies that offer fiduciary services to the public.
iii. The explicit prohibition of certain express or implied reciprocal
agreements regarding distributions, possibly excluding such prohibitions
derived from general fiduciary law.
h. The project relating to private trust companies was omitted from the 2014-
2015 Plan. Unlike decanting, however, it cannot be said that private trust
companies are a priority, or that the contemplated guidance will be issued
soon. But meanwhile, the principles reflected in the proposed revenue ruling,
including the reliance on “firewalls,” will be relied on by those contemplating
and organizing private trust companies and employing them as trustees of
family trusts. If and when the IRS does issue guidance in this area, it is likely
that such guidance will not be harsher in any material way than the guidance
in the proposed revenue ruling.
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