Deloitte LLP Seeks to Eliminate Redundancy in Estate Basis Reporting

The distribution of an estate is frequently subject to one or more formula clauses in favor of one or more testamentary trusts where asset selection is left to the discretion of the executor. As noted above, distributions, particularly of the estate's residue, are not generally undertaken until any estate tax controversy is settled. Thus, it is common that formula bequests are made in favor of testamentary trusts that, at the time of the required filing of Form 8971, do not exist under state law -- i.e., no trustee has been appointed, no TIN requested, and no Form 56 has been filed (an "Unfunded Trust"). Nonetheless, the proposed regulations require a Schedule A to be provided to the Unfunded Trust notwithstanding there is no one who can legally take receipt of the Schedule A. The final regulations should clarify that such situations are governed by the unlocated beneficiary exception of Prop. Reg. § 1.6035-1(c)(4). Specifically, basis information should not be required to be reported to Unfunded Trusts until 30 days after the in-kind distribution.

b. Reconciliation of Beneficiaries on Form 706 and Form 8971

If basis reporting is not to be extended to all assets received in kind, the final regulations should clarify that it is not anticipated that every beneficiary identified on Form 706, Part 4 and on Schedule O are to receive a Schedule A. The final regulations should reflect that Schedule A reporting is anticipated only with respect to residual beneficiaries and beneficiaries receiving specific bequests in kind that are not otherwise excepted assets. This modification would assist the IRS in review of Schedules A against the related Forms 706, Part 4 and Schedule O, should it need to reconcile which beneficiaries listed on Forms 706 received assets subject to the basis consistency rules.

c. Exception from Reporting for Beneficiaries Outside the U.S. Tax System

Currently, the instructions for Form 8971 indicate that "a form with an answer of 'unknown' will not be considered a complete return." Further, the Form requires a TIN be provided for each beneficiary receiving assets from the estate.

The final regulations should clarify the executor's responsibilities with respect to beneficiaries who refuse to provide a SSN (a not uncommon reaction with heightened concern regarding identity theft) and with respect to beneficiaries that do not now have and are unlikely to obtain a TIN in any event or are not in possession of a TIN at the filing of the Form 8971 (e.g., nonresident alien beneficiaries, public charities including, but not limited to, local places of worship and municipalities). We note as a matter of probate law, the failure to provide a SSN or TIN is not grounds to withhold a legacy or bequest.

The final regulations should be revised to provide that assets passing to a nonresident alien beneficiary or a public charity are excluded assets. If such an exclusion is not added, in the case of a nonresident alien beneficiary, the final regulations should permit "NRA," "foreign" or "unknown-foreign" be allowed as an appropriate TIN designation for such beneficiary. Much like the suggestion in the immediately preceding comment, this modification would assist the IRS in review of Schedules A against the related Forms 706, Part 4 and Schedule O.

d. Assets Not Under the Control of the Executor

Pursuant to §§ 2035-2038, 2041 and 2044, assets not owned at the date of death by the decedent are still includable in the decedent's gross estate, reported on the Form 706, and therefore are subject to reporting under § 6035. Inclusion is frequently encountered with irrevocable inter vivos trusts, trusts subject to a general power of appointment over the full corpus of the trust, private foundations and assets transferred to a partnership or other closely-held entity that is not a trust. Notwithstanding the required estate inclusion, the disposition of such assets, whether by sale, exchange or distribution, may never be reported to the executor. The final regulations should clarify that the proper recipient of the Schedule A for such assets is the tax managing partner or similar officer of the entity, a trustee of the trust or a manager of the private foundation.

Prop. Reg. § 1.6035-1(b)(1)(ii) provides that cash (other than a coin collection or other coins or bills with numismatic value) is excepted from the basis reporting requirements. The final regulations should clarify whether foreign currency is included within the definition of cash.

b. IRD Assets

Prop. Reg. § 1.6035-1(b)(1)(ii) provides that IRD (as defined in § 691) is excepted from the basis consistency reporting requirements. The final regulations should clarify whether IRD assets having basis (e.g., installment notes receivable, commercial annuity products, certain retirement assets, including some IRAs) also qualify as excepted assets.

c. Assets Involved in a Taxable Sale or Exchange

Pursuant to the broad authority granted Treasury under § 6035(a)(1), consideration should be given to requiring Schedule A reporting for all in-kind asset distributions to be filed not later than the due date of the Form 1041 (U.S. Income Tax Return for Estates and Trusts) for the year such distributions are made. In the alternative, if the basis reporting requirement for policy reasons is determined to extend only to assets included on the Form 706 that are to be distributed in kind, then Schedule A reporting should be limited to only such in-kind distributions where the estate tax final value is the carryover basis supplied to such beneficiary. To remove ambiguity, the final regulations should clarify that Schedule A reporting is not required for beneficiaries who receive a pecuniary bequest, regardless of whether it has been funded on the due date of the Form 8971, since the in-kind satisfaction of such a bequest always results in gain or loss recognition.

Prop. Reg. § 1.6035-1(b)(1)(iv) provides that property sold, exchanged, or otherwise disposed of by the estate in a transaction in which capital gain or loss is recognized is excepted from Schedule A reporting. The final regulations should clarify that the exception is extended to assets distributed in kind that were acquired during the estate's administration and assets the basis of which has been increased or decreased by virtue of being the object of a transaction which gave rise to gain or loss (e.g., the funding of a pecuniary bequest in kind). Eliminating unnecessary information reporting, e.g., for assets to which the carryover basis rules do not apply, would enhance the IRS' ability to monitor basis reporting by those beneficiaries subject to the basis consistency rules.

d. Assets for which Gain or Loss is Not Possible

Prop. Reg. § 1.6035-1(b)(1)(ii) provides that cash is excepted from the basis reporting requirements. Further, Prop. Reg. § 1.6035-1(b)(1)(iv) provides an exception for assets converted to cash in a gain or loss recognition transaction. However, a Form 706 will typically include a number of assets that cannot give rise to a gain or loss transaction when liquidated (e.g., life insurance proceeds, tax and other refunds, notes and other evidences of indebtedness where value is equal to the outstanding principal, Roth IRAs, etc.).

While many of these will be converted to cash in the ordinary course of estate administration, some may not. The final regulations should clarify that such assets are also exempt from Schedule A reporting.

e. Tangible Personal Property

Treas. Reg. § 20.2031-6(b) provides a de minimis threshold of $3,000 for tangible personal property. Property, as a class, having an artistic or intrinsic value in excess of that amount must have an appraisal. The de minimis threshold of $3,000 is frequently ignored in practice in no small part because the cost of obtaining an appraisal for such items may equal or exceed their aggregate value; instead, a good faith estimate is often provided by the executor. If the Treas. Reg. § 20.2031-6(b) threshold is indeed to set an objective limitation for Schedule A reporting, Treasury must consider increasing the $3,000 limit, which has remained static since 1958. We note that in 1958, the applicable exclusion amount was $60,000, implying that detail would not be required where such property did not exceed 5% of the total estate. Consider that for 2016 an estate tax return is required for estates exceeding $5,450,000; a 1958 equivalent percentage would now have a dollar value of $272,500.

If, as a result of this regulations project, the threshold of Treas. Reg. § 20.2031-6(b) is not to be updated, the final regulations should be modified to not reference Treas. Reg. § 20.2031-6(b), but to provide a separate indexed threshold to govern the required Schedule A reporting; for example, the greater of $50,000 or 2% of the value of the decedent's residences as reported on the Form 706.

In any event, the final regulations should provide guidance as to the determination of the basis of an item of tangible personal property that is not the subject of a separate valuation when such asset is either sold or contributed to a charity. At least two possibilities come to mind: first, that the aggregate basis reported on the Form 706 is applied to offset the sales price on a first-in, first-out basis until the aggregate basis is exhausted, after which subsequent property sales shall have a basis of zero; or second, that the beneficiary is required to obtain evidence of the value of the item as of the date of death or alternate valuation date in order to ascribe basis to such asset.

f. "Bulk" Assets

It is not uncommon to have the aggregate value of similar items reported as a single item on Form 706 (e.g., a wine collection, precious metals, bulk gem stones) ("Bulk Assets"). The aggregate value of such Bulk Assets may be very high, but the value of each constituent part is unlikely to be very large. The final regulations should clarify that the executor is under no obligation to provide greater detail with respect to asset identification for the Form 8971 than appears in the Form 706 and its related attachments. To do otherwise would undermine the ability of the executor to rely on the software which produced the Form 706 to also produce the Form 8971.

Similar to the bulk reporting of tangible property noted above, preparers routinely simplify reporting on Form 706 for brokerage accounts by reporting only the aggregate account information and aggregate value on Form 706, Schedule B, then attaching as an exhibit an itemization containing detail on the individual securities held. While such assets should be excluded assets by virtue of the reporting required by § 6045, if such is not the case, the final regulations (or in the alternative, the Form instructions) should clarify that attachments augmenting a reported item on the Form 8971 is acceptable in providing a Schedule A recipient greater information detail. This modification is crucial to allowing Form 8971 to be prepared in conjunction with Form 706, using the same software platform with minimum of adjustments.

g. Assets for Which Basis Reporting Already Exists

In order to accurately determine gain or loss with respect to the sale or exchange of traded securities, under § 6045(g), a broker is required to report, among other data, the adjusted basis of a security. Generally, under § 6045(g)(3)(A), covered securities include stock in a corporation, mutual fund and dividend reinvestment plan shares, bonds, options, commodity derivatives and other complex securities covered under Treas. Reg. § 1.6045-1.

Securities obtained by gift or inheritance are included in the definition of covered securities. Thus, the receiving broker is entitled to, and the transferring broker, under Treas. Reg. § 1.6045A-1(b)(8), is required to, report adjusted basis equal to the fair market value of the security on the date of death (unless the broker receives different instructions from the estate representative, or unless the transferor neither knows nor can readily ascertain the fair market value of a security on the date of death). Such securities must also be identified as inherited. As a consequence, basis information with respect to any security with a CUSIP number is already maintained by the broker, making any additional Schedule A reporting redundant and potentially misleading. The final regulations should provide an exception for covered securities that are subject to basis reporting requirements under §§ 6045 and 6045A.

A general power of appointment subject to a dollar limitation (e.g., a surviving spouse given a general power of appointment over the greater of $5,000 or 5% of the net asset value of a credit shelter trust as of a set measuring date) occurs frequently. The powerholder is required to report the amount of the entitlement on Schedule H, but details as to the assets subject to estate inclusion are not required in order to comply with the requirements of the estate tax. Furthermore, unless the general power of appointment was actually exercised by the decedent, the executor may not be aware of the nature, value and disposition of the assets over which the lapsed power was operative. Under such circumstances, the final regulations should clarify that assets subject to a general power of appointment that is subject to a dollar limitation are exempt from Schedule A reporting; or, in the alternative, the value of the general power of appointment subject to a limitation shall be reported as a single asset on a Schedule A delivered to the trustee of the trust subject to the general power of appointment.

b. Community Property

Section 1014(b)(6) provides that property held as community property receives a step-up in basis for the surviving spouse's one-half share as well as for the decedent's one-half share, if at least one-half of the whole of the community interest is included in the decedent's gross estate. The last clause clearly contemplates that the post-mortem division of the community property may result in a disproportionate sharing of community assets and that § 1014 basis applies to those assets included in the decedent's gross estate and to the survivor's community property interest in assets which are reported as owned half by the decedent. The final regulations should address two items: first, whether the surviving spouse's share of community property is subject to Schedule A reporting; and second, that Schedule A reporting for community property is properly delayed under the unlocated beneficiary rule of Prop. Reg. § 1.6035-1(c)(4) until such time as the community property settlement is made, if such settlement date is later than the due date for filing Form 8971.

c. Reporting Basis for Fractional Share Assets

Prop. Reg. § 1.6035-1(c)(1) states: "For purposes of this provision, the beneficiary of a life estate is the life tenant, the beneficiary of a remainder interest is the remainderman(men) identified as if the life tenant were to die immediately after the decedent, and the beneficiary of a contingent interest is a beneficiary, unless the contingency has occurred prior to the filing of the Form 8971. If the contingency subsequently negates the inheritance of the beneficiary, the executor must do supplemental reporting in accordance with paragraph (e) of this section to report the change of beneficiary." Such a requirement assumes access by the executor to vital information, including health information, of all such beneficiaries that in many cases will not be available. Further, it requires the executor to determine whether § 7520 is properly applied in determining the value of the various actuarial interests, given the health of the parties in question. Such determinations are not required to comply with the estate tax.

Making such determinations is not properly within the scope of an executor's responsibilities. The final regulations should instead clarify that in situations in which multiple beneficiaries share actuarial interests in a single asset, that the Schedule A reporting for each such beneficiary is to be the asset's full final value with a notice that such basis is subject to an allocation under the uniform basis rules, with respect to which they should consult their tax adviser. By assigning the responsibility for allocation of basis to the party with the information required to calculate such allocation, this modification would reduce potential basis reporting errors.

d. Remove the "Zero Basis Rule" of Prop. Reg. § 1.1014-10(c)(3)

The proposed regulations address the basis determination for property discovered after the filing of an estate tax return and for property omitted from an estate tax return, Pursuant to Prop, Reg. § 1.1014-10(c)(3)(i)(B), if the executor does not report the after-discovered or omitted property on an initial or supplemental estate tax return filed prior to the expiration of the statute of limitations, the basis to the beneficiary of the omitted property is zero. Further, Prop. Reg. § 1.1014-10(c)(3)(ii) provides that if no return is filed, and if the inclusion of the after-discovered or omitted property would have generated or increased the estate tax liability, the result is that the basis of all property receives a zero basis until an estate tax return is filed.

Section 1014 generally provides that the basis of property received by inheritance is the fair market value on the date of the decedent's death. The exceptions to this general rule preserve carryover basis from the decedent to his or her successors where the fair market value of the asset reflects realized but unrecognized income. Treas. Reg. § 1.1014-2(a)(5) specifically provides that it is not necessary that "an estate tax return be required to be filed for the estate of the decedent or that an estate tax be payable" in order for § 1014 to apply. Section 1014(f) is to ensure consistency in the reporting of basis, it is not intended to determine basis or to override the general rule of § 1014(a). The Code simply does not support any interpretation which denies a successor in interest at least carryover basis for an inherited asset; consequently, the final regulations should remove the zero basis rule.