On Aug. 5, 2011, the Internal Revenue Service issued long-awaited (and much-needed) guidance on the treatment of basis for estates of decedents who died in 2010 that elect not to have the estate tax apply. The IRS also issued guidance for those making the election on the allocation of the generation-skipping transfer tax exemption.
The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax for the year 2010. The EGTRRA also made the generation-skipping transfer tax inapplicable to generation-skipping transfers made in 2010.
However, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 re-instated the estate tax for 2010 (at levels also applicable to 2011 and 2012), but gave executors an option to opt out of the estate tax and be subject to the modified carryover basis provisions of the EGTRRA and Code Section 1022. Under those modified carryover basis provisions, the aggregate basis increase still available under Code Section 1022 is $1.3 million and the spousal property basis increase is $3 million.
REV. PROC. 2011-41
If the executor of an estate of a decedent who dies in 2010 makes an election under Code Section 1022, that section applies to determine a recipient's basis in all property acquired from the decedent, regardless of the year in which the property is sold or distributed. Revenue Procedure 2011-41 clarifies the property to which the carryover basis rules apply and to which the executor may make allocations of basis increase. The revenue procedure provides a safe harbor related to the interpretation and application of the election. The safe harbor applies if the executor makes the Code Section 1022 election, follows the procedures provided in the revenue procedure, and does not take any contrary position on a tax return for the estate.
Rev. Proc. 2011-41 also explains the calculation of the amount of basis increase available to the estate and how that basis increase may be allocated to the property. After the allocation, the adjusted basis in any such property may not exceed the fair market value of that property at the decedent's death. The revenue procedure also clarifies the determination of fair market value. One clarification made by the revenue procedure is that the full amount of unrealized capital losses will increase the amount of allocable basis. Community property issues are also addressed.
The revenue procedure also discusses several other issues, such as the holding period of inherited property, the tax character of that property, the depreciation of the property, the application of the passive activity loss rules, recognition of gain on satisfaction of a pecuniary bequest with appreciated property, sale or exchange treatment of transfers to nonresident aliens, and testamentary charitable remainder trusts.
Notice 2011-66 describes how to make an election under Code Section 1022 and to allocate the generation-skipping transfer tax exemption. An executor of a decedent who died in 2010 may make an irrevocable election under Code Section 1022 by filing Form 8939 on or before Nov. 15, 2011. The allocation of basis increase and the value of all property are also to be reported on the form. The property to be reported includes all property acquired from the decedent except cash and property that constitutes income in respect of a decedent. It also includes appreciated property acquired from the decedent that was required to be included on the donor's Form 709 gift tax return if such property was acquired for less than adequate and full consideration during the three-year period ending on the date of decedent's death.
Although the IRS had initially said that the final form would be issued at least 90 days before the due date, this guidance states only that the final form will be available in early fall of 2011, likely to be well less than 90 days before the due date. Nevertheless, only four very limited exceptions to the November 15 due date are specified.
The notice discusses procedures to follow if inconsistent positions are taken with the filing of both a Form 8939 and a Form 706, the estate tax return, by different persons. If the parties do not clarify their position within 90 days, the IRS will make a facts and circumstances determination as to whether a valid election has been made.
Donors may elect out of the automatic allocation of the generation-skipping transfer tax exemption to direct skips occurring during 2010. The available exemption can be allocated by attaching Schedule R to Form 8939. The election out for inter vivos direct skips can be made on Form 709 or payment of the generation-skipping transfer tax with Form 709. A number of issues related to the determination of basis are also addressed.
For direct skips, a taxable distribution, or taxable termination that occurred on or after Jan. 1, 2010, and on or before Dec. 16, 2010, the due date for Form 709 is Sept. 19, 2011. Form 8939 Schedule R is due on Nov. 15, 2011, along with the rest of Form 8939.
The Nov. 15, 2011, deadline for filing Form 8939 is not very far away, and the final form has not yet been issued as of this writing. Due to the limited time available to file Form 8939 or Form 706, the estate tax return, tax practitioners should act quickly to assess which route is in the best interests of the client's estate.
Practitioners must also start now to identify the property to which carryover basis applies if the election on Form 8939 is made, to determine the valuation of hard-to-value assets, and to determine how to allocate basis among the assets. Allocation of basis can become a very contentious issue, making potential winners and losers among various beneficiaries.
The IRS stated in August that it plans to issue regulations to confirm the guidance in Notice 2011-66, and comments are requested on the notice.
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