by Mark Scott and Scott L. Goldberger
Close to two years ago, large estates became subject to a new set of federal tax rules that impose additional, and sometimes onerous, reporting requirements on fiduciaries and force beneficiaries to take tax positions consistent with that reporting. The rules were intended to close an alleged income tax loophole for those who inherit property. The government estimates that the new rules will increase tax revenues by $1.54 billion over 10 years.1 However, many tax practitioners think that this figure is grossly exaggerated; they question whether the loophole was meaningfully exploited in the first place. Moreover, the additional burden and cost to estates and beneficiaries of complying with the rules may outweigh any additional tax revenues. The Treasury Department and Internal Revenue Service have attempted to clarify the rules by releasing temporary and proposed regulations2 and tax forms with two sets of instructions.3 The guidance has been helpful, but there are still many unanswered questions.
To understand the purpose and impact of the new regime, it is necessary to have a basic understanding of the income tax rules applicable to inherited property. When a beneficiary inherits property, that beneficiary generally is required to take an initial income tax basis in the property equal to its fair market value on the date of the decedent’s death.4 Then, if and when the beneficiary sells the property, the taxable gain or loss is determined using that basis (taking into account any applicable adjustments for depreciation, improvements, etc., between the dates of inheritance and sale). Traditionally, if a federal estate tax return was filed for an estate, the value reported on the return was presumed to be the fair market value on the date of the decedent’s death.5 The beneficiary could rebut the presumption with clear and convincing evidence.6 In most cases, the value reported on the estate tax return was required to be used by the beneficiary as the initial basis.
The government feared that beneficiaries were ignoring the values reported on estate tax returns and overstating their basis in inherited property, leading to excessive depreciation deductions and smaller gains (or larger losses) on subsequent sales of the property. To combat the perceived abuse, Congress added two new sections to the Internal Revenue Code — §6035, which requires fiduciaries of certain estates to report asset values to the estate’s beneficiaries; and §1014(f), which provides generally that a beneficiary’s initial basis in inherited property may not exceed the value as finally determined for estate tax purposes.7 These sections apply to each estate that files an estate tax return after July 31, 2015, provided the estate was required to file a return.8 The due date of the estate tax return is irrelevant; if the return was due on or before July 31, 2015, but is filed after July 31, 2015, the estate will nevertheless be subject to the new rules.
The Reporting Requirement
As noted above, if an estate fiduciary (or other person) files an estate tax return — Form 706 for a U.S. citizen or domiciliary, or Form 706NA for a noncitizen nonresident — after July 31, 2015, and the return was required to be filed under §§6018(a) and 6018 (b), then the fiduciary must comply with the new basis reporting requirements.9 In 2017, an estate tax return is required to be filed whenever a U.S. domiciliary or citizen’s gross estate, plus taxable gifts, exceeds the $5,490,000 applicable exclusion.10 An estate tax return is required to be filed for a noncitizen, nonresident whose gross U.S.-situs property exceeds $60,000.11
To facilitate the new reporting regime, the IRS issued Form 8971, information regarding beneficiaries acquiring property from a decedent. In addition to filing Form 8971 with the IRS, the fiduciary must furnish to the person inheriting the property and to the IRS a statement that identifies the property received, including the value as finally determined, as prescribed by the Treasury secretary. The IRS prescribed statement is now in the form of Schedule A, an attachment to Form 8971.
Form 8971 and Schedule(s) A generally must be filed with the IRS no later than the earlier of 1) the date that is 30 days after the date on which Form 706 or 706-NA is required to be filed (including extensions); or 2) the date that is 30 days after the date that the Form 706 or 706-NA is actually filed. However, if the estate tax return is filed late, then the Form 8971 and Schedule(s) A are due 30 days after the filing date. In addition, the fiduciary must certify on Form 8971 the date (using the same time requirements) on which Schedule A was sent to each beneficiary.
However, no Form 8971 or Schedule A is required to be filed when 1) the Form 706 is filed solely to elect portability of the deceased spousal exclusion amount; 2) the gross estate plus adjusted taxable gifts is less than the basic exclusion amount; 3) the Form 706 was filed only for an allocation or election respecting the generation-skipping transfer tax exemption; or 4) estate tax-related compliance, such as Forms 706-QDT, 706-CE, and 706-GS(D), is filed.12
Form 8971, with attached Schedule(s) A, is a separate filing requirement from the Form 706 or Form 706-NA, and should not be attached to the estate tax return.
Schedule A must be furnished to each beneficiary acquiring any interest in property included in the decedent’s gross estate.13 In addition to individuals, the proposed regulations clarify other types of beneficiaries that must receive Schedule A, including 1) life tenant, remainderman, and contingent interest beneficiaries who would receive property if the present interest beneficiary were to die immediately after the decedent; 2) estates and trusts, with the information given to the fiduciary as opposed to the underlying beneficiaries; and 3) business entities, with the information given to the entity as opposed to the business owners.14 Therefore, when the entire estate passes to a revocable trust, you can simply provide a single Schedule A to the trustee of the revocable trust.
A fiduciary filer must use reasonable due diligence to identify and locate all beneficiaries. If the fiduciary is unable to locate a beneficiary by the due date of the information return (Form 8971) and statement (Schedule A), the fiduciary must explain the efforts the fiduciary took to locate the beneficiary and to satisfy the obligation of reasonable due diligence.15 Similar to other requirements to provide updated information, if the fiduciary subsequently locates the beneficiary, a supplemental return and statement must be provided to the IRS and the beneficiary within 30 days of locating the beneficiary.16 If the fiduciary is unable to locate a beneficiary and later distributes the property to a different beneficiary who was not identified in the original filings as the recipient of that property, then the fiduciary must file supplemental information with the IRS within 30 days of the property being distributed.17
The reporting rules also require that the beneficiary’s tax identification number (TIN) be disclosed. The instructions provide that if the fiduciary requested the TIN in writing and has not received it by the filing date, then enter “REQUESTED” in the appropriate field and attach a copy of the solicitation to “avoid inquiries from the IRS.” A supplemental Form 8971 and corresponding Schedule A must be filed with the IRS once the TIN has been obtained.18
In the first draft of the Form 8971 instructions, a missing TIN resulted in an incomplete and incorrect filing, potentially subject to penalties. Many estates have foreign beneficiaries who have never previously been required to file U.S. tax compliance. Therefore, in many instances, a foreign beneficiary does not have an existing individual TIN. The application and requirements, under §6109(i), needed to obtain an individual TIN are often onerous and can take several months to complete and receive the individual TIN. These reasons possibly persuaded the IRS to issue revised Form 8971 instructions to clarify that if a foreign beneficiary is not required to provide an individual TIN, enter “Not Required” in the appropriate field.19
The fiduciary must list all items of property, with exceptions, that could be used, in whole or in part, to fund the beneficiary’s distribution.20 Thus, in situations when assets have not been distributed prior to the Form 8971 filing date, the same property may be reflected on multiple Schedules A. Unfortunately, this could cause confusion among beneficiaries, including a misguided expectation that beneficiaries will receive property that ultimately is not distributed to them. Property that does not have to be reported includes 1) cash, presumably to include cash deposits in bank and brokerage accounts (other than a coin collection or other coins or bills with numismatic value); 2) income in respect of a decedent (i.e., individual retirement accounts, qualified plans, annuities, installments notes); 3) tangible personal property for which an appraisal is not required (i.e., household and personal effects having a value of no more than $3,000); and 4) property that was included in the gross estate, but has been sold by the fiduciary in a transaction in which capital gain or loss is recognized.21
The Proposed Regulations provide examples of the reporting requirements for property. Illustratively, assume the estate fiduciary attaches, to the Form 706, an itemization of household and personal effects, specifically naming and valuing each article; none of the articles having a value in excess of $100 are grouped. Included in the household items are a painting, a rug, and a clock, each having a value in excess of $3,000. If the fiduciary obtained an appraisal from a competent appraiser of recognized standing and ability or a disinterested dealer in the class of personalty involved, then the fiduciary will include on the Schedule A statement only the painting, rug, and clock.22
If all or any portion of property that was previously reported (or was required to be reported) on an information return (Form 8971) and statement (Schedule A) is subsequently transferred (by gift or otherwise) by the original recipient in a transaction in which a related transferee determines its basis, in whole or part, by reference to the original recipient’s basis, then the transferor is required to file a supplemental Schedule A.23 In this case, the original recipient transferor must provide the required Schedule A reflecting the transferee information to the IRS and to the transferee within 30 days after the transfer date.24
If the subsequent transfer occurs before the final value is determined, the transferor must provide the estate fiduciary with a copy of the supplemental statement filed with the IRS and furnished to the transferee.25 The notification to the fiduciary of the subsequent change in ownership (before final value is determined) may require the fiduciary to issue a subsequently filed supplemental statement to the transferee beneficiary as opposed to the original recipient.26
A related transferee means any member of the transferor’s family, any controlled entity, and any trust of which the transferor is a deemed owner for income tax purposes.27 Generally, a family member means 1) the individual’s spouse; 2) any ancestor or descendant of such individual or individual’s spouse; 3) any sibling of the individual; and 4) any spouse of an individual described in two and three.28
Supplemental filings are required whenever a change occurs that causes the previously filed information to be incorrect.29 Two exceptions apply: A supplemental filing is not required to 1) correct an inconsequential error or omission; or 2) specify the actual distribution of property previously reported as being available to satisfy the interests of multiple beneficiaries.30 Errors and omissions that are never inconsequential are those related to a TIN, a beneficiary’s surname, the value of the asset the beneficiary is receiving from the estate, and the significant items in the beneficiary’s address.31 The supplemental information and statement must be filed no later than 30 days after 1) the final value is determined; 2) the fiduciary discovers incorrect or incomplete information; or 3) a supplemental estate tax return is filed reporting additional assets.32
The instructions also provide guidance on the preparation of the power of attorney and declaration of representative, Form 2848, in connection with Form 8971 and Schedule(s) A. When completing Form 2848, the fiduciary, not the estate, is the “taxpayer” to be listed in line 1. In addition, the fiduciary’s TIN, as opposed to the decedent or estate TIN, is used. When completing line 3, you are to use “civil penalties” in the description of matter column. For the tax form number column, use “Form 8971/Schedule A.” In the year(s) or period(s) column, enter the decedent’s date of death using the four-digit year and two-digit month conventional YYYYMM.33
The Consistency Requirement
New code §1014(f) provides that the basis of property acquired from a decedent shall not exceed the property’s final value as determined for estate tax purposes.34 The “final value” is 1) the value reported on the estate tax return once the period of limitation for assessment of estate tax has expired without that value having been timely adjusted or contested by the IRS; 2) the value determined by the IRS once the period of limitations for assessment and for claim for refund or credit have expired with the value having been timely contested; 3) the value determined in an agreement; or 4) the value determined by court.35 If the final value has not been determined, the basis may not exceed the value furnished in Schedule A.36
However, these requirements apply only to property whose inclusion in the gross estate increases the estate tax liability.37 Therefore, if the estate is not subject to any estate tax, the beneficiaries are not subject to the basis consistency requirement under §1014(f). If the estate owes tax, all property included in the gross estate is subject to the consistency requirement, except 1) property received by a spouse, charity, or trust that qualifies for the marital or charitable deductions; and 2) tangible personal property for which an appraisal is not required (i.e., household and personal effects having a value of no more than $3,000).38 The exclusion of nontaxable property makes sense because with no tax at stake, the fiduciary may not be as motivated to report an accurate value on the estate tax return. Yet, being exempt from the consistency requirement does not relieve the estate from complying with the reporting requirements discussed above. Thus, for example, if the entire estate is comprised of marital or charitable deduction property, the fiduciary would still be required to file Form 8971 and to provide the beneficiaries with Schedule A (other than for cash, IRD, or other property that is exempt from reporting, as explained above).
What if a property was omitted from the estate tax return, perhaps because it had not been discovered prior to filing? If a supplemental estate tax return is filed before the expiration of the limitations period for the assessment of tax,39 then the usual rules (discussed in the prior paragraph) apply.40 Thus, the beneficiary’s basis would be the final value determined for estate tax purposes or, if no determination has been made, the value furnished on Schedule A. But, if a supplemental return is not filed, the beneficiary’s basis in the omitted property will be zero.41
A zero basis could be disastrous for the beneficiary, leading to an artificially large taxable gain (or artificially small loss) if and when the beneficiary sells the property. The absence of basis also could deprive the beneficiary of valuable depreciation deductions in the years following the beneficiary’s inheritance of the property. Therefore, it is not a surprise that the rule has been denounced by practitioners. The criticism is due, in part, to the belief that there is no duty to disclose after-discovered property if the estate tax return was filed in good faith.42 Moreover, although it seems irrational that the zero-basis rule would apply to cash or to marital and charitable deduction property, which is otherwise exempt from the consistency rule, these issues have not yet been addressed in guidance from Treasury or the IRS.
Penalties apply if the fiduciary fails to 1) file a timely Form 8971 or Schedule A; 2) include all information required to be shown; 3) include correct information; or 4) file a correct supplemental Form 8971 or Schedule A by the due date. The penalty is $260 per return (a single penalty can be assessed for each Form 8971 and Schedule A), but is reduced to $50 per return if the return is filed within 30 days after the due date.43 The maximum penalty per year — for example, if the filer is a fiduciary for many estates — is $3,193,000, or $532,000 for returns not more than 30 days late. Larger penalties may apply for intentional disregard of the reporting requirements, although there is a disconnect between the penalty amounts stated in the instructions to Form 8971 and those stated in the code. The instructions provide that “the minimum penalty is at least $530 per [return], with no maximum penalty,” whereas the code provides that the penalty is the greater of $50044 and “10 percent of the aggregate amount of the items required to be reported correctly.”45 Either way, ignoring the reporting requirements does not appear to be a sound strategy.
The penalty for using an inconsistent basis is more straightforward, but potentially significant. If an underpayment of tax results from a beneficiary claiming a basis that exceeds the amount determined under §1014(f), the penalty is 20 percent of the underpayment.46
Repeal of the Estate Tax — What it Might Mean for Basis Consistency
At the time this article was submitted, the Trump administration and congressional leaders were working on a plan for comprehensive tax reform. A detailed discussion of the various tax reform proposals is beyond the scope of this article, but one common thread among the proposals was the repeal of the estate tax. Would repeal bring about the death of the basis consistency rules? Well, maybe.
If there is no estate tax, the current rules cannot be applicable because both the reporting and consistency requirements are inextricably tied to the values determined for estate tax purposes and reported on the estate tax return. However, the purpose of the basis consistency rules — preventing beneficiaries from understating their basis in inherited property — may become even more important in an estate-tax-free environment. A popular prognostication has been that, if the estate tax is repealed, it might be coupled with some form of modified carryover basis system, like the system in place in 2010, when the estate tax was repealed for one year before it returned in 2011.47 With modified carryover basis, subject to some exceptions, beneficiaries inherit the decedent’s basis in the estate’s assets. But how can the beneficiary determine what the decedent’s basis was, particularly if the beneficiary is not also the fiduciary of the estate and does not have access to the decedent’s income tax returns and other financial records? And how can the IRS continue to compel the beneficiary to use the appropriate basis? The obvious answer appears to be that Congress could enact revised basis consistency rules, which might bear a striking resemblance to the current system. So, don’t purge these rules from your mind just yet!
It is hard to predict how the new basis reporting and consistency rules may evolve in the future. For now, fiduciaries of estates and their advisors need to familiarize themselves with the existing rules, in order to avoid unnecessary penalties and to comply with their duties to the estate’s beneficiaries.
1 See The Joint Committee on Taxation’s Estimated Revenue Effects of the Revenue Provisions Contained in Titles II and IV of H.R. 3236, The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Rep’t No. JCX-105-15.
2 See Prop. Reg. §§1.1014-10(f) and 1.6035-1(i) (providing that the regulations will be effective when they are finalized, but may be relied upon in the meantime).
3 The IRS released initial instructions to Form 8971 in January 2016. It released revised draft instructions in July and final instructions in September.
4 I.R.C. §1014(a)(1). However, some exceptions apply. See §1014(a)(2)-(4). For example, if the fiduciary elects to use the alternate valuation date of six months after the decedent’s death, the beneficiary’s basis would be equal to the value on such date. §1014(a)(2).
5 Treas. Reg. §1.1014-3(a).
6 Rev. Rul. 54-97, 1954-1 C.B. 113. However, a taxpayer, by his or her previous actions or statements, may be estopped from rebutting the presumption. See id.
7 See §2004 of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, P.L. 114-41.
8 Prop. Reg. §§1.1014-10 and 1.6035-1.
9 I.R.C. §6035(a)(1) and (2); Prop. Reg. §1.6035-1; see also I.R.C. §2203 (defining the term “executor” to include the executor or administrator of the decedent, or, if there is none appointed, qualified, or acting in the U.S., then any person in actual or constructive possession of any property of the decedent).
10 I.R.C. §§6018(a)(1) and 2010(c); Rev. Proc. 2016-55, 2016-45 IRB 707.
11 I.R.C. §6018(a)(2).
12 Prop. Reg. §1.6035-1(a)(2).
13 I.R.C. §6035(a).
14 Prop. Reg. §1.6035-1(c)(1) and (2).
15 Prop. Reg. §1.6035-1(c)(4).
18 Prop. Reg. §1.6035-1(e)(4)(i).
19 Instructions for Form 8971 and Schedule A (Rev. Sept. 2016).
20 Prop. Reg. §1.6035-1(c)(3).
21 Prop. Reg. §1.6035-1(b)(1); see also Treas. Reg. §20.2031-6(b).
22 Prop. Reg. §1.6035-1(b)(1).
23 Prop. Reg. §1.6035-1(f).
28 I.R.C. §§2704(c)(2) and 2701(b)(2)(A) or (B).
29 I.R.C. §6035(a)(3)(B).
30 Prop. Reg. §1.6035-1(e)(3).
31 Treas. Reg. §1.6035-1(e)(2) (citing Treas. Reg. §301.6772-1(b); see also Instructions for Form 8971 and Schedule A (Rev. Sept. 2016)).
32 Prop. Reg. §1.6035-1(e)(4)(i).
33 Instructions for Form 8971 and Schedule A (Rev. Sept. 2016).
34 I.R.C. §1014(f)(1)(A).
35 Prop. Reg. §1.1014-10(c)(1).
36 I.R.C. §1014(f)(1)(B); Prop. Reg. §1.1014-10(c)(2).
37 I.R.C. §1014(f)(2).
38 See Prop. Reg. §1.1041-10(b); see also Treas. Reg. §20.2031-6(b).
39 The limitations period is three years, except in the case of a fraudulent return or one with a “substantial omission.” I.R.C. §6501.
40 Prop. Reg. §1.1014-10(c)(3)(i)(A).
41 Prop. Reg. §1.1014-10(c)(3)(i)(B).
42 See Steve R. Akers, Basis Consistency and Selected Other Income Issues Facing Executors, 51 U. Miami Heckerling Inst. on Est. Plan., Ch. 44, ¶¶ II.G.2. (2017) (citing David Pratt & George Karibjanian, Filing a Supplemental Estate Tax Return After Probate Litigation, 36 Est. Pl. 17 (Sept. 2009)).
43 The amounts are subject to adjustment for inflation.
44 This amount is adjusted for inflation. I.R.C. §§6721(f) and 6722(f).
45 I.R.C. §§6721(e)(2) and 6722(e)(2).
46 I.R.C. §6662.
47 See §§501, 541, and 542 of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Pub. L. No. 107-16, 107th Cong., 1st Sess., 115 Stat. 38.
Mark Scott is a principal at Kaufman, Rossin & Co., P.A., in Miami, focusing primarily on estate, trust, and gift tax planning and compliance. He received his J.D. and LL.M. in taxation from Chicago-Kent College of Law and his B.A. from the University of Florida.
Scott L. Goldberger is a principal at Kaufman, Rossin & Co., P.A., in Boca Raton. He received his J.D. from Georgetown University Law Center and a master’s degree and B.S. in accounting from the University of Florida.
This column is submitted on behalf of the Tax Section, William Roy Lane, Jr., chair, and Christine Concepcion, Michael Miller, and Benjamin Jablow, editors.