Over the next 20 to 30 years, the United States is expected to experience one of the largest transfers of wealth in modern world history (Andrew Osterland, “Advisors Brace $30 Trillion ‘Great Wealth Transfer,’” CNBC.com, June 16, 2016, https://cnb.cx/2HmTYXU). In fact, various estimates project that U.S. baby boomers will transfer over $30 trillion in assets during this period. CPAs, as well as attorneys with gift- and estate-related practices, are poised to experience a substantial increase in client volume. Advisors should be aware, however, of recent legislative changes regarding estate reporting requirements. These changes will affect how executors compile reports with the IRS regarding both decedents and their heirs, beginning July 31, 2015.
The changes are contained within Internal Revenue Code (IRC) section 1014(f) and its proposed regulations, which require the beneficiary’s basis for inherited property to be consistent with the property’s estate tax value. The rule is designed to prevent executors from reporting a low property value for estate tax purposes while distributing the same property to beneficiaries with a higher basis. While the rule is simple in concept, the intricacies of section 1014(f) and its administrative requirements can be difficult to anticipate. In addition, many of the regulations that affect section 1014(f) are still in their proposed form and leave professionals with little guidance. Although the anticipated wealth transfer should be a boon for CPAs and attorneys with estate tax practices, there are potential traps for the unwary.
This article focuses on the issues raised in the comments to the proposed regulations that address the administrative uncertainties of IRC section 1014(f). Many of the comments on the proposed regulations involve the following questions:
- Which executors are subject to the reporting requirements?
- Are the proposed filing requirements and deadlines realistic?
- Which assets are subject to the basis consistency rules?
- What is the impact of omitted property and the effects of noncompliance?
- Are there other considerations for CPAs serving as executors?
Who Is Subject to the Reporting Requirements?
Generally, any executor of an estate that must file an estate tax return under IRC section 6018 must also comply with the basis consistency reporting requirements. The definition of executor for basis consistency purposes is the same as the definition used under IRC section 2203 for estate tax purposes [Proposed Regulations section 1.1014-10(d) and 1.6035-1(g)(2)]. This includes any executor or administrator of the decedent, as well as any person who maintains possession or control of the decedent’s property.
An executor is generally only required to file an estate tax return under IRC section 6018 if the gross value of the estate exceeds the Unified Lifetime Credit Exclusion [Proposed Regulations section 1.6035-1(a)(1)]. Therefore, if a gross estate does not exceed the Unified Lifetime Credit Exclusion, the executor does not generally need to follow the basis consistency reporting requirements. Furthermore, if an estate tax return is filed only to make a generation-skipping transfer election or portability election under IRC section 2010(c)(5), then the executor does not generally need to comply with the reporting requirements [Proposed Regulations section 1.6035-1(a)(2)].
This reporting requirement can prove difficult for executors because some beneficiaries may not be known by the return due date.
Filing Requirements and Deadlines
The filing requirements are met by filing Form 8971, Information Regarding Beneficiaries Acquiring Property from a Decedent, and the attached Schedule A [IRC section 6035; Proposed Regulations section 1.6035-1(g)(1)]. Form 8971 lists the names, taxpayer identification numbers, and addresses of each beneficiary. Preparers should also attach a different Schedule A for each beneficiary. Each Schedule A should contain 1) a description of the properties the beneficiary has received, 2) whether the item increased the estate tax liability, 3) the valuation date, and 4) the property’s estate tax value. In addition to filing Form 8971 and Schedule A with the IRS, executors must also provide all beneficiaries with a copy of their respective Schedule As.
Executors do not have long to file the necessary schedules. Generally, Form 8971 and Schedule A must be filed within 30 days of filing the estate tax return or the due date of the estate tax return [IRC section 6035(a)(3)(A)(i-ii)]. This reporting requirement can prove difficult for executors because some beneficiaries may not be known by the return due date. For example, litigation determining the legal heirs may create uncertainty in the filing of Form 8971.
According to the proposed regulations, if the property allocation among possible beneficiaries is unknown by the due date, one is allowed to report the same property to multiple beneficiaries [section 1.6035-1(c)(3)&(4)]. Furthermore, if a beneficiary’s location is unknown at the due date, the preparer may report the specific methods used to locate the missing beneficiary on Form 8971. A supplemental Form 8971 and Schedule A must then be filed with the IRS within 30 days of either locating a missing beneficiary or a change in property allocation, as well as to each affected beneficiary (also within 30 days). Finally, CPAs may ease the time burden by simply filing an extension for the estate tax return, which will also extend the deadline for the Form 8971 and Schedule A reporting.
Which Assets Are Subject to the Consistency Rules?
Generally, any property that is owned by the decedent at the date of death and includible in the decedent’s gross estate is subject to these requirements [Proposed Regulations section 1.1014-10(b)(1)]. There is, however, a $5,490,000 Unified Transfer Tax Credit Exclusion for decedents dying in 2017 (IRC section 2010), which increases to $11,200,000 in 2018 under the Tax Cuts and Job Act. Only property that generates an estate tax liability is required to maintain consistency. For example, assume that two properties with a combined estate value of $5,490,001 are distributed to a beneficiary in 2017, and there were no lifetime gifts by the decedent. In this case, both properties are deemed to increase the estate tax liability. If, instead, the properties had a combined value of $5,490,000 or less, neither property would be subject to the basis consistency rules or the reporting requirements.
Properties subject to estate tax deductions do not increase the estate tax liability; therefore, these properties do not need to meet the consistency requirements.
Properties subject to estate tax deductions, such as the marital deduction and charitable deduction, do not increase the estate tax liability; therefore, these properties do not need to meet the consistency requirements [Proposed Regulations section 1.1014-10(b)(2)]. They must, however, still be reported as a distribution on Form 8971 because they are includible in the gross estate. The executor should note on Schedule A of Form 8971 that the property does not increase the estate tax liability.
Finally, there are other exceptions from the Form 8971 asset reporting requirements, but these are generally for administrative convenience. They include cash (other than coin collections), certain tangible personal property for which an appraisal is not required under Treasury Regulations section 20.2031-6(b), and property sold or exchanged by the estate [Proposed Regulations section 1.6035-1(b)(1)(i-iv)].
Omitted Property and Adjustments in Valuation
In some cases, an executor may discover that he has omitted property from the original Form 8971 after it has been filed. The general rule is that a beneficiary must take a zero basis if a property has not been reported on Form 8971. Even if the executor files an amended Form 8971, the beneficiary must still take a zero basis if the statute of limitations has passed [Proposed Regulations section 1.1014-10(c)(3)(i)(A-B)]. If, however, the executor files an amended Form 8971 within the statute of limitations, the beneficiary will have a basis equal to the property value reported on Form 8971.
In addition, adjustments can be made to the basis limits to include adjustments for gains recognized by the decedent’s gross estate, post-death capital improvements, and depreciation. For example, if a beneficiary has a new roof installed on an inherited home, the basis is increased by the cost of the improvement.
Penalties for Noncompliance
In addition to the potential loss of basis discussed above, preparers should note that there is an accuracy-related penalty imposed on beneficiaries for any portion of an underpayment of taxes due to an inconsistent basis [IRC sections 6662(b)(8) and 6662(k)]. The penalty is a flat 20% of the underpaid tax. For preparers, there is currently a $260 penalty for a failure to file each Form 8971 due. The maximum underpayment penalty is $3,193,000 per calendar year [IRC section 6721(a)].
Considerations and Recommendations
In general, proposed regulations do not have the effect of law, as they represent the IRS’s proposed interpretation of the law. Due to the vagueness of IRC section 1014, however, it would be prudent for executors to adhere to the proposed regulations, as they provide a reasonable guide to follow. Furthermore, they provide substantial authority as described in Treasury Regulations section 1.6662-4(d)(3)(iii). It is also reasonable to follow the proposed basis consistency regulations, because the final Treasury Regulations are likely to take a similar form. Therefore, prudent advisors should familiarize themselves with the intricate details of these requirements and the exceptions applicable in special circumstances. Preparers following these guidelines should find that return positions supported by the proposed regulations generally will not be challenged by the Treasury Department.