IRS PROPOSES ANTI-ABUSE EXCEPTION TO ANTI-CLAWBACK REGULATIONS

By: Megan C. (Neal) Knox, McDonald & Kanyuk, PLLC

In April 2022, the IRS issued a proposed regulation (REG-118913-21) that would provide an exception to the anti-clawback regulations that were adopted in November 2019.  The proposed regulation would except from the anti-clawback rules “transfers includible in the gross estate, or treated as includible in the gross estate for purposes of section 2001(b).” 

  1. Background – The Anti-Clawback Rule.

Under the Tax Cuts and Jobs Act (“TCJA”), beginning on January 1, 2018, the basic exclusion amounts (“BEA”) for gift and estate tax purposes temporarily increased from $5 million (indexed for inflation) to $10 million (indexed for inflation).  On January 1, 2026, the BEA will automatically decrease to $5 million (indexed for inflation). 

As a result of the TCJA, practitioners were concerned that a portion of a donor’s gifts made after January 1, 2018 and before to January 1, 2026 might be “clawed” back into such donor’s estate at death if he or she died after January 1, 2026, thereby denying the donor of the full benefit of the higher BEA amount on the previous gifts.  In November of 2019, the IRS adopted “anti-clawback regulations” that allow a decedent’s estate to calculate its estate tax credit using the higher of the BEA applied to lifetime gifts or the BEA applicable at death. See Treas. Reg. §20.2010-1(c).   

In the preamble to the anti-clawback regulations, the IRS foresaw certain potential abuses of these regulations.  For certain inter-vivos transfers made during the increased BEA period that are included in the decedent’s estate after the BEA has decreased, the anti-clawback regulations actually produce a “bonus” because in calculating the estate tax for these types of transfers, the gift is excluded from “adjusted taxable gifts” on line 4 of the estate tax return.  The IRS declined to address these potential abuses in the anti-clawback regulations, opting instead to reserve them for further consideration after proper notice and commenting.

  1. The Proposed “Anti-Abuse” Exception.

In part to prevent the abuse foretold in the preamble of the anti-clawback regulations, the proposed regulation would add a new subparagraph (3) to Treas. Reg. §20.2010-1(c), excepting “transfers includible in the gross estate, or treated as includible in the gross estate for purposes of Code §2001(b)” from the anti-clawback regulations.  The proposed regulation specifically lists (without limitation) four specific categories of transfers that are excepted from the anti-clawback regulations.  The four non-exhaustive categories of transfers that fall within the anti-abuse exception are as follows:

  1. Transfers included in the gross estate under Code §§2035 – 2038 and §2042 regardless of whether all or any part of the transfer was deductible under Code §2522 (charitable deduction) or Code §2523 (marital deduction);
  2. Transfers made by enforceable promise to the extent they remain unsatisfied as of the date of the decedent’s of death;
  3. Transfers described in Treas. Reg. §§25.2701-5(a)(4) or 2.2702-6(a)(1), i.e., certain applicable retained interests in corporations or partnerships (Code §2701) or trusts (Code §2702); and
  4. Transfers that would have been described in Paragraphs 1 – 3 above “but for the transfer, relinquishment, or elimination of an interest, power or property, effectuated within 18 months of the date of the decedent’s death by the decedent alone, by the decedent in conjunction with any other person or by any other person…. [unless] effectuated by the termination of the durational period described in the original instrument of transfer by either the mere passage of time or the death of any person.”

However, the anti-clawback regulations will continue to apply to transfers includible in the gross estate when the taxable amount of the gift is not material, i.e., when the taxable amount is 5 percent or less of the total amount of the transfer. 

The proposed regulation would apply only to estates of decedents dying on or after April 27, 2022 but would apply even if the gift subject to the anti-abuse exception to the anti-clawback rules was made before April 27, 2022.  This regulation is a proposed regulation and is subject to change.  Proposed regulations are not binding.  They carry no more weight in court than a position advanced in a brief.

Upcoming Trusts & Estates Events at the BBA – May 2022

By: Bryce Helfer, Nixon Peabody and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

Planning With Nongrantor Trusts. Monday, May 16, 2022, 12:00 PM to 2:00 PM. Industry expert and ACTEC Fellow Jere Doyle will walk attendees through the basics of nongrantor trusts, which are anything but basic.  Discussion will cover federal and state income tax considerations, planning for qualified small business stock, special deductions available to trusts, charitable deductions, capital gains and DNI, bequests, expenses and other rules unique to nongrantor trusts.

 

IRS Issues Proposed SECURE Act Regulations

By: Patricia E. Malley, Burns & Levinson LLP

In late February 2022, the IRS released proposed regulations under the SECURE Act which has proven to be one of the most significant pieces of retirement benefits legislation in recent years.  The proposed regulations (which consist of 275 pages) address how the required minimum distribution (“RMD”) rules will work for defined contribution plans (i.e. IRAs, 401(k)s and 403(b)s) and their owners, plan participants and beneficiaries.

This blog post will highlight some of the key clarifications addressed by the proposed regulations.

Clarification Regarding Birthdate

The SECURE Act raised the age for which retirees must start to withdraw money from applicable retirement plans from age 70 ½ to 72.  Thus, under the Act, where an individual reached the age of 70 ½ in 2019, they were required to take their RMD by April 1, 2020.  However, if an individual reached age 70 ½ in 2020 or later, they would be required to take their RMD by April 1 of the year after reaching age 72.

Practitioners raised concerns over how this change in the required beginning date would impact surviving spouses who were named as the sole beneficiary of an employee’s retirement account.  Previously, the law allowed a spouse to delay distributions if the deceased employee was not receiving RMDs during lifetime until such time as the deceased employee would have been required to receive such RMD (i.e. at age 70 ½).  The concern raised was whether the change would mean that spouses who had previously inherited their interest in a deceased employee’s retirement account prior to the effective date of the SECURE Act might still be required to receive distributions based on the 70 ½ age rule.  The proposed regulations clarify that surviving spouses may delay distributions until the end of the calendar year in which the employee would have attained age 72.  Similarly, a spouse who has elected to roll over a retirement account into his or her own name may delay distributions until the surviving spouse reaches their own required beginning date.

Clarification Regarding 10-Year Rule

A key component of the SECURE Act was its elimination of the ability of beneficiaries other than a spouse or other so-called “eligible designated beneficiary” (“EDB”) [1] to “stretch” distributions over their life expectancies.  Now, under the SECURE Act, distributions to non-spouse and non-EDB individuals must be completed within 10 years following the death of a plan participant or IRA owner (distributions to spouse or EDB beneficiaries may be stretched over their life expectancies).

When the SECURE Act was enacted, there was some confusion over the 10-year period particularly the timing of when distributions were required to be made from the account to the beneficiaries.  As drafted, the proposed regulations clarify that if an account owner dies before his or her required beginning date (typically April 1st of the year after his or her 72nd birthday), the 10-year rule requires that the account be distributed by December 31st of the tenth year following the year of death.  However, if an account owner dies after his or her required beginning date, the 10-year rule applies and the beneficiary must take annual RMDs in years one through nine.

Clarification Regarding Age of Majority

 When enacted, the SECURE Act failed to define the age of majority for a child named as a beneficiary of an employee’s retirement plan. 

As drafted, the proposed regulations clarify that a child of an employee will be considered to be above the age of majority on his or her 21st birthday and therefore will no longer be considered an EDB unless he or she is disabled.[2]  While this age is somewhat inconsistent with what is considered the age of majority in most states (and, to a certain extent, what practitioners thought would be the applicable age for purposes of determining whether a child would be considered an EDB excepted from the 10-year rule above) it is worth noting that it is consistent with what is considered the age of majority in the gift tax context.

Clarification Regarding Definition of Disability

Currently, the SECURE Act relies on the Internal Revenue Code definition of disability (provided under section 72(m)(7) of the IRC) which provides a standard of disability based on whether an individual is unable to engage in “substantial gainful activity.”  However, this standard can be difficult to apply particularly when the individual in question is under the age of 18.  Thus, the proposed regulations provide rules for determining whether an individual who is under the age of 18 is disabled for purposes of being considered an EDB.  In addition, the proposed regulations impose a new documentation requirement for chronically ill and disabled beneficiaries.

Additionally, the proposed regulations provide a safe harbor for determining whether a beneficiary is disabled.  If, as of the date of the employee’s death, an individual has been determined to be disabled within the meaning of 42 U.S.C. 1382c(a)(3), then that individual will be considered disabled for purposes of being considered an EDB.

(Additional) Clarification regarding Trusts as Beneficiaries

It is worth noting that the proposed regulations continue to maintain the concept of a see-through trust whereby certain beneficiaries are treated as direct beneficiaries of an employee if the trust meets the see-through trust requirements.  Although consistent with the examples that are in the current regulations, the proposed regulations provide additional fact patterns that are intended to address issues raised in private letter rulings particularly where a trust has EDB and non-EDB beneficiaries.

Applicability

The proposed regulations will apply for purposes of determining RMDs and for distributions on or after January 1, 2022.  For 2021 individuals must continue to apply the current regulations but take into account a reasonable and good faith interpretation of the SECURE Act amendments, which compliance with the proposed regulations will satisfy.

Comments

As a reminder the regulations discussed above are proposed regulations and therefore are subject to change as a result of comments submitted by the public.

Members of the public who wish to submit comments on the proposed regulations will have until May 25, 2022 to submit written or electronic comments.

Commenters are encouraged to submit public comments electronically via the Federal eRulemaking Portal at www.regulations.gov however paper submissions may be sent to: CC:PA:LPD:PR (REG-105954-20), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.  A public hearing is scheduled for June 15, 2022

[1] For purposes of the SECURE Act, EDBs are defined as: (i) the employee’s surviving spouse; (ii) the employee’s child who is under the age of majority; (iii) a disabled individual; (iv) a chronically ill individual; or (v) an individual no more than 10 years younger than the employee.

[2] Please note that the proposed regulations do appear to allow defined benefit plans that have used the prior definition of age of majority to retain that plan provision, thus, grandfathering their definition of “age of majority”.  Therefore, some care will need to be exercised when a minor child becomes the beneficiary of an owner’s retirement account.

Upcoming Trusts & Estates Events at the BBA – March 2022

By: Bryce Helfer, Nixon Peabody and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

BBA Webinar: Turning 18 – Guardianship, Benefits and Housing for Young Adults with Special Needs. Tuesday, March 15, 2022, 12:00 PM to 1:00 PM.  For children with special needs, turning 18 is a major turning point. Now that the child is no longer a child, the parent or other caregiver will need to address changes in available benefits, needs, as well as their ability to make medical and financial decisions on behalf of the disabled person who is now a legal adult.  Join our panelists as they discuss three of the major planning points: government benefits, housing and guardianship. Attendees will also receive a “Turning 18” checklist specifically drafted for special needs families.

BBA Webinar: The Delaware Advantage for Personal Trusts Monday, March 28, 2022, 10:00 AM to 11:00 AM. Delaware is generally renowned for its trust and tax law advantages and its innovative estate planning vehicles. Further, it is regarded as one of the best places for trust administration. Even if your clients do not live in Delaware, there are reasons to consider establishing a trust in Delaware or moving an existing trust to Delaware. Delaware has over 100 years of established trust law and Wilmington Trust is one of the firms that has helped to develop these laws. Jeff Wolken, Wilmington Trust’s national expert in Delaware trust planning, along with Kerry Reeves, will go over everything you ever wanted to know about Delaware trusts.

 

The Massachusetts Estate Tax, the Governor’s Proposal, and Out-of-State Real and Tangible Personal Property

By: Paul M. Cathcart, Jr., Hemenway & Barnes LLP

The Massachusetts Estate Tax, the Governor’s Proposal, and Out-of-State Real and Tangible Personal Property

In late January 2022, the Baker-Polito Administration filed a “comprehensive tax proposal” which would make several changes to the Massachusetts estate tax, including by increasing the Massachusetts exemption amount; eliminating the so-called “cliff effect” of the Massachusetts estate tax; and modifying the method for taking into account a resident decedent’s out-of-state real and tangible personal property when computing Massachusetts estate tax.[i]  House Bill 4361, 192nd Gen. Ct. §§ 11–12 (filed Jan. 26, 2022).  The first two proposed changes have been publicized and covered elsewhere, whereas the third proposed change has not been and is discussed in this post.

The Massachusetts estate tax is computed based on a decedent’s federal taxable estate, see G.L. c. 65C, § 2A; former I.R.C. § 2011, which in the case of a Massachusetts resident decedent may include value attributable to real or tangible personal property located in states other than Massachusetts.  If those other states also tax the decedent’s estate, Massachusetts allows a credit for taxes paid.  If they do not, the Massachusetts statute purports to subject the out-of-state property to tax in the same manner as the decedent’s other (in-state) property.

Since at least 2016, executors of the estates of Massachusetts resident decedents have been well-advised to consider deviating from what the statute purports to require.  That year, the Middlesex Probate and Family Court held that a resident decedent’s interest in a foreign entity that held foreign real property was an interest in foreign real property and, consequently, not subject to Massachusetts estate tax.  Dassori v. Commissioner of Revenue, Docket No. MI14E0042QC (June 30, 2016).  In that case, the taxpayer argued that the United States Constitution prohibited Massachusetts from taxing out-of-state real property, and the Commissioner of the Massachusetts Department of Revenue did not dispute that argument.  Eric T. Berkman, Estate Tax Application Ruled Unconstitutional, Mass. Law. Wkly., Aug. 29, 2016 (quoting counsel for the taxpayer).  So, although the court did not hold that out-of-state real property is not subject to Massachusetts estate tax, the case further popularized this proposition.

Consistent with Dassori, at least some executors have been advised to report a value of $0 for real and tangible personal property located outside of the Commonwealth.  Compared to reporting at fair market value, this generally has the effect of reducing Massachusetts tax at the highest marginal rate that would otherwise apply.

The Administration’s proposal calls for a resident decedent’s Massachusetts estate tax instead to be reduced in proportion to the value of the decedent’s out-of-state real and tangible personal property (whether or not any other jurisdiction subjects that property to tax).[ii]  Compared to reporting such property at fair market value, this would have the effect of reducing Massachusetts tax at the average rate to which the decedent’s estate is otherwise subject.  Depending on how an executor of a Massachusetts resident decedent previously has reported out-of-state real and tangible personal property, this could result in more Massachusetts estate tax being reported than under current practice (because that average rate is lower than the highest otherwise-applicable marginal rate), or less if the executor has been reporting in accordance with the current statute notwithstanding the Dassori argument.

If adopted, the proposal may be subject to challenge.  However, the proposal appears to be on at least more solid constitutional footing than the current statute.  See generally Jerome R. Hellerstein et al., State Taxation ¶ 21.10 (3d ed. 2001 with updates through January 2022, online version accessed on Checkpoint).

[i] Another lesser-known quirk would also be eliminated:  The exemption would no longer be reduced by lifetime taxable gifts.

[ii] This mirrors how Massachusetts taxes nonresident decedents on their in-state real and tangible personal property.

Upcoming Trusts & Estates Events at the BBA – February 2022

By: Bryce Helfer, Nixon Peabody and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

BBA Webinar: “Fixing” Irrevocable Trusts: Decanting, Non-Judicial Settlement Agreements, and Other Tools.  Thursday, February 10, 2022 12:00 PM to 1:00 PM.  This program will provide an introduction to various methods for changing the course of an existing Massachusetts irrevocable trust, including how and when to consider: (1) modification, (2) reformation, (3) decanting, and (4) a non-judicial settlement agreement.

BBA Webinar: The Messy Intersection of Divorce and Trust Law – Everything but PfannenstiehlTuesday, February 15, 2022 12:00 PM to 1:00 PM.  Panelists will discuss various estate and trust related issues that might arise during divorce proceedings, including conflicts between the terms of marital/divorce agreements and estate planning documents as well as the rights of non-parties in divorce proceedings when trust interests are implicated.

 

Last Month at the BBA – Trusts & Estates Section Events in January 2022

By: Rebecca Tunney, Goulston & Storrs and Bryce Helfer, Nixon Peabody, Communications Committee, Trusts and Estates Section

Trusts & Estates Section Programs at the BBA last month: 

BBA Webinar: Introduction to Irrevocable Trusts. This program provided an introduction to the use of irrevocable trusts in estate planning, including income and estate tax implications, drafting considerations, and avoiding potential pitfalls.

BBA Webinar: Trusts & Estates Mid-Year Review.  An annual event not to be missed, the Trusts & Estates Mid-Year Review covered recent federal and state case law, legislation and tax law matters.

 

Upcoming Trusts & Estates Events at the BBA – January 2022

By: Bryce Helfer, Nixon Peabody and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

BBA Webinar: Introduction to Irrevocable Trusts. Thursday, January 6, 2022 10:00 AM to 11:00 AM.  This program will provide an introduction to the use of irrevocable trusts in estate planning, including income and estate tax implications, drafting considerations, and avoiding potential pitfalls.

BBA Webinar: Trusts & Estates Mid-Year Review. Monday, January 24, 2022 10:00 AM to 11:30 AM.  An annual event not to be missed, the Trusts & Estates Mid-Year Review covers recent federal and state case law, legislation and tax law matters.

 

What’s New for Estate and Gift Tax

By: Katelyn Allen, Nutter

IRS Issues Final Regulations that Establish $67 User Fee for Persons Requesting Issuance of Estate Tax Closing Letter.

TD 9957: Effective Date: October 28, 2021

            With the issuance of TD 9957, effective October 28, 2021, the IRS effectively established a $67 user fee for persons requesting the issuance of an IRS Letter 627, also known an as estate tax closing letter.

            All estates filing returns after the October 28, 2021 implementation date are required to request the issuance of an estate tax closing letter and pay the $67 user fee through the federal government fee payment portal, www.pay.gov.  In navigating the payment portal, the person authorized to request an estate tax closing letter will first select the agency (Department of the Treasury: Internal Revenue Service) and will then select “Estate Tax Closing Letter User Fee”. 

            The requestor will be required to submit an online form on the pay.gov portal, providing the decedent’s information, the executor’s information, and the amount of tax due as reflected on the Form 706 or Form 706-NA filed with the IRS. Once the information has been entered and the form has been submitted, the requestor must pay the user fee.  The user fee can currently be paid by credit or debit card, PayPal account, Amazon account, or via an ACH transfer from a private bank account.  The IRS specifically states that a requestor should not submit the online form or pay the user fee until nine months after the date of filing.

National Archives and Records Administration (NARA)’s Federal Records Centers reduces 75-Year Retention Period for Estate Tax Returns to 40 Years.

            Effective February 11, 2022, the National Archives and Records Administration (NARA)’s Federal Records Centers will reduce the current period of 75 years for retention of estate and gift tax returns to 40 years. 

            The NARA has indicated that the ultimate goal for the government-wide policy change is to transition federal record keeping to fully electronic, as well as reduce the volume of records stored and the storage costs for these records.

            Taxpayers are encouraged to request copies of older estate and gift tax returns in advance of the February 11, 2022 deadline.  Once the National Archives and Records Administration approves the shorter retention period, the IRS will be instructed to destroy estate and gift tax returns in the Federal Records Centers that are older than 40 years.

            In order to request a copy of an older estate and/or gift tax return, the requestor must have authorization to receive a copy of the return on behalf of the estate, in the case of an estate tax return.  The requestor must submit a completed Form 4506 (Request for Copy of Tax Return), provide the decedent’s name, address, and social security number, a copy of the decedent’s death certificate, and prove a fiduciary relationship through either a copy of Letters Testamentary approved by the court or a completed Form 56 (Notice Concerning Fiduciary Relationship).  The payment of a fee of $50 for each return requested is also required. 

Last Month at the BBA – Trusts & Estates Section Events in November 2021

By: Rebecca Tunney, Goulston & Storrs and Bryce Helfer, Nixon Peabody, Communications Committee, Trusts and Estates Section

Trusts & Estates Section Programs at the BBA last month: 

Estate, Gift and GST Tax Basics for the New Estate Planner. This program will provide an introduction to the estate, gift, and generation-skipping transfer taxes. Our speakers will describe the key components of each tax, explain how the taxes relate to one another, and provide context for how each tax is relevant for purposes of preparing an estate plan. This program is particularly relevant for new estate planners.

Serving as a Conservator: The Impact of Hornibrook v. Richard for Fiduciaries.   Hear from the attorneys who argued the case in front of the SJC, Kristyn M. Kelley and Ethan C. Stiles, on the details of the recent Supreme Court Decision, Kevin Hornibrook v. Cherilyn Richard and its implications for future Conservators.  Our speakers will provide an overview of the facts of the case, their respective positions as argued to the SJC and provide insight on their perspectives on the outcome of the case.