Posts Categorized: Tax Update

IRS Releases Proposed Regulations on Taxing Expatriates’ Gifts and Bequests to U.S. Citizens and Residents

By, Caitlin Glynn of Rackemann, Sawyer & Brewster

Recent guidance has been issued to implement Internal Revenue Code Section 2801 (“Section 2801”) which imposes a succession tax on U.S. citizens and residents who receive gifts or bequests from individuals who relinquished U.S. citizenship or ceased to be lawful permanent residents of the United States on or after June 17, 2008 and were “covered expatriates” as defined by the Statute.

IRC Section 2801 Explained

Section 2801 was added to the Internal Revenue Code by The Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART Act”).  In passing the HEART Act Congress determined that it was appropriate and in the interests of tax equity to impose a tax on U.S. citizens and lawful residents who receive from an expatriate a gift or bequest that would otherwise not be subject to U.S. estate and gift tax.  Under Section 2801 the receipt of covered gifts or covered bequests by U.S. citizens or residents from covered expatriates is subject to tax.  For purposes of calculation of the tax on the gift or bequest, the amount of the gift is its fair market value as of the date of receipt and the tax imposed is the highest applicable gift and estate tax rate (currently 40 percent).

Section 2801 is distinctive in that it imposes the tax on the recipient of the gift or bequest, rather than the donor or estate of the decedent.  The tax will be imposed whether the donor or decedent acquired the property transferred before or after expatriation.  The tax will not apply to those gifts that do not exceed the gift tax annual exclusion amount for the year.   The tax is also reduced by the amount of any gift or estate tax paid to a foreign country with respect to a covered gift or bequest.

Previous Guidance from the IRS

On July 20, 2009 the Treasury Department and the IRS issued Announcement 2009-57.  This Announcement states that the IRS intends to issue guidance under Section 2801.  The Announcement further provides that tax payments and filing requirements of the statute are deferred pending the issuance of final regulations.

The Proposed Regulations

The Proposed Regulations amend Title 26 by adding Part 28, “Imposition of Tax on Gifts and Bequests from Covered Expatriates.”  The proposed Regulations are divided into seven sections and include Sections 28.2801-1 to 28.2801-7.  See Internal Revenue Bulletin 2015-39.

Section 28.2801-1 sets forth the general rule of liability for the tax, that the tax is imposed on U.S. citizens or residents who receive covered gifts or covered bequests from a covered expatriate.  Domestic trusts and foreign trusts electing to be treated as domestic trusts are treated in the same manner as U.S. citizens.  Section 28.2801-2 provides definitions for Section 2801, including important terms such as “covered expatriate,” “covered bequest,” “domestic trust,” “foreign trust” and “power of appointment.”  “Covered expatriate” is defined by reference to Section 877A(g)(1).  Section 877A(g)(1) generally defines a “covered expatriate” as an individual who expatriates on or after June 17, 2008, and whose average annual net income for the period five taxable years before expatriation exceeds $124,000 (subject to a cost of living adjustment), or whose net worth as of expatriation is $2 million, or who cannot certify that they have complied with filing requirements for the five taxable years before expatriation, subject to certain exceptions.

Section 28.2801-3 addresses rules and exceptions applicable to the definitions of covered gift and covered bequest.  In general, the following transfers are excluded from such definitions: qualified disclaimers of property made by the covered expatriate; taxable gifts reported on a covered expatriate’s timely filed gift tax return and property included in the covered expatriate’s gross estate and reported on such expatriate’s timely filed estate tax return, provided that the gift and estate tax due is timely paid; donations to a charitable organization that would be deductible for gift or estate tax purposes; or transfers to a U.S. citizen spouse if such transfer would otherwise qualify for the gift or estate tax marital deduction.

Section 28.2801-4 provides specific rules regarding who is liable for the payment of the Section 2801 tax as well as how to compute the tax. As outlined above, a U.S. citizen or resident who receives a covered gift or a covered bequest is liable for the tax.  A domestic trust that receives a covered gift or covered bequest is treated as a U.S. citizen and is thus liable for the tax.  Of note, a non-electing foreign trust is not liable for the Section 2801 tax.  Thus, a U.S. citizen or resident who receives a distribution from a non-electing foreign trust is liable for the Section 2801 tax to the extent the distribution is attributable to covered gifts or covered bequests.  This Section also provides rules for contributions to charitable remainder trusts (CRTs) made by covered expatriates for the benefit of one or more charitable organizations and the benefit of a U.S. citizen or resident other than the charitable organization. The value of the charitable organization’s remainder interest in a CRT is excluded from the definition of a covered gift or covered bequest.  The value of the interest of the non-charitable U.S. citizen or resident in such contributions to the CRT is a covered gift or bequest and thus taxable, unless otherwise excluded.

Section 28.2801-5 provides guidance on the treatment of foreign trusts.  If a covered gift or covered bequest is made to a foreign trust, the tax applies to any distribution from that trust to a recipient who is a U.S. citizen or resident. The section also discusses how a foreign trust can elect to be a U.S. trust for purposes of Section 2801.

Section 28.2801-6 addresses how the basis rules under Sections 1014, 1015(a) and 1022 impact the determination of the U.S. recipient’s basis in the covered gift or the covered bequest.  This Section also clarifies the applicability of the GST tax to some Section 2801 transfers, among other special rules and cross-references.  Of note, unlike Section 1015(d), which generally allows gift tax paid on the gift to be added to the donee’s basis, Section 2801 does not provide for a similar basis adjustment.

Section 28.2801-7 provides guidance on the responsibility of a U.S. recipient to determine if a tax under Section 2801 is due.  The Treasury Department and IRS recognize that because the tax imposed by Section 2801 is on the recipient, rather than the donor or the estate of the decedent (that has access to the information related to whether the donor or decedent is a covered expatriate), U.S. taxpayers may have difficulty determining whether a tax is due. To aid the taxpayer, the IRS may disclose returns and return information upon request.

December 9, 2015 is the deadline for written or electronic comments to the above regulations.

IRS Announces Inflation Adjustments for 2016

By, Kerry Reilly, Esq.

Income Tax:

  • Highest Tax Bracket for Estates and Trusts. An estate or trust will be subject to the highest income tax bracket and Medicare surtax if taxable income exceeds $12,400 (increased from $12,300 in 2015).
  • Foreign Earned Income Exclusion. For taxable years beginning in 2016, the foreign earned income exclusion amount under §911(b)(2)(D)(i) is $101,300 (increased from $100,800 in 2015).
  • Expatriation to Avoid Tax. For calendar year 2016, under §877A(g)(1)(A), unless an exception under §877A(g)(1)(B) applies, an individual is a covered expatriate if the individual’s “average annual net income tax” under §877(a)(2)(A) for the five taxable years ending before the expatriation date is more than $161,000 (increased from $160,000 in 2015).
  • Tax Responsibilities of Expatriation. For taxable years beginning in 2016, the amount that would be includible in the gross income of a covered expatriate by reason of §877A(a)(1) is reduced (but not below zero) by $693,000 (increased from $690,000 in 2015).

Gift Tax:

  • Annual Exclusion for Gifts. The annual exclusion for gifts remains at $14,000 for 2016.
  • Annual Exclusion for Gifts to Non-Citizen Spouse. The first $148,000 of gifts to a spouse who is not a citizen of the United States shall not be considered a taxable gift by the donor (increased from $147,000 in 2015).
  • Large Gifts Received from Foreign Persons. Gifts from foreign persons in excess of $15,671 in aggregate must be reported to the IRS (increased from $15,601 in 2015).

Estate Tax

  • Unified Credit Against Estate Tax. The basic exclusion amount for an estate of any decedent dying during calendar year 2016 is $5,450,000 (increased from $5,430,000 in 2015).
  • Valuation of Qualified Real Property in Decedent’s Gross Estate. For an estate of a decedent dying in calendar year 2016, if the executor elects to use the special use valuation method under §2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from electing to use §2032A for purposes of the estate tax cannot exceed $1,110,000 (increased from $1,100,000 in 2015).
  • Interest on Certain Portions of Estate Tax Payable in Installments. For an estate of a decedent dying in calendar year 2016, the dollar amount used to determine the “2-percent portion” (for purposes of calculating interest under §6601(j)) of the estate tax extended as provided in §6166 is $1,480,000 (increased from $1,470,000 in 2015).

See Rev. Proc. 2015-53 for more details.

Proposed Changes to the Massachusetts Estate Tax

By, Kerry Reilly, Esq.

On January 15, 2015, Representative Shawn Dooley ((R), 9th Norfolk), et al., sponsored H.R. 2489 (replacing current Section 2A under Mass. Gen. Laws Chapter 65C). A hearing on the bill took place on October 20, 2015. This bill would, among other things:

  1. Repeal the current Massachusetts estate tax threshold of $1,000,000 and tie that threshold to “50 percent of the basic exclusion amount as defined in Section 2010 of the [Internal Revenue] Code” for those individuals dying on or after January 1, 2016.
  2. Allow for the exclusion of the principal residence from the Massachusetts gross estate provided the decedent was a resident of Massachusetts at the time of his/her death. The definition of “Massachusetts gross estate” has been changed to include this election.
  3. Allow the surviving spouse to apply the deceased spouse’s unused exclusion amount to his/her gross estate.   This would bring the Massachusetts estate tax exclusion in line with Federal tax laws allowing portability of estate tax exclusions between spouses.
  4. The”principal residence” and DSUEA elections would be made by the decedent’s Personal Representative on the decedent’s Massachusetts estate tax return.
  5. Lastly, the proposed bill would also simplify the tax table used to determine the Massachusetts estate tax liability, as follows:
If the Massachusetts taxable estate is: Over………… But Not OverThe Massachusetts estate tax
shall be:
$0 – $5,000,00010% of the taxable estate
$5,000,000 – $10,000,000$500,000 plus 11% of the excess over $5,000,000
$10,000,000 – $20,000,000$1,050,000 plus 12% of the excess over $10,000,000
$20,000,000+$2,250,000 plus 13% of the excess over $20,000,000

As of October 29th, no additional action has been taken with respect to this proposed bill.

The full text of the proposed bill can be found here:

Basis Consistency Requirements

By, Susan A. Robb of First Republic Trust Company

On July 31, 2015, the President signed the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the “Highway and Transportation Funding Act of 2015, Part II”) into law. The new law, which extended the Highway Trust Fund expenditure authority, enacted Sections 1041(f) and 6035 of the Internal Revenue Code. These new rules address the basis of property received from a decedent and require personal representatives of taxable estates to provide a statement to both the IRS and to any person acquiring an interest in property included in the decedent’s gross estate for federal estate tax purposes.

Under the stepped up basis rules of § 1014, the basis of property acquired from a decedent is generally the property’s fair market value, either on the date of death or the alternate valuation date. In the past, beneficiaries receiving such property were not required to use the same value reported by the estate. Beneficiaries could claim the property’s fair market value (and therefore their basis) was higher than the estate tax value. § 1041(f) now provides that the basis of property received from a decedent shall not exceed the value of that property as finally determined for federal estate tax purposes or, if the value has not yet been determined for federal estate tax purposes, the value of that property as reported on a statement provided pursuant to § 6035.

The new law applies to property for which a federal estate tax return is filed after July 31, 2015. However, pursuant to Notice 2015-57, the § 6035 reporting requirements have been delayed until February 29, 2016. The delay should allow the IRS and Treasury Department to issue additional guidance regarding compliance with § 1041(f) and § 6035.

See Also: Internal Revenue Bulletin: 2015-36 (Notice 2015-57)






By:  Kerry Reilly, Esq.

Estate of James A. Elkins, Jr. v. Commissioner

13-60472 (5th Cir.)

Filed: September 15, 2014


James A. Elkins, Jr. (“Decedent”), a Texas resident, owned a fractional share of 64 pieces of modern art at the time of his death.  Decedent owned 50% of the interest in two pieces of art and 73.055% interest in the other 62 pieces.  The Decedent’s children (“Petitioners”) held the remaining interests in the artworks and also served as the Executors of his estate.  Two of the art pieces were subject to a “lease agreement” whereby no interest in the works of art could be disposed of without the assent of all co-owners and no co-owner could transfer or assign his/her “rights, duties and obligations” without the prior agreement of all other co-owners.  With respect to the remaining pieces, a “Co-Tenants Agreement” governed each.  That agreement contained similar limitations.

In determining the estate taxes due upon the death of Mr. Elkins, the Petitioners retained Sotheby’s Inc. to determine value of the individual pieces and the Decedent’s pro-rata share of the artworks and Deloitte, LLP to determine the appropriate discount for lack of control and marketability.

Upon the timely filing for the Decedent’s Form 706, the Internal Revenue Service refused to allow any discount for the works of art and assessed a penalty against the Decedent’s estate of $9,068,266.    The Decedent’s estate challenged this penalty.

Tax Court Proceedings:

In the Tax Court proceedings, the Petitioners supplied evidence from three experts in addition to the Sotheby’s and Deloitte reports – a Texas lawyer, who was an expert on the time and cost associated with litigating restraints on alienation, an expert on valuation of fractional interests in property and an expert in the art market.

The Commissioner supplied one (admitted) rebuttal witness who claimed that “no recognized, [or established] market” existed for partial interests in works of art. In refusing to deviate from the “no discount” position the Commissioner supplied no evidence as to what an acceptable discount might be in the event the Tax Court disagreed.

The Tax Court rejected the Commissioner’s position that no discount was applicable under the “willing buyer/seller” test, however it also rejected the valuations provided by the Petitioners and applied its own discount of 10% for each work of art and assessed the related penalty.  The Decedent’s estate appealed.


Is the Decedent’s estate taxable on the undiscounted value of the fair market value of the artworks or the discounted value; and if it is the discounted value which discounted value applies (1) the Tax Court’s 10% or (2) the percentages supplied by the Decedent’s estate?

Discussion and Decision:

The Fifth Circuit affirmed the Tax Court’s ruling with respect to the rejection of the Commissioner’s argument as to the “zero discount” because a “willing buyer and seller” would take into account the various restrictions on the artwork.    The Fifth Circuit strongly disagreed with the Tax Court’s application of its own unsupported discount amount.

In this concisely written opinion, the Court spent a fair amount of time discussing burdens of proof and evidentiary standards.  The Court noted that the “uncontradicted, unimpeached and eminently credible” nature of the Petitioner’s evidence and the complete lack of evidence from the Commissioner should have resulted in a decision for the Decedent’s estate with respect to the value of the discounts.

The Court noted that the “reversible error” was mainly found Tax Court’s analysis of the “willing buyer/seller” test.  The Court took issue with the Tax Court’s extensive focus on the Decedent’s children as the remaining owners, its insufficient attention to the “willing buyer” and the assumption that the “buyer” would immediately flip his/her interest back to the children at a market rate.  The Court noted that the Decedent’s children are “sophisticated, determined and financially independent,” and that they had rejected entirely the thought of ever selling their interests in the artwork, or the artwork itself.    The Court further notes that in the ‘absence of an established market,’ with the subjective characteristics of the other owners and the time and money it would cost a prospective “willing buyer” to overcome the legal restraints on the artwork the “willing buyer” would likely demand further discounting.

The Court (1) affirmed the Tax Court’s rejection of the “no fractional ownership discount” assertion, (2) affirmed the Tax Court’s holding that the Decedent’s estate may apply fractional-ownership discounts, (3) reversed the Tax Court’s holding that 10% was the appropriate discount, (4) held that the appropriate discounts were those supplied by the estate of the Decedent and (5) rendered judgment in favor of the Petitioners for $14,359,508.21 plus statutory interest.


The Court also noted, in a footnote, that the Commissioner’s rebuttal witness actually weakened the Commissioner’s argument in that by stating that “no recognized market” existed for fractional interests in artwork, the discounts applied to the various pieces should have been greater.

Favorable Tax Court ruling upholds trustees’ activities as qualifying trust for material participation exception under IRC Section 469 (and the net investment income tax under IRC Section 1411)

Author:  Alison E. Lothes, Esq., Gilmore, Rees & Carlson, P.C.

In Frank Aragona Trust et al. v. Commissioner, 142 T.C. No. 9, the Tax Court ruled in favor of the taxpayer, holding that a trust could and did materially participate in real estate rental activities, qualifying for the exception to the passive activity rules under IRC Section 469.  This case is helpful, as there are currently no regulations and very few rulings on how to apply the “material participation” rules to trusts.  The IRS has been interpreting the exception to be very limited but the Court agreed with the taxpayer that the activities of the trustees, including those in their capacity as employees of an entity owned by the trust, could be considered when determining whether the trust materially participated in the real estate rental business.

A majority of the trust’s business was operated through a wholly owned LLC but the trust also operated some of its real estate business directly and some through other entities.  The trustees were intertwined in the LLC, other entities and the business.  The LLC employed three of the trustees as full time employees (along with other employees, including a controller, maintenance workers, leasing agents and clerks).   Two of the trustees also held minority interests in several of the entities in which the trust was also a member.

The trust filed fiduciary income tax returns claiming losses relating to its rental real estate activities and characterized those activities as non-passive.  The IRS disagreed and determined that the rental real estate activities were passive, and as a result limited certain deductions and net operating loss carrybacks.

Under IRC Section 469, a passive activity is any activity which involves the conduct of a trade or business in which the taxpayer does not materially participate.  Generally, rental activities are considered passive activities unless (1) more than one-half of the personal services provided by the taxpayer during the taxable year are performed in real property trades or businesses in which the taxpayer materially participates and (2) the taxpayer performs more than 750 hours of services during the year in real property trades or businesses in which the taxpayer materially participates.  “Material participation” requires that the taxpayer be involved in the operation of an activity on a “regular, continuous and substantial” basis.

The IRS argued that a trust cannot qualify for the exception because it cannot perform “personal services.”  It claimed that the legislative history indicates that “personal services” can only be performed by an individual.  In the alternative, the IRS argued that even if the trust could perform personal services, when assessing whether the trust materially participates in an activity, only the activities of the trustees (and not the employees) can be considered.  In addition, the IRS sought to exclude the activities of the trustees that were not solely related to their fiduciary duties.  For example, the IRS argued that the activities of the trustees who were employees of the LLC could not be taken into account because those activities should be attributed to them as employees, not fiduciaries.  It also argued that a portion of the activities of the trustees who owned interests in the entities should be attributed to their personal ownership in the entities, rather than to their activities on behalf of the trust.

The Tax Court disagreed.  It noted that the trustees’ fiduciary duties to administer the trust in the interest of the beneficiaries are not put aside when they work for the LLC owning the real estate.  Therefore, their activities as employees of the LLC should be considered when determining whether the trust materially participated in its real estate operations.  It is interesting to note that the Tax Court did not determine whether the activities of the non-trustee employees should be considered because it was not necessary to the decision.  Lastly, the Tax Court held that the trustees’ individual minority interests in entities of which the trust was also a member did not impact the trust’s material participation because the combined minority interests in each entity held by the trustees were less than 50% and in all cases were less than the trust’s interest.

This case is very helpful for taxpayers in that the Tax Court adopted a relatively broad interpretation of whose activities (and in what capacity those activities are undertaken) may be attributed to the trust when determining if the trust materially participates in an activity.  This has recently become even more important because of the new 3.8% tax on net investment income under IRC Section 1411.  Non-passive trade or business income is not considered net investment income and so is not subject to the tax under IRC 1411.  This ruling may make it a little easier for trusts to prove that they are “materially participating” in a trade or business to avoid the 3.8% tax.


Author: Alison I. Glover, Esq., Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.


The revenue procedure provides a simplified method for estates which were below the estate tax filing threshold and failed to file an estate tax return to elect portability.  This procedure provides relief to executors who may have been unaware of or misunderstood the filing requirement and also to executors of estates of same-sex couples who were recognized as spouses after the filing date.

Estates meeting the specified requirements will avoid having to file for relief under §301.9100-3.


Sections 302(a)(1) and 303(a) of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 allow the estate of a decedent who is survived by a spouse to make a “portability election” – which allows the surviving spouse to apply the decedent’s Deceased Spousal Unused Exclusion Amount (“DSUE”) to the surviving spouse’s own transfers during life and at death. The DSUE amount is defined as the lesser of “(A) the basic exclusion amount, or (B) the excess of the applicable exclusion amount of the last deceased spouse of the surviving spouse over the amount with respect to which the tentative tax is determined under Section 2001(b)(1) on the estate of the deceased spouse.” In order for the surviving spouse to apply the decedent’s DSUE amount to the surviving spouse’s transfers, the surviving spouse must elect portability of the DSUE amount on a timely filed Form 706, which must include a computation of the DSUE amount. The due date of an estate tax return required to elect portability is 9 months after the decedent’s date of death or the last day covered by extensions.

In 2013, United States v. Windsor struck down portions of the Defense of Marriage Act (“DOMA”). Previously, DOMA prevented the Service from recognizing same-sex marriages. According to Rev. Rul 2013-17, the Windsor decision allows, among other benefits, the surviving spouse of a same-sex married couple to make a portability election upon the death of his/her spouse.

The due date for estates required to file an estate tax return is prescribed by statute. However, if an executor is not required to file an estate tax return but may file an estate tax return to elect portability, the due date for electing portability is prescribed by regulation (20.2010-2T(a)).  Accordingly, an executor may seek relief under Section 301.9100-3 for a late filing.  In general, relief will be granted if the taxpayer acted reasonably and in good faith and the grant of relief will not prejudice the government. The Service has issued several letter rulings under Section 301.9100-3 granting an extension of time to elect portability under Section 2010(c)(5)(A) in situations in which the decedent’s estate was not required to file an estate tax return.


This revenue procedure applies if:

  • The taxpayer is the executor of the estate of a decedent who:
    • Has a surviving spouse;
    • Died after December 31, 2010 and on or before December 31, 2013; and
    • Was a citizen or resident of the United States on the date of death.
  • The taxpayer was not required to file an estate tax return because decedent’s estate was under the applicable filing threshold;
  • The taxpayer did not file a timely estate tax return;
  • The taxpayer files a complete and properly prepared Form 706 on or before December 31, 2014; and
  • The taxpayer states on the top of the Form 706 that the return is “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER SECTION 2010(c)(5)(A).”

Provided that all of these requirements are met, the taxpayer’s Form 706 will be considered to have been timely filed, unless it is subsequently determined that the taxpayer actually owed estate tax, in which case the relief will not be granted.

Limitations Period for Claim for Credit or Refund by the Surviving Spouse

To obtain a credit or refund of an overpayment of tax by reason of a portability election made under this revenue procedure, the surviving spouse (or the executor of the estate of a deceased surviving spouse) must file a claim for credit or refund of tax before the general limitations period. For example, a predeceasing spouse (“S1”) died on January 1, 2011. The assets included in the gross estate of S1 were under the exclusion. The surviving spouse (“S2”) did not file a Form 706. S2 died on January 14, 2011. S2’s taxable estate was over the exclusion. S2’s executor filed a Form 706 and paid estate tax on October 14, 2011. Under this revenue procedure, S2’s executor should file a claim for refund by October 14, 2014 – even if the estate of S1 has not yet filed a Form 706 under this procedure to make the portability election. Assume that in 2015, the Service determines that (i) S1’s estate has met the requirements for a grant of relief under this revenue procedure and is deemed to have made a valid portability election, (ii) accepts S1’s return with no changes, and (iii) issues an estate closing letter to S1’s estate. The refund claim filed by S2’s executor in anticipation of the filing of Form 706 by S1’s executor will be considered a protective claim for credit or refund of tax.

Effective Date; Pending Requests

This Revenue Procedure is effective on January 27, 2014. With respect to any ruling requests pending on January 27, 2014, the executor may rely on this revenue procedure, withdraw the letter ruling request and receive a refund of its user fee.

Steinberg v. Commissioner

Net, Net Gifts: Donee Assumption of Section 2035(b) Tax Liability
Steinberg v. Commissioner, 141 T.C. No. 8, Code Sec. 2035(b), 2512(b)
Issued September 30, 2013

Author: Kerry Reilly, Esq.


In April 2007, Jean Steinberg (“Taxpayer”) entered into a “net gift agreement” with her four adult daughters.  Under the net gift agreement, Taxpayer made gifts of cash and securities to each of her four daughters (“Donees”).  In exchange, the Donees agreed to assume responsibility for any federal gift tax imposed as a result of the gift and any federal or state estate tax imposed on the gift under Section 2035(b) in the event the Taxpayer passed away within three years of the gift.

Taxpayer filed a timely Form 709 for tax year 2007 reflecting a net gift amount of approximately $71.6 million and total gift tax of approximately $32 million.  An appraiser, hired by the Taxpayer, calculated the amount of the net gift by reducing the fair market value of the gift by (1) the gift taxes paid by the Donees and (2) the actuarial value of the potential Section 2035(b) estate tax (approximately $5.84 million).

The Internal Revenue Service (IRS) mailed a notice of deficiency disallowing Taxpayer’s entire discount for the Donees’ assumption of the potential 2035(b) tax liability ($5.84 million) and increasing the gift taxes due by approximately $1.8 million.

The IRS requested a summary judgment on one issue only – whether a Donees’ promise to pay any federal or state estate tax liability that may arise under Section 2035(b) may constitute consideration in money or money’s worth within the meaning of Section 2512(b). (emphasis added)

Discussion and Analysis:

Under Internal Revenue Code Sec. 2035(b), the decedent’s gross estate is increased by the amount of any gift tax paid by the decedent or the decedent’s estate on any gift made by the decedent during the three years prior to the decedent’s death.  Under Internal Revenue Code Sec. 2512(b) the amount of the gift is the amount by which the value of the transferred property exceeds the value of the consideration received in money or money’s worth.

The IRS claimed that the Donees’ assumption of the potential Section 2035(b) estate tax failed to build-up or contribute to (“replenish”) Taxpayer’s estate, (monetarily or otherwise) providing only “peace of mind” and therefore failed as consideration under the “estate depletion” theory of gift tax.  The “estate depletion” theory determines what constitutes consideration in money or money’s worth.  If a donor’s estate has not been replenished, then that donor has not received consideration. The IRS rested its claims in part on the Tax Court’s holding in McCord v. Commissioner, 120 T.C. 358 (2003), rev’d and remanded sub nom.  Succession of McCord v. Commissioner, 461 F.3d 617 (5th Cir. 2006) ((a) donees’ assumption of the taxpayer’s 2035(b) estate tax liability was too speculative to be reduced to monetary value and (b) any benefit from the donees’ assumption of the Section 2035(b) tax liability would accrue to the donor’s estate rather than the donor).

The Court agreed with the Court of Appeals and reversed its position in McCord with respect to the “too speculative” claim.  It held that assumption of the potential Section 2035(b) tax liability was not too speculative because a “willing buyer and seller in appropriate circumstances may take into account a donee’s assumption of [this] liability in arriving at a sale price.”  The Court noted that “many courts have held that the value of stock received by gift or bequest must be reduced by capital gains tax regardless of the lack of indication that the capital gains will be triggered by the donee or beneficiary in the near future.” E.g. Estate of Jelke v. Commissioner, 507 F.3d 1317, 1319, 1333 (11th Cir. 2007).  The Court also noted that these cases show it is possible to determine the value of built-in capital gains on the valuation date despite the uncertainty of surrounding factors (i.e. rates, potential repeal of tax, future sale/trigger date, amount of tax due from beneficiary/donee, etc.) and that there is a “possibility that an appropriate method may likewise exist to fix the value of the potential Section 2035(b) estate tax liability…”

The Court also reversed its position on McCord with respect to the “estate depletion” theory.  It held that its prior distinction between a donor and his/her estate was incorrect and that “they are inextricably bound.”  The Court also reasoned that when the Donees assumed the gift tax liability the Taxpayer’s assets were “replenished” by the amount of the gift tax liability assumed by the Donees because the “consideration may discharge [the donor] from liability…the benefit to the donor in money or money’s worth, rather than the detriment to the donee determines the existence…of consideration.” Commissioner v. Wemyss, 324 U.S. 303, 306-308 (1945). The Court reasoned that likewise the assumption of the liability for the potential 2035(b) tax by the Donees may also replenish the Taxpayer’s assets because the Taxpayer’s estate would be relieved of that liability.

Significant Holdings:

The IRS’ motion for summary judgment was denied.  The majority opinion stated that IRS failed to show, as a matter of law, that the Donees’ assumption of the Taxpayer’s potential Section 2035(b) estate tax liability cannot be considered money or money’s worth within the meaning of Section 2512(b).  The majority also held that there were disputes of material fact with respect to whether the Donees’ assumption of potential Section 2035(b) estate tax liabilities constituted consideration in money or money’s worth.  The majority did not enumerate any of these issues however.

A concurring opinion stated that this holding creates a potential valuation issue for the future – that the legal obligation of the Donees to pay the Section 2035(b) estate taxes could be considered an “asset” of the Taxpayer’s estate.  This new asset may result in a windfall to the Donees if the Taxpayer does not die within the three-year period, or could result in the Donees potentially paying an amount in estate taxes that is greater than the discount received.

A second concurring opinion stated that with respect to the “too speculative” theory, neither party had asked the Court to consider that issue, thus the Court’s discussion of that point was premature.  This concurring opinion reflected that with respect to the “estate depletion” theory, the IRS may be able to show that the Donees agreement to pay the Section 2035(b) taxes did not in fact increase the Taxpayer’s estate and was in fact merely (1) a way to apportion the tax within the estate and among the beneficiaries as the Donees will “pay” the taxes either as part of the net gift agreement or in the receipt of a smaller inheritance (if the taxes were paid by the Taxpayer’s estate), and further that (2) the net gift agreement simply memorializes an obligation that the Donees have under New York State law, thus the value of the net gift agreement as it relates to the Section 2035(b) obligation is merely as a “enforcement mechanism.”

The dissenting opinion provides numerous calculations detailing the difference in gift and estate tax amounts due for the gift and net, net gift scenarios if the taxpayer dies within three years of making the gift.  These calculations are provided as illustrative examples that the allowance of the Section 2035(b) payment by the Donees is contrary to Congress’ purpose in enacting Section 2035(b), i.e. to mitigate in part a disparity between the tax bases subject to the gift and estate tax, respectively.  The opinion provides that the allowance of the deduction for the potential Section 2035(b) taxes “allows the transferor to render more lenient the gift taxation (if no Section 2035(b) liability arises) and the estate taxation [(if that liability does arise)].”

2014 Inflation-Adjusted Figures

Nikki Marie Oliveira, Esq., LL.M., Bass, Doherty & Finks, P.C.
Michelle B. Kalas, Esq., Riemer & Braunstein LLP

The IRS recently announced the following inflation-adjusted items for 2014:

Gift Tax 

  • Annual Exclusion for Gifts.  The annual exclusion for gifts remains at $14,000 for 2014.
  • Annual Exclusion for Gifts to Non-U.S. Citizen Spouse.  The annual exclusion for gifts to a non-U.S. citizen spouse under §§ 2503 and 2523(i)(2) increases to $145,000 for 2014 (up from $143,000 in 2013).
  • Notice of Large Gifts Received from Foreign Persons.  For 2014, gifts from foreign persons in excess of $15,358 in a taxable year are required to be reported (the threshold in 2013 was $15,102).

Estate Tax

  • Federal Estate Tax Applicable Exclusion Amount.  For estates of decedents dying in 2014, the federal estate tax applicable exclusion amount under § 2010 is $5,340,000 (an increase of $90,000 from 2013).
  • Valuation of Qualified Real Property in Decedent’s Gross Estate.  For estates of decedents dying in 2014, if the personal representative elects to use the special use valuation method under § 2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from the election for purposes of the estate tax cannot exceed $1,090,000 (formerly $1,070,000 in 2013).
  • Interest on a Certain Portion of the Estate Tax Payable in Installments.  The dollar amount used to determine the “2-percent portion” for calculating interest under § 6601(j) of the estate tax extended as provided in § 6166 is $1,450,000 for 2014 (up from $1,430,000 in 2013).

Income Tax

  • Foreign Earned Income Exclusion.  Under § 911(b)(2)(D)(i), this figure is now $99,200 (previously $97,600 in 2013).
  • Tax Responsibilities of Expatriation. The exemption for appreciation in assets recognized by a covered expatriate is increased to $680,000 for expatriations that occur in 2014.
  • Expatriation to Avoid Tax. The standard for determining whether an expatriate is a “covered expatriate” under section 877A(g)(1) is based on whether his or her average annual net income tax exceeded $157,000 for the five taxable years ending before the date of expatriation for tax years beginning in 2014.

Long-Term Care Insurance Premiums

  • For 2014, the limitations under § 213(d)(10) regarding a portion of eligible long-term care insurance policy premiums to be treated as a medical expense for itemizing deductions is based on the taxpayer’s age, as follows:

Age                             Per Individual
40 and under               $370
41-50                           $700
51-60                           $1,400
61-70                           $3,720
71+                              $4,660

Please see Rev. Proc. 2013-35 for additional inflation updates.

Revenue Ruling 2013-17 Clarifies Application of Windsor

Author: Alison Lothes, Esq., Sullivan & Worcester LLP

In Revenue Ruling 2013-17 (8/29/2013), the U.S. Department of Treasury and the Internal Revenue Service issued guidance regarding the application of U.S. v. Windsor, 570 U.S. ___ (2013), which held that the exclusion of same sex couples from the definition of marriage under the Defense of Marriage Act was unconstitutional.  The ruling contained three important determinations.

First, same-sex couples will be considered married for federal tax purposes if they are lawfully married under state law based on the state of the “celebration” (i.e., legal ceremony) of their marriage.  This means that if a couple has been legally married in one state, but later moves to another state which does not recognize same-sex marriage, the couple will still be considered married for federal tax purposes, regardless of their domicile.  The ruling reasoned that this was a natural development of Revenue Ruling 58-66, which held that a couple married through common-law continues to be treated as married for federal purposes even if they move to a state which does not recognize common-law marriages.

Second, the terms “husband”, “wife”, “spouse” and “marriage” will be interpreted in a gender neutral way to refer to persons married in a same-sex marriage.  The Ruling noted that these terms appear in more than 200 Code provisions and Treasury regulations, and that a gender-neutral construction is necessary to avoid constitutional problems under Windsor and consistent with legislative history.

Third, the terms “spouse” and “husband” and “wife” do not include persons who have entered into a domestic partnership, civil union or other formal relationship other than marriage that may be recognized by a state. This applies to both same-sex or opposite-sex couples.

The ruling noted that while the ruling will be applied prospectively as of September 16, 2013, taxpayers may file original, amended, or adjusted returns declaring their marital status as long as the statute of limitations has not expired.  Therefore, amended returns may generally be filed for 2010, 2011 and 2012.  In addition, further guidance will be issued regarding how Windsor will apply to employee benefits and plans.