August 25, 2015
Scott M. Pohar
Frost, Ruttenberg & Rothblatt, PC
Key Highlight: Issues related to New IRC Section 6035
Have you filed a Form 706, US Estate Tax Return after 7/31/15? If so, did you complete the new statement required to be filed with the service and each beneficiary within 30-days after filing? If you are starting to sweat, don’t worry too much yet. You now have until February 29, 2016 in order to complete and file this new statement under IRS Notice 2015-57. So instead of complying now, or within the 30-days after filing of an estate tax return, the due date is now 2/29/16 for these new statements. This doesn’t mean we don’t have to worry about preparing them as they are still required just delayed. With this deadline now being delayed, let’s discuss some of the requirements, and some possible issues that will require a supplemental statement. Hopefully, we will have a clearer understanding when the IRS issues some rules, or regulations.
President Obama recently signed into law the “Surface Transportation and Veterans Health Care Choice Improvement Act of 2015”, known as the Highway bill. This bill had many provisions that changed the due dates for various returns, and also the extensions. Although these are very interesting, what I want to focus on is the obscure new IRC Section 6035.
The IRS has long thought that the reporting of cost basis on inherited property was not consistent with what is reported on the estate tax returns, Form 706, and the amounts that the beneficiaries reported at the time of sale of the property. How does the Service get people to match this correctly, and report it correctly? Well this new IRC Section 6035 is an attempt to have some consistency. Although, I am very hesitant to think this is a good idea, I believe the cost of complying with the new requirement could greatly outweigh any revenue earned.
So let me summarize the law first and then raise questions that I will try to answer, given that the Service has given no guidance at this point.
For any federal estate tax return required to be filed, 30 days after the date on which the return was required to be filed (including extensions, if any), or 30 days of an adjustment to any information originally reported, the executor/trustee must provide a statement to the Service, and to ALL persons “who hold a legal or beneficial interest in the property to which such return relates”, a statement identifying the value of each interest in such property as reported on the estate tax return, and such other information with respect to such interest as IRS may prescribe.
By the way, the date of enactment is now! For ALL returns filed after 7/31/15, now extended until 2/29/2016.
All this sounds very simple since I was able to summarize in one long sentence. However, let’s discuss some questions and issues with Format, Questions to consider, What returns are included, Possible Adjustments and Penalties for failure to produce the statement.
Format of Statement:
A statement seems simple enough. What should be included in the statement?
What will we attach to the statement?
Will the IRS provide a form in the future?
Should we provide a separate form for each beneficiary?
Based on information the Service required on Form 8939, in 2010 when there was no estate tax and a carry-over basis, I suspect the Service will want a separate statement for each beneficiary. This will help with the privacy that should be required of the beneficiaries.
Obviously, the Service is going to try and match the statements to the cost basis reported by the beneficiaries on their income tax return, so they will require enough information to be able to do so. If we just provide copies of Form 706, Schedules A-I, then there is no privacy and no indication as to what asset each individual is receiving. Therefore, I believe the statement should definitely include the following:
Estate’s Name, Executor Name, address and decedent’s SSN to match the Form 706 data.
Beneficiaries’ name, address and SSN or EIN if a trust.
Listing of assets that each beneficiary should or could receive. In this case, I believe if it is the residue, then possibly copies of Form 706 schedules can be attached.
For stocks/bonds, include the number of shares in total and the cost per share.
I would break the statement into two parts:
Assets specifically devised, or that have a beneficiary designation, or jointly owned property, like personal property, home place, IRA, etc., and
Assets that will either relate to the residue or are calculated within the trust document, which calculation will not have been completed until final estate/trust distribution.
Be sure to provide disclaimers especially regarding personal property where the “realized loss” may not be deductible.
Until further clarification is provided, I believe the address to mail the statement should be the same address that you used to file the estate tax return.
Obviously, this information should be retained by either the beneficiary or the trust in a permanent file somewhere for ease of access.
Questions to consider:
Is the information that we provide relevant to each beneficiary?
What if the beneficiary is only a specific devisee and gets none of the residue?
What if some or all of the assets are sold prior to filing the estate tax return?
Why does the IRS believe that providing information that may be as much as 15 months old seems relevant?
What about items that don’t get a step-up in basis, like items of Income in Respect of Decedent (IRD)(i.e. IRA)?
Is there a lack of privacy with the attachments?
Do we know what assets will go to each individual?
Does giving this information lead a beneficiary to believe they are receiving all of these assets?
Should we get the beneficiary to sign off that they received the document?
As you can see there are many questions that I don’t believe we have all the answers at this point. I will try to give relevant information that may answer some of these questions. However, I don’t believe either the new IRC Code Section 6035 or the summaries so far written give us clues as to what is required to be done.
To make the answers relevant to each beneficiary, I believe advisors will need to account for the assets thoroughly until the estate tax return is filed. Have the assets been sold, or exchanged? If so, I believe we should report what they may be entitled to receive based on the document. Just attaching copies of Form 706 schedules could provide very unclear information to both the Service and the beneficiary. This would possibly make more change forms necessary in the long run.
As I mentioned, if we provide separate statements for each beneficiary, this should help with the issue of privacy and relevant information to all. If a beneficiary, whether an individual or a trust, is getting the residue, then a listing of all assets remaining can be included in the statement to each of the persons receiving a percentage of the residue. I do believe in the case of a residual beneficiary that a statement at the bottom should indicate that this is not a list of assets that each will receive at the end of the estate/trust administration, however, in accordance with Code Section 6035, we are providing the most up to date information to comply with this code section. During the period of administration, many changes can be made to this trust that could affect this information, and if such change is required to be reported by the Service, we will provide more information at that time to correct this information.
Assets that have no basis, like items of IRD, should be reported at zero to make sure no one is confused as to the basis. If all assets are sold, I believe a schedule showing the cash amount that each beneficiary is receiving and not a listing of assets owned at death. Since there is no indication as to what should be provided, a summary or more descriptive information can be given.
As for having the beneficiary sign-off, we could give the beneficiary and updated list of assets at the time of distribution and get them to sign off on the receipt and refunding agreement, although not required, that we should be sending at that point. Therefore, I don’t believe that a signature of the report filed within 30 days of the estate tax filing deadline would be required.
Should you file the tax return with all Federal Forms 706 filed with the service including if we are just filing to obtain portability of exemption between spouses?
Portability which came into the law in 2011 is allowed in IRC Section 2011(c). IRC Code Section 6035 states that “the executor of any estate required to file a return under section 6018 (a) or (b) shall furnish…” Unfortunately under IRC Section 6018(a), the IRS includes Section 2011(c) in paragraph 6018(a)(1). Although the words just indicate to use the basic exclusion in effect under this section, portability is included also in IRC Section 2010(c)(4) and (5). In order to make the election for portability, then one must file an estate tax return. Many commentators have concluded that the statement is not required in the case of electing portability. I think we will have to wait for further guidance to decide if it is required in the case of filing for portability. In the meantime, I believe we should file the statement with a return just filed for portability. If later issued regulations spell out that a statement should be filed, then the estate would be subject to penalty.
Why would we not file just to be safe from a conservative point of view? I suggest that we file this statement with all Federal Estate Tax Returns filed for any reason to be conservative in our approach. Why take a chance when the service will not know what to do with the statement anyway (No harm no foul).
If a Federal return is filed only for state purposes, then no statement needs to be filed with the secretary.
What Adjustments under IRC Section 6035(a)(3)(B) will require a supplemental statement to be filed?
This paragraph indicates that if an adjustment is made under either paragraph (1) or (2), after the statement is filed, then a supplemental statement is required to be filed within 30 days after the adjustment is made.
Many commentators have interpreted this to mean if a supplemental Form 706 is filed, or if changes are made through a court action or via audit adjustment, then a supplemental statement should be filed. This is a pretty basic approach, and we really don’t know what Section 6035 means by the word “adjustments”.
From my perspective I was wondering if other adjustments to basis while assets are held in an estate/trust would be included in the definition of “adjustments”.
Funding a pecuniary bequest that requires gain to be realized. The beneficiary would then have basis equal to fair market value at the time of funding, and not from date of death.
Same outcome will apply if the estate/trust elects to realize gains under Section 643(3).
What about basis in partnership/s-corp which requires yearly adjustments to basis based on the K-1 income, expense, capital contributions and distributions?
Passive activities that accumulate losses, as is the case with publicly traded partnerships. When these are distributed to a related party, then the basis is adjusted by the amount of losses that cannot be carried forward to the recipient.
Stock splits, or spin-offs that require a basis allocation different than as originally shown.
Rental, investment property additions during estate administration. (e.g. a new roof, or new furnace, etc.)
I’m sure there are other cases in which the cost basis will be different than what was reported on the estate tax return and included in the statement that we will be filing. I think it is obvious that the Service would like to be able to match the reporting of basis by the beneficiary, whether an individual or a trust with the statement that is filed reporting this cost basis. If that is the case, then I believe other adjustments will be necessary. If we don’t tell them how will the beneficiary know the starting point in which to continue to calculate their correct cost basis?
I don’t believe a supplemental statement should be provided if an asset is sold within the trust prior to distribution after the original statement was issued. This type of change would not be necessary, since the beneficiary will never have to report this sale on their tax return, especially if we put the proper disclaimers at the bottom.
Penalties for not filing the statement?
A new section defining definitions of statements now appears in Section 6724(d)(1)(D) of the code and under “Payee Statements”, IRC Section 6724(d)(2)(II) . Failure to file an information return under IRC Section 6721 or failure to furnish correct payee statements under IRC Section 6722 indicate that between 7/31/15 and 12/31/15, the penalty would be based on $100 per return not filed. After 12/31/15, that penalty goes up to $250 per return. Remember that we do believe that a separate return should be filed for each beneficiary, which if the estate/trust has 10 total beneficiaries, then that penalty could be assessed at $100 per return. Because of the newness of the situation and since no instruction has been given, one could ask for abatement of penalty.
The bill also included changes to IRC Section 1014, which speak about proper tax basis reporting for beneficiaries. This was included to make sure the individual does not claim more basis than that which is allowed by the step-up on the estate tax return. The penalty for an individual is related to inconsistent reporting under IRC Section 6662, which can be 20% of the additional tax due to the understatement.
As you can see from this analysis, there are MANY more questions than answers. However, we cannot delay filing the statements as that could subject your firm to risk, however, to find the proper formats and rules, we will need to wait until after we get more guidance from the IRS. Stay tuned!
Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.