Form 8939 May Eventually Be Due for Estates of Some 2010 Decedents, But the IRS Still Has Not Finalized the Form, Instructions or Due Date

Form 8939 for estates and trusts of decedents who died during 2010 still hasn’t been finalized by the Internal Revenue Service.  The last draft Form 8939 posted by the IRS was dated 12/16/2010.

It’s a good thing that the default provision for the estates of decedents who died during 2010 is the 2011 federal estate tax law, with its $5,000,000 exemption and automatic step-up in basis for assets includible in the federal gross estate.  Many estates under $5,000,000 will probably not want to elect to be treated under 2010 law and deal with the uncertainties of what assets are entitled to a step-up in basis, so the unavailability of Form 8939 won’t matter to them.  Unfortunately, estates that want to opt out of 2011 law and elect 2010 law still don’t have access to the form or instructions, or even an estimate from the IRS of when they will be completed.

It was once thought that Form 8939 would be due at the same time as the decedent’s 2010 federal income tax return.  The IRS has recently announced, however, that Form 8939 should not be filed with the decedent’s final income tax return.  Filers of Form 8939 will be given at least 90 days after the form is eventually finalized to file it, and will have access to information about the form and Internal Revenue Code Section 1022 through future Publication 4895, entitled “Tax Treatment of Property Acquired from a Decedent Dying 2010.”

March 14, 2011 – 12:38 am Categories: Federal Estate Tax, Internal Revenue Code Sec. 1022, Step-up in Basis | Post a comment

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Should Retired Persons Consider Converting Their IRAs to Roth IRAs?

Beginning in 2010, the federal tax law allowed all persons who have IRAs to convert them, in whole or in part, to Roth IRAs. A special 2010 rule allowed taxpayers to divide the taxable income cause by the conversion between the 2011 and 2012 tax returns.

One reason for a retired person to consider converting an IRA to a Roth IRA is that the retired person may be in a lower income tax bracket than the eventual beneficiaries. For this reason, deferring income tax by keeping the IRA could cause overall higher taxes. Retired persons may want to consider converting just enough of their IRAs to use up their lower income tax brackets.

Another reason for a retired person to consider converting an IRA to a Roth IRA involves MassHealth or Medicaid planning for a married couple. If one spouse enters a nursing home, that spouse is allowed to keep only $2,000, and often the last-minute plan is to get all the other assets over into the name of the spouse who is still at home. To get the institutionalized spouse’s assets down to the $2,000 level can often mean closing out the IRA and incurring all of the income tax on the IRA in that calendar year. Rather than running the risk of having to transfer the IRA in one calendar year and cause the maximum amount of income taxes, some retired couples should consider whittling down their IRAs by making partial conversions to Roth IRAs while they are still healthy.

A third reason for Massachusetts residents to convert from an IRA to a Roth IRA is that there is a Massachusetts estate tax beginning at $1,000,000 of a person’s net worth at death, and no credit is given to the estate for the unpaid income taxes on the decedent’s IRA. The estate tax would be reduced or perhaps even eliminated if the IRA owner became responsible for paying the taxes on the IRA.

February 11, 2011 – 3:41 pm Categories: Federal Estate Tax, Massachusetts Estate Tax | Post a comment

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Avoiding the Inadvertent Creation of General Powers of Appointment in Durable Powers of Attorney and Trusts

As Presented at the 2000 Elder Law Institute in Colorado Springs, Colorado
(A) Definition of general power of appointment

The inadvertent creation of a general power of appointment can create tax problems for the powerholder. A general power of appointment, which is the broadest possible form of a power of appointment, is defined as a power that is exercisable in favor of the holder, his/her estate, his/her creditors, or the creditors of his/her estate. A general power of appointment would permit a holder to use the assets for his/her own benefit, and is treated as if the powerholder owned the property outright. Unfortunately, under Internal Revenue Code section 2041, the powerholder will have the entire property subject to the power included in his/her gross estate for federal estate tax purposes. Although the regulations under section 2041 generally discuss trusts, nothing therein eliminates the possibility that section 2041 could be applied to gift-giving powers in durable powers of attorney, although no Tax Court or appellate division case has reached that holding.

(B) Exceptions

(1) Only in conjunction with power’s creator

One exception to general power of appointment treatment is a power exercisable only in conjunction with the creator of the power. Because the principal of a durable power of attorney could revoke it, it is possible that any durable power of attorney could fall within this exception, thereby eliminating the problem of the agent being deemed to possess a general power of appointment.

(2) Only in conjunction with substantial adverse interest

A second such exception is a power exercisable only in conjunction with a person who has a substantial adverse interest in the property.

(3) Limited by ascertainable standard

A third such exception which will not be included in the powerholder’s gross estate if properly drafted is a power which is limited by an ascertainable standard relating to health, education, support or maintenance of the powerholder. Such a power must be limited to the extent that the holder’s duty to exercise or not to exercise the power is reasonably measurable in terms of the holder’s needs for health, education, support or maintenance. In particular, the regulations state that a power of appointment is limited by an ascertainable standard if, it is exercisable for the powerholder’s (1) support; (2) support in reasonable comfort; (3) maintenance in health and reasonable comfort; (4) support in his/her accustomed manner of living; (5) education, including college and professional education; (6) health; (7) medical, dental, hospital and nursing expenses and expenses of invalidism. Cases have consistently held that clauses exercisable for the “comfort, welfare, or happiness” of the powerholder is not limited by the requisite ascertainable standard, as well as a power to an “accustomed standard of living” or “to continue an accustomed mode of living.” See Revenue Ruling 77-60, 1977-1 CB 282. In determining whether a power is limited by an ascertainable standard, the regulations state that it is immaterial whether the beneficiary is required to exhaust his/her other income before the power can be exercised. What is not clear in the regulations and case law, however, is the extent to which the powerholder must invade his/her assets first.

(C) Examples of common powers at risk of being deemed general powers of appointment

(1) 5 x 5 withdrawal power

A power often given to the surviving spouse to withdraw annually the greater of 5% of a trust or $5,000.00 (a 5 x 5 power) is includable in the surviving spouse’s estate as a general power of appointment, and therefore should not be routinely given in a credit shelter trust. For example, consider a husband and wife who each had $675,000.00 in each of their own names; if he had died on 2/1/00 leaving behind a $675,000.00 credit shelter trust and then she died on 12/1/00, there would have been no federal estate tax. If he had given her a 5 x 5 power exercisable at any time over his trust, however, 5% of it would be includable in her gross estate, and the resulting estate tax would have been $12,487.50. If the flexibility of allowing the surviving spouse to have a 5 x 5 power on such a trust is desired, perhaps its exercise should be limited to a particular time (perhaps a particular day of the year or month) to minimize the possibility of its inclusion in the survivor’s estate.

(2) Discharge of legal obligation

A power exercisable for the purpose of discharging a legal obligation of a decedent or for his/her pecuniary benefit is considered a general power of appointment. Thus, a Trustee should generally not be given the power to use funds to discharge a legal obligation of support, especially for minor children. See Section 2041(a)(2) and Reg. 20.2041-1(c)(1). This problem can be alleviated by use of an ascertainable standard.

(3) UTMA/UGMA accounts

Since the Custodian of a UTMA or UGMA account has broad powers which are not deemed to be limited by an ascertainable standard, the assets in such accounts can be includable in the federal gross estate of a parent Custodian. See Estate of Jack Chrysler, 44 T.C. 55 (1965) and Estate of Harry Prudowsky, 55 T.C. 890 (1971).

Resigning as custodian can be deemed to be the release of a general power of appointment, so a parent custodian must survive the resignation by more than three (3) years or else Section 2035 could be deemed to apply and render the account includable in the parent’s federal gross estate.

(4) Trustee removal/replacement powers

The IRS generally takes the position that an unfettered right to remove or replace a Trustee is tantamount to having the power to put in place a Trustee who will do the powerholder’s bidding, including making distributions to the powerholder. Thus, Revenue Ruling 95-58, 1995-2 CB 191 should be considered whenever a Trustee removal or replacement power is being drafted. The power to appoint a Trustee who or which is related or subordinate to the powerholder, as those terms are defined in Section 672(c), should be avoided. That Revenue Ruling served as a revision to Revenue Ruling 79-353, which has held that if the donor possessed the power to remove and replace trustees, the donor was deemed to possess all of the discretionary powers of the trustee.

(5) Reciprocal trust theory

The IRS attempts to uncross transfers to unveil their economic substance. Annual exclusion gifts by a taxpayer to a brother’s three children accompanied by annual exclusion gifts from the brother to the taxpayer’s children have been uncrossed, with all of the gifts being deemed made by the parent to the children. See Schultz, 493 F.2d 1225 (CA-4, 1974). Similarly, in Estate of Bischoff, 69 T.C. 32 (1977), trusts established by two grandparents and reported as completed gifts, each of which trusts appointed the other to be Trustee of a discretionary trust for their grandchildren, have been uncrossed. Further, trusts created by partners for each other’s children in order to maximize their use of Crummey powers have met a similar fate. See Rev. Rul. 85-24, 1985-1 CB 329.

Of concern to many elder law attorneys should be the decision in PLR 9235025, whereby the decedent was deemed to have a general power of appointment over his share of a trust established by their father. The decedent and his brother were co-Trustees of each other’s trust share, and the IRS concluded that the power that each of them had was not limited by an ascertainable standard, even though under state law neither of them could contribute in a decision to distribute corpus to himself. The IRS inferred from the reciprocal nature of the control that they had over each other’s trust share that the powers would be exercised on a reciprocal basis, so that each of them could ensure that he received whatever he wanted.

State case law may help prevent the inadvertent creation of a general power of appointment, including via the reciprocal trust theory. For example, in Dana v. Gring, 374 Mass. 109, 371 N.E.2d 755 (1977), a trust permitted the Trustees to distribute trust corpus as they “deem necessary or desirable for the purpose of contributing to the reasonable welfare and happiness” of the settlor’s daughter, who was a co-Trustee. The court considered whether or not the daughter possessed a power of appointment by virtue of her being a Trustee, and whether that power was limited by an ascertainable standard. The court held that the Trustees’ power of distribution was fiduciary in nature and was necessarily limited by a fiduciary obligation to safeguard the corpus for the remainderman. The court reasoned that under Massachusetts law the daughter, as Trustee, could not have participated in the Trustee’s decisions as to the amount that could have been distributed for her own benefit and did not therefore possess a general power of appointment.

(6) Gift-giving powers in durable powers of attorney

As a general rule, the power to take something and use it as though it were yours is what the estate taxation of a GPA is all about, and that’s precisely what exists if an agent under a durable power of attorney has the unfettered power to make gifts. In the trust context, a GPA could result in estate tax inclusion in both the principal’s estate and the powerholder’s estate in an irrevocable income-only trust where the grantor reserves a SPA and grants a GPA to someone else whose death precedes the grantor’s death. The same result could occur in the DPOA context.

(a) Principal right to revoke deemed consent to gift

One argument regularly advanced against the proposition that a GPA exists is that the continuing right to revoke the DPOA operates as the implied consent of the principal to the gift, thereby falling under an exception under IRC 2041. Nothing in the Code or Regulations seems to minimize my uneasiness; the closest point in the Regulations to this discussion is that a GPA does not exist if exercisable only with “the consent or joinder of the creator of the power.” Having looked up these words in Black’s Law Dictionary, I do not feel this situation meets the consent or joinder definitions.

In support of this argument, there are tax cases where the agent makes gifts on the principal’s deathbed and the checks are cashed after the principal’s death. For example, in Estate of Sarah H. Newman v. Commissioner, 111 T.C. 81, the court concluded that the funds were includable in the principal’s federal gross estate because the principal could have stopped payment on the checks. The IRS and the court may have concluded that the principal’s consent is necessary to complete the gift made by the agent.

Unfortunately, those cases do not address what happens if the agent dies first. The fact that the principal’s assets could be gone before the DPOA is revoked, and could be removed due to fear of an imminent revocation, is where I have the biggest problem with this issue: instead of helping the principal, the agent could be helping the agent (to the principal’s assets).

(b) Fiduciary duties of agent to principal under common law

The strongest argument against classifying the agent’s gift giving power as a power of appointment is to assert the common law principles of the principal-agent relationship. Whatever action the agent takes would then be deemed the action of the principal and not that of the agent. Local law (i.e., the common law) would then apply, resulting in the principal, and not the agent, being deemed in possession of the property right, with the agent only being deemed an instrument of the principal. Under this analysis, the conclusion that the agent possesses a property right independent of the property right of the principal would be to ignore the common law relationship of principal and agent. Unfortunately, in my view, the power or action of the agent under this analysis appears to be safeguarded merely by the label placed on the relationship, which is a form over substance analysis often rejected by the IRS.

In support of this argument is that there is case law in which agents who misused their power to enrich themselves with the assets of the principal had to repay the principal. Under common law, the agent has fiduciary duties, and an agent who misuses the power by making unwanted gifts must repay the principal. The agent cannot possibly abuse the relationship, however, if the agent has the unrestricted power to take everything.

The bigger issue not covered by the common law, then, involves an agent who is not misusing the power, but merely using a broad self-dealing power given to the agent. It strikes me that a self-dealing power to make a gift to yourself without notice or knowledge of the person who originally gave you that power is not a common law principal-agency relationship. The notion of agency, as I see it, is that you are acting FOR the principal; the power to take is acting for yourself. In Black’s Law Dictionary, Fifth Edition, under Principal, subheading Law of Agency, it says: “The term “principal” describes one who has permitted or directed another (i.e. agent or servant) to act FOR HIS BENEFIT AND SUBJECT TO HIS DIRECTION AND CONTROL (emphasis added). If all fiduciary duties are stripped in the document, it is hard to imagine that the principal could have a successful cause of action against an agent who takes everything.

A comparable example exists with the estate taxation of limited partnerships. Where a person gives away limited partnership interests but remains a general partner with broad management powers over the partnership, there is no estate tax inclusion under IRC 2036 because the fiduciary duty of the general partner to the limited partners restricts the management powers. If, on the other hand, the partnership agreement releases the general from liability so that the fiduciary duty cannot be enforced, there would be estate tax inclusion.

(c) Possible need for preventative drafting

There is a point where intellectual analysis should be overridden by a gut instinct or common sense, and the downside should be an important consideration. My “tax common sense” says this is not something to intellectually rationalize away, especially where the IRS once came out of the blue with a ruling that trustee removal powers constituted GPAs, as discussed earlier. A similar ruling regarding DPOAs could end up forcing estate planning and elder law attorneys to reexamine every file where a DPOA had been drafted for a client.

In “Gift-Giving by an Agent Under a Durable Power of Attorney” Estate Planning, Vol. 26, No. 8 (October 1999), the editorial board decided that the practice note accompanying the article should be: “Draft a durable power of attorney carefully to ensure that potentially disadvantageous tax consequences will not result from the powers granted to the Agent.” Whether or not the author of the article was correct in his analysis and conclusion, the article quite possibly has been read by many federal estate tax auditors, so it makes great sense to draft a DPOA that eliminates the agent’s downside risk, instead of running the risk of having to go to Tax Court or beyond at great expense.

Assume for a moment the worst case scenario: that BB gave CC a DPOA with the unlimited ability to make gifts to CC without notice to BB, and that CC dies and the IRS requires inclusion of all of BB assets in CC’s gross estate for federal estate tax purposes. If the estate taxes are apportioned, BB would owe what would have been an avoidable estate tax, and may have a claim against the draftsperson. If CC’s will had the typical boilerplate provision requiring that estate taxes would be paid from CC’s estate, would CC’s estate have a malpractice action against the draftsperson based on a third-party beneficiary claim or negligent interference with the right to inherit? Would lack of privity be a defense? Would it matter if the draftsperson gave a warning to BB? Must the warning also have gone to CC?

With respect to DPOAs that are presently being drafted, a narrow, tailored gifting power should be drafted. It may be advisable to limit the power by an ascertainable standard, or to require the consent of an adverse party before the gift-giving power can be exercised or, if there is no such adverse party, to have a “special agent” appointed to make gifts to the family but not to himself/herself. Where there is probably no cause of action from an appointed agent that is not represented by the draftsperson, the main concern should be not having the spouse of the principal (whom the draftsperson is often also representing) end up with a general power of appointment.

January 27, 2011 – 4:18 pm Categories: Federal Estate Tax, Gift Tax, Irrevocable Trusts, Powers of Appointment, Revocable Trusts | Post a comment

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Traps for the Unwary Regarding Internal Revenue Code Section 1022 for 2010 Deaths

We may be stuck with Internal Revenue Code Section 1022 being the tax law for estates of decedents who die during 2010.  Here are a few traps for the unwary regarding this law:

(1)  The law allows $1,300,000 of basis increase, plus an additional $3,000,000 for a surviving spouse. Increasing the decedent’s basis means somebody has to figure out the decedent’s exact basis in his/her assets. Old deeds and purchase-and-sale agreements may need to be tracked down, and a lot of tedious, time-consuming work will have to be put in on mutual funds and dividend reinvestment plans.

(2)  In addition to the $1,300,000 or $4,300,000 basis increase, additional increases are allowed if the decedent had capital loss carryovers or net operating loss carryovers. That means in some cases the decedent’s final income tax return will need to be prepared first.

(3) Assets with unrecognized capital losses as of the time of the decedent’s death cause the decedent’s estate to have additional basis increases equal to the amount of the unrecognized capital losses. There is no requirement in Section 1022 that this additional basis adjustment be utilized on the asset with the unrecognized capital loss.

(4) Internal Revenue Code Section 121(d)(11) allows the decedent’s estate, the decedent’s qualified revocable trust or the decedent’s beneficiary (as defined under Section 1022) to utilize the decedent’s $250,000 capital gains exclusion on a sale of the decedent’s principal residence. There does not appear to be any time limitation on the usage of this exclusion, so in some many cases it could be wasteful (and legally actionable) to use the Section 1022 basis increase on the decedent’s principal residence without taking Section 121 into account.  This means that the basis adjustment for many estates without surviving spouses under 2010 law can effectively be $1,550,000.

(5) Under Internal Revenue Code Section 6716, there is a $10,000 penalty for failure to file Form 8939 on a timely basis.

(6) Form 8939 is due at the time of the decedent’s final income tax return, so in many cases placing Form 1040 on extension may be advisable to give the Executor more time to gather all the necessary information for Form 8939.

(7) Beneficiaries are required to be sent information about the basis increase within 30 days after Form 8939 is filed. Failure to do so can result in a $50 penalty per beneficiary.

(8) Only an “executor” can allocate the basis increase, and that term is not defined within Section 1022, but under Treasury Regulation 20.2203-1, the term “executor” includes an executor or administrator, but if there is no executor or administrator, the term means “any person in actual or constructive possession of any property of the decedent, ” and the term can actually include “the decedent’s  agents and representatives; safe-deposit companies, warehouse companies, and other custodians of property in this country; brokers holding, as collateral, securities belonging to the decedent; and debtors of the decedent  in this country.”  Thus, the lack of an executor or administrator being appointed for a decedent’s estate can mean the possibility exists for different persons or entities to file competing Forms 8939 with different basis adjustments (and perhaps the first one filed wins).

(9) It is possible that the Executor’s basis allocation decisions on a timely-filed Form 8939 may be final, binding and unamendable even  if self-serving, biased or irrational.

(10) Where the date that the decedent acquired the property is required, Executors and their accountants may find that attempting to list the separate purchases made in dividend reinvestment plans to achieve a step-up in basis on each investment may not be worth the time and effort.

(11) The first version of Form 8939 withdrawn by the IRS did not require an explanation of why the Executor of the estate believes the asset would be entitled to a step-up in basis under Internal Revenue Code Section 1022. Thus, technical issues as to whether life estates, reserved powers of appointment or irrevocable trusts are “owned by the decedent” and “received from the decedent” under Internal Revenue Code Section 1022 may not be flagged except, perhaps, where an “[a]ccurate description of the property” is required. Even though the basis of an asset is a question of fact that the IRS can later bring up, a decision will have to be made as to how much information to include on Form 8939.

(12) It is possible, but not certain, that filing Form 8939 will begin the 3-year clock against the IRS on valuation issues.

(13) Internal Revenue Code Section 1022 has specific safe harbor provision for qualified revocable trusts but not for revocable trusts. (A qualified revocable trust is simply a revocable trust that is elected to be treated as part of the decedent’s estate for income tax purposes under Section 645(b)(1).) To be conservative and assure the possibility of a step-up in basis for assets held in a revocable trust for someone who dies during 2010, it seems that the Executor of the decedent’s probate estate and the Trustee of the decedent’s revocable trust should make the election under Section 645(b)(1) to treat the trust as a qualified revocable trust for income tax purposes.

(14) It appears that an automatic basis increase would occur for smaller estates, but the question remains whether estates of less than $1,300,000 should also file the return.  My opinion is that the return should be filed, for how else would the IRS, many years down the road, be able to determine whether a legitimate step-up in basis is being claimed?  If the burden is someday placed back on the taxpayer to prove that the estate was less than $1,300,000, how would the taxpayer be able to prove that point?  In addition, it may make sense to file the return for smaller estates if attempting to achieve a step-up in basis on questionable items under Internal Revenue Code Section 1022, such as reserved life estates (see http://wp.me/pRFoy-8k), reserved powers of appointment (see http://wp.me/pRFoy-90) and irrevocable grantor trusts (see http://wp.me/pRFoy-fW).

December 9, 2010 – 7:58 pm Categories: Internal Revenue Code Sec. 1022, Irrevocable Trusts, Jointly-Held Interests, Life Estates, Marital Issues, Powers of Appointment, Revocable Trusts, Step-up in Basis | Post a comment

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When Are Assets in an Irrevocable Trust Eligible for a Step-up in Basis in 2010 under the Modified Carryover Basis Rules?

As I have suggested in earlier blog posts about Internal Revenue Code Section 1022, it seems that the modified carryover basis rules were not well-written by the 2001 Republican Congress that passed them.  It is possible that Congress may have wanted to allow a step-up in basis in very limited circumstances, but it appears to me that broad catch-all descriptions in Section 1022(e) such as “inheritance” and “[a]ny other property passing … by reason of death” were placed there to allow liberal interpretation of this tax law.  From that standpoint, it appears that the assets in an irrevocable trust may often be eligible for a step-up in basis.

As I suggested in Which Powers of Appointment Are Eligible for a Step-up in Basis in 2010 under the Modified Carryover Basis Rules?, it appears that the assets in an irrevocable trust that contains a reserved special power of appointment can be eligible for a step-up in basis.  A deeper reading of Section 1022, however, reveals other step-up opportunities as long as the assets are deemed owned by the decedent under Section 1022(d) and received from the decedent under Section 1022(e).

The grantor trust rules in Internal Revenue Code Sections 671-679 have long determined whether someone should be treated as the owner of an irrevocable trust for income tax and capital gains tax purposes.  In particular, Internal Revenue Code Sections 673-678 all begin with the general rule that the “grantor shall be treated as the owner of any portion of a trust” described in that section.  Since none of those sections are specifically negated in Section 1022, it appears that ownership under the grantor trust rules should suffice as the decedent’s ownership under Section 1022.  While there are special rules about ownership under Section 1022(d), those rules do not appear to be an exhaustive list.  Further, when Congress intended to negate certain planning maneuvers being treated as ownership in Section 1022, such as powers of appointment given to a decedent, it specifically did so. 

Thus, it appears that grantor trusts meet the “owned by the decedent at the time of death” standard in Section 1022(d)(1).  It is not much of a stretch to state that assets that were deemed “owned” by the decedent during lifetime were then at the time of death ”received” from the decedent.  Assets in a grantor trust established and funded by the decedent would then fit into the category in Section 1022(e)(3) of “other property passing from the decedent by reason of death to the extent that such property passed without consideration.”

December 8, 2010 – 8:06 pm Categories: Internal Revenue Code Sec. 1022, Irrevocable Trusts, Powers of Appointment | Post a comment

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Are All Revocable Trusts Eligible for a Step-up in Basis under the Modified Carryover Basis Rules?

Under Internal Revenue Code Section 1022, which is effective only during 2010, the Executor or Personal Representative of an estate may increase the basis of certain assets up to $60,000 for nonresident aliens, and up to $1,300,000 for unmarried decedents who are not nonresident aliens.

Having already looked at Section 1022 and dealt with life estates ( Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue Code Section 1022?  and  More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010) and powers of appointment (Which Powers of Appointment Are Eligible for a Step-up in Basis in 2010 under the Modified Carryover Basis Rules?), I figured revocable trusts would be an easy topic, but it isn’t, and the more I look at this statute the more illogical it appears. 

To qualify for the step-up in basis under 2010 tax law, an asset must be considered to be owned by the decedent under Section 1022(d) and considered to be acquired from the decedent under Section 1022(e).  Anything owned by a revocable trust established by the decedent would seem to be acquired from the decedent as a result of the decedent’s death, but are those assets considered “owned” by the decedent?  For some reason, Congress took pains to include “qualified revocable trusts” in Section 1022(d)(1)(B)(i) in the list of assets deemed owned by the decedent, and also in Section 1022(e)(2)(A) in the list of assets passing from the decedent.  (A qualified revocable trust is simply a revocable trust that is elected to be treated as part of the decedent’s estate for income tax purposes under Section 645(b)(1).)  It seems that assets in all revocable trusts would qualify as an “inheritance” under Section 1022(e)(1), and also under Section 1022(e)(2)(B) where the decedent had reserved rights to “alter or amend,” so why would Congress have specifically mentioned qualified revocable trusts?  Would that be because only an executor can allocate the basis increase?  Is it possible that the specific inclusion of qualified revocable trusts in Section 1022(e)(2)(A) means that Congress didn’t want other revocable trusts to be eligible for a step-up in basis?

The more logical conclusion is that Congress wanted Section 1022(e)(2)(B) to be a catch-all provision for trusts for purposes of the step-up, and that all revocable trusts are eligible for a step-up in basis.  That conclusion leads to the further conclusion that Congress meant Section 1022(d)(1)(A) to be broadly interpreted, as qualified revocable trusts are mentioned in both Section 1022(d) and Secton 1022(e), and if Congress had meant the special rules in Section 1022(d) to be an exhaustive list, then there would have been no reason for Congress to have included other trusts in Section 1022(e)(2)(B).

To be conservative and assure the possibility of a step-up in basis for assets held in a revocable trust for someone who dies during 2010, it seems that the Executor or Personal Representative of the decedent’s probate estate and the Trustee of the decedent’s revocable trust should make the election under Section 645(b)(1) to treat the trust as a qualified revocable trust for income tax purposes.  There is the possible risk that a failure to do so would result in no step-up, and the election provides a safe harbor for the step-up.

The same sloppy “thinking” in 2001 that caused this one-year tax law to take effect in 2010 is evident throughout Internal Revenue Code Section 1022.

December 2, 2010 – 7:29 pm Categories: Internal Revenue Code Sec. 1022, Revocable Trusts, Step-up in Basis | Post a comment

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Which Powers of Appointment Are Eligible for a Step-up in Basis in 2010 under the Modified Carryover Basis Rules?

If you look at Internal Revenue Code Section 1022 too quickly, you may conclude that a decedent’s estate in 2010 cannot ever receive any step-up in basis by virtue of any power of appointment.  After all, Section 1022(d)(1)(B)(iii) specifically states:  “The decedent shall not be treated as owning any property by reason of holding a power of appointment with respect to such property.” A deeper look into Section 1022, however, can reveal step-up opportunities.

Perhaps what Congress was trying to do with 1022(d)(1)(B)(iii) was eliminate certain tax games with powers of appointment.  One such game was to grant a general power of appointment to a spouse to attempt to receive a complete step-up in basis on the assets affected by it.  By making the surviving spouse’s trust property subject to a limited, general power of appointment for debt payment during administration of the deceased spouse’s estate, the surviving spouse’s appreciated trust property would be included in the gross estate of the first spouse to die.  Section 1022(d)(1)(B)(iii) would kill this abusive tax game.

Under Section 1022(e)(2)(A), the step-up in basis is available in 2010 to a trust “with respect to which the decedent reserved the right to make any change in the enjoyment thereof through the exercise of a power to alter, amend or terminate the trust.”  That language, in part, describes a power of appointment that is reserved (as opposed to one that is granted to another person).  Thus, a trust with a reserved power of appointment seems to be deemed “acquired” from the decedent under Section 1022(e).   The problem is that to qualify for the step-up in basis under 2010 tax law, an asset must also be considered to be owned by the decedent under Section 1022(d), and powers of appointment are generally excluded, but if Congress didn’t already believe that a decedent with a reserved power of appointment over a trust owned the trust’s assets at the time of death for purposes of Section 1022(d), then why would Congress have included Section 1022(e)(2)(A)?  Congress is deemed to know that a reserved power of appointment causes the powerholder to be treated during lifetime as the owner of the trust for income tax and capital gains tax purposes under the grantor trust rules in Sections 671-679.  I conclude that a reserved power of appointment in a trust allows the opportunity for a step-up in basis.

What about a reserved power of appointment in a deed? Back in 1990-1992, when the field of elder law was young, I proposed in several articles (including in Estate Planning, NAELA Quarterly and The ElderLaw Report) that a power of appointment could be reserved in a deed to avoid treatment as a completed gift and cause a step-up in basis. Many of such deeds may now be in existence.  Where the gift was incomplete when the deed was recorded, and is not completed until the powerholder’s death, the property is still owned by the decedent for estate and gift tax purposes at the time of death, and passes without consideration at that time, so such a deed may be eligible for the step-up in basis. Still, due to the literal language in Section 1022(d)(1)(B)(iii), it may be considered a stretch to obtain the step-up in basis in 2010, but if all of the parties involved in the deed were to transfer their interests to an irrevocable trust that mirrors the terms in the deed, the step-up possibility would be strengthened. If the holder of the reserved power of appointment in the deed also reserved a life estate, however, the step-up could be obtained via the reserved life estate. See Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue Code Section 1022?  and  More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010

November 28, 2010 – 7:27 pm Categories: Internal Revenue Code Sec. 1022, Life Estates, Powers of Appointment, Step-up in Basis | Post a comment

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Can a Life Estate That Was Retained (But Not Explicitly Reserved) Be Eligible for a Step-up in Basis under Internal Revenue Code Section 1022?

Some tax professionals are trying to find an argument that a retained (as opposed to reserved) life estate can obtain a step-up in basis under the modified carryover basis rules in effect for estates of decedents who die during 2010.  I have already covered  whether an explicitly reserved life estate  is eligible for a step-up in basis during 2010 under Internal Revenue Code Section 1022, and concluded that the possibility exists.  (See Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue Code Section 1022?  and  More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010)  The deeper question that is now being posed by some tax professionals is whether a life estate that was not reserved can nevertheless be considered “retained” by the conduct of the parties after the gift, and thereby be eligible for a step-up in basis under the modified carryover basis rules.  Based on the language in Section 1022, I do not believe such a retained life estate has any chance whatsoever of being eligible for a step-up in basis.

Under pre-2010 law, an asset that was includible in the decedent’s gross estate for federal estate tax purposes always received a step-up in basis.  A retained life estate, includible under Internal Revenue Code Section 2036, was one of those assets, and a line of tax cases developed that defined the word “retained” as including not only a life estate that was explicitly reserved, but also life estates that were retained by agreement, understanding, assumption or conduct of the parties. That meant that under Internal Revenue Code Section 2036, the real estate of someone who had completely given it away could be pulled back into the decedent’s gross estate.  For pre-2010 deaths, Section 1014 allowed a step-up in basis for assets pulled back into the gross estate under section 2036, but, unfortunately, neither of those laws are in effect for decedents who die during 2010.

For 2010 deaths, Section 1022 requires that assets be owned by the decedent at the time of death and received from the decedent at that time, and those are much stricter standards than were required under Sections 2036 and 1014 in previous years.  Tax positions formerly available utilizing Section 2036 are irrelevant in 2010, as there is no language in Internal Revenue Code Section 1022 that would allow an argument that the conduct of the parties after the gift would be equivalent to the retention of ownership.  The retained life estate argument is an extreme stretch on the “owned by the decedent” test, but even if that argument were to pass muster, the argument in favor of the step-up would still fail on the “received from the decedent” requirement of the statute.  If full legal title to the real estate was already given away, at the time of death the donees of the lifetime gift cannot possibly receive from the decedent what they have already completely owned.

Claiming that assets that were given away during lifetime were nevertheless owned by the decedent and received from the decedent at the time of death, and receive a step-up in basis under Internal Reveue Code Section 1022, seems to me to be a frivolous tax argument.  We’ll know better how much leeway tax professionals will have to take such a position when we finally see the new tax return that is in the process of being created by the Internal Revenue Service for allocation of increased basis for 2010 deaths.

November 19, 2010 – 8:14 pm Categories: Internal Revenue Code Sec. 1022, Life Estates, Step-up in Basis | Post a comment

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A Reserved Life Estate May Be Eligible for a Step-up in Basis under Internal Revenue Code Section 1022?

I’ve seen several blog posts this year that state the conclusion that a life estate is not entitled to obtain a step-up in basis upon the life tenant’s death in 2010, but I have yet to see any analysis on how those lawyers got to their conclusion.  Congress is well aware of the existence of life estates, as Internal Revenue Code Section 2036 specifically addresses them; if Congress intended to exclude life estates from receiving a step-up in basis under Internal Revenue Code Section 1022, it seems that Congress would have specifically mentioned them, as it did with several other common estate planning techniques.

To qualify for the step-up in basis under 2010 tax law, an asset must be considered to be owned by the decedent under Section 1022(d) and considered to be acquired from the decedent under Section 1022(e).  To determine whether a reserved life estate is entitled to a step-up in basis, the issue needs to be broken down into 2 questions.

Question 1:  At the time of death, does a decedent “own” the property which is the subject of a reserved life estate?

It is true that Section 1022(d) does not include life estates in its description of special rules on what is considered owned by the decedent, but life estates could be covered by the general rule.  Powers of appointment are less commonly utilized and not as well-known, but were expressly excluded under Section 1022(d)(1)(B)(iii), so Congress knew how to exclude certain planning techniques when it wanted to do so. If life estates were intended to be excluded, why were they not specifically mentioned?  A power of appointment is not a possessory interest, yet Congress took pains to exclude it from the possibility of a step-up in basis.  It seems illogical for Congress to have specifically excluded a nonpossessory interest but to be silent if it also intended to exclude a possessory interest such as a life estate.  Further, it is possible that the phrase “at the time of death” could be interpreted to exclude a life estate, because death terminates the interest, but since a reserved power of appointment was specifically mentioned and would also terminate at death, it doesn’t appear that the “at the time of death” phrase was intended by Congress to mean “after” death.  I therefore conclude that Congress must not have intended to exclude reserved life estates from the definition of what is owned by a decedent at the time of death.

I cannot speak for all 50 states, but under Massachusetts law, the life tenant has exclusive possession of the entire property during the life tenant’s lifetime.  The life tenant is entitled to all the rents and profits from the property and pays all current real estate taxes. Remainderpersons do not have the right to petition for partition because they do not have a present possessory interest in the premises.  At the time of the life tenant’s death, the life tenant has an ownership interest to the exclusion of the remainderpersons, and a reserved life estate may therefore fit the ownership test in Section 1022(d).

Question 2:  Does a remainderperson “acquire” from the decedent the property which is the subject of a reserved life estate?

If you agree with the analysis in Question 1, then this question probably poses little obstacle to the step-up in basis. The language in Section 1022(e)(3) includes “property passing from the decedent by reason of death to the extent that such property passed without consideration,” and where the property passes to the remainderpersons without consideration upon the life tenant’s death, that description could easily include a reserved life estate.  A question could arise on whether they received it “from” the decedent, but the possession does transfer based on the decedent’s actions.  The open issue on the step-up in basis would be whether, since the remainder interest was already vested, it was the entire value of the property that was “acquired,” or merely the actuarial value of the life estate at death; still, since the entire possession transfers upon the life tenant’s death, a strong argument could be made for the full step-up in basis (subject to the other limitations in the law of a total of $1,300,000 for most estates).

I had asked for feedback on elder law listservs about my position that a life estate may be eligible for a step-up in basis in 2010, and one disagreeing commentator wrote:

“The basis step up is limited to property that passes by reason of death. When a life estate is established the legal ownership of the property is separated into 2 fee interests, the life estate and the remainder. Each can be leased, mortgaged and are subject to foreclosure. Therefore, the remainder interest did not pass by reason of death. The passing of title took place when the life estate was retained. All that happened is the remainder interest VESTED upon death. As a result, no step up.” 

These points are well-taken. Our disagreement is zeroed in on the attributes of a life estate.  My point remains that the life tenant has exclusive possession during lifetime, and the home that is the subject of the reserved life estate remains completely controlled by the life tenant.  Use and possession by the remainderpersons is prevented until the life tenant’s death. While theoretical separation of the interests may occur, no actual separation occurs, and the theoretical separation does not give a present, usable benefit to the remainderpersons, as the life tenant controls whether the actual separation can occur by sale or partition.  The remainderpersons don’t have anything real until the death occurs, and they receive their usable interest without consideration only as a result of the life tenant’s death.

Section 1022(e)(1-3) covers bequests, devises, inheritances, revocable trusts and many irrevocable trusts, so there isn’t much left to be covered by Section 1022(e)(4), which includes “Any other property passing from the decedent by reason of death to the extent that such property passed without consideration.” What type of ownership interest would Section 1022(e)(4) be covering that isn’t already covered by (1), (2) and (3)? If life estates were meant to be excluded, perhaps Section 1022(e)(4) would only cover assets held jointly or subject to a transfer-on-death designation, but if Congress was intending to create such strict limitations, those interests could have been specifically mentioned.  The language of Section 1022(e)(4) seems to indicate that Congress intended it to be a broad category.

Conclusion:  It’s not an absolute slam dunk that life estates are entitled to a step-up in basis under Internal Revenue Code Section 1022, but there is at least a solid argument that they weren’t excluded and that they fit the definition of what is entitled to a step-up.

November 14, 2010 – 7:23 pm Categories: Internal Revenue Code Sec. 1022, Life Estates, Step-up in Basis | Post a comment

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When Is an Asset Considered “Acquired from the Decedent” under Internal Revenue Code Section 1022?

It seems that the more I look at Internal Revenue Code Section 1022, the more questions I have.  Let’s look closely at the “acquired from the decedent” requirement in 1022(e), which I’ve posted below:

1022(e) Property acquired from the decedent

    For purposes of this section, the following property shall be

considered to have been acquired from the decedent:

        (1) Property acquired by bequest, devise, or inheritance, or by

    the decedent’s estate from the decedent.

        (2) Property transferred by the decedent during his lifetime–

            (A) to a qualified revocable trust (as defined in section

        645(b)(1)), or

            (B) to any other trust with respect to which the decedent

        reserved the right to make any change in the enjoyment thereof

        through the exercise of a power to alter, amend, or terminate

        the trust.

        (3) Any other property passing from the decedent by reason of

    death to the extent that such property passed without consideration.

At first blush, it may appear that Congress meant for (e)(1) to deal with all estate issues, for (e)(2) to deal with all trust issues, and for (e)(3) to deal with anything else, but why in (e)(1) did Congress specifically reference bequests, devises and inheritances when it would have sufficed to mention the decedent’s estate?  The extra phrases must have been placed in the law for a reason, and the comma after the word inheritance is significant, in that it seems to separate (e)(1) into two sections: “bequest, devise, or inheritance” and “the decedent’s estate.”  Further, the definition of “inheritance” found at law.com is “whatever one receives upon the death of a relative due to the laws of descent and distribution, when there is no will. However, inheritance has come to mean anything received from the estate of a person who has died, whether by the laws of descent or as a beneficiary of a will or trust.”  Black’s Law Dictionary, Fifth Edition goes even further on the definition of inheritance and includes assets which pass “by operation of law.”  Based on this way of reading (e)(1), I conclude that Congress probably intended that the phrase “acquired from the decedent” include inheritances from trusts.

On the other hand, (e)(2) seems to suggest limited step-up opportunities for assets in trusts.  Under (e)(2)(B), the step-up would be limited to trusts established by the decedent with a reserved power to alter, amend or terminate, so many irrevocable trusts would not be eligible for a step-up in basis, but perhaps Congress, already having dealt with bequests, devises and inheritances in (e)(1), wanted to make sure that certain other grantor trusts not be eligible for a step-up in basis, and was expressing its intention to exclude powers that had been given to the decedent to attempt to obtain a step-up in basis. 

If (e)(1) and (e)(2) were meant to cover estate and trust issues, then (e)(3) was meant to cover any other types of transfers, such as jointly-held assets and transfer-on-death, pay-on-death and beneficiary designations.  It also seems that a so-called Ladybird deed, where the owner of real estate deeds it away but reserves the right to retrieve it, fits into the (e)(3) category, although it may be questioned whether the non-exercise of a reserved power could be considered passing “from” the decedent. 

Two other common types of transfers, a reserved power of appointment and a reserved life estate, are more problematic, but may also fit under (e)(3).  A reserved power of appointment in a deed is not a possessory interest but can also fit into the (e)(3) category because the real estate was a vested interest subject to divestment, and the real estate passes without consideration when the original owner dies and the divestment possibility is eliminated; until the power holder’s death, the person or entity to whom the real estate was deeded cannot sell or mortgage it, and is therefore not the owner in any significant economic sense. 

A reserved life estate may fit under (e)(3) because the person or trust to which the real estate was deeded does not have possession during the life tenant’s lifetime, and, at the time of the life tenant’s death, the life tenant has an ownership interest to the exclusion of the holder of the remainder.  Under this type of analysis, even though title passed when the deed was recorded and the remainder interest became vested at that time, the real estate could still be viewed as passing “from” the decedent.

November 9, 2010 – 8:12 pm Categories: Internal Revenue Code Sec. 1022, Irrevocable Trusts, Jointly-Held Interests, Life Estates, Powers of Appointment, Revocable Trusts, Step-up in Basis | Post a comment

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Internal Revenue Code Section 2511(c) Affects Charitable Remainder Trusts Funded During 2010

Unfortunately, the tax law known as EGGSTRA passed by the Republican-controlled Congress in 2001 and signed into law by President George W. Bush has made intelligent estate planning difficult for quite some time, and the 2010 estate and gift tax law is a mess.   Unintended consequences may have resulted, and Internal Revenue Code Section 2511(c), effective only for gifts made during 2010, may significantly affect charitable remainder trusts.

The Internal Revenue Service has already attempted to provide guidance about Internal Revenue Code Section 2511(c).  IRS Notice 2010-19 states that “[C]ertain transfers in trust are treated as transfers of property by gift even though such transfers would have been regarded as incomplete gifts, or would have been treated as transfers under the gift tax provisions in effect prior to 2010. … Section 2511(c) broadens the types of transfers subject to the transfer tax under Chapter 12 to include certain transfers to trusts that, before 2010, would have been considered incomplete and, thus, not subject to the gift tax.  Accordingly, each transfer made in 2010 to a trust that is not treated as wholly owned by the donor or the donor’s spouse … is considered to be a transfer by gift of the entire interest in the property under section 2511(c).”

Doesn’t this language mean that a transfer to a trust is either a completed gift or it is not, and that there’s nothing in between? If so, perhaps nobody should establish and fund a charitable remainder trust during 2010. First, one way of reading the current IRS interpretation of Internal Revenue Code Section 2511(c) is that the entire amount contributed to a charitable remainder trust is a completed gift, even the amount retained as the income interest. Under that interpretation, only part of the gift would be deemed to charity, and the remainder would utilize the grantor’s $1,000,000 lifetime gift tax exemption. Second, a trust that provides for a successive income interest would also be treated as a completed gift, because the retention of a power of appointment over that interest (as is usually done) would not cause it to be an incomplete gift during 2010.

For another opinion on this topic, see Section 2511(c) and Charitable Gift Planning

November 6, 2010 – 8:04 pm Categories: Gift Tax, Irrevocable Trusts, Powers of Appointment | Post a comment

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Welcome to Estate Taxation

This blog is written by Brian E. Barreira, an estate planning, probate and elder law attorney with offices at 18 Samoset Street, Plymouth, Massachusetts, and 175 Derby Street, Unit 18, Hingham, Massachusetts.  Brian was named a Massachusetts Super Lawyer® in Boston Magazine in 2009 and 2010. Brian is listed in The Martindale-Hubbell Bar Register of Preeminent Lawyers in the fields of Elder Law and Trusts & Estates, Wills & Probate. Brian’s biographical website can be found at www.elderlaw.info

Nothing on this blog should be considered to be legal advice or tax advice.

November 5, 2010 – 6:36 pm Categories: Federal Estate Tax | Post a comment

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