Estate Tax Round-Up: An Overview of Recent Developments

Posted by Christian Wynns on March 13th, 2016

In 2016, the federal gift and estate tax exemption increases to $5.45 million (up from $5.43 million for 2015). But that’s not all that’s changed. In recent months, there have been several significant developments on the estate tax front. Here are some tips to help you stay atop the changes.

New Basis Consistency Rules for Inherited Assets

For federal income tax purposes, the tax basis of an inherited asset is generally adjusted to reflect its fair market value (FMV) as of the deceased’s date of death or six months after the date of death if the estate executor or personal representative chooses to use the alternative valuation date. Similarly, an asset that’s included in the federal estate tax return of the deceased’s estate (Form 706) should be valued at its FMV as of the same date.

Until recently, there was no explicit requirement for an heir’s basis in an inherited asset to be the same as the value reported for the asset on Form 706. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 addressed this inconsistency, requiring that an heir’s basis in inherited property be the value of that property that is reported on Form 706. This change is intended to help the IRS better track income tax liabilities when inherited assets are eventually sold.

The new rule is effective for assets included in estate tax returns filed after July 31, 2015. But it applies only if the asset in question actually increases the estate’s estate tax liability. Therefore, it doesn’t apply to assets of estates that are valued at less than the applicable estate tax exemption.

New Basis Consistency Statements

To help implement the basis consistency rules, executors (or personal representatives) of estates that are large enough that they’re required to file Form 706 must provide statements reporting the FMV of assets that are included in the estate to both the IRS and the heirs who receive those assets. This reporting requirement is effective for estate tax returns filed after July 31, 2015. The basis consistency statements must be filed with the IRS by the earlier of:

1.  30 days after Form 706 is filed, or

2.  30 days after the due date for Form 706, including any extensions.

In Notice 2015-57, the IRS announced a delayed initial due date for these statements. Statements that would otherwise be due to the IRS or heirs of affected estates before February 29, 2016, aren’t due until that date. This delay gives the IRS more time to develop additional guidance on how to comply with the new basis consistency reporting rules.

Important note: The new reporting rules don’t apply when Form 706 is filed solely to make the portability election to transfer the deceased’s unused estate tax exemption to a surviving spouse.

Beware of the “Remote Possibility” Threshold for Charitable Income Tax Deductions

The U.S. Tax Court recently denied an estate’s income tax deduction for an amount the deceased intended to leave under the terms of her will to a charitable organization.

The estate had become entangled in a legal dispute with the deceased’s brother regarding his ownership rights in a condo that had been left to a charity. (The brother lived in the condo.) After paying legal and administrative expenses, the estate was short of funds. Although the deceased’s will set aside a specific amount for the charity in question, the Tax Court concluded that the estate fell under a rule that disallows a charitable deduction unless there is only a remote possibility that the amount intended for a charity won’t be turned over to the charity.

Because the estate’s executor was aware that a prolonged legal fight with the deceased’s brother was more than just a remote possibility at the time the charitable deduction was claimed on the estate’s income tax return, the Tax Court decided that the IRS had acted properly in disallowing the deduction. (Estate of Eileen S. Belmont, 144 TC 84.)

In a similar case, the Tax Court concluded that an estate wasn’t entitled to charitable income tax deductions for amounts it claimed were set aside for two churches. The estate, which was embroiled in litigation with potential heirs seeking a portion of the funds in question, failed to show that there was only a remote possibility that the amounts designated for the churches would wind up going to other parties. Therefore, the Tax Court ruled that the IRS had acted properly in denying the charitable write-offs. (Estate of John D. DiMarco, TC Memo 2015-184.)

Protect Yourself from Being Held Personally Liable for Unpaid Tax Bills

Sometimes an estate’s assets are insufficient to pay the deceased’s federal income and gift tax liabilities and the estate’s federal estate tax liability. When this happens, the estate’s executor or personal representative may be held personally liable for the unpaid taxes if:

1.  Other debts of the estate are paid and/or distributions to heirs and beneficiaries are made before paying the tax liabilities, and

2.  The executor or personal representative knows that the estate’s remaining assets will be insufficient to pay the tax liabilities.

In a recent U.S. district court decision, the executor made distributions from the estate to himself and his siblings even though he knew that the estate owed a tax bill of over $2 million. Because he depleted the estate’s assets before paying the tax bill, he was held personally liable for the unpaid amount. As a result, the court upheld the validity of an IRS lien that was placed against the executor’s personal assets. (U.S. v. David Stiles, Pennsylvania District Court, December 12, 2014, 114 AFTR 2d 2014-6809.)

Consult with a Pro

The federal and state gift and estate tax rules are complicated and ever-changing. Experienced legal and tax professionals can help you navigate them. By seeking professional advice, you can avoid mistakes that can cost the estate and even you personally.