Recent developments in estate planning: Part 2

Contributors: Members of the Ernst & Young National Tax Department in Private Tax

This is the second of two installments of an annual update on recent developments in estate planning. It covers developments in gift and generation-skipping transfer (GST) tax plus inflation adjustments and relevant proposals in President Joe Biden’s administration’s fiscal-year 2024 budget. The first installment, in the October issue, concerned tax issues of formation and administration of trusts as well as estate taxation. Together, the two installments cover developments that occurred between August 2022 and June 2023.

Gift tax: Valuation

In Cecil,¹ the Tax Court determined the appropriate discounts that should apply for lack of control and lack of marketability in a gift tax deficiency case involving intrafamily gifts of stock in an S corporation. The corporation owned the Biltmore House, a historic mansion and museum in Asheville, N.C.

Background

William Cecil was the grandson of George Vanderbilt and inherited the family’s home, the Biltmore House, and its surrounding estate. Cecil was married to Mary Ryan Cecil (the taxpayers). They had two children, Bill and Dini, and five grandchildren.

The Biltmore House was held inside an S corporation, The Biltmore Co. (TBC), which at the time of the trial was owned entirely by the taxpayers and their children. TBC operates primarily in the travel and tourism/historic hospitality industry. During 2010, TBC operated at least 17 lines of business and employed 1,304 individuals (over 1,800 combined full- and part-time employees if associated businesses are included).

As of Nov. 30, 2010, TBC had assets and liabilities of $53,580,000 and $33,349,000, respectively. Included in its assets were agricultural land in North Carolina and a multimillion-dollar portfolio of fine art, antiques, and other collectibles. TBC had 46 trademarks and a trade name registered with the U.S. Patent and Trademark Office.

In 2003, the family instituted a family-business preservation program. This was designed to educate family members regarding the business to ensure TBC remained in the family, to require that family members who worked in the business have appropriate business acumen, and to require that family members adhere to a family code of conduct.

In 2009, the shareholders of TBC entered into a shareholder’s agreement with the purpose of providing: (1) the continued ownership and control of TBC shares; (2) the harmonious and future conduct of the business; and (3) a stock-transfer mechanism to operate when a shareholder dies, becomes incapacitated, or otherwise needs to sell company stock. This mechanism essentially operated to give the shareholders of TBC a first right of refusal if a stockholder received an offer to buy TBC shares from outside the family.

As of Nov. 18, 2010, TBC had seven shares of Class A voting common stock and 9,993 shares of Class B nonvoting common stock. The Class A shares were owned by William (three shares, via a revocable trust), Mary (one share), Bill (one share), Dini (one share), and Bill and Dini as tenants in common (one share). The Class B shares were owned by William (9,337 shares, via a revocable trust), Bill (328 shares), and Dini (328 shares). The Class A shares were held in a voting trust, all decisions of which were to be made by a majority vote of the trustees. Any decision to sell any land, structure, assets, or stock of TBC or any business entity required a two-thirds vote of the trustees. The trustees set TBC’s policies and general operating procedures relating to its operation.

Gifts

On Nov. 18, 2010, Mary transferred her Class A share to Bill and Dini in undivided equal shares. On Nov. 19, 2010, William transferred his 9,337 Class B shares to his five grandchildren nearly equally along family lines. The smaller block of Class B stock went to Dini’s two children, and the larger block of Class B stock went to Bill’s three children. All gifts were subject to the obligation of the donee to pay any tax associated with the gifts.²

On their 2010 gift tax returns, the taxpayers reported a value of $3,308 per share for the Class A stock and $2,236 per share for the Class B stock. The taxpayers chose to split their gifts, and each reported total gifts of $10,438,766. After auditing the taxpayers’ gift tax returns, the IRS issued notices of deficiencies, having determined that the valuation method the taxpayers used understated the value of the shares of TBC stock.

Valuations

For purposes of filing their return, the taxpayers obtained an appraisal from the accounting firm Dixon Hughes. In determining the value of the TBC shares, Dixon Hughes used a weighted average using an asset approach and an income approach.

At trial, the taxpayers presented two experts. One, from the firm Adams Capital, appraised the TBC stock on the income approach using the discounted-cashflow method and a market approach applying the guideline public company (GPC) method and the comparable-transaction method. The GPC method estimates the fair market value (FMV) of a business based on a comparison to publicly traded companies in similar lines of business. The valuation included “tax-affecting” to take into consideration future tax burdens on pretax cashflows. The expert rejected using the net asset value (NAV) method for valuing the assets of TBC because the number of shares was too small to force a liquidation and because he was told by TBC’s owners and management that TBC would not be liquidated in the foreseeable future.³

The taxpayers’ other expert, from Bannister Financial, valued the TBC stock on the income approach using the net-cashflow method and the GPC method. This included tax-affecting the net cash flows using the S corporation economic adjustment model. This expert also chose not to use the NAV method because the interest being valued was a minority interest with no power to force a liquidation.

In contrast, the IRS’s expert, with Morrison Valuation and Forensic Services, applied the NAV method. After an art appraiser with the IRS estimated how much the artwork in the Biltmore House was worth, the Morrison expert valued the TBC shares, taking the artwork into consideration as part of the valuation. This expert also valued the TBC stock using the income approach’s discounted future benefits method. The expert’s valuation also included tax-affecting to take into consideration future tax burdens on pretax cashflows.

The Tax Court summarized the per-share valuations of the experts as shown in the table “Experts’ valuations in Cecil ,” below.

Tax-affecting

The Tax Court first addressed the use of tax-affecting the valuation of TBC stock, noting that all three experts had used this method in rendering their valuations. The court noted its longstanding position that tax-affecting is generally not a consideration in the valuation of S corporation stock except in exceptional cases. However, in this case, the court noted that all three experts agreed that tax-affecting should be considered in the valuation of the TBC stock, and, therefore, the court was satisfied with its use. The court then sided with the IRS’s expert that the taxaffecting rate should be 17.6%.

Review of valuations

The Tax Court next addressed the valuations of the three experts. The court rejected the IRS’s valuation using the NAV approach because TBC was an operating company, the continuing existence of which was not in jeopardy. Thus, it determined that TBC’s earnings, rather than its assets, were the best measure of its stock value. Although the court agreed with the taxpayers’ experts that the GPC method was the appropriate method to value TBC’s stock, it found flaws in each of the valuations. Nonetheless, the court determined that the flaws in the valuation by Adams Capital were not fatal to the overall valuation and found that this valuation, with an adjustment of the 17.6% tax-affecting rate, was the truest reflection of the value of the stock’s prediscount FMV.

Discounts

The Tax Court accepted Adams Capital’s 20% discount for lack of control. It declined to apply a discount for lack of voting rights. The court accepted the IRS’s discount rates of 19% for the Class A stock, 22% for the smaller block of Class B stock that went to Dini’s children, and 27% for the larger block of Class B stock that went to Bill’s children, for lack of marketability.

In its ruling, the Tax Court determined that the value of the TBC stock should be tax-affected at a rate of 17.6%; that the gifted stock was subject to a 20% discount for lack of control; and that the gifted stock was subject (depending on its size and class) to 19%, 22%, or 27% discounts for lack of marketability.

In the end, the taxpayers, whose experts’ valuations the court largely accepted, prevailed.

Gift tax: Adequate disclosure

In Schlapfer,⁴ the Tax Court held that the IRS’s gift tax assessment against an individual was untimely because he had adequately disclosed the gift of a life insurance policy to family members in his disclosure packet for the Offshore Voluntary Disclosure Program (OVPD), which commenced the three-year limitation period for assessment.

Background

The taxpayer was born in Switzerland and had ties to both the United States and Switzerland. He lived in Switzerland before moving to the United States in 1979; he became a U.S. citizen in 2007.

In 2006, the taxpayer applied for a variable life insurance policy (VLIP) on the lives of various relatives, issued by a Swiss insurance company and held by a Swiss custodian. The taxpayer and his current spouse were the primary beneficiaries; his three children and one stepchild were the secondary beneficiaries. On Jan. 23, 2007, the taxpayer requested that his mother be made the policyholder of the VLIP, and the next day, his mother signed the necessary paperwork to become the policyholder. On April 23, 2007, the taxpayer and his mother requested that the VLIP be assigned to the taxpayer’s mother, aunt, and uncle. On May 31 of the same year, the necessary paperwork was executed, making the taxpayer’s mother, aunt, and uncle the policyholders of the VLIP.

In 2013, the taxpayer entered into the OVDP, which offered U.S. taxpayers with undisclosed income from offshore assets a chance to become compliant with U.S. income tax liabilities and reporting obligations. Among the items that the taxpayer submitted as part of his disclosure packet for the OVDP was a gift tax return for the year 2006, which disclosed that he had transferred his entire interest in a Panamanian corporation, European Marketing Group Inc., (EMG) to his mother. The taxpayer’s OVDP disclosure packet further noted that the gift tax return was a protective filing because he was not yet a U.S. citizen (he became one in 2007) and did not intend to permanently reside in the United States until he later obtained his U.S. citizenship. The gift stemmed from the taxpayer’s assignment of the VLIP (which held the EMG shares) to his mother. The taxpayer listed the EMG stock as the gift rather than the VLIP because the OVDP instructions required taxpayers to disregard certain entities that hold underlying assets, and the taxpayer believed the VLIP was such an entity.

On June 4, 2014, as part of the review of the taxpayer’s OVDP submission, the IRS sent the taxpayer an Information Document Request, which asked him to provide documentation of the gift of EMG stock to his mother and to substantiate the claim that the transfer was not subject to U.S. gift tax. The taxpayer submitted responses to the IRS’s requests. In August 2016, the IRS concluded that there was no taxable gift in 2006 because the taxpayer did not complete the gift of the VLIP until May 31, 2007, the date on which the necessary paperwork was executed making the taxpayer’s mother, aunt, and uncle the policyholders of the VLIP.

On Oct. 17, 2019, the IRS issued the taxpayer a notice of deficiency, in which it determined a gift tax liability of approximately $4.5 million and additions to tax of approximately $4.3 million. The taxpayer filed an action in the Tax Court challenging the IRS’s determinations. The IRS filed a motion for summary judgment requesting the court to find, as a matter of law, that the gift of the VLIP occurred in 2007. The taxpayer filed a cross-motion for summary judgment asking the court to find, as a matter of law, that the statute of limitation for assessment of gift tax had expired before the notice of deficiency was issued because he had adequately disclosed the gift on his 2006 gift tax return that was filed in his 2013 submission to the IRS under the OVDP.

Adequate disclosure

In general, Sec. 6501 provides that the IRS has three years to assess gift tax after a gift tax return has been filed. An exception applies for gifts that are not shown or not “adequately disclosed” on a gift tax return.⁵ In such cases, the IRS may assess gift tax at any time. The statute of limitation applies even if a transfer adequately disclosed on a gift tax return is determined to be incomplete for gift tax purposes.

The Tax Court focused on whether the taxpayer adequately reported the transfer of the VLIP on the 2006 gift tax return, stating that it was immaterial when the gift was completed. The IRS argued that the gift was completed in 2007 and should have been disclosed on the taxpayer’s 2007 gift tax return. However, the taxpayer did not file a gift tax return in 2007. Thus, the court determined that if the taxpayer adequately disclosed the gift on his 2006 gift tax return, the statute of limitation on the gift of the VLIP would have begun to run.

The Tax Court began its analysis by reciting the general requirements for adequate disclosure.⁶ It next discussed whether a taxpayer must comply strictly or substantially with the adequate-disclosure rules. The court concluded that the preamble to Regs. Sec. 301.6501(c)-1(f) suggested that substantial compliance could satisfy those rules.⁷

The Tax Court next analyzed each component of the adequate-disclosure rules. First, the court looked at whether the taxpayer had properly described the gift and any consideration received for it. It reasoned that if the gift was of the EMG stock, he had strictly complied with this requirement. However, if the gift was of the VLIP, the taxpayer had not strictly complied because his gift tax return did not describe a transfer of a life insurance policy. The court, however, determined that the taxpayer had substantially complied with this requirement because the taxpayer had prepared the gift tax return in light of the OVDP’s requirement that he disregard all entities holding his foreign assets — and he believed the VLIP to be an “entity.” It further noted that the value of the VLIP was predominantly determined by the EMG stock’s value, so the taxpayer’s describing the transferred property as EMG stock “goes to the nature of the gift.” The court found that the description was sufficient to alert the IRS as to the nature of the gift, so the taxpayer had met this requirement.

The next requirement is that the gift tax return set forth the identity of the parties. The Tax Court again determined that the taxpayer had not strictly complied with this requirement because the gift tax return and the information in his OVDP submission mentioned only that he had transferred the VLIP to his mother — it failed to mention that it had also been transferred to his aunt and his uncle. The court, however, determined that the taxpayer had substantially complied with this requirement, noting that a failure to list the identity and relationship of each donee was not essential to the requirement’s overall purpose — to provide the IRS with information to understand the nature of the transfer. The court determined that listing his mother on the gift tax return was sufficient for the IRS to understand the relationship between the taxpayer and the donees.

The final requirement was that the taxpayer provide the method used to determine the gift’s value. The Tax Court again found that the taxpayer had not strictly complied with this requirement because the gift tax return did not contain a statement describing how he determined the value of the gift. The court, however, concluded that the taxpayer had substantially complied with this requirement because, if one were to assume the gift was of the EMG stock (the primary asset of the VLIP), the taxpayer had provided financial information sufficient to apprise the IRS of the method used to determine its value. The court noted that the taxpayer’s OVDP submission contained balance sheets, statements of net earnings, dividends paid, and operating results of EMG — all of which are documents identified in the gift tax return’s instructions that could be submitted to determine a gift’s value. The court further noted that, although not all financial documents required by the adequate-disclosure regulation had been supplied, the taxpayer had complied with the instructions in the gift tax return to fulfill this requirement. Even though the gift was the VLIP rather than EMG stock, the court concluded that the taxpayer substantially complied with this requirement because the VLIP’s principal asset was EMG stock. Thus, the documents submitted to support the EMG stock’s value substantially complied with the requirement to support the VLIP’s value.

Having determined that the taxpayer had substantially complied with the adequate-disclosure filing requirements with the filing of his 2006 gift tax return regarding the gift of the VLIP, the Tax Court held that the three-year statute of limitation for the assessment of gift tax on the gift of the VLIP had run out before the IRS issued the notice of deficiency, as the statute of limitation commenced running on Nov. 20, 2013 (the date of the OVDP submission), and the IRS did not assess gift tax until Oct. 17, 2019. Thus, the court granted the taxpayer’s cross-motion for summary judgment.

GST tax: Late allocation

In a letter ruling,⁸ the IRS granted an estate an extension of time to allocate enough of a donor’s remaining GST tax exemption to cause a charitable remainder annuity trust (CRAT) for the benefit of her grandson to have an inclusion ratio of zero and to allocate any remaining GST tax exemption to the CRATs of her son and daughter.

The decedent died, and the residue of her revocable trust was divided into three CRATs, one each for the benefit of her two children and her grandson. The estate tax return failed to allocate GST exemption to the grandson’s CRAT. On realizing this failure, the estate filed a ruling request for an extension of time to file an amended estate tax return to allocate GST exemption.

Pursuant to Sec. 2632(e)(1), any portion of a decedent’s GST exemption that has not been allocated on the decedent’s estate tax return is deemed to be allocated (1) to property that is the subject of a direct skip occurring at such individual’s death, and (2) to trusts with respect to which such individual is the transferor and from which a taxable distribution or a taxable termination might occur at or after such individual’s death.⁹ Because, for GST tax purposes, a charity is considered assigned to the generation of the donor,¹⁰ the CRAT was not a skip person to which GST exemption is automatically allocated; however, the grandson was a skip person. Thus, the decedent’s remaining available GST exemption was allocated pro rata among the three CRATs, because all the CRATs’ current or contingent annuity recipients were skip persons.

Sec. 2642(g)(1)(A)(i) allows the IRS to grant extensions of time to properly allocate a GST exemption. Sec. 2642(g) (1)(B) provides that, in determining whether to grant a taxpayer an extension of time, “all relevant circumstances” are to be taken into account. This section also authorizes the IRS to prescribe regulations under this section, but it has not yet done so. However, Notice 2001-50 provides that, for purposes of Sec. 2642(g)(1)(B), taxpayers are instructed to file a request for a ruling under the general relief provisions in Regs. Sec. 301.9100-3.

In general, relief under Regs. Sec. 301.9100-3 will be granted if the taxpayer establishes to the satisfaction of the IRS that the taxpayer “acted reasonably and in good faith” and that the grant of relief “will not prejudice the interests of the government.” The regulations further provide that a taxpayer is deemed to have acted reasonably and in good faith if the taxpayer reasonably relied on a qualified tax professional.

Based on the facts and representations made by the estate, the IRS determined that the estate was entitled to relief; therefore, it granted an extension of time to allocate GST exemption to the grandson’s CRAT.

The ruling does not discuss the requirement that the relief “will not prejudice the interests of the government.” Regs. Sec. 301.9100-3(c) (1)(i) provides that the interests of the government are prejudiced “if granting relief would result in a taxpayer having a lower tax liability in the aggregate for all taxable years affected by the election than the taxpayer would have had if the election had been timely made.” Under the facts of the ruling, it was unclear when the ruling request was filed — before or after the first annuity payment was owed to the grandson. If the request was made after the first annuity payment was owed to the grandson, presumably, the interests of the government would have been prejudiced, as the annuity payment would have been a taxable distribution as defined in Sec. 2612(b) and GST tax would have been due.

Inflation adjustments

The IRS released Rev. Proc. 2022-38, which sets forth inflation adjustments for various tax items for 2023:

• Unified credit against estate tax: The basic exclusion amount is $12,920,000 for determining the amount of the unified credit against estate tax under Sec. 2010.
• Valuation of qualified real property in decedent’s gross estate: If the executor elects to use the special-use valuation method under Sec. 2032A for qualified real property, the aggregate decrease in the value of the qualified real property resulting from electing to use Sec. 2032A for purposes of the estate tax cannot exceed $1,310,000.
• Gift tax annual exclusion: The gift tax annual exclusion for gifts of a present interest is $17,000. The gift tax annual exclusion for gifts of a present interest to a spouse who is not a U.S. citizen is $175,000.
• Interest on a certain portion of estate tax payable in installments: The dollar amount used to determine the “2% portion”¹¹ is $1,750,000.

The annual adjusted rates are based on the annual Chained Consumer Price Index for All Urban Consumers (CCPI- U) as of Aug. 31 each year. Prior to enactment of the law known as the Tax Cuts and Jobs Act of 2017,¹² these adjustments were based on the Consumer Price Index (CPI). Generally, the C-CPI-U lags behind the CPI because it takes into consideration the effect of substitutions that consumers make in response to changes in relative prices. While the annual CPI as of Aug. 31, 2022, was 8.3%, the C-CPI-U was 7.9%. An increase of this size has not been seen in almost 40 years.

The increase in the gift tax annual exclusion amount and the basic exclusion amount will allow taxpayers to give more of their estates away, thereby ultimately reducing any estate tax that may be due upon their deaths. For planning purposes, the increase in the basic exclusion over that of the previous year amounts to $860,000, allowing for additional leveraging of estate planning strategies to minimize a taxpayer’s estate. This must be balanced against a sharp increase in interest rates, which has reduced the effectiveness of these estate planning strategies.

President Biden’s budget proposals

The Biden administration’s fiscal-year 2024 budget proposal was released March 9, 2023.¹³ Highlights of the provisions affecting trusts, gifts, and estates are included here. In most cases, the proposals would be effective for tax years beginning after Dec. 31, 2023.

Treat transfers of appreciated property by gift or at death as realization events

This proposal generally would require the donor or deceased owner of an appreciated asset to realize a capital gain at the time of its transfer, calculated as the excess of the asset’s FMV on the date of the gift or date of death over the decedent’s basis in the asset. Other attributes of the proposal include the following:

• The gain would be reported as taxable income to the donor or to the decedent’s estate on the federal gift or estate tax return or on a separate capital gains return.
• Capital losses and carryforwards from transfers at death could offset capital gains and up to $3,000 of ordinary income on the decedent’s final income tax return.
• Tax imposed on gains deemed realized at death would be deductible on the decedent’s estate tax return.
• Gain on unrealized appreciation also would be recognized by a trust, partnership, or other noncorporate entity that owns certain property if the property has not been involved in a recognition event within the prior 90 years.¹⁴

Generally, transfers would be defined under the Code’s gift and estate tax provisions and would be valued at the value used for gift or estate tax purposes. For purposes of imposing capital gains tax:

1. A transferred partial interest generally would be valued at its proportional share of the FMV of the entire property.
2. Transfers of property into, and distributions in kind from, a trust (other than a grantor trust deemed wholly owned and revocable by the donor) would be recognition events.
3. Transfers of property to and by a partnership or other noncorporate entity would be recognition events if the transfers have the effect of a gift to the transferee.

Various exclusions would apply, including the following:

• Transfers to a U.S. spouse or to charity would convey the donor’s or decedent’s carryover basis.
• Gain would not be recognized on tangible personal property (excluding collectibles).
• The current $250,000 per-person exclusion for capital gain on a principal residence would apply to all residences and would be portable to the decedent’s surviving spouse.
• The current exclusion for capital gain on certain small business stock would also apply.
• A lifetime gift exclusion of $5 million per donor would be provided for recognition of other unrealized capital gains on property transferred by gift.

A taxpayer could elect not to recognize unrealized appreciation of certain family-owned and -operated businesses until the business is either sold or ceases to be family-owned and -operated. Also, a taxpayer could elect a 15-year, fixed-rate payment plan for the tax on appreciated nonliquid assets transferred at death.

The proposal would be effective for gains on property transferred by gift and on property owned at death by decedents dying after Dec. 31, 2023, and on certain property owned by trusts, partnerships, and other noncorporate entities on Jan. 1, 2024.

The provision would cause an income tax realization event at the time of the transfer. The amount of gain realized would be the excess of the asset’s FMV on the date of gift or date of death over the decedent’s basis in the asset. Therefore, the taxpayer will be deemed to have sold the transferred asset, resulting in phantom income with no corresponding proceeds from the deemed sale to pay the income tax resulting from the deemed sale.

The part of the provision regarding the gain realized by a trust, partnership, or other noncorporate entity is aimed at preventing taxpayers from being able to steer clear of the deemed-sale rule for the assets transferred to these entities, even if they were subject to the deemed-sale rule because the transfer was by gift or bequest. While this provision may be relatively easy to apply to transfers in trust, it would be very complicated to apply to partnerships and noncorporate entities — especially if these entities are carrying on a trade or business. Presumably, S corporations are corporate entities and therefore not subject to this provision. Regarding trusts, this provision is similar to a Canadian tax provision that subjects the assets of a trust to a deemed-sale rule every 21 years.

Require a defined value formula clause to be based on a variable that does not require IRS involvement

If a gift or bequest used a defined value formula clause that determines value based on the result of the IRS’s involvement, the proposal would deem the value of the gift or bequest to be the value as reported on the corresponding gift or estate tax return. However, a defined value formula clause would be effective if (1) the unknown value is determinable by something identifiable (other than IRS activity), such as an appraisal that occurs within a reasonably short period after the date of the transfer (even if after the due date of the return); or (2) the defined value formula clause is used for the purpose of defining a marital or exemption-equivalent bequest at death based on the decedent’s remaining transfer-tax exclusion amount.

This proposed provision is new. Taxpayers use defined value form ulas in association with gifts of property that have no readily ascertainable market value (e.g., closely held stock) so as to avoid unintended gift tax consequences. Various types of such clauses are used in gifts of property, but all consider “defined value” to represent the value “as finally determined for gift tax purposes.” In general, a donor obtains an appraisal to determine value. However, the value is not definitive until the IRS can no longer challenge it.¹⁵ If the IRS challenges the stated value of a gift on a return and successfully establishes that the value was higher than disclosed on the return, the defined value clause requires that the excess is either returned to the donor, transferred to the donor’s spouse or to charity, or becomes an incomplete gift. The IRS has challenged these types of clauses in the courts based on public-policy concerns¹⁶ and generally has been unsuccessful.

Simplify the gift tax exclusion for annual gifts

The proposal would eliminate the present-interest requirement for gifts that qualify for the gift tax annual exclusion. Instead, the proposal would define a new category of transfers (without regard to the existence of any withdrawal or put rights) and would impose an annual limit of $50,000 per donor, indexed for inflation after 2024, on the donor’s transfers of property within this new category that would qualify for the gift tax annual exclusion. The new $50,000 limit would not provide an exclusion in addition to the annual per-donee exclusion; rather, it would be a further limit on amounts that otherwise would qualify for the annual per-donee exclusion. Thus, if a donor’s transfers in the new category in a single year exceed a total of $50,000, the excess would be taxable; this would be true even when the total gift to each individual donee did not exceed $17,000. The new category would include transfers in trust (other than to a trust described in Sec. 2642(c) (2)), transfers of interests in passthrough entities, transfers of interests subject to a prohibition on sale, transfers of partial interests in property, and other transfers of property that the donee cannot immediately liquidate, without regard to the donee’s rights of withdrawal, rights to put property to the donee in return for cash, or similar rights.

This proposed provision is new. Under current law, a gift might be structured to allow a donee or donees to immediately withdraw from the transfer an amount up to the gift tax annual exclusion, so that the transfer is considered the gift of a present interest and therefore eligible for the gift tax annual exclusion. The extent to which the transfer is a gift of a present interest is determined by the extent of the withdrawal powers conveyed. Under this provision, the extent of withdrawal powers held by individuals would no longer determine how much of the transfer is eligible for the gift tax annual exclusion; it simply provides an overall exclusion for the entity.

Improve tax administration for trusts and estates

Expand the definition of “executor”: The administration proposes to move the existing definition of “executor” from Sec. 2203 to Sec. 7701 so that it will apply for all tax purposes, authorizing the executor to do anything on the decedent’s behalf “in connection with the decedent’s pre-death tax liabilities or other tax obligations that the decedent could have done if still living.” The proposal would apply upon enactment, regardless of when a decedent died.

This proposal is a carryover from President Barack Obama’s budget proposals. The proposal would make the definition applicable for all tax purposes, not just estate tax purposes. Currently, it is not clear that an executor can handle tax matters that may have arisen before the death of the taxpayer, e.g., an income tax audit or final income/gift tax return.

Increase the limit on the reduction in value of special-use property: The proposal would increase to $13 million (the amount is currently $1.31 million) the cap on the maximum valuation decrease for “qualified real property” elected to be treated as special-use property. This property generally includes real estate used in family farms, ranches, and timberland. The proposal would apply to the estates of decedents who die on or after the date of enactment.

This provision was rumored to have been considered in drafting the Build Back Better Act¹⁷ but never made it into the act. Sec. 2032A allows real property used in a farm or business to be valued for estate tax purposes based on its actual use rather than on its best use.

Extend 10-year duration for certain estate and gift tax liens: The proposal would extend the current 10-year duration of the automatic lien and allow it to continue during any deferral or installment period for unpaid estate and gift taxes. This extension would apply to 10-year liens in effect on the date of enactment as well as to the automatic lien.

Another carryover from President Obama’s budget proposals, it would extend the general estate tax lien applicable to all estate tax liabilities under Sec. 6324 past the normal 10-year period to the expiration of the deferral period that the decedent’s estate elected under Sec. 6166. This proposal responds to the Tax Court’s decision in Estate of Roski,¹⁸ which held that the IRS had abused its discretion when it required a bond or lien of all estates that elected under Sec. 6166 to pay estate tax in installments. The court held that Congress intended the IRS to determine on a case-by-case basis whether the government’s interest is at risk before requiring security from an estate making an election under Sec. 6166.

Require reporting of estimated total value of trust assets and other information about the trust: The proposal generally would require certain domestic and foreign trusts administered in the United States to annually report certain information to the IRS. This reporting requirement would apply to trusts that on the last day of the tax year have an estimated total value exceeding $300,000 or gross income for the tax year exceeding $10,000 (with both amounts indexed for inflation after 2024). Further, any trust, regardless of its value or income, would be required to annually report its inclusion ratio whenever the trust makes a distribution to a nonskip person, along with information regarding any trust modification or transaction with another trust that occurred during that year.

This proposed provision is new. The reporting would be done on the trust’s annual income tax return or as otherwise provided by Treasury. The trust would have to provide general information, including the name, address, and taxpayer identification number of each trustee and grantor, as well as the general nature and estimated total value of the trust’s assets.

Change the GST tax characterization of certain tax-exempt organizations: The proposal would ignore trust interests held not only by charities described in Sec. 501(c)(3) (as under current law), but also by other tax-exempt organizations for purposes of the GST tax.¹⁹ As a result, including any tax-exempt organization as a permissible distributee of a trust would not prevent a taxable termination subject to GST tax from occurring. The proposal would apply in all tax years beginning after the date of enactment.

This proposed provision is new. It would treat tax-exempt entities that are not charities the same as charities for purposes of determining whether the tax-exempt entity has an interest in the trust. The result is that they will be ignored for purposes of determining whether a trust has a taxable termination for GST tax purposes.

Modify the definition of a guaranteed annuity from a charitable lead annuity trust (CLAT): The proposal would require that (1) annuity payments made at least annually to charitable beneficiaries of a CLAT must be a level, fixed amount over the term of the CLAT; and (2) the value of the remainder interest at the CLAT’s creation be at least 10% of the value of the property used to fund the CLAT, thereby ensuring a taxable gift on creation of the CLAT. The proposal would apply to all CLATs created after the date of enactment.

This proposed provision is new. The requirement that the amount of the annuity payment be level and fixed over the term of the CLAT is meant to prevent having the annuity increase each year by a certain percentage over the previous year. The advantage to this strategy is that the assets in the CLAT may stay in the CLAT for a longer period than if the annuity is a level, fixed amount, thereby increasing the likelihood of the CLAT’s success — i.e., more assets transferred to the remainder beneficiaries. Currently, a CLAT can be structured so that the present value of the annuity stream equals the initial FMV of the assets funding the CLAT (put another way, “zeroing out” the CLAT), which results in no gift tax consequences. The 10% remainder requirement would result in gift tax consequences in creating a CLAT.

Limit duration of GST tax exemption: Under the proposal, the GST tax exemption would apply only to (1) direct skips and taxable distributions to beneficiaries no more than two generations below the transferor and to younger-generation beneficiaries who were alive when the trust was created, and (2) taxable terminations occurring while any person described in (1) is a beneficiary of the trust. As a result of these changes, the benefit of the GST exemption would not last for the entire duration of the trust. “Instead, the GST exemption would only shield the trust assets from GST tax for as long as the life of any trust beneficiary who either is no younger than the transferor’s grandchild or is a member of a younger generation who was alive at the creation of the trust,” Treasury explains in the Greenbook.²⁰ The proposal would apply on and after the date of enactment to all trusts subject to the GST tax, regardless of the trust’s inclusion ratio on the date of enactment.

This proposed provision is new. For purposes of determining the duration of GST exemption, a trust created before the date of enactment (i.e., a grandfathered trust) would be deemed to have been created on the date of enactment. As a result, trust assets would be exempted from GST tax only during the life of any beneficiary who is no younger than the grandchild of the transferor or a beneficiary who is a member of a younger generation who was alive at the creation of the trust. After this period, the inclusion ratio of the trust would increase to 1 and the entire trust would no longer be exempt from GST tax.

Modify tax rules for grantor trusts: When a remainder interest in a grantor retained annuity trust (GRAT) is created, the proposal would require that interest to have, for gift tax purposes, a minimum value equal to the greater of 25% of the value of the assets transferred to the GRAT or $500,000 (but not more than the value of the assets transferred). Any decrease in the annuity during the GRAT term would be prohibited; the grantor could not exchange assets held in trust without recognizing gain or loss for tax purposes; GRATs would be required to have a minimum 10-year term and a maximum term of the life expectancy of the annuitant plus 10 years.

These provisions are a carryover from President Obama’s budget proposals as well as prior proposed legislation. Currently, GRATs may be structured to have no gift tax consequences because the present value of the annuity payments to the grantor equals the FMV of the assets transferred to the GRAT. GRATs are especially useful when the taxpayer has little or no remaining gift tax exemption. The minimum-value requirement would eliminate the ability to create a GRAT that has no gift tax consequences, severely limiting its usefulness in an estate plan.

The prohibition on decreasing annuity payments would eliminate the “front-loading” of GRATs with other assets so that more of the main asset that is the target for using the GRAT is preserved for the remainder beneficiary.

Requiring a minimum term would make a GRAT riskier for estate planning; this is because a GRAT’s transfer-tax benefits are typically achieved when the grantor outlives the GRAT term. Requiring a maximum term would prevent 99-year GRATs that some taxpayers have created so that the amount includable in the grantor’s estate under Sec. 2036 is very small.

Adjust a trust’s GST inclusion ratio on transactions with other trusts: Under the proposal, a trust’s purchase of (1) assets from (or interests in) a trust subject to GST tax or (2) any other property subject to GST tax would be treated as a change in trust principal; this, in turn, would require redetermination of the purchasing trust’s inclusion ratio at the time of purchase.

This proposed provision is new. Currently, one trust’s purchase of another trust’s assets at FMV would not require a redetermination of the purchasing trust’s inclusion ratio.

Modify the tax treatment of loans from a trust: Loans that a trust makes to a trust beneficiary would be treated as a distribution for both income and GST tax purposes. These rules would apply after the year of enactment to loans that trusts make and to existing loans renegotiated or renewed.

This proposed provision is new. Under the provision, to the extent a trust has distributable net income in the year a loan is made, the loan would have income tax consequences to the beneficiary and, to the extent the loan is to a skip person,²¹ it would have GST tax consequences to the beneficiary.

Revise the valuation of partial/ fractional interests in certain assets transferred intrafamily:

The proposal would replace Sec. 2704(b), which disregards the effect of liquidation restrictions on FMV. Instead, the proposal would provide that the value of a partial interest in nonpublicly traded property²² transferred to (or for the benefit of) the transferor’s family member would equal the interest’s pro rata share of the collective FMV of all interests in that property held by the transferor and the transferor’s family members, with that collective FMV being determined as if held by a sole individual. For this purpose, family members would include the transferor, the transferor’s ancestors and descendants, and the spouse of each described individual.

In applying this rule to an interest in a trade or business, passive assets would be segregated and valued as separate from the trade or business. Thus, the FMV of the family’s collective interest would be the sum of the FMV of the interest allocable to a trade or business (not including its passive assets) and the FMV of the passive assets allocable to the family’s collective interest, determined as if the passive assets were held directly by a sole individual. Passive assets are assets not actively used in the conduct of the trade or business and thus would not be discounted as part of the interest in the trade or business.

This valuation rule would apply only to intrafamily transfers of partial interests in property in which the family collectively has an interest of at least 25% of the whole. The proposal would apply to valuations as of a valuation date on or after the date of enactment.

This proposed provision is new. It is designed to nullify discounts²³ that may be associated with transfers of partial interests in property²⁴ among family members. Treasury and the IRS have had limited success in the courts in applying Sec. 2704 to intrafamily transfers.

Footnotes

¹Cecil, T.C. Memo. 2023-24.

²I.e., net gifts.

³Within the next 30 years.

⁴Schlapfer, T.C. Memo. 2023-65.

⁵I.e., disclosed on the return or in a statement attached to the return in a manner adequate to apprise the IRS of the nature of the item that was the subject of the gift.

⁶As provided in Regs. Sec. 301.6501(c)-1(f).

⁷T.D. 8845.

⁸IRS Letter Ruling 202233002.

⁹I.e., a trust that may benefit skip persons.

¹⁰Sec. 2651(f)(3).

¹¹For purposes of calculating interest under Sec. 6601(j) of the estate tax, with time for payment extended as provided in Sec. 6166.

¹²The law known as the Tax Cuts and Jobs Act, P.L. 115-97.

¹³U.S. Office of Management and Budget, Budget of the U.S. Government, Fiscal Year 2024 (March 9, 2023); Treasury, General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals (Greenbook) (March 9, 2023).

¹⁴Applicable to property held on or after Jan. 1, 1942, that is not subject to a recognition event after Dec. 31, 1941, so that the first recognition event would be deemed to occur on Dec. 31, 2032.

¹⁵Generally, three years from the date on which the gift tax return disclosing the gift is filed.

¹⁶See Procter, 142 F.2d 824 (4th Cir. 1944); Wandry, T.C. Memo. 2012-88. See also Action on Decision 2012-004.

¹⁷The Build Back Better Act, H.R. 5376, passed by the House of Representatives on Nov. 19, 2021, but not enacted. Portions were incorporated into the Inflation Reduction Act of 2022, P.L. 117-169.

¹⁸Estate of Roski, 128 T.C. 113 (2007).

¹⁹I.e., other organizations designated as tax-exempt in Sec. 501(c).

²⁰Treasury, General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals (Greenbook), p. 122, (March 9, 2023).

²¹ As the term is defined for GST tax purposes.

²²Real, personal, tangible, or intangible.

²³E.g., for lack of marketability or lack of control.

²⁴Except an operating trade or business.

Contributor

Justin Ransome, CPA, J.D., MBA, is a partner in the National Tax Department of Ernst & Young LLP in Washington, D.C. He would like to thank members of the firm’s National Tax Department in Private Tax for their contributions to this article, as well as Fran Schafer for her thoughtful comments. The views expressed here are those of the author and do not necessarily reflect the views of Ernst & Young LLP. For more information about this article, contact thetaxadviser@aicpa.org.

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