A Surge of Administrative Guidance

In the last four months, administrative guidance
has addressed four significant topics.

Dear Readers Who Follow Washington Developments:

In the last four months the Treasury Department and the IRS have released guidance – in proposed or final form – on four topics that significantly affect estate planning:

• Proposed “Anti-Abuse” Exception to the Anti-Clawback Regulations
• Updated Actuarial Tables Under Section 7520
• Effects of Guarantees and Present Value Concepts on Estate Tax Deductions
• Expanded Relief for Portability Elections

FIRST – A TRIBUTE TO JOHN BIXLER

In my first year as an associate at Miller & Chevalier in the spring of 1976, John Bixler asked me to help him with some of his estate planning clients who would be affected by the estate and gift tax changes in the Tax Reform Act of 1976 then being considered in Congress. Two of those clients passed away the following year, and the managing partner of the firm asked me to step away, at least temporarily, from the corporate tax controversy path I was on and make a nearly full-time commitment to help John in the administration of those estates and the tax issues, including estate tax audits and litigation, that resulted. Well, like any two-year associate would, I said yes. I had never planned to be an estate planner; that’s how it happened. And I never looked back.

Besides drafting documents, John, as the chair of the ABA Tax Section’s Administrative Practice Committee, pulled me into coauthoring, under both our names, a pair of articles for the American Law Institute and American Bar Association on the 1976 Act – my first articles. He also encouraged and supported my own involvement in the ABA and in due course my election to ACTEC. In 1993, Bill Weinsheimer, the chair of ACTEC’s Editorial Board, asked John (who was then a Regent) to write a quarterly article for ACTEC Notes (now the ACTEC Law Journal) on developments in Washington, following Lloyd Leva Plaine’s decision to step back from her quarterly articles that she had called “View from the Bridge.” John agreed and enlisted me to help him with what he called the “Washington Report.” And as it had always been with us, John made sure it was a collaboration. He never adopted the traditional assumption that I would do the research and the drafting, and he would just review and edit it. Sometimes I would draft the article and he would edit it, but sometimes he would draft the article and I would edit it, and often we shared those roles the same way with various parts of a single article. His mentoring wasn’t just show-and-tell; it always included allow-and-watch. And again John put both our names on the “Washington Reports.”

We kept it up for 13 years – 52 issues – even after 1998 when we left Miller & Chevalier, John for Ross, Marsh & Foster, and I for McGuireWoods. In the Fall 2004 issue, John insisted that the Journal start putting my name first, and by the Spring of 2006 he had decided to step back himself and take a very well-deserved break from writing. I was uncomfortable with continuing the “Washington Report” in that format without John. But at the 2006 annual ACTEC meeting, incoming Vice President Bjarne Johnson suggested that we take the article completely virtual and name it “Capital Letter,” which continues John’s legacy in that form to this day.

John Bixler, my mentor to whom I owe so much, passed away on June 17, 2022. His wife Mitzi had predeceased him. I thank their three children for sharing their dad with the estate planning profession and with ACTEC. They and their families have my sincerest sympathy. John might have cringed if he had seen some of the technical detail or even some of the policy critique in this Capital Letter, and he might have wondered why I was still writing about the Tax Reform Act of 1976 anyway (see Part 1 below), but he would have encouraged me to do it my way, and thus his legacy of mentoring lives on.

NEXT – THE ADMINISTRATIVE GUIDANCE

PROPOSED “ANTI-ABUSE” EXCEPTION TO THE ANTI-CLAWBACK REGULATIONS

Background

Item 3 under the heading of “Gifts and Estates and Trusts” in the 2021-2022 Treasury-IRS Priority Guidance Plan is described as “Regulations under §2010 addressing whether gifts that are includible in the gross estate should be excepted from the special rule of §20.2010-1(c).” We had been waiting for those proposed regulations since November 2019 when the final regulations on the “anti-clawback” “special rule” were published. T.D. 9884, 84 Fed. Reg. 64995 (Nov. 26, 2019). This April we got them. REG-118913-21, 87 Fed. Reg. 24918 (April 27, 2022).

Although neither the statute nor the regulations use the word “clawback,” the regulations carry out the mandate of the 2017 Tax Act in new section 2001(g)(2), which provides that Treasury “shall prescribe such regulations as may be necessary or appropriate to carry out this section with respect to any difference between (A) the basic exclusion amount under section 2010(c)(3) applicable at the time of the decedent’s death, and (B) the basic exclusion amount under such section applicable with respect to any gifts made by the decedent.”

The concern that prompted that mandate for regulations is that the anti-clawback remedy added in 2010 as subsection (g) (now paragraph (1) of subsection (g)) addressed only changes in tax rates, and the 2017 Tax Act did not change any rates when it doubled the basic exclusion amount (“BEA”). New paragraph (2) obviously contemplated that the regulations would reach a similar result for the potential sunset of the doubled exclusion amount, but left the details to the IRS and Treasury.

To illustrate the concern, assume that an unmarried individual made a $9 million gift (the donor’s only lifetime gift) in 2019 when the indexed exclusion amount was $11.4 million. With no change in the law, the donor dies in 2026 with a taxable estate of $20 million. Assume further that the 2026 $5 million exclusion amount (indexed) is $6.8 million. (These numbers – $9 million, $11.4 million, and $6.8 million – are the same numbers that are used in the examples in the 2019 regulations and the current proposed addition to the regulations.) With a 40 percent rate and the exclusion amount used up, the intuitively correct estate tax is 40 percent of $20 million, or $8 million. But without anti-clawback relief the estate tax turns out to be $8,880,000, producing a “clawback penalty” of $880,000. Other ways to look at this $880,000 are:

• 40 percent of the amount by which the $9 million gift exceeded the $6.8 million date-of-death exclusion amount; or
• the gift tax on the gift if the gift had been made in 2026; or
• the additional estate tax on a taxable estate of $29 million if the gift had not been made at all.

In other words, all the benefit the 2017 Tax Act apparently promised this donor for making a gift before the sunset would be wiped out by the sunset.

The November 2019 regulations added new Reg. §20.2010-1(c) (with the former paragraphs (c), (d), and (e) re-lettered (d), (e), and (f)), stating the heart of the anti-clawback rule as follows (emphasis added):

“If the total of the amounts allowable as a credit in computing the gift tax payable on the decedent’s post-1976 gifts, within the meaning of section 2001(b)(2), to the extent such credits are based solely on the basic exclusion amount as defined and adjusted in section 2010(c)(3), exceeds the credit allowable within the meaning of section 2010(a) in computing the estate tax, again only to the extent such credit is based solely on such basic exclusion amount, in each case by applying the tax rates in effect at the decedent’s death, then the portion of the credit allowable in computing the estate tax on the decedent’s taxable estate that is attributable to the basic exclusion amount is the sum of the amounts attributable to the basic exclusion amount allowable as a credit in computing the gift tax payable on the decedent’s post-1976 gifts.”

In other words, in the example above, because $9 million of basic exclusion amount used for the 2019 gift (the only post-1976 lifetime gift) is greater than the $6.8 million basic exclusion amount otherwise allowable in computing the 2026 estate tax, that larger amount of $9 million is used instead of $6.8 million to calculate the credit for estate tax purposes.

Comments on This Approach

The approach of the 2010 explicit statutory anti-clawback rule in section 2001(g)(1) – specifically section 2001(g)(1)(A) – was that the rates in effect at the time of death would be used to calculate the hypothetical “tax imposed by chapter 12” on pre-2026 adjusted taxable gifts – in other words, the “total gift tax paid or payable” that is deducted on line 7 of the estate tax return. Before the proposed regulations were released, therefore, there was speculation that the regulations under section 2001(g)(2) would mirror the regulations under section 2001(g)(1) and provide that line 7 would be changed from zero to $880,000 (which is what the 2019 gift tax would have been if 2026 law had applied in 2019). After subtracting that amount, line 8, and therefore line 12, would be $880,000 smaller, which would exactly eliminate the clawback penalty.

But the regulations take a different approach. The preamble to the 2018 proposed regulations implies that other approaches were considered, but concludes that “in the view of the Treasury Department and the IRS, the most administrable solution would be to adjust the amount of the credit … required to be applied against the net tentative estate tax” to a credit “based on the larger amount of BEA … that was used to compute gift tax payable” – in other words, by adjusting the basic exclusion amount (“BEA”) entered on line 9a of the estate tax return.

By increasing the amount on line 9a, rather than the amount on line 7, of the estate tax return, the regulations achieve the same result, because both lines 7 and 9a are subtractions in the estate tax calculation. But the estate tax return instructions already devoted over two pages (pages 6-9) to line 7, including a 24-line worksheet. An incremental increase of complexity in what already had a reputation for being a challenge might have been easier to process than adding a new challenge to line 9a, which previously required only 21 words of instructions. Needless to say, IRS personnel see more returns than any member of the public does, they see the mistakes, and they hear the complaints. Presumably – hopefully – they contributed to the assessment that the line 9a approach is “the most administrable solution.” And in a way it mirrors section 2001(g)(2) itself, which expresses Congress’s clawback concern in 2017 in terms of the basic exclusion amount.

That approach should work fine if the law is not changed and sunset occurs January 1, 2026. But, although the examples in Reg. §20.2010-1(c)(2) assume that the donor’s “date of death is after 2025,” the substantive rule in Reg. §20.2010-1(c) applies by its terms whenever “changes in the basic exclusion amount … occur between the date of a donor’s gift and the date of the donor’s death.” It is not limited to 2026 or to any other particular time period. The 2010 statutory rule in section 2001(g)(1) and the 2017 statutory call for regulations in section 2001(g)(2) are not limited to any time period either. Therefore, if Congress makes other changes in the law, particularly increases in rates or decreases in exemptions, and doesn’t focus on the potential clawback issue in the context of those changes, the generic anti-clawback regime of section 2001(g)(1) and (2) and these regulations could produce a jigsaw puzzle of adjustments going different directions that may strain the notion of administrability cited in the preamble.

One more point: As noted in Development Number Three in the “Top Ten Estate Planning and Estate Tax Developments of 2021” (Capital Letter Number 55), much of the complexity in the tax calculation reflected in the instructions to line 7 of the estate tax return and in the instructions (pages 12-17) to Schedule B of the gift tax return (as well as in the wording of Reg. §20.2010-1(c) itself quoted above) is traceable to the decision of Congress in the Tax Reform Act of 1976 to replace the separate gift tax and estate tax exemptions with a “unified credit,” which Congress viewed as “more equitable” because in an environment of graduated rates “a deduction or exemption tends to confer more savings on larger estates.” Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1976, 94th Cong., 2d Sess. 531 (1976), copying Tax Reform Act of 1976, Supplemental Report of the Senate Committee on Finance on Additional Committee Amendment to H.R. 10612, 94th Cong., 2d Sess. 13 (July 20, 1976), and Estate and Gift Tax Reform Act of 1976, Report of the House Ways and Means Committee, 94th Cong., 2d Sess. 15 (Aug. 2, 1976). Of course, even then it was necessary to have the concept of an “exemption equivalent” to determine the estate tax return filing requirement under section 6018. Then the Taxpayer Relief Act of 1997 turned the calculation around and started with an “applicable exclusion amount.” Then came portability, temporarily in 2010 and permanently in 2012, and the need to introduce both a “basic exclusion amount” and a “deceased spousal unused exclusion amount” as components of the “applicable exclusion amount.” Meanwhile, whatever it’s called, the exemption/exemption equivalent/applicable exclusion amount/basic exclusion amount grew to levels far exceeding the top estate tax bracket, making the 1976 “equity” argument largely moot. Nevertheless, while the conversion to a “unified credit” may have resulted in more complexity in preparing returns, the “clawback” issues could arise in the context of a change to either a credit or an exemption (or rates).

An Anti-Abuse Warning

The preamble to the 2019 regulations added:

“A commenter recommended consideration of an anti-abuse provision to prevent the application of the special rule to transfers made during the increased BEA period that are not true inter vivos transfers, but rather are treated as testamentary transfers for transfer tax purposes. Examples include transfers subject to a retained life estate or other retained powers or interests, and certain transfers within the purview of chapter 14 of subtitle B of the Code. The purpose of the special rule is to ensure that bona fide inter vivos transfers are not subject to inconsistent treatment for estate tax purposes. Arguably, the possibility of inconsistent treatment does not arise with regard to transfers that are treated as part of the gross estate for estate tax purposes, rather than as adjusted taxable gifts. An anti-abuse provision could except from the application of the special rule transfers where value is included in the donor’s gross estate at death. Although the Treasury Department and the IRS agree that such a provision is within the scope of the regulatory authority granted in section 2001(g)(2), such an anti-abuse provision would benefit from prior notice and comment. Accordingly, this issue will be reserved to allow further consideration of this comment.”

The commenter the preamble cites is the Tax Section of the New York State Bar Association, in its February 20, 2019, letter to Treasury and the IRS.

The Proposed “Anti-Abuse” Addition

In April, Treasury proposed to add an exception to the regulations that would do what the 2019 preamble foretold and would address the “anti-clawback bonus.” REG-118913-21, 87 Fed. Reg. 24918 (April 27, 2022). The proposal would add a new subparagraph (3) to the anti-clawback paragraph (c) that was added to Reg. §20.2010-1 in 2019. Proposed Reg. §20.2010-1(c)(3)(i) provides exceptions from the special anti-clawback rule for “transfers includible in the gross estate, or treated as includible in the gross estate for purposes of section 2001(b).” It elaborates such transfers as “including without limitation” the following four specific types of transfers:

A. Traditional “String” Gifts. The first type of transfer addressed by the proposed exception is described in Proposed Reg. §20.2010-1(c)(3)(i)(A) as “Transfers includible in the gross estate pursuant to section 2035 [gifts completed by a transfer or by a relinquishment of a power within three years of death], 2036 [transfers with a retained life estate], 2037 [transfers taking effect at death], 2038 [revocable transfers], or 2042 [life insurance proceeds], regardless of whether all or any part of the transfer was deductible pursuant to section 2522 [charitable gifts] or 2523 [gifts to the donor’s spouse].”

This is as forecast in the 2019 preamble. Although it might appear at first to be harsh and “anti-taxpayer,” in fact it would simply preserve the “clawback” that provisions like section 2036 (and their predecessors) have been designed by Congress to achieve since at least the 1930s.

The clearest way to illustrate that might be by comparing adaptations of the tables included in Capital Letter Number 55. In the example above, for estate tax purposes the $9 million of basic exclusion amount used for the 2019 gift is substituted for the $6.8 million basic exclusion amount that otherwise would be applicable. The elimination of the clawback penalty by that substitution is illustrated in the following table, based on the estate tax return, by changing the entry on line 9a from $6.8 million (the assumed 2026 basic exclusion amount) to $9 million (the amount of the 2019 basic exclusion amount used for computing the 2019 gift tax).

To illustrate the circumstances in which the proposed exception might apply, consider again the example above (which is drawn from the final and proposed regulations): a $9 million gift in 2019 and an otherwise taxable estate of $20 million and basic exclusion amount of $6.8 million in 2026. But in this case the gift is of such nature that the value of the property is included in the donor’s gross estate under, for example, section 2036, thereby making the taxable estate $29 million (assuming no intervening change in value), while the gift itself is excluded from “adjusted taxable gifts” (line 4 of the estate tax return) under the last phrase of section 2001(b). In that case, the intuitively correct estate tax seems to be the tax on a taxable estate of $29 million, which is $8,880,000 (as shown under “Illustrating Clawback” in the above table, calculated on the tax base of $29,000,000 on line 5 after adding adjusted taxable gifts in that case). Two ways of looking at that $8,880,000 are:

• $11,545,800 (the tax on $29,000,000 under the section 2001(c) rate schedule) minus $2,665,800 (the applicable credit amount, which is the tax on the applicable exclusion amount of $6,800,000 under the section 2001(c) rate schedule) = $8,880,000, or
• 40 percent times (the taxable estate of $29,000,000 minus the applicable exclusion amount of $6,800,000) = 0.4 × $22,200,000 = $8,880,000.

Thus, application of the anti-clawback calculation in this case would not eliminate an $880,000 clawback penalty, it would in effect produce an $880,000 anti-clawback bonus, which the proposed exception would correct, as the following table indicates.

Thus, the proposed exception would work appropriately for this type of transfer.

B. Gifts by Enforceable Promise. The second type of transfer addressed by the proposed exception is described in Proposed Reg. §20.2010-1(c)(3)(i)(B) as “Transfers made by enforceable promise to the extent they remain unsatisfied as of the date of death.” Such transfers were not explicitly targeted in the 2019 preamble. But, because the donor/promisor keeps the enjoyment of the property until the promise is satisfied, there certainly is a resemblance to section 2036. As the preamble observes, such transfers have been excluded from adjusted taxable gifts under Rev. Rul. 84-25, 1984-1 C.B. 191.

But it isn’t quite that simple. As ACTEC has recommended in its July 25, 2022, comments on the proposed regulations, the exception would do a better job of addressing its stated objectives if it were revised to clarify that it applies only when the promise actually results in a gift, and in any event not to the extent the decedent received adequate and full consideration in money or money’s worth for the promise.

C. Certain Chapter 14 Transfers. The third type of transfer addressed by the proposed exception is described in Proposed Reg. §20.2010-1(c)(3)(i)(C) as “Transfers described in §25.2701-5(a)(4) or §25.2702-6(a)(1)” of the regulations. This fulfills the explicit attention of the 2019 preamble to “certain transfers within the purview of chapter 14 of subtitle B of the Code.” In two helpful paragraphs, the current preamble explains why Treasury and the IRS did not consider it necessary to also amend Reg. §25.2701-5 (as the comments of the Tax Section of the New York State Bar Association had recommended) or, similarly, Reg. §25.2702-6(b).

The proposed exception, however, is expressed in a short-cut manner that might leave its actual scope overly-broad or at best unclear. ACTEC’s comments also point out clarifications and suggest examples that could address these shortcomings.

D. A New Eighteen-Month Rule. The fourth type of transfer addressed by the proposed exception is described in Proposed Reg. §20.2010-1(c)(3)(i)(D) as “Transfers that would have been described in paragraph (c)(3)(i)(A), (B), or (C) of this section but for the transfer, relinquishment, or elimination of an interest, power, or property, effectuated within 18 months of the date of the decedent’s death by the decedent alone, by the decedent in conjunction with any other person, or by any other person” (emphasis added).

While similar to the existing three-year rule of section 2035(a), this provision is conspicuously extended to affirmative actions not by the decedent but “by any other person.” As such, it could apply to events within 18 months of death that would not cause inclusion in the gross estate under section 2035(a), thus going beyond the assumed purpose of protecting the statutory “clawback” objective of section 2035. Indeed, the preamble describes these events more narrowly as “the transfer, elimination, or relinquishment within 18 months of the donor’s date of death of the interest or power that would have caused inclusion in the gross estate” (emphasis added). A description in the preamble of course would probably not override the obviously intentional extension to actions of other persons in the proposed regulation itself, but it could provide support for the objection that the proposed regulation is overly broad.

A possible rebuttal to that objection is that section 2001(g)(2), after all, authorizes not only regulations that are “necessary” but also regulations that are “appropriate,” a standard that is more subjective and open to interpretation. It is noteworthy that, while the 18-month rule might overlap section 2035(a) with respect to most actions by the decedent, to the extent it goes beyond actions by the decedent it is moderated by the limitation to 18 months.

It is tempting to view 18 months as just a compromise split of three years, but it can also be viewed as applying the test for the non-deathbed (more precisely, “not terminally ill”) presumption in Reg. §25.7520-3(b)(3), which states:

“The mortality component prescribed under section 7520 may not be used to determine the present value of an annuity, income interest, remainder interest, or reversionary interest if an individual who is a measuring life dies or is terminally ill at the time the gift is completed. For purposes of this paragraph (b)(3), an individual who is known to have an incurable illness or other deteriorating physical condition is considered terminally ill if there is at least a 50 percent probability that the individual will die within 1 year. However, if the individual survives for eighteen months or longer after the date the gift is completed, that individual shall be presumed to have not been terminally ill at the date the gift was completed unless the contrary is established by clear and convincing evidence.”

Reg. §§1.7520-3(b)(3) and 20.7520-3(b)(3)(i) are similar.

This “terminally ill” model is consistent with the description in the preamble, which follows its reference to causing “inclusion in the gross estate” with a reference to “effectively allowing the donor to retain the enjoyment of the property for life” – that is, for all of life except for the last 18 months or less.

In the proposed anti-clawback exception, however, this 18-month test is offered not as a rebuttable presumption, but as a bright-line test. It seems reasonable to wonder why there isn’t the opportunity to avoid this 18-month rule by demonstrating, for example, that death within 18 months was caused by an accident or an illness that was not detected at the time of the relevant action. But, on the taxpayer-friendly side, it should also be noted that the bright-line test, unlike the section 7520 regulations, does not permit “the contrary” to be demonstrated if the person survives longer than 18 months.

The proposed bright-line test would be simple to administer and might for that reason be viewed as “appropriate,” even if not “necessary.” Also, any effort to find a “bright side” to the “bright-line” test might include the observation that if the regulations are finalized reasonably promptly – say, by the end of next year – there would still be time for persons who might contemplate a covered transfer, relinquishment, or elimination action but are fearful of the 18-month “clawback” to take that action more than 18 months before January 1, 2026, the earliest date the regulations would have an effect under current law.

Proposed Reg. §20.2010-1(c)(3)(ii)(B) provides that this 18-month rule does not apply to “Transfers, relinquishments, or eliminations … effectuated by the termination of the durational period described in the original instrument of transfer by either the mere passage of time or the death of any person” (emphasis added). This exception should encourage more attention to the provision of such durational periods when drafting original instruments of transfer.

ACTEC’s comments also address the 18-month rule, including a request for an explanation of what is intended when section 2035(a) does not otherwise apply and including the recommendation that the 18-month rule follow the model of section 2035(d) in excluding “any bona fide sale for an adequate and full consideration in money or money’s worth.”

Other Scenarios?

Of course, the phrase “including without limitation” in Proposed Reg. §20.2010-1(c)(3)(i) leaves open the possibility that scenarios other than the four scenarios spelled out would also be excepted from the anti-clawback rules. But the description “includible in the gross estate, or treated as includible in the gross estate for purposes of section 2001(b)” ought to be quite objective and easy to apply in most cases.

Five Percent De Minimis Rule

Proposed Reg. §20.2010-1(c)(3)(ii)(A) provides that the exception from the anti-clawback rules would not apply, and the anti-clawback rules in the 2019 regulations would continue to apply, to “Transfers includible in the gross estate in which the value of the taxable portion of the transfer, determined as of the date of the transfer, was 5 percent or less of the total value of the transfer.” The preamble explains this limitation by comparison to similar rules applicable to reversionary interests in sections 2037(a)(2) (estate tax consequences of the retention of a reversionary interest), 2042(2) (estate tax consequences of the possession of an “incident of ownership” in a life insurance policy), and 673(a) (consequences of a reversionary interest on the determination of grantor trust treatment). That makes sense because the types of transfers targeted by the exception do resemble reversionary interests. A 5 percent de minimis rule might also make sense because such transfers by definition would use a small amount of the doubled basic exclusion amount (“BEA”) compared to the total amount transferred. The preamble adds that “This bright-line exception … is proposed in lieu of a facts and circumstances determination of whether a particular transfer was intended to take advantage of the increased BEA without depriving the donor of the use and enjoyment of the property.”

Examples

The proposed addition to the regulations includes, in Proposed Reg. §20.2010-1(c)(3)(iii), seven reasonably helpful, but not particularly surprising, examples, illustrating the treatment of various combinations and amounts of gifts of cash and promissory notes, gifts to GRATs and GRITs, and use of DSUE amounts. Among other things, the examples confirm the results of the examples in the 2019 regulations that in the case of a portability election the DSUE amount is applied before the surviving spouse’s basic exclusion amount.

Effective Date

The contemplated addition to the regulations would apply only prospectively – that is, only to the estates of decedents dying on or after April 27, 2022, the date the proposed addition was published in the Federal Register. But it should also be noted that it would apply to the calculation of the future estate tax, even if the gift includible, or treated as includible, in the gross estate was made before April 27, 2022. Thus, it should be expected to first apply to the estate of someone who dies after December 31, 2025, when the “sunset” enacted in 2017 occurs, which the preamble to the proposed addition acknowledges. In that way, it would achieve the “anti-abuse” outcome described above with respect to gifts made and other lifetime actions taken since 2017 that result in estate includability, even if those lifetime actions were taken before April 27, 2022 – indeed, as early as January 1, 2018.

UPDATED ACTUARIAL TABLES UNDER SECTION 7520

Item 9 under the heading of “Gifts and Estates and Trusts” in the 2021-2022 Treasury-IRS Priority Guidance Plan is described as “Regulations under §7520 regarding the use of actuarial tables in valuing annuities, interests for life or terms of years, and remainder or reversionary interests.”

The previous mortality tables used to value life estates, remainders, annuities, and other factors dependent on life expectancies were based on 2000 census data and became effective May 1, 2009. Before that, mortality tables had taken effect on May 1, 1989, and May 1, 1999. Section 7520(c)(2) mandates revision of the tables at least once every 10 years. Thus, the tables provided by this guidance project were due by May 1, 2019. They have been delayed in part because the decennial life table data that form the basis for those tables was not compiled and made available by the National Center for Health Statistics of the Centers for Disease Control and Prevention until August 2020.

New tables, based on 2010 census data, are addressed in lengthy proposed regulations (REG-122770-18) released on May 4, 2022, and published in the Federal Register on May 5, 2022 (87 Fed. Reg. 26806). The new tables are available on the IRS website. The 2010 census data on which these new tables are based show significantly increased longevity, especially for older persons, compared to the 2000 census data. Accordingly, these new tables will produce significantly higher values for life interests and significantly lower values for remainder interests following life interests. For any given section 7520 interest rate, this will result, for example, in larger charitable deductions for charitable lead annuity trusts (CLATs) for the life of an individual, but smaller charitable deductions (and more difficulty satisfying the 10 percent remainder test and 5 percent exhaustion test) for charitable remainder annuity trusts (CRATs). Valuations based on a fixed term and not life expectancies are affected only by the monthly section 7520 rate and will not be affected by these new tables.

Effective Dates and Transitional Rules

In view of the tardiness of these tables, the proposed regulations include special effective date and transitional rules. The new tables will generally take effect on what is described as “the applicability date of the Treasury decision adopting these regulations as final regulations.” That date is “proposed” to be “the first day of the month following the date on which the Treasury decision adopting these regulations as final regulations is published in the Federal Register.” (The implication of the word “proposed” is that the final regulations could prescribe a different date, although that seems unlikely.)

Under Proposed Regs. §§20.2031-7(d)(3) and 25.2512-5(d)(3) (other specific proposed regulations have similar provisions), for gifts or dates of death on or after January 1, 2021, and before the “applicability date,” the mortality component of any applicable value, including a charitable deduction, may be determined under either the 2000 tables or these new 2010 tables “at the option of the donor or the decedent’s executor.” That choice must be the same choice with respect to all valuation elements of the same transfer and, for estate tax purposes, all transfers occurring at death. Specifically, those proposed regulations state:

“The decedent’s executor [or “with respect to each individual transaction, the donor”] must consistently use the same mortality basis with respect to each interest (income, remainder, partial, etc.) in the same property, and with respect to all transfers occurring on the valuation date. For example, gift and income tax charitable deductions with respect to the same transfer must be determined based on factors with the same mortality basis, and all assets includible in the gross estate and/or estate tax deductions claimed must be valued based on factors with the same mortality basis.”

The interest rate will be the applicable rate under section 7520 (which rates have continued to be published monthly without interruption) in effect for the month of the transfer or death.

Applying the rules already contained in Reg. §§1.7520-2(a)(2), 20.7520-2(a)(2), and 25.7520-2(a)(2), the preamble notes that, in the case of a charitable deduction, if the taxpayer elects under section 7520(a) to use the rate for one of the two preceding months, and that elected month is “prior to January 1, 2021” (in other words, it is November 2020 or December 2020), then only the 2000 mortality tables may be used to compute the mortality component.

The proposed regulations say nothing about transfers or deaths on or after May 1, 2019, and before January 1, 2021, thus implying that all valuations in such cases must still be made under the 2000 mortality tables.

Comments on the Effective Dates and Transitional Rules

ACTEC submitted comments on these proposed regulations on July 5, 2022. Emphasizing that “Code section 7520 mandates the adoption of new tables no less frequently than once every 10 years” (emphasis in original), the comments correctly conclude that “it seems appropriate, and perhaps legally required under Code section 7520, that the proposed new tables be available, at the election of the taxpayer, for any transactions occurring on or after May 1, 2019.”

To illustrate, consider the case of a CLAT created for the lifetime of the creator’s spouse by gift or at death on or after May 1, 2019, but before January 1, 2021. As noted above, the significantly increased longevity reflected in the 2010 census data would result in a significantly larger charitable deduction than the proposed regulations would allow. It seems that the donor or the decedent’s estate is entitled to that larger deduction by statute. Even conceding that the delay in completing these tables was due to circumstances beyond anyone’s control and thus was not anyone’s “fault,” it certainly wasn’t the fault of that donor or decedent, and it is not fair to deny the donor or the estate what the statute mandates.

But there is more. Suppose the annuity payment from the CLAT was defined as a percentage of the value of the property transferred to the CLAT (as allowed by Reg. §20.2055-2(e)(2)(vi)(a)), and that percentage was determined by a formula intended to achieve a certain estate or gift tax result – “zeroing out” the CLAT, for example, or something like that. And, for a pre-2021 transfer, it is likely that the gift or estate tax return has already been filed. The IRS has been wary of attempts to change those kinds of calculations in a manner that looks retroactive, as seen as early as Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944), rev’g and rem’g 2 T.C.M. 429 (1943), cert. denied, 323 U.S. 756 (1944), and as recently as Estate of Moore v. Commissioner, T.C. Memo. 2020-40. Therefore, whether the transition date is January 1, 2021, or May 1, 2019, or something in between, it is essential that the election allowed by the transitional rule relate back to the original transfer date for all purposes, with no possibility of challenge. This could be achieved, for example, by explicitly stating in the regulations that choosing the option provided by the transitional rule will not be treated as a condition subsequent or in any other way that would prevent or limit the application of a formula or other condition in a transfer document intended to determine the amount, value, character, or tax treatment of a transfer in whole or in part with reference to the mortality assumptions, even if a return reporting that transfer has already been filed.

EFFECTS OF GUARANTEES AND PRESENT VALUE CONCEPTS ON ESTATE TAX DEDUCTIONS

Item 5 in the 2021-2022 Treasury-IRS Priority Guidance Plan is described as “Regulations under §2053 regarding personal guarantees and the application of present value concepts in determining the deductible amount of expenses and claims against the estate.” Proposed regulations were released on June 24, 2022, and published in the Federal Register on June 28, 2022. REG-130975-08, 87 Fed. Reg. 38331.

Background

This project has an interesting history. Its origin can be traced to a project first announced in the 2003-04 Priority Guidance Plan, relating to the valuation of claims against the estate, especially claims being pursued in litigation pending on the date of the decedent’s death. It was intended in part to address a conflict among the federal courts of appeals, with the Fifth, Tenth, and Eleventh Circuits unwilling to consider post-death events and the Eighth Circuit apparently more willing to do so. Estate of Smith v. Commissioner, 198 F.3d 515 (5th Cir. 1999); Estate of McMorris v. Commissioner, 243 F.3d 1254 (10th Cir. 2001); Estate of O’Neal v. United States, 258 F.3d 1265 (11th Cir. 2001); Estate of Sachs v. Commissioner, 856 F.2d 1158 (8th Cir. 1988).

That guidance project produced regulations proposed in April 2007 and finalized in October 2009. But that was not the end of it. Among other things, the 2007 proposed regulations had drawn a distinction between noncontingent (fixed) obligations and contingent (uncertain or contested) obligations. Those proposed regulations had attempted to allow the immediate deduction of noncontingent obligations, but limited to the discounted present value of those obligations, and a dollar-for-dollar deduction for contingent obligations, but only when those obligations were determined and paid. Public comments to the proposed regulations objected to that dichotomy, and Treasury and the IRS decided to finalize the regulations without addressing that issue and to reserve that issue for future consideration. They elaborated the significance of present value concepts in this paragraph in the preamble to the 2009 final regulations (T.D. 9468, 74 Fed. Reg. 53652 (Oct. 20, 2009)):

“Some commentators suggested that the disparate treatment afforded noncontingent obligations (deduction for present value of obligations) versus contingent obligations (dollar-for-dollar deduction as paid) is inequitable and produces an inconsistent result without meaningful justification. These commentators requested that the final regulations allow an estate to choose between deducting the present value of a noncontingent recurring payment on the estate tax return, or instead deducting the amounts paid in the same manner as provided for a contingent obligation (after filing an appropriate protective claim for refund). The Treasury Department and the IRS find the arguments against the disparate treatment of noncontingent and contingent obligations to be persuasive. The final regulations eliminate the disparate treatment by removing the present value limitation applicable only to noncontingent recurring payments. The Treasury Department and the IRS believe that the issue of the appropriate use of present value in determining the amount of the deduction allowable under section 2053 merits further consideration. The final regulations reserve §20.2053-1(d)(6) to provide future guidance on this issue.”

That future guidance, which has now led to the current proposed regulations, first appeared in the 2008-2009 Priority Guidance Plan.

A Big Delay After 2009

So let’s recap: A guidance project in 2003, proposed regulations in 2007, a new follow-up guidance project in 2008, final regulations with that issue deferred in 2009, and then new proposed regulations in – 2022? A big gap. And this is not the only guidance project with such a history.

What happened after 2009? Well, the simple answer is 2010. The repeal of the estate tax and GST tax and their replacement with carryover basis, all sunsetted at the end of the year. Even though that had been in the law since 2001, many were not expecting it. With Republican gains in Congress in an extraordinary three consecutive elections (2000, 2002, and 2004) and more Republicans in the Senate than there had been since Herbert Hoover was President, many thought the repeal would be made permanent. In July 2005, just before the August recess, Senate Majority Leader Bill Frist of Tennessee filed a “cloture” motion, basically “calling the question” (which requires approval of 60 Senators) on a House-passed bill that could have made repeal of the estate tax permanent or possibly replaced it with, for example, a much lower estate tax rate like 15 percent. When the Senate was scheduled to reconvene on September 6, the day after Labor Day, this would have been perhaps the second item of business. But by Labor Day, the terrific losses wrought by Hurricane Katrina had become a way-too-awkward backdrop for repeal or substantial reduction of the estate tax, and the vote was postponed. When the vote was finally held on June 8, 2006, support had weakened, and it gained only 57 votes, falling three votes short.

Efforts continued as late as December 16, 2009, when Finance Committee Chairman Max Baucus (D-Montana) asked the Senate for unanimous consent to take up a bill that would freeze 2009 law (including an estate tax exemption of $3.5 million, a gift tax exemption of $1 million, a top rate of 45 percent, and a stepped-up basis at death for appreciated assets), approve an amendment to extend 2009 law for only two months, and approve the bill as amended. In response, Republican Leader Mitch McConnell (R-Kentucky), asked Senator Baucus to agree to consideration of an amendment reflecting, as Senator McConnell described it, “a permanent, portable, and unified $5 million exemption that is indexed for inflation, and a 35-percent top rate.” Predictably, Senator Baucus objected to Senator McConnell’s request, whereupon Senator McConnell objected to Senator Baucus’s request, and all practical hopes of transfer tax legislation in 2009 died. And 2010 arrived like few had expected with very little preparation, other priorities like clawback (discussed above) and portability (discussed below) emerged, and other guidance was delayed.

Where the cause and effect were in all this is debatable. But the delays have been palpable. And picking this project up where it was left in 2009, as one of four developments in less than four months, explains the use of “Surge” in the title of this Capital Letter. And with proposed regulations from 2008 (extensions of time to allocate GST exemption), 2015 (transfers from expatriates under section 2801), and 2016 (consistent basis rules) still pending on the Priority Guidance Plan, the catch-up “surge” might not be over.

Back to the Present (Value) – With a Three-Year Grace Period

The June 2022 Proposed Reg. §20.2053-1(d)(6) specifically addresses the issues in the paragraph from the 2009 preamble quoted above and the use of “present value concepts” in the Priority Guidance Plan. Except for unpaid principal of mortgages and other indebtedness deductible under Reg. §20.2053-7, it would require a present-value discounting of claims and expenses not paid or expected to be paid within a “grace period” ending three years after the decedent’s death. Under Proposed Reg. §20.2053-1(d)(6)(i)(B), the discount rate to be used would be the applicable federal rate determined under section 1274(d) for the month in which the decedent died, compounded annually. Whether that is the mid-term rate (3-9 years) or long-term rate (over 9 years) would be determined by the length of time from the date of the decedent’s death to the date of payment or expected date of payment. Proposed Reg. §20.2053-1(d)(6)(vi) provides that any such discounted deduction is “subject to adjustment” to reflect any change in the amount or timing of the payment while the statute of limitations on assessment of estate tax has not run or a claim for refund is pending.

Comments on Discounting and the Three-Year Grace Period

The preamble to the proposed regulations offers the following explanation and justification of the three-year grace period:

“The Treasury Department and the IRS propose to amend the regulations under section 2053 to incorporate present-value principles in determining the amount deductible under section 2053 for claims and expenses (excluding unpaid mortgages and indebtedness deductible under §20.2053-7). The Treasury Department and the IRS recognize, however, that estates often cannot pay every deductible claim and expense within a short time after the decedent’s death and that sound tax administration should balance the benefit of more accurately determining the amounts not passing to the beneficiaries of an estate garnered from applying present-value principles with the administrative burden of applying those principles to deductible claims and expenses that occur during a reasonable period of administration of the estate. The Treasury Department and the IRS understand that a significant percentage of estates pay most, if not all, of their ordinary estate administration expenses during the three-year period following the decedent’s date of death. This three-year period takes into account a reasonable time for administering and closing the estate. The Treasury Department and the IRS note that a reasonably short period of time between the decedent’s death and the payment of a claim prevents the lack of a present-value discount from significantly distorting the value of the net (distributable) estate. Applying present-value principles in computing the deductible amount of those claims and expenses paid more than three years after the decedent’s death strikes an appropriate balance between benefits and burdens.”

Many – perhaps almost all – estates are closed, or, as the preamble puts it “pay most, if not all, of their ordinary estate administration expenses,” within three years after the decedent’s date of death. But that is not necessarily true of estates subject to federal estate tax. Often a taxable estate, being typically a larger and more complex estate, requires steps that can be quite involved, including (1) marshaling and valuing assets (which could be of several kinds, spread among several jurisdictions, domestic and foreign); (2) liquidating assets (marketing, negotiating and documenting the sale, and collecting the sales price, sometimes over time); (3) managing assets (which could be operating businesses facing transitions, successions, and more negotiations or renegotiations as a result of the decedent’s death); (4) determining the appropriate allocations of assets among beneficiaries (including special tangible assets, which sometimes require discussion and in effect a type of “negotiation”); (5) making distributions (including documenting, receipting, and sometimes packing, shipping, and insuring); (6) obtaining court approvals; (7) preparing accountings, reports to beneficiaries, and of course tax returns; and (8) dealing with any will contest or other litigation.

But perhaps the biggest (and “reasonable”) cause for being conservative and not rushing the closing of the estate is to make sure that liabilities are identified and provided for, including the federal estate tax itself. Even if the federal estate tax return is filed without an extension, the normal three-year statute of limitations on assessment of additional tax will not run until three years and nine months after the date of the decedent’s death – necessarily beyond the three-year grace period. Of course, many of these related administration expenses, as well as claims, can still be actually paid within three years, not deferred, and the deferral of distributions themselves, which might be the most common consequence of conservative administration, will ordinarily not directly implicate the three-year grace period. Moreover, if there is an estate tax audit, the resolution of the audit can often be the occasion for claiming more deductions.

Overall, though, while extending the administration of an estate beyond three years can certainly be “reasonable” under the circumstances, three years does seem to be “an appropriate balance between benefits and burdens.” The underlying principle of discounting future payments is not surprising – we discount receivables for purposes of determining the amounts includable in the gross estate; it’s hard to object to discounting payables for purposes of section 2053 deductions. Three years both acknowledges that principle of discounting and acknowledges that death is unplanned and disruptive and the executor needs time to get things together. To be sure, the three years in the proposed regulations is a “cliff,” meaning that a payment expected to be made 35 months after death would not be discounted at all but a payment expected to be made 37 months after death would be discounted for the whole 37 months. But that may be an unavoidable consequence of striking a fair and administrable balance.

Comment on Math

Proposed Reg. §20.2053-1(d)(6)(i)(B) states that:

“The present value of each post-grace-period payment is calculated by discounting it from the payment date or expected date of payment to the decedent’s date of death. The applicable discount rate is the applicable Federal rate determined under section 1274(d) for the month in which the decedent’s death occurs, compounded annually. The length of time from the decedent’s date of death to the date of payment or expected date of payment will determine whether the Federal rate applicable to that payment is the Federal mid-term rate or the Federal long-term rate.”

Proposed Reg. §20.2053-1(d)(6)(ii) adds that each post-grace-period payment, including each payment that is one of multiple payments, is calculated as the “amount of future payment × [1 ÷ (1 + i)]^t where t is the amount of time (expressed in years and fractions of years) from the day after the decedent’s date of death to the payment date or expected date of payment; and i is the applicable discount rate.”

While that seems straightforward, and most of these calculations will probably be done by appraisers or return preparers with access to sophisticated calculation programs, it still seems that the principles of administrability and balance would probably also be served by finding ways to simplify these calculations. For example, the final regulations might provide for:

• “Rounding” to the nearest calendar month, or, more precisely, to use as the payment date the day of the month corresponding to the decedent’s date of death (a kind of “anniversary,” except it’s monthly) immediately preceding the actual expected date of payment.
• An assumption that each “month” measured from the date of death is exactly one-twelfth of the year and that the discount calculated under the formula for each such “month” (again, measured from the decedent’s date of death) is exactly one-twelfth of the additional discount for that “year.”
• A determination of how to deal with dates of death and/or dates of payment so that it is clear in all cases how many months are included when the calendar months involved may have a different number of days, especially where the date of death is later than the 28th day of the calendar month.

It may be best that these assumptions are mandatory and not elective, so there would be no incentive to do all the calculations each way and choose the most favorable outcome in order to avoid criticism. But if these assumptions are nevertheless made elective, perhaps it should be possible to make or not make each election independently, so that professionals with more sophisticated computer programs, for example, would not be disadvantaged.

Deduction of Interest on Taxes

A new Proposed Reg. §20.2053-3(d) (with the current paragraphs (d) and (e) redesignated paragraphs (e) and (f)) addresses the deduction of interest as an estate administration expense.

Proposed Reg. §20.2053-3(d)(1)(i) affirms the nondeductibility of interest on federal estate tax deferred under section 6166, in accordance with section 2053(c)(1)(D), which was added to the Code in 1997. The primary motivation for this change in 1997 had been to “eliminate the need to file annual supplemental estate tax returns and make complex iterative computations to claim an estate tax deduction for interest paid.” Staff of the Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997 (“Bluebook”) 71 (Dec. 17, 1997), copying Revenue Reconciliation Act of 1997, Report of the Senate Committee on Finance, 105th Cong., 1st Sess. 48 (June 20, 1997), and Revenue Reconciliation Act of 1997, Report of the Committee on the Budget of the House of Representatives, 105th Cong., 1st Sess. 356 (explanatory language transmitted by the Ways and Means Committee) (June 24, 1997). The 1997 action was accompanied by a presumably compensating reduction of the interest rate on the deferred estate tax on the first $1 million of value (indexed for inflation, $1.64 million in 2022) to 2 percent. Ironically, in January-March 2011, October 2011-March 2016, and, recently, July 2020-March 2022, the regular interest rate on deferred tax has been 3 percent, which, net of the 35 percent (in 2011 and 2012) and 40 percent (since 2013) estate tax savings from a deduction, would have produced an effective rate of interest on the entire deferred amount of tax of roughly (not time-adjusted) 1.95 percent and 1.8 percent, respectively – in other words, lower than the 2 percent rate that had presumably been viewed as a bargain in 1997 (when the regular interest rate was 9 percent).

Proposed Reg. §20.2053-3(d)(1)(ii) and (iii) affirm and amplify the requirement of Reg. §20.2053-3(a) that to be deductible the payment of interest must be “actually and necessarily incurred in the administration of the decedent’s estate.” Proposed Reg. §20.2053-3(d)(1)(ii) states that interest on federal estate tax deferred under section 6161 or 6163 meets that requirement because of “a demonstrated need to defer payment,” while other interest on unpaid federal tax or interest payable under state or local law “generally” meets that requirement. But Proposed Reg. §20.2053-3(d)(1)(iii) provides that interest does not meet that requirement “to the extent the interest expense is attributable to an executor’s negligence, disregard of applicable rules or regulations (including careless, reckless, or intentional disregard of rules or regulations) as defined in [Reg. §1.6662-3(b)(2)], or fraud with intent to evade tax.” Because the proposed regulation confirms that interest on federal tax is “generally” deductible, it should be presumed (hoped?) that this exception would be applied with moderation and balance.

Deduction of Interest on Loans

Proposed Reg. §20.2053-3(d)(2) addresses “interest on a loan entered into by the estate to facilitate the payment of the estate’s tax and other liabilities or the administration of the estate.” It proposes that such interest “may be deductible depending on all the facts and circumstances.” In general, citing Reg. §20.2053-1(b)(2), the proposed regulation would require that the loan and the interest expense be “bona fide,” and, again echoing Reg. §20.2053-3(a), would require that “both the loan to which the interest expense relates and the loan terms must be actually and necessarily incurred in the administration of the decedent’s estate and must be essential to the proper settlement of the decedent’s estate.” The proposed regulation goes on to provide a non-exclusive list of 11 factors it describes as “factors that collectively may support a finding that the interest expense also satisfies the additional requirements under §20.2053-1(b)(2) and paragraph (a) of this section.”

For example, the eighth factor, in subdivision (viii) of Proposed Reg. §20.2053-3(d)(2), is (emphasis added):

“The estate’s illiquidity does not occur after the decedent’s death as a result of the decedent’s testamentary estate plan to create illiquidity; similarly, the illiquidity does not occur post-death as a deliberate result of the action or inaction of the executor who then had both knowledge or reason to know of the estate tax liability and a reasonable alternative to that action or inaction that could have avoided or mitigated the illiquidity.”

The preamble elaborates (emphasis added):

“Among the reasons an estate might enter into a loan arrangement is to facilitate the payment of the estate’s taxes and other liabilities or the administration of the estate. Some estates face genuine liquidity issues that make it necessary to find a means to satisfy their liabilities, and incurring a loan obligation on which interest accrues may be the only or best way to obtain the necessary liquid funds. However, if illiquidity has been created intentionally (whether in the estate planning, or by the estate with knowledge or reason to know of the estate tax liability) prior to the creation of the loan obligation to pay estate expenses and liabilities, the underlying loan may be bona fide in nature but most likely will not be found to be actually and necessarily incurred in the administration of the estate.”

Later the preamble states (emphasis added) that “if, taken in their entirety, the facts and circumstances indicate that either the need for the loan or any of the loan terms are contrived to generate, or increase the amount of, a deduction for the interest expense, the interest is not deductible.”

Comment on Interest on Loans

A lot of entirely legitimate “estate planning,” especially in the context of family-owned and -operated businesses, includes the creation of safeguards to preserve family ownership, which necessarily prevent or seriously limit transfers outside the family. The side effect could of course be viewed as “illiquidity.” Estate planners would welcome some assurance that such resulting “illiquidity” is unquestionably “genuine” (as the preamble puts it), and that such legitimate business planning is not the target, and should not even be a collateral object, of these regulations.

At a minimum, there should be some clarification in the preamble to the final regulations. But acknowledgment in the regulations themselves would be much more preferable, perhaps both with substantive text and with positive and negative examples. As for the substantive text, a starting point (albeit timid) might be the approach taken in the proposed multiple-trust regulations that were released on August 16, 2018, amplifying the test in section 643(f)(2) that “a principal purpose of such trusts is the avoidance of … tax.” Proposed Reg. §1.643(f)-1(b) stated: “A principal [tax-avoidance] purpose for establishing or funding a trust will be presumed if it results in a significant income tax benefit unless there is a significant non-tax (or non-income tax) purpose that could not have been achieved without the creation of these separate trusts.” The final section 643 regulations in 2019 dropped this downgrading of the “principal purpose” standard to a “significant income tax benefit” standard. But such a “significant non-tax purpose” safe harbor may well be a helpful reinforcement of the suggestion in Proposed Reg. §20.2053-3(d)(2) that “all the facts and circumstances” must be considered and of the overall theme of the proposed regulations that they are seeking an “appropriate balance.”

Choice of Lender

The ninth and tenth “factors that collectively may support a finding that the interest expense also satisfies the additional requirements” of the regulations, in subdivisions (ix) and (x) of Proposed Reg. §20.2053-3(d)(2), are (emphasis added):

“(ix) The lender is not a beneficiary of a substantial portion of the value of the estate, and is not an entity over which such a beneficiary has control (within the meaning of section 2701(b)(2)) or the right to compel or direct the making of the loan.

“(x) The lender or lenders are not beneficiaries of the estate whose individual share of liability under the loan is substantially similar to his or her share of the estate.”

Comment on the Choice of Lender

It is understandable that the IRS and Treasury would be concerned about structures that might try to convert distributions to beneficiaries in their capacities as beneficiaries into interest payments that are deductible in computing the estate tax. Or concerned about borrowing from a family-owned entity that might own enough liquid assets to have accommodated the funding of the estate’s tax and other obligations with a simple distribution, as analyzed in Estate of Koons v. Commissioner, 686 Fed. Appx. 779, 119 AFTR 2d 2017-1609 (11th Cir. 2017), aff’g T.C. Memo. 2013-94, and cases cited therein. But it is also the experience of many estate planners that the option of borrowing from a family-owned entity, including an operating business, may be not only most convenient but also most protective of the viability of that entity or business whose owners are faced with tax liabilities that shareholders of public corporations, for example, could satisfy simply by sales of stock that do not affect the company. The proposed regulations would not prohibit the deduction of interest in such cases; they simply offer “factors” to be weighed. Again, estate planners would welcome some assurance in the final regulations that such weighing would strike an “appropriate balance.”

Graegin Loans

In any event, a big effect of these proposed regulations is that Graegin loans (see Estate of Graegin v. Commissioner, T.C. Memo. 1988-477), which prohibit prepayment of either principal or interest and therefore have been held to allow a full undiscounted estate tax deduction for the payment of interest that might be deferred for, say, 15 years, would lose that element of their effectiveness. Even if such loans satisfy the “bona fide” and “actually and necessarily incurred” tests, the interest would be expected to be paid more than three years after the decedent’s death and thus would be discounted under Proposed Reg. §20.2053-1(d)(6).

Personal Guarantees

New Proposed Reg. §20.2053-4(d)(5)(ii) addresses the “personal guarantees” component of the guidance project. Currently, Reg. §20.2053-4(d)(5) affirms that under section 2053(c)(1)(A), except for pledges or subscriptions addressed in Reg. §20.2053-5, deducting a claim based on a promise or agreement requires that the promise or agreement was bona fide (that is, was bargained for at arm’s length and, in the case of a claim involving a family member, meets the requirements of Reg. §20.2053-1(b)(2)(ii)) and was in exchange for adequate and full consideration in money or money’s worth. The new subdivision (ii) would provide that those tests are met by a decedent’s agreement to guarantee a debt of an entity if, at the time the guarantee is given, either the decedent had an interest in the entity and had control of the entity within the meaning of section 2701(b)(2) or the maximum liability of the decedent under the guarantee did not exceed the fair market value of the decedent’s interest in the entity. The amount deductible is reduced to the extent the guaranteed debt is taken into account in computing the value of the gross estate or the estate has a right of contribution or reimbursement.

Appraisals

Reg. §20.2053-4(b) and (c), part of the 2009 amendments of the regulations, incorporate the “qualified appraisal” and “qualified appraiser” concepts from the context of valuing charitable gifts for income tax purposes into the context of valuing certain claims against the estate for estate tax purposes. The preamble to the current proposed regulations acknowledges that those concepts are an awkward fit, and proposed amendments to those regulations would replace it with a list of requirements for an appraisal that is more focused on the section 2053 context. One of those requirements, in Proposed Reg. §20.2053-4(b)(1)(iv)(F) and (c)(i)(iv)(F), is that the appraisal be signed by the appraiser “under penalties of perjury.”

Comment on Appraisals

The requirement that the appraiser sign the appraisal “under penalties of perjury” is apparently unprecedented, not appearing anywhere in the Code or regulations, and it is especially surprising in a context that requires the appraiser to be unrelated and therefore less likely to have first-hand knowledge of the underlying facts. It appears that it should be deleted from the final regulations.

Effective Date and Timing

As proposed, the changes in the proposed regulations would apply to the estates of decedents dying on or after the date the final regulations are published in the Federal Register.

The preamble to the proposed regulations requests public comments by September 26, 2022, and schedules a public hearing by teleconference, if requested, on October 12, 2022.

EXPANDED RELIEF FOR PORTABILITY ELECTIONS

Background

Portability of a deceased spouse’s unused gift and estate tax exclusion amount (“DSUE amount”) to the surviving spouse was enacted for 2011 and 2012 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Act) and made permanent by the American Taxpayer Relief Act of 2012. Because portability was seen as a simplification, it was a surprise to some that section 2010(c)(5)(A) required it to be affirmatively elected. But the analogs of gift-splitting and joint income tax returns that were cited in support of portability require affirmative elections, and a requirement of an election had been included in every legislative proposal of portability since 2006, despite criticisms. It is possible that Congress thought an election by the predeceased spouse’s executor was necessary in order to keep that spouse’s estate tax return open to audit under section 2010(c)(5)(B) for the limited purpose of determining the amount of unused exclusion amount (not to make adjustments to that return itself, which is governed by the regular statute of limitations). The 2012 preamble to Temporary Reg. §20.2010-2(a), which confirmed that the portability election must be made on a “timely filed” estate tax return of the predeceased spouse, adds that “this rule will benefit the IRS as well as taxpayers choosing the benefit of portability because the records required to compute and verify the DSUE amount are more likely to be available at the time of the death of the first deceased spouse than at the time of a subsequent transfer by the surviving spouse by gift or at death, which could occur many years later.”

The question is what is “timely.” Section 2010(c)(5)(A) requires that the portability election be made on an estate tax return, but may not be made “if such return is filed after the time prescribed by law (including extensions) for filing such return.” Section 6075(a) designates nine months after the date of the decedent’s death for filing “returns made under section 6018(a)” (and section 6081(a) allows extensions of up to six months). Section 6018(a), however, requires a return for the estate of a U.S. citizen or resident only “where the gross estate … exceeds the basic exclusion amount” – that is, an estate tax return required for estate tax purposes. An estate tax return filed only to elect portability is not addressed. That takes us to section 6071, which states that when the time for filing is “not otherwise provided for” by the Internal Revenue Code, it shall be prescribed “by regulations.”

Temporary regulations (T.D. 9593, 77 Fed. Reg. 36150 (June 18, 2012)) and identical proposed regulations (REG-141832-11, id. at 36229) were released on Friday, June 15, 2012, just barely within 18 months after the enactment of the 2010 Tax Act on December 17, 2010, and therefore permitted by section 7805(b)(2) to be retroactive to January 1, 2011. Final regulations, very similar to the temporary and proposed regulations, were released on June 12, 2015, three days before the temporary regulations would have expired under section 7805(e)(2). T.D. 9725, 80 Fed. Reg. 34279 (June 16, 2015). Reg. §20.2010-2(a)(1) establishes the due date of the return for “an estate that elects portability” as the same as a return required for estate tax purposes – nine months after death, plus any extension. And perhaps the most notable and welcome feature of the regulations pertaining to such returns required only to make the portability election is the relaxed requirement for reporting values of estate assets in Reg. §20.2010-2(a)(7)(ii).

On January 27, 2014, the IRS published Rev. Proc. 2014-18, 2014-7 I.R.B. 513. It noted that the due date of an estate tax return not required for estate tax purposes but filed only to elect portability is prescribed by the portability regulations, not by statute, and therefore extensions of time to make the portability election are allowed under Reg. §301.9100-3, and the IRS had granted such “9100 relief” in several letter rulings. Accordingly, the revenue procedure provided a simplified method to obtain an extension of time by simply filing the otherwise late estate tax return on or before December 31, 2014, and stating at the top of the return “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER §2010(c)(5)(A).”

On June 9, 2017, the IRS published Rev. Proc. 2017-34, 2017-26 I.R.B. 1282, similar to Rev. Proc. 2014-18, basically extending the available relief for filing a late portability-election-only return through the later of January 2, 2018, or the second anniversary of the decedent’s death. The extension of time was obtained by filing an estate return stating at the top “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER §2010(c)(5)(A).” The revenue procedure explained the two-year period this way:

“Making the simplified method of this revenue procedure available after January 2, 2018, to estates during the two-year period immediately following the decedent’s date of death should not unduly compromise the ability of the taxpayer or the Service to compute and verify the DSUE amount because the necessary records are likely to be available during that period. In addition, limiting the availability of this simplified method to that two-year period could be beneficial to the surviving spouse or the surviving spouse’s estate in two ways. First, it increases the likelihood that the portability election will be made before the surviving spouse or the executor of the surviving spouse’s estate is required to file a gift or estate tax return, thus eliminating the need to file such a return without claiming any DSUE amount and then, after the portability election has been made, having to either file a supplemental return or file a claim for a credit or refund. Second, if the allowance of the portability election made pursuant to this revenue procedure and the corresponding revised computation of the surviving spouse’s applicable credit amount would result in a credit or refund of the surviving spouse’s gift or estate tax, the availability of the simplified method during the two-year period may reduce the risk that the period under §6511 for filing a claim for that credit or refund (generally, extending three years from the date of filing or, if later, two years from the date of payment) would expire before the portability election could be made pursuant to this revenue procedure.”

Current Expansion of Relief

Rev. Proc. 2022-32, 2022-30 I.R.B. 101 (published July 8, 2022), expands the relief provided by Rev. Procs. 2014-18 and 2017-34 until the fifth anniversary of the decedent’s death, by filing an estate return prepared in accordance with Reg. §20.2010-2(a)(7) that states at the top “FILED PURSUANT TO REV. PROC. 2022-32 TO ELECT PORTABILITY UNDER §2010(c)(5)(A).” It explains:

“Since the publication of Rev. Proc. 2017-34, the IRS has continued to issue numerous letter rulings under §301.9100-3 granting an extension of time to elect portability under §2010(c)(5)(A) in situations in which the decedent’s estate was not required by §6018(a) to file an estate tax return and the time for obtaining relief under the simplified method had expired. The IRS has observed that a significant percentage of these ruling requests have been from estates of decedents who died within five years preceding the date of the request.”

As in the previous revenue procedures, the relief allowed by Rev. Proc. 2022-32 does not require a ruling request or user fee, but beyond the fifth anniversary of the decedent’s death 9100 relief will continue to be available. Also, after an executor takes advantage of this relief, if it is determined that an estate tax return was required under section 6018(a) for estate tax purposes after all, the relief under Rev. Proc. 2022-32 will be “deemed null and void ab initio.”

Comment on the Concerns of Rev. Proc. 2017-34

Rev. Proc. 2022-32 does not mention the observations in Rev. Proc. 2017-34 that a two-year limit would minimize the likelihood that an amended gift or estate tax return or claim for refund by the surviving spouse or the surviving spouse’s executor might be required or that the statute of limitations on obtaining a refund might have run. Consistently with Rev. Proc. 2017-34, Rev. Proc. 2022-32 does affirm that if the surviving spouse or the surviving spouse’s executor pays gift or estate tax that later proves to be an overpayment because of a subsequent portability election for the predeceased spouse’s estate made pursuant to this relief, a refund must be claimed before the statute of limitations has run.

As a practical matter, however, if such a return by the surviving spouse or the surviving spouse’s executor is required, especially a return that results in the payment of tax, someone involved in preparing the return or advising about its preparation would probably have had the opportunity to notice the need for a portability election.

Ronald D. Aucutt

© Copyright 2022 by Ronald D. Aucutt. All rights reserved.