The Administration’s Fiscal Year 2023 Budget Proposals

The Treasury Department’s General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals offers a few new ideas and a lot of refining and refocusing of ideas previously offered.

Dear Readers Who Follow Washington Developments:

The Treasury Department released its “General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals” (popularly called the “Greenbook”) on March 28, 2022. Many of its proposals resemble legislative proposals made last year (including in the Fiscal Year 2022 Greenbook) that were not included in the “Build Back Better Act” (H.R. 5376) stalled in the Senate after being passed by the House of Representatives on November 19, 2022.

In an election year with a sharply divided Congress, it is possible – if not likely – that none of the Greenbook proposals will be acted on. On March 15, 2022, President Biden signed the Consolidated Appropriations Act, 2022 (Public Law 117-105), which provides funding for the federal government for the fiscal year ending September 30, 2022. That Act was not a budget reconciliation act, however, leaving open the theoretical possibility that the budget reconciliation process could still be used to enable the Senate, without needing 60 votes to end debate, to pass a presumably trimmed-down version or replacement of the “Build Back Better Act,” possibly including some of these Greenbook proposals. On the other hand, the funding of the government through September 30 removes one of the motivations that has produced last-minute congressional tax legislation in the past to prevent a politically embarrassing government shutdown. After September 30, with the November 8 elections even closer, and after November 8, with a “lame-duck” Congress, such legislation seems even less likely.

So it is possible that some of the following proposals could be picked up and added to some pending bill for a number of reasons – including policy, revenue, conformity and balance, negotiation, inattention, or a combination of these. But it would not be easy.

Even so, whenever we see legislative proposals articulated like this, it is important to pay attention, because they are constantly evolving and could be pulled from the shelf and enacted, if not this year then in the future when the political climate is different. Such proposals never completely go away. And each time they are refined and updated, we can learn more about what to watch for and how to react.

INDIVIDUAL INCOME TAX RATES, INCLUDING CAPITAL GAINS

Like last year’s Greenbook, the current Greenbook proposes (at page 29) to accelerate the return of the top marginal individual income tax rate to 39.6 percent (as it was before 2018 and will be again in 2026 under the 2017 Tax Act), effective January 1, 2023. Unlike last year, however, it would lower the levels of taxable incomes at which that rate would apply to $450,000 for joint returns, $400,000 for unmarried individuals (other than surviving spouses), $425,000 for heads of households, and $225,000 for married individuals filing separate returns. After 2023, the thresholds would be indexed for inflation using the “Chained CPI” (“C-CPI-U”) that was introduced in the 2017 Tax Act. This proposal is estimated to raise approximately $187 billion over the next 10 fiscal years. (Overall, the tax increases proposed by the Greenbook are estimated to raise revenue over the next 10 fiscal years by about $2.5 trillion.)

Also mirroring last year’s Greenbook, the current Greenbook proposes (at page 31) to tax capital gains and qualified dividends at the same rate as ordinary income (that is, 37 percent under current law or 39.6 percent as proposed). This would apply to taxpayers with taxable income (not adjusted gross income as in last year’s proposal) over $1 million ($500,000 for married individuals filing separately). It would be effective for gains “required to be recognized” and dividends received on or after the date of enactment (not the puzzling “date of announcement” as in last year’s proposal).

DEEMED REALIZATION OF CAPITAL GAINS

In terms almost identical to last year’s Fiscal Year 2022 Greenbook, discussed in Capital Letter Number 52, the current Greenbook (at pages 30-33) again advocates the “deemed realization” of capital gains upon transfers by gift and at death.

Effective Date

The proposal would take effect on January 1, 2023. But it would apply to pre-2023 appreciation; there would be no “fresh start” as, for example, in the 1976 carryover basis legislation.

Realization Events

Gain would be explicitly recognized on transfers by gift or at death, equal to the excess of an asset’s fair market value on the date of the gift or death over the donor’s or decedent’s basis in that asset. The Greenbook does not mention holding periods or distinguish short-term and long-term gain. The Greenbook also does not specifically incorporate the alternate valuation date for transfers at death, although it does state generally that a transfer “would be valued at the value used for gift or estate tax purposes.”

Taxpayer, Return, and Deductibility

The Greenbook states that the gain would be reported “on the Federal gift or estate tax return or on a separate capital gains return.” Reassuringly, however, the Greenbook confirms that the gain “would be taxable income to the decedent” and, consistently with that characterization, explicitly adds that “the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate (if any).” That means that, after all exclusions are used, the proposed 39.6 percent capital gains rate and the current 40 percent estate tax rate would produce a combined tax rate on appreciation of 63.76 percent (0.396 + 0.4 × (1 – 0.396)).

Exclusion for Tangible Personal Property

The Greenbook would exclude “tangible personal property such as household furnishings and personal effects (excluding collectibles).”

Exclusion for Transfers to Spouses

The Greenbook would exclude “transfers to a U.S. spouse.” There is no elaboration of the term “U.S. spouse” (for example, citizen or resident), and there are no special provisions targeted to spousal trusts. Transfers to a spouse would carry over the transferor’s basis. Thus, the effect of excluding transfers to spouses would be simply to defer the application of the deemed realization rules until the spouse’s disposition of the asset or the spouse’s death.

Exclusion for Transfers to Charity

The Greenbook would exclude “transfers … to charity.” It adds that “the transfer of appreciated assets to a split-interest trust would be subject to this capital gains tax, with an exclusion from that tax allowed for the charity’s share of the gain based on the charity’s share of the value transferred as determined for gift or estate tax purposes.” Like transfers to a spouse, transfers to charity would carry over the transferor’s basis.

Other Exclusions

The Greenbook proposes a unified exclusion of capital gains for transfers both by gift and at death of $5 million per person (up from $1 million last year), indexed for inflation after 2022 and “portable to the decedent’s surviving spouse under the same rules that apply to portability for estate and gift tax purposes.” The Greenbook adds that this would “result … in a married couple having an aggregate $10 million exclusion,” but, like last year’s Greenbook, it does not explain exactly how that would be accomplished for lifetime gifts when there has been no “decedent” or “surviving spouse.” The Greenbook does not address whether the use of the exclusion for lifetime gifts is mandatory or elective. But it adds, quixotically and without further elaboration, that the $5 million exclusion “would apply only to unrealized appreciation on gifts to the extent that the donor’s cumulative total of lifetime gifts exceeds the basic exclusion amount in effect at the time of the gift.” Could it be saying, in effect, that a lifetime gift must actually generate a gift tax liability for the donor to use this $5 million exclusion of gain during life? So the first $12 million or so of gifts would trigger recognition of gain, and after that gifts with $5 million of appreciation would escape deemed realization, and after that gifts would trigger gain again? Odd.

But in an apparent reversal of last year’s Greenbook, the current Greenbook states that “the recipient’s basis in property, whether received by gift or by reason of the decedent’s death, would be the property’s fair market value at the time of the gift or the decedent’s death” (except, presumably, for excluded transfers to spouses and to charity discussed above). Last year’s Greenbook, not surprisingly, included the caveat that “the donee’s basis in property received by gift during the donor’s life would be the donor’s basis in that property at the time of the gift to the extent the unrealized gain on that property counted against the donor’s $1 million exclusion from recognition.” Could it be that the current Greenbook would increase that proposed $1 million exclusion to $5 million and at the same time allow a stepped-up basis even if the gain is excluded? Although surprising, that would be a significant simplification.

In addition, the Greenbook confirms that the exclusion of $250,000 per person of gain from the sale or exchange of a taxpayer’s principal residence under section 121 would apply to the gain realized under this proposal with respect to all residences, and it adds that that exclusion would be made “portable to the decedent’s surviving spouse.” In this case the application of the portability model to lifetime gifts may be less of an issue because section 121(b)(2) itself doubles the exclusion to $500,000 for joint returns involving jointly used property.

The Greenbook also confirms that the exclusion under current law for capital gain on certain small business stock under section 1202 would apply.

Netting of Gains and Losses

For transfers at death, capital losses and carry-forwards would be allowed as offsets against capital gains and up to $3,000 of ordinary income, mirroring the current income tax rules for lifetime realization events in sections 1211 and 1212. There is no mention of relaxing the rules of section 267 prohibiting the deduction of losses from sales or exchanges between related persons, but it seems almost certain that those rules would be relaxed in any provision for taking losses into account at death, where transfers to related persons are the norm.

Valuation

As noted above, the Greenbook contemplates that a transfer generally “would be valued at the value used for gift or estate tax purposes.” The Greenbook adds that “a transferred partial interest generally would be valued at its proportional share of the fair market value of the entire property.” In other words, no entity-level discounts. But, elaborating the word “generally,” which is new this year, the Greenbook also helpfully adds that “this rule would not apply to an interest in a trade or business to the extent its assets are actively used in the conduct of that trade or business.”

Special Rules for Trusts and Entities

The Greenbook provides that transfers into, and distributions in kind from, a trust would be recognition events, unless the trust is a grantor trust deemed wholly owned and revocable by what the Greenbook calls “the donor.” Again there is no exclusion or exemption for pre-2023 gain, and indeed the Greenbook explicitly states that the proposal would apply to “certain property owned by trusts … on January 1, 2023.” In other words, this proposed recognition treatment would apply to distributions of appreciated assets to both current and successive or remainder beneficiaries of preexisting trusts, including, for example, both the grantor (or grantor’s spouse) and the remainder beneficiaries of a pre-2023 GRAT, DAPT, or SLAT. With regard to revocable trusts, the deemed owner would recognize gain on the unrealized appreciation in any asset distributed (unless in discharge of the deemed owner’s obligation) to anyone other than the deemed owner or the deemed owner’s “U.S. spouse” (again undefined), and on the unrealized appreciation in all the assets in the trust when the deemed owner dies or the trust otherwise becomes irrevocable.

Last year’s Greenbook went a lot farther and, surprisingly, provided that the rules about transfers into and distributions in kind from a trust would also apply to a “partnership” or “other non-corporate entity,” without further explanation. The current Greenbook clarifies that this extension to such entities applies “if the transfers have the effect of a gift to the transferee.”

The Greenbook also proposes, in effect, a 90-year mark-to-market rule:

“Gain on unrealized appreciation also would be recognized by a trust, partnership, or other non-corporate entity that is the owner of property if that property has not been the subject of a recognition event within the prior 90 years. This provision would apply to property not subject to a recognition event since December 31, 1939, so that the first recognition event would be deemed to occur on December 31, 2030.”

Again assets of partnerships and other entities are included, in this case without a gift-equivalent requirement or other explanation. Because December 31, 2030, is 91, not 90, years from December 31, 1939, it appears that the Greenbook contemplates recognition only at the end of the year, but the Greenbook does not clarify that. And, because it does not depend on any arguable recognition “event” like a gift, death, or other transfer, this 90-year mark-to-market rule is probably the feature of this proposal that would most likely attract a constitutional challenge.

Deferral of Tax

The Greenbook also provides that “taxpayers could elect not to recognize unrealized appreciation of certain family-owned and -operated businesses until the interest in the business is sold or the business ceases to be family-owned and operated.” This is a helpful clarification of last year’s Greenbook, which provided only that the “payment of tax … would not be due.” Deferral could increase the amount of tax if there is more appreciation, but it could also prevent the payment of tax to the extent the value of the business declines (which sometimes happens after the death of a key owner). That approach would apparently also tax the realization event at whatever the tax rates happen to be at the time, which might sometimes be a vexing consideration in the executor’s decision to make this election.

If that election is made, would it still be true, as the Greenbook states in the context of exclusions immediately before its discussion of deferral, that “the recipient’s basis in property, whether received by gift or by reason of the decedent’s death, would be the property’s fair market value at the time of the gift or the decedent’s death”? Probably not, because mere deferral of deemed realization (regardless of the amount of gain deferred) is much different from the total escape from realization provided by the limited exclusion. Thus, the loss of a stepped-up basis at intervening deaths could make this ultimate income tax liability much more severe than under current law.

And of course the statutory language implementing this Greenbook proposal should be expected to include definitions of a “business,” “family-owned,” and “family-operated” and possibly rules for the identification of assets that should be excluded from the deferral because they are not used in the business, and such definitions and rules might also create or aggravate challenges over a long-term deferral. The IRS would also be authorized to require reasonable security at any time from any person and in any form acceptable to the IRS, which could be another complication for the family business, for example in raising capital, over a long-term deferral.

In addition, the Greenbook would allow “a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets such as publicly traded financial assets and other than businesses for which the deferral election is made.” Details about start dates and interest rates are not provided, but the proposal appears much broader and more robust than, for example, section 6166 with its multiple qualification tests.

Administrative Provisions

The Greenbook envisions (but without details) a number of other legislative features, covering topics such as a deduction for the full cost of related appraisals, the waiver of penalties for underpayment of estimated tax attributable to deemed realization of gains at death (which, of course, would not have been foreseeable), a right of recovery of the tax on unrealized gains, rules to determine who selects the return to be filed, consistency in valuation for transfer and income tax purposes, and coordination of the changes to reflect that the recipient would have a basis in the property equal to the value on which the capital gains tax is computed.

Regulations

Treasury would be granted authority to issue any regulations necessary or appropriate to implement the proposal, including reporting requirements that could permit reporting on the decedent’s final income tax return, which would be especially useful if an estate tax return is not otherwise required to be filed. In a tacit acknowledgment of the harshness of enacting such a proposal without a “fresh start” for basis as in 1976, the Greenbook explicitly contemplates that the regulations will include “rules and safe harbors for determining the basis of assets in cases where complete records are unavailable.”

Revenue Estimate

Taxing capital gains at the same rate as ordinary income for taxpayers with taxable income over $1 million and the proposed “deemed realization” of capital gains together are estimated to raise approximately $174.5 billion over the next 10 fiscal years.

MINIMUM TAX ON THE WEALTHIEST TAXPAYERS

This provision, new in the current Greenbook (at pages 34-36), is an adaptation of Senator Wyden’s “Treat Wealth Like Wages” proposal, rolled out to a very lukewarm reception as his “Billionaires Income Tax“ on October 27, 2021. The Greenbook version proposes a minimum tax, effective January 1, 2023, of 20 percent of total income, generally including unrealized capital gains, for taxpayers with “wealth” (that is, assets minus liabilities) greater than $100 million. Taxpayers could choose to pay the minimum tax liability in equal annual installments over nine years for the first year of minimum tax liability and over five years for subsequent years. The minimum tax payments would be treated as a prepayment to be credited against subsequent taxes on realized gains to avoid taxing the same amount of gain more than once.

Taxpayers with tradable assets constituting less than 20 percent of their wealth would be treated as “illiquid” and could elect to include the unrealized gain only for tradable assets in determining the annual minimum tax, “subject to a deferral charge upon, and to the extent of, the realization of gains on any non-tradable assets” (not to exceed 10 percent of unrealized gains). No estimated payments would be required for the minimum tax. Taxpayers with wealth over the $100 million threshold would have to report annually the total basis and total estimated value of assets in each specified asset class, with alternatives to appraisals available for valuing non-tradable assets.

This proposal is estimated to raise approximately $361 billion over the next 10 fiscal years. The constitutionality of such a new tax on unrealized appreciation would likely be challenged in court.

MODIFY INCOME, ESTATE AND GIFT TAX RULES FOR CERTAIN GRANTOR TRUSTS

The Greenbook (at page 40) laments that “individuals who own assets expected to appreciate in value use two common techniques for reducing estate taxes that exploit the gift and income tax features of grantor trusts to remove value from their gross estates.” Those two exploitative techniques turn out to be GRATs (which many would point out were created by Congress in section 2702(b)(1)) and sales of appreciating assets to grantor trusts (which, likewise, many would point out are facilitated by Congress’s use of the phrase “treated as the owner” in sections 673 through 677 and its treatment of income tax as a liability of that owner under section 671). Be that as it may, the Greenbook (at pages 40-42) invites Congress to blaze a new trail.

GRATs

Like the Obama Administration Greenbooks, and similarly to section 8 of Senator Sanders’ “For the 99.5 Percent Act” (S. 994) introduced March 25, 2021, the Greenbook would impose on GRATs

• a minimum term of 10 years,
• a maximum term of the life expectancy of the annuitant plus 10 years,
• a prohibition on any decrease in the annuity during the GRAT term (which otherwise might be used to reduce the amount includable in the grantor’s gross estate if the grantor dies before the end of the GRAT term),
• a minimum remainder value equal to the greater of 25 percent of the assets contributed to the GRAT or $500,000 (but not more than the value of assets contributed to the GRAT), which would put an end to the very common and effective technique of zeroed-out or nearly-zeroed-out GRATs, and
• a prohibition on the grantor’s acquisition of any asset from the GRAT in an exchange without recognizing gain or loss on the exchange.

This proposal would apply to GRATs created on or after the date of enactment. If this proposal gained traction and was given a reasonable chance of being enacted, that might encourage the creation and funding of GRATs before enactment, which would avoid the first four limitations, particularly the huge fourth limitation of a minimum 25 percent remainder value. But merely creating a GRAT before enactment would not necessarily avoid the fifth limitation, because the proposals discussed in “Special Rules for Trusts and Estates” above and “Recognition of Gain on Sales Transactions with Grantor Trusts” below would apparently also require a GRAT to recognize gain if the annuity payments were made with appreciated assets. (The gain recognition risk might be minimized, if feasible, by using a longer term GRAT in which the annuity amounts were low enough that they could be satisfied out of income, not with in-kind distributions.)

Recognition of Gain on Sales Transactions with Grantor Trusts

For trusts not fully revocable by the deemed owner, “the transfer of an asset for consideration between a grantor trust and its deemed owner” would result in the recognition of gain. The proposal uses the term “deemed owner” (which implies that it includes a person other than the grantor under section 678) and also the term “grantor trust” (which sometimes implies that a trust treated as owned by a person other than the grantor is not included). The proposal would apply both to sales and to transfers in satisfaction of an obligation (such as an annuity or unitrust payment) with appreciated property. It would apply to transactions on or after the date of enactment. And it would significantly overlap with the deemed realization proposals for trusts discussed in “Special Rules for Trusts and Estates” above.

Payment of Income Tax by Deemed Owner as Gift

The payment by the “deemed owner” of income tax on the income of a “grantor trust” would be a gift by the deemed owner “unless the deemed owner is reimbursed by the trust during that same year” in which the tax is paid. Again, the proposal uses the clashing terms “deemed owner” and “grantor trust.”

The Greenbook states that the gift would generally occur “on December 31 of the year in which the income tax is paid.” Acknowledging the need for some exceptions to that rule, the Greenbook adds “if earlier, immediately before the owner’s death, or on the owner’s renunciation of any reimbursement right for that year.” But even that addition does not specifically provide for cases where the reimbursement is made only in the trustee’s discretion and not as the deemed owner’s “right,” or where the “reimbursement right” terminates other than by the owner’s renunciation, or when grantor trust (or “deemed owned”) status itself terminates other than by the owner’s death. Likewise, the Greenbook does not address how to determine the year in which the deemed owner pays the income tax on the trust’s income when some of the deemed owner’s income tax liability is paid by quarterly estimated payments, three of which have been made in the year before the income tax return is filed, or by overpayments applied from the previous year’s return. It is almost certain, however, that all such payments would be treated as made in the year the tax is due, because otherwise the notion of being “reimbursed by the trust during that same year” would make no sense.

And of course the annual reimbursement of such taxes pursuant to either a requirement or an exercise of discretion pursuant to an understanding or prearrangement would create a risk of including the value of the trust assets in the grantor’s gross estate under section 2036 as applied in Rev. Rul. 2004-64, 2004-2 C.B. 7.

This proposal would apply to all trusts created on or after the date of enactment (which, if the proposal gains any traction, could provide an incentive to create and fund grantor trusts before the date of enactment).

Revenue Estimate

These proposals together are estimated to raise approximately $41.5 billion over the next 10 fiscal years.

CONSISTENT VALUATION OF PROMISSORY NOTES

Background

Loans with an interest rate equal to the applicable federal rate (AFR) incorporated into section 7872 are not treated as gifts, but the lender may take the position that the note should be discounted for gift tax purposes on a later re-transfer or for estate tax purposes at death because the interest rate is lower than a commercial rate at the time. Section 7872, added to the Code by the Deficit Reduction Act of 1984 (Public Law 98-369, July 18, 1984), authorized the issuance of regulations to address the estate tax valuation of notes, and proposed regulations were promptly promulgated but have never been finalized. Meanwhile, although the note is included in the decedent’s gross estate, it is possible that it could be valued for estate tax purposes at less than its face amount, under general valuation principles, because section 7872 is not an estate tax valuation rule. That would be especially true if interest rates rise between the date of the sale and the date of death.

Section 7872(i)(2) states:

“Under regulations prescribed by the Secretary, any loan which is made with donative intent and which is a term loan shall be taken into account for purposes of chapter 11 [the estate tax chapter] in a manner consistent with the provisions of subsection (b) [providing for the income and gift tax treatment of below-market loans].”

Proposed Reg. §20.7872-1 (published on August 20, 1985, barely a year after the enactment of section 7872) states:

“For purposes of chapter 11 of the Internal Revenue Code, relating to estate tax, a gift term loan … that is made after June 6, 1984, shall be valued at the lesser of:

“(a) the unpaid stated principal, plus accrued interest; or

“(b) the sum of the present value of all payments due under the note (including accrual interest), using the applicable Federal rate for loans of a term equal to the remaining term of the loan in effect at the date of death.

“No discount is allowed based on evidence that the loan is uncollectible unless the facts concerning collectibility of the loan have changed significantly since the time the loan was made. This section applies with respect to any term loan made with donative intent after June 6, 1984 [the effective date of section 7872], regardless of the interest rate under the loan agreement, and regardless of whether that interest rate exceeds the applicable Federal rate in effect on the day on which the loan was made.”

The estate planner’s answers to the proposed regulation would include the arguments that

•  the proposed regulation is not effective unless and until it is finalized,
•  the loan represented by the installment note is not a “gift term loan” because it uses an interest rate calculated to avoid below-market treatment under section 7872(e), and
•  with respect to both this proposed regulation and section 7872(i)(2) itself, the loan is not made “with donative intent” because the transaction is a sale, not a gift.

With respect to the first point, it is arguable that section 7872(i)(2) itself requires consistency even in the absence of regulations (although it still might be unclear what “consistency” means in that context). Tax Court Judge Tannenwald distinguished between “how” regulations and “whether” regulations in Estate of Neumann v. Commissioner, 106 T.C. 216 (1996). Section 2663(2) provides that “the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this chapter, including … regulations (consistent with the principles of chapters 11 and 12) providing for the application of this chapter [the GST tax] in the case of transferors who are nonresidents not citizens of the United States.” This, Judge Tannenwald held, refers to a “how” regulation that is not a necessary condition to the imposition of the GST tax on transfers by nonresident noncitizens. Similar results with reference to the phrase “under regulations” (which is the phrase also used in section 7872(i)(2)) were reached in Francisco v. Commissioner, 119 T.C. 317 (2002), and Flahertys Arden Bowl, Inc. v. Commissioner, 115 T.C. 269 (2000). Compare section 465(c)(3)(D), which provides that a special rule “shall apply only to the extent provided in regulations prescribed by the Secretary.” Alexander v. Commissioner, 95 T.C. 467 (1990). Also compare Frazee v. Commissioner, 98 T.C. 554 (1992), and Estate of True v. Commissioner, T.C. Memo. 2001-167, aff’d, 390 F.3d 1210 (10th Cir. 2004), discussing other proposed regulations under section 7872.

Under section 7805, the proposed regulations could probably be expanded even beyond the strict mandate of section 7872(i)(2), and, under section 7805(b)(1)(B) such expanded final regulations might even be made effective retroactively to the publication date of the proposed regulations in 1985. But, unless and until that happens, most estate planners have seen no reason why the estate tax value should not be fair market value, which, after all, is the general rule, as elaborated in Reg. §20.2031-4:

“The fair market value of notes, secured or unsecured, is presumed to be the amount of unpaid principal, plus interest accrued to the date of death, unless the executor establishes that the value is lower or that the notes are worthless. However, items of interest shall be separately stated on the estate tax return. If not returned at face value, plus accrued interest, satisfactory evidence must be submitted that the note is worth less than the unpaid amount (because of the interest rate, date of maturity, or other cause), or that the note is uncollectible, either in whole or in part (by reason of the insolvency of the party or parties liable, or for other cause), and that any property pledged or mortgaged as security is insufficient to satisfy the obligation.”

The 2015-2016 Treasury-IRS Priority Guidance Plan for the 12 months beginning July 1, 2015, released on July 31, 2015, included a project, new that year, titled “Guidance on the valuation of promissory notes for transfer tax purposes under §§2031, 2033, 2512, and 7872.” It was retained in the 2016-2017 Priority Guidance Plan but dropped from the slimmed-down 2017-2018 Plan published October 20, 2017, by the Trump Administration. It is not clear that this guidance project was related to Proposed Reg. §20.7872-1, which it does not cite. This project was joined in the 2016-2017 Plan by an item under the subject of “Financial Institutions and Products” described as “Regulations under §7872. Proposed regulations were published on August 20, 1985.” When the promissory notes project was dropped from the subject of “Gifts and Estates and Trusts” in the 2017-2018 Plan, that item under “Financial Institutions and Products” remained. It was carried over to the 2018-2019 Plan, but dropped from the 2019-2020 Plan.

The Current Greenbook Proposal

Rather than following through on the existing statutory authority to adopt regulations addressing the issue, however, Treasury is now proposing in the Greenbook (at pages 43-44) a legislative solution that would limit the discount rate used to value the note for estate tax purposes to “the greater of the actual rate of interest of the note, or the applicable minimum interest rate for the remaining term of the note on the date of death.” The Greenbook adds:

“The Secretary and her delegates (Secretary) would be granted regulatory authority to establish exceptions to account for any difference between the applicable minimum interest rate at the issuance of the note and actual interest rate of the note. In addition, the term of the note would be treated as being short term regardless of the due date, or term loans would be valued as demand loans in which the lender can require immediate payment in full, if there is a reasonable likelihood that the note will be satisfied sooner than the specified payment date and in other situations as determined by the Secretary.”

Exceptions “to account for any difference between the applicable minimum interest rate at the issuance of the note and actual interest rate of the note” would certainly be appropriate. Otherwise, for example, a note with a commercially reasonable interest rate, such as a note a seller of a home might take back from an unrelated buyer, might be artificially overvalued for estate tax purposes if its true value was depressed because market interest rates had risen.

Subject to what such regulations might provide, it appears that valuing a note by discounting future payments of principal and interest at a discount rate equal to that interest rate would be tantamount to simply valuing the note at its face amount of unpaid stated principal plus accrued interest, the same as in Proposed Reg. §20.7872-1(a) or, for that matter, the general rule in Reg. §20.2031-4 (both quoted above).

The Greenbook states that “the proposal would apply to valuations as of a valuation date on or after the date of introduction.” Presumably that means the introduction of legislation specifically drafted to implement proposals in this Greenbook, but it is left to the legislation itself to clarify that. In any event, the date of introduction is a rather bold effective date approach, usually reserved for cases where Congress perceives a particular abuse or other need for urgency. An argument for urgency, of course, could be somewhat awkward in a context that includes proposed regulations that have been pending since 1985. On the other hand, the argument described above that section 7872(i)(2) itself already requires consistency could make it awkward to object to that effective date as a surprise or as unfair.

This proposal is estimated to raise approximately $6.4 billion over the next 10 fiscal years.

LIMITED DURATION OF GST EXEMPTION

The Greenbook (at page 48) muses that “at the time of the enactment of the GST provisions, the law of most States included the common law Rule Against Perpetuities (RAP) or some statutory version of it …” It’s easy to see where that is headed.

The Greenbook (at pages 48-49) proposes:

“The GST exemption would apply only to: (a) direct skips and taxable distributions to beneficiaries no more than two generations below the transferor [for example, to grandchildren but not great-grandchildren of the transferor], and to younger generation beneficiaries who were alive at the creation of the trust; and (b) taxable terminations occurring while any person described in (a) is a beneficiary of the trust.”

Therefore, trusts would continue to be exempt, not for the full life of the trust (for example, throughout the entire applicable rule against perpetuities period), but only for the life of any first- or second-generation beneficiary or any younger generation beneficiary who was alive at the creation of the trust. The “reset” rule of section 2653(a) would not apply. The Greenbook states that the special rule in section 2653(b)(2) for “pour-over trusts” created from a trust (whether under the trust instrument or under a decanting authority) would continue to apply, with such pour-over trusts deemed to have the same date of creation as the initial trust for purposes of determining the duration of the GST exemption.

This provision limiting the duration of the allocation of GST exemption would apply retroactively to existing trusts, but for purposes of determining the duration of the GST exemption “a pre-enactment trust would be deemed to have been created on the date of enactment.”

By allowing allocation of GST exemption and only limiting how long it lasts, the Greenbook proposal could be less harsh than, for example, section 9 of Senator Sanders’ “For the 99.5 Percent Act,” which in effect would deny any exemption allocation if the trust could last longer than 50 years.

Not surprisingly, this proposal focused on trust distributions to great-grandchildren is not projected to affect revenue over the next 10 fiscal years.

MISCELLANEOUS TRUST AND ESTATE TAX PROVISIONS

A section of the Greenbook (at pages 45-47) titled “Improve Tax Administration for Trusts and Decedents’ Estates” proposes a number of changes, none of which were included in last year’s Greenbook.

Expanded Definition of Executor

The definition of executor would be moved from section 2203 to section 7701, and the authorized party could act for all tax purposes (including with respect to pre-death tax liabilities). This would apply after enactment regardless of a decedent’s date of death.

Increased Benefit of Special Use Valuation

As in the House Ways and Means Committee’s version of the “Build Back Better Act,” the Greenbook proposes to increase the limit on the reduction in value of special use property from $750,000 (indexed, $1.23 million in 2022) to $11.7 million, applicable for decedents dying on or after the date of enactment. Despite this proposal’s family-business-friendly curb appeal, however, it would not really reduce the estate tax on a family farm or business as such; it would merely prevent a tax, for example, on a speculative prospect of development that is faced by such businesses very unevenly.

Extension of 10-Year Estate and Gift Tax Lien

The automatic 10-year lien for estate and gift tax would be extended during any deferral or installment period for unpaid estate and gift taxes. This provision would apply for existing 10-year liens and for the automatic lien that applies for gifts made or estates of decedents dying on or after the date of enactment.

Reporting of Estimated Value of Trust Assets

In a change that could be very burdensome and very significant, trusts would be required to file with the IRS annual reports including the name, address, and taxpayer identification number (TIN) of each trustee and grantor of the trust, and general information with regard to the nature and estimated total value of the trust’s assets (which might be satisfied by identifying an applicable range of estimated total value on the trust’s income tax return). The reporting requirement would apply to taxable years ending after the date of enactment for trusts valued over $300,000 or with gross income over $10,000.

Revenue Estimate

These proposals together are estimated to decrease revenue by $326 million over the next 10 fiscal years, probably attributable to the relaxation of the limit on the availability of special use valuation.

NOT INCLUDED IN THE GREENBOOK

The Fiscal Year 2023 Greenbook proposals do not include the following measures that were in the September 15, 2021, House Ways and Means Committee version of the “Build Back Better Act”:

• A reduction of the estate and gift tax exclusion amount prior to 2026.
• A new section 2901 aligning the income tax and transfer tax treatment of grantor trusts (although, as discussed above, the Greenbook would remove two huge tax advantages of grantor trusts – (1) the grantor’s payment of income taxes as a transfer free of gift tax and (2) the grantor’s ability to enter into sales, swaps, or other transactions with the trust without an income tax recognition event).
• Look-through valuation rules for nonbusiness assets in entities.

Ronald D. Aucutt

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