On August 9, 2013, Assistant Secretary of the Treasury for Tax Policy Mark Mazur, Acting Commissioner of Internal Revenue Daniel Werfel, and IRS Chief Counsel Bill Wilkins released the 2013-2014 Priority Guidance Plan
. Meanwhile, on August 1, President Obama had nominated a new Commissioner of Internal Revenue.
2013-2014 PRIORITY GUIDANCE PLAN
The 2013-2014 Priority Guidance Plan contains 324 projects (up only slightly from 317 last year) described as “priorities for allocation of the resources of our offices during the twelve-month period from July 2013 through June 2014 (the plan year). The plan represents projects we intend to work on actively during the plan year and does not place any deadline on completion of projects.”
The Plan contains the following 11 items under the heading of “Gifts and Estates and Trusts”:
1. Final regulations under §67
regarding miscellaneous itemized deductions of a trust or estate. Proposed regulations
were published on September 7, 2011.
2. Guidance concerning adjustments to sample charitable remainder trust forms under §664
3. Guidance concerning private trust companies under §§671
, and 2601
4. Regulations under §1014
regarding uniform basis of charitable remainder trusts.
5. Revenue Procedure under §2010(c)
regarding the validity of a QTIP election on an estate tax return filed only to elect portability.
6. Final regulations under §2032(a)
regarding imposition of restrictions on estate assets during the six month alternate valuation period. Proposed regulations
were published on November 18, 2011.
7. Guidance under §2053
regarding personal guarantees and the application of present value concepts in determining the deductible amount of expenses and claims against the estate.
8. Regulations under §2642
regarding the allocation of GST exemption to a pour-over trust at the end of an ETIP.
9. Final regulations under §2642(g)
regarding extensions of time to make allocations of the generation-skipping transfer tax exemption. Proposed regulations
were published on April 17, 2008.
10. Regulations under §2704
regarding restrictions on the liquidation of an interest in certain corporations and partnerships.
11. Guidance under §2801
regarding the tax imposed on U.S. citizens and residents who receive gifts or bequests from certain expatriates.
Most of these items have been carried over from past years. In fact, the average length of time these 11 items have been on the Priority Guidance Plan is about 6¼ years. Except for items 5 and 8, these projects were described and analyzed in Capital Letter No. 32
. There are no significant updates for those nine projects.
Item 5: The Validity of QTIP Elections in Portability-Only Returns
Item 5 is the only new topic this year and represents an issue highlighted by the enactment of “portability” for two years in the 2010 Tax Act
and permanently in the 2012 Tax Act
. It was one of many topics that ACTEC recommended in its letter of April 30, 2013.
The issue is traceable to Rev. Proc. 2001-38, 2001-24 I.R.B. 1335
, which announced circumstances in which the IRS “will disregard [a QTIP] election and treat it as null and void” if “the election was not necessary to reduce the estate tax liability to zero, based on values as finally determined for federal estate tax purposes.” The revenue procedure states that it “does not apply in situations where a partial QTIP election was required with respect to a trust to reduce the estate tax liability and the executor made the election with respect to more trust property than was necessary to reduce the estate tax liability to zero.” The revenue procedure states that it “also does not apply to elections that are stated in terms of a formula designed to reduce the estate tax to zero.” Thus, the paradigm case to which the Rev. Proc. 2001-38
applies is the case where the taxable estate would have been less than the applicable exclusion amount anyway, so the estate would not be subject to federal estate tax, but the executor listed some or all of the trust property on Schedule M of the estate tax return and thus made a redundant QTIP election.
Rev. Proc. 2001-38
is a relief measure. The transitional sentence in Rev. Proc. 2001-38
between the summary of the background law and the explanation of the problem states that “[t]he Internal Revenue Service has received requests for relief in situations where an estate made an unnecessary QTIP election.”
With portability of unused unified credit from a deceased spouse to a surviving spouse, which was made permanent in the 2012 Tax Act
, an estate tax return to elect portability might be filed that is not necessary for estate tax purposes because the value of the estate is below the filing requirement. For such a return, a QTIP election is obviously not required to reduce the federal estate tax, because there will be no tax in any event. But, in approaches to portability widely discussed among commentators, a QTIP election might still be made to support a reverse-QTIP election for GST tax purposes, to gain a second basis step-up at the death of the surviving spouse, or for some other reason. The existence of Rev. Proc. 2001-38
raises the question whether such a QTIP election might be treated as an election that “was not necessary to reduce the estate tax liability to zero” and therefore as “null and void.”
Rev. Proc. 2001-38
goes on to state that “[t]o establish that an election is within the scope of this revenue procedure, the taxpayer must produce sufficient evidence to that effect. For example, the taxpayer [the surviving spouse or the surviving spouse’s executor] may produce a copy of the estate tax return filed by the predeceased spouse’s estate establishing that the election was not necessary to reduce the estate tax liability to zero.” Thus, it might be thought that Rev. Proc. 2001-38
is simply inapplicable if the surviving spouse or the surviving spouse’s executor does not affirmatively invoke it. But the example of “produc[ing] a copy of the estate tax return filed by the predeceased spouse’s estate establishing that the election was not necessary to reduce the estate tax liability to zero” is a bit troubling in the portability context, because it is exactly that return that will have elected portability and therefore will be the basis for any application of portability by the surviving spouse or the subsequent executor, and any return filed only to elect portability will necessarily show that the QTIP election was not necessary to reduce estate tax.
Nevertheless, the “relief” nature and origin of Rev. Proc. 2001-38
, the likelihood that a revenue procedure announcing the Service’s administrative forbearance cannot negate an election clearly authorized by statute, and the unseemliness of denying the collateral benefits of a QTIP election to smaller estates while allowing it to larger estates all suggest that a QTIP election should be respected in such a case. This view is reinforced by the explicit reference in Reg. §20.2010-2T(a)(7)(ii)(A)(4
) to QTIP elections in returns filed to elect portability but not otherwise required for estate tax purposes, a reference that would make no sense if any such QTIP election were necessarily “null and void.” Clarifying that result is evidently what this new item on the Priority Guidance Plan is about. It is not always the case that the appearance of a project on the Priority Guidance Plan makes it clear what the outcome of the project will be, but it is clear in this case.
On the other hand, Rev. Proc. 2001-38
could appear, in effect, to make the consequences of a QTIP election elective on the basis of what could be very long hindsight, permitting the QTIP election to be repudiated even on the estate tax return filed after the surviving spouse’s death. That actually seems to have been a potential result ever since Rev. Rul. 2001-38 was published, and it is not really changed by portability. If there is any suspense in the current guidance project, it is in seeing if and how that dilemma is acknowledged and addressed.
Item 8: Allocation of GST Exemption at the End of an ETIP
Item 8 was new last year (as item 7). Despite the vague reference to “a pour-over trust at the end of an ETIP,” we know that it is probably aimed, at least in part, at the continuing trusts that are sometimes provided for at the end of the annuity period in a GRAT. This is because the public correspondence suggests that this project is derived from a request for guidance from the AICPA, first made in a letter dated November 10, 2004, and reprised in a letter dated June 26, 2007, which stated:
The issues presented here are best illustrated by considering the following fact pattern:
Taxpayer creates an irrevocable trust, Trust Z, in which a qualified annuity interest (as defined in section 2702(b)) is payable to the taxpayer or his estate for 10 years. Upon the termination of the annuity interest, Trust Z is to be separated into two trusts, Trust A and Trust B. Trust A is for the exclusive benefit of Taxpayer’s children and grandchildren. Trust B is for the exclusive benefit of Taxpayer’s children. Trust A is to receive from Trust Z so much of the Trust Z’s assets as is equal to Taxpayer’s remaining GST exemption, if any. Trust B is to receive from Trust Z the balance of Trust Z’s assets, if any, after funding Trust A. The taxpayer is alive at the end of the 10 years.
Presumably, the transfer to Trust Z is an indirect skip to which GST exemption will be automatically allocated at the end of the ETIP. Will the automatic allocation rules apply to all the assets remaining in Trust Z at that time? If so and if the taxpayer wants to allocate GST exemption only to the assets going to Trust A, the taxpayer should timely elect out of the automatic allocation rules of section 2632(c), and then affirmatively allocate GST exemption only to the assets going into Trust A at the end of the ETIP. Is that possible?
In the alternative, the automatic allocation rules may apply only to the transfer going into Trust A because Trust B is not by definition a GST trust. Because of the application of the ETIP rules, the transfer from the taxpayer for GST purposes would occur only at the time that the assets are funded into Trust A. If that is the case, then the taxpayer does not need to do anything affirmatively to ensure that GST exemption is allocated to Trust A and not Trust B as he or she desires.
It has been our experience that many trusts are structured in a manner similar to the above referenced fact pattern. By letter dated November 10, 2004, the AICPA submitted comments on the proposed regulations on electing out of deemed allocations of GST exemption under section 2632(c). In that letter, guidance was requested on these issues. The preamble to the final regulations (T.D. 9208) acknowledged this request for the inclusion in the regulations of an example addressing the application of the automatic allocation rules for indirect skips in a situation in which a trust subject to an ETIP terminates upon the expiration of the ETIP, at which time the trust assets are distributed to other trusts that may be GST trusts. According to the preamble, the Treasury Department and the Internal Revenue Service believed that this issue was outside the scope of the regulation project and would consider whether to address these issues in separate guidance.
In addition to the clues in this AICPA letter to what the new guidance project might be aimed at, there are two other lessons to be learned from the letter, one discouraging and one encouraging. The discouraging lesson is that it can sometimes take up to eight years or longer for a relatively straightforward suggestion about a common and innocent technique to be acknowledged in a formal guidance project, although we do know that some of these suggestions receive thoughtful attention and preliminary work even without formal acknowledgment. The encouraging lesson is that perseverance pays off, in this case the perseverance of our friends at the AICPA. The letter in which ACTEC suggested a clarification of Rev. Proc. 2001-38
as a Priority Guidance Plan project also recommended 11 other topics, some of which ACTEC has proposed in various contexts for a number of years, but none of which were picked up this time. Even so, ACTEC and those Fellows who work hard to identify and draft such recommendations can be encouraged that patience is often rewarded after all. And that is a good lesson to keep in mind while turning to the next subject related to the Priority Guidance Plan.
The Omission of Decanting
The 2011-2012 Priority Guidance Plan
included, as item 13, “Notice on decanting of trusts under §§2501 and 2601.” This project was new in 2011-2012, but it had been anticipated for some time, at least since the publication at the beginning of 2011 of Rev. Proc. 2011-3, 2011-1 I.R.B. 111
, in which new sections 5.09, 5.16, and 5.17 included decanting among the “areas under study in which rulings or determination letters will not be issued until the Service resolves the issue through publication of a revenue ruling, revenue procedure, regulations or otherwise.” (Sections 5.01(16), (23), and (24) of Rev. Proc. 2013-3, 2013-1 I.R.B. 113
, continue this designation.)
On December 20, 2011, the IRS published Notice 2011-101, 2011-52 I.R.B. 932
, asking for comments from the public on the tax consequences of decanting transactions – the transfer by a trustee of trust principal from an irrevocable “Distributing Trust” to another “Receiving Trust.” The Notice listed 13 facts and circumstances as examples of the factors that might affect the tax consequences and on which it was seeking comments. ACTEC submitted comments, including a proposed revenue ruling, on April 2, 2012.
But decanting was omitted from the 2012-2013 Priority Guidance Plan
and again this year. Technically, the 2011-2012 Plan promised only a “Notice,” and Notice 2011-101
was indeed that. So the project could not just be carried over; it would have to be reformulated and refocused. Many readers will think that something like “Guidance on decanting” would work fine. But, as noted above in the discussion of GST exemption allocations at the end of an ETIP, it is not easy to get a project on the Priority Guidance Plan, and furthermore, the absence of such a formal project does not mean that those responsible for preparing the ultimate guidance are not thinking about decanting issues, including those analyzed in ACTEC’s comments.
A Section 501(c)(4) Aside
In contrast to the typical complicated and prolonged process to get a project on the Priority Guidance Plan, sometimes it’s easy and quick. A case in point, selected not really at random, is item 3 under the heading of “Exempt Organizations,” new this year, described as “Guidance under §501(c)(4) relating to measurement of an organization’s primary activity and whether it is operated primarily for the promotion of social welfare, including guidance relating to political campaign intervention.” Although the prose is labored – there seem to be just a few too many words – the source and purpose are unmistakable to any tax observer who has not been on the back side of the moon since May 3. This is a part of the response to the uproar that erupted on that day about the Internal Revenue Service’s handling of applications for recognition of tax exemption, especially by applicants seeking recognition as “social welfare organizations” under section 501(c)(4)
that have or appear to have a political agenda or motivation or an interest in the outcome or conduct of political campaigns.
The overall discussion is way too broad and fluid to be summarized fairly in a Capital Letter. Both uninformed accusations and uninformed defenses seem to have obscured the sunshine our government should have. Aside from exceedingly difficult process and personnel issues, this discussion has highlighted the anomaly that section 501(c)(4)(A)
exempts “[c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare,” Reg §1.501(c)(4)-1(a)(2)(i) holds that “[a]n organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community,” and Reg §1.501(c)(4)-1(a)(2)(ii) adds for good measure that “[t]he promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office.” So, some ask – some curiously, some cynically – what is it? Is “public welfare” an “operated exclusively” test” or a “primarily engaged” test? Does any
“participation … in political campaigns” (which “[t]he promotion of social welfare does not include”) prevent exclusive
operation for the promotion of social welfare? Or is “primarily” really a mechanical 51 percent test? Or how about 40 percent if the other two
activities are only 30 percent each? And how can such activities be quantified anyway?
Apparently only the last few questions will be within the scope of this Priority Guidance Plan project. Notice that the description of this project in the Priority Guidance Plan does not challenge the difference in wording between the statute and the regulation (as many observers have). It appears to accept the regulation and seeks only to provide metrics for its application. Critics will have a field day, and Capital Letters defers to them. The only purpose here is to show how a familiar tool like the annual Priority Guidance Plan can understandably be infused and shaped by the headlines of the day. This project, while important, is likely to play only a small role, if any, in calming the larger storm. The process and personnel issues will continue to dominate.
NOMINATION OF A NEW COMMISSIONER OF INTERNAL REVENUE
Into this storm the new Commissioner of Internal Revenue must parachute. Under section 7803(a)(1)(B)
of the Internal Revenue Code – not the most discussed Code section at CLE programs – the Commissioner serves a five-year term that begins on November 13 of every year ending with 7 or 2. Douglas Shulman’s term ended last November. The President could have nominated a new Commissioner about ten months ago. For all we know he tried; it can’t be easy.
On August 1, the President announced his intention to nominate John Koskinen. Famously, because everything any Administration official says about the IRS these days is scrutinized, the President described the nominee as “an expert at turning around institutions in need of reform.” Although he practiced law in the 1960s, the fact that he does not have a tax background has of course been noticed. But section 7803(a)(1)
mandates that the appointment of the Commissioner “shall be made from individuals who, among other qualifications, have a demonstrated ability in management” and says nothing specifically about a tax background. It might be thought that a tax background is assumed, but section 7803(c)(1)(B)(iii)(I)
, in prescribing the qualifications for the National Taxpayer Advocate, does specify “a background in customer service as well as tax law.” In fact, since the enactment of the Internal Revenue Service Restructuring and Reform Act of 1998, which was passed after sensational hearings and charges of abuse (imagine that!), no tax professional has served as Commissioner; the last was Peggy Richardson in 1993-97. (Two ACTEC Fellows have been Commissioners, Larry Gibbs in 1986-89 and Shirley Peterson in 1992-93. Shirley had chaired ACTEC’s Transfer Tax Study Committee in its early days in the 1980s, and Larry went on to be a member of the Board of Regents in the 1990s.)
John Koskinen, whom I know and respect, has the temperament and managerial instincts for the job and the times. He deserves our support and best wishes. Perhaps mercifully, his “five-year term” will end in November 2017.