Capital Letters
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More Analysis of Estate Tax Revenue Raisers

Capital Letter No. 18
September 30, 2009

Analysis of revenue raisers by the staff of the Joint Committee on Taxation raises fascinating questions, but the big question remains what Congress will do about the estate tax itself.

Dear Readers Who Follow Washington Developments:

Congress has returned from the August recess and worked through September.  Whether meaningful progress has been made on health care reform depends on whom you ask.  Progress on other congressional priorities is even less evident.  ACTEC Fellows and other estate planners, who have “known” for years that there will be congressional action regarding the estate tax before the end of 2009, are beginning to seriously wonder.

Into this uncertainty it was inevitable that confusion would drop.

Capital Letter Number 17 described the three revenue-raising proposals related to the estate and gift tax on pages 119-23 of the Treasury Department’s “General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals” (popularly called the “Greenbook”), which was released on May 11, 2009.  On September 8, 2009, the staff of the Joint Committee on Taxation released a publication entitled “Description of Revenue Provisions in President’s Fiscal Year 2010 Budget Proposal, Part One: Individual Income Tax, Estate and Gift Tax Provisions” (the “JCT Description”).  The JCT Description adds insights to the Greenbook’s descriptions and analysis, but at times it even seems to contradict the Greenbook, without explanation.

For example, the first Greenbook proposal is entitled “Require Consistency in Value for Transfer and Income Tax Purposes.”  The Greenbook, at page 119, states (emphasis added) that “[t]his proposal would require that the basis of the property in the hands of the recipient be no greater than the value of that property as determined for estate or gift tax purposes (subject to subsequent adjustments).”  Regarding this proposal, the JCT Description states (emphasis added):

The proposal requires that the basis of property received by reason of death under section 1014 generally must equal the value of that property claimed by the decedent’s estate for estate tax purposes.…

Under the proposal there would be instances in which the value of an asset reported by an executor to an heir differs from the ultimate value of the asset used for estate tax purposes. For example, if the IRS challenges an estate valuation and prevails, the executor will have reported to the heir a valuation that is artificially low, and the heir may arguably be overtaxed on a subsequent sale of the asset. This same problem exists under present law to the extent the initially reported estate tax value is presumptively the heir’s basis. To provide complete consistency between estate tax valuation and basis in the hands of an heir may be impractical as ultimate determination of value for estate tax purposes may depend upon litigation, and an heir may sell an asset before the determination of value for estate tax purposes.

By requiring the value of an asset reported for transfer tax purposes to be reported and used by the heir or donee in determining basis, however, the proposal has the salutary effect of encouraging a more realistic value determination in the first instance.  This salutary effect would be lost if there were a relief mechanism for transferees and transferors (and recoupment for the government) if the basis used by transferees differed from the fair market value ultimately determined for transfer tax purposes.  Thus, the proposal does not contain any such relief mechanism.

The JCT Description portrays a regime that many would find harsh and unfair – if the estate tax value of an asset is increased on audit, the recipient’s basis is not correspondingly increased, meaning that the same appreciation in value could be subject to both estate tax and income tax in apparent defiance of the principles of section 1014.  But the Greenbook says very bluntly that the recipient’s basis will be the value “as determined for estate or gift tax purposes,” which ordinarily is interpreted to mean the same as “finally” determined, namely after audit.[1]

On the other hand, the approach depicted in the JCT Description might explain the surprisingly high Treasury estimate that the proposal would raise tax revenue by $1.87 billion over ten years, compared to less than $50 million over ten years for a similar proposal floated by the staff of the Joint Committee on Taxation in January 2005.  (Curiously, in June 2009 the JCT staff estimated the ten-year revenue gain from the Administration proposal at $935 million, exactly half the Treasury estimate.)

Regarding the Greenbook’s proposal labeled “Modify Rules on Valuation Discounts,” Capital Letter Number 17 speculated:

Using section 2704(b) as a framework, the proposal would create a more durable category of “disregarded restrictions.”  Disregarded restrictions would “include” restrictions on liquidation of an interest that are measured against standards prescribed in Treasury regulations, not against default state law.  Thus, no change in state law would affect the reach of the statute….

Although the Greenbook does not say so, it is possible that that the “disregarded restrictions” in view, which “include” certain limitations on liquidation (the current scope of section 2704(b)(2)(A)), may also include other restrictions, such as restrictions on management, distributions, access to information, and transferability.  If so, this proposal might call for reconsideration of the famous disclaimer in the 1990 conference report that “[t]hese rules do not affect minority discounts or other discounts available under [former] law.”  H.R. Rep. No. 101-964, 101st Cong., 2d Sess. 1137 (1990).

Of this Administration proposal the JCT Description states that “because the proposal targets only marketability discounts, it would not directly address minority discounts that do not accurately reflect the economics of a transfer.”  The JCT Description goes on to point out that other possible approaches include the “look through” rules of the Clinton Administration’s budget proposals and the JCT staff’s own 2005 proposals, as well as the aggregation rules of the 2005 proposals and the Reagan Administration’s “Treasury I.”

This is a strange conundrum.  Current law is explicitly addressed only to restrictions on liquidation.  The JCT Description discusses current law and the Administration proposal with reference to restrictions on liquidation, which it views as supporting either a minority discount or a marketability discount, but then seems to deny both its own analysis that restrictions on liquidity might “address minority discounts” and the possibility that the Administration proposal contemplates an expansion of current law that could reach other minority discounts.  Meanwhile, the JCT Description admits that because most of the details of the Administration proposal are left to regulations, “it is difficult to determine how the proposal is intended to operate” after all.

In short, the JCT Description portrays the Administration proposal on basis as arguably harsher than it is, but seems to view the proposal on valuation discounts as more timid than it might be.  In the past, Treasury and congressional staffs have often collaborated in preparing documents like these.  These two documents – the Administration’s Greenbook and the JCT Description – appear to be in competition.

With regard to the Administration proposal requiring a minimum ten-year term for GRATs, both the Greenbook and the JCT Description focus on the effect of the proposal in increasing the mortality risk of a GRAT, not necessarily its equally or even more important effect in diminishing the upside from volatility.  The JCT Description notes that even a ten-year GRAT could be used “as a gift tax avoidance tool.”  As an alternative way of achieving more accurate valuation, the JCT staff publication suggests valuation of the remainder interest for gift tax purposes at the end of the GRAT term when the remainder is distributed.  Such a “hard to complete” approach would have dramatic consequences beyond the use of GRATs.  Indeed, study and critique of such a “hard to complete” approach when it was floated by the Reagan Administration’s “Treasury I” in 1984 was one of the principal early tasks of ACTEC’s Transfer Tax Study Committee.

While these musings are interesting to hard-core observers of the legislative process, they are not what any of us thought we would be examining with one quarter left before the estate tax is repealed.  Capital Letters continues to bet that some variation of 2009 law (with a 45 percent rate and a $3.5 million exemption) will becomes the “permanent” estate tax law.  See Capital Letter Number 13.  Whether that will happen this year, as both the Administration’s proposed budget and the Congressional Budget Resolution contemplate, or some time next year following only a one-year extension of 2009 law is still not clear.  Using a seasonal metaphor, we will have to wait to see if the key event of the last quarter is a pass, a punt, or a fumble.  Only in Washington would “permanence” be provided one year at a time!

Ronald D. Aucutt   © 2009 by Ronald D. Aucutt. All rights reserved

[1] In contrast, while the parenthetical phrase that follows in the Greenbook – “subject to subsequent adjustments” – may be a reference to audit adjustments, it probably contemplates only other adjustments prescribed by the Code, such as the increases in basis for the gift tax and GST tax attributable to appreciation under sections 1015(d) and 2654(a), and adjustments to basis for subsequent improvements, depreciation, and the like.