For the estates of decedents who died in 2010, January 17, 2012, is the due date for filing IRS Form 8939
(Allocation of Increase in Basis for Property Acquired From a Decedent) if the executor chooses to elect out of the 2010 federal estate tax into the “modified carryover basis” rules that had been applicable for 2010 before Congress enacted the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010
(“the 2010 Tax Act
”) in December 2010. Obviously, work on the Forms 8939 that need to be filed is well underway. But not everything about Form 8939
Background and Role of Form 8939
When “retroactively” reinstating the estate tax for 2010, Congress, in effect, made it optional, by permitting executors of the estates of decedents who died in 2010 to elect out of the estate tax. Many assumed that an election out of the estate tax was provided in order to prevent a constitutional challenge that would have created years of uncertainty. Section 301(c) of the 2010 Tax Act
provides that “[s]uch election shall be made at such time and in such manner as the [IRS and Treasury] shall provide.” Meanwhile, the original Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)
, which had suspended the federal estate tax for 2010, had replaced it with a “modified carryover basis” regime and, through section 6018 of the Internal Revenue Code, had required reporting to the IRS and to recipients of property regarding the values and bases of assets acquired from a decedent. Before the 2010 Tax Act
was enacted, the IRS had released a draft of Form 8939 for that purpose.
Notice 2011-66, 2011-35 I.R.B. 179
, and Rev. Proc. 2011-41, 2011-35 I.R.B. 188
(released on August 5, 2011, and discussed in Capital Letter No. 29
), provided the first substantive guidance about both the election out of the estate tax (which Notice 2011-66
called the “Section 1022 Election”) and the carryover basis reporting. Notice 2011-76, 2011-40 I.R.B. 479
, followed on September 13, 2011, and, among other things, fixed the final due date of the Form 8939
as January 17, 2012. That due date is now about a week away, and section 7 of Rev. Proc. 2011-41
estimates that Form 8939
will be completed and filed by 7,000 executors. Form 8939
raises many issues and presents many challenges. Some of those challenges stem from quirks that can be traced to the fact that the context and operation of Form 8939
is so different from other forms that “many of us are used to.”
The Obvious and Not-So-Obvious Quirks
Don’t Miss the January 17 Due Date
Obviously, any due date for filing an information return with the IRS is important. But there are special features and consequences of the January 17 due date for the Form 8939
that make it especially unforgiving.
Many of us are used to
an “automatic” six-month extension of time to file returns such as annual income and gift tax returns and estate tax returns. But there is no “automatic” six-month extension of time to file Form 8939
, and the IRS will not grant extensions of the January 17 due date.
It is true that Notices 2011-66
allow an executor to quite freely amend Form 8939
at any time within six months of the due date – that is, through July 17, 2012. That would include such things as updating the identity, description, character, value, acquisition date, basis, and recipient of assets and making or changing allocations of basis increases to those assets. And additional allocations of the $3,000,000 Spousal Property Basis Increase may be made at any time, so long as a supplemental Form 8939
for that purpose is filed no later than 90 days after each distribution of additional property to the surviving spouse.
But no amended or supplemental Form 8939 may make or revoke the election out of the estate tax.
The decision to make the Election must be made and reported on Form 8939
by January 17. In addition, no amendments of any kind will be allowed unless a Form 8939 is filed timely
– that is, no later than January 17.
Therefore, even when information for the Form 8939
is incomplete and supplementation by July 17 might be needed, the executor (including a trustee, if there is no court-appointed executor) must file a Form 8939
, completed as fully as possible, by January 17. Many of us are used to
late-filing penalties that are modest, or in the case of many tax returns are a percentage of some tax that is otherwise payable. But the penalty for filing Form 8939 late can be exposure of the entire estate to a 35 percent federal estate tax that would otherwise not be payable.
Many of us are used to
the instructions for the federal estate tax return
), which provide that “[i]f there is more than one executor, ... it is sufficient for only one of the co-executors to sign the return.” But the instructions for Form 8939 say nothing about co-executors.
It is not clear if that omission is significant.
Remember That Even Some “Nontaxable” Estates Might Need a Section 1022 Election
Many of us are used to the idea that executors of estates larger than the $5,000,000 estate tax exemption should obviously consider a Section 1022 Election in order to avoid the higher estate tax rate, even at the cost of additional capital gains taxes when the decedent’s assets are sold by the executor, trustee, or beneficiaries. Not so obviously, executors of some estates smaller than $5,000,000 should also make the Section 1022 Election.
For example, property in a QTIP trust of which the decedent was the beneficiary as surviving spouse is not “property acquired from a decedent,” as defined in section 1022(e), and therefore is not subject to the carryover basis rules. Thus, if a 2010 “estate” consists of such a QTIP trust in which the assets declined in value, plus cash and modest other assets (perhaps less than the $1,300,000 basis increase that can be allocated to those assets), then the election might be considered in order to preserve the higher basis of the assets in the QTIP trust (because that basis would be stepped down under section 1014 if the estate tax applied).
Example: Peter (the predeceased spouse) died in 2007, and his wife Susan (the surviving spouse) died in 2010. At the time of her death, Susan owned assets with a value of $1,000,000 and a basis of $400,000. Susan was also the beneficiary of a QTIP trust created at Peter’s death, which had a value of $5,000,000 when Peter died in 2007, but, as with many investments, had declined to a value of $3,000,000 at the time of Susan’s death in 2010, but with no change in its assets except for value.
Because Susan’s gross estate for federal estate tax purposes would be $4,000,000 (her assets worth $1,000,000 plus the QTIP trust assets of $3,000,000), there would be no federal estate tax, and there might seem to be no reason to elect out of an estate tax that would be zero. But, although the $400,000 basis of Susan’s assets would be stepped up to the date-of-death value of $1,000,000, the $5,000,000 basis of the assets of the QTIP trust would be stepped down to the date-of-death value of $3,000,000. If the QTIP trust assets go up in value in the future, an additional $2,000,000 might be subjected to a capital gains tax because of that loss of basis.
On the other hand, if Susan’s executor elects out of the estate tax, the $400,000 basis of Susan’s assets will still be increased to $1,000,000 by the $1,300,000 basis increase, but the basis of the assets of the QTIP trust, to which the carryover basis rules do not apply, will still be $5,000,000. The $2,000,000 loss of basis and resulting potential increased capital gains tax are avoided.
Therefore, Susan’s executor should elect out of the federal estate tax, even though there would have been no federal estate tax on Susan’s estate.
Don’t Overlook Trusts Omitted from Form 8939 When Allocating GST Exemption
In addition to the Section 1022 Election out of the estate tax and the resulting carryover basis reporting and allocations, Form 8939
is used to allocate GST exemption to trusts as to which there could be generation-skipping transfers (taxable distributions or taxable terminations) in the future. The GST exemption allocations are made on Schedule R of Form 8939
. The automatic allocation rules of section 2632(e)
will apply if the executor files a Form 8939
without attaching a Schedule R
, or to the extent the Schedule R
does not allocate all of the decedent’s available GST exemption.
It is not an accident that the schedule used for allocating GST exemption on Form 8939
is labeled Schedule R
. There is no Schedule B through Q. The Schedule R for Form 8939
is obviously patterned after the Schedule R that accompanies Form 706
, and they are virtually identical. But there is a hugely significant way in which this
Schedule R differs in its relationship to the rest of the Form 8939
. Many of us are used to
preparing estate tax returns and using Schedule R to calculate GST tax and allocate GST exemption with respect to transfers reported on that estate tax return. That is also true in the case of the Form 8939
. But in the case of the Form 8939
, there may be trusts exempt from carryover basis and therefore not otherwise reported or addressed on Form 8939
at all, of which the decedent nevertheless is treated as the transferor for GST tax purposes and for which therefore GST exemption might be needed
The most common example might again be a QTIP trust of which the decedent was the surviving spouse and lifetime beneficiary. Often such QTIP trusts will have been divided at the predeceased spouse’s death into “exempt” and “non-exempt” trusts for GST tax purposes, with the exempt trust designed and funded to absorb the predeceased spouse’s available GST exemption under an actual or deemed “reverse QTIP election.” The Form 8939
is the occasion for allocating GST exemption to any non-exempt QTIP trust at the surviving spouse’s death.
In the preceding example of Peter and Susan, if the entire $3,000,000 QTIP trust were a non-exempt trust that continued for Peter’s and/or Susan’s descendants, Susan’s executor should use Schedule R of Form 8939 to allocate $3,000,000 of GST exemption to the QTIP trust, as well as up to $1,000,000 of GST exemption to generation-skipping trusts created by Susan, even though that QTIP trust is exempt from the carryover basis rules and does not appear anywhere else on the Form 8939
In addition to QTIP trusts, other trusts to which GST exemption might be allocated but which are not otherwise reported on Form 8939 include a grantor retained annuity trusts (GRAT) in which there is no reversion if the grantor dies during the GRAT term and any other trust the assets of which are not treated as “acquired from a decedent” under section 1022(e).
When there is only one generation-skipping trust or the total of such trusts is no greater than the available GST exemption (as in Susan’s example), this is not so critical, because the automatic allocation rules will fully allocate GST exemption to the generation-skipping trust or trusts. But in the larger estates that are the more typical candidates for the Section 1022 Election and the filing of Form 8939
, it could be more important that the executor make an intentional allocation of GST exemption, just as in the case of estate tax returns for large estates in years other than 2010. If the GST exemption is not allocated or not completely allocated, the automatic allocation rules of section 2632(e)
will allocate the available GST exemption, first pro rata to direct skips and then pro rata to trusts with generation-skipping potential.
In allocating GST exemption, the executor is able to take into account the true generation-skipping potential of a trust, and might, for example, make no allocation or a smaller allocation to a trust for which there is a greater likelihood of substantial distributions to non-skip persons like the decedent’s surviving children (or children of a deceased child). The automatic allocation rules are not as strategic or discriminating as the executor’s affirmative allocation of GST exemption might be.
Moreover, it is not even clear, as the IRS has made it clear in the case of 2010 inter vivos
gifts, that there would be no automatic allocation of GST exemption to an outright direct skip under section 2632(e)(1)(A)
, which would be a complete waste of GST exemption in the 2010 world of a zero GST tax rate.
All of these considerations highlight the need for a timely filed Form 8939 to report the executor’s affirmative GST exemption allocations, which, in turn, take into account all trusts the value of which would have been included in the decedent’s gross estate under estate tax rules, not just trusts otherwise mentioned on the Form 8939.
Be Careful with “Formula” Allocations of Basis Increases or GST Exemption
Many of us are used to
allocating an estate among beneficiaries, such as between a surviving spouse and a credit shelter trust, by the use of formulas. Many of us are used to
allocating GST exemption on a formula basis, allocating, for example, “the smallest amount of the Decedent’s available GST exemption necessary to produce an inclusion ratio of zero for the Trust.” Indeed, Reg. §26.2632-1(d)(1)
confirms that “[a]n executor may allocate the decedent’s GST exemption by use of a formula.” One of the reasons these techniques work is that the estate tax audit is a short-term proposition. The audit will end, a court will rule, or the statute of limitations will run, and the values and thus the allocations will then be finally determined.
But it is quite clear that a Form 8939
is unlikely to be audited as such. As an occasion for seeking “9100 relief” for making or increasing an allocation of basis increase late, Notice 2011-66
refers to the contingency that “the FMV of property reported on the Form 8939 is adjusted as the result of an IRS examination or inquiry.” This must refer to an IRS challenge to the basis claimed on a subsequent sale of the property (or possibly for depreciation or similar purposes). The effect of such a challenge could only be to reduce
the date-of-death value of the property, which is the ultimate cap for allocations of basis increases. (In other words, the 9100 relief contemplated by Notice 2011-66
must be the late additional allocation of basis increase to another
asset.) In such an environment, an allocation of basis increase by formula might not be finally determined for years or even decades.
Formula allocations of either basis increases or GST exemption, or both, might still work, but the prudence and effectiveness of such allocations will vary considerably from estate to estate on the basis of the asset composition, trust structure, and expectations regarding dispositions. In using any such formula allocations, however, the formulas should be tailored to the two large differences between Form 8939
and the traditional estate tax return that many of us are used to
– first, the final determinations might not be known for decades, and, second, any adjustments of values reported on the Form 8939
are likely to be decreases
in value, not increases.