A DECADE OF DISRUPTED TAX GUIDANCE
For ten years, what might have seemed like routine and orderly tax guidance has fallen prey to a flood of interruptions and distractions, but it can still achieve substantive successes.
Dear Readers Who Follow Washington Developments:
Last month was an important tenth anniversary (at least important for purposes of this Capital Letter) that we can all be quite confident passed largely unobserved. On October 20, 2009, the Federal Register contained final regulations, effective on that date, regarding the consideration of post-death events in determining the amounts deductible as claims against the estate under section 2053 (74 Fed. Reg. 53652). The regulations originated in a notice of proposed rulemaking published in the Federal Register on April 23, 2007 (72 Fed. Reg. 20080), pursuant to a Treasury-IRS regulation project opened in 2003. So far so good – about four years to propose regulations, almost exactly two and a half years to finalize them.
But one subparagraph of the final regulations, Reg. §20.2053-1(d)(6), is blank. It is labelled simply “[Reserved].” It turns out that the proposed regulations would have allowed a deduction for only the present value of certain noncontingent but as yet unpaid obligations, but would have allowed a dollar-for-dollar deduction of certain contingent obligations. The Preamble to the final regulations explained that some commentators had suggested that that distinction “is inequitable and produces an inconsistent result without meaningful justification.” As a result, the Preamble continues: “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.” Fair enough – it is always reassuring when the notice-and-comment process works as intended.
But a decade later, there is still no such guidance. In fact, it would not be too much of a stretch to view the publication of most of the section 2053 regulations in October 2009 as the last estate tax guidance to be published in an environment of order and intentionality. For a decade.
If we think about it, it is not hard to remember what happened after October 2009. 2010! Not just 2010 the year. But 2010 the repeal of the estate tax and institution of carryover basis, both sunsetted one year later in 2011. Congress did provide for exactly such a one-year repeal in the Economic Growth and Tax Relief Reconciliation Act of 2001. But sometime in that decade that was expected to be fixed, maybe by making repeal permanent, maybe by scaling it back some. Perhaps the best chance was a vote scheduled in the Senate for right after Labor Day in 2005 that could have led to permanent repeal. But the Senate was overwhelmed by the pressures of responding to Hurricane Katrina, which had slammed into Mississippi and Louisiana the previous week. And when the vote was finally taken the following June, the fervor might have waned, and the vote fell three votes short. Consideration in August of a House-passed compromise with a permanent $5 million exemption and 30 percent rate, both to be phased in by 2015, picked up only one more vote. And in the November 2006 election the control of both the House and Senate changed.
Meanwhile, if Treasury and IRS personnel had been left free to establish their own priorities, all indications are that they would have given top priority to guidance under section 2801, which had been enacted on June 17, 2008, in the Heroes Earnings Assistance and Relief Act (“HEART” Act) of 2008. Section 2801 is a problematic attempt to engraft onto the existing transfer tax an accessions tax that requires the recipient of a gift or bequest from an expatriate to know that expatriate’s tax profile. Announcement 2009-57, 2009-29 I.R.B. 158 (released July 16 in the fateful year of 2009, barely a year after the enactment of section 2801), seemed to acknowledge the challenge by stating that the due date of both the reporting and the payment of the new tax would not be determined until guidance could be issued. That guidance project first appeared in the 2008-2009 Treasury-IRS Priority Guidance Plan in September 2008 as the seventh item under the heading of “Tax Administration” and was moved in the 2009-2010 Plan in November 2009 to the seventeenth item under the heading of “Gifts and Estates and Trusts.” Proposed regulations were published in 2015, and Proposed Reg. §28.6071-1(d) confirms that no return will be due under section 2801 until at least 18 months after the regulations are finalized. The regulations have not been finalized yet, and it seems obvious that with a nominal effective date of June 17, 2008, the longer the project takes the harder it will be, but the harder it is the longer it might take. Hopeless chaos. The project was dropped from the Priority Guidance Plan in 2017.
To recap, here are examples of the developments of the past ten years that have undoubtedly affected the process of regular planned guidance:
- The one-year inapplicability (as in “this chapter shall not apply”) of the estate and GST taxes in 2010, under sections 2210 and 2664 enacted in 2001.
- The 2010 carryover basis regime of section 1022 enacted in 2001.
- Retroactive reinstatement of the estate tax, with an election out of estate tax into carryover basis, provided by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Tax Act”).
- Conversion of the inapplicability of the GST tax in 2010 to the applicability of a zero rate for 2010 in the 2010 Tax Act, in order to preserve the continuous application of the GST tax rules from year to year.
- The “anti-clawback” rule of section 2001(g) added by the 2010 Tax Act.
- Cost-of-living adjustments to the applicable exclusion amount, beginning in 2012.
- Portability of the exclusion amount from a deceased spouse to the surviving spouse enacted in the 2010 Tax Act.
- The two-year postponement of the 2011 sunset by the 2010 Tax Act.
- The permanence provided by the American Taxpayer Relief Act of 2012, enacted two days after the postponed sunset.
- Updating the definition of “spouse,” etc. in light of United States v. Windsor, 570 U.S. 12, 133 S. Ct. 2675 (2013), and Obergefell v. Hodges, 5576 U.S. 644, 135 S. Ct. 2584 (2015). See T.D. 9785 (Aug. 12, 2016).
- The consistent basis rules of sections 1014(f) and 6035 abruptly enacted in the Surface Transportation and Veterans Health Care Choice Improvement Act on July 31, 2015, reminiscent of the awkward impulse to blend two tax systems in the HEART Act of 2008.
- Stricter standards and procedures for evaluating the relative benefits and burdens of “significant regulatory actions” under Executive Order 13789 (April 21, 2017).
- The 2017 Tax Act, including, among many other things, a new anti-clawback mandate in section 2001(g)(2), the strain on deductions of estate and trust administration expenses under section 67(e) and the passthrough of those expenses to beneficiaries in the final year of an estate or trust under section 642(h), the new qualified business income deduction under section 199A, the renewed interest in the multiple trust rule of section 643(f), and a new 2026 sunset.
With the possible exception of the consistent basis rules, it cannot be said that these are bad developments – just that the timing of these developments was unexpected and could not be planned for. Thus we mark a decade of distraction and crisis management.
Effect Seen in the 2019-2020 Priority Guidance Plan
Thus it should be no surprise that when Treasury and the IRS released their 2019-2020 Priority Guidance Plan on October 8, 2019, there was little that was new.
Under the heading of “Implementation of Tax Cuts and Jobs Act (TCJA),” we still have, as Item 46, “Final regulations under §2010 addressing the computation of the estate tax in the event of a difference between the basic exclusion amount applicable to gifts and that applicable at the donor’s date of death. Proposed regulations were published on November 23, 2018.” These are the “anti-clawback” regulations that were discussed in Capital Letter Number 46.
Under the heading of “Burden Reduction,” Item 13 is “Final regulations under §§1014(f) and 6035 regarding basis consistency between estate and person acquiring property from decedent,” and Item 17 is “Final regulations under §2642(g) describing the circumstances and procedures under which an extension of time will be granted to allocate GST exemption.” That the consistent basis regulations, especially, still are identified as “burden reduction” continues to fuel optimism that the final regulations will provide substantial relief from the burdensome and, to many, unnecessary and unauthorized provisions in the proposed regulations that would require every beneficiary to receive within 30 days after the estate tax return is filed a list of all the assets that might be distributed, would require certain assets omitted by the executor in good faith to get a zero basis in the hands of the beneficiary, and would require endless reporting to successive donees. Both the consistent basis regulations (including those three serious flaws) and the GST exemption regulations are discussed in Capital Letter Number 44.
And under the heading of “General Guidance,” the topic of “Gifts and Estates and Trusts” includes the same four items as the 2018-2019 Plan: the basis of grantor trust assets at death under section 1014, the imposition of restrictions on estate assets during the six-month alternate valuation period under section 2032, the carryover from the 2008 regulations on the deduction of claims against the estate under section 2053 (discussed above), and regulations under section 7520 regarding the use of actuarial tables in valuing annuities, interests for life or terms of years, and remainder or reversionary interests. These items are also discussed in Capital Letter Number 44. The new actuarial tables were due by May 1, 2019, but they have not been published yet. Presumably, when the contemplated regulations are published, they will provide appropriate transitional relief for anyone who relied on the outdated actuarial tables in structuring or valuing a transfer after April 30, 2019.
Deductibility of Estate and Trust Administration Expenses
Item 6 under the heading of “Implementation of Tax Cuts and Jobs Act (TCJA)” in the 2019-2020 Priority Guidance Plan is described as “Regulations clarifying the deductibility of certain expenses described in §67(b) and (e) that are incurred by estates and non-grantor trusts.”
Notice 2018-61, 2018-31 I.R.B. 278, released on July 13, 2018, indicates that regulations anticipated from this project should clarify that estate and trust administration expenses continue to be deductible because of section 67(e), despite the eight-year “suspension” of section 67(a) by section 67(g), added by the 2017 Tax Act. It is likely, however, that deductibility will continue to be limited by the harsh treatment in Reg. §1.67-4(b)(4) and (c)(2) of fiduciary investment advisory fees, including the portion of a “bundled” fiduciary fee attributable to investment advice. Notice 2018-61 states flatly that “nothing in section 67(g) impacts the determination of what expenses are described in section 67(e)(1).” This is serious, because it means that until 2026, instead of merely subjecting certain investment advice expenses to a floor equal to 2 percent of adjusted gross income, these expenses will be disallowed altogether.
Notice 2018-61 also indicates that regulations will address the availability of “excess deductions” to individual beneficiaries under section 642(h) on termination of an estate or trust, and the Notice asked for comments on that issue. On February 19, 2019, ACTEC submitted comments providing detailed analysis of the history and operation of section 642(h). The ACTEC comments recommended that excess final year deductions allowed in computing the adjusted gross income of an estate or trust, including the costs of administration described in section 67(e)(1), be allowed in computing a beneficiary’s adjusted gross income.
The instructions to the 2018 Form 1041, dated February 5, 2019, appear to assume a favorable resolution of that issue. In the specific instructions for line 22, Taxable Income, on page 26, the instructions state: “If the estate or trust has for its final year deductions (excluding the charitable deduction and exemption) in excess of its gross income, the excess is allowed as an itemized deduction to the beneficiaries succeeding to the property of the estate or trust.” On page 36, at the beginning of the specific instructions for Schedule K-1, Beneficiary’s Share of Income, Deductions, Credits, etc., the instructions warn: “Note. Section 67(g) suspends miscellaneous itemized deductions subject to the 2% floor for tax years 2018 through 2025. See Notice 2018-61 for information about allowable beneficiary deductions under section 67(e) and 642(h).” But later, on page 39, the instructions confirm: “If this is the final return of the estate or trust, and there are excess deductions on termination (see the instructions for line 22), enter the beneficiary’s share of the excess deductions in box 11 [Final year deductions], using code A. Figure the deductions on a separate sheet and attach it to the return.”
In contrast, the instructions for line 16 of the 2018 Form 1040, Schedule A (“Other Itemized Deductions”), dated December 10, 2018 (page A-12), had stated that “Only the expenses listed next can be deducted on line 16,” followed by a list that did not include excess deductions on termination of an estate or trust. In this respect, however, the instructions are identical to the instructions for line 30 of the 2017 Schedule A, dated February 15, 2018 (page A-13), before the 2017 Tax Act applied when there was no doubt that excess deductions on termination could be deducted.
The regulations, of course, will supersede the instructions. It might appear that there is less explicit authority for regulations to address this issue than the explicit above-the-line provision for estates and trusts themselves in section 67(e). Indeed, Reg. §1.642(h)-2(a) explicitly states the opposite: “The deduction is allowed only in computing taxable income and must be taken into account in computing the items of tax preference of the beneficiary; it is not allowed in computing adjusted gross income.”
But an eight-year suspension of a fiduciary’s authority to pass these excess deductions on to beneficiaries could have a terribly disruptive effect on the fiduciary’s decisions regarding the timing of the payment of expenses, the timing of distributions, and the timing of the termination of the estate or trust, all to the frustration of beneficiaries and for no discernable policy purpose. For that reason, it should be expected that Treasury and the IRS will work hard to find a way to justify regulatory relief from such a burden. As the ACTEC comments point out, section 642(h) provides that the excess deduction “shall be allowed as a deduction, in accordance with regulations prescribed by the Secretary“ (emphasis added). Just as the current regulations clarify that these deductions are not allowed above the line in computing adjusted gross income, so should the new regulations be expected to clarify that these expenses of estate or trust administration, which are not suspended by section 67(g), continue to be deductible by beneficiaries, whether above the line or below the line or in some other way – “in accordance with regulations prescribed by the Secretary“ as the statute says.
In that way, this period of more than a decade since the last environment of relatively orderly regulatory process will still have produced another substantive success when, as with the section 2053 regulations of October 2009, Treasury and the IRS have listened to comments.