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Significant recent developments in estate planning.

This article--the first of two parts--examines recent developments in estate, gift and generation-skipping transfer tax planning. Specifically, this part discusses legislation and regulations, including, among other items, estate tax repeal proposals; the Hubert final regulations; Sec. 6501 (c)(9) adequate disclosure final regulations; andproposed regulations on charitable remainder annuity trusts, grantor retained annuity trusts and grantor retained unitrusts.


* Adequate disclosure final regulations detail the information to be disclosed to trigger the running of the SOL.

* Hubert final regulations clarify the distinction between estate "transmission" expenses and estate expenses.

* Treasury cracked down on perceived abuses in the areas of CRTs, GRATs and GRUTs.

This two-part article focuses on recent developments in estate, gift and generation-skipping transfer (GST) taxes. This-part analyzes current legislative and regulatory developments in areas such as estate tax repeal; increase in the Social Security earnings limit; exclusions indexed for inflation; separate-share regulations; updated mortality tables; and lowered group-term life insurance rates. The second part, in the September issue, will focus on cases and rulings on estate and gift tax.

Legislative Developments

Estate Tax Repeal

Senator Jon Kyl (R-AZ) is leading the legislative charge to repeal the estate and gift taxes. The senator (and many of his colleagues) contend that death should not be a taxable event.

During fall 1999, the House and Senate passed legislation to repeal the Federal estate and gift taxes.(1) President Clinton vetoed the bill on Sept. 23, 1999; no attempt was made to override the veto. That legislation contained a grand "wish list"--individual income and capital gains tax cuts, estate and gift tax repeal, etc. The legislative measures were extremely broad; thus, the veto did not attract any significant negative press or public outcry.

However, the estate tax repeal issue is far from dead. Numerous legislative proposals were introduced during the recent political primary season.(2) The proposals varied significantly and have potentially broad effect outside of gift and estate tax collections. Even though the income, gift and estate tax rules are found in different chapters of the Code, they tend to be interdependent (e.g., basis adjustments). In fall 1999, the AICPA Tax Section, recognizing the need for additional study and the opportunity for legislative assistance, created an Estate Tax Repeal/Carryover Basis Task Force, which is working closely with legislative representatives to gather data, analyze each of the legislative proposals and facilitate change. A change in Presidential administration may add further impetus, but the issue is far more complex than it first appears.

Although no direct legislative changes were made to the estate and gift taxes during the past 12 months, some indirect measures were enacted, as discussed below. Social Security Earnings Limit

On April 7, 2000, legislation(3) repealed the earnings limit for working taxpayers aged 65 to 69, effective for tax years ending after 1999. Under prior law, affected taxpayers were forced to forfeit $1 of Social Security benefits for every $3 of wages in excess of the earned income limit ($17,000 in 2000).

The repeal of the earnings limit will encourage more workers to remain in the workforce. While this might have a positive effect on a U.S. economy that has a shortage of qualified labor, it will also create estate planning ramifications for entrepreneurs.

First-generation entrepreneurs are often reluctant to turn over the reins to the next generation. The earnings limit alone will not convince entrepreneurs to retire, but it will encourage them to create an income stream independent of wages.

Exclusions Indexed

The Taxpayer Relief Act of 1997 indexed a number of exclusion items, beginning in 1999. The 2000 changes were released in Rev. Proc. 99-42.(4)

Gift tax annual exclusion: The annual exclusion remains at $10,000 per person for 2000. The adjustment to Sec. 2503 is in $1,000 increments as necessary to reflect inflation. However, the relatively low inflation levels over the past two years have yet to affect this exclusion.

Noncitizen spouses: Taxpayers can transfer unlimited amounts of property to a U.S. citizen spouse under the marital deduction. However, if the spouse is not a U.S. citizen, the exclusion was historically limited to $100,000 under Sec. 25230)(2). For 2000, the Sec. 25230) (2) exclusion amount increased to $103,000.

GST tax exemption: The GST tax exclusion increased to $1,030,000 for 2000 (from $1,010,000 in 1999).

Special-use valuation: An executor may elect to value real property used in a farm or business on the basis of the property's actual use, rather than its highest and best use. Under Sec. 2032A, the maximum allowable deduction was $750,000; the 2000 indexed amount is $770,000.

Sec. 6166 tax deferral for closely held businesses: The 2% interest rate for the applicable portion of the estate tax payable in installments is increased to $1,030,000 for 2000.

Receipt of large foreign gifts: For tax years beginning in 2000, recipients of gifts from certain foreign persons may have to report them under Sec. 6039F if the aggregate value received in a calendar year exceeds $10,931.

Regulatory Developments

Treasury published three sets of estate planning final regulations in December 1999, all of which were discussed in proposed form in last year's update articles.(5) The discussion below focuses on some of the significant changes in the final regulations.


The final regulations(6) clarify the distinction between "estate transmission expenses" and "estate management expenses" for purposes of determining the effects of administration expenses on the value of property qualifying for the marital and/or charitable deduction. Transmission expenses are expenses that would not have been incurred but for the decedent's death and the necessity of collecting assets, paying debts and death taxes and distributing the decedent's property to heirs and legatees. Management expenses are incurred during a reasonable period of administration for the investment, preservation and maintenance of estate assets. Regs. Sec. 20.2056(b)-4(a) is effective for individuals dying after Dec. 2, 1999.

The final regulations are fairly straightforward. First, the marital and/or charitable deduction is reduced by all transmission expenses the estate paid. Second, management expenses paid from the marital or charitable portion of the estate do not reduce the marital and/or charitable deduction.

However, the effect of management expenses can differ, depending on the executor's actions. First, if a management expense relates to assets allocated to another portion of the estate, payment of the expense from the marital portion will reduce the marital deduction; payment of the expense from the charitable portion will reduce the charitable deduction. Second, if the executor deducts a management expense on Form 706, U.S. Estate (and Generation-Skipping Transfer) Tax Return, instead of on Form 1041, U.S. Income Tax Return for Estates and Trusts (as is the executor's option), the management expense will reduce the marital and/or charitable deduction.

The regulations attempt to achieve what the IRS argued in Hubert(7)--estate transmission expenses reduce the marital and/or charitable deduction, regardless of whether they are deducted on Form 706 or 1041. The deduction of transmission expenses on Form 1041, however, will result either in the estate's exemption equivalent portion being reduced or in a higher estate tax.

Observation: IRS Field Service Advice (FSA) 9921004(8) adds to the Service's perspective. The FSA concluded that an executor's discretionary authority to allocate an administration expense against postmortem estate income might reduce the marital deduction if it is a material limitation on the surviving spouse's right to income. Whether it is a material limitation is a facts-and-circumstances determination. This conclusion parallels the materiality tests contained in the pre-Hubert regulations; it is surprising that no attempt was made to relate the FSA to the current regulations project. Thus, wills and trusts should remove the executor's or trustee's discretion and require expenses to be allocated in a manner consistent with the new regulations.

Gift Tax Adequate Disclosure

Final regulations(9) define disclosure adequate to trigger the three-year statute of limitations (SOL) for both Federal gift and estate tax purposes. Treasury considered many of the practitioner comments in revising the proposed regulations.

Gifts: Regs. Sec. 301.6501(c)-1(f)(2) and (3) require taxpayers to furnish the following information (either on a gift tax return or an attached statement) to start the SOL running:

1. A description of the transferred property and any consideration received by the transferor.

2. The identity of (and relationship between) the transferor and transferee.

3. If the transfer is in trust, the trust's tax identification number and a description of the terms. (A copy of the trust instrument may be attached in lieu of a description.)

4. A detailed description of the method used to determine the transferred property's fait market value, including any financial data used and any discounts or restrictions considered. (Alternatively, an appraisal from a qualified appraiser may be attached.)

5. A statement of any position taken in the gift: tax return that is contrary to any current regulation or revenue ruling.

Nongifts: Regs. Sec. 301.6501-(c)1(f)(4) does not offer relief for transactions not disclosed because they are not considered a gift (e.g., an installment sale). Transactions "in the ordinary course of business" (e.g., salary and rent) are deemed adequately disclosed if they are consistently reported by all of the parties on their income tax returns. However, while the regulations do not clearly define "in the ordinary course of business" the preamble states that sales between a parent and a child do not qualify. Why are salary and rent payments by a controlled corporation to a related party in the ordinary course of business, while installment sales are not? Is the insertion of a corporation or trust as an intermediary sufficient to create a business environment? Is a stock redemption "in" the ordinary course of business, but not a cross-purchase between family members? The rule appears to lack consistency.

Observation: After the final regulations, it may be prudent to disclose related-party transactions on a gift tax return, with an explanation as to why the transaction is not a gift. One might also consider reporting nontaxable transactions involving grantor-type trusts on both the trust's and the individual's income tax returns, with an adequate disclosure statement.

Separate-Share Rules

Final regulations(10) clarify the definition of separate shares for estate tax purposes and narrow the application of the Sec. 663(c) separate-share rules. Under Regs. Sec. 1.663(c)-4(a), bequests of specific sums of money or property are not separate shares and, thus, do not receive any portion of the income or appreciation earned during the estate administration period, unless specifically called for in the governing instrument.

Substantively separate and independent shares created for different beneficiaries are treated under the final regulations as separate estates in computing distributable net income and applying the Secs. 661 and 662 distribution provisions. A qualified revocable trust electing under Sec. 645 to be treated as part of an estate for Federal income tax purposes is a separate share; there may be additional separate shares within the trust.

CRT Prop Regs.

Sec. 664 proposed regulations(11) were issued to prevent the misuse of charitable remainder trusts (CRTs). The Service's attack is focused on CRTs that seek to convert appreciated assets into cash, while avoiding the capital gains tax on the gain from their disposition. The typical transaction involves a taxpayer who contributes highly appreciated assets to a CRT for a short term and a high payout rate. The CRT trustee pays out the annuity in a calendar year before the trust's sale of the assets. As a result, the parties characterize the distribution as a tax-free return of corpus under Sec. 664, rather than as income.

Observation: The regulations were promulgated under what Treasury believes was a broad grant of regulatory authority contained in Sec. 643(a)(7). The AICPA Tax Division submitted comments to Treasury disputing the apparent source of this power. Sec. 643(a)(7) was enacted in 1996 as one of a host of statutory changes aimed specifically at combating certain foreign trust abuses. According to the AICPA comments, Congress's positioning of this statute suggests that it may not have intended for Sec. 643(a)(7) to be applied other than to combat certain specific abuses involving foreign nongrantor trusts. The comments view as invalid Treasury's attempt to create regulations in this instance.

GRAT/GRUT Prop. Regs.

The Service has been increasingly concerned about grantor retained annuity trusts (GRATs) and grantor retained unitrusts (GRUTs) that allow taxpayers to defer required annual payments under Sec. 2702. In particular, it observed instances in which installment notes are distributed in lieu of a cash payment.

Prop. Regs. Sec. 25.2702-3(b) provides that the issuance of a note, other debt instrument, option or other financial arrangement will not constitute a payment for Sec. 2702 purposes.(12) The proposed regulations would apply retroactively, but allow a transition rule for trusts created before Sept. 20, 1999. Trusts created after that date must expressly prohibit the trustee from issuing a note, option or other debt instrument to meet the annual payment requirement.

Updated Mortality Tables

The IRS issued proposed regulations under Sec. 7520,(13) containing new tables for valuing annuity interests arising under Secs. 642, 664, 2031 and 7520, generally applicable to the value of annuities, interests for life or a term of years and remainder or reversionary interests for valuation dates after April 30, 1999. However, transition rules permit use of the old tables for transfers before July 1, 1999. The same tables must be used to measure the life interest and the remainder interest in the same transaction.

Observation: The revised tables reflect longer life expectancies and will tend to benefit GRATs and charitable lead trusts.

Group-Term Life Insurance Rates

The IRS issued proposed regulations(14) in January 1999 that became final on July 1, 1999. Regs. Sec. 1.79-3(d)(2) lowered the Table I amounts for group-term life insurance policies, to reflect the recent mortality improvements.


In the September issue, Part II of this article will examine cases and rulings in myriad areas, including gifts of family limited partnership interests, charitable split-dollar insurance arrangements, qualified personal residence trusts, valuation discounts and retirement planning.

Editor's note: Mr. Whitlock is a member of the AICPA Tax Division's Estate Tax Repeal/Carryover Basis Task Force.

(1) H.R. 2488, the "Taxpayer Refund and Relief Bill of 1999."

(2) See, e.g., H.R. 8, the "Death Tax Elimination Act of 2000."

(3) H.R. 5, the "Senior Citizens' Freedom to Work Act of 2000."

(4) Rev. Proc. 99-42, IRB 1999-46, 568.

(5) See Pye and Vail, "Significant Recent Developments in Estate Planning (Parts I and II)," 30 The Tax Adviser 574 (August 1999) and 30 The Tax Adviser 642 (September 1999).

(6) TD 8846 (12/2/99); see also Ann. 2000-3, IRB 2000-2, 296.

(7) Est. of Otis C. Hubert, 520 US 93 (1997).

(8) IRS FSA 9921004 (2/2/99).

(9) TD 8845 (12/2/00); see VanderMeulen, Tax Clinic, "Gift Tax SOL Disclosure Final Regs.," 31 The Tax Adviser 295 (May 2000).

(10) TD 8849 (12/27/99); see Cox, Tax Clinic, "Final Regs. for Separate-Share Rules Issued," 31 The Tax Adviser 210 (April 2000).

(11) REG-116125-99 (10/18/99).

(12) REG-108287-98 (6/22/99); see Tubandt, Tax Clinic, "Prop. Regs. Affecting GRATs and GRUTs," 30 The Tax Adviser 698 (October 1999).

(13) REG-103851-99 (4/30/99).

(14) TD 8821 (5/28/99).

For more information about this article, contact Mr. Whitlock at (312) 207-1040 or

Brian T. Whitlock, J.D., LL.M., CPA Partner

Blackman Kallick Bartelstein, LLP Chicago, IL
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Title Annotation:part 1
Author:Bartelstein, Blackman Kallick
Publication:The Tax Adviser
Geographic Code:1USA
Date:Aug 1, 2000
Previous Article:Registration, listing and disclosure of potentially abusive corporate tax shelters.
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