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2004
Index (back)
Report 10
Thursday, January 8
2:00 - 5:15 p.m. FUNDAMENTALS PROGRAM
Preparing and Filing the Form 706: Who, What, How,
When and Where
Glen A. Yale
Reporter: Jason Havens Esq.
REPORTER'S SUMMARY: This was an excellent presentation on
preparing and filing the federal estate tax return, even for
those who have prepared returns for many years. Glen was both
entertaining and informative. His excellent outline guides
you through the crucial preliminary steps and then through
each part of the actual IRS Form 706. He pointed out several
nuances of each schedule and the proper way to report common
and uncommon property items. His materials also include several
useful checklists, client letters, client memoranda, and a
sample estate tax return.
REPORTER'S COMMENTS: References with only numerals are generally
IRC citations. "GE" refers to "gross estate."
"DOD" refers to "date of death." "FMV"
refers to "fair market value." "IRD" refers
to "income in respect of a decedent."
SECTION 1: GENERAL MATTERS:
1.03: Executor files 706 under penalty of perjury.
Preparer: Treas. Circular 230
1.04: Preparer/Client Relationship: Same for attorney or
CPA. See Bria v. U.S. (D. Conn. 2002) (attorney representing
executor and withdrawal; subpoena for attorney's records;
standard to assert privilege; held that communications and
NOT underlying facts covered). Therefore, PUT NOTHING IN FILE
that do not want IRS to see.
Engagement letter: CHECKLIST. Identify client, confidentiality
defined, scope of engagement (and maybe what is BEYOND scope,
e.g., exclude opinion on documents used to prepare 706 such
as other tax returns -- see ACTEC COMMENTARIES, which are
available via Internet), financial terms, termination, and
required disclosures.
Time table for preparing and filing 706: Key to prepare good
draft 706 by 8 months after date of death because MIGHT NEED
DISCLAIMERS (and might need to obtain court approval).
File ownership: Executor by default but may be changed by
engagement
1.05: Filing threshold: Adjusted taxable gifts + specific
exemption for post-9/8/1976 gifts + gross estate on DOD. Disregard:
deductions, alternate valuation, special use valuation, and
QFOBI.
1.06: Obtaining information: Checklist: income tax returns,
checks/registers, balance sheets (see Trompeter v. Comm.,
T.C. Memo. 1998-35), insurance policies, decedent's mail,
previous estate tax returns (e.g., for SS or child), decedent's
will, decedent's employer.
1.08: Where filed: Hand-delivered or mailed or private delivery
service to Cincinnati (no electronic filing due to attachments);
non-residents must file in Philadelphia.
1.09: Date of death: Refer to death certificate (or process
to correct); time and date controls based on decedent's DOMICILE
TIME ZONE (even if dies in another time zone), but foreign
death is time zone where decedent actually dies. If presumptive
death (e.g., 9/11/2001), IRS says 7 years of absence (PLR
8526007), but conflicts with some state laws (e.g., TX is
based on court decree of death).
1.10: Responsibility for payment: Executor not responsible
UNLESS distributions made and knowledge of insufficient estate
assets. US v. First Midwest Bank/Ill., N.A., 1997 WL 675192
*13 (N.D. Ill. 1997).
1.11: Deadline: 9 months after DOD (same as disclaimers)
but extension of six months. If late, lose 6166 extended payout
and penalties but only election lost.
1.12: Extensions: Automatic 6 months (Form 4768) and no more
unless regulatory extension (e.g., in Iraq). Extension to
PAY generally allowed. See Treas. Reg. 20.6161-1. Longer-term
payout available, e.g., for closely-held business (6166) or
future reversion/remainder (6163), BUT bond required (sometimes
twice value of estate tax) and difficult to obtain sometimes.
1.14: Penalties:
Undervaluation (6662(e)(2)) but avoided if substantial authority
for tax treatment, disclosure of relevant facts, or reasonable
reliance on appraisal (see, e.g., Sammons v. Comm.,
838 F.2d 330 (9th Cir. 1988)).
Civil Fraud: 6663: 75% of underpaid tax. See Trompeter
v. Comm., No. 99-70805 (9th Cir. 2002).
Criminal Fraud: 7201
1.15: Estate tax liens: 6324 (10 years)
1.16: Deficiencies: 6501 (generally three-year rule but exceptions
for false/fraudulent return (no time limit), omissions (six-year
period but see Estate of Helen G. Williamson v. Comm.,
72 TCM (CCH) 687 (1996)). Can obtain discharge from personal
liability via 2204 (no increase re: audit probabilities or
anything else).
1.17: Amending Return: No such thing, but "supplemental
information" allowed. See Treas. Reg. 20.6081-1(d). Does
NOT cure fraud. See Badaracco v. Comm., 464 U.S.
386, 294 (1984). If audit, must disclose assets omitted in
good faith; if no audit, NO NEED to disclose omitted assets
if good faith. Claim for refund: 6511(a): Must be filed within
3 years of original 706 and prior to any court action. See
Zeier v. US, 80 F.3d 1360, 1363-64 (9th Cir. 1996) (what NOT
to do).
SECTION 2: VALUATION:
2.02: Defined: Treas. Reg. 20.2031-1(b): Hypothetical willing
buyer-willing seller. Q of fact.
2.03: Date: Estate of McClachey v. Comm., 147 F.3d
1089, 1091 (9th Cir. 1998).
2.04: Alternate valuation: 2032 (6 months)
2.05: Valuation and basis: 1014(a): FMV @ DOD unless IRD
(691).
2.06: Valuation Discounts: Lack of marketability, FLPs, key-person,
time-value of money
SECTION 3: REQUIRED INFORMATION:
3.08: Disclaimers: 2518: Refusal to accept transfer.
Required questions: gift tax returns (Q 7 -- reasonable inquiry
re: unreported gifts)
SECTION 4: SCHEDULE A -- REAL ESTATE:
4.01: When completed: Generally only probate real property.
4.04: Required information: Describe with enough detail that
IRS can locate. See Treas. Reg. 20.6018-3(a).
4.05: Valuation: Property tax value acceptable if FMV. See
20.2031-1(b). Can use appraisal or sale close to DOD. Appraiser
engagement letter checklist (6.07(D)(3)). Appraisal report
review checklist (4.05(C)(5)). Discounts (fractional interest,
market absorption, catastrophic events).
4.07: Mortgages: Reported on Schedule K unless non-recourse
(and then report net figure on Schedule A).
4.10: Alternate valuation: Rent prior to DOD included. Mineral
production post-DOD included. Should UPDATE appraisals from
DOD to AVD (include in engagement letter).
4.11: Attachments: Appraisals, ad valorem tax appraisal,
and/or closing statement (if value based on sale).
SECTION 6: SCHEDULE B -- STOCKS/BONDS:
6.01: When completed: When GE includes ANY stocks or bonds
Three categories: closely held, publicly traded, or blocks
of publicly traded.
6.03: Stocks: See 706 Instructions p. 12; Treas.
Reg. 20.6018-3(c)(2). Dividends listed separately.
6.04: Bonds:
6.06: Valuation: 706 Instructions p. 13; Treas. Reg. 20.2031-2.
Recommendation to use valuation services.
6.07: Closely held stock: Obtain appraisal. See Rev. Rul.
59-60.
6.15: Attachments: quotations, discount support, appraisals,
more information for closely held stock.
SECTION 7: SCHEDULE C -- MORTGAGES/NOTES/CASH:
7.01: When completed: Self-explanatory.
7.02: How reported: Order to list items.
7.03: Mortgages: Valuation: See Treas. Reg. 20-2031-4.
SCINs: See Estate of Musgrove v. US, 95-2 USTC para.
60,204 (Fed. Cl. 1995). Below-market loans: 7872.
7.05: Cash in possession: Cash on hand.
7.06: Cash in banks: See Treas. Reg. 20.6018-3(c)(3).
7.08: Attachments: Appraisals, copies of notes reported at
less than remaining balance, but NOT bank statements (just
indication that reviewed by preparer).
SECTION 8: SCHEDULE D -- INSURANCE ON DECEDENT'S LIFE:
8.01: Reporting life insurance: All insurance, even if not
included in GE (explain if not includible). Obtain Form 712
from insurance companies; provides value.
8.02: Inclusion in GE: 2042
8.03: Policy held by corporation: Only included in valuing
corporation and decedent's stock in corporation IF proceeds
payable to corporation. If proceeds NOT payable to corporation
and attributable to decedent (more than 50% of stock), then
includible.
8.06: Insurance otherwise included: Listed on Schedule D,
but reported on Schedule G (2035-38).
8.08: ILITs: List by describing trust and note no incidents
of ownership held.
SECTION 9: SCHEDULE E JOINTLY-OWNED PROPERTY:
9.01: When completed: Joint tenancies WROS and tenancies
by the entirety. Listed EVEN IF not includible in GE.
9.02: Qualified joint interests:
9.05: Disclaimer of joint interests: See Treas. Reg. 25-2518-1
& -2.
SECTION 10: SCHEDULE F -- OTHER MISC. PROPERTY:
10.01: When completed: Must answer three questions EVEN IF
no property needs to be listed. Appraisals might be required.
10.02: Property reported: Checklist: Automobiles (http://www.kbb.com),
coin collectibles (see Trompeter v. Comm., T.C. Memo.
1998-35), contraband (see TAM 9207004 (amazing!)); Sammons
v. Comm., 838 F.2d 330 (9th Cir. 1988); Paul Adams, 50
TCM (CCH) 48 (1985)), personal effects (list required: Treas.
Reg. 20.2031-6(a)), jewelry (get AUCTION HOUSE appraisal because
approved by IRS), lawsuit (see Estate of Smith v. Comm.)
Marital/2044 property and duty of consistency required (see
Estate of Letts v. Comm., 190 TC 290 (1997)) but certain
QTIP property not included if QTIP not required to reduce
prior estate to zero (see Rev. Proc. 2001-38).
SECTION 11: SCHEDULE G -- TRANSFERS DURING DECEDENT'S LIFE:
Custodian on UTMA/UGMA account: Includible because allowed
to discharge debt of decedent.
[SECTIONS 12, SCHEDULE H, through 23, SCHEDULE U, not discussed
due to lack of time.]
2:00 - 3:30 p.m. Special Sessions III
Reporter: Carol Warnick Esq.
III-D The Uniform Trust Code: Your State Might Be
Next
Prof. David M. English
Judith W. McCue
Scot W. Bouton
The Uniform Trust Code has been enacted to date in five states,
Kansas, Arizona, Nebraska, New Mexico, and Wyoming. It is
under consideration or study in over 30 other states.
Most American trust law developed prior to 1900. The world
we live in is so different now. Two examples, (1) at that
time there was no federal tax system and (2) marriages may
not have been happy but they lasted longer. Trust are much
more common now, yet trust law in many states is very thin.
While much of the UTC codifies the common law, it does make
some significant changes.
Remember, for the most part, the UTC contains default provisions
which can be drafted around. When asked why not leave everything
up to the draftsman, the reply was that because of the increased
use of trusts, many trusts are being drafted by planners who
do not really understand the law or the issues involved, or
maybe even come out of a book or a trust kit. The feeling
is that some protection should be provided by enacting these
basic laws.
The most controversial issue that has come up so far has
been the notice and reporting requirements to beneficiaries.
Section 813 of the UTC fills out and adds detail to the trustee's
duty to keep the beneficiaries informed of administration.
When in doubt, the UTC favors disclosure to beneficiaries
as being the better policy.
Section 103(12) defines a "qualified beneficiary"
as a beneficiary who, on the date the beneficiary qualification
is determined, (A) is a distributee or permissible distributee
of trust income or principal; (B) would be a distributee or
permissible distributee of trust income or principal if the
interests of the distributees described in subparagraph (A)
terminated on that date; or (C) would be a distributee or
permissible distributee of trust income or principal if the
trust terminated on that date. This definition essentially
includes the remainder beneficiaries but leaves out alternative
and contingent remaindermen.
Public policy issues permeated the notice discussions. Grantors
generally expect to have more control in a trust environment
than if their will was being probated, and many Grantors do
not want the beneficiaries alerted to the trust until absolutely
necessary. This must be balanced with the rights of the beneficiary
to protect themselves. States are using a variety of approaches
when they adopt the UTC. .
Article 3 deals with representation, and many feel this is
the most valuable part of the UTC. It provides comprehensively
for the representation of beneficiaries and others unable
to represent themselves, both with respect to notices and
consents, and without judicial intervention. Virtual representation
(of minors, unborn beneficiaries, etc. is allowed.)
Modification and termination of trust provisions were discussed.
Due to increasing use of long-term trusts, there is a need
for greater flexibility in the rules about when a trust may
be modified or terminated. Must also remember that the primary
objective of trust law is to carry out the settlor's intent.
The beneficiaries and the settlor can get together and terminate
a trust. This is a codification of well-settled common law.
However, remember, the 643 final regs do not bless the termination
of a trust. Also a potential Strangi issue. under 2036(a)(2).
Section 411 of the UTC allows for the settlor and the beneficiaries
to modify or terminate a trust. Is this a taxable power? 2038
regs say that if a power is based on state law it is not a
taxable power under 2038. The 2036 regs do not say that. If
the settlor participates in the modification or termination
of a trust then are all irrevocable trust taxable a la Strangi?
One major change is to do away with the presumption that
a spendthrift provision is a material purpose barring the
beneficiaries from compelling termination of a trust. Used
to be that a spendthrift clause was not in a trust unless
it was a material purpose of the trust. Now they are almost
boilerplate. (Spendthrift provisions did not originate in
England like most of our trust law. They originated in Massachusetts.)
UTC also allows for termination of an uneconomic trust (a
value of $50,000 or less) without a court order or any other
special procedure.
3:45 - 5:15 p.m. Special Sessions IV
Reporter: Carol Warnick Esq.
IV-B Formulas, Fractions and Ratios - Oh My!
S. Stacy eastland
A Christopher Sega
Stacy Eastland began the presentation talking about the McCord
case. He discussed his thinking in setting up the transaction
and what he thinks can be gleaned from the case.
Possible "Bad News" from McCord:
1. Transactions with charities are not considered transactions
with unrelated adverse parties for a majority of the court.
2. This case is precedent for the proposition that a transferor
may have to pay gift taxes based on a transaction over which
the transferor had no control. (The kids negotiations with
the charities to buy out the charities' interests.)
3. There appears to be an implication that defined formula
clauses will only be recognized if the major words "as
finally determined for Federal gift tax purposes" are
included somewhere in the formula clause. (This would not
be practical in commercial transactions between nonrelated
parties.)
4. If a future Tax Court adopts the reasoning of the concurring
opinion of Judge Swift, no charitable deduction would be allowed
for any gifts of partnership interest to charities, unless
under (i) the assignment documents, (ii) the partnership agreement,
or (iii) the applicable state property law that charity is
immediately admitted to the partnership as a full-fledged
member.
Possible "Good News" from McCord:
1. If the assignment document provides that the donee is
an assignee, and other surrounding facts are consistent with
the assignment document, the Tax Court will recognize that
what a hypothetical willing buyer will pay for the transferred
interest is only based on assignee rights That recognition
by the Court may have a profound effect on the amount of the
marketability discount that is allowed.
2. It appears that all but two judges of the current Court
will find a defined value formula clause is not against public
policy when it involves a charity and will even allow a charitable
deduction that may be substantially above what the charity
actually receives. A majority of the Court allowed the donors
a charitable deduction that was approximately 28% above that
the charities ultimately received.
3. The case strongly suggest that a majority of the Court
would be prepared to allow pecuniary defined value formula
clauses, which incorporated the phrase "as finally determined
for federal gift tax purposes." This seems especially
so where the value as finally determined will be divided among
the donees and be retained by them in the proportions provided
by the formula, with no "buyout" by one donee of
another prior to final valuation For instance, defined value
formula clauses incorporating that phrase in which the excess
value over a stated dollar amount goes to a grantor retained
annuity trust, or to a marital deduction trust, appear to
have the support of all but two of the judges on the Tax Court.
They discussed a possible technique where the next tier donee
is a limited power of appointment trust. You can use the same
trust that receives the first tier gift (a single trust with
2 sub-trusts - one trust representing the gift element over
which you retained a limited power of appointment, and the
other trust where the gift would be complete.) Make both trusts
grantor trusts so if ever there is a change in the income
interest, the grantor still pays the tax. If there are adjustments,
no amended income tax returns will have to be filed. If the
property is sold, the sale proceeds can be allocated between
the two sub-trusts and adjustments made later if necessary.
Sega: He liked the fact that in McCord. Stacy used the donor
advised fund of the community foundation...He asked Stacy
if he thought that the fact it was a donor advised fund had
anything to do with the decision in McCord? Stacy
said he thinks that what made the court mad was the lack of
an independent appraisal (even though they were instructed
to obtain one, but chose not to.)
Stacy Eastland discussed another type of transaction discussed
on page 19 of his special session materials, using a formula
defined value clause so the gift element can go into a transaction
where you minimize the taxable gift, such as a GRAT.
He briefly discussed GRATs in comparison with sales to defective
trusts. GRATs have advantages in that there is a built in
revaluation clause. GRATs have the disadvantage that you can
die early before the term of the GRAT is up. You can do cascading
GRATs to deal with that risk. The problem still remains that
interest rates can go up. (His aside was that you never know
when Jimmy Carter may be re-elected.)
The advantage to sales to defective trusts is that you can
lock in today's low interest rates.
Example 4 in his materials uses a formula amount, a note
coming back, the words "as finally determined for federal
gift tax purposes", and if the value exceeds the dollar
amount, the excess goes to a GRAT. Hopefully, the worst that
can happen is that the donor does not end up selling as much
to the kids as he had hoped.
Think of this in terms of the Strangi problem. If
you are looking for an exit strategy, one might be to do this
type of transaction, or do a redemption, and to the extent
the value exceeds your dollar amount, the excess goes to the
GRAT.
Example 5 places the whole partnership interest into a GRAT
followed by a formula defined value transfer of the retained
annuity in the GRAT to an Intentionally Defective Grantor
Trust. Stacy said it was hard to see how you can get in trouble
with this on a short term GRAT.
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