«Aggregated Summary of Reports Provided by ABA-PTL and ACTEC-Prac List serves 2015 Heckerling Estate Planning INSTITUTE Edited, Aggregation of On-Site ...»
Aggregated Summary of Reports
Provided by ABA-PTL and ACTEC-Prac List serves
2015 Heckerling Estate Planning INSTITUTE
Edited, Aggregation of On-Site Reporter Summaries
Monday, January 12
9:00 - 12:15
Fundamentals Program #1
Basis – Banal? Basic? Benign? Bewildering? (Focus Series) Howard M. Zaritsky, Lester B. Law
Basis used to be a simple tax concept of only modest importance to estate planners, but recent tax law changes
have made income tax planning more important than estate tax planning for some clients, and the use of such techniques as intentional grantor trusts, contingent powers of appointment, private annuities, Alaska community property trusts, joint exempt step-up trusts (JESTs), and trust commutation have made basis sometimes very difficult to determine and even harder to integrate into an estate plan. This session will explore the rules of basis and their increasing importance in estate planning.
Reporter: Beth Anderson Esq.
Mr. Zaritsky’s and Mr. Law’s materials consisted of 245 pages of which they covered nearly every topic in their three hour lecture. They started the lecture with a reminder that the rules of estate planning have changed and practitioners must focus on the balance of estate and income taxes and that balance will vary among the states, and touched on the history of tax basis and general terminology.
Next they briefly covered what types of issues can lead to an adjustment (increase or decrease) in basis. While normally we think of carrying charges (mortgage interest paid) as deductions, if a taxpayer does not have income to apply the deduction, then the taxpayer may elect under §266 to capitalize the carrying charge and increase the property’s basis.
They reminded us that under §1015 gifts of appreciated property have basis depending on whether the property is later sold for a gain or a loss and it’s important to track the basis on gift tax returns so you can later accurately determine the gain or loss. To avoid loss of the loss, it’s better for the donor to sell the depreciated asset (to take advantage of the difference between the donor’s basis and FMV) and gift the cash to the donee rather than gift the asset to the donee who would have to use the FMV at date of gift as basis to determine loss at the subsequent sale.
§1015(d)(6) provides for an adjustment to basis on the gift taxes paid attributable to the net appreciate in the value of the gift. See §1.1015-5(c)(5) for an example.
Turning next to §1014, normally we think of this as new basis for assets included in the decedent’s estate, but it’s broader than estate inclusion and may apply to assets that are not included in the estate, but that are still acquired by the decedent. As pointed out later in the lecture, income, gift and estate taxes are not quid pro quo and you can get an income tax basis adjustment on assets that do not trigger gift or estate taxes. For example, Rev Rul. 84-139 provides that property owned by a non-resident alien is not subject to US estate taxes but still receives a date of death FMV basis adjustment.
The discussion then flowed into transfers of appreciated property in contemplation of death. The general rule under §1014(e) is such that the donor cannot gift property to the donee in contemplation of donee’s death and receive a step-up in basis when donee’s estate transfers the property back to the donor unless the done lives more than one year from the date of the transfer. The discussion turned on whether the donee’s estate could transfer the property to a trust in which the donor had an interest or could later be added to the trust. The theoretical answer is that the adjusted basis should be denied for the value of the donor’s interest in the trust. The practical answer –what’s the value of an interest in a discretionary trust. Instead, you can create a bifurcated creditor shelter trust and provide that any assets received from the donor within one year of death are placed in a trust for the benefit of the children and any additional assets needed to max out the estate tax exclusion amount that were not received from the donor within one year of death are placed in a trust for the benefit of the donor and children, and any assets in excess of the exclusion amount are in the martial trust.
The presenters briefly touched on the importance of holding periods for determining long term (one year and a day) and short term capital gains, and reminded us that the gifts or non-recognition events usually allow for tacking of the donor’s/contributor’s holding period for the recipient, but sales do not, so you may have two different holding periods for a part sale/part gift transaction. Holding period for recipient of property from the decedent is long term so long as the recipient is the one who sells the property.
Uniform Basis Rule was the next topic, and provides that an asset acquired from the donor or decedent has a single basis even if multiple people with different interests own an asset. Therefore, each individual’s portion of the basis will vary based on different facts including life expectancy, interest rate, terms of the trust or type of interest owed.
The next big topic was basis planning with portability and the ability to get two basis adjustments, one on the death of each spouse. Both presenters advised that portability should be the default or go to estate plan which is then adjusted for non-tax reasons such as second marriages, creditor issues, spendthrift, asset protection, collateral tax issues – GST planning.
They next transitioned into ways to “fix” the old credit shelter trusts for better basis:
Distribute assets to Spouse;
Trust protector can grant a general power of appointment to Spouse;
Modify the trust (start drafting trusts) with contingent general power of appointment similar to GST general power over assets that exceed the DSUEA; or Delaware Tax Trap if it’s available in your state and under your document Of these 4 methods, Mr. Zaritsky prefers a combination of the contingent general power of appointment and the ability of the trust protector to grant a general power to the spouse. The first provides a back stop in the event the trust protector fails to act. It is extremely difficult to draft a formula general power of appointment over the specific assets and not exceed the amount which would incur estate tax, and it’s also difficult to find a trustee or trust protector willing to either distribute assets to the spouse or grant a general power to the spouse for fear that after the spouse’s death the assets won't be in the hand of the trust beneficiaries.
Just before the mid-way break, the presenters pulled out the big guns and started discussing partnership tax. They stared slowly, with terminology and general conceptualization of the relationship between the partners and the partnership whether this relationship is an aggregate theory or entity theory. Generally, for basis purposes, the partner and partnership are under the aggregate theory – think of them as combined units instead of separate entities. Recall when a partner makes a contribution of assets in exchange for interest in the partnership, the assets have an Inside Basis equal to the basis of the contributor (transferred basis) and the new partner has an Outside Basis in the partnership interest equal the basis of the assets contributed. For example, partner contributes blackacre with basis of 100 and value of 500 in exchange for a 50% interest in the partnership, the inside basis of the blackacre is 100 and the outside basis of the partnership interest is also 100.
Recognition of gain usually occurs in the estate planning area because of “boot” and investment partnerships (§351). Boot is the receipt of cash or other property, by the partner, other than a partnership interest. Boot triggers a recognition of gain to the extent it exceeds the partners outside basis.
Outside basis is increased by the amount of partnership debt assumed by the partner, and it’s decreased by any partner’s debt that is relieved, but what is the basis on the note contributed to a partnership. Unlike a c-corp, which provides that a note has basis equal to fair market value, a note contributed to a partnership in exchange for a partnership interest has zero basis until payments are actually made, and subsequently the outside basis of the partnership interest is also zero.
Next, they discussed two types of distributions from a partnership, liquidating and non-liquidating and how they affect inside and outside basis. A liquidating distribution is a return of capital and termination of the partnership interest, and a non-liquidating distribution is a distribution that isn’t liquidating. Gain may be recognized on either type of distribution, but loss can only be recognized on a liquidating distribution.
Basis is reduced in a non-liquidating distribution by the amount of cash received and the basis of any property transferred. For example, Janet has an outside basis in J,LP of 100. J,LP makes a distribution to Janet of 5 in cash and land with a FMV of 15 and basis of 5. Janet’s outside basis in the partnership is reduced by the value of the cash received (5) plus the basis of the land (5) from 100 to 90, and Janet takes a carryover basis in the land (5). When the land is later sold she will have to recognize the built in gain.
In a liquidating distribution the entire outside basis is allocated to the cash and property received. For example, Z is a partner with an outside basis of 20 and as part of the liquidation of his partnership interest, Z receives 8 in cash and land with an inside basis of 10 and value of 21. Z’s outside basis is reduced from 20 to 12 because of the 8 in cash and the remaining 12 is allocated to the land thereby adjusting its basis from 10 to 12.
754 election to adjust a partner’s inside basis on the partnership assets and timing of recognition of income. When a partner dies the outside basis receives a date of death fair market value adjustment but the inside basis of the partnership assets do not, unless a 754 election is made. The election applies to a transfer of an interest in an partnership by sale or exchange or upon the death of a partner (§743 is triggered). The partnership makes the election for the partner and it only affects the transferee (new) partner. It requires tracking all of the partnership assets and keeping a separate 754 inside basis for that partner. The process can be complicated and time consuming when there are multiple elections (more than one partner dies) and depreciable assets (real property).
Interesting note, is whether a 754 election should apply at the end of estate administration and the funding of the trust. §761(e) provides that with respect to §743, any distribution of an interest in a partnership (not otherwise treated as an exchange) shall be treated as an exchange. So the distribution of the partnership interest from the estate to the trust could trigger an additional 754 election.
Grantor Trusts vs. Non-Grantor Trusts and Notes is the next cluster of topics discussed. The section started with a recap of the Rothstein case and Rev Rul 85-13 and the concept that sales to grantor trusts are non-recognition events because the grantor is deemed to own the trust assets for income tax purposes. Because grantor is deemed the owner of the trust assets, when the trustee purchases grantor’s assets for a note, the basis of the note is zero (similar to partnership note) because the basis in the assets cannot be allocated to the assets and the note. If the grantor later sells the note to a third party, then there should be recognition of gain for the value of the note (or at least the purchase price).
While grantor is living and the grantor trust status is “on” basis is not going to change, but there may be a basis adjustment if the grantor trust status terminates during grantor’s life. Increase basis for the appreciation from the net gift tax paid.
Termination of grantor trust status at death and basis adjustment without a recognition event. Recall, at the beginning of this outline, income and estate taxes are not quid pro quo, and basis may be adjusted when property is acquired from the decedent. At the death of the grantor, the grantor trust status terminates and the assets that were deemed owned by the grantor are not acquired from the decedent by the trust arguably creating a date of death basis adjustment under Rev Rul 85-13 and §1014, but good luck finding an accountant to sign a return using this theory.
Basis with private annuities and self-cancelling installment notes (SCINs). Private annuities and SCINs are usual tools for clients that are not likely to outlive their actuarial life expectancies.
Annuitant (seller’s) basis is divided into three parts: return of capital, gain (difference between the present value and adjust life expectancy), and annuity (interest like and makes up the rest of the annuity payment). The buyer’s (obligor) basis varies on the situation, for a gain, basis is the present value. Loss cannot be recognized until payments are made and if at a loss the basis is the value of the payments.
SCINs carry a premium because of the risk that the full value will not be paid before the note is cancelled at death.
That premium may increase the basis because it increases the value of the note. The premium may be a higher interest rate, larger payment or some combo of the two. As payments on the note are made, the basis of the note increases, but there should not be an adjustment at death for cancellation of debt. The obligation only applies while the transferor is living, at death there is no longer an obligation and therefore nothing to cancel. Judge Halpern’s dissent in Frane. The argument is compelling unless you are in the 8th circuit in which case the majority opinion in Frane controls and income is recognized by the estate as IRD. IRD does not get a basis adjustment.
The final topic of discussion was double basis step-up planning with the JEST and Community Property Trusts of Alaska and Tennessee.