Driven by client demand and the inherent nature of estate planning, where the tax impact can’t truly be calculated until years after the planning is first implemented, practitioners often need to look into their crystal balls to predict what changes in the law may be on the horizon. With the outcome of the November 2022 election resulting in a Congress that will no longer be controlled solely by Democrats, it’s less likely that any substantial tax legislation that would have a bearing on trusts and estates will make it to President Biden’s desk when compared to the first two years of his administration. This anticipated dearth of legislation doesn’t mean 2023 will be a year of no changes. Various regulatory projects are in the works that could be proposed or finalized over the course of the year. Here’s a summary of some of the most relevant regulatory projects that are in the works that estate planners should be aware of.
Basis Adjustment/Reporting
Over the past decade, resulting from the passage of the American Taxpayer Relief Act of 2012, there’s been a paradigm shift from an estate planner’s primary focus on transfer taxes to income taxes. The basis adjustment that occurs under Internal Revenue Code Section 1014 is important to income tax conscious estate planning, and while several proposals to eliminate or reduce its benefits failed to pass in the outgoing Congress, it will be impacted by two regulatory projects.
The first item is the proposed regulations (regs) regarding the basis consistency and reporting requirements under IRC Sections 1014(f) and 6035, which were included as a revenue raiser in the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. These IRC sections require that certain beneficiaries of property from an estate can’t report a basis that exceeds the value for estate tax purposes and imposes additional reporting obligations on the party filing the estate tax return by requiring the filing of Form 8971 with the Internal Revenue Service and sending Schedule As to that form to certain beneficiaries. Proposed regs were issued in 2016 and have yet to be finalized but are expected to be in the near future. Some of the more controversial provisions of the proposed regs are: (1) property required to be but not reported for estate tax purposes will have a zero basis for income tax purposes; and (2) the impractical reporting of value to all beneficiaries who might receive the property as opposed to those who are actually receiving it. The outcome of this regulatory project will have an immediate impact on the administration of large estates and could have a greater reach in the future if the basis reporting requirements are ever expanded to the basis of gifted assets.1
The second item is a “new” regulatory project regarding whether Section 1014 applies to grantor trusts whose assets aren’t included in a decedent’s estate, such as an intentionally defective grantor trust. This isn’t an entirely new project because it’s been an issue the IRS has turned its attention to in the past. Some estate planners have argued that although assets of a grantor trust may not be subject to estate taxes, they should still receive a basis adjustment under Section 1014(b). While those who make this contention are correct that Section 1014(b) isn’t a quid pro quo that an asset must be subject to estate taxes to receive a basis adjustment, many estate planners don’t believe there’s a statutory basis for such trusts to receive a basis adjustment. In Chief Counsel Advice 200937028, the IRS stated that it “strongly disagree[d]” with the position there should be a basis adjustment. In 2015, the IRS issued guidance that it would no longer issue rulings on the issue and soon after indicated in its Priority Guidance Plan that it would develop regulatory guidance.2 In the 2021-2022 Priority Guidance plan the regulatory project was dropped, but on Nov. 4, 2022, the project made a return in the 2022-2023 Priority Guidance Plan. It’s expected that if such regs are proposed, they’ll make clear there will be no basis adjustment.
Proposed Clawback Regs
Estate planners already have Dec. 31, 2025 circled on their calendars because of the anticipated high level of activity that will occur if the exemption is halved at the start of 2026 in the absence of legislative action. When the exemption was temporarily increased by the 2017 Tax Cuts and Jobs Act, the mechanics of how the computation of taxes would work after the exemption decreased were left to regulatory action. In 2019, the IRS finalized regs that would allow taxpayers the benefit of the higher exemption for transfers made prior to the exemption being reduced. This was in an effort to avoid what would be effectively a retroactive tax on gifts for those who didn’t exceed the exemption at the time of gifting but whose lifetime gifts exceeded the exemption in effect at the time of death or future gift, which practitioners often refer to as “clawback.” When these anti-clawback regs were finalized in 2019, their preamble stated that a commentator recommended consideration of anti-abuse rules, which the IRS later added as a project to the 2021-2022 Priority Guidance Plan. The outcome of this regulatory project would have a direct impact on the planning practitioners will be considering in 2023 through 2025.
On April 27, 2022, the IRS released proposed anti-abuse regs. These regs don’t replace the 2019 anti-clawback regs, but instead supplement them by providing an identified list of transfers that won’t benefit from the higher credit amount that would otherwise be allowed under the anti-clawback regs. Unsurprisingly, transfers that were included back in a transferor’s gross estate by virtue of various string provisions won’t receive the benefit of the use of the increased exemption amount. The new proposed regs also provide the value of transfers made by an enforceable promise wouldn’t receive the benefit of the increased exemption to the extent it wasn’t paid. In addition, certain transfers identified in the Chapter 14 regs wouldn’t receive the benefit of the increased exemption. These proposed anti-abuse regs went a step further, perhaps too far, to prevent taxpayers from navigating around these rules with deathbed planning by eliminating the benefit of the increased exemption for any transfers that would have otherwise been included because they were one of the previously described transfers that was changed within 18 months of the date of the taxpayer’s death. This time period is interesting given that the estate tax string provisions use a 3-year lookback period. The proposed regs also provide various exceptions to the rule.
Estate Tax Deductibility
The estate tax is, simplistically put, a tax on a decedent’s net worth. The tax isn’t imposed on the value of the gross estate, but on the taxable estate, which takes into consideration various deductions and losses. As the ultimate tax liability is impacted by deductions, there’s a concern that deductions might be overstated or have no purpose other than to reduce the estate tax liability. In 2008, a project was added to the Priority Guidance Plan, stated as “Guidance under §2053 regarding personal guarantees and the application of present value concepts in determining the deductible amount of administration expenses and claims against the estate.”3 Fast-forward nearly 14 years later to June 2022 when the IRS released proposed regs on this issue.4 There are several items in the proposed regs planners need to be aware of for both estate administration and estate planning.
First, there will be an introduction of what the proposed regs call a 3-year “grace period,” when deductions for payments that are expected to occur by the 3-year anniversary of a decedent’s death may still be entirely deducted as they currently are.5 For items that will be paid after the grace period, the amount of the deduction isn’t the amount to be paid, but the present value of that amount. Second, the proposed regs make clear that interest on the estate tax liability under IRC Sections 6161 or 6163 (but not IRC Section 6166) and penalties are generally deductible but may not be deducted if they’re a result of “such conduct by the executor, the interest expense is attributable to an executor’s negligence, disregard of the rules or regulations, or fraud with intent to evade tax.”6 Third, the proposed regs issue guidance on when personal guarantees may be deducted for estate tax purposes.
The fourth item of interest is regulatory guidance related to what estate planners refer to as “Graegin loans,” whereby estates take loans from related parties to pay its liabilities and deduct the interest payments that will be paid to related parties for estate tax purposes.7 The IRS has challenged such arrangements given the potential for abuse whereby estates take loans with high interests payments when the interest is paid back to another part of the family’s wealth structure while at the same time reducing estate taxes. Recent jurisprudence on the topic has created factors that the court will look to in determining whether the interest payments should be allowed as a deduction under IRC Section 2053.8 The proposed regs largely restate those factors set forward by the Tax Court. However, the proposed regs go much further by disallowing the deduction if the estate’s liquidity was created as a result of the decedent’s estate planning even if that planning was done for entirely legitimate non-tax reasons.
The Secure Act
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in late 2019. This legislation generally eliminated what were known as “stretch IRAs,” in which the designated beneficiary’s life expectancy would be used instead of the original account owner’s. Except in limited circumstances, the SECURE Act requires retirement accounts to be paid out to the designated beneficiary within 10 years. There’s been confusion as to whether distributions need to be made prior to the tenth year. In February 2022, the IRS issued proposed regs that dictate that the distribution requirements will depend on whether the decedent had reached the age when required minimum distributions (RMDs) needed to begin. For decedents who had reached that age, the account “must be distributed at least as rapidly as under the distribution method being used under section 401(a)(9)(A)(ii) as of the date of the employee’s death.”9 For account owners who died before being required to take RMDs, no distribution is required until the 10th year.10 The proposed regs stated that they would apply for distributions starting in 2022, but the government provided relief in October 2022 by issuing Notice 2022-53, which stated that the proposed regs would apply no earlier than 2023. Despite this reprieve, these regs, if finalized in their current form, will have a direct and immediate impact on estate planning with retirement accounts.
The Year Ahead
Although 2023 may be a year of legislative gridlock, this won’t stop all change given the regulatory projects in the works. Practitioners should also know that this summary didn’t cover all regulatory projects in the works but the ones most relevant and recent. During the course of the year, others may very well come to the fore. The point is that while the last two years planners were carefully following draft legislative text, the attention this year will be more on guidance coming from the Treasury.
Endnotes
1. For a more detailed explanation of these proposed regulations see James I. Dougherty and Eric Fisher, “Treasury Releases Proposed Regulations on Basis Consistency: IRS provides guidance on Form 8971 and Schedule A,” www.wealthmanagement.com/estate-planning/treasury-releases-proposed-regulations-basis-consistency (March 9, 2016).
2. Revenue Procedure 2015-37 (June 15, 2015), 2015-2016 Priority Guidance Plan (July 31, 2015).
3. 2008-2009 Priority Guidance Plan (Sept. 10, 2008).
4. 87 Fed. Reg. 38331 (June 28, 2022), “Guidance Under Section 2053 Regarding Deduction for Interest Expense and Amounts Paid Under a Personal Guarantee, Certain Substantiation Requirements, and Applicability of Present Value Concepts.”
5. Proposed Treasury Regulations Section 20.2053-1(d)(6).
6. Prop. Treas. Regs. Section 20.2053-3(d).
7. Estate of Graegin v. Commissioner, T.C. Memo. 1988-477.
8. Estate of Koons v. Comm’r, T.C. Memo. 2013-94, aff’d 686 Fed. Appx. 779 (11th Cir. 2017); Estate of Duncan v. Comm’r, T.C. Memo. 2011-255; Estate of Black v. Comm’r, 133 T.C. 340 (2009). For a more detailed explanation of the evolution of Graegin loan jurisprudence, see Marissa Dungey and James I. Dougherty, “Intra-Family Loans to Provide Liquidity for Estates 25 Years After Graegin,” Connecticut Bar Association, Estates & Probate Newsletter (January 2014).
9. Prop. Treas. Regs. Section 1.401(a)(9)-2(a)(4).
10. Prop. Treas. Regs. Section 1.401(a)(9)-3.