critical elections for trust, gift and estate returns:...

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Critical Elections for Trust, Gift and Estate Returns: Forms

1041, 709 and 706; GST, QTIP, 663(b), 645WEDNESDAY, JULY 10, 2019, 1:00-2:50 pm Eastern

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July 10, 2019

Critical Elections for Trust, Gift and Estate Returns: Forms 1041, 709 and 706; GST, QTIP, 663(b), 645

Jonathan L. Grob, Attorney

McGrath North Mullin & Kratz

[email protected]

Christine G. Pronek, CPA, Partner

PKF O’Connor Davies, LLP

[email protected]

Notice

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The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

Fiduciary Return and Estate Tax Elections

July 10, 2019

Christine G. Pronek, CPA, MST

[email protected]

908-967-6806

6

Topics:

Fiduciary Return Elections▪ 65 Day Election

▪ IRC 645 Election

▪ Choice of Fiscal Year

Estate Tax Elections▪ Portability

▪ QTIP Election

▪ Deduction of Expenses

7

Fiduciary Return Elections

8

65 Day Election (IRC 663(b))

• Available to estates and complex trusts.

• Ability to treat any distribution made within first 65 days of subsequent

tax year as having been made in the prior year (by March 5, 2020 for

2019)

− If the amount(s) distributed within the first 65 days of the subsequent

year exceed the amount needed for the election, only the portion for

which the election is desired needs to be included in the election

• Shift income out of compressed trust/estate income tax brackets to

beneficiaries (try to avoid highest tax rates and Medicare surtax)

− 37% rate once taxable income over $12,750 for 2019

9


• Allows for “hindsight planning” to determine if shifting income out of the

estate to the beneficiaries is desirable

− Communication between the fiduciary return preparer and

beneficiaries’ individual income tax return preparer(s) is key

• Maximum amount for which the election can be made is the greater of

FAI or DNI

• Check the box in the Other Information section on page 2 of Form 1041

and attach election statement

10


▪ Sample election for a trust

11


12

IRC 645 Election

− Inclusion of qualified revocable trust with estate income tax return

– Qualified revocable trust is a trust that was treated as owned by the decedent under IRC

676 due to a power to revoke that was exercisable by the decedent

− Allows fiscal year-end instead of calendar for trust activity

− Reduces administrative burden of filing two separate income tax returns

− Allows the trust to take advantage of certain income tax provisions that are only

allowable for estates

13

IRC 645 Election

▪ Allows the trust to take advantage of certain income tax provisions

that are only allowable for estates

• The allowance to deduct up to $25,000 of losses from rental real

estate activities against non-passive income for the first two

years after the deceased owner’s death (provided the decedent

actively participated in the rental real estate activity)

• Not having a two-year deadline for qualifying as an eligible S

corporation shareholder if the trust owns S corporation stock.

• Being eligible to deduct losses for funding pecuniary bequests

with noncash property distributions.

14

IRC 645 Election

Making the election

- Check the box on page 1 of Form 1041 and include trust’s EIN (new EIN

obtained following the death of the decedent)

- Attach Form 8855, Election to Treat a Qualified Revocable Trust as Part of

an Estate, to the timely filed (including extensions) tax return for the first

tax year of the related estate

- Irrevocable election once made

- Election period – begins on the date of the decedent’s death and ends on

the earlier of:

- the day on which the electing trust and related estate have distributed

all of their assets or

- the day before the applicable date.

15

IRC 645 Election

16

IRC 645 Election

17

IRC 645 Election

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IRC 645 Election

19

− Option to use any month for year-end (cannot be more than a 12 month year)

− Election made when Form 1041 is filed, not upon applying for the estate EIN or upon filing the extension

− Deferring Income/Accelerating Deductions

– Choosing optimal fiscal year – income deferral, acceleration of deductions, avoidance of wasting deductions, timing of income inclusion on the beneficiaries’ income tax returns vs the estate’s income tax return

– Fiscal year beginning 2/1/18 ending 1/31/19 defers income reporting (assuming distributions made) by beneficiary to 2019

– 11/30/18 estate year-end - 12/31/18 Schedule K-1 from a pass-through entity would be included in the 11/30/19 year-end

Choice of Fiscal Year

20

▪ Example: The Estate of Jane Doe’s current fiscal year

ends 11/30/18. Jane’s estate owns an interest in a

partnership, Jane Doe, LLC, that has a calendar year-

end. The Schedule K-1 for the partnership’s year ending

12/31/18 will be included in the estate’s income tax

return for the year ending 11/30/19, resulting in an almost

full year of deferral in reporting the income.


21

▪ Final year considerations

• Excess deductions on termination not allowed through 12/31/2025

• Capital losses of the estate pass out to the beneficiaries

• If the estate has an interest in a passive activity that is being distributed to a

beneficiary (other than in satisfaction of a pecuniary bequest), any suspended

PALs associated with the activity at the time of distribution increase the basis of

the interest to the beneficiary.

• An NOL of the estate passes out to the beneficiaries to be utilized on their

individual income tax returns

− In tracking the number of years remaining for the NOL carryover, the final year

of the estate and the first year in which the beneficiary reports the NOL count

as two separate years.


22

Estate Tax Elections

23

Portability (IRC 2010(c)(5)(A))

▪ Introduced in 2011 (DSUE – deceased spouse’s unused exclusion)

▪ Available only to surviving spouse

▪ Impact of remarriage of surviving spouse

• DSUE of most recently deceased spouse

▪ DSUE used first when gifting

▪ Not applicable for GST exemption

▪ Form 706, United States Estate Tax Return, must be filed to elect

portability

▪ If filing Form 706 and portability is not wanted, executor must

affirmatively opt out in Part 6, Section A of Form 706

24

Portability

25

Portability

▪ Simplified Relief Method for Late Portability Election

− Rev. Proc. 2017-34 (eff. 6/9/17) – Provides a simplified method of obtaining relief under Treas. Reg. 301.9100-3 for the late filing of an estate tax return that is under the filing threshold and being filed to make a portability election. (Since the end of the last relief period, December 31, 2014, and prior to this Rev. Proc., estates under the filing threshold that were filing for portability had to request a private letter ruling and pay a substantial fee to obtain relief for a late portability election.)

− If the estate is over the filing threshold (whether taxable or not) and the return is filed late, then no portability is allowed and no relief available.

26

Portability


(cont.)

• The following criteria must be met:

− Decedent must be survived by a spouse.

− Decedent died after 12/31/10.

− Decedent was a U.S. citizen or resident at time of death.

− Gross estate must be under the filing threshold and an

estate tax return was not filed timely.

27

Portability


(cont.)

• Steps to take:

− Executor of the estate must file Form 706 on or

before the second anniversary of the decedent’s

date of death

− “Filed Pursuant To Rev. Proc. 2017-34 To Elect

Portability Under IRC 2010(c)(5)(A)” must be written

at the top of Form 706

28

Portability

▪ NOTE: IRC 2010(c)(5)(B) – IRS can examine the

estate tax return of the predeceased spouse when a

portability election was made to review the DSUE

amount even after the statute of limitations for

assessing estate or gift tax of that spouse has expired.

29

Portability

▪ Portability Planning - Direct assets of the pre-deceased spouse to the surviving spouse free of trust

− Pros:– If surviving spouse is in a lower income tax bracket than trust would be

then less income taxes

– Get basis step-up at surviving spouse’s death

– Avoid costs of trust administration

− Cons: – No trust protection (creditor, divorce, fiduciary management of assets)

– Deceased spouse had no control over direction of assets

– Asset appreciation after first spouse’s death is not sheltered

– GST exemption is not portable

– Consider state estate tax exemptions that can be lost if assets left entirely to surviving spouse

31

QTIP Election

▪ Qualified Terminal Interest Property (QTIP) is property that passes from the decedent in which the surviving spouse has a qualifying income interest for life.

▪ Executor can make an election to claim a marital deduction for all or a portion of an interest in the qualified terminal interest property by listing the property on Schedule M of Form 706.

▪ If a return was not filed timely, the election can be made on the first return filed after the due date.

▪ The election can also be made on an amended Form 706 filed before the extended due date for filing the original estate tax return

▪ Once made, the election is irrevocable.

32

QTIP Election

33

QTIP Election

▪ Requirements for a QTIP trust (IRC 2056(b)(7)):

• All trust accounting income must be payable to the surviving spouse (SS) at least annually for life

• No one (including the SS) has a power to distribute or appoint assets to any person other than the SS during the SS’s lifetime

• Trust may hold unproductive assets only if the trust document requires, or permits the SS to require, the trustee to either make the property productive or convert it to productive property within a reasonable time (some exceptions for residential property and tangible assets held for use by the SS)

• Executor of the decedent’s estate must elect on the estate tax return to have some or all of the trust property qualify for the marital deduction.

34

QTIP Election with Portability

▪ Utilizing the QTIP election with the portability election to obtain a

double step-up for the assets

▪ Prior to portability, typical planning to avoid estate tax for a

married couple was the combination of a credit shelter trust and a

marital trust.

▪ The QTIP election to fund the marital trust does not reduce the

deceased spouse’s exemption/amount available for portability

▪ When the value of the marital trust is included in the surviving

spouse’s estate, the remaining amount of the “ported” exemption

from the deceased spouse will be available to defray the estate

tax implications.

35


▪ The inclusion of the trust assets in the surviving spouse’s estate allows for the basis of those assets to be stepped-up again (initially were stepped-up on the predeceased spouse’s death) hopefully without any estate tax impact due to the SS having her exemption and the ported exemption.

▪ If the decedent resided in a state that has an estate tax, that estate’s exemption amount needs to be factored into the planning to avoid wasting that exemption or unintentionally incurring state estate tax on the first spouse’s death. NOTE: Most of the states that have an estate tax do not recognize portability at the state level. Consider hybrid plan of portability election/QTIP trust/credit shelter trust.

36


▪ Rev. Proc. 2001-38 states that the IRS would disregard

a QTIP election made in situations where it was not

needed to reduce the estate tax liability to zero.

▪ Rev. Proc. 2016-49 excludes from the scope of Rev.

Proc. 2001-38 estates in which the executor made a

portability election.

37


▪ Reverse QTIP Election

• Decedent spouse is treated as the transferor of the trust property for GST purposes instead of the surviving spouse

• Avoid wasting the decedent spouse’s GST exemption (portability does not apply to this exemption)

• Irrevocable election

• Election made by listing the qualifying property on Schedule R, Part 1, line 9 of the Form 706

• QTIP trust can be split into two trusts with the reverse QTIP election being made to obtain an inclusion ratio of zero for one of the trusts

• Rev. Proc. 2004-47 outlines the process for requesting a late reverse QTIP election

38


39

Deducting Expenses

• Comparison of estate tax savings vs income tax savings• Consider limitations on the 1041 (disallowed 2% floor deductions

and allocations to tax-exempt income)

• Consider timing of payment vs income recognition on the 1041

• Consider impact on marital deduction (and amount of exemption available for portability) and charitable deductions on the 706

• Estate transmission expenses

• Estate management expenses

40

Deducting Expenses

• Examples of expenses that can be taken on either Form 706 or Form 1041 but not both:– Executor commissions; legal and accounting fees; appraisal fees and probate

fees

• Examples of expenses that can be taken on both returns (DRD - deductions in respect of decedent):– Expenses related to the decedent’s business allowable under IRC 162; interest

expense allowable under IRC 163; taxes allowable under IRC 164; investment expenses under IRC 212 and percentage depletion allowable under IRC 611.

41

Deducting Expenses

• Election statement outlined in Treas. Reg. 1.642(g)-1 may be handled in either of two ways:

• Attached to each Form 1041 on which the deductions, which would otherwise have been allowable on the Form 706, are being taken.

• Filed within the statutory period of limitation for the respective Form 1041 with the appropriate IRS Center for the return.

– Must be filed in duplicate with both statements signed by the executor.

– Consideration should be given to not filing the election statement for the deductions until the earlier of the final estate tax assessment or the statute of limitations for the 1041.

42

Deducting ExpensesSummary of Estate or Income Tax Deduction Alternatives

43

Q & A

GIFT TAX ELECTIONS:

Generation Skipping Transfer Tax

Jon Grob

44

45

I. Basic Tax Structure

46

The Basic Tax Structure

• Exemption and Tax Rate

– In 2019, the GST Exemption is $11,400,000

• Not portable

• Inflation adjusted

– The tax rate is 40%.

– History:

• 1987 – 1998 ($1,000,000; 55%)

• 1999 – 2009 ($1,010,000 - $3,500,000; 45% - 55%)

• 2011 - 2017 – ($5,000,000 - $5,490,000; 35% - 40%).

47

The Basic Tax Structure

• What is an inclusion ratio?

– Every trust (and direct skip) has an inclusion ratio.

– If no amount of GST exemption has been affirmatively or

automatically allocated to a trust (or direct skip), its inclusion ratio

is 1. This means GST tax applies to all taxable terminations and

taxable distributions (or to 100% of the direct skip).

– If GST exemption has been allocated fully to all transfers to the

trust (affirmatively or automatically) or to the direct skip, the

inclusion ratio is 0. This means the trust (or direct skip) is GST tax

exempt.

– Basic Formula:

• 1 – (GST Exemption Allocated / Property Transferred).

48

II. Three Options for Classifying Gifts

49

Three Options for Classifying Gifts

• Part 1 – Not a direct or indirect skip

50


• Part 2 – Direct skip

51


• Part 3 – Indirect skip

52

III.Direct Skips

53

Direct Skips

• What is a lifetime direct skip?– A taxable gift occurs and property passes to a skip person.

– GST exemption is automatically allocated to the direct skip.

• Gifts made after 12/31/1995.

• Who is a “skip person”?

– A natural person two or more generations below the donor.

– Spouses are in the same generation as the donor and a spouse’s

issue are assigned to generations based on the spouse’s family.

– Adopted / half-blood are included as donor’s issue.

54

Direct Skips

• Who is a skip person?

– For persons who are not issue of the donor (or spouse), then

count years:

• Age separated by 12.5 years or less = same generation.

• Age separated by 12.5 – 37.5 years = one generation below.

• 37.5 years+ = two generations below (and each 25 years

thereafter is a new generation).

55

Direct Skips


– Predeceased parent rule

• Grandchild moves up to the deceased child’s generation.

• Must occur prior to the completion of the gift.

– Thus, if a completed gift is made to a trust and then a

child dies, move up rule does not apply.

56

Direct Skips


– A trust if:

• All interests are held by skip persons or

• No person holds an interest (e.g. neither income nor

principal is currently distributable to any person) and no non-

skipping person is among the possible future distributees.

57

Direct Skips


– Trust Skip Person Example:

• Trust provides for current and future distributions of income

and principal for the benefit of only grandchildren and more

remote descendants.

• Trust provides no current distributions of income and

principal and at the end of a stated term or measuring life,

the property is distributed only to grandchildren or more

remote descendants.

58

Direct Skips


– NOTE: many “Crummey” trusts are not skip persons:

• Usually non-skip beneficiaries / withdrawal right holders.

59

Direct Skips

• GST Annual Exclusion

– Direct skips to natural persons.

– Gifts to certain trusts:

• A direct-skip transfer;

• To a trust that has only one beneficiary during the

beneficiary’s life; and

• The assets of which will be fully includable in that

beneficiary’s gross estate if the trust does not terminate

before the beneficiary dies.

61

IV.Indirect Skips

62

Indirect Skips

• What is an indirect skip

– A transfer subject to gift tax (that is not a direct skip) made to a

“GST Trust.”

– GST exemption is automatically allocated to indirect skips (like

direct skips), but direct skips have priority.

• For indirect skips after 12/31/2000.

63

Indirect Skips


– A “GST Trust” is a trust that could have a taxable termination or

taxable distribution UNLESS:

• More than 25% to be distributed to non-skip persons before

age 46.

• More than 25% subject to a general power of appointment or

a distribution to the estate of a non-skip person that is likely

to occur before age 46.

• More than 25% to non-skip persons who must be alive on

the death of another person who is 10 years older than such

persons.

64

Indirect Skips


– A “GST Trust” is a trust that could have a taxable termination or

taxable distribution UNLESS:

• Any portion would be included in the gross estate of a non-

skip person, other than the transferor, if the non-skip person

died immediately after the transfer (excluding an amount

equal to the annual gift tax exclusion).

• Trust is a CLAT, CLUT, CRAT, or CRUT.

65

V. Opting In/Out of Automatic Allocation

66

GST Elections – Direct Skips

• Direct Skip Opt-Out

– GST exemption is automatically allocated to direct skips to the

maximum extent available to obtain a zero (0) inclusion ratio

UNLESS, opt-out.

67

GST Elections – Direct Skips

• Direct Skip Opt-Out

– Attach a statement clearly describing the transaction and the

extent to which the automatic allocation is not to apply.

– The result: GST tax is due with the return.

– Automatic allocation or opt out (in either event) is irrevocable

after the due date of the 709.

68

GST Elections - Indirect Skips Three Elections

• “Election 1”

– Elect NOT to have the automatic allocation rules apply to the

current transfer made to a particular trust.

• “Election 2”

– Elect NOT to have the automatic allocation rules apply to both

the current transfer and any and all future transfers made to a

particular trust.

• “Election 3”– Elect to treat any trust as a GST trust for purpose of the

automatic allocation rules for any or all transfers.

69


• Election 1 must be made on the return for the year in which the

indirect skip occurs.

• Election 2 and 3 may be made on a return for the year in which the

election is to become effective.

• In all cases, an explanation attached to the return is required.

70


• What does this mean?

– Elect out of the automatic allocation rules for: • (1) one or more prior-year transfers subject to an ETIP made to a

specified trust.

• (2) one or more current transfers to a specified trust.

• (3) one or more future transfers to a specified trust.

• (4) all future transfers made by the transferor to all trusts (regardless

of whether the trust is in existence at the time of the election out), or

• (5) any combination of transfers described in items (1) through (4),

above.

– Elect IN by treating a trust as a GST Trust for:• (A) Any current transfer;

• (B) Any selected future transfer;

• (C) All future transfers; or

• (D) Any combination of paragraphs (A) through (C).

71

GST Elections – Affirmatives Allocation

• Notice of Allocation

– Usually done via a formula for audit protection

– “Donor hereby allocates to Trust the smallest amount of GST

exemption necessary to produce an inclusion ratio that is

closest to or, if possible, equal to zero.”

72

VI. Late and Retroactive Allocations

73

• Late Allocation

– This can be favorable to a taxpayer who wishes to allocate

GST exemption to a pre-existing trust.

– Often this also results in dividing a pre-existing trust into an

exempt and non-exempt trust.

– The late allocation can apply to the value of the trust

property on the first day of the month during which the late

allocation is made with an appropriate election. The

allocation is effective when filed. Late allocations may not

be available in certain situations.


74

• Retroactive Allocations

– If a non-skip person with an interest in a trust passes away,

such person is a lineal descendant of the donor’s

grandparent, and is assigned to the generation immediately

below the donor (i.e., child), then a retroactive allocation of

GST exemption may be made on a 709 that would be timely

for a gift made in the year of the person’s death.

– Donor must be alive.

– Example: Donor makes gifts to a trust that provides for

children and grandchildren. The trust is not a “GST Trust”

because all property passes to children at age 35. Donor’s

child unexpectedly predeceases the Donor before age 35

resulting in a taxable termination.


75

VII. Estate Tax Inclusion Period

76

Estate Tax Inclusion Period

– An allocation of GST exemption to transferred property

that would be included in the decedent’s estate or

spouse’s estate (other than by reason of 2035) is not

effective until the end of the “ETIP.”

– The “ETIP” or “estate tax inclusion period” is the period

during which the value of the transferred property

would be included in the estate of the decedent or

spouse.

– If any part of a trust is subject to an ETIP, no GST

exemption allocation can be made to any part of the

trust during the ETIP.

– Example: GRATs; Spousal Crummey Powers

77

Estate Tax Inclusion Period

– At the end of the ETIP, an automatic allocation may

result if there is a taxable termination, distribution or

transfer to a “GST Trust” even if not desired.

– Opt out is available before the end of the ETIP

(Election 2).

78

VIII. When to Allocate GST Exemption

79

When to Allocate GST Exemption

– Lifetime direct skips

• Otherwise, tax is due.

– Indirect Skips and Other Trusts:

• Drafting should avoid imposition of GST tax.

• Balance step-up in basis on a child’s death with potential

estate tax for wealthy children when skipping generations.

– With high exemptions, many “old” trusts are being

modified or dealt with in a way to force estate tax

inclusion to obtain the benefits of the step-up in basis.

• Avoid wasting exemption

• For wealthy clients, dynastic / perpetual trusts can provide a

very efficient mechanism for transferring wealth.

GIFT TAX ELECTIONS:

Gift Splitting

Jon Grob

80

81

I. Basic Rules

82

Gift Splitting

• Basic Rules

– A married individual may make a gift to a third party and,

with the consent of such individual’s spouse, may elect

treat the gift as having been made one-half by the actual

donor and one-half by the spouse for gift tax purposes.

– Spouses are joint and severally liable for any gift tax owed

– At the time of the gift, spouses must be married and be

either U.S. citizens or residents.

– The election to gift-split must be made on a gift tax return.

– The election must relate to all gifts made during the year

for which the return is filed.

83

Gift Splitting

• Basic Rules

– Gift splitting not available when:

• Gifts made at a time when the spouses were not married.

• Gifts made if a spouse dies or spouses divorce during the

year and either spouse remarries during the year.

• Gifts made after the death of one spouse.

• Gifts made while either spouse was a nonresident alien.

• Gifts where a spouse has an interest or general power of

appointment.

84

Gift Splitting

• Basic Rules

85

Gift Splitting

• Basic Rules

– Both spouses may elect to gift-split on the donor's gift tax

return if only the donor made taxable gifts in that year.

– Each spouse should file a separate gift tax return and also

sign the other spouse’s gift return if both made taxable

gifts.

– Election is irrevocable when the period for filing the gift tax

return for the relevant year (without extensions) has

expired.

– Election applies for both gift and GST purposes.

86

II. Spousal Interests

87

Gift Splitting

• Spousal interests

– A gift that is made both to a third party and to a spouse can

be gift-split only if and to the extent that the interests are

ascertainable at the time of the gift and are severable.

• Beware: Spousal access trusts (SLATs).

• See Wang, TC Memo 1972-143.

– A gift cannot be split if a spouse has a general

power of appointment.

• Beware: Crummey trusts with spousal withdrawal rights.

88

Gift Splitting

• Spousal interests

– Even if a gift does not qualify for gift splitting for gift tax

purposes as a result of a spousal interest, if the election is

made, the gift is treated as made one-half by each spouse

for GST tax purposes.

• Treas. Reg. 26.2652-1(a)(4)

GIFT TAX ELECTIONS:

Using Portability

Jon Grob

89

90

Portability

– Proper procedure was followed on deceased

spouse’s Form 706.

– Last deceased spouse only.

• May use exemption of multiple spouses if used prior to

death of next spouse.

– Deceased spouse’s exemption is used first for

lifetime taxable gifts.

– Use of the DSUE amount may result in

examination of deceased spouse’s Form 706.

91

Using Portability

critical elections for trust, gift and estate returns:...

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