On July 26, 2022, the Tax Section of the Florida Bar (the “Tax Section”) submitted “Comments on Proposed Treasury Regulations Relating to the Basic Exclusion Amount Applicable to the Computation of Federal Estate and Gift Taxes.” The Proposed Regulations[1] are specifically targeting the situation where taxpayers made certain types of gifts after 2017 and then died after the basic exclusion amount (the “BEA”) is reduced.
Under current law, the reduction in the BEA is scheduled to occur January 1, 2026, but federal legislation could be enacted prior to that date which could accelerate the timing of this reduction.
Special thanks to Jolyon D. Acosta, Cullen I. Boggus, Mark R. Brown, Steven M. Hogan, Andrew T. Huber, David A. Lappin, Brian M. Malec, Melodie M. Menzer, William G. Smith, Alfred J. Stashis Jr., and Christopher C. Weeg for their hard work on preparing this comment.
The Tax Section’s comments raise the following concerns that need clarification:
1. Concerns about the 18 Month Rule.
The Tax Section’s comments infer that the “18 Month Rule” appears to be targeted at eliminating the “strings” of ownership shortly before death. The 18 Month Rule in the Proposed Regulations generally provides that in certain circumstances, a decedent will be considered to have maintained or been in an arrangement on his or her date of death if he or she was in the arrangement at least 18 months before the date of death.
The most common example of when this will apply is if the decedent agreed to lend money under a promissory note or other loan arrangement and then actually satisfied the loan less than 18 months before the decedent’s date of death. In this situation, the loan will still be considered to be outstanding, so that the assets that were used to repay the loan, or an amount equal to the loan amount, will still be subject to federal estate tax without use of the temporary exemption.
The comment writes the following:
Proposed § 20.2010-1(c)(3)(i)(D) generally provides that the special rule “does not apply to transfers includible in the gross estate, or treated as includible in the gross estate for purposes of [Internal Revenue Code] section 2001(b), including . . . transfers that would have been described in paragraph (c)(3)(i)(A), (B), or (C) of this section but for the transfer, relinquishment, or elimination of an interest, power or property, effectuated within 18 months of the date of the decedent’s death by the decedent alone, by the decedent in conjunction with any other person, or by any other person.” [emphasis added].
The Tax Section wants the Treasury to clarify the 18 Month Rule because it indicates that the transfer of an interest is prior to the decedent’s death [emphasis added]. Despite the Proposed Regulation’s adoption of this 18 Month Rule, a statutory three-year rule would in certain cases still cause a loss of bonus BEA, pursuant to section 2035 targeted gifts.[1] Additionally, the Tax Section notes the inconsistency that may be created in implementing valuation tables under section 7520 where the determination of a terminally ill person can be affected if that individual survives past 18 months, but such presumption can be rebutted by clear and convincing evidence. The Tax Section recommends the 18 Month Rule be reduced to 12 months to be consistent with section 1014(e).[2] The Tax Section notes that abusive transactions are the target of the Proposed Regulations, which can still be “adequately captured” with a 12 month rule, and that “legitimate transactions will be less likely to inadvertently be captured.”
The Proposed Regulations provide that the 18 Month Rule provides an exception for transfers that are “effectuated by the termination of the durational period described in the original instrument of transfer by either the mere passage of time or the death of any person” [emphasis added]. It is unclear what documentation is appropriate to fit the “original instrument of transfer,” as well as whether “any person” includes the donor.
The Tax Section requests clarification as to whether a bona fide sale[3] of an interest by the taxpayer could be captured by the 18 Month Rule. The transfers under the Proposed Regulations may be construed to apply to a bona fide sale of a taxpayer’s interest within the 18 month period prior to the taxpayer’s death, although general estate tax principals suggest that it should not be since such a sale is excluded from section 2036(a).
The Tax Section requests additional guidance to illustrate the application of the Proposed Regulations to section 2701 transfers.[4] The comment provides, “capturing the anti-abuse intent in this area could prove challenging, and thus, provision of and reliance on bright-line rules with respect to equity interest transfers would be beneficial to provide clarity to taxpayers.”
2. Application of the 18 Month Rule to QPRTs.
A Qualified Personal Residence Trust (“QPRT”) is a common estate planning tool that is an irrevocable trust designed to hold a primary (or secondary) residence and remove its value from a taxpayer’s taxable estate. Any value the home accrues between the time the taxpayer (grantor) creates the trust and transfers ownership will not be counted for tax purposes; the home will not be subject to federal estate tax whatsoever if the grantor survives the QPRT term. The grantor use the gift tax exemption up to the discounted value of the home as of the date that the QPRT receives title thereto. The grantor will be considered to have made a gift based upon the discounted value that applies pay as of the day he or she established the trust. The grantor is treated as making a taxable gift equal to the value of the remainder interest; if the grantor dies before the end of the QPRT term, the retained interest triggers estate tax inclusion under section 2036, but the grantor is not considered to have made a gift when the trust was established is this occurs.
The Tax Section’s comment provides that the Proposed Regulations appear to make clear “the exception to the special rule would operate to include the value of QPRT property in the grantor’s gross estate if the grantor died during the QPRT term, since the retained right to use the QPRT property would constitute a transfer includible in the gross estate pursuant to section 2036.”
The Tax Section recommends including the following example to the Proposed Regulations with respect to QPRTs:
Example: Individual A transfers a personal residence worth $7 million to a Qualified Personal Residence Trust within the meaning of §25.2702-5(c) whose terms provide that Individual A may continue to use the home for a certain term of years. The taxable portion of the transfer is $2.7 million. A died during the term of the QPRT. The entire QPRT corpus is includible in the gross estate pursuant to §20.2036-l(c)(2). Because the value of the taxable portion of the transfer was more than 5 percent of the total value of the transfer determined as of the date of the gift, the 5 percent de minimis rule in paragraph (c)(3)(ii)(A) of this section is not met and the exception to the special rule found in paragraph (c)(3) of this section applies to the gift. The credit to be applied for purposes of computing A ’s estate tax is based on the $6.8 million basic exclusion amount as of A ’s date of death, subject to the limitation of section 2010(d).
3. Application of the Proposed Regulations to donors gifting an entity interest where the donor owes a bone fide note obligation to the entity.
It may be unclear how the Proposed Regulations would apply if a donor transfers an interest in an entity that has extended a loan to the donor, which is common in closely-held entities. The Tax Section requests additional guidance to clarify that bona fide[5] loans outstanding at the obligor’s death to an entity in which the debtor has previously gifted an interest are not subject to the exceptions to the special rule. The Tax Section’s comment provides, “from a policy standpoint, such loans should not be treated the same as the transfer of an enforceable promise because they are not abusive transactions.” Without additional guidance, it may be unclear whether a donor’s bona fide repayment obligation to the entity could be captured by the rules relating to the transfer of an enforceable promise.
4. Policy concerns with the application of the Proposed Regulations to Chapter 14 gifts.
Chapter 14 established safe harbor rules – specific exemptions for GRATs and QPRTs – such that certain retained annuity interests and retained unitrust interests are not valued at zero. These safe harbor rules are in recognition that gifts established under GRAT and QPRT structures are bona fide inter vivos gifts, and are not abusive because they are established by statute. The Tax Section asks the Treasury to consider the Proposed Regulations, and address the policy concerns, of whether the application of the Proposed Regulations should not apply to a gift structured in accordance with Chapter 14’s safe harbor rules. The comment provides, “it seems appropriate that a taxpayer should benefit from the increased BEA available as of the date of the original gift.”
5. Clarification for application of exceptions to the “special rule” in the context of GST tax.
The Tax Section’s comment asks the Treasury to consider providing an example for guidance on the effect of the exception to the special rule for GST tax purposes. The Proposed Regulations seek to claw back prior gifts into the calculation of estate tax, even though such prior gifts are not includible in the decedent’s gross estate, but is unclear whether this will impact (i) the allocation of GST exemption made by the taxpayer at the time of the gift during the increased BEA period, or (ii) the GST tax calculated for a decedent’s estate where the application of the Proposed Regulations results in an increase in the decedent’s estate tax.
6. Clarification of policy for the disparate treatment of satisfactions of an enforceable promise versus outright gifts of cash (or other property).
The Proposed Regulations depart from traditional principles used in common planning situations with respect to the treatment of a taxpayer’s lifetime gift of cash or other assets. Per a longstanding Revenue Ruling, to the extent that the note had been paid prior to the decedent’s death, the assets used to satisfy the note would not be included in the decedent’s estate, and therefore the satisfied note (or the satisfied portion thereof) would be included in the decedent’s adjusted taxable gifts.[6] The Tax Section’s comment asks the Treasury clarify “the rationale for the disparate treatment between outright cash gifts and gifts by enforceable promise which are satisfied within 18 months of the grantor’s death.”
7. Request for additional consideration to the Proposed Regulations’ effective date.
The Proposed Regulations will be applicable to the estates of decedents dying on or after April 27, 2022. This may be too late for a taxpayer to escape the application of the 18 Month Rule. The Tax Section asks that the effective date of the 18 Month Rule should be, at a minimum, applicable only to the estates of decedents dying on or after the date final regulations are issued, or on or after the date which is 18 months after final regulations are issued.