RECENT DEVELOPMENTS 2015: SELECTED FEDERAL CASES, RULINGS AND STATUTES ILLINOIS CPA SOCIETY MAY 10, 2016 Robert E. Hamilton Ryan A. Walsh Hamilton Thies & Lorch LLP 200 South Wacker Drive, Suite 3800 Chicago, Illinois 60606 © 2016 Robert E. Hamilton All Rights Reserved RECENT FEDERAL DEVELOPMENTS FEDERAL REGULATIONS AND ADMINISTRATIVE MATTERS A. Rev. Proc. 2015-53, 2015-44 I.R.B. at 615 (November 2, 2015) sets forth the inflation- adjusted figures for exclusions, deductions and credits for 2016. In the estate and gift tax area these figures are the following: Applicable Exclusion Amount Increases to 5,450,000 Annual Exclusion: Remains at $14,000 Foreign Spouse Annual Exclusion: Increases to $148,000 §2032A Aggregate Decrease: Increases to $1,110,000 §6601(j) 2% Amount: Increases to $1,480,000 §6039F Gifts From Foreign Persons Increases to $15,671 39.6% Bracket for Trusts and Estates Income over $12,400 B. 2014-15 Priority Guidance Plan. On July 31, 2015, Treasury and the Internal Revenue Service released their joint priority guidance plan for 2015-2016. The plan includes the following initiatives: GIFTS AND ESTATES AND TRUSTS: 1. Guidance on qualified contingencies of charitable remainder annuity trusts under §664. COMMENT: This initiative is new, and relates to Section 664(f), which permits certain contingencies to accelerate the termination of a charitable remainder trust. 2. Final regulations under §1014 regarding uniform basis of charitable remainder trusts. Proposed regulations were published on January 17, 2014 and final regulations published in August, 2015. See part E, infra. 3. Guidance on basis of grantor trust assets at death under §1014. COMMENT: This initiative is also new and relates to the position of some practitioners that a grantor’s death, which causes the obligation to report income to shift from the grantor to the trust, is an event under Code section 1014(b)(1) that allows for a step-up in basis on the trust assets even though they are not included in the grantor’s estate. See also Revenue Procedure 2015-37, which provides that until the Service resolves the issue through publication of a revenue ruling, revenue procedure, regulations, or otherwise, it will not issue rulings to taxpayers concerning whether the assets in a grantor trust receive a § 1014 basis step-up at the death of the deemed owner of the trust for income tax purposes when those assets are not 2 includible in the gross estate. The Revenue Procedure is effective for ruling requests received after June 15, 2015. Rev. Proc. 2015-37, 2015-26 I.R.B. 1196. This issue involves, among others, assets that have been sold to a grantor trust and which are not includible in the estate of the grantor-decedent at his or her death. Because the assets are not includible in the decedent’s estate, there is no step-up under Section 1014(b)(9). However, there is precedent under Section 1014(b)(1) that assets not includible in the decedent’s estate can receive a basis step up. See, for example, Rev. Rul. 84-139, 1984-2 C.B. 168 dealing with foreign real property owned by a foreign person and passing to a U.S. Person at death. See also PLR 201544002, also dealing with foreign grantors, in which the Service granted the ruling request because it was received before the June 15, 2015 effective date of the Rev. Proc. Rev. Rul. 84-139 concluded that the property was inherited from a decedent and eligible for basis step up under 1014(b)(1). The argument for a Section 1014(b)(1) basis step up for grantor trust assets is that when a grantor dies the ownership of the trust assets changes, for income tax purposes, from the now-deceased grantor to the trustee, and this transfer of ownership comes within the language of (b)(1) allowing a step up for “property acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent.” 4. Revenue procedure under §2010(c) regarding the validity of a QTIP election on an estate tax return filed only to elect portability. COMMENT: This provision was first proposed in 2013 and arises from a concern that if a QTIP election is made but is not necessary to reduce federal estate tax, it may not be effectively recognized. See, e.g. Rev. Proc. 2001-38, 2001-2 C.B. 24, and PLRs 201345006 and 201338003. See also part G, infra, discussing the final portability regulations. Note also that a recent private letter ruling – PLR 201615004 – granted taxpayer relief under Rev. Proc. 2001-38 in an unusual situation. Under the facts of the ruling, the estate made a QTIP election on Schedule M of the decedent’s estate tax return for a trust that qualified for the marital deduction under Section 2056(b)(5) (a general power of appointment trust). QTIP was unnecessary to qualify for the marital deduction. In a later year the martial trust wanted to engage in a commutation of interests, but appeared to be concerned that Section 2519, which treats any disposition of an income interest as a deemed distribution of the remainder of the trust, would be implicated in the commutation. The Service granted the relief. The situation is a little odd because Rev. Proc. 2001-38 discusses situations where the QTIP election is made over a credit shelter trust – i.e,. a trust that would not have generated any tax absent a marital deduction – or over a trust where the taxable estate was not sufficient to cause tax. In either case the QTIP election is not necessary to reduce estate tax. Here it is also true that had the QTIP election not been made, there would be no reduction in estate tax, but for a completely different reason – that the trust already qualified for the marital deduction. 5. Guidance on the valuation of promissory notes for transfer tax purposes under §§2031, 2033, 2512, and 7872. COMMENT: This proposal is new and arises, perhaps, from the disconnect between valuing notes for gift tax purposes by reference to adequate interest as a so-called “safe harbor” and then valuing the same notes for estate tax purposes at fair market value, subject to substantial discounts. There was an interesting discussion in the Recent Developments portion of the 2016 Miami Institute regarding this issue, which has application in some inter-generational life insurance planning. For federal gift tax 3 purposes the taxpayer will maintain that a note with interest at the applicable federal rate at the time of issuance should be valued at face. Absent some other consideration (lack of collectability, for example), taxpayers who have used the AFR have been on pretty safe ground. Under Section 7872 a loan of money at AFR is valued for gift tax purposes at face. Two Tax Court cases have extended the application of gift tax valuation at AFR to notes issued for a sale of property (Frazee v. Commissioner, 95 T.C. 554 (1992)) and to notes issued in connection with a buy/sell transaction (True v. Commissioner, T.C. Memo 2001-167). Current proposed regulations under Section 2512 refer to Section 1012 for note valuation, and proposed regulations under Section 1012 in turn refer to Section 1274, which uses AFR. Several private letter rulings have “blessed” the use of AFR in intra-family transaction when considering possible gift issues. See PLR 9408018 and PLR 9535026. The material accompanying the Recent Developments discussion at this year’s Miami Institute point out that if the AFR exceeds 6%, additional care will have to be taken in the planning stage. The Seventh Circuit has adopted the position that the “safe harbor” 6% rate in installment contracts governed by Section 483 applies for all purposes of title 26 (which includes chapters 11 and 12), so that notes meeting the Section 483 safe harbor of 6% may be valued at face notwithstanding that actual interest rates may be greater. See, e.g., Ballard v. United States, 854 F 2d 185 (7th Cir. 1988). The Eight and Tenth Circuits have taken the position that although Section 483 applies for all purposes of title 26, it only deals with how to allocate payments between principal and interest, and that valuation for gift tax purposes will not be governed by the 6% safe harbor. See, e.g., Krabbenhoft v. Commissioner, 939 F.2d 529 (8th Cir. 1991); Schusterman v. United States, 63 F. 3d 986 (10th Cir. 1995). When a person dies is the note valued pursuant to AFR principles or does the estate apply fair market value principles? The difference can be significant, especially where a note may not be due for a considerable period of time – for example where a note issued in connection with life insurance premium financing is not due until the death of a child of the note holder. Section 7872(i)(2) authorized Treasury to issue regulations regarding the chapter 11 valuation of notes and since 1985 there has been a proposed regulation that, if enacted, would apply to term loans made “with donative intent.” If the loan was issued at the appropriate AFR to begin with, it’s hard to see how the loan could be characterized as one made with donative intent for the reasons stated above. Obviously the Service believes it is being whipsawed by the variance in valuation principles, and thinks the practice is abusive. At the Recent Developments session of the 2016 Miami Institute the comment was to expect a fight over this at the audit level. In this connection, note Morrissette v. Commissioner, 146 T.C. No.