Unless the executor of the estate of an individual who died in 2010 makes the Internal Revenue Code §1022 election, the estate is subject to the federal estate tax. If the executor makes the IRC §1022 election, neither the estate tax law nor IRC §1014 applies, and the basis of property acquired from the decedent is determined under the modified basis rules of §1022 and initially is the property's fair market value as of the date of death or the decedent's adjusted basis, whichever is less. The §1022 election is made by timely filing a Form 8939.
The final version of Form 8939 was only released last month. Many executors and their attorneys are in the process of analyzing the form and its instructions, so that they can timely file the Form 8939 by its due date of January 17, 2012. This article is intended to provide guidance to executors and attorneys in that situation.
First, the IRS generally will not grant an extension of time to file Form 8939, accept a late filed Form 8939, or accept an amended Form 8939 filed after January 17, 2012. An exception relates to an amended Form 8939 for the sole purpose of allocating Spousal Property Basis Increase to eligible property, which must be filed within 90 days after the date of the distribution of the qualified spousal property to which Spousal Property Basis Increase is allocated on that form.
Generally, once the executor makes the §1022 election, the election is irrevocable. However, an election made before January 17, 2012 can be revoked by filing a subsequent Form 8939, on or before the due date, on which the box at the top of the form designated for revocation is checked. If there are two or more "executors," any inconsistency between or among them that cannot be resolved by them will be resolved by the IRS.
Within 30 days after filing Form 8939, the executor must furnish to each recipient of property acquired from the decedent a written statement showing the information required by IRC §6018(e), whether or not the executor allocates any basis increase to that property. Schedule A of Form 8939 is such a statement. Updated statements must be furnished within 30 days after filing an amended or supplemental Form 8939 or receiving notice of an adjustment from the IRS. The executor cannot file a Form 706 and a conditional Form 8939 that would be effective only if an estate tax audit results in an increase in the gross estate above the applicable exclusion amount in IRC § 2010(c), according to the instructions.
IRC § 6716 provides a $10,000 penalty for failing to file Form 8939 on time and for failing to provide the information required, except for reasonable cause. The penalty for failing to provide recipients of property acquired from the decedent with the information required by §6018(e) is $50 for each such failure, or 5% of the fair market value of the property for intentionally failing to do so. "Property acquired from the decedent" does not include the decedent's interest in a QTIP trust previously established by the decedent's spouse.
Section 1022 does not apply to the right to receive income in respect of a decedent ("IRD"), and the executor is not required to list IRD on Form 8939.
Property eligible for an increase in basis under §1022 (up to its fair market value at the date of death) must have been owned by the decedent at that time. In the following situations the decedent will be treated as owning - or not owning - the following property:
a. The decedent is treated as owning one-half of the property held in joint tenancy or tenancy by the entirety with his or her surviving spouse.
b. The decedent is treated as owning any other joint tenancy-owned property in proportion to the consideration furnished by him or her.
c. The decedent is treated as owning property in his or her "qualified revocable trust," but the decedent is not treated as the owner of any other property by virtue of holding either a general or special power of appointment with respect to the property.
d. Both halves of community property owned at the date of death by the decedent and his or her surviving spouse are treated as owned by the decedent and acquired from him or her.
e. Property acquired by the decedent by lifetime gifts within three years before his or her death from someone other than his or her spouse is not eligible for the §1022 basis increase(s).
There are two components to the General Basis Increase: an Aggregate Basis Increase of $1,300,000 (but only $60,000 for non-resident aliens), and a Carryover/Unrealized Losses Increase. The latter increase includes the following: (i) capital loss carryover under IRC §1212(b); (ii) net operating loss carryover under IRC §172; and (iii) losses that would have been allowed under IRC §165 if the property acquired from the decedent had been sold at fair market value immediately before death.
Additionally, the estates of married decedents may take advantage of a Spousal Property Basis Increase. This starts with a basis increase of $3,000,000, which applies to both "outright transfer property" and "QTIP property," as well as to qualified charitable remainder trust property under IRC §664 if the surviving spouse is the sole non-charitable beneficiary and the trust would have qualified for the marital deduction under IRC §2056(b)(8) but for the §1022 election. The Spousal Property Basis Increase applies to property sold by the executor before being distributed, but only if the executor certifies on Form 8939 that the net proceeds from the sale will be distributed to or for the benefit of the decedent's surviving spouse in a qualifying manner.
Following is an example of how §1022 might apply to a married couple's community property in California. Suppose a decedent and his or her surviving spouse own two items of community property - a home worth $5 million with a $2 million basis, and stock worth $5 million with a $3.7 million basis, and the decedent's half of the community property is distributable to a bypass trust for the benefit of the surviving spouse and the couple's issue. If the property is allocated pro rata between the surviving spouse and the bypass trust, the General and Spousal Property Basis Increases would be allocated as follows:
● Decedent's property: The decedent's ½ of the home, worth $2.5 million, is allocated to the bypass trust with its $1 million of existing basis and its potential to receive up to $1.5 million additional basis. The decedent's ½ of the stock, also worth $2.5 million, is allocated to the bypass trust with its $1.85 million of existing basis and its potential to receive up to $0.65 million of additional basis. In the aggregate, $2.15 million of property exceeding the existing basis is eligible for basis increase. However, since this bypass trust cannot qualify to receive Spousal Property Basis Increase, only $1.3 million of General Basis Increase is available. Therefore, $0.85 million of gain would still be subject to tax on later sales ($2.15-$1.3=$0.85).
● Surviving spouse's property: The surviving spouse owns ½ of the home, worth $2.5 million, with its $1 million of existing basis, and ½ of the stock, also worth $2.5 million, with its $1.85 million of existing basis. In the aggregate, $2.15 million of property exceeding the existing basis is eligible for basis increase. However, this is less than the $3.0 million of Spousal Property Basis Increase that is available for allocation. Therefore $0.85 million of basis adjustment is lost ($3.0-$2.15=$0.85).
If instead the home is allocated to the surviving spouse and the stock is allocated to the bypass trust, the basis of the home could be increased by the $3.0 million Spousal Property Basis Increase to $5 million, and the basis of the stock could be increased by $1.3 million General Basis Increase to $5 million, and the full amount of the basis increases would be utilized, covering the entire date-of-death value of all of the community property.
Naturally other factors will need to be considered, such as the ability to discount partial interests in assets for estate tax purposes on the surviving spouse's death, but the example illustrates the type of analysis necessary in allocating basis adjustments under §1022 for the estates of decedents who died in 2010 and did not elect out of the federal estate tax system.
Morrison & Foerster's Trusts and Estates group provides sophisticated planning and administration services to a broad variety of clients. If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or PMcCabe@mofo.com.
© Copyright 2011 Morrison & Foerster LLP. This article is published with permission of Morrison & Foerster LLP. Further duplication without the permission of Morrison & Foerster LLP is prohibited. All rights reserved. The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Morrison & Foerster LLP or any of its clients. The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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