Errors made in the preparation or filing of federal estate and generation skipping transfer (GST) tax returns can be costly, both in terms of the federal transfer taxes due as well as the additional amounts assessed for penalties and interest. Likewise, errors made in the drafting of a client’s estate plan documents, or changes in circumstances between the execution of the client’s estate plan documents and the client’s death, can also create unnecessary transfer tax liabilities. On the other hand, a post-death event, such as the payment of a significant liability or claim by the estate, or a casualty loss, that has occurred well after the filing of the Estate’s 706 can still provide substantial estate tax savings to the Decedent’s estate. This article will look at some options that are available to the practitioner, including several that have actually been used by the author in the past few years, to deal with these situations and which resulted in substantial savings of both transfer taxes and penalties and interest for the client.
Failure to Make Alternate Valuation Election
As most practitioners who settle estates are aware, where the total value of the assets of an estate that is paying estate tax has diminished in value between the date of the decedent’s death and six months after the decedent’s death, the estate, under IRC Section 2032, may elect to use an alternate valuation date (instead of the date of the decedent’s death) in valuing the assets for federal estate tax purposes. Under IRC Section 2032, the alternate valuation date is six months after the decedent’s date of death unless the asset is sold or distributed prior to this date and then the alternate valuation date becomes the date of sale or distribution. The use of the alternate valuation election can save significant estate taxes, especially where the stock market experiences a market correction or crash after the decedent’s death, or the real estate market incurs a sudden drop in value such as what was experienced in the Fall of 2008 when the Great Recession hit.
In order to make this election, the Code requires that the alternate valuation election be made on a timely filed federal estate tax return (i.e., on a return that is timely filed within nine months of the decedent’s death or on a return filed no later than fifteen months after a decedent’s death pursuant to a timely filed estate tax return extension request). IRC § 2032(d).
What can be done, then, when an estate fails to make a timely alternate valuation election? Is the availability to make the election lost? Fortunately, it is not. Under Treas. Reg. Sections 301.9100-1, 301.9100-3, and 20.2032-1(b)(3), the IRS may grant an estate an extension of time to make an alternate valuation election where the estate failed to make the election on the federal estate tax return filed with the IRS. In order to obtain this relief (known as 9100 relief), the estate must satisfy three requirements: 1) the estate filed its federal estate tax return no later than one year after the due date of the return (including any extension of time actually granted), 2) the estate has acted reasonably and in good faith, and 3) the granting of relief by the IRS to the estate to make the alternate valuation election will not prejudice the interests of the government. Treas. Reg. § 301.9100-(3)(a).
As to the first requirement, the estate must have filed its federal estate tax return within one year after its original due date (which would be no later than 21 months from the date of the decedent’s death), or if a timely extension request had been made by the estate before the expiration of the original due date, within 27 months after the decedent’s death. If the estate cannot show that its estate tax return was filed within this one-year period, then the IRS has made it clear in a number of Private Letter Rulings (PLRs) that it will not consider the grant of 9100 relief to the estate. Consequently, a delinquent estate tax return that is “too delinquent” (i.e., never filed or filed past this one year period), will not qualify for this relief. However, so long as the estate can show that the return has been filed within this one year period, then the Estate may request 9100 relief to claim the alternate valuation election, even if the request for relief is made several years after the original filing of the return. In the situation I was recently involved in, our client was able to obtain 9100 relief from the IRS to make the alternate valuation election several years after the filing of the original estate tax return while the estate and the IRS were in the middle of Tax Court litigation over the estate’s federal estate tax liability.
As to the requirement that the estate must show that it acted reasonably and in good faith, the 9100 Regulations state that an estate and its executor will be deemed to have acted reasonably and in good faith if the executor reasonably relied on a qualified tax professional to prepare the 706, including a tax professional employed by the executor of the estate, and the tax professional failed to make, or advise the estate to make, the alternate valuation election on the 706. See Treas. Reg. § 301.9100-3(b)(1)(v). This is the hardest requirement to satisfy as it requires factual evidence that not only did the tax professional (the estate’s attorney or accountant) who was engaged by the executor to prepare the 706 for the Estate fail to make the election on the return (even though it was available because of a decrease in asset values) or advise the executor of the availability of this election, but also that the tax professional was qualified to prepare the 706 and that it was reasonable for the executor to rely on this tax professional (i.e., the executor had no reason to question the competency of the tax professional to handle the preparation of the 706).
The typical facts where the IRS has ruled that this second requirement has been met by an estate are situations where the attorney or accountant for the estate, otherwise qualified (many times the decedent’s personal estate planning attorney or accountant whom the decedent has relied upon for estate planning or tax preparation work during the decedent’s lifetime), mistakenly fails to consider the alternate valuation election during the preparation of the 706. After the 706 is filed, the same tax preparer (or someone else retained by the executor to assist with the estate administration or estate tax audit) discovers that the estate should have elected alternate valuation in order to reduce the overall estate tax liability. The IRS has granted, in a substantial number of PLRs with these facts, 9100 relief to make the alternate valuation election. See PLRs 200930028 (April 9, 2009), 201109014 (Mar. 4, 2011), 201118013 (May 6, 2011), 201122009 (June 3, 2011), and 201431017 (April 15, 2014). In the case I was recently involved in, we were able to obtain 9100 relief for the estate to file an alternate valuation election where the decedent’s long-time tax preparer did not make the alternate valuation election on the 706. The estate had experienced a significant reduction in the value of its real estate as a result of the onset of the Great Recession in the Fall of 2008. Our ability to claim alternate valuation through 9100 relief saved the estate well over $100,000 plus interest, a substantial estate tax savings for our client.
What about the third requirement, that the granting of the relief won’t prejudice the interests of the government? You might think that the mere granting of this relief would prejudice the interests of the government in that it is allowing the taxpayer to pay less estate tax to the Treasury because of some mistake or failure of the taxpayer or its preparer. However, where the IRS has found that the first two requirements outlined above have been satisfied, the IRS has repeatedly found that its interests are not prejudiced and allowed an estate additional time to make this election. See PLRs 200449028 (Dec. 3, 2004), 200438036 (Sept. 17, 2004), 2004438014 ( Sept. 17, 2004) and 200406039 (Feb. 6, 2004).
Requesting 9100 relief from the IRS is not an easy process. The request must be made in the form of a private letter ruling request to the IRS National Office. There is a user fee that must be paid to the IRS to request the ruling, and of course, the legal fees to prepare the ruling request can be significant. In addition, if the IRS has questions about the ruling request that can’t be resolved by a telephone conference, the estate representative may also have to travel to the IRS National Office in Washington, DC to meet with the National Office’s estate tax attorneys to address their concerns. However, if the difference between the date of death valuation and the alternate valuation of the estate is substantial, it can be well worth the expenditure of time and money to request this relief, as it was for our client who was able to get its estate tax liability significantly reduced.
Failure to Make Estate Tax Portability Election
A number of recent PLRs issued by the IRS indicate that 9100 relief may also be used to obtain additional time to make the estate tax portability election where the decedent’s estate failed to file a 706 to elect portability to the surviving spouse of the deceased spousal unused exclusion amount (DSUE). Until Dec. 31, 2014, the IRS had provided in Rev. Proc. 2014-18 a simplified (and more or less automatic) method for obtaining additional time within which to claim estate tax portability of a decedent’s DSUE for decedents who died after Dec. 31, 2010 and before Dec. 31, 2013. So long as the decedent was a citizen or resident of the United States at death, had a surviving spouse, and the estate was not otherwise required to file a federal estate tax return (i.e., the total of the decedent’s gross estate and adjusted taxable gifts was less than the IRC Section 6018(a) $5 million, adjusted for inflation, filing threshold), the IRS would allow the Estate to elect portability so long as the 706 making the portability election was filed with the Service by Dec. 31, 2014.
This simplified method of obtaining 9100 relief to make this election is now gone, but the IRS has indicated in a number of recent PLRs, PLRs 201535004 (May 12, 2015), 201537010 (April 29, 2015), 201539021 (June 24, 2015), and PLRs 201544001, 201544002 and 201544003 (Oct. 30, 2015) that it is still willing in certain situations to grant an extension of time to an estate to file a 706 to elect estate tax portability. The estate must still satisfy the same requirements set forth in Rev. Proc. 2014-18 above. It appears from a reading of these PLRs that the estates were successfully able to show that either the executor was unaware of the availability of this election at the time the estate was being settled or the executor reasonably relied on a qualified tax professional (an attorney or accountant) who failed to make, or advise the executor to make, the portability election. The rulings do not tell us when the decedent died but presumably a decedent who died even as early as 2011 could still seek this relief. This relief may be of tremendous value to surviving spouses whose estates are now over the $5.45 million estate tax limit and would like to have the ability to go back and capture their deceased spouse’s DSUE in order to eliminate or reduce their estate tax liability at their death. This relief will now require a “full bore” private letter ruling request and the payment of user fees (and the attorney’s fees required to prepare the request), but this may be worthwhile if it can save the surviving spouse’s estate as much as $2 million or more in estate tax.
It should be noted, though, that all these rulings point out that the portability election granted pursuant to 9100 relief will subsequently be voided by the IRS if it is later shown that the decedent’s estate was over the IRC Section 6018(a) filing threshold at the time of the decedent’s death. Thus, it is imperative that the state and its tax preparer, before seeking a PLR for this relief, accurately determine the total fair market value of the decedent’s estate at the decedent’s death as well as the total value of the decedent’s adjusted taxable gifts (including those that may have not been previously reported on a gift tax return) to ensure that the IRC Section 6018(a) filing threshold was not exceeded at the time of the decedent’s death.
Use of Disclaimers to Save Generation-Skipping Transfer Taxes
There are a number of IRS Rulings approving the use of a qualified disclaimer by an estate in order to save the estate tax marital deduction where a marital trust was improperly drafted and did not comply with the IRC Section 2056(b)(7) requirements for a qualified terminable interest property (QTIP) trust. See PLRs 9629023 (April 23, 1996) and 9018046 (Feb. 5, 1990) and TAM 9003007 (Oct. 6, 1989). There are also a number of PLRs where the IRS has allowed a qualified disclaimer (in combination with a court approved trust reformation) to cure a defective charitable deduction bequest, such as a defective Charitable Remainder Trust. See PLRs 200010019 (Mar. 10, 2000), 9532026 (May 12, 1995) and 9347013 (Aug. 19, 1993).
Disclaimers can also be used to take advantage of a decedent’s unused generation-skipping transfer (GST) tax exemption and to reduce other transfer taxes at the decedent’s death. For example, in PLR 199944038 (Aug. 11, 1999), disclaimers by the decedent’s children and more remote issue enabled a decedent’s estate to maximize the use of the decedent’s GST exemption as well as to direct the excess of the decedent’s estate above her GST exemption amount to a family foundation that was named as the final beneficiary of the decedent’s estate should all of her issue predecease her.
Disclaimers can also be used to eliminate GST taxes that are triggered either inadvertently or as a result of a drafting error. For example, if the terms of the decedent’s Will or Revocable Trust have created a “direct skip” generation skipping transfer that is in excess of the decedent’s remaining GST tax exemption (perhaps because the decedent had used all of his GST exemption on lifetime gifts to his grandchildren and then did not revise his estate plan documents) and will consequently generate GST taxes on the estate, and the Will or Trust document provides that the final beneficiary of these assets, in the event all of the skip persons are deceased at the time of the decedent’s death, is a non-skip person (such as the decedent’s child or children), then a qualified disclaimer by all of the skip persons can avoid the assessment of this additional 40% transfer tax at the decedent’s death. Of course all of the requirements of a qualified disclaimer under IRC Section 2518 must be satisfied (including the time requirements and the non-acceptance of benefits by the beneficiary prior to the execution of the disclaimer). If the beneficiary is either a minor or incompetent, such beneficiary’s disclaimer may be executed by his or her guardian, but only with the prior or subsequent approval of the Clerk of Court, or if required, a resident superior court judge. N.C.G.S. § 31B-1(9d).
Obviously, there are many requirements that would need to be met in a relatively short period of time to get this disclaimer completed prior to the filing of a decedent’s estate tax return, but if accomplished, the tax savings can be substantial, especially since an additional 40% GST tax (on top of a 40% federal estate tax) would leave only 20% of the value of the decedent’s bequest in the hands of the decedent’s family. Even if the child who receives the disclaimed property will be subject to estate tax at his death, the deferral of these transfer taxes will provide the child with the time to take advantage of other transfer tax savings strategies, like making annual exclusion gifts of the disclaimed property to his descendants, or perhaps directing this property to charitable entities that qualify for the estate tax charitable deduction and which are a beneficial object of the child and his family.
Post-death events that occur even as late as during the estate tax return audit phase can also generate transfer tax savings for an estate. In my own experience, I have seen the IRS allow an IRC Section 2054 casualty loss deduction for a vacation home which was destroyed by a hurricane during the estate tax audit of the estate’s 706. The IRS has also allowed adjustments (increases) to an estate’s IRC Section 2053 deductions for deficiency judgment payments made by an estate where the decedent was a guarantor on a loan secured by real estate owned by the decedent through an entity and the real estate was foreclosed upon and sold by the lender for less than the amount of the loan. If the estate incurs such a loss or is required to pay a substantial claim during the estate tax audit process, it is critical that the attorney assert this adjustment with the Service during audit. In addition, if there is a possible claim against the Estate that has not yet been finally determined at the time of the filing of the 706, the tax preparer should list this potential claim on the 706 in order to put the IRS on notice before audit. With a current federal estate tax flat rate of 40%, these losses and claims payments can help to reduce the after-tax effect on an estate of these expenditures.
Abatement or Reduction of Penalties
Penalties can sometimes be abated or reduced through negotiation with the IRS. Our law firm has been successful in obtaining abatement or reduction of penalties (including negligence, undervaluation and late filing penalties) through the IRS appeals process as a part of the settlement of estate tax litigation in the United States Tax Court. Under IRS and Tax Court procedures, all estate tax cases filed in the Tax Court are immediately assigned to an IRS Appeals officer for possible settlement between the parties. This Appeals process enables an estate to have an additional opportunity to attempt to settle its case with the IRS. The Appeals Officer will be an attorney, well versed in estate tax law, who will review all of the facts and legal issues and weigh the relative strengths of each side’s case as well as the hazards (including the costs to the government) of litigating the case in Tax Court. If all else has failed during the estate tax audit process, this may be a good option to pursue for your client.
Estate and GST tax issues created by miscues or oversights can be costly to an estate. Conversely, a post-death event that is devastating to an estate can at least generate some estate tax savings which may help to ameliorate the loss. Hopefully, this article has provided some options that may be available to the trusts and estates practitioner in order to eliminate or at least minimize the damage.