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49th Heckerling Institute on Estate PlanningIncome Tax BasisBy: Martin M. Shenkman, CPA, MBA, PFS, AEP, JDFundamentals Program: Planning for Income Tax Basis.Changing planning paradigm.$12M estate use to be viewed as a large estate, and it would have faced a substantial estate tax. Now, however, the estate tax will be negligible, but the potential income tax impact much more dramatic. This makes the need to plan for basis step-up far more important for most estates than to plan for the reduction of estate tax.For wealthier clients basis step up must be maximized as well as estate tax reduction planned for. While cost basis is commonly referred to for income tax purposes there are a myriad of definitions and nuances to consider. The impact of whether there is an exchange, or other type of transfer may affect which basis rules apply. As another example, in the year 2010 the odd rules for basis applied. IRC Sec. 1022.What is basis?What the tax law defines as basis may not be identical to a laypersons definition of the investment in a property. It is not what you invest since if you build a home your labor is not factored in as part of basis although it is clearly a valuable investment.Basis is used to determine gain and loss on disposition.There are a myriad of technically defined terms with respect to basis.Basis can be adjusted up and down when you make additions (e.g., subsequent contributions). Interest and taxes on unproductive and unimproved real property as carrying charges, which are normally viewed as deductions, IRC Sec. 266 permits an election to add these as part of income ment: “No deduction shall be allowed for amounts paid or accrued for such taxes and carrying charges as, under regulations prescribed by the Secretary, are chargeable to capital account with respect to property, if the taxpayer elects, in accordance with such regulations, to treat such taxes or charges as so chargeable.”Under Regulations refers to an original tax return. Therefore, this cannot be done retroactively on an amended return.There can be deletions or reductions to basis from depreciation, amortization, etc.Now use MACRS as the depreciation calculation (prior law was ACRS) depreciation standards. IRC Sec. 168.Basis of property acquired by gift.The basis of property received as a gift is determined under IRC Sec. 1015.If acquired by gift after 1920 when rules enacted the basis of the done is generally the same as the basis was in the hands of the donor (the last donor who did not receive the property by gift). Comment: “If the property was acquired by gift after December 31, 1920, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift, except that if such basis (adjusted for the period before the date of the gift as provided in section 1016) is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value…”Different basis used if it is a gift of appreciated (fair market value is greater than basis) or depreciated (fair market value less than basis) property. The character may be different than anticipated because of partnership or other adjustments.The above calculation as to whether the fair market value of the property is less than, or more than, the basis at the date of the gift requires a determination of the effective date of the gift. This is determined under IRC Sec. 2511 and is when the donor relinquishes dominion and control under the gift tax rules. Compare the donor’s tax basis to the fair market value on that date.Three scenarios:Donee can sell for more than basis. Use the donor’s adjusted basis for determining gain.Donee sells the asset at a price that is between the donor’s adjusted basis and the fair market value of the date of the gift. No gain or loss is recognized in this instance when “in between.”The donee sells the property for less than then the lower of: (i) fair market value at the date of gift, (ii) and the carry over basis amount. Loss can be recognized.Be certain on gift tax returns Form 709 that basis is disclosed. Often this is not done because clients do not have the data or simply do not provide the information.Gift tax paid may affect basis.The donee’s tax basis in the gifted property is increased for the gift tax paid on the gift transfer.This basis adjustment applies regardless of whether it is the donor or donee who pays the gift tax.If you paid gift taxes on the net appreciation of the property given 1015(d)(6) you must determine gift tax allocable to the net appreciation of the asset given away.This basis adjustment appears to be added on as the gift tax is paid. However, if the gift property is sold by the donee before the donor actually pays the gift tax it appears that you can presume that the tax will be paid and so the basis should be ment: “(6) Special rule for gifts made after December 31, 1976 (A) In general In the case of any gift made after December 31, 1976, the increase in basis provided by this subsection with respect to any gift for the gift tax paid under chapter 12 shall be an amount (not in excess of the amount of tax so paid) which bears the same ratio to the amount of tax so paid as— (i) the net appreciation in value of the gift, bears to (ii) the amount of the gift. (B) Net appreciation. For purposes of paragraph (1), the net appreciation in value of any gift is the amount by which the fair market value of the gift exceeds the donor’s adjusted basis immediately before the gift.”Inter-spousal Lifetime Gifts.IRC Sec. 1015 rules do not apply to inter-spousal gifts. Instead of 1015 IRC Sec. 1041 applies. IRC 1041 generally treats inter-spousal transfers as gifts.IRC Sec. 1014 Addresses Basis of Property Received from a Decedent.1014(a) Basis of property in hands of person acquiring the property from a decedent is either the fair market value on the date of death or if applicable on the alternate valuation date value (AVD).1014(b) what does it mean to be “acquired from a decedent?” There is a list of definitions/provision in 1014(b).If the property is included in the gross estate you will receive a basis adjustment but this is not the only standard. It has to be acquire from the decent. It does not have to be included in the gross estate to get a basis step up. This raises interesting issues in the grantor trust area.The property may have been transferred during life but still included in the donor’s estate, e.g. the regulations discuss as an example a gift in contemplation of death (old regulations) but under current law a more apt example would be the donor dying with a retained interest in the asset given. There would be a basis step-up.If you make a transfer and the transferee takes depreciation deductions those reduce basis. Community munity property has grown in importance in recent years. If one spouse dies owning property characterized as community property only ? of the property is included in the gross estate, but all of the property receives a basis step-up. When a client from a non-community property state has community property you may wish to segregate that property to retain the community property status since it may then benefit from this double basis step up afforded to community property. Generally, community property assets will remain “community property” unless that status is destroyed. Consider separating this property into a separate trust. If you instead the client has income from say a community property account deposited into one spouse’s separate bank account, that might taint the characterization of the entire property, not just the income so deposited, as non-community property.IRC Sec. 1014(e).This is a significant exception adopted in 1981 when the unlimited marital deduction was ment: (e) Appreciated property acquired by decedent by gift within 1 year of death (1) In general In the case of a decedent dying after December 31, 1981, if— (A) appreciated property was acquired by the decedent by gift during the 1-year period ending on the date of the decedent’s death, and (B) such property is acquired from the decedent by (or passes from the decedent to) the donor of such property (or the spouse of such donor), the basis of such property in the hands of such donor (or spouse) shall be the adjusted basis of such property in the hands of the decedent immediately before the death of the decedent.There was a concern with an unlimited marital deduction that if spouse was terminally ill the well spouse could transfer all asset to the ill spouse to get a basis step up on the ill spouse’s death.If H receives property from W within one year of death and she leaves it back to H, that property should get a carryover basis, not a step-up.This is not really an in “contemplation of death” concept, but rather based on a time frame -- within the one year time frame.Maximizing basis step up is a substantial consideration. If you can transfer property by gifting to a terminally ill spouse why not try it? First be certain that there are no creditors of that spouse, and that the transferor spouse will really get the assets back (not some other party).Comment: consider who the agent is of the donee spouse’s durable power of attorney. Even if the will provides for a bequest back from ill W to H what if W’s children from a prior marriage are her named agents? What if H dies unexpectedly before W those asset that H transferred may pass to W’s children instead if his.Planning concept – “triangulate” the planning. H gifts assets to W and W bequeaths assets with basis step up to the children an there is no issue under 1014(e). Also be careful not to trigger an inadvertent estate tax. So this could be a useful planning tool up to the exemption amount. Comment: This is a clever planning idea that might become more common in the appropriate circumstances. Use the triangulation approach with a bequest in the ill spouse’s will to a trust to which the transferor spouse can be added, and use the liquidation of assets following death, recommended below, to begin the tolling of the income tax statute of limitations.The more difficult issue is what if the property is bequeathed to the trust in which the transferor spouse is a discretionary beneficiary? There are no regulations just legislative history and several PLRs. If it comes back to a trust of which the transferor/surviving spouse is a beneficiary, the basis step up should be disallowed to the extent of the transferor/spouse’s proportionate interest in the trust. So for example, if the transferor is a beneficiary pursuant to an ascertainable standard or income beneficiary that can be determined. If the H has an interest only as a discretionary beneficiary how can you evaluate this? Comment: What does POA provide for? How are the finances of the clients structured? What steps might be useful to have prepared to be ready to trigger this planning? Might it pay to have pre-arranged transfer documents and other steps so that a transfer can be completed? Comment: Perhaps use a technique like a hybrid trust, analogous to what has been discussed in the DAPT context, where the transferor spouse can be added in the future as a beneficiary.The time period after which the transferor spouse might be added is after the statute of limitations. But waiting until after the running of the estate tax statute of limitations has run may not be sufficient. That might not be the relevant statute of limitations to be concerned about since it is an income tax issue, not an estate tax issue. If the trust sells off all assets shortly after funding (subject to wash sale rules which may limit losses and other considerations) and buys new investment assets the gain will be triggered and the income tax statute of limitations will also begin to toll. Comment: Will the statute run? What about the 25% rule? Could the IRS argue prearrangement and fraud to prevent tolling statute of limitations?This should not be a trust protector who may well be in a fiduciary capacity but rather a person acting in a non-fiduciary capacity.Caution, if this is documented Use a bifurcated marital trust into two components:I leave any assets given to me by my spouse within one year of my death.I leave any assets not given to me by my spouse within one year of death.IRD. No basis step up under IRC Sec. 1014 for IRD. IRC Sec. 691.There is no clear definition. The definition is cobbled together from cases, Code and Regulations. Here is a simple framework to identify IRD in general terms: If you treat the decedent as an accrual basis taxpayer, determine what should have been taxed had they been accrual basis, that is what should be taxed as IRD. That is not a complete definition, but a workable start.GST.IRC Sec. 2654(a)(1) and (2) basis adjust from ment: “Except as provided in paragraph (2), if property is transferred in a generation-skipping transfer, the basis of such property shall be increased (but not above the fair market value of such property) by an amount equal to that portion of the tax imposed by section 2601 (computed without regard to section 2604) with respect to the transfer which is attributable to the excess of the fair market value of such property over its adjusted basis immediately before the transfer. The preceding shall be applied after any basis adjustment under section 1015 with respect to the transfer.”If as a result of death there is a termination of the interest and a GST tax is imposed you are to adjust the basis in same manner as you would under IRC Sec. 1014. You have a death, taxable termination and a GST tax is paid, you get a date of death step up.2654(a)(1) in all other cases if there is an adjustment because of GST tax, treat it in same manner as under the gift tax rules.Holding Period.Determines whether long versus short term gain will be realized. You must hold the property for “more than one year” in order to have a long term capital gain. IRC Sec. 1222.The time period is really one year and one full day.For depreciated property received by gift, there is a possibility that for gain calculations you use basis of donor, but for calculation of a loss you would instead use the fair market value on the date of gift. If you use the donor’s basis and tack the holding period.For loss property the rule is different. You use fair market value. So there is no tacking in this instance since it is not based on a carryover basis. So the holding period starts on the date of the gift.For a part gift/part sale the holding period is allocated to the proportions of asset.Inherited property if sold within one year of death you can use a long term holding period but the person selling the property has to be the person who received the property from the decedent. The person who sells must have inherited directly from the decedent. IRC Sec. 1015; 1222.IRC Sec. 1022 if you had a special election in 2010 use carry over basis and if you have transferred basis, then holding period tacks. If you do not have carry over basis no tacking.Uniform basis rule for trusts and estates.Basis is apportioned among beneficiaries in proportion of their interests. So if you have an income interest and remainder beneficiary you can apportion basis based on actuarial interests of the income and remainder beneficiaries. The apportionment is also affected by age and interest rates. Although the trust uniform basis may remain the same but the beneficiaries’ shares will vary over time. The regulations say to allocate basis based on relative interests. But if you have a HEMS right or a strictly discretionary interest how can you allocate basis? What value is attributable to these interests for purposes of determining apportionment?The uniform basis rule applies in two important situations. One is how depreciation deductions should be allocated. This can be different then state law rules. These rules are important when CRT interests are sold. There is a market in the sale of remainder trust interests and there are companies that make a business of acting as middlemen for these transactions. If a term interest is sold it is deemed to have a basis of zero unless it is part of a transaction in which all interests in the trust are being sold to a third party. If a unitrust interest holder sells his interest to a third party investor, no matter as to his age or interest or the uniform basis, the seller’s basis is zero for gain calculation purposes. The code does not address whether the remainder beneficiary would get the selling beneficiary’s interests. It should. This could be an issue if it is a term remainder non-charitable interest. If the parties agree to a commutation in which each is “cashed/asseted” out, then this rule applies. The term beneficiary gets no basis. The term beneficiary could have a gain and the remainder beneficiary could have a loss.Uniform basis rules are different for a life estate followed by a remainder free of trust. So the rules are different for the same asset whether in or out of trust.Proving Basis.There is a myth that if you cannot prove the basis it is zero. If you don’t have documentation the basis may still be something, it is not necessarily zero. The initial burden is on the taxpayer to provide the information.Burnett v. Houston 283 US 223 if the taxpayer provides some relevant information the IRS should agree to some basis.Cohan v. Commr. 39 F. 2nd 540, case provided that if sufficient information is provided the IRS cannot simply ignore it.IRC Sec. 7491, if you believe you will have to go to court and you can provide information but the IRS is not being reasonable, use this provision. Once you have done what this provision requires you may shift the tax burden of proof from the taxpayer to the IRS.Portability.Tax reasons.Why would a smaller client with minimal estate tax exposure not want the double basis step up?The tax reason is to focus on the double step up.What about a client/couple with an estate between $5,430,000 and $10,860,000 – if they won’t get beyond upper limit so that a federal estate tax is triggered, why not use portability.If there are non-tax reasons such as asset protection, second or later marriage, etc. then use trust ment: Nuclear families may be a smaller proportion of our client bases then many realize. Consider: “In 1970, 40 percent of households were married couples with children. Such households made up just 19 percent of homes in 2013.” What if each spouse has $10M.H leaves all asset into a QTIP’able trust for W.Use a reverse QTIP for $5M to safeguard the GST exemption.Surviving spouse gets $5M outright and now has $15M (her original $10M plus the $5M that was inherited directly and not place din the trust).W creates a $5M grantor trust shortly after H’s death using H’s DSUE. This is analogous to the bypass trust but is a grantor trust so more powerful.Four ways to gain basis step up.Give independent trustee or trust protector right to distribute assets out to surviving spouse so that they will be included in that spouse’s estate and be stepped-up on his/her death.This is a relatively easy approach to use.Independent trustee merely distributes and included in surviving spouse’s estate under IRC Sec. 2033.The difficult issue is who will do this? An institutional trustee will not be comfortable doing this. Whether or not an individual trustee or protector is willing to do so will be dependent on the family circumstances.You need to make sure that the trustee acts and does so before the death of the surviving spouse.You have to verify that there are no creditor issues affecting the surviving spouse.The trustee will have to obtain the information as to exemption remaining in order to do this analysis.Accurate information as to the surviving spouse’s health is essential to making a decision and this may be quite difficult.If surviving spouse transfers or bequeaths assets to unintended beneficiaries the trustee will be sued.What if assets increase substantially in value and create an unintended estate ment: The potential potholes with this type of approach are significant. If there is any family friction or concern would anyone act?Use independent trust protector the right to create a general power of appointment in favor of the surviving spouse to create estate inclusion.This is very complex to draft.You want to pick assets with lowest basis. But not necessarily since some asset may not be sold for the foreseeable future. So you really want assets that will trigger the most gain in the nearest term. So merely selecting assets is quite complex.Will the creation of the power work in the particular state?Be cautious that there are no other clauses in the instrument that will prevent this from occurring properly.This complex concept has to be explained to the client.The benefit of this is that it can function automatically. The problems with this are legion, the drafting and asset selection are both ment: This can be nearly impossible to ascertain. The parent/client may be adamant that the heirs will vacation in the family cottage forever. The heirs hate going there and will sell as soon as the parent dies. The planners and the client may not know this.Kurz v. Commr. 101 TC 44 case raises issues with this and the result may not be as intended. Kurz suggest that there must be a real economic effect to the power independent of its tax ment: What is the impact of this to a general power of appointment contained in a silent trust so that the power holder is never informed of it?The clause may not give you enough general power but giving some general power, complimented by the actions of an independent trustee or protector acting, can be in combination the best approach. Include in the documents a contingent general power of appointment. To the extent of any unused exclusion at second spouse’s death that portion of assets will be subject to this contingent power of appointment.This must be done on a timely basis which will be difficult.You don’t want to over-include assets.This act will likely occur near death so the circumstances will be difficult.Delaware tax trap trigger where allowed to be triggered.Create non-general powers of appointment to continue without violating the rule against perpetuities.IRC amended to prevent this. If you try to create these special powers it may trigger estate inclusion.This is complex to understand and it may be identified in reading the document.Some states have statutes that prevent you from violating the Delaware tax erning instrument savings clauses may prevent this from being effective.The Delaware tax trap approach puts the burden on the client.The chance of getting the exactly correct answer in any of these approaches is close to zero.State death tax issues may significantly change the above. Part Gift-Part Sale.Charitable bargain sale more capital gains is paid on sale component. This arises in bargain sales to charities and gift annuities.The adjusted basis of the property has to be apportioned based on fair value.Basis in Partnership. General comments.Subchapter K of the Code.Partnerships includes FLPs and LLCs, whatever is deemed a partnership for tax purposes. It has more than two owners and elects to be taxed as a partnership or is taxed as a partnership.Several theories underlying partnership taxation. Aggregate theory provides that the partner owns the partnership so that the partner and partnership are treated as/taxed as one unit. The entity theory in contrast looks at FLP as a separate entity from its partners. Both theories apply. But for basis discussions the aggregate theory seems to predominate.Issues to consider.How basis is affected in the typical estate planning transactions?Inside and outside basis and how each is determined.How is basis created on contributions to the partnership?How is basis adjusted while the partnership is in operation? This affects outside basis.Effect of ordinary distributions and liquidating distributions and impact on inside and outside basis.Negative basis.What happens to basis on gifts to a grantor trust, to heirs, or a non-grantor trust?IRC Sec. 754 election mechanics.Inside versus outside basis.Outside basis is the basis of the partner in his partnership interest.Inside basis what is the partnership’s basis in the asset inside the entity. This could be the combination of what each contributing partner paid for the property contributed. Basis on contribution of assets.Generally no gain is recognized on contributions to partnership. IRC Sec. ment: Watch out for the investment company rules for security FLPs and LLCs.Contribution of a partner’s note to the partnership. When note is repaid you get basis. Contrast this to a C corporation that if you transfer a note to a C corporation you get basis equal to the fair value of the note. But if a C corporation later elects S status it is unclear what should happen.Basis by other than contribution.Purchase of partnership interest provides basis for the partnership interest purchased -- outside basis. The inside basis, other than if there is a 754 election made, is not effected.Basis commonly transferred by gift. Dad gifts LP interest to son then son will have basis. IRC Sec. 1015. No change on gift to grantor trust. Since this is a non-recognition event basis and holding period should not be affected. Rev. Rul. 85-13.Inheritance – same general rules apply. Outside basis gets a step up and this is the most common use of a 754 election to obtain as commensurate increase in inside basis.Operations.Income increases basis, and losses reduce basis.There is no such thing as negative basis. There can be a negative capital account. They are different concepts. Capital account is an accounting concept. A negative capital account results when the partner received distributions greater than what is contributed.Assets distributed out of partnership.Non-liquidating distributions.No loss ever recognized.Basis is adjusted.If there is no gain or loss on the distribution then basis should be unchanged.Cash distributions reduce basis.Property distributions result in a distribution of basis. No step up in basis occurs. This can defer gain recognition until the distributee partner eventually sells.What if receive $120,000 distribution and basis of $100,000? It will trigger gain of $20,000. IRC Sec. 731(a).Be careful to evaluate distribution to be aware of possible gain.Liquidating distributions.As a general rule the outside basis is used to become the basis of the assets distributed. If outside basis is $100 the tax law tries to allocate the outside basis to those assets.Cash is allocated first and consumes basis = fair market value, dollar for dollar. The remaining basis, after the allocation to cash, is then allocated. Transfers to grantor and non-Grantor Trusts.Rev. Rule. 85-13 it is as if no transaction has occurred on transfer to grantor trust. See above.If there are basis adjustment limitations and suspended losses, confirm in advance whether they may be eliminated. If the LP is a passive activity the passive activity losses on a gift will be deferred and wont’ be used until death or sale.Testamentary transfers.Consider whether there is IRD inside the partnership.When value partnership interest consider IRD items since these get zero basis.Generally you get a step up in basis on outside basis. But generally there is no adjustment inside the partnership.Partnership taxation tries to minimize double taxation and that is the intent of the 754 adjustment – to eliminate disparity between inside and outside basis.Generally you would want to make the election to avoid disparity. However, the election can be complex and create significant accounting burdens.Must track basis for each type of assets. Create 754 account. If have multiple deaths each will have their own 754 account. You will also need a separate account to track for regular tax and AMT tax purposes. The administrative burdens can be significant.754 adjusts only the inside basis. Usually the outside basis was changed as a result of death or sale or exchange and was increased. So assets attributable solely to that partner are adjusted.Any distribution of any interest in a partnership not otherwise treated as an exchange will be treated as an exchange. When an estate funds a trust as part of distributions to beneficiaries that creates a second basis adjustment (after death). IRC Sec. 761. It does not appear that anyone follows this. Funding a pecuniary bequest should logically result in a step-up but does this result in another 754 election on funding a non-pecuniary bequest?Passive Activity Losses.If you die and the passive activity losses is less than differential in basis you can use it all against passive income from the activity, or against other income.Grantor Trust Basis Issues.Often not clear what the correct answer is, there are often multiple rules.Rothstein v. US, 735 F.2d 704 case 2nd Circuit. Non-grantor trust.Grantor sold property for a note.Trust wanted to claim higher basis and grantor would pick up gain on installment sale.Court said IRS is incorrect and taxpayer does not continue to own the asset.IRS responded with Rev. Rul. 85-13 saying that grantor owns assets after which are held by grantor trust so you cannot have a true sale and cannot have a basis increase.If Rothstein is correct then note sale transactions would not work. But after several subsequent rulings to Rev. Ru. 85-13 that is now the law.On sale to grantor trust basis is an income tax issue and for income tax purposes the sale to a grantor trust is a non-event.If grantor trust status terminates while grantor is alive you should pick up gift tax on net appreciation. If you are dealing with an installment sale under exemption amount and there is no encumbrance it should be a non-event. If debt is in excess of basis this results in recognition of gain. The real issue is what happens on death and grantor trust status terminates on death? There is not a good answer. There is not an answer on which everyone agrees. Look at 85-13. If property is encumbered by debt in excess of basis there is no gain recognized, basis gets stepped up and gain disappears. Basis created by a non-recognition event. Chief Counsel advisory CCA 200937028 provided that death is not a recognition event.What about assets inside trust? What happens to their basis? Is it a receipt of property from a decedent under IRC Sec. 1014? Consider Rev. Rule 85-13 and IRC Sec. 1014. Careful reading of the Code and provisions is important. There is a gap. Consider that for a non-resident alien you can get a basis step up with no quid-pro-quo.Private Annuities.These transactions could be more certain than SCINs.Basis issues are quite important and the rules are complex. The annuitant/seller – basis is important because what is paid is divided into three parts: return of capital (amortized over life expectancy on a straight line basis), capital gain, and the annuity component which is the rest of the payments (in a normal sale this would be interest but the payor cannot deduct it in a private annuity transaction so it is referred to as an annuity not interest payment).Regulations proposed in 2006 still have never been finalized. They are still on the priority guidance list. These provide all gain must be recognized in year of sale. When finalized the regulations will be effective retroactively to the 2006 proposal date. If the sale is to a grantor trust it is a non-recognition event.What is basis to obligor/buyer? This is important to calculate depreciation on the property purchased. What is basis if obligor/buyer re-sells property while seller/annuitant is alive? It is the sales price, the present value of future payments. If you sell at a loss then basis is only what you have paid so you cannot generate a loss in this instance.At obligor’s death basis is adjusted down to the amount, if less, that has in fact been paid. Use a private annuity or SCIN only if you have a seller whose actual life expectancy is significantly shorter than actuarial tables predict. This means living longer than one year (really 18 months) but a lot less than they should have. In light of recent IRS statements you might prefer the private annuity to the SCIN. Comment: See Akers outline and notes at Tuesday morning’s session.If death occurs early the buyer’s basis will be reduced.If buyer was taking accelerated depreciation and then as a result of death the amount is reduced buyer may have an amount less than what was paid. Since there can be no negative basis some commentators might view the differential as current gain to recognize. There is no real authority for this so presumably few practitioners if any would report this.SCINs.Note that will disappear on death. An asset is sold but the note received will disappear on death as a result of the cancellation feature. Actuarially it must be anticipated that you have to outlive the note. So if you outlive the note you will get back more than you gave up so as with the annuity above, you want to do SCINs for those that will die within their actuarially life expectancy.Create a SCIN when you believe what you will receive in return will be less. Estate of Moss v. Commr. 74 TC 1239 there is nothing to include in the estate value.But you must receive a premium as either increased interest or an increased payment to compensate for the cancellation feature. A combination of the two can be used. GCM 35903 the buyer’s basis is the fair value of the assets exchanged.Example: Father (F) sells property to Son (S). Property in son’s hands is fair market value of property since anticipate that note will be paid. The issue is should that income really be recognized? The IRS position is that the amount not paid must be recognized to justify basis. The note you created only applies if you are alive. If you are dead there is no obligation so that there is no cancellation of the obligation. The argument that might be made is no more recognition of the income because there was no cancellation of the debt because the debt only existed while alive. Better reasoning under Estate of Frane v. Commr. 98 TC 341 is that there is no cancellation of indebtedness.How can you manage basis?The JEST trust is an attempt made to get community property like treatment in a non-community property state.TAM 9308002.Spouses serve as co-trustees. Could require that all of trust assets could be subject to debts and taxes of grantor. H delivers statement to W saying I want all joint assets. Under 2041 and Regs thereunder it is a general power of appointment so that if H dies first what H contributed is included in his estate. What W put in is also included in H’s estate because H has a general power of appointment over these assets.IRS questioned whether there is really a general power of appointment but concluded that it was. Several cases stand for proposition that a power of appointment over a trust someone else can revoke does not make this situation the equivalent to the requirement of having to have someone consent to the exercise of that power.This is a transfer revocable up until the date of death. It is a gift the moment before death and qualifies for the estate tax marital deduction. However IRS said IRC Sec. 1014(e) is a problem. The IRS views the initial transfer as incomplete until the moment before death so the transfer is a no-basis increase.This approach can be used to assure use of large unified credit and should work.The problem is was the gift made effective at the moment before death or the moment after? If effective after death there is no marital deduction. JEST.The problem of 1014(e) was addressed with joint estate step up trust, or “JEST.” This looks similar to tax basis revocable trust. The assets of the donor/surviving spouse that are included only because of general power of appointment. The JEST can minimize the problems of 1014(e). It is a means to get a basis step up on the first death if that spouse has insufficient assets.Alaska and Tennessee statutes differ from other community property states. Everything you acquire is separate property unless you agree that it is community property. All community property states allow you to opt in for separate property, but in Alaska and Tennessee you have to opt in for any property to be covered. Both Alaska and Tennessee have provisions for a trust with situs in that state even though the grantors of the trust do not live in that state. The situs of property held by a trust is usually the situs of the trust. You must have a trustee in Alaska (Tennessee). The trustee must have certain functions like preparing tax returns and maintaining records and have possession of some of the assets. Some commentators would want trustee to be in charge of all trustee functions and have all asset held in the trust to minimize the risks of an argument with the IRS over conflict of laws. The statute requires mandatory statement advising the client about the consequences of this and that the client must seek competent counsel.Does this technique work? There are no cases on point. But the general rules on situs support this. A key case is 1944 Supreme Court case Harmon.Alan Gassman’s summary of the above discussion.With portability, you are not as concerned with the problem of the first spouse not having money. In fact, the best portability comes from an insolvent estate of the first spouse. They got no use of their exemption. The only problem is convincing them to file a federal estate tax return. This can be a little tricky. Somebody has to pay for preparing the return. The problem of 1014(e) was addressed by Alan Gassman and a couple of other lawyers in a series of articles - where they created what they call "The Joint Estate Step-Up Trust" (or "JEST"). The concept looks a great deal like the tax basis revocable trust, with one very clever distinction, and that is that the assets of the donor surviving spouse that are includible only because of the General Power of Appointment (where the first spouse to die does not have enough assets to fully fund their exemption) to bring the estate up to the exemption amount, which are thus includible only because of 2041, and are attributable to the property that was owned by and contributed by the surviving spouse. These will go into a non-marital trust that the surviving spouse is not a beneficiary of, and the rest is for marital deduction funding. That absolutely ought to work in terms of 1014(e). You still have the question of whether the spousal gift is the moment before or the moment after, and when you are explaining the technique to the client in writing, you need to point out this one little tiny item of uncertainty. You can state that you think it unlikely that this will be a problem - that all the private rulings take favorable positions. All of them. There are none taking an unfavorable position. That's something. We can cite them, but we can't rely on them, but it is still something…So they have some significance.Once the client can get past that one little piece of risk, I think the JEST is a great technique for what it is seeking to do. It is a way to minimize the problems of 1014(e). I commented earlier that you can accomplish the same concept if you are dealing with an inter-spousal gift within one year of death, you say "fine, the access I was given within one year of death is a little different - non-marital trust. It is a great technique-- - the cases I mentioned about the - whether or not it is really a general power. I had a debate with Mitch Ganns, who said - the rulings don't really say that, and I went back and read them, and said, yes they do really say in my opinion they really do say that, and while Mitch is one of those people I usually defer to in judgment - I really disagree on this one.So, the JEST actually is a workable technique to get the basis step-up on the estate of the spouse to die, when they don't have money or enough money. It is a way around 1014(e) - the tax basis revocable trust - not so much.The JEST is a material improvement.Page 201 - I've got to say, that Alaska and now, Tennessee, community property trust is probably the simple best basis play in estate planning, and no one seems to be using it, and I am a little - I think it is outrageous that it isn't being proposed more often, but there it is.We mentioned that community property has a really swell rule that both sides get a basis step-up on the first spouse's death. (Howard continued to cover the Alaska and Tennessee Community Property Trust discussion, stating that it is the best technique available).Basis in life insurance policies.It is not premiums paid, it is premiums paid less the portion of the premium that went towards term ment: See Larry Brody’s discussion and outline from the Wednesday afternoon special session.CITE AS:?LISI?Estate Planning Newsletter #2271?(January 15, 2015) at 2015 Leimberg Information Services, Inc. (LISI).?Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.? ................
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