Originally published on Forbes.com.
The Chief Counsel has issued advice (CCA 201622032) that may discourage taxpayers from settling on estate tax valuation. Or maybe it is just a cautionary tale for advisors to better coordinate income and estate tax planning. It is about basis and the statute of limitations. Try to keep calm.
About Basis
Since we have an income tax, not a gross receipts tax, we only recognize a net number when we sell something. We subtract from the proceeds of the sale our “basis” for the item that we sold. In the simplest situation the basis will be what we paid for the item, but of course there are exceptions. I wrote up a handy little reference to basis and came up with six other possibilities besides cost basis. I can’t promise you I did not miss something. Here is the type of basis that was being considered in the CCA. To quote myself:
Inherited Property Basis – The basis of property acquired by inheritance is the fair market value at the date of death (or six months later if alternate valuation was elected). Unless of course the person you inherited it from died in 2010. Don’t get me started.
A Stipulated Decision
The situation that the Chief Counsel was dealing with was the aftermath of a settlement that an estate had entered into with the IRS. Some asset (Let’s call it “the thing”) had been included in the estate at a value that the IRS thought was too low. After duking it out for some period of time, apparently several years, the IRS and the taxpayer came to a meeting of the minds. They signed a stipulated decision document which was entered by the Tax Court. It seems pretty likely that some additional estate tax was paid. Presumably more than the taxpayer wanted to pay, but less than the IRS was hoping for.
A Silver Lining
The taxpayers thought that the effect of the extra estate tax might be mitigated somewhat. That’s because, during the time they were duking it out with the IRS, the estate had sold “the thing” (or maybe part of it). The gain had been reported on 1041. My inference is that “the thing” was sold for more than it had been valued at by the estate. That probably had not helped with the valuation argument.
Regardless, the estate could now amend its Form 1041 claiming a higher basis, which means a lower gain and accordingly a lower income tax.
These Things Take A Long Time
There was a catch, though. The statute of limitations had expired on the income tax return. These things do take a long time. In the Estate of Sarah Holliday, which I covered, the Tax Court decision was delivered on March 17, 2016. Ms. Holliday had died in 2009. So the statute had run on maybe three of the 1041s that the estate had filed by then.
Mitigation
There is a rule that mitigates the statute of limitations in situations like this. And this is where the CCA gets ugly. They admit that the relevant rules apply to situations kind of like this, but not exactly like this. The essence of the argument is that a stipulated decision is not the same as a ruling by the Tax Court.
In order for the mitigation provisions to apply, the first requirement is that there be a determination, as defined by IRC section 1313(a). The decision of the Tax Court in the estate tax (Form 706) case is what the estate is relying on as the determination. While this may appear to meet the definition of section 1313(a)(1), it is our position that it does not.
Because the value of the asset was determined through settlement negotiations that did not result in agreement on the merits, but instead resulted in a general agreement on the appropriateness of settlement in order to resolve the case, the mitigation provisions do not apply and the refund claim should be denied as untimely.
The Big Balance Sheet In The Sky
I’ve reached out to my legal brain trust on this, but nobody has gotten back to me. So you will have to be content with a CPA perspective. Many accountants will find this CCA very disturbing. That’s because deep in our guts, we have this sense that everything should balance. You should be able to trace numbers from one place to another. They should reconcile. Many of us are quite passionate about it, particularly the ]elderly who spent their youth toiling over thirteen column sheets of green paper with pencils and adding machines and then referencing the finally balanced results .
The number for basis on the 1041 and the number for value on the 706 are defined the same, so, darn it, they should be the same number. But you know what. Until the 2015 Surface Transportation Act, that was not the law. There was not even a requirement that the executor tell the recipient of the asset what the fair market value of the assets was.
I discovered this early in my career. I was checking a Form 1040 which had several securities sold with zero basis. That struck me as altogether implausible. When I inquired about it I was told that the executor, a different person from the taxpayer, had forgotten to report those securities on the Form 706. So it was only fair that we take zero basis. Only that was not the law. That was the big balance sheet in the sky.
I was rather delighted that I had saved some money for the taxpayer we were working for. The preparer, who sometimes seemed like he was an undercover IRS agent, was outraged. I think he hated me after that, although it was hard to tell, because he rarely spoke to anybody.
Practical Observations
Over the years, I have often noted that coordination of income tax, estate tax and probate accounting tends to be less than optimal. I would think that there should have been at least a protective refund claim filed on the Form 1041 while the fight over the Form 706 was ongoing. Also, if you are going to fight about valuation on the Form 706, if it is at all possible from a practical viewpoint, wait to sell the asset until after the fight is over. That might seem like the tail wagging the dog, but if you have a taxable estate, the estate tax is a pretty heavy tail.
I might take this CCA up again if I get more commentary.
Other Coverage
CharitablePlanning.com has something on this, but it seems to be behind a pay wall and you know what a big spender I am. Same deal with Tax Notes.
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