IRS issues rules for new estate basis reporting

Hands and calculatorUpdate on March 31, 2016: The IRS has provided additional transition relief, postponing the initial reporting deadline from March 31, 2016, to July 31, 2016. So estates that filed an estate tax return after July 31, 2015, must now file new Form 8971 by the later of July 31 or 30 days after Form 706 was filed.

The IRS has issued proposed and temporary regulations implementing new legislation that requires estates to begin reporting the value of assets by March 31. The requirements were enacted as part of a 2015 highway spending bill (P.L. 114-41).  The legislation added Sections 1014(f) and 6035. Section 1014(f) generally requires heirs to use the estate tax value of assets received from an estate as their income tax basis for that asset, while Section 6035 requires executors to report the estate tax value of assets to the heirs and to the IRS.

Most estates filing estate tax returns after July 31, 2015, are subject to the new rules.   Affected estates are now generally required to report the estate tax value of assets on information returns that must be furnished to the IRS and beneficiaries within 30 days of filing the estate tax return (Form 706).

The IRS issued two notices (Notice 2015-57 and Notice 2016-19) delaying the reporting requirements so it could create forms and guidance. The IRS has since released Form 8971 and its instructions along with proposed regulations that are incorporated into temporary regulations.

The temporary regulations do not provide any additional transition relief for now. They instead affirm that the deferral of the reporting requirement ends March 31, 2016. Most estates that filed an estate tax return after July 31, 2015, must file new Form 8971 by the later of March 31 or 30 days after Form 706 was filed.

Background Taxpayers generally enjoy a step-up in basis on inherited assets so that their income tax basis in an asset equals the asset’s fair market value on the date of death. The IRS has long been concerned that it is “whipsawed” when estates argue for a low valuation for estate tax purposes only for an heir to argue for a higher valuation for income tax basis purposes.

The new legislation generally requires a consistent value for both purposes by limiting basis to the estate value for assets reported on an estate tax return. It penalizes taxpayers who claim a basis higher than this amount, but the bulk of the compliance burden actually falls on estates, which must now perform new reporting on the value of assets.

Who is required to report The reporting is generally required only for estates that must file an estate tax return. So it applies to estates that must file Form 706 because their assets exceed the lifetime estate and gift tax exemption (currently $5.45 million), not estates filing returns filed simply to make portability or other elections. Beneficiaries may also be required to report if they are required to file Form 706 because the executor is unable to make a complete estate tax return.

When reporting is required After the transition relief expires on March 31, 2016, covered estates will be required to furnish Form 8971 to the IRS and statements to all beneficiaries by the earlier of 30 days from when Form 706 is filed or 30 days from the due date of the return including extensions. If a required estate tax return is never filed, the basis of all assets that were required to be reported will be zero for the heirs.

If an executor cannot find a beneficiary, the executor must describe the efforts to locate the beneficiary when filing Form 8971 and file a supplemental return once the beneficiary is located.

If the valuation of an asset is adjusted after the return is filed, the executor must provide a supplemental statement to the IRS and beneficiaries within 30 days of the adjustment. Thus, for example, if, upon audit, the IRS adjusts the estate tax value of a covered asset (and the estate agrees to the new value), the new value must be reported to the IRS and the appropriate heir.

What is reported The reporting is required of all property that increases the federal estate liability. This generally means that if any estate tax liability is incurred, all of the property in the gross estate is subject to reporting, with several specific exceptions:
  • Property qualifying for the charitable or marital deduction is not reported because it does not increase the federal estate tax liability.
  • Cash and income in respect of a decedent is excluded.
  • Reporting is not required for household and personal effects valued at $3,000 or less under Treas. Reg. Sec. 20.2031-6(b).

If, by the time Form 8971 is due, the executor does not know which heir may receive a particular asset, the estate must report the value of the asset to all the heirs who might receive it.

If an executor discovers that an asset was improperly omitted from a required estate tax return, the estate may report the asset on a supplemental estate tax return (assuming the statute of limitations is still open). If the statute has expired, the omitted property is assigned a basis of zero for the heir.

Subsequent transfers If an heir transfers an inherited asset that was subject to reporting to a related transferee, the original recipient is required to file a supplemental statement documenting the new ownership with the IRS and furnish it to the transferee. If the estate tax statute of limitations is still open, the original transferee must also notify the estate of the identity of the new owner of the property. (If the estate subsequently adjusts the value of the asset, it must notify the new owner of the change in basis.)

Next steps Most executors who have filed an estate tax return since August of 2015 must file new Form 8971 by the end of March 2016. Several stakeholders have already asked the IRS for additional transition relief, but unless and until any is granted, taxpayers should be preparing to comply.

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