March 23 Update: The IRS has announced in Notice 2016-27 that the first forms will now be due on June 30, 2016, and not March 31, 2016 as originally provided in Notice 2016-19 that accompanied these proposed regulations.

Coming up on the second extended due date for the first filings of Form 8971, the “consistent basis reporting” form required to be filed by estates that filed a Form 706 that showed tax due after July 31, 2015 that would have been due on or before March 31, 2016, the IRS has released proposed regulations (REG-127923-15) and a temporary regulation (TD 9757) that provide guidance for the initial filings, as well as other filings due before the publication of final regulations.

In the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 Congress added new IRC §6035. The provision imposed two reporting mandates on estates in order to prevent estates from paying estate tax based on one claimed value and then later having heirs claim a higher basis in the asset for income tax reporting, arguing that the estate’s value was in error or, more likely, just betting that the IRS would never actually discover the discrepancy.

The reporting requirement is imposed by IRC §6035(a)(1) which provides:

(1) In general

The executor of any estate required to file a return under section 6018(a) shall furnish to the Secretary and to each person acquiring any interest in property included in the decedent’s gross estate for Federal estate tax purposes a statement identifying the value of each interest in such property as reported on such return and such other information with respect to such interest as the Secretary may prescribe.

Thus the estate must furnish a statement to the IRS identifying the reported value of each asset that was included in the gross estate, as well as giving that information to each person who acquired the interests and identifying these individuals in the report to the IRS. Form 8971 and the related Schedule A to Form 8971 are used to report these items.

The due date for both filing this form to the IRS and for providing the information to beneficiaries is outlined in IRC§6035(b)(1) which provides:

(3) Time for furnishing statement

(A) In general. Each statement required to be furnished under paragraph (1) or (2) shall be furnished at such time as the Secretary may prescribe, but in no case at a time later than the earlier of—

(i) the date which is 30 days after the date on which the return under section 6018 was required to be filed (including extensions, if any), or

(ii) the date which is 30 days after the date such return is filed.

(B) Adjustments

In any case in which there is an adjustment to the information required to be included on a statement filed under paragraph (1) or (2) after such statement has been filed, a supplemental statement under such paragraph shall be filed not later than the date which is 30 days after such adjustment is made.

While this law technically applied for and returns filed after the date of enactment (July 31, 2015), the IRS twice delayed the due dates for the initial returns to be filed, eventually stating that the due date for any return would be the later of the date under the statute (the 30 day rule) or March 31, 2016.

The second delay, that pushed initial filings from February 29, 2016 to March 31, 2016, was to allow the IRS time to publish regulations giving guidance for filings. These regulations, released by the IRS late in the afternoon of March 2, 2016, provide that guidance.

The temporary regulation (Reg. §1.6035-2T) simply puts in the form of a regulation the due date relief for initial filings provided for in Notice 2016-19, and thus is the far less interesting of the two documents—it will be moot less than a month after its publication.

The proposed regulations found in REG-127923-15 are far more significant. While issued solely as proposed regulations, the regulations provide that taxpayers may rely upon these regulations before the date of publication of the final rules. As a practical matter, since they represent the only real guidance the IRS has issued on the topic, professionals preparing Form 8971 will need to consult these rules, as will taxpayers preparing income tax returns for taxpayers who have received covered property from an estate.

The proposed regulations are issued under three separate IRC Sections. Proposed Regulation §1.1014-10 deals with reporting of consistent basis by taxpayers who receive covered property from an estate, Proposed Regulations §§1.6035-1 and 2 deal with the reporting requirements imposed on covered estates (including determining which estates are required to file the form), while Proposed Regulation 1.6662-8 deals with the accuracy related penalty to be imposed on taxpayers who report a basis higher than that reported by the estate on Form 8971 on their income tax returns.

Information Reporting Regulations (Proposed Regulation §1.6035-1)

Proposed Regulations §§1.6035-1 and 2 are most logical starting point for looking at these rules, since the existence of the requirement for the estate to file these information reporting forms is what triggers the consistent reporting requirement at the beneficiary level.

One major issue that lead to concerns was whether estates that may not have technically been required to file a return but nevertheless did so (for instance, to make a portability election under IRC §2010 to allow use of the unused exemption on the surviving spouse’s estate) were required to file this form. The final regulations provide specific exceptions, including an exception for those estates filing solely to make a portability election. Proposed Reg. §1.6035-1(a)(2) provides:

(2) Exception. Paragraph (a)(1) of this section applies only to the executor of an estate required by section 6018 to file an estate tax return. Accordingly, notwithstanding § 20.2010-2(a)(1), the executor does not have to file or furnish the Information Return or Statement(s) referred to in paragraph (a)(1) of this section if the executor is not required by section 6018 to file an estate tax return for the estate, even if the executor does file such a return for other purposes, e.g., to make a generation-skipping transfer tax exemption allocation or election, to make the portability election under section 2010(c)(5), or to make a protective filing to avoid any penalty if an asset value is later determined to cause a return to be required or otherwise.

The actual reporting is governed by Proposed Reg. §1.6035‑1(a)(1) which provides that the values to be reported are the “final values” as defined in Proposed Reg. §1.1014‑10(c).

Generally final value is defined by Proposed Reg. §1.1014‑10(c)(1), providing for a “checklist-style” list of final values:

(c) Final value –

(1) Finality of estate tax value. The final value of property reported on a return filed pursuant to section 6018 is its value as finally determined for purposes of the tax imposed by chapter 11. That value is --

(i) The value reported on a return filed with the Internal Revenue Service (IRS) pursuant to section 6018 once the period of limitations for assessment of the tax under chapter 11 has expired without that value having been timely adjusted or contested by the IRS,

(ii) If paragraph (c)(1)(i) of this section does not apply, the value determined or specified by the IRS once the periods of limitations for assessment and for claim for refund or credit of the tax under chapter 11 have expired without that value having been timely contested;

(iii) paragraphs (c)(1)(i) and (ii) of this section do not apply, the value determined in an agreement, once that agreement is final and binding on all parties; or

(iv) paragraphs (c)(1)(i), (ii), and (iii) of this section do not apply, the value determined by a court, once the court's determination is final.

Obviously, in the normal situation none of those tests will be met when the Form 8971 is required to be filed. The presumption will be that the first rule will apply—the Form 706 values, if not challenged by the IRS, will become the final values. But if those are changed, the estate will be required to supply new values. Until such time as there is a change, though, the beneficiary will be required to respect the originally reported numbers on the Form 8971. [Proposed Reg. §1.1014‑10(c)(2)]

The property for which reporting is required, as well as property exempted from reporting, is found in Proposed Reg. §1.6035‑1(b)(1) which provides:

(b) Property for which reporting is required –

(1) In general. The property to which the reporting requirement under paragraph (a)(1) of this section applies is all property reported or required to be reported on a return under section 6018. This includes, for example, any other property whose basis is determined in whole or in part by reference to that property (for example as the result of a like-kind exchange or involuntary conversion). Of the property of a deceased nonresident non-citizen, this includes only the property that is subject to U.S. estate tax; similarly, this includes only the decedent's one-half of community property. Nevertheless, the following property is excepted from the reporting requirements --

(i) Cash (other than a coin collection or other coins or bills with numismatic value);

(ii) Income in respect of a decedent (as defined in section 691);

(iii) Tangible personal property for which an appraisal is not required under § 20.2031-6(b); and

(iv) sold, exchanged, or otherwise disposed of (and therefore not distributed to a beneficiary) by the estate in a transaction in which capital gain or loss is recognized.

The property described in (iii) is generally the household and personal effects reported on the estate tax return that don’t trigger the special rule for “articles having a marked artistic or intrinsic value” that require an appraisal.

This list clears up a number of questions raised by practitioners regarding this form, eliminating assets for which there is little or no benefit to be realized by the government in having them listed on Schedule A—after all, the government has no real problem dealing with basis of cash received and assets that have been sold by the estate also present no threat (as well as no obvious way to report those assets on the form).

Proposed Reg. §1.6035-1(c) has information regarding identifying and reporting to beneficiaries.

Proposed Reg. §1.6035‑1(c)(1) contains the following language dealing with certain beneficiaries who are not directly receiving property:

For purposes of this provision, the beneficiary of a life estate is the life tenant, the beneficiary of a remainder interest is the remainderman(men) identified as if the life tenant were to die immediately after the decedent, and the beneficiary of a contingent interest is a beneficiary, unless the contingency has occurred prior to the filing of the Form 8971.

One important item to note is that an executor may have a duty to supplement if the contingency is eventually resolved so that the contingent beneficiary does not receive assets from the estate. As the proposed regulation continues:

If the contingency subsequently negates the inheritance of the beneficiary, the executor must do supplemental reporting in accordance with paragraph (e) of this section to report the change of beneficiary.

Generally Proposed Reg. §1.6035‑1(c)(2) provides that if the beneficiary is not an individual, the estate reports to the appropriate representative of the entity (for a trust or estate) or the entity itself (for a business entity).

However if that entity later transfers the assets to another party in a transaction in which there is carryover of basis to the receiving party, supplemental reporting by the executor is required.

If, by the time the reporting is required under this rule, the executor has not determined what property will be transferred to each beneficiary, Proposed Reg. §1.6035-1(c)(3) provides the following:

(3) Beneficiary not determined. If, by the due date provided in paragraph (d) of this section, the executor has not determined what property will be used to satisfy the interest of each beneficiary, the executor must report on the Statement for each such beneficiary all of the property that the executor could use to satisfy that beneficiary's interest. Once the exact distribution has been determined, the executor may, but is not required to, file and furnish a supplemental Information Return and Statement as provided in paragraph (e)(3) of this section.

Effectively, the beneficiary is given a list of everything he/she might receive, even though the beneficiary will not receive all of it. This time the executor is not required to file a supplemental return when the issue is resolved, though the executor may do so.

The regulations also address the situation where the executor has been unable to locate the beneficiary by the date for filing the form, as well as dealing with the case where the executor is never able to locate that beneficiary and eventually distributes that property to a different beneficiary. In that case Proposed Reg. §1.6035‑1(c)(4) provides:

(4) Beneficiary not located. An executor must use reasonable due diligence to identify and locate all beneficiaries. If the executor is unable to locate a beneficiary by the due date of the Information Return provided in paragraph (d) of this section, the executor must so report on that Information Return and explain the efforts the executor has taken to locate the beneficiary and to satisfy the obligation of reasonable due diligence. If the executor subsequently locates the beneficiary, the executor must furnish the beneficiary with that beneficiary's Statement and file a supplemental Information Return with the IRS within 30 days of locating the beneficiary. A copy of the beneficiary's Statement must be attached to the supplemental Information Return. If the executor is unable to locate a beneficiary and distributes the property to a different beneficiary who was not identified in the Information Return as the recipient of that property, the executor must file a supplemental Information Return with the IRS and furnish the substitute beneficiary with that beneficiary's Statement within 30 days after the property is distributed. See paragraph (e)(1) of this section. A copy of the substitute beneficiary's Statement must be attached to the supplemental Information Return.

The duty to supplement is going to create a number of concerns with executors. The proposed regulations provide a general requirement to supplement, as well a list of cases where no supplemental report is required.

The general rule for providing supplemental reporting is found in Proposed Reg. §1.6035‑1(e) which provides:

(e) Duty to supplement. –

(1) In general. In the event of any adjustment to the information required to be reported on the Information Return or any Statement as described in paragraph (e)(2) of this section, the executor must file a supplemental Information Return with the IRS including all supplemental Statements and furnish a corresponding supplemental Statement to each affected beneficiary by the due date described in paragraph (e)(4) of this section.

(2) Adjustments requiring supplement. Except as provided in paragraph (e)(3) of this section, an adjustment to which the duty to supplement applies is any change to the information required to be reported on the Information Return or Statement that causes the information as reported to be incorrect or incomplete. Such changes include, for example, the discovery of property that should have been (but was not) reported on an estate tax return described in section 6018, a change in the value of property pursuant to an examination or litigation, or a change in the identity of the beneficiary to whom the property is to be distributed (pursuant to a death, disclaimer, bankruptcy, or otherwise). Such changes also include the executor's disposition of property acquired from the decedent or as a result of the death of the decedent in a transaction in which the basis of new property received by the estate is determined in whole or in part by reference to the property acquired from the decedent or as a result of the death of the decedent (for example as the result of a like-kind exchange or involuntary conversion). Changes requiring supplement pursuant to this paragraph (e)(2) are not inconsequential errors or omissions within the meaning of § 301.6722-1(b) of this chapter.

Those items exempted from the supplemental reporting mandate are found at Proposed Reg. §1.6035‑1(e)(3)—and the list is not terribly long:

(3) Adjustments not requiring supplement –

(i) In general. A supplemental Information Return and Statement may but they are not required to be filed or furnished --

(A) To correct an inconsequential error or omission within the meaning of § 301.6722-1(b) of this chapter, or

(B) To specify the actual distribution of property previously reported as being available to satisfy the interests of multiple beneficiaries in the situation described in paragraph (c)(3) of this section.

The second exception is one we already noted (when the executor finally distributes property to the beneficiary where the basis of assets available had been disclosed), so the inconsequential error is the one we’ll look at in more detail.

This exception references existing Reg. §301.6722-1(b) which deals with a failure to furnish correct payee statements. There is a limited exception found there that provides generally that:

(1) In general. An inconsequential error or omission is not considered a failure to include correct information. For purposes of this paragraph (b), the term “inconsequential error or omission” means any failure that cannot reasonably be expected to prevent or hinder the payee from timely receiving correct information and reporting it on his or her return or from otherwise putting the statement to its intended use. [Reg. §301.6722‑1(b)(1)]

However the regulation goes on to note that some errors can never be an inconsequential error or omission. Reg. §301.6722-1(b)(2) provides:

(2) Errors or omissions that are never inconsequential. Errors or omissions relating to the following are never inconsequential:

(i) A dollar amount,

(ii) The significant items in the address of a payee, which is the address provided by the payee to the filer,

(iii) The appropriate form for the information provided (i.e., whether or not the form is an acceptable substitute for an official form of the Internal Revenue Service), and

(iv) The manner of furnishing a statement required undersections 6042(c), 6044(e), 6049(e), and 6050N(b). The Internal Revenue Service may, by administrative pronouncement, specify other types of errors or omissions that are never inconsequential.

The rules also can impact the recipient of the property if that person gifts or otherwise transfers the property to another related party where the recipient’s basis is determined in whole or in part by the transferor’s basis. Proposed Reg. §1.6035‑1(f) deals with this situation.

The rule begins by providing generally:

If all or any portion of property that previously was reported or is required to be reported on an Information Return (and thus on the recipient's Statement or supplemental Statement) is distributed or transferred (by gift or otherwise) by the recipient in a transaction in which a related transferee determines its basis, in whole or in part, by reference to the recipient/transferor's basis, the recipient/transferor must, no later than 30 days after the date of the distribution or other transfer, file with the IRS a supplemental Statement and furnish a copy of the same supplemental Statement to the transferee. The requirement to file a supplemental Statement and furnish a copy to the transferee similarly applies to the distribution or transfer of any other property the basis of which is determined in whole or in part by reference to that property (for example as the result of a like-kind exchange or involuntary conversion). [Proposed Reg. §1.6035‑1(f)]

Thus, if a child receives property from a parent’s estate and then, 10 years later, gifts that property to his/her son, the child will need to file a Form 8971 to supplement their parent’s original Form 8971, now reporting the property is in the hands of the grandchild of the original decedent.

If the original recipient transfers the property before the estate is required to file a Form 8971, the original recipient still must file this form but has a more limited reporting responsibility. As the proposed regulation continues:

In the case of a supplemental Statement filed by the recipient/transferor before the recipient/transferor's receipt of the Statement described in paragraph (a) of this section, the supplemental Statement will report the change in the ownership of the property and need not provide the value information that would otherwise be required on the supplemental Statement. [Proposed Reg. §1.6035‑1(f)]

In some cases the basis of the property will have changed since the property was distributed to the beneficiary (such as if the property has been subject to depreciation, etc.). In that case the transferor still must report the original basis received from the estate, but can provide information on the adjustment as noted below:

If the transferor chooses to include on the supplemental Statement provided to the transferee information regarding any changes to the basis of the reported property as described in § 1.1014-10(a)(2) that occurred during the transferor's ownership of the property, that basis adjustment information (which is not part of the requirement under section 6035) must be shown separately from the final value required to be reported on that Statement.

In a case where the transfer occurs before a “final value” is set, the following provisions apply to push future notifications back on the executor who now will send future reports to the new holder of the property:

In the event the transfer occurs before the final value is determined within the meaning of proposed § 1.1014-10(c), the transferor must provide the executor with a copy of the supplemental Statement filed with the IRS and furnished to the transferee in order to notify the executor of the change in ownership of the property. When the executor subsequently files any Return and issues any Statement required by paragraphs (a) or (e) of this section, the executor must provide the Statement (or supplemental Statement) to the new transferee instead of to the transferor.

Consistent Basis Reporting by Beneficiary Rules (Proposed Reg. §1.1014-10)

The other key issue involves the basis reporting by the beneficiary. Generally a beneficiary who receives property from an estate takes over a fair market value under IRC §1014 that is either tied to the date of death or, if applicable, the alternate valuation date. Congress has now added a consistency requirement to reporting, backing it up with an accuracy related penalty should a beneficiary report a higher basis than was claimed by the estate.

The general “consistent basis” rule is described in Proposed Reg. §1.1014‑10(a)(1):

(a) Consistent basis requirement -- (1) In general. The taxpayer's initial basis in property described in paragraph (b) of this section may not exceed the property's final value within the meaning of paragraph (c) of this section. This requirement applies whenever the taxpayer reports a taxable event with respect to the property to the Internal Revenue Service (IRS) (for example depreciation or amortization) and continues to apply until the property is sold, exchanged, or otherwise disposed of in one or more transactions that result in the recognition of gain or loss for Federal income tax purposes, regardless of whether the owner on the date of the sale, exchange, or disposition is the same taxpayer who acquired the property from the decedent or as a result of the decedent's death.

Property that is subject to this rule is generally described in Proposed Reg. §1.1014‑10(b)(1) which provides:

(1) In general. Property subject to the consistency requirement in paragraph (a)(1) of this section is any property that is includable in the decedent's gross estate under section 2031,any property subject to tax under section 2106, and any other property the basis of which is determined in whole or in part by reference to the basis of such property (for example as the result of a like-kind exchange or involuntary conversion) that generates a tax liability under chapter 11 of subtitle B of the Code (chapter 11) on the decedent's estate in excess of allowable credits, except the credit for prepayment of tax under chapter 11.

However, there is a broad exclusion for property for which a change in the reported value on the Form 706 would not have changed the estate tax. This exclusion is described in Proposed Reg. §1.1014‑10(b)(2) as follows:

(2) Exclusions. For purposes of paragraph (b)(1) of this section, property that qualifies for an estate tax charitable or marital deduction under section 2055, 2056, or 2056A, respectively, does not generate a tax liability under chapter 11 and therefore is excluded from the property subject to the consistency requirement in paragraph (a)(1) of this section. For purposes of paragraph (b)(1) of this section, tangible personal property for which an appraisal is not required under § 20.2031-6(b) is deemed not to generate a tax liability under chapter 11 and therefore also is excluded from the property subject to the consistency requirement in paragraph (a)(1) of this section.

Also, an exception is provided for a true “no tax” estate even if there is a requirement that the estate file an estate tax return. Proposed Reg. §1.1014‑10(b)(3) provides:

(3) Application. For purposes of paragraph (b)(1) of this section, if a liability under chapter 11 is payable after the application of all available credits (other than a credit for a prepayment of estate tax), the consistency requirement in paragraph (a)(1) of this section applies to the entire gross estate (other than property excluded under paragraph (b)(2) of this section) because all such property contributes to the liability under chapter 11 and therefore is treated as generating a tax liability under chapter 11. If, however, after the application of all such available credits, no tax under chapter 11 is payable, the entire gross estate is excluded from the application of the consistency requirement.

The proposed regulations also address the issue where the basis of an asset is modified by operation of the IRC. Some commentators had expressed concern that the provision as written suggested that no such basis adjustments would be allowed for inherited property subject to the consistency requirement.

In Proposed Reg. §1.1014‑10(a)(2) the IRS allows for such changes, providing:

(2) Subsequent basis adjustments. The final value within the meaning of paragraph (c) of this section is the taxpayer's initial basis in the property. In computing at any time after the decedent's date of death the taxpayer's basis in property acquired from the decedent or as a result of the decedent's death, the taxpayer's initial basis in that property may be adjusted due to the operation of other provisions of the Internal Revenue Code (Code) governing basis without violating paragraph (a)(1) of this section. Such adjustments may include, for example, gain recognized by the decedent's estate or trust upon distribution of the property, post-death capital improvements and depreciation, and post-death adjustments to the basis of an interest in a partnership or S corporation. The existence of recourse or non-recourse debt secured by property at the time of the decedent's death does not affect the property's basis, whether the gross value of the property and the outstanding debt are reported separately on the estate tax return or the net value of the property is reported. Therefore, post-death payments on such debt do not result in an adjustment to the property's basis.

What about the issue where property was either omitted from the estate tax return or discovered after the return was filed. The IRS has determined the consistency rules still apply—and if taxpayers and executors aren’t careful, that basis will become zero.

Proposed Reg. §1.1014-10(c)(3) provides for dealing with this property.

If the error is discovered and an original or supplemental Form 706 is filed with the IRS before the expiration of the statute of limitations on the assessment of estate tax against the estate, then the standard supplemental or original reporting rules apply. Thus, the beneficiary’s basis will be tied to the basis reported by the estate. [Proposed Reg. §1.1014-10(c)(3)(i)(A)]

If the error is discovered after the statute of limitations period has expired on assessing estate tax against the estate, then the result is that the basis of this unreported property becomes zero in the hands of the beneficiary. [Proposed Reg. §1.1014-10(c)(3)(i)(A)] Note that this opens up a number of issues regarding the IRS challenging long after the fact whether, for instance, property held in a family limited partnership should have been brought back into the estate under the retained life estate provisions of IRC §2036.

If not estate tax return was filed, but the newly discovered property would have required a return to be filed the basis of the property will be set to zero as an “incentive” file the potentially very late Form 706. Proposed Reg. §1.1014‑10(c)(3)(ii) provides:

(ii) No return under section 6018 filed. If no return described in section 6018 has been filed, and if the inclusion in the decedent's gross estate of the after-discovered or omitted property would have generated or increased the estate's tax liability under chapter 11, the final value, for purposes of section 1014(f), of all property described in paragraph (b) of this section is zero until the final value is determined under paragraph (c)(1) or (2) of this section. Specifically, if the executor files a return pursuant to section 6018(a) or (b) that includes this property or the IRS determines a value for the property, the final value of all property described in paragraph (b) of this section includible in the gross estate then is determined under paragraph (c)(1) or (2) of this section.