Some Tax Elections and Actions for Consideration by the Personal Representative

Langdon Owen
May 13, 2009 — 2,076 views  
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The Personal Representative of a decedent's estate (including the trustee of a revocable trust where the trustee serves the same function) should consider some planning moves, including making or not making certain available tax elections.  In addition to the matters described in this outline, the personal representative occasionally may be requested by beneficiaries to cooperate in their separate planning strategies; this can be done so long as the personal representative is careful to meet applicable fiduciary duties.  Naturally, such duties are always of concern, as well, where a choice is in the discretion of the personal representative alone.  Some choices will be relatively easy, others will be quite the opposite.  (Who has tax reporting and paying responsibilities, what those responsibilities entail, and what the consequences may be from a failure to meet those responsibilities, are dealt with in a separate outline entitled Selected Creditor and Tax Issues for Estates, Especially Insolvent and Financially Stressed Estates.)

1. Some Tax Elections.  Such elections and actions may, in appropriate cases and where necessary qualification conditions are met, include the following major matters.

   (a) Returns Required.  Filing necessary tax returns is required, including decedent's final federal and state income tax return through date of death (Form 1040, Utah Form TC 40), the estate's federal and state income tax returns from date of death forward (Form 1041, Utah Form TC 41), decedent's gift tax returns for gifts prior to death (Form 709) (Regs. § 25.6019-1(g)), the estate's estate tax return (Form 706), and any state estate or inheritance tax return (Utah Form TC 44R).  In some cases, there may be other returns required for payroll tax (e.g., for a sole proprietor), certain excise taxes, etc.
   (b) Final Income Tax Return.  On the final income tax return, the choices include whether or not:
      (i)    to file the return as a joint return with the spouse;
      (ii)    to report savings bond value increases (i.e., accrued interest) on the final return or on the estate's fiduciary income tax return;
      (iii)    to deduct medical expenses (if paid by the estate with a year of death) where the gross estate is below the estate tax threshold (IRC §§ 2053(a), 213(c)); or
      (iv)    to request prompt assessment and discharge of liability (IRC §§ 6501(d) and 6905) (note: the IRC § 6905 request for discharge only applies to a court-appointed personal representative, not to a trustee or other person serving a similar function).

   (c) Gift Tax.  The choices for gift tax returns include whether or not:
      (i)    to use the split-gift provisions for the use of annual exclusions (IRC § 2513) gift-splitting for gift-tax purposes will also be effective for generation-skipping tax purposes (IRC § 2652(a)(2)); or
      (ii)    to request prompt assessment and (for a court-appointed personal representative) discharge of liability for gift and generation skipping tax (IRC §§ 6501, 6905, 2661).

   (d) Fiduciary Income Tax.  The choices for the fiduciary income tax return include:
      (i)    electing the estate's taxable year (the calendar year or a fiscal year (Regs. § 1.441-1T(b)(2)) (often the year ending with the month before the month in which the decedent died is chosen);
      (ii)    whether or not to elect to treat a trust as part of the estate (IRC § 645) for the first two years after death where no estate tax return is due, or until six months after final estate tax determination, whichever applies;
      (iii)    whether or not to elect to treat in-kind distributions as carrying with them distributable net income (IRC § 643(e)); this affects the beneficiary's basis, the taxability of various beneficiaries, the timing of gain and whether the tax is at ordinary rates or capital gain rates (without the election, no gain is taxable to the estate, and later gain recognized by the beneficiary on sale will likely be taxed at capital gain rates) (see also 2a below relating to trapping distributions);
      (iv)    whether to treat a distribution made within 65 days after end of estate's fiscal year as if it were made on the last day of year (IRC § 663(b)).

   (e) Estate Tax.  The choices for the estate tax return include those described below:
      (i)    whether to use date of death value (IRC § 2031) or to make the all- or-none election to use the alternate six months after date of death value (IRC § 2032(c));
      (ii)    whether to use the conservation easement exclusion (IRC § 2031(c)) which applies to up to 40% of the property's value, capped at an exclusion limitation;
      (iii)    whether to elect special use valuation as to some or all real property used in a family farm or business, subject to a valuation reduction cap (IRC § 2032A);
      (iv)    whether to elect QTIP marital deduction treatment, where applicable (IRC § 2056(b)(7)); note that the requirements for the election must be met when the election is made, rather than at date of death (Clayton Est. v. Comm'r, 976 F.2d 1486 (5th Cir. 1992); Regs. § 20.2056(b)-7(d)(3)(ii));
      (v)    whether, if the QTIP election is made, to also make the reverse QTIP election for generation-skipping tax purposes (IRC § 2652(a)(3));
      (vi)    whether to take certain deductions as estate tax or as income tax deductions, such as administration expenses (IRC § 2053), losses (IRC § 2054) (see IRC § 642(g) on the waiver needed from the personal representative if the deductions are to be used on the fiduciary income tax return);
      (vii)    whether to use the special rules on stock redemptions to pay estate tax and administrative expenses, thus avoiding dividend treatment (IRC § 303); although this section is not elective, qualification may be obtained by planning ahead;
      (viii)    how to allocate any generation-skipping tax exemption (see IRC § 2632);
      (ix)    whether to elect to use tax-deferral provisions, such as IRC § 6166 (for closely held farms and businesses, providing a five-year deferral and 10-year payment period with low interest (2%) for a period of time) or IRC 6161(a) (12-month extension for reasonable cause), IRC 6161(a)(2) (up to 10-year extension for undue hardship), or IRC § 6163 (until six months after a remainder interest becomes possessory);
      (x)    whether to request early determination of tax and discharge of personal liability of the personal representative (IRC § 2204).

2. Some Other Planning Options.  There are other tax planning options available to the personal representative in certain circumstances, such as:

   (a) Trapping Distributions.  Whether or not to make what are called trapping distributions in funding trusts.  A distribution from the estate to a trust of distributable net income (usually along with a distribution of assets) is a distribution of income from the estate, but for state law trust accounting is treated as the receipt of principal not distributable to the trust's income beneficiaries.  The trust ends up paying the tax on the distributable net income it received.  With the trust rates reaching the highest marginal rates as quickly as they do now, this is seldom a good idea any more, so it may be well in many cases to avoid trapping distributions. Also, the Tax Court has treated beneficiaries as receive a share of the "income" at least where the beneficiary would otherwise receive tax-exempt trust income, applying a character of income preservation and a no-specific tracing of items policy.  Van Buren v. Comm'r, 89 T.C. 1101 (1987).

   (b) Disclaimers.  Qualified disclaimers may be made by beneficiaries in order to have assets wind up with appropriate persons.  IRC § 2518; UCA § 75-2-801.  The estate itself can also make a qualified disclaimer.  Such a disclaimer by the estate may be useful in the event of closely timed deaths or where the estate is insolvent.  See, generally, In re Stanford, 369 B.R. 609 (10th Cir. BAP (Wyoming) 2007) (disclaimer may not be a fraudulent transfer under bankruptcy law).  A fiduciary should also be able to disclaim a fiduciary power, for example, where the power would create inconvenient tax consequences for the fiduciary or someone else.  The requirements are:
      (i)    the disclaimer must be written and adequately describe the property or interest disclaimed;
      (ii)    it must be received by the property transferor or title holder or representative within nine months after the transfer creating the disclaimed interest (e.g., the death of the decedent) or after the disclaimant reaches age 21 (note, double or more disclaimers are possible, but all need to be completed in the nine-month period); a probate estate filing would be appropriate for a disclaimer of an interest in the estate or for a disclaimer by the estate itself (see UCA § 75-2-801(2)(a));
      (iii)    the disclaimant must not accept the property or any benefit from it; and
      (iv)    the property must pass without direction from the disclaimant to the transferor's spouse or someone other than the disclaimant (i.e., the spouse may disclaim for the spouse's own benefit, for example, the disclaimed property may pass from a marital trust to a family trust.

   (c) Partnership Basis Election.  The IRC § 754 election relating to partnership interests should be obtained through the partnership-taxed organization in order to obtain a step-up in the "inside" basis of the underlying assets of the organization. (Please see separate outline.)

   (d) S-corporations.  Steps may be needed to maintain the S-election for small business corporations, such as disclaiming or distributing stock or dividing trusts into qualified trusts which may be shareholders.  Only certain limited kinds of trusts may be S-corporation shareholders.  IRC § 1361.

   (e) Retirement Plans.  The personal representative may need to take steps, such as making distribution elections or disclaimers, to minimize the income tax which may arise from qualified retirement plans or IRAs.  

Langdon Owen


Langdon T. Owen, Jr. is a member of the law firm of Parsons Kinghorn Harris, p.c. in Salt Lake City, Utah. Mr. Owen is a transactional lawyer who practices in the areas of estate and tax planning, business and commercial transactions involving both corporate and partnership taxed enterprises (including tax, employment, and benefit issues relating to such transactions), loans and creditors' workouts, pension and profit sharing plans, health care law, probate, and real estate.