[Federal Register Volume 63, Number 241 (Wednesday, December 16, 1998)]
[Proposed Rules]
[Pages 69248-69251]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33125]
[[Page 69248]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 20
[REG-114663-97]
RIN 1545-AV45
Marital Deduction; Valuation of Interest Passing to Surviving
Spouse
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
effect of certain administration expenses on the valuation of property
which qualifies for the estate tax marital or charitable deduction. The
proposed regulations define estate transmission expenses and estate
management expenses and provide that estate transmission expenses, but
not estate management expenses, reduce the value of property for
marital and charitable deduction purposes. This document also provides
notice of a public hearing on these proposed regulations.
DATES: Written comments must be received by February 16, 1999. Outlines
of topics to be discussed at the public hearing scheduled for April 21,
1999, at 10 a.m., must be received by March 31, 1999.
ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-114663-97), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
114663-97), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the Internet by selecting the ``Tax Regs''
option on the IRS Home Page, or by submitting comments directly to the
IRS Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in Room 2615, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Deborah Ryan (202) 622-3090; concerning submissions of comments, the
hearing, and/or to be placed on the building access list to attend the
hearing, LaNita Van Dyke (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
On March 18, 1997, the Supreme Court of the United States issued
its decision in Commissioner v. Estate of Hubert, 520 U.S. 93 (1997)
(1997-32 I.R.B. 8), in which it considered the proper interpretation of
Sec. 20.2056(b)-4(a) of the Estate Tax Regulations. On November 24,
1997, the IRS issued Notice 97-63 (1997-47 I.R.B. 6), requesting
comments on alternatives for amending Sec. 20.2056(b)-4(a) in light of
the Supreme Court's Estate of Hubert decision. Section 2056(b)(4)
provides that, in determining the value of an interest in property
which passes from the decedent to the surviving spouse for purposes of
the marital deduction, account must be taken of any encumbrance on the
property or any obligation imposed on the surviving spouse by the
decedent with respect to the property. Section 20.2056(b)-4(a) of the
Estate Tax Regulations amplifies this rule by providing that account
must be taken of the effect of any material limitations on the
surviving spouse's right to the income from the property. The
regulation provides, for example, that there may be a material
limitation on the surviving spouse's right to the income from marital
trust property where the income is used to pay administration expenses
during the period between the date of the decedent's death and the date
of distribution of the assets to the trustee.
The facts in Estate of Hubert are similar to a common fact pattern
wherein the decedent's will provides for a residuary bequest to a
marital trust which qualifies for the marital deduction and also
provides that estate administration expenses are to be paid from the
residuary estate. Further, the will (or state law) permits the executor
to use the income generated by the residuary estate (otherwise payable
to the marital trust) to pay administration expenses, and the executor
does so. The issue before the Supreme Court in Estate of Hubert was
whether the executor's use of the income to pay estate administration
expenses was a material limitation on the surviving spouse's right to
the income which would reduce the marital deduction under
Sec. 20.2056(b)-4(a).
The issue in Estate of Hubert also involved the estate tax
charitable deduction, and the proposed regulations relate to the
valuation of property for both marital and charitable deduction
purposes. However, for simplicity and clarity, this discussion focuses
on the provisions of the estate tax marital deduction.
In Estate of Hubert, the Commissioner argued that the payment of
administration expenses from income is, per se, a material limitation
on the surviving spouse's right to income for purposes of
Sec. 20.2056(b)-4(a), and, therefore, the value of the marital bequest
should be reduced dollar for dollar by the amount of income used to pay
administration expenses. The Court agreed that the value of the marital
bequest should be reduced if the use of income to pay administration
expenses is a material limitation on the spouse's right to income. The
Court found, however, that the regulation does not define material
limitation and that the Commissioner had not argued that the use of
income in this case was a material limitation. Thus, the Court held for
the taxpayer.
In Notice 97-63 (November 24, 1997), the IRS requested comments on
possible approaches for proposed regulations in light of the Estate of
Hubert decision. Notice 97-63 suggested three alternative approaches
for determining when the use of income to pay administration expenses
constitutes a material limitation on the surviving spouse's right to
income. One approach distinguished between administration expenses that
are properly charged to principal and those that are properly charged
to income and provided that there is a material limitation on the
surviving spouse's right to income if income is used to pay an estate
administration expense that is properly charged to principal. A second
approach provided a de minimis safe harbor amount of income that may be
used to pay administration expenses without constituting a material
limitation on the surviving's spouse's right to income. A third
approach provided that any charge to income for the payment of
administration expenses constitutes a material limitation on the
spouse's right to income.
Notice 97-63 also asked for comments on whether the test for
materiality should be based on a comparison of the relative amounts of
the income and the expenses charged to the income; whether materiality
should be based on projections as of the date of death rather than on
the facts that develop afterwards; and whether present value principles
should be applied.
In response to Notice 97-63, several commentators suggested that
local law should be determinative of whether an expense is a proper
charge to income or principal. If the testamentary document directs the
executor to charge expenses to income, and the charge is allowed under
applicable local law, then the charge to income should not be treated
[[Page 69249]]
as a material limitation on the spouse's right to income.
This approach was not adopted because statutory provisions relating
to income and principal may vary from state to state, and this would
result in disparate treatment of estates that are similarly situated
but governed by different state law. Moreover, in states that have
adopted some form of the Uniform Principal and Income Act, the
definitions of principal and income, and the allocation of expenses
thereto, can be specified in the will or trust instrument and given the
effect of state law. Thus, simply following state law was thought to be
too malleable to protect the policies underlying the marital and
charitable deductions.
Several commentators agreed with the de minimis safe harbor
approach whereby a certain amount of income could be used to pay
administration expenses without materially limiting the surviving
spouse's right to the income. Under this approach, the safe harbor
amount is determined in two steps: first, the present value of the
surviving spouse's income interest for life is determined using
actuarial principles and, second, the resulting amount is multiplied by
a percentage, for example, 5 percent.
The proposed regulations do not adopt this approach. Although a de
minimis safe harbor approach would provide a bright line test for
determining materiality in the context of the marital deduction, it is
unclear how this approach would apply for charitable deduction purposes
because there is no measuring life for valuing the income interest.
One commentator suggested that, consistent with the plurality
opinion in Estate of Hubert, the test for materiality should be
quantitative, based upon a comparison between the amount of income
charged with administration expenses and the total income earned during
administration. The commentator, however, considered the requirement
that projected income and expenses be presently valued to be
impractical, complex, and uncertain. Another commentator considered a
quantitative test to be impractical. A third commentator suggested that
a quantitative test would require a factual determination in each case
and, as a result, the period of estate administration would be greatly
prolonged.
Because these tests for materiality appear to be complex and
difficult to administer, the proposed regulations adopt neither a
quantitative test nor a test based on present values of projected
income and expenses.
Many commentators opposed an approach in which every charge to
income is a material limitation on the spouse's right to income. Two
commentators contended that adoption of this approach would effectively
overrule the result in Estate of Hubert.
One commentator suggested the approach adopted in the proposed
regulations, a description of which follows, and two commentators
suggested similar approaches.
Explanation of Provisions
After carefully considering the comments, the Treasury and the
Internal Revenue Service have determined that a test based on what
constitutes a material limitation would prove too complex and would be
administratively burdensome. For this reason, the proposed regulations
eliminate the concept of materiality and, instead, establish rules
providing that only administration expenses of a certain character
which are charged to the marital property will reduce the value of the
property for marital deduction purposes. It is anticipated that these
rules will have uniform application to all estates, will be simple to
administer, and will reflect the economic realities of estate
administration. These same rules will also apply for purposes of the
estate tax charitable deduction.
Under the proposed regulations, a reduction is made to the date of
death value of the property interest which passes from the decedent to
the surviving spouse (or to a charitable organization described in
section 2055) for the dollar amount of any estate transmission expenses
incurred during the administration of the decedent's estate and charged
to the property interest. Such a reduction is proper because these
expenses would not have been incurred but for the decedent's death. No
reduction is made for estate management expenses incurred with respect
to the property and charged to the property because these expenses
would have been incurred even if the death had not occurred. However, a
reduction is made for estate management expenses charged to the marital
property interest passing to the surviving spouse if the expenses were
incurred in connection with property passing to someone other than the
surviving spouse and a person other than the surviving spouse is
entitled to the income from that property. Estate transmission expenses
are all estate administration expenses that are not estate management
expenses and include expenses incurred in collecting estate assets,
paying debts, estate and inheritance taxes, and distributing the
decedent's property. Estate management expenses are expenses incurred
in connection with the investment of the estate assets and with their
preservation and maintenance during the period of administration.
Proposed Effective Date
These regulations are proposed to be effective for estates of
decedents dying on or after the date the regulations are published in
the Federal Register as final regulations.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and, because
the regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for April 21, 1999, beginning
at 10 a.m. in Room 2615 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th Street entrance, located
between Constitution and Pennsylvania Avenues, NW. In addition, all
visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond
the immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the building
access list to attend the hearing, see the FOR FURTHER INFORMATION
CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit written
comments and an
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outline of the topics to be discussed and the time to be devoted to
each topic (signed original and eight (8) copies) by March 31, 1999. A
period of 10 minutes will be allotted to each person for making
comments. An agenda showing the scheduling of the speakers will be
prepared after the deadline for receiving outlines has passed. Copies
of the agenda will be available free of charge at the hearing.
Drafting Information
The principal author of these proposed regulations is Deborah Ryan,
Office of the Assistant Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 20
Estate taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 20 is proposed to be amended as follows:
PART 20--ESTATE TAX; ESTATES OF DECEDENTS DYING AFTER AUGUST 16,
1954
Paragraph 1. The authority citation for part 20 continues to read
in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In Sec. 20.2055-1, paragraph (d)(6) is added to read as
follows:
Sec. 20.2055-1 Deduction for transfers for public, charitable, and
religious uses; in general.
* * * * *
(d) * * *
(6) For the effect of certain administration expenses on the
valuation of transfers for charitable deduction purposes, see
Sec. 20.2056(b)-4(e). The rules provided in that section apply for
purposes of both the marital and charitable deductions. This paragraph
(d)(6) is effective for estates of decedents dying on or after the date
these regulations are published in the Federal Register as final
regulations.
Par. 3. Section 20.2056(b)-4 is amended by:
1. Removing the last two sentences of paragraph (a).
2. Adding paragraph (e).
The addition reads as follows:
Sec. 20.2056(b)-4 Marital deduction; valuation of interest passing to
surviving spouse.
* * * * *
(e) Effect of certain administration expenses--(1) Estate
transmission expenses. For purposes of determining the marital
deduction, the value of any deductible property interest which passed
from the decedent to the surviving spouse shall be reduced by the
amount of estate transmission expenses incurred during the
administration of the decedent's estate and paid from the principal of
the property interest or the income produced by the property interest.
For purposes of this subsection, the term estate transmission expenses
means all estate administration expenses that are not estate management
expenses (as defined in paragraph (e)(2) of this section). Estate
transmission expenses include expenses incurred in the collection of
the decedent's assets, the payment of the decedent's debts and death
taxes, and the distribution of the decedent's property to those who are
entitled to receive it. Examples of these expenses include executor
commissions and attorney fees (except to the extent specifically
related to investment, preservation, and maintenance of the assets),
probate fees, expenses incurred in construction proceedings and
defending against will contests, and appraisal fees.
(2) Estate management expenses--(i) In general. For purposes of
determining the marital deduction, the value of any deductible property
interest which passed from the decedent to the surviving spouse shall
not be reduced by the amount of estate management expenses incurred in
connection with the property interest during the administration of the
decedent's estate and paid from the principal of the property interest
or the income produced by the property interest. For marital deduction
purposes, the value of any deductible property interest which passed
from the decedent to the surviving spouse shall be reduced by the
amount of any estate management expenses incurred in connection with
property that passed to a beneficiary other than the surviving spouse
if a beneficiary other than the surviving spouse is entitled to the
income from the property and the expenses are charged to the deductible
property interest which passed to the surviving spouse. For purposes of
this subsection, the term estate management expenses means expenses
incurred in connection with the investment of the estate assets and
with their preservation and maintenance during the period of
administration. Examples of these expenses include investment advisory
fees, stock brokerage commissions, custodial fees, and interest.
(ii) Special rule where estate management expenses are deducted on
the federal estate tax return. For purposes of determining the marital
deduction, the value of the deductible property interest which passed
from the decedent to the surviving spouse is not increased as a result
of the decrease in the federal estate tax liability attributable to any
estate management expenses that are deducted as expenses of
administration under section 2053 on the federal estate tax return.
(3) Examples. The following examples illustrate the application of
this paragraph (e). In each example, the decedent, who dies after 2006,
makes a bequest of shares of ABC Corporation stock to the decedent's
child. The bequest provides that the child is to receive the income
from the shares from the date of the decedent's death. The value of the
bequeathed shares, on the decedent's date of death, is $3,000,000. The
residue of the estate is bequeathed to a trust which satisfies the
requirements of section 2056(b)(7) as qualified terminable interest
property. The value of the residue, on the decedent's date of death,
before the payment of administration expenses and estate taxes, is
$6,000,000. Under applicable local law, the executor has the discretion
to pay administration expenses from the income or principal of the
residuary estate. All estate taxes are to be paid from the residue. The
state estate tax equals the state tax credit available under section
2011. The examples are as follows:
Example 1. During the period of administration, the estate
incurs estate transmission expenses of $400,000, which the executor
charges to the residue. For purposes of determining the marital
deduction, the value of the residue is reduced by the federal and
state estate taxes and by the estate transmission expenses. If the
transmission expenses are deducted on the federal estate tax return,
the marital deduction is $3,500,000 ($6,000,000 minus $400,000
transmission expenses and minus $2,100,000 federal and state estate
taxes). If the transmission expenses are deducted on the estate's
income tax return rather than on the estate tax return, the marital
deduction is $3,011,111 ($6,000,000 minus $400,000 transmission
expenses and minus $2,588,889 federal and state estate taxes).
Example 2. During the period of administration, the estate
incurs estate management expenses of $400,000 in connection with the
residue property passing for the benefit of the spouse. The executor
charges these management expenses to the residue. For purposes of
determining the marital deduction, the value of the residue is
reduced by the federal and state estate taxes but is not reduced by
the estate management expenses. If the management expenses are
deducted on the estate's income tax return, the marital deduction is
$3,900,000 ($6,000,000 minus $2,100,000 federal and state estate
taxes). If the management expenses are deducted on the estate tax
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return rather than on the estate's income tax return, the marital
deduction remains $3,900,000, even though the federal and state
estate taxes now total only $1,880,000. The marital deduction is not
increased by the reduction in estate taxes attributable to deducting
the management expenses on the federal estate tax return.
Example 3. During the period of administration, the estate
incurs estate management expenses of $400,000 in connection with the
bequest of ABC Corporation stock to the decedent's child. The
executor charges these management expenses to the residue. For
purposes of determining the marital deduction, the value of the
residue is reduced by the federal and state estate taxes and by the
management expenses. The management expenses reduce the value of the
residue because they are charged to the property passing to the
spouse even though they were incurred with respect to stock passing
to the child and the spouse is not entitled to the income from the
stock during the period of estate administration. If the management
expenses are deducted on the estate's income tax return, the marital
deduction is $3,011,111 ($6,000,000 minus $400,000 management
expenses and minus $2,588,889 federal and state estate taxes). If
the management expenses are deducted on the estate tax return rather
than on the estate's income tax return, the marital deduction
remains $3,011,111, even though the federal and state estate taxes
now total only $2,368,889. The marital deduction is not increased by
the reduction in estate taxes attributable to deducting the
management expenses on the federal estate tax return.
(4) Effective date. This paragraph (e) applies to estates of
decedents dying on or after the date these regulations are published as
final regulations in the Federal Register.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-33125 Filed 12-15-98; 8:45 am]
BILLING CODE 4830-01-P