Tax Law Update - February 2011Tax Law Update - February 2011

Estate's beneficiaries aren't entitled to an estate's unused loss carryovers — In Chief Counsel Advice 201047021 (Nov. 26, 2010), the beneficiaries of an estate weren't entitled to deduct unused carryover losses attributable to the insolvent estate.

The residue under the taxpayer's will passed to the taxpayer's spouse, and then, upon the spouse's death, in equal shares to the descendants of four individuals. At the time of the taxpayer's death, the taxpayer had unpaid income taxes relating to joint returns filed with the taxpayer's spouse. The administrator of the taxpayer's estate entered into a settlement agreement with the United States, which was approved by a local court and consented to by the administrator of the estate of the taxpayer's spouse (the spouse died after the taxpayer but before the settlement had been reached).

The settlement originally provided that the taxpayer's estate was deemed insolvent and that the United States was to receive all proceeds of the estate, less administrative expenses. But, a subsequent consent agreement reduced the judgment to a fixed amount.

The estate incurred a capital loss carryover under Internal Revenue Code Section 1212. IRC Section 642(h)(1) states that if on the termination of an estate or trust, the estate or trust has a net operating loss carryover under IRC Section 172 or a capital loss carryover under IRC Section 1212, then such carryover or such excess shall be allowed as a deduction in accordance with regulations prescribed by the Secretary to the beneficiaries succeeding to the property of the estate or trust. The Treasury regulations provide that the phrase “beneficiaries succeeding to the property of the estate or trust” means “those beneficiaries upon termination of the estate or trust who bear the burden of any loss for which a carryover is allowed, or any excess of deduction over gross income for which a deduction is allowed, under IRC Section 642(h).” This is further defined, in the case of a testate estate, to mean the residuary beneficiaries (including a residuary trust) and not specific legatees or devisees, pecuniary legatees or other non-residuary beneficiaries.

The ruling held that the individual beneficiaries of the estate were no longer considered beneficiaries after the estate entered into the settlement agreement to transfer all the proceeds of the estate to the United States because, as a legal matter, the individual beneficiaries could no longer receive anything. Any losses incurred by the estate were to the detriment of the United States rather than the individual beneficiaries. Therefore, the estate's beneficiaries shouldn't be entitled to any of the estate's unused loss carryovers under IRC Section 642(h)(1).

District court holds IRS action to recover estate taxes is timely — In United States v. Kulhanek et al., 2010-2 USTC (Dec. 8, 2010), the U.S. District Court of the Western District of Pennsylvania denied the decedent's daughters' motion to dismiss the Internal Revenue Service's action to collect unpaid estate taxes.

The estate of Robert Q. Roth held various assets including a retirement account, insurance policy and stock in a small business. Robert's daughters received distributions from the retirement account and the insurance policy. The estate retained the interests in the small business and made an election to defer payment of estate taxes under IRC Section 6166 over 10 years. Seven years after filing the estate tax return, the estate sold the stock.

The United States filed an action to collect unpaid estate taxes from Robert's daughters, as transferees of Robert's estate, under IRC Section 6324(a)(2), which provides that, “If the estate tax imposed by chapter 11 is not paid when due, then the … transferee … or beneficiary, who receives … property included in the gross estate … to the extent of the value, at the time of the decedent's death, of such property, shall be personally liable for such tax.”

Robert's daughters mistook the U.S. action as an action to collect estate taxes pursuant to the special lien provision of IRC Section 6324(a)(1). IRC Section 6324(a)(1) provides that if the estate tax isn't paid in full, a lien is imposed on the gross estate of a decedent. The lien has an absolute duration of 10 years (measured from the date of death), without exception. Robert's daughters argued that the U.S. action was time-barred because it was started more than 10 years after the date of Robert's death. However, the court held that the U.S. action under IRC Section 6324(a)(2) against the beneficiaries of the estate wasn't subject to the absolute 10-year rule applicable to the special lien, but was instead subject to the general statute of limitations rules under IRC Sections 6501 and 6502.

The 10-year statute of limitations period under IRC Section 6502(a)(1) begins to run upon “assessment of the tax.” However, the period is suspended by the election to defer estate tax payments under IRC Section 6166. Therefore, since the estate's Section 6166 election preceded the assessment of the tax, the statute of limitations didn't begin to run until the estate sold its stock in the small business (that is, when the extension period under IRC Section 6166 ended). Since the United States filed its complaint within 10 years of the date of sale, its action was timely.

2010-2011 Priority Guidance Plan is published — The Office of Tax Policy and the IRS released the Priority Guidance Plan for 2010-2011 (the Plan). The Plan includes the following as priority items for taxes relating to gifts, estates and trusts: