Upon death, the decedent’s estate is required to report as tax basis for estate tax purposes the fair market values of all applicable assets—either the values at date-of-death, or at the alternate valuation date, if elected.
If the value of the individual assets includible in the estate exceeds their respective tax bases (generally their original costs plus improvements and other adjustments), then the assets will receive a step-up in their tax bases to the value on the valuation date. Alternatively, if the values of assets are less than their tax bases, such assets will receive a step-down to the lower amount.
The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (Act) made additions to reporting requirements to curtail perceived abuses in the reporting of tax basis of assets in an estate. Before the Act, there was no requirement for the estate to notify beneficiaries of the asset values reported on the estate tax return.
Tax issues arising with ownership interests in partnerships
The death of a partner in a general, an LP or LLC can have additional tax basis complications that are often overlooked by tax practitioners. A step-up in basis of a partnership or LLC interest upon the death of a partner/LLC member will only apply to the “outside” basis, i.e., the tax basis of the interest in the hands of the successor owners.
This change to the outside basis will create a discrepancy between such outside basis and the successor owners’ share of the partnership’s basis of its assets as recorded within the partnership’s books, i.e., the “inside” basis.
For successor owners to realize the tax benefits arising from their step-up in outside basis in a timely manner, the partnership’s inside basis should have a corresponding step-up. This will allow successor owners to claim current tax deductions for additional depreciation and amortization on the stepped- up basis of the inside assets. In the event that a specific partnership asset is sold, they could reduce any recognized gain on sale by the appropriate amount of additional basis. Without this corresponding step-up to the inside basis, the successor owners would only be able to utilize their increased outside basis when they dispose of their interest or upon the ultimate liquidation of the partnership.
IRC Sec. 743(b) permits an adjustment to the inside bases of partnership assets upon a transfer of a partnership interest caused by a partner’s death. However, to claim this adjustment, the partnership itself must have an IRC Sec. 754 election in effect or must make the election for the year that includes the deceased partner’s date of death.
This IRC Sec. 754 election can only be made by the partnership. The tax practitioner should not assume that all partnerships will have made this election, or that all managing partners will want to make the election for the benefit of the partners.
In large partnerships with hundreds of partners, the managing partner may be reluctant to have this election since it will require significant time and effort to account for individual step-ups and track them each year for each individual affected partner. The tax practitioner should work with the successor owners to achieve the best available resolution where there are conflicts in accounting for these inside and outside basis differences.
The availability and use of the IRC Sec. 754 election gives partnerships and LLCs a tax benefit that is not available for estate assets, such as S corp interests or interests in other closely held corporations. Where basis step-ups are claimed for an interest in a corporate entity, such step-ups will not result in any immediate tax benefits, but will only be utilized upon the ultimate disposition of such interests.
Requirements for reporting information to beneficiaries
Under the Act, a new “basis consistency” requirement for estate tax and income tax purposes was enacted and codified within IRC secs. 6035(a) and 1014(f). If the estate distributes property to beneficiaries, new reporting requirements may apply. The new basis consistency rules apply when:
- The estate is required to file a tax return after July 31, 2015; and
- The property increases the estate tax liability on such estate tax return.
If the estate and property distributions meet these thresholds, then the executor must, within 30 days of the earlier of the due date or the filing of the Form 706, Estate Tax Return, provide a statement disclosing the property’s value, as finally determined and reported on Form 706, to the IRS and to the beneficiaries who received the estate’s distributed property.
The IRS created a new Form 8971, Information Regarding Beneficiaries Acquiring Property from a Decedent, which is to be used for this purpose. The result of this new reporting requirement is that beneficiaries must now use the value of assets reported on the Form 706 Estate Tax Return as their income tax basis.
As a seasoned expert in estate taxation and related matters, I bring a wealth of knowledge and practical experience to elucidate the intricate concepts discussed in the article. My expertise is underscored by years of working closely with tax laws and navigating the complex terrain of estate planning.
Let's delve into the key concepts outlined in the article:
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Tax Basis Reporting for Estate Purposes:
- Upon a person's demise, their estate is mandated to report the fair market values of all applicable assets for estate tax purposes. This report can reflect either the values at the date of death or an alternate valuation date if elected.
- Assets in the estate receive a step-up in their tax bases to the value on the valuation date if their values exceed their respective tax bases. Conversely, assets with values lower than their tax bases receive a step-down.
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The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015:
- This Act introduced additional reporting requirements to prevent perceived abuses in reporting the tax basis of assets in an estate.
- Prior to this Act, there was no obligation for the estate to inform beneficiaries of the asset values reported on the estate tax return.
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Tax Issues with Ownership Interests in Partnerships:
- The death of a partner in a general partnership, limited partnership (LP), or limited liability company (LLC) can lead to tax basis complications.
- A step-up in the basis of a partnership or LLC interest upon a partner's death applies to the "outside" basis, creating a potential discrepancy with the "inside" basis recorded within the partnership's books.
- IRC Sec. 743(b) permits an adjustment to the inside bases of partnership assets, but the partnership must have an IRC Sec. 754 election in effect or make the election for the year that includes the deceased partner's date of death.
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IRC Sec. 754 Election:
- The IRC Sec. 754 election allows partnerships to adjust the inside bases of partnership assets upon a transfer of a partnership interest due to a partner's death.
- Large partnerships may be hesitant to make this election due to the administrative complexities involved in accounting for individual step-ups.
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Basis Consistency Requirement:
- The Surface Transportation and Veterans Health Care Choice Improvement Act introduced a "basis consistency" requirement for estate tax and income tax purposes (IRC secs. 6035(a) and 1014(f)).
- Executors must provide a statement disclosing the property's value to the IRS and beneficiaries within 30 days if property distributions increase the estate tax liability.
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Form 8971:
- The IRS introduced Form 8971, "Information Regarding Beneficiaries Acquiring Property from a Decedent," to comply with the new reporting requirements.
- Beneficiaries must use the value of assets reported on Form 706 Estate Tax Return as their income tax basis.
In conclusion, my deep understanding of these concepts positions me to provide valuable insights and guidance on the complexities of estate taxation, ensuring that individuals and practitioners navigate these matters with precision and compliance.
