1. Example 1: Exclusion of Political or Certain Charitable Transfers

2. Example 2: Current Year Taxable Gifts

3. Example 3: Direct Payments Exception - Medical and Tuition

4. Example 4: Direct Payments Exception - Relationship to Donee, and Qualifying Medical Care

5. Example 5: Bargain Sale

In connection with an upcoming advanced planning course I will be hosting (stay tuned for further announcements and bookmark December 3 or 10 if interested), along with a repeat of what we hope will become an annual foundations in estate planning course (bookmark November 10 or 19 if interested), I realized that the bridge between these two courses requires transfer tax knowledge. As such, I am working on content series to map out principles of gift tax, estate tax, and GST tax through examples and explanations. This is the first installment of the gift tax content series.

In these examples, our hypothetical family will be Joe Smith who is married to Jane Smith. They have two children, Chad Smith and Claire Jones (nee Smith). They also have three grandchildren - Grant Smith (Chad’s child), and Gregory Jones and Glinda Jones (Claire’s children). Unless otherwise stated, all Smith family members and descendants are U.S. citizens. Also, unless otherwise stated, there are no other gifts to take into account for prior years.

Subscribe now

Example 1: Exclusion of Political or Certain Charitable Transfers

At the end of 2026, Joe has a cash windfall. He wants to support his local Chamber of Commerce, and also make a donation to a political action committee. What are the gift tax implications?

If we look to IRC Section 2501(a)(1), we see that the gift tax is a tax imposed on transfers of property by “gift” for the calendar year. However, it does not apply to all transfers. Some transfers are not considered “gifts” and are excluded from the application of paragraph (1) of such Code Section.

According to IRC Section 2501(a)(6), one such exception is a transfer to a tax-exempt organization described in IRC Sections 501(c)(4), (c)(5), or (c)(6). Chambers of commerce are listed under IRC Section 501(c)(6), so long as they are “not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.” Accordingly, this transfer would not be a “transfer of property by gift,” and this would not be subject to gift tax regardless of amount. We will later discuss the requirements to file a gift tax return, but even if a gift tax return were filed this transfer would not need to be reported on the return.

The same holds true for the transfer to a political action committee, as IRC Section 2501(a)(4) also exempts from “gifts” any transfer to a political organization described in IRC Section 527(e)(1).

The core lesson here is that the transfers that are not treated as “gifts” in IRC Section 2501(a) form one type of “exclusion” from gift tax that never need to be reported on a gift tax return. We will next explore another form of exclusion that nonetheless needs to be first reported on a gift tax return before subtracting the excluded amounts.

Example 2: Current Year Taxable Gifts

Joe Smith gives Chad and Claire each $10,000 in cash on December 31, 2026. Assume they have immediate access to the cash on that date, regardless of form of transfer. What are the gift tax implications?

Again, IRC Section 2501(a)(1) imposes a tax on “transfers of property by gift” for any calendar year. Since December 31 falls in the 2026 calendar year, and since none of the exceptions from the definition of “gifts” applies to this transfer to Joe’s children, the $20,000 in total gifts will be treated as gifts occurring in 2026. For these purposes, cash is treated as property (although other tax concepts may distinguish cash from property, such as the principles of C corporations or nonrecognition transactions for income tax purposes).

Under Treas. Reg. Section 25.2501-1(a)(1), this tax applies to the “value” of transfers of property. All gifts for a calendar year are taken into account, resulting in an aggregate figure informally defined throughout the Code provisions on gift tax as being the “total amount of gifts” for the calendar year after taking into account certain exclusions to be discussed. Since cash is property, its value is inherent here. But this tax only applies to the extent the aggregate value of the calendar-year transfers of property by gift exceeds the following:

• Exclusions under IRC Section 2503;

• Deductions under IRC Section 2522 (for qualifying transfers to charity); and

• Deductions under IRC Section 2523 (for qualifying transfers to a spouse).

While the regulation speaks to the defined term “calendar period,” which includes quarters for years 1971-1981, you will practically always be dealing with calendar years as noted in the plain statutory language of IRC Section 2501(a)(1). We will see this term revisited in IRC Section 2502(a) below.

This tax is computed as provided in IRC Section 2502. If tax is owed, IRC Section 2502(c) states that the donor - i.e., the person making the gift - will pay the tax. This is further clarified by Treas. Reg. Section 25.2511-2(a), which states that the gift tax is an “excise” upon the donor’s act of making a transfer by gift. Determination of whether a tax is owed starts with IRC Section 2001(c), which creates a common rate schedule shared between the gift tax and the estate tax. As we will later learn, gift and estate taxes are cumulative - meaning that the rate brackets in this table apply on a cumulative basis. Under current law, these brackets are not adjusted for inflation - although the gift tax basic exclusion amount, which we will later learn about, is adjusted for inflation. The rates for these brackets range from 18% to 40%.

(Image credit: Cornell Law School Legal Information Institute; https://www.law.cornell.edu/uscode/text/26/2001)

If we look to the second bracket, before taking into account IRC Sections 2503, 2522, and 2523 above, we see that gifts valued at $20,000 or less are subject to a tax of (1) $1,800, plus (2) 20% of the excess over the first $10,000. In this case, that would seem to give us a tax of $3,800. We will circle back to why this is not accurate soon, but for the time being we might also look at these brackets and wonder if we can just make gifts in the lower brackets every year to minimize our gift tax.

Unfortunately, the answer is no. If you look to IRC Section 2502(a), you see that the gift tax is actually the excess of (1) the “tentative” gift tax for “taxable gifts” in both the current calendar year and all prior calendar periods, minus (2) the “tentative” gift tax for all prior calendar periods. Again as a reminder calendar periods will generally include all calendar years (going back to 1932), but includes calendar quarters for years 1971-1981.

The net effect of this cumulative calculation is that your “tentative” tax on all prior calendar years’ gifts is always recalculated for the year in which the most recent “taxable gifts” are being made. We will visit the term “taxable gifts” soon, but for now this recalculation always includes the gift tax rate table in effect for the year of the most recent taxable gifts. It is for this year that you will calculate the gift tax and, if necessary, file a gift tax return to the extent required under IRC Section 6019. As we will later discuss, even if you are not required to file a gift tax return it still may be a good idea to do so. Note that the gift tax rates and rate table have remained unchanged for many years, but if there were to be a legislative change to these rates then the new rates would apply. A subsequent example will explore this concept further, but for now we see this dynamic play out on Part II, lines 1-6 of Form 709:

(Image credit: IRS Form 709 (Rev. 2025); https://www.irs.gov/pub/irs-pdf/f709.pdf)

Our next stop is IRC Section 2503(a), which defines “taxable gifts” to be the total gifts for the calendar year minus the deductions in Subchapter C (of Subtitle B of the Internal Revenue Code of 1986). The deductions listed in this Subchapter are the aforementioned IRC Sections 2522 and 2523 (charitable and marital, respectively). However, these deductions can only be taken to the extent that the gifts that generate the deductions are “included in the amount of gifts against which such deductions are applied” under IRC Section 2524. This is further defined in Treas. Reg. Section 25.2524-1 as being the total amount of gifts for the calendar period. While this had implications during the calendar quarter system and prior limitations on the marital deduction itself, this now largely serves as a matching principle that prevents deductions and exclusions from exceeding the total gifts so that there can never be a negative gift amount.

That brings us back to IRC Section 2503. Recall that the gift tax applies to transfers of property that are treated as gifts for any given calendar year, by value. The figure we are concerned with is the “total amount of gifts” for the calendar year, which conceptually ends up being net of exclusions of certain transfers of property during the year from the definition of “gifts.” The first such exclusion is found in IRC Section 2503(b), which describes what is commonly called the annual exclusion against gift tax.

This annual exclusion is determined on a per-donee basis. While the identity of any one or more donees does not need to be ascertainable in order for the gift tax to apply (see Treas. Reg. Section 25.2511-2(a)), this identity is required in order to receive the annual exclusion. While we will later illustrate this concept, it is important to note for now that the annual exclusion does not apply to a “future interest” in property under IRC Section 2503(b)(1).

This Code Section goes on to state that the annual exclusion will consist of the first $10,000 of gifts to a person in any calendar year. This $10,000 figure is adjusted for inflation under IRC Section 2501(b)(2). While the calculation is done on an annual basis, there is only an increase in the annual exclusion to the extent that the inflation-adjusted amount (after rounding down) is expressed in an increment of $1,000. For 2026, this per-donee figure is $19,000. But if in a given year the inflation-adjusted figure was $19,530, for example, it would not be rounded up to $20,000 since the flush language of IRC Section 2501(b)(2) only allows rounding down to the last whole increment of $1,000. Thus, until this inflation-adjusted figure equals or exceeds $20,000 on a raw (pre-rounding) basis there will be no increase to of the annual exclusion to $20,000.

This takes us back to our example above. Joe Smith can exclude the first $19,000 of gifts to each of his family members. Since he only made gifts to two family members - Chad and Claire - we only count their annual exclusions. And since Joe’s $10,000 gifts to each of them did not exceed $19,000 this means his gifts for the year would not include these transfers. The fact that these are direct cash transfers means that they would not be future interests.

However, if Joe had gifted all $20,000 to Chad instead of dividing up the gift then Joe would only have had one annual exclusion of $19,000 (with respect to Chad, as a donee) available. In such a case, the first $19,000 would not have counted in gifts for the year but the excess $1,000 would.

But unlike the amounts excluded from the raw definition of “gifts” in IRC Section 2501(a), the gifts that are excluded by the annual exclusion cannot be omitted from a gift tax return if one is required to be filed. That being said, assuming these are Joe’s only gifts for the year, IRC Section 6019(1) provides that no gift tax return needs to be filed if no gifts for the year exceed the annual exclusion under IRC Section 2501(b). Thus, Joe does not need to file a gift tax return here.

Example 3: Direct Payments Exception - Medical and Tuition

During 2026, Chad approaches Joe and expresses a desire to enroll his son, Grant, in private school. Joe is supportive and generously offers to assist with the cost. What are the gift tax implications of Joe’s assistance?

With any gift of this sort, since the gift tax is based on the value of the transfer we would usually want to know the amount of assistance out of the gate. We would also want to know whether this assistance came directly from Joe or, instead, if it came from a 529 plan or even a separate trust previously established for the benefit of Grant.

Before getting into the amount of direct assistance from Joe, however, it is important to note the exclusion set forth in IRC Section 2503(e). This Code Section generally provides, under 2503(e)(1), that a “qualified transfer” will not be included in total gifts for the year. Code Section 2503(e)(2) goes on to define a qualified transfer as a direct payment, on behalf of any person, as of tuition or medical expenses. This direct payment requirement means that the tuition or medical expenses must be paid directly to the source.

So, if Joe were to pay tuition directly to the private school (assuming such school is described in IRC Section 170(b)(1)(A)(ii), which generally means the school must be run as a legit school with faculty, regularly-attending pupils, and a regular curriculum), the amount paid would not be included in Joe’s gifts regardless of the amount. If, however, he were to give the funds to Chad or Grant with the intent that they would use it to pay Grant’s tuition then this exception would not apply (because it is no longer a direct payment for the purpose of paying tuition).

Notably, as with the transfers excluded from the definition of gifts in IRC Section 2501(a), the transfers excluded under IRC Section 2503(e) do not have to be reported on a gift tax return. And while we are not covering generation-skipping transfer (GST) tax in this content series, IRC Section 2641(c)(3)(B) generally provides that transfers described in IRC Section 2503(e) will also be excluded from GST tax. Otherwise, the GST tax would usually be a factor where there are transfers to a grandchild as would be the case from Joe to Grant.

We would also need to know whether the payment was purely tuition. Under Treas. Reg. Section 25.2503-6(b)(2), this exclusion does not extend to expenses that are not direct tuition such as “books, supplies, dormitory fees, board, or other similar expenses… .”

Example 4: Direct Payments Exception - Relationship to Donee, and Qualifying Medical Care

Joe Smith is scrolling social media and comes across some videos from a Michael Jackson impersonator. Joe is impressed with the impersonator’s dance skills and moves. Joe also notices that the impersonator is taking up a GoFundMe to get plastic surgery to more accurately match the late Michael Jackson’s appearance. Joe wants to support this budding star but, conscious of the gift tax exclusion under IRC Section 2503(e), sends a DM to the impersonator inquiring as to whether he can help pay the cosmetic surgeon directly. The impersonator says yes and forwards Joe the payment information for a GoFundMe.

Before looking at the expenses themselves, note that IRC Section 2503(e)(2) speaks only to amounts paid on behalf of “an individual.” It does not require any sort of preexisting relationship or familial status. So, Joe could conceivably claim this exclusion even for a random social media personality.

While IRC Section 2503(e)(2)(B) generally treats direct payments of expenses for medical care as qualified transfers, it also notes that medical care must fall under the definition of IRC Section 213(d) in order to be qualified.

If we turn to IRC Section 213(d)(9)(A), we find out that the term “medical care” does not include cosmetic surgery that is not necessary to correct a deformity arising from either a congenital defect, disfiguring disease, or personal injury resulting from accident or trauma. Since the impersonator’s desire seems to only be matching the appearance of a celebrity, the cosmetic surgery in question probably would not qualify as medical care. Thus, any amount paid by Joe would not qualify for the 2503(e) exclusion.

Note also that if this had been medically necessary surgery, insurance may have covered it. Under Treas. Reg. 25.2503-6(b)(3), amounts reimbursed by insurance would not qualify for the gift tax exclusion to the extent of the reimbursement. However, direct payments of insurance premiums would qualify according to that regulation.

Again, it is also relevant that the impersonator provided a GoFundMe link. Since a payment to a GoFundMe would not be a direct payment, it would not qualify for this gift tax exclusion even if the contribution is used for qualifying medical care. Thus, as requested, Joe would need to pay the surgeon (or treating institution) directly.

Example 5: Bargain Sale

Joe sells to Chad a parcel of real estate that is worth $1,000,000. The purchase price paid by Chad is $600,000, and Joe’s basis in the land is $300,000. What are the gift tax consequences?

Since this is a sale, we may wonder if this is a transfer of property by gift. The answer is that the transfer, which is called a bargain sale, can be partially a gift and partially a sale. The question is whether there is a positive difference between the fair market value and the purchase price.

In this case, since the land is worth $1,000,000 but Chad only paid $600,000, IRC Section 2512(b) considers this land to have been “transferred for less than adequate and full consideration in money or money’s worth.” As a result, this Code Section deems the excess of the value over the consideration to be a gift.

Value is defined in Treas. Reg. Section 25.2512-1 as being “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.” This amount is commonly known as fair market value, or FMV for gift tax purposes.

Further guidance for this outcome is found in Treas. Reg. Section 25.2512-8, which states that a gift for gift tax purposes can “embrace as well sales, exchanges, and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money’s worth of the consideration given therefor.”

But, this is where we get to stack some concepts. Assuming no other gifts had been made by Joe to Chad this year, the gift tax annual exclusion could exclude the first $19,000 of this net $400,000 transfer from the total amount of gifts for the calendar year since this is a present interest transfer (as we will later explore). As a result, the actual gift amount - defined as the “taxable gift” under IRC Section 2503(a) above - would be $381,000 ($400,000 minus $19,000).

We will also table basis for later, but it is important to note here that gift tax is only concerned with value. The basis is an income tax concept. But since this is a transfer that is in part a sale and in part a gift we must analyze the two prongs in tandem. From Joe’s perspective, the amount realized ($600,000) is compared to his basis ($300,000) to determine whether there is gain or loss on the sale under Treas. Reg. 1.1001-1(e)(1). This would result in $300,000 in taxable gain to Joe. And from Chad’s perspective, Treas. Reg. Section 1.1015-4(a)(1) generally provides that his basis will be the greater of the amount paid by Chad, or Joe’s basis in the property - meaning that Chad’s basis will be his purchase price.

So, if Chad were to turn around and sell the property for its FMV, the $400,000 gift amount (including the amount otherwise excluded from Joe’s gifts for the year because of the annual exclusion) would become his gain in the property.

What if, however, this sale was to an outside third party? Would Joe be penalized by socking him with a taxable gift for an ordinary business transaction? We will start the next article in this series by addressing this question.

Share

Subscribe now

1. Where We Left Off

2. Pecuniary Shares, Fractional Shares, and GST Tax Exemption

3. Satisfying Dollar Amount with Non-Cash Assets

4. Pecuniary Share Rules and Ordering

5. Key Takeaways

Where We Left Off

In our last GST tax article, we took a bit of a tangent from recent discussions on separate shares to consider how Crummey withdrawal rights can affect a trust’s status as a GST trust and, thus, its eligibility for automatic allocation of GST tax exemption. But in keeping with the other articles in this series, which have explored whether and to what extent separate shares of a trust might be respected for GST tax purposes, the topic for this article will pick back up with automatic allocation of GST tax exemption at a transferor’s death.

Previously, we explored how pecuniary amounts might be treated in terms of separate allocation of GST tax exemption from a survey-level perspective. The plain reading of these rules, contained in Treas. Reg. Sections 26.2654-1(a)(1)(ii) and 26.2642-2(b)(2), can leave one with the impression that they are designed for direct cash distributions to an individual recipient that in turn are satisfied with assets in-kind. However, there are several nuances to this outcome that broaden its reach.

For many decedents, they will die without having assets that exceed the amount of their remaining GST tax exemption. Post-OBBBA, this is especially true given that we now not only have a “permanent” $15,000,000 GST tax exemption (pegged to the estate tax basic exclusion under IRC Section 2631(c)) but also that this amount is indexed for inflation each year starting in 2027. As discussed in this article, since adjustments to this $15,000,000 base apply to the entire base and do not factor in amounts that have already been used, the inflationary increase to this base amount in terms of sheer added dollars per year can also outpace the natural growth in value of an individual’s estate who is below the exclusion threshold on a sheer dollar basis.

For example, a 3% increase to the $15,000,000 exemption would create a $450,000 increase. Yet, for someone who has an estate of only $5,000,000, a commensurate $450,000 increase to their net worth would mean a return of 9% for the year. Put simply, many estate tax problems are ones that you either inherit or grow into. But given this mathematical adjustment, it will take longer for many people below a certain threshold to “grow” into having an estate tax problem.

What about those, however, who inherit it? And what does this have to do with GST tax? And, why might we care for those who are well under the threshold amount and not growing into it? As previously noted, certain automatic allocation rules apply at the death of a transferor. At the very least, this creates a rule of certainty whereby if Form 706 is not filed to affirmatively allocate the exemption then the trustees of any trusts must be able to “prove” that there was enough exemption allocated (by value at date of death) to create a zero inclusion ratio (ZIR) trust.

And for trusts created when this exemption was much lower, such that the trust or a share thereof might have had an inclusion ratio of greater than zero, this problem is often dealt with by giving one or more beneficiaries a general power of appointment over the trust or a portion thereof. This becomes the classic case of where an estate tax problem might be “inherited” at the powerholder’s death under IRC Section 2041 while, in turn, the powerholder might also have to allocate their own remaining GST tax exemption to the portion of the trust included in their gross estate.

These issues all lead up to the potential application of the pecuniary share rules.

Pecuniary Shares, Fractional Shares, and GST Tax Exemption

In a scenario where the value of what is included in the gross estate exceeds the remaining or available GST tax exemption, this available GST exemption might be expressed as a dollar value. In such a scenario, the documents themselves (trust(s) or will) and possibly state fiduciaries’ powers laws might permit a trustee or executor to split a trust or share into two parts - one that has a ZIR to the extent of the decedent’s remaining GST tax exemption (or the difference in between the trust value and remaining exemption as we will discuss below), and the rest that has an inclusion ratio of one (since no GST tax exemption is available to allocate).

Since the available GST tax exemption is expressed as a dollar amount in such a scenario, that is where the pecuniary share rules come into play. This is the more common situation encountered in administering an estate or trust, and we will discuss the implications of these rules below.

Before we do, however, it is important to note that there is a way to avoid these rules. To the extent permitted under the governing instruments or applicable law, the allocations of property between the (ZIR) GST-exempt share and the non-exempt share can instead be made on a fractional basis. While often not acknowledged as such, this funding method essentially treats the respective shares as being pari passu in terms of timing and order of funding, with the only difference being the amounts allocated to each. In such a case, the target dollar value of each share is compared to the total amount being divided to determine the fraction of this total amount that will be allocated to each share. In turn, assets get divided between the shares (on a direct tenant-in-common basis, or on a percentage ownership basis for entities). Income and capital gains from the shared assets are divided between the shares on a similar fractional basis.

Contrast this with the pecuniary funding approach, which creates a different ordering rule both from a funding perspective and from the perspective of how the two shares are treated under the GST tax rules we will discuss below. In this situation, the pecuniary amount comes first and the trustee or executor often has the choice of which assets to allocate to the pecuniary share. After this pecuniary amount is taken into account, the balance of property being divided is treated as the residuary share (for this purpose in isolation, and not necessarily as the entire “residuary” of the estate or trust in question).

Knowing this difference and what is mandated under governing instruments and law becomes crucial. While the trustee’s or executor’s power to pick-and-choose which assets get allocated to each share might be relevant for making this determination, it is not always the controlling factor. Instead, Treas. Reg. Sections 26.2654-1(b)(1)(i)-(ii) point us to the powers in the governing instrument and applicable law as the controlling factors to consider (at least for property included in the transferor’s gross estate). Let’s consider why these broader rules exist, and then explore their application.

Satisfying Dollar Amount with Non-Cash Assets

Read more

ABOUT THE AUTHOR: Tim Harden is a CPA with Brady Martz, who works with estates, trusts, and individuals to provide tax saving strategies and compliance services. He has an extensive background in the field of trust, estate, and gift tax, including the areas of probate, asset protection, and complex trust and estate planning with tax compliance, including roughly 16 years as an attorney in this area prior to changing his focus to public accounting.

Table of Contents

1. Introduction

2. Current Statute and Regulations

3. History of Gift Tax Return Extension

4. Possible Reasons for Confusion, and a Call for Comments

Introduction

In this article we examine a myth or misconception that arises periodically with regard to the extension of time to file a gift tax return. There are two ways to extend the time to file a gift tax return beyond the April 15^th filing deadline. First, there is an automatic 6-month extension if the individual’s income tax return is extended on Form 4868. Second, a separate gift tax extension form, Form 8892, can be filed. There are different approaches among practitioners to filing these forms. Some prefer to file an 8892 for every gift tax return that will not be filed by the deadline. Others find that either to be unnecessarily conservative or perhaps just burdensome. These practitioners take stock of their inventory of gift tax returns and only file extensions on Form 8892 for ones for which the income tax return will not be extended.

Subscribe now

The above-referenced myth arises in this area, and it comes up periodically in questions or comments we get from practitioners. The issue is this: what happens if the income tax return is filed before the October 15^th extended deadline? Does the extended deadline for the gift tax return expire then, or does it last all the way until the October 15^th deadline regardless?

Our position, based on the statute and regulations, is that the extension of the gift tax return lasts the full six months to October 15^th regardless of the timing of the filing of the income tax return. This is the plain reading of the statute and regulations, and they really do not provide any reason to believe otherwise. Therefore, we are calling it a myth, but it is akin to an urban legend, like giant alligators living in the sewers, because it is difficult to pin down its origin. Because of this slipperiness, we are open to comments if any readers know of conflicting authority. Below, we analyze the current statute and regulations, but we will also cover the history of the gift tax return extension to attempt to determine from where this thinking may have arisen.

Current Statute and Regulations

The statute for the extension of gift tax returns is 26 USC 6075. It reads at 6075(b)(2): “Any extension of time granted the taxpayer for filing the return of income taxes imposed by subtitle A for any taxable year which is a calendar year shall be deemed to be also an extension of time granted to the taxpayer for filing the return under section 6019 for such calendar year.” Section 6019 is the general section dealing with gift tax returns. Thus, from this section we see the linkage between the income tax extension and the gift tax return extension. The lack of detail of the section does leave some room for doubt though.

However, Regulation 25.6075-1(b)(1) makes things more explicit. It says that if a taxpayer “…is granted an extension of time for filing the return of income tax imposed by Subtitle A of the Internal Revenue Code, then such taxpayer shall also be deemed to have been granted an extension of time for filing the gift tax return under section 6019 for such calendar year equal to the extension of time for filing the income tax return.” Likewise, Regulation 25.6081-1(a) provides: “…an automatic six-month extension of time granted to a donor to file the donor’s return of income under Section 1.6081-4 of this chapter shall be deemed also to be a six-month extension of time granted to file a return on Form 709.” Thus, when the income tax return extension is filed granting a six-month extension, an automatic extension of six months applies to the gift tax return as well. There is nothing in the statute or regulations that would shorten this period due to filing the income tax return earlier. This is fairly logical as well, because it would impose a significant tracking responsibility on the IRS if it had to keep track of the date that every income tax return was filed in order to know what the due date of that taxpayer’s gift tax return was. In addition, there is reason from the history of the gift tax return extension to believe that the IRS would not have set up the extension regime in such a manner.

History of Gift Tax Return Extension

The history of the gift tax return and its extensions could shed some light on the origin of this myth. The current era of annual gift tax returns dates back to gifts made in the 1982 calendar year. For over a decade prior to that, gift tax returns had to be filed and gift tax paid on a quarterly basis. It does not appear that an extension of time was available for gift tax returns under that regime. Most practitioners, and certainly most taxpayers, were likely overjoyed when the system when back to annual filings in 1982.

An extension was available for gift tax returns in this era beginning in 1982, but there were some quirks. Through 2003, there were two choices for extending a gift tax return. First, it could be extended automatically if the income tax return was extended. However, the second option varied from today, because there was no Form 8892. Instead, as you can read in the 2003 instructions for Form 709, the extension could only be obtained by writing a letter to the Cincinnati Service Center. In addition to a request for an extension, the letter also had to explain the reasons for the delay. This changed for the 2004 tax year, when Form 8892 was rolled out. Similar to today, there was no requirement to list a reason for the delay in filing the gift tax return on Form 8892. Submitting the form secured an automatic extension.

Another interesting wrinkle was that through 2004, the extension for both the income tax return and the gift tax return was only four months, so that both returns were due on August 15th. This changed for the 2005 tax year to the 6-month extension with which we are familiar. Thus, by 2005 both Form 8892 and the full 6-month extension were in place just as they are currently.

Is it possible that people still remember the early deadline from 20 plus years ago, leading to confusion today about the extension of a gift tax return? It might not seem likely, but tax knowledge and practices do seem to have a way of sticking around, particularly if changes occurred during the lifetimes of the parties involved.

Possible Reasons for Confusion, and a Call for Comments

While not providing a clear-cut answer, this history is illuminating and does help provide some possible ideas as to the origin of this tax myth. Here we will discuss the possible origins and then ask that if any readers have any contrary authority or ideas to please provide them. There are three main possibilities that occur to us.

The first is the memory of the prior four-month extension. The theory here would be that people remember gift tax returns being due earlier, in the summer, in the past and do not remember that income tax returns were also due at that time. The filing of a gift tax return is an unusual occurrence for most taxpayers, while income tax returns are an annual occurrence. Thus, it is reasonable that a prior gift tax return being due in the summer instead of the fall would stand out more than an earlier deadline for income tax returns. This does not seem highly likely but is possible.

The second is one is an exception to the gift tax extension rule not covered above provided in the Regulations: “…the time for filing the return made under section 6019 for the calendar year which includes the date of death of the donor shall not be later than the time (including extensions) for filing the return made under section 6018 (relating to estate tax returns) with respect to such donor.” 26 CFR 25.6075-1(b)(2). That means the death of a taxpayer can accelerate the due date for a gift tax return. A hypothetical situation where this would apply would be if the donor died on January 2, 2026. The initial due date of the estate tax return would be October 2, 2026, and the extended deadline would be April 2, 2026. Therefore, in that situation, the gift tax return would be due before April 15^th. That is not much of a difference, but it is earlier. In addition, if no extensions were filed, the gift tax return could be due even earlier than that.

Here we have a rule that causes the acceleration of the due date of the gift tax return, but is it likely to be the source of the myth? It seems unlikely. This exception applies in so few circumstances that it doesn’t seem frequent enough to cause that much confusion, even in the situation where an extension was not filed for the 706. It just seems too rare.

The third possibility relates to issues with the interplay between the filing of the income tax return, the gift tax return, and the Form 4868. Miscommunications can be an issue, particularly if the preparers of the income tax return and gift tax return are different. What if the gift tax return preparer’s plan was to rely on the income tax return extension, and the income tax preparer decided to file the income tax return by the deadline and not file the extension? This happens at times, and the gift tax return would then be late if there were no Form 8892 filed. This situation may well have given rise to the idea that filing the income tax return early could terminate the gift tax return extension, but it does rely on the assumption that the Form 4868 is never filed, and the income tax return is filed before April 15th.

Another similar wrinkle comes from a line in the gift tax return instructions. They contain the statement that you may only use the Form 4868 “…to extend the time for filing your gift tax return if you are also requesting an extension of time to file your income tax return.” There is an implication here that if you file a Form 4868 to extend the time for the income tax return but then ultimately file the income tax return before the deadline that the Form 4868 might not be valid to extend the gift tax return. Would that actually be the case? It seems not based on the Regulation cited above. That Regulation provides that the gift tax return extension is deemed to be granted when the income tax extension is granted. It shouldn’t matter at that point when the income tax return is filed. Filing the income tax return before April 15^th wouldn’t be any different than filing it on October 15^th, it would just be a lot earlier than the extended deadline. That is the most obvious reading of the statute, but this line does introduce some ambiguity, and it could well be the source of this myth. One recommendation for practitioners would be to make sure that if they are relying on the Form 4868 being filed that it is actually filed and that the income tax return is not being filed before April 15^th. If it will be filed before April 15^th, then filing a Form 8892 might be a worthwhile safeguard here.

And now we open it up to the readers. Is there any authority or scenario to which you can point that we have not covered here? Please e-mail us if you have any insights, comments, or additions on what we have covered or missed.

Share

Subscribe now

The spousal lifetime access trust (SLAT) is a planning tool that has grown in popularity over the last decade and a half for a variety of reasons, not the least of which is the ability of a grantor to indirectly benefit through a spousal beneficiary. However, estate tax risks aside this dynamic can make the SLAT a “bet-to-stay-married” strategy. Contrast this with direct retained interests like GRATs and QPRTs, which can be more aptly described as “bet-to-live” strategies. But today’s case analysis starts with an undercurrent of the SLAT’s status as a grantor trust, which may continue after divorce as a cruel tax outcome that piggybacks off the loss of indirect access through the grantor’s spouse. That is, unless the terms of the trust permit grantor trust status to be terminated through any variety of means, not the least of which is the termination of the grantor spouse’s interest.

Subscribe now

In a recent opinion from the U.S. District Court for the District of New Hampshire, Shchegoleva v. Shchegolev, 2026 U.S. Dist. LEXIS 156405 (July 15, 2026), the dynamics of a SLAT during the pendency of two monumental events - a divorce, and a sale of a company for which an interest was held by the SLAT - collided. But unlike the cases in this area which commonly examine a SLAT from the perspective of its classification as, or effect upon, separate versus marital property and the division thereof this case instead attacked the change in trustee and situs of the trust itself.

To set the stage, it is perhaps too restrictive to simply label the trust in question as a SLAT. The Court in this case did describe it as a SLAT (based on testimony from the drafting attorney), but perhaps its core function can better be described as a GST non-exempt GRAT remainder trust into which remaining assets of two GRATs (after final annuity payments) were transferred. The grantor had transferred some shares of his company into these GRATs which later terminated and poured their remainder(s) over into the non-exempt trust, and this company was sold to Adobe in “the first half of 2026” for a sum that was in the neighborhood of at least $1 billion dollars. While not directly stated in the Court’s opinion, it is likely that the GRATs had the effect of shifting hundreds of millions of dollars of growth outside of the grantor’s estate. The Court later reflected the purpose of the actions in question in this case as being motivated by “several hundred million dollars” flowing into the non-exempt trust when this sale closed.

In an overlapping timeline the grantor, Oleg, had filed a petition for divorce from his (then-)wife, Elena, in Spain in February 2025. The divorce was finalized in February 2026. The Court noted that the two of them are “still litigating the division of their marital assets,” but this was not the core issue at play. Neither was a “deemed death” clause which terminated Elena’s interest in the non-exempt trust we described as a SLAT above at the time of Oleg’s filing of a divorce petition. The drafting attorney and other witnesses testified in the case that this type of clause is commonplace in SLATs (although, in the author’s opinion it is more common to see a spouse’s beneficial interest terminate upon the issuance of a decree of divorce even though this might not always be the optimal approach).

Instead, the issue became primarily one of jurisdiction. It raised some important points on the determination of trust situs, as well as the trustee’s power (directly or even inadvertently) to change situs under the terms of the trust or applicable law. Central to this question of jurisdiction was Elena’s attempt to prevent a shift of situs of trust assets to Wyoming by preliminary injunction relating to her underlying claims of fraudulent transfer, invalid trust, unjust enrichment and constructive trust. These claims were all based on Elena’s allegation that “Oleg used the other defendants to orchestrate a fraudulent scheme to deprive Elena, at the time of her divorce from Oleg, of her share of approximately $1 billion in jointly owned marital assets.”

Let’s explore what maneuvering led to this outcome in the first place. Please note that while we cannot cover all points of this lengthy case, this summary is designed to hit the highlights that are valuable for trusts and estates practitioners and divorce counsel alike.

Change in Trustee and Situs

As Oleg juggled both divorce and the impending sale of his company, several legitimate concerns arose which he addressed in turn. Each was possible due to his retained powers to change the trustee, change the trust (investment) advisor, and appoint and remove a trust protector. In terms of timeline, here were the relevant events:

• September 21. 2023: Institutional New Hampshire trustee for the non-exempt trust was removed and replaced with Oleg’s Massachusetts-based attorney, because the GRAT remainder was about to be paid into the trust (consisting of company shares) and the hourly fees of Oleg’s attorney would be less than the AUA fees of the institutional trustee as applied to the value of these shares.

• June 20, 2024: Oleg executed an instrument removing Elena as Trust (investment) Advisor of the non-exempt trust, and named himself. This role served in a fiduciary capacity.

• January 6, 2025: Oleg’s attorney as trustee of the non-exempt trust acknowledged receipt of this instrument changing Trust Advisor.

• February 7, 2025: Oleg filed for divorce in Spain, which triggered the deemed death clause described above which terminated Elena’s beneficial interest in the trust.

• February 20, 2026: Divorce was finalized, subject to ongoing litigation on division of marital assets.

• March 8, 2026: A private Wyoming trust company, created by Oleg but owned by two individual independent professional fiduciaries (one of whom is an attorney) through their own entity, is formed.

• March 17, 2026: Oleg’s attorney resigned as trustee at Oleg’s request, in order to avoid possible income tax in Massachusetts at the close of the sale.

• March 18, 2026: The Wyoming PTC is appointed as trustee, then on the sale day executes an instrument to exercise an express power in the non-exempt trust to transfer situs to Wyoming. This document was prepared by Oleg’s attorney.

• April 6, 2026: Elena filed her complaint relating to the claims set forth above.

• April 17, 2026: A trust protector is appointed by partners in Oleg’s attorney’s law firm.

• April 20, 2026: The trust protector exercises a power to terminate grantor trust status in anticipation of the pending sale.

• April 24, 2026: Trust protector is removed.

• May 8, 2026: The Court held a hearing on Elena’s motion for a temporary restraining order (filed “[s]hortly after she filed her complaint”), through which she requested that the Court “restrain [Oleg, the Wyoming PTC, and other defendants] from hypothecating or otherwise dissipating the [company] shares or any proceeds received in exchange for those shares upon the closing… .”

Analysis

While other trusts and defendants were named in the main complaint, the Court’s analysis in this case related solely to Elena’s request for a preliminary injunction against the Wyoming PTC to restrict any hypothecation or dissipation of assets (due to a stipulation between Elena and other named parties that was not joined by the Wyoming PTC).

Much of the Court’s analysis and holding focused on whether personal jurisdiction could be exercised in New Hampshire over the Wyoming PTC. Elena’s arguments for assertion of personal jurisdiction did not necessarily follow the three-pronged analysis established in the 1st Circuit but instead focused on three separate theories.

The first was that, by accepting trusteeship of the non-exempt trust, the Wyoming PTC submitted to jurisdiction under the New Hampshire Trust Code. However, while the non-exempt trust did state that New Hampshire would be its initial principal place of administration the trust included express provisions permitting the trustee to change situs. The exercise of this power was to be “‘conclusive and binding on all persons interested or claiming to be interested in’ the trust.” The Court determined that by accepting trusteeship, Oleg’s attorney had changed situs to Massachusetts. Further, the express terms of the trust prevailed - especially the power of the trustee to change situs - over the trust’s initial assignment of place of administration as well as default provisions of the New Hampshire Trust Code. In that regard, the trust did not expressly require a written instrument to change situs thus (contrary to Elena’s argument), the lack of such an instrument did not render the change in situs invalid.

On that note, however, the Wyoming PTC had later executed an actual instrument changing situs. But Elena’s second argument was that this exercise of the power to change situs was invalid, because the New Hampshire Trust Code required notice to be given to the qualified beneficiaries and no such notice was given. But to tack on to the Court’s determination that situs had been in Massachusetts at the time, the Court concluded that the New Hampshire Trust Code’s provisions on a change in situs could not apply. And even if they did, the Court interpreted these provisions to be more in the nature of a duty of the trustee and not as a strict procedure that could void the change of situs if notice was not provided. The Court also concluded that this notice provision was one that could be altered by a trust provision so, even if the New Hampshire Trust Code applied, the express terms of the trust did not require notice to be provided. (And as a side note, Elena was not a beneficiary at the time due to the deemed death clause so at best she would have only received notice as guardian for two of their three children who were minors at the time.)

Finally, Elena argued that the Wyoming PTC was effectively an alter ego for Oleg. Similarly, with respect to the effect of the choice of situs provision she had argued that Oleg’s prior appointment of his personal attorney as trustee had been a scheme that was not bona fide and thus was not effective to change situs. But for each such allegation, the Court noted that the record simply did not support it at this preliminary injunction stage. With respect to the alter ego theory in particular, the Court stated, “Elena relies on nothing more than unsupported innuendo, nearly all of which was directly belied by the evidence presented at the preliminary injunction hearing.”

Notwithstanding the fact that the lack of personal jurisdiction was sufficient to deny Elena’s preliminary injunction, the Court also briefly addressed the other preliminary injunction factors. The Court concluded that Elena had not met her burden of showing either (1) a likelihood of success on the merits of her underlying claims, or (2) irreparable harm in the absence of injunctive relief.

Within this analysis is a discussion of Elena’s likelihood of success on her fraudulent transfer claim. New Hampshire, which has adopted the Uniform Fraudulent Transfers Act and not its less-friendly sequel, the Uniform Voidable Transfers Act, required evidence of an actual intent to defraud for which Elena did not present any direct evidence. Further, assuming Elena was a creditor, the Court found Oleg’s assertion credible that he was not contemplating divorce when the trusts were first created and funded. The Court also game weight to Oleg’s attorney’s testimony that he would not prepare a SLAT if the grantor was intending to divorce at the time of creation. Thus, the transfers could not have rendered Oleg unable to satisfy any marital property claims (since such claims did not exist, nor were contemplated, at the time of the transfer of assets to the trusts).

Likewise, with respect to the analysis of any badges of fraud or actual intent to defraud the Court offered the following which bears quoting verbatim for its utility in analyzing whether transfers to third party trusts could violate fraudulent transfer laws in similar situations:

Assuming without deciding that Elena constitutes a creditor under the statute, there is simply no evidence to support her claims of a fraudulent transfer. The evidence offered at the preliminary injunction hearing shows that the trusts at issue in this case were routine estate-planning documents containing standard clauses. There is no evidence that the trustees administering the Non-Exempt Trust are insiders. The trustees were and are professional, independent fiduciaries and have acted at all times in the best interest of the Trust’s beneficiaries. Oleg and his agents changed the trustees for legitimate and lawful reasons. The evidence in the preliminary injunction record establishes that Oleg has not retained possession or control beyond that typically retained by trust grantors. Oleg’s remaining control over the assets is limited and imposes fiduciary duties upon him. Moreover, Oleg made no attempt to conceal the Non-Exempt Trust upon its creation. Instead, Elena was a beneficiary. In short, there is nothing in the record at the preliminary injunction stage to suggest that Oleg took any actions to hinder, delay, or defraud.

Key Takeaways

It is important not to read too much into this case because it relates only to a motion for preliminary injunction, and does not strike directly at the heart of the more frequently-raised issue of how SLAT property might be treated in a divorce property settlement. But it does reinforce the fact that trustees are fiduciaries who have overriding fiduciary duties, and that as noted by the Court the breach of these duties for outcomes such as lack of notice could have been valid claims if not for trust terms that expressly authorized the outcomes at issue.

But at the end of the day, without directly stating it the Court did apply its analysis largely to the four corners of the trust instrument. This was, of course, aided by the lack of any evidence proffered for Elena’s allegations of shady dealings or hidden maneuvering to deny her access to the trust assets. The Court’s opinion, outside of a brief statement on how the “deemed death” clause was described by witnesses as a common trust provision for a SLAT, did not call into question the express terms of the trust itself or the interpretation thereof. And while we cannot read too much into the absence of such a challenge it does perhaps reveal how sound drafting is the best first line of defense, and strict adherence to the express terms of the trust (for a valid, provable purpose) is a great second line of defense. After all, at no point was it asserted that the actions taken were in direct violation of express powers granted in the trust.

For those serving as trust protectors, while the actions of the trust protector were not necessarily part of any actions that could have harmed Elena, the fact that the trust protector’s actions were not challenged is itself comforting. At the very least, this case serves as an additional data point that (as Oleg’s attorney testified) it is “good practice to employ a Trust Protector only when there is an immediate need for action, particularly in light of the broad powers that the Trust instrument grants to the position.” (As an aside, the opinion stated that the trust protector was paid a fee of $60,000 for their brief service.)

It is also helpful and perhaps comforting for practitioners that the Court’s fraudulent transfer analysis, even though not necessary to dispense with Elena’s motion for injunctive relief (after concluding there is a lack of personal jurisdiction), nonetheless takes a positive view of the transfers to the trusts, the terms of the trust (including the deemed death clause), the legitimacy of the trustees and their actions as fiduciaries, and the reasons for changing the trustees. Of course, one could argue that the timing was indeed suspect when we explore the confluence of Oleg’s commencement of the divorce and the billion-dollar sale of his company. Nonetheless, the fact that Oleg and his estate planning attorney not only dotted their i’s and crossed their t’s but made sure the record supported that dotting and crossing perhaps stands as evidence of good defensive practice for an ultra-high net worth, illiquid (at the commencement of planning) client.

Subscribe now

Share

1. Background

2. Code Section 1045, in General

3. Other Types of Gains and Transfers

4. Conclusion

Background

Let’s explore a hypothetical. Your client comes to you and explains that they just sold their company (or a stake in it) for many multiples of their initial investment, after holding their equity for 2 years and 11 months. They are concerned about recognizing all of that gain this year, and are curious about their options. But in the process, they also express that they are not necessarily ready to “cash out” on life. A serial entrepreneur, they would have no qualms about starting or investing in a new business - perhaps by rolling over the cash proceeds of the sale into another venture.

While there is no “best” first question to ask, perhaps a “good” first question is:

Did the equity you sold consist of shares or interests in a C corporation?

Subscribe now

At first glance, you might see the 2 year and 11 month holding period and ask yourself why. After all, even under the new rules (which could not apply as of the date of first publication of this article given that OBBBA is only ~14 months old) the minimum holding period for the gain exclusion on qualified small business stock (QSBS) has not been satisfied. And this assumes to begin with that the equity that was sold would have met the other QSBS requirements to begin with.

But what if those other QSBS requirements, other than the holding period, had indeed been satisfied? Do we have any options beyond the usual suspects? This is where IRC Section 1045 could come into play. For estate planners, and trustees alike (especially for trusts that hold C corporation stock in smaller businesses), this Code Section should be part of your arsenal. Let’s explore why.

Code Section 1045, in General

For QSBS that has been held for more than 6 months, IRC Section 1045(a) (if elected) generally permits the gain realized on the sale to be reduced by the cost of newly-purchased qualified small business stock that is acquired within 60 days of the sale. Only the excess of this realized gain over such cost would then, in turn, be recognized.

Read more

ABOUT THE AUTHOR: Tim Harden is a CPA with Brady Martz, who works with estates, trusts, and individuals to provide tax saving strategies and compliance services. He has an extensive background in the field of trust, estate, and gift tax, including the areas of probate, asset protection, and complex trust and estate planning with tax compliance, including roughly 16 years as an attorney in this area prior to changing his focus to public accounting.

Table of Contents

1. Background

2. Facts of Case

3. Relevant Statutes

   1. Creditors’ Claims Against a Revocable Trust

   2. Exemption for 401(k) Proceeds

   3. Exemption for Life Insurance

4. Key Takeaways

Background

One part of the trusts and estates area that has developed over time is estate and trust administration. This is due to an increasing number of people basing their estate plans on revocable living trusts rather than relying on wills. In response, states have updated their trust codes to account for this new reality and to attempt to integrate trust administration with probate administration. While they have probably done a reasonably good job, the bare fact that there are two systems creates more complications than if there were only one. On top of that, there are also contractual transfer mechanisms such as beneficiary designations that further complicate things.

The Michigan Supreme Court case In re Estate of Jennifer L. Fowler (SC Docket No. 167501-3) was decided on July 20, 2026 and adds some clarity to the area. Specifically, the Court considered whether life insurance and 401(k) proceeds payable to a revocable living trust were subject to creditors’ claims related a wrongful death judgment in the probate court against the estate. The Court held that both assets were exempt from creditor claims on the basis of the reasoning discussed below.

Facts of Case

This case arose from a sad set of circumstances. Helen Fowler was 79 years old and suffering from dementia. Her daughter Jennifer was her patient advocate. In November of 2018, Jennifer brought Helen from the assisted living facility where she had been living to Jennifer’s home. Jennifer then killed Helen and herself. Subsequently another of Helen’s daughters obtained a wrongful judgment against Jennifer’s estate. Jennifer’s probate estate did not have sufficient funds to pay the judgment. However, she did have life insurance and a 401(k), both of which named her revocable living trust as the beneficiary.

Therefore, the question arose as to whether Jennifer’s trust, as recipient of these funds, was subject to creditor claims against Jennifer’s probate estate, specifically the wrongful death judgment. Michigan has certain statutes that are relevant to this decision, which are discussed more fully below. Based on an analysis of these statutes, the probate court determined that Jennifer’s trust was liable for the wrongful death judgment to the extent of the life insurance proceeds but not the funds from the 401(k). The Court of Appeals held that both the 401(k) and life insurance proceeds were subject to creditors’ claims.

Jennifer’s trust appealed this decision, leading to the current Supreme Court decision.

Relevant Statutes

The analysis of the Michigan Supreme Court can be broken down into three parts based on the three relevant parts of the statute. First, is a revocable trust liable for the claims of creditors from the probate estate of the deceased grantor? Second, if so, are proceeds from a 401(k) payable to the trust subject to these creditors’ claims? Third, and finally, again granting the first premise as true, are life insurance proceeds payable to the trust subject to the creditors’ claims? The reason the Court set up its analysis this way is because of the structure of the statute. The statute begins by laying out a general rule about the liability of revocable trusts for creditors’ claims arising in probate and then provides for exceptions to that general rule.

In the next three sections, we will examine the court’s conclusions on these three points in order.

Creditors’ Claims Against a Revocable Trust

Jennifer had a revocable trust that became irrevocable at death, but the creditor claims at issue here arose against her probate estate. Thus, the first question is whether the statute applies to make her revocable trust liable for the creditor claims arising in her probate estate. The relevant portion of the statute reads:

(1) The property of a trust over which the settlor has the right without regard to the settlor’s mental capacity, at his or her death, either alone or in conjunction with another person, to revoke the trust and revest principal in himself or herself is subject to all of the following, but only to the extent that the settlor’s property subject to probate administration is insufficient to satisfy the following expenses, claims, and allowances:

(a) The administration expenses of the settlor’s estate.

(b) An enforceable and timely presented claim of a creditor of the settlor, including a claim for the settlor’s funeral and burial expenses.

(c) Homestead, family, and exempt property allowances.

MCL 700.7605.

The court first focused on the language in the statute that reads: “a trust over which the settlor has the right…at his or her death…to revoke the trust and revest principal in himself or herself.” Clearly this language describes a revocable trust of the type that Jennifer employed. The court then spent some time analyzing the history of the use of revocable trusts as will substitutes as well as how the laws of other states treat the situation governed by the statute. It concluded: “In sum, the text of the statutes, relevant commentary, and underlying law show that the Legislature’s purpose in enacting…(the statute)…was to codify the liability of a revocable trust used as a will substitute for the debts of the deceased settlor.” Id. at 15.

From the discussion of the court, it seems that there may have been an argument regarding the timing of the trust becoming irrevocable. It’s not entirely clear what that argument was, because the court does not spell it out, but it perhaps might have to do with distinguishing the liability for estate creditor claims of trusts that become irrevocable before death from those that become irrevocable at death. Regardless, the court completely dismisses the relevance of this argument and concludes that because Jennifer’s trust was revocable up to death that it falls squarely within the ambit of the statute and would be subject to estate creditor claims.

That is, of course, subject to the exceptions in the statute that we consider next.

Exemption for 401(k) Proceeds

The court next considered whether the exemption provided in the statute for retirement plan proceeds applied here. The relevant part of the statute reads:

A trust established as part of, and all payments from, an employee annuity described in section 403 of the internal revenue code, 26 USC 403, an individual retirement account described in section 408 of the internal revenue code, 26 USC 408, a Keogh, or HR-10, plan, or a retirement or other plan that is qualified under section 401 of the internal revenue code, 26 USC 401, shall not be considered to be a trust described in subsection (1).

MCL 700.7605(2).

This is somewhat of a confusingly worded statute, so the court considered it piece by piece.

Jennifer’s 401(k) had been under the DTE Electric Company Savings & Stock Ownership Plan, and the court concluded that it was the type of plan qualified under IRC Section 401 that the statute references. Further, the court stated that all the parties agreed that Jennifer’s trust itself would not be a “trust established as part of” a 401(k) plan. It was her own separate, revocable trust. Thus, upon cursory reading, it might appear that this exemption would not apply.

However, that would be to ignore the words “and all payments from”. This is where the statute gets challenging. Clearly, a 401(k) trust, such as the one that the employer holds, is not “considered to be a trust described in subsection (1).” But reading the payments language with the rest of the statute renders something like “all payments from…(a 401(k) plan)…shall not be considered to be a trust described in subsection (1).” Id. at 18. Read literally, that does not make a lot of sense, or it is a completely obvious statement. The court held here that it had to read this provision in context with the whole statute: “Reading Subsections (1) and (2) together, the intent of the Legislature is to treat ‘all payments from’ a 401(k) plan as not part of a revocable trust liable for creditor and other claims.” Id. at 20.

Therefore, if the payment from Jennifer’s 401(k) plan is not part of a revocable trust liable for creditor claims under the statute, then to the extent that her revocable trust contained the funds from the 401(k) account, it would not be responsible for the judgment from the wrongful death statute.

Exemption for Life Insurance

After holding that the 401(k) proceeds were exempt, the court turned to the question of whether the same would be true for the life insurance. The relevant portion of the statute reads:

For purposes of this section, property held or received by a trust to the extent that the property would not have been subject to a claim against the settlor’s estate if it had been paid directly to a trust created under the settlor’s will or other than to the settlor’s estate, or property received from a trust other than a trust described in this section, shall not be considered trust property available for the payment of administration expenses, a claim against the settlor’s estate, or an allowance described in subsection (1).

MCL 700.7605(4).

For this subsection to be applicable, the life insurance proceeds would have to be exempt from creditors’ claims based on a different statute under the “to the extent that the property would not have been subject to a claim” language above. In this case, Jennifer’s trust pointed to MCL 500.2207(2), a Michigan statute which exempts life insurance proceeds from creditor claims unless the beneficiary is the insured or the insured’s executor or administrator, or there was fraudulent intent involved.

Jennifer’s trust argued that this triggered the exemption in MCL 700.7605(4) because the life insurance proceeds were not paid to Jennifer’s estate. In contrast, Helen’s estate focused on the term “administrator” and argued that this is equivalent to trustee. However, the court disagreed that a trustee is like an executor or administrator, because the term “executors or administrators” has been defined in both law dictionaries, in the Michigan Estates and Protected Individuals Code, and in prior Michigan case law as essentially the person appointed to be in charge of the probate estate. Further, the Michigan Trust Code never uses the term “administrator” as substitute or equivalent for “trustee.”

Therefore, in holding that MCL 500.2207(2) was applicable in this case, the court also held that the exemption in MCL 700.7605(4) was applicable and that the life insurance proceeds were not reachable for the wrongful death judgment either.

Key Takeaways

1. Even in a situation where a statute seems relatively clear, its meaning cannot be presumed. In this case, there were three levels of court decisions as to which funds were exempt, if any, and none of the three levels agreed with each other. As practitioners, it is easy to fall into the habit of presumption as to what a statute means, but unless a court has decided its meaning like this one, caution should be the rule in interpretation.

2. This case cleared up a possible estate plan funding difficulty, at least in Michigan. Naming the revocable trust as the beneficiary of retirement plans and life insurance is fairly common, but that practice would have had to have been weighed against the possibility of subjecting those proceeds to creditor claims. This is especially troubling when they would not have been if they were payable directly to beneficiaries. In that regard, this decision helps estate planners.

3. This case reinforces the importance of making sure that beneficiary designations are completed. In this case if they had not been and a rule making the default beneficiary the probate estate applied, then these funds would have been subject to the judgment against the probate estate.

Subscribe now

Share

If you would like to consider joining the State of Estates Ambassador program, applications are open - please click here to fill out the survey.

Table of Contents

1. Background

2. Facts of Fields, Revisited

3. Resolving Limitations of Power of Attorney

4. Fraud and Elder Abuse

5. Conclusion

Background

For over 20 years, the planning strategy of using family limited partnerships to achieve valuation discounts has carried with it a lot of baggage. Many planners still use such a strategy for gifting purposes, as the fair market value of such interests often (properly) reflects discounts for lack of control and lack of marketability. However, especially for estate tax purposes, a long line of cases going back to Strangi v. Commissioner, 417 F.3d 468 (5^th Cir. 2005) has called into question the efficacy of such a discount for estate tax purposes when a contributor to a family limited partnership dies.

Subscribe now

The issue is not whether the value of a family limited partnership interest, as included in the gross estate, has a fair market value that reflects discounts for lack of control and lack of marketability. It does, otherwise it would be difficult to claim such discounts are permissible for gift tax purposes but not estate tax purposes. Instead, the issue revolves around the application of IRC Sections 2036(a)(1) and (a)(2). These Code Sections recognize that some transfers or exchanges can be made on paper during life, but do not represent a true shift of value outside of the gross estate (including the value of control or marketability) if in turn the decedent had retained benefit and/or control from the transferred assets until death.

In other words, an interest in family limited partnership is indeed included in the gross estate at its fair market value. But in turn IRC Section 2036(a) operates as a rule to also include in the gross estate the value of assets transferred during a decedent’s life, over which (1) possession, use, or enjoyment of the transferred property or income therefrom, or (2) the right to control who will possess or enjoy the property or its income.

As applied to a family limited partnership, this effectively reexamines the substance of the transaction in which assets are initially exchanged for the interest in the family limited partnership itself. And in turn, as examined in Estate of Powell v. Commissioner, 148 T.C. No. 18, 148 T.C. 392 (2017), the “double-counting” of the family limited partnership interest itself and the assets exchanged for that interest (that are pulled back into the gross estate under IRC Section 2036(a)) is mitigated by IRC Section 2043. This latter Code Section reduces the value of included assets under IRC Sections 2035-2038, or 2041 (at date-of-death value or AVD), by the value (as determined at the time of exchange) of consideration received for such assets.

In other words, the exchange itself is not disregarded. Instead, where IRC Section 2036(a) applies to a family limited partnership interest, the value is by creating the following steps in the calculation of the gross estate:

+ Value of limited partnership interest owned by decedent at date of death (under IRC Sections 2031 and 2033);

+ Value of assets included in the gross estate at date of death (under IRC Section 2036(a));

- Value of limited partnership interest received in exchange for such assets during life, at the time of such exchange (under IRC Section 2043).

So, does this mean every single transfer to an entity in exchange for an interest is automatically suspect and at risk for the application of IRC Section 2036(a) (or even 2038)? Not necessarily. If we look to IRC Section 2036(a) itself, we see the following parenthetical as a carve-out:

…(except in case of a bona fide sale for an adequate and full consideration in money or money’s worth)…

Without getting into the broader question of which you apply first – 2036(a), with a knock-out of a bona fide sale (as usually applied by courts), or a bona fide sale which in turn prevents you from having to analyze for the application of IRC Section 2036(a) – this concept of a bona fide sale has been the subject of many decisions in the long string of family limited partnership cases. It also played a central role in the appeal of the Tax Court’s 2024 decision in Estate of Fields v. Commissioner, which we discussed in a prior article. The Fifth Circuit recently issued its opinion in this case on June 8, 2026.

Facts of Fields, Revisited

As with prior cases like Strangi and Powell, Fields involved an end-of-life transfer of substantially all of a decedent’s assets to a family limited partnership in exchange for a limited partnership interest that accounted for >99% of the outstanding partnership interests. As in these prior cases, it involved an agent under a durable power of attorney making these transfers on the decedent’s behalf during their life. And finally, as in these prior cases, it involved the agent in turn retaining a general partnership interest (or control thereof) after the transfer.

Read more

• A new staff writer, Tim Harden;

• An ambassador program, that can get you a free one-year subscription;

• Upcoming live programs; and

• Pending approvals for CPE and CLE credit.

Introducing Tim Harden

There is only so much I can do as a force of one on this newsletter. For that reason, I am excited to announce that Tim Harden has joined me to assist me with content development, content review, and frequent article contributions.

You may have seen Tim’s recent or past articles, but his experience as both a CPA and a practicing attorney will bring some fresh and unique perspectives to this newsletter and some expanded offerings (including CPE credit, as I will discuss below) that we hope to offer in 2027 and beyond.

Ambassador Program

Part of why I started this newsletter was to provide the level of education and content that I wish I’d had access to early in my career as an associate in an estate planning law firm. But beyond that, I am also passionate about fostering thought leadership and serving as a mentor.

So, for those who are interested I am opening up an ambassador program. In exchange for support of the newsletter - whether in the form of promotion on social media, or contributions to the newsletter itself, or both - you will receive a free one-year subscription. And if you already pay for a subscription, a prorated year will extend from the time of your next renewal date.

In addition to full newsletter access, you will also receive:

• The opportunity to work more closely with me on questions you encounter in your practice;

• Behind-the-scenes participation in content development, research, and writing - including beta access to estate planning tools being developed in stealth; and

• Support in developing and promoting your own brand, practice, and thought leadership.

If you are interested in learning more, you can e-mail me at griffin@griffinbridgers.com, reach out on LinkedIn, or complete the following survey:

Apply to be an Ambassador

If you are not interested but know someone who might benefit, especially associates or staff within your firm, please feel free to forward this on or share.

Share

Please note that depending on interest I may need to cap participation and that I cannot guarantee that you will be accepted as an ambassador. Likewise, I must limit this program to wealth transfer professionals - this is not an offering for the lay audience.

The Estate Planning Intensive

Last year, I started the Estate Planning Intensive with Jennifer Belmont Jennings as a way to bring our collective experience in teaching estate planning through various CFP preparation programs to a broader audience that often lacks this level of focused education and training. We are excited to bring back the Estate Planning Intensive this year, but with two tracks:

• A foundations of estate planning program, with two dates to choose from - November 10th or 19th; and

• An advanced planning course, with two dates to choose from - December 3rd or 10th.

As a bridge between the two, there will be an optional content series presenting foundations of gift and estate tax in an examples-and-explanations format.

Details will be announced soon, including agendas. The programs will be held in live webinar format, and we will tentatively be seeking CLE credit in select states based on interest and initial registrations. We may also provide CPE credit, to be discussed as follows.

Seeking NASBA Accreditation

While I have not yet obtained accreditation, many CPAs frequently ask if CPE credit is available for at least recorded programs I provide and possibly even for newsletter articles. For that reason, I will be working on obtaining accreditation as a CPE sponsor from NASBA (who recently updated their guidelines for sponsors). Stay tuned for more information on that, as beyond the accreditation itself we will be working on ways to track the necessary attendance, quizzes, evaluations, and certificates.

Depending on the success of that program and growth in readership, further CE offerings for other wealth transfer disciplines will be explored.

Conclusion

I continue to be astounded by how many of you read, subscribe, and support this newsletter. To express my thanks and gratitude, not only will I keep doing what I do but I also hope that some of the new and pending benefits above will also add value for you. Other features that I cannot announce yet are in the works behind the scenes, but if there is anything you would like to see included please reach out.

Share

Subscribe now

The grantor trust series is close to having run its course, but what subsequent articles in this series will do is walk back through the grantor trust principles in an examples-and-explanations type of format. That format will be reflective of a lot of upcoming content that is planned for this newsletter.

For now, however, we will start with a simple question. Does a gift-splitting election by spouses have any effect on grantor trust status?

Subscribe now

The Rules

The gift-splitting election, described in IRC Section 2513, generally causes all gifts made during a calendar year by either spouse to be treated as if they were made one-half by each spouse. This is a gift tax rule that decouples the identity of the “donor” of each gift from the economic reality of which donor actually owned the property being transferred. In other words, while there is no true “joint” gift tax return this election recognizes that spouses can sometimes be one gifting unit.

This election, if made for a calendar year, applies to all gifts for the year (or for the portion of the year during which the spouses are married) other than gifts to the other spouse. Thus, for example, interests in which a donee spouse is granted a general power of appointment are disregarded. Likewise, if the donee spouse and other third parties have an interest in the transferred property (such as for a transfer in trust), Treas. Reg. Section 25.2513-1(b)(4) provides that the gift can only be split to the extent that transfers to third parties are ascertainable and severable.

The utility of such an election is that where one spouse owns, as their separate property, the property being transferred then the other spouse can apply their gift tax annual exclusion and/or lifetime applicable credit even though they did not own the property being transferred. But, if the consenting spouse did actually own an interest in the property (as might be the case for community property or jointly-owned property) then the gift is respected as having come from them to the extent of their interest in the transferred property.

In other words, the gift-splitting election only technically changes the gift tax outcomes for an interest in gifted property that was not owned by the consenting spouse.

This has special relevance when it comes to other taxes, as the gift-splitting election is solely a gift tax rule. For generation-skipping transfer (GST) tax purposes, IRC Section 2652(a)(2) clarifies that the gift-splitting election will also apply for purposes of treating each spouse as the “transferor” of their one-half portion for GST tax purposes. However, no such corollary seems to appear in the grantor trust rules.

Under Treas. Reg. 1.671-2(e), we see the following sentence:

However, a person who creates a trust but makes no gratuitous transfers to the trust is not treated as an owner of any portion of the trust under sections 671 through 677 or 679.

Put simply, this ties status as “grantor” (the necessary ticket to entry for grantor trust status) as being tied to actual gratuitous transfers. In the case of a gift-splitting election, if one spouse is the “grantor” unilaterally making all gratuitous transfers to the trust then this rule suggests that the consenting spouse to the gift-splitting election could not also be a grantor. This would be the case even if both spouses formally signed as “grantors” or “settlors” of the trust itself.

However, we would be remiss if we skipped over the preceding sentences of this rule. The first sentence defines a grantor as being someone who “directly or indirectly makes a gratuitous transfer… of property to a trust.” We also see the following third sentence:

If a person creates or funds a trust on behalf of another person, both persons are treated as grantors of the trust.

Since gratuitous transfers can include indirect transfers of property, and since status as grantor can include situations where another person funds a trust on your behalf, does this mean that a gift-splitting election can cause the consenting spouse to be a grantor?

Further Analysis

Most likely, the answer would be no. The gift-splitting election does not, in and of itself, cause a consenting spouse to be the “grantor” of any portion of trust property not actually transferred by that spouse. The gift-splitting election is, in spirit, an election of convenience that is designed to simplify gift tax reporting. The utility of the election does not appear to extend beyond the gift tax itself. We can take the fact Congress created a specific GST tax recognition for the gift-splitting election to perhaps be further evidence that if they had intended to do the same for income tax and grantor trusts, they would have created such a rule.

In terms of indirect transfers, or transfers on behalf of an actual grantor, these exceptions are likely intended to apply in scenarios where a person actually owns an interest in the property being transferred to the trust. Thus, for example, if an agent transfers an individual’s property to a trust it stands to reason that the person represented by the agent would be a grantor. (The question of the agent being grantor is a great subject for a subsequent article). Likewise, indirect transfers appear to be illustrated in Treas. Reg. Sections 1.671-2(e)(4)-(5), which describe transfers from a partnership, corporation, or existing trust. In each scenario, the property being transferred can be traced back to some property interest actually held by a grantor in an entity or in property previously added to a transferor trust.

In other words, it appears that our originally-quoted rule from above – that one cannot be a grantor without gratuitously transferring property they own to the trust – holds true. So in a pure gift-splitting scenario, where a consenting spouse makes no transfers, the gift-splitting election itself should not cause the consenting spouse to be a deemed income tax owner of property they did not actually contribute to the trust. The ability of spouses to elect to jointly or separately file for income tax purposes likely supports this outcome as well.

Key Takeaways

This silent decoupling of the gift-splitting election from the grantor trust rules means that planners must be cautious when planning for transactions between a spouse and the trust. For example, an exercise of a substitution power may not extend to a consenting spouse who has not actually contributed property to a trust (and even if they had, it only extends to the property they actually gratuitously transferred). The death of the contributing spouse could turn off grantor trust status for the entire trust instead of just one-half.

Keep in mind, though, that our core rule is tracing contributions to the respective spouses with respect to state-law property interests. So, for example, a contribution of community property to a trust (even though one contributing spouse might hold sole title to the property) would be treated as a contribution made one-half by each spouse so long as the non-titled spouse indicated the requisite consent (as a community property owner, and not as a gift-splitting election) to the transfer.

However, the utility of these outcomes relates only to the identification of the grantor to begin with. From there, we must determine if the grantor (or the grantor’s spouse under the spousal unity rule, or IRC Section 677(a)) has retained a power or interest sufficient to cause them to be taxed on the trust’s income. If not, this issue becomes moot.

Share

ABOUT THE AUTHOR: Tim Harden is a CPA with Brady Martz, who works with estates, trusts, and individuals to provide tax saving strategies and compliance services. He has an extensive background in the field of trust, estate, and gift tax, including the areas of probate, asset protect, and complex trust and estate planning with tax compliance, including roughly 16 years as an attorney in this area prior to changing his focus to public accounting.

Table of Contents

1. Introduction

2. Comparison with Allocation of Items of Income and Expense and Example

3. Curveball: The Reserve Exception

4. Maneuvering with Section 179

5. Conclusion

Introduction

In Part 1 of this article, we considered the importance of depreciation rules in the context of proper tax reporting for nongrantor trusts and estates that own depreciable assets such as business interests or rental property. The general rule is that the depreciation deduction will follow the apportionment of the trust income between the trust and the beneficiary. Further, there is an exception for trusts, but not estates, that maintain a reserve for depreciation. Thus, the first part covered the general rules with respect to this area. This Part 2 covers three areas: a specific comparison of the rules for apportioning depreciation versus the allocation of items of income and expense; the reserve exception to the depreciation apportionment rules; and, finally, Section 179 with regard to trusts.

Subscribe now

Comparison with Allocation of Items of Income and Expense and Example

As covered in the first part of this article, the Code provides that the allowable depreciation deduction is to be apportioned between the beneficiaries and the trust based on trust income allocable to each. Code Section 167(d). What does “trust income” mean in this context? The Code provides that “’income,’ when not preceded by the words ‘taxable,’ ‘distributable net,’ ‘undistributed net,’ or ‘gross,’ means the amount of income of the estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law.” Code Section 143(b). That means trust accounting income.

In contrast, when considering the amounts of income that pass out to a beneficiary, it is “…treated as consisting of the same proportion of each class of items entering into distributable net income of the trust.” Treas. Reg. 1.652(b)-2. Distributable net income is essentially based on the taxable income of the trust, with the main modifications being the exclusion of capital gains or losses and tax-exempt income. Code Section 643(a). Under the Code and Regulations, then, allocation of items of income and expense is generally based on the proportion of DNI going out to the beneficiary. For example, take the simplified case of a trust that had dividend income of $6,000 and net rental income of $6,000, for a total taxable income of $12,000. If it were a complex trust and $6,000 was distributed to the income beneficiary, then 50% of each of the categories of income would be allocated to the beneficiary, or $3,000 of dividend income and $3,000 of rental income.

With that background in mind, we can see where the difference in apportionment of depreciation can come in.

Read more

1. Background

2. Code Sections 704(c) and 721(b), in General

3. Code Section 1041

4. Conclusion, and a Solution?

Background

While we have not yet explored partnership taxation in great detail in this newsletter, a couple of prior articles have discussed general nuances thereof along with the application of the partnership taxation regime to spouses contributing community property to a tax partnership.

Subscribe now

As a bit of background, the rules governing tax partnerships are contained in Subchapter K of Subtitle A, Chapter 1 of the Internal Revenue Code of 1986. These rules are often referred to in shorthand as “Subchapter K.” The rules of Subchapter K apply to any entity that is assigned the tax status of “partnership” under the check-the-box rules. Subchapter K is unique in that it cannot be elected as a tax status under such rules, as opposed to a C corporation or S corporation (assuming the S corporation election eligibility requirements are met). That being said, two or more separate taxpayers who create an entity that is not a corporation at the state level are in a sense choosing to be a tax partnership governed by Subchapter K unless an exception under IRC Section 761 is met.

There are compelling non-tax reasons to create an entity such as a limited partnership or LLC at the state level, especially in estate planning, such as ease of transfer, ease of management, and charging order protection. But, since a state-law partnership or LLC with at least two equity owners will be assigned the default tax status of partnership under Subchapter K, this casts a wide net, as it means under IRC Section 6031(a) that every tax partnership must file IRS Form 1065 annually. And while Treas. Reg. Section 1.6031(a)-1(a)(3)(i) permits a partnership with no income to avoid filing, this exception only applies if the partnership also has no deductions or credits. So, for example, a partnership that incurs a deductible expense or holds depreciating property will still have to file Form 1065.

This comes as a shock to spouses who create a tax partnership as the sole partners or members for non-tax purposes, especially those who file jointly or who do not have a profit-seeking motive. There is no per se joint filer exception to the application of Subchapter K and its filing requirements, since spouses are separate taxpayers who could elect to be taxed separately. And while spouses can elect disregarded entity status where a partnership or LLC is funded solely with community property, this election is not available to those living in the majority of states (since only a handful of states have mandatory community property laws). Likewise, the qualified joint venture exception (to the application of Subchapter K) between spouses of IRC Section 761(f) is much more narrow than it appears at first glance. This exception is reserved for entities not formally registered with the state (which excludes LLCs and most limited partnerships), and requires the conduct of a trade or business in which the spouses materially participate (as opposed to simply holding investments).

One such area where Subchapter K can lead to a spousal penalty is found in the application of IRC Sections 704(c)(1)(B) and 721(b). We will first explore 704(c) and 721(b), and then look at how the problems they seek to solve may not exist between spouses outside of the partnership form.

Code Sections 704(c) and 721(b), in General

Code Section 704(c) is largely broken into two rules.

The original rule, under IRC Section 704(c)(1)(A), is designed to prevent a partner who contributes appreciated or depreciated property from shifting a tax gain or loss to other partners (to the extent of accrual before contribution to the partnership itself, based on FMV/book value at the time of contribution). This original rule applies when such property is sold, and allocates the gain or loss first to the contributing partner to the extent of the spread between the basis and FMV at the time of contribution.

The newer rule of IRC Section 704(c)(1)(B), later enacted, was designed to curb an abuse whereby Subchapter K could be used to achieve an exchange of assets without recognition of gain. In IRS Notice 2009-70, citing S. Finance Comm. 101st Cong., 3 Revenue Reconciliation Act of 1989, Explanation of Provisions Approved by the Committee on Oct. 3, 1989, 196 (Comm. Print 1989), the Service explained that:

It was Congress’s view that the prior law made it “possible for partners to circumvent the rule requiring pre-contribution gain on contributed property to be allocated to the contributing partner.”

In other words, if two parties were to just exchange assets directly there would be recognition of gain or loss outside of narrow nonrecognition exceptions (such as IRC Section 1031, for example, for real property). One such exception we will discuss below, as applied between spouses, is IRC Section 1041. As we will discuss, a direct exchange or transfer of property between spouses (or even former spouses incident to divorce) generally is a nonrecognition transaction leading to carryover basis.

Yet, for any partners in a partnership - regardless of degree of relationship or lack thereof - this second rule of IRC Section 704(c)(1)(B) is designed to curb the ability to use a tax partnership to effect a tax-free exchange of assets under the rules of Subchapter K. This is one prong of what are known as the mixing bowl rules, which generally create a 7-year lockdown period. If during this 7-year period, property that was contributed by one partner to the partnership is distributed to a different partner then IRC Section 704(c)(1)(B) applies to treat this as a deemed “sale” of the property to the distributee partner at its fair market value. The outcome is recognition and allocation of 704(c) gain or loss to the contributing partner as if the property had been sold to a third party under the original rule. However, gain or loss in excess of the 704(c) gain or loss does not get recognized and allocated among the partners as it would be if there was a third-party sale of the property. Code Section 737 generates a similar result where property other than contributed property is distributed to a contributing partner within 7 years.

Before exploring this further, note that this is not the only area of concern where Subchapter K is involved. Under IRC Section 721(b), as previously discussed, contributions of concentrated securities positions by partners can lead to recognition of gain at the time of exchange of assets for an interest in the (tax) partnership. This is, in effect, an acceleration of 704(c) gain that might otherwise get deferred and can have the effect of wiping out the future application of IRC Section 704(c) in and of itself. The purpose behind such outcome extends beyond the mere exchange of title of assets to the broader creation of the economics of diversification through Subchapter K, which otherwise would not be possible without gain recognition if a singular partner were to sell off concentrated positions outside of a partnership to achieve diversification.

This relationship between IRC Sections 721 and 704(c) is not direct or express but will come into play later when we explore the only ruling of value in this area between spouses. For now, however, let’s explore how the problem these Code Sections seek to solve may not exist for spouses who are not subject to Subchapter K.

Code Section 1041

This outcome can be unexpected for spouses holding interests in an entity that operates within Subchapter K, especially where different assets are contributed by each spouse. And to see why, we need to explore what happens in the absence of Subchapter K.

As noted above, IRC Section 1041(a)(1) provides that no gain or loss can be recognized on a “transfer of property from an individual to” a spouse. So, for example, let’s say one spouse has a concentrated portfolio of Apple stock. The other spouse has a concentrated portfolio of NVIDIA stock. Regardless of whether the spouses file jointly or separately, IRC Section 1041(a)(1) would allow them to directly or indirectly swap or exchange their shares in each portfolio. This could be by direct transfers between their individual brokerage accounts, or even could be the outcome of creating a joint brokerage account. (Note that such an outcome generally creates 50/50 ownership between spouses for estate tax purposes under IRC Section 2040, but could be an incomplete gift that in turn becomes traceable to individual contributions of a transferor spouse for disclaimer purposes under Treas. Reg. Section 25.2518-2(c)(4)(iii).)

However, if the spouses were to instead contribute their respective portfolios to a state-law partnership or LLC that is subject to Subchapter K then they lose this ability to effect a tax-free exchange that might otherwise exist under IRC Section 1041(a)(1). In such a case, IRC Section 721(b) itself could force gain recognition up front in a manner that creates the same outcome as a taxable exchange. And if IRC Section 721(b) does not apply, as might be the case if the spouses did not contribute securities up front, then a subsequent distribution of property back out to the spouse who was not the contributor of such property could invoke IRC Section 704(c)(1)(B) or 737 to cause gain recognition to the extent of the precontribution gain in such property.

As of now, there is no spousal exception to any of these Code Sections. No rulings have addressed the application of IRC Section 704(c)(1)(B) or 737 between spouses directly, but PLR 200317011 recognized that IRC Section 721(b) would not apply to spousal contributions to a partnership if the spouses first swapped assets under IRC Section 1041 to avoid the reach of that gain recognition rule when in turn assets were contributed to the partnership. Although the results are inequitable, for now we can assume that if Congress had intended to include a spousal exclusion it would have done so.

Unfortunately, the express terms of IRC Section 1041 do not provide us any relief – primarily because IRC Section 1041(a) by its terms only applies to a transfer from “an individual” and not from a third party like a partnership. A glimmer of hope may be found in Treas. Reg. Section 1.1041-1T, which recognizes opportunities for transfers by a third party to be treated as transfers on behalf of a spouse but these exceptions may be too narrow to recharacterize all transfers as being of a nature that IRC Section 1041 can somehow supersede the application of IRC Section 704(c) or, alternatively, layer in a nonrecognition rule for gain or loss that might otherwise be recognized under the mixing bowl rules.

Generally, if we look to Treas. Reg. Section 1.1041-1T(a), Q&A-2, Example 3, we find the following example which itself seems unclear:

Assume the same facts as in example (2) [permitting IRC Section 1041 nonrecognition to apply for a sale from a sole proprietorship owned by one spouse to the other], except that X Company is a corporation wholly owned by A. This sale is not a sale between spouses subject to the rules of section 1041. However, in appropriate circumstances, general tax principles, including the step-transaction doctrine, may be applicable in recharacterizing the transaction.

But, if we look to Treas. Reg. Section 1.1041-1T(c), Q&A-9, we see requirements set forth for a transfer to a third party on behalf of a spouse. Since this only covers transfers to a third party and not from a third party, we can assume that the recharacterization rule from the Example above would not apply to a transfer to a partnership. And at best this third-party transfer rule would cover the contribution to the partnership under IRC Section 721(b). This possibility was not covered by PLR 200317011, but that is not necessarily because it did not apply but is likely due to (1) the application of a PLR just to the facts submitted and (2) that the pre-contribution application of a direct 1041 swap between spouses rendered the issue of a transfer on behalf of a spouse to a third party (the partnership) to be moot.

And while the Example above highlights the possibility of step transaction principles applying, in that specific scenario we need to understand the motivation. Since one spouse in that Example was the sole shareholder of a C corporation that in turn was selling property to the non-shareholder spouse, the argument could be made that the shareholder spouse was benefitting from that transfer and perhaps was attempting an end-run at the alternative – that (1) the property is distributed out of the corporation to the shareholder spouse in a way that triggers IRC Section 301, and then (2) the shareholder spouse was deemed to sell the property to the non-shareholder spouse in a transaction that indeed qualifies for IRC Section 1041. In effect, this is a transaction that is presumably directed by and benefits the shareholder spouse so the shareholder spouse (instead of the C corporation itself) should be subject to the tax consequences of that sale.

We could argue the same in the 704(c) scenario – that a distribution of property contributed by one spouse, to the other spouse, benefits the contributing spouse in this manner. The problem becomes that 704(c) still causes that contributing spouse to incur tax liability for the transfer, because the nature of the partnership is that the spouse is not shifting tax liability to it but instead that it is generating pass-through tax liability. And if we just apply the bare facts of such Example to a situation where a partnership owned by spouses sells property to a spouse, the outcome of IRC Section 704(c)(1)(B) is to treat a distribution as a deemed sale to the non-contributing distributee spouse (to the extent of 704(c) gain) to begin with.

Which brings us to the nature of Subchapter K. It serves (in the author’s opinion) as a set of book and tax accounting principles to align the economic benefits derived by each partner with the tax on those economic benefits. But this accounting is necessary because while the partnership itself is not a tax-paying entity under Subchapter K, it is respected as an independent legal owner of property for state-law purposes that in turn conveys other state-law benefits previously alluded to (centralized management and charging order protection). This squares with the state-law principle that the partners are generally not treated as direct owners of their proportionate shares of partnership property, contrasted with the principle of Treas. Reg. Section 301.7701-1(a)(2) that joint ownership of property in and of itself does not create an entity (like a partnership) for tax purposes.

Conclusion, and a Solution?

So, if we return to our original premise - that spouses are unfairly penalized for the use of the partnership form when the harms that 704(c) and 721(b) seek to prevent cannot exist outside of the partnership between spouses – we find that the non-tax protections of the partnership form may create a colorable reason as to why this is the case. Since Subchapter K aligns the economic benefits of ownership of property through an entity taxed as a partnership (including non-tax benefits) with the actual taxation of these benefits, it stands to reason that a rule intended only for transfers of direct property interests between spouses (IRC Section 1041(a)) perhaps cannot extend to exchanges of economic benefits between them through Subchapter K.

But we also come back to a core principle that IRC Section 1041(a) could apply to a direct exchange of partnership interests between spouses. And it is true that this could even be used to avoid the application of IRC Section 704(c) if portions of interests can be carved off to proportionately correspond to the contributed assets themselves. But for now it does not appear that exchanges of economic benefits within the partnership itself can be disregarded, even if spouses file jointly.

Now, it is worth noting that the disguised sale rules of IRC Section 707(a)(2)(B) could possibly come into play, especially where these rules might treat the combined spousal contributions and distributions as being a “transaction between 2 or more partners acting other than in their capacity as members of the partnership.” This may (if applicable) invoke an exception to IRC Section 704(c) itself set forth in Treas. Reg. Section 1.704-3(a)(5) which exempts a sale of property to the partnership from 704(c) itself.

This possibility of an interspousal disguised sale will be discussed in a subsequent article, but for now it is important to consider that these same issues can arise where two grantor trusts (each wholly-owned by each spouse, respectively) contribute to a partnership or receive distributions. In PLR 201927003, a spouse’s sale of a partnership interest to a trust that was a grantor trust for which the other spouse was the deemed income tax owner (of all trust assets and income) was deemed to be a sale between spouses for purposes of IRC Section 1041. This could have special importance for SLATs in particular, as discussed in a prior article. It also means that grantor trusts wholly-owned by each respective spouse (like SLATs) could themselves exchange assets and claim the nonrecognition rule of IRC Section 1041, even though this might be outside of the limited one-way scope of PLR 201927003. But since 704(c) applies to any partner, the same issue would arise for a contribution of different assets to a tax partnership by the trusts even if the differences are slight.

As noted above, subsequent articles will pull the thread of whether relief can be found through a disguised sale, or other exceptions to IRC Section 704(c). But for now, the safest way to avoid the trap of IRC Section 704(c)(1)(B) for spouses contributing property to a tax partnership is to have spouses equalize their asset ownership before contribution through transfers described in IRC Section 1041(a), and/or to ensure that distributions to spouses are proportionate or consist only of respective spouses’ contributed property. For securities, this may mean tracing and equalizing assets on a tax-lot by tax-lot basis. Transfers of just community property can avoid this by giving the option to elect disregarded entity status under Rev. Proc. 2002-69, but this outcome may not be possible for trusts that are intended to hold separate property for estate and gift tax planning purposes. Grantor trusts (like SLATs) wholly owned by each respective spouse could also potentially be covered by IRC Section 1041(a) in effectuating such a precontribution swap for purposes of minimizing exposure to the subsequent application of IRC Sections 721(b) and 704(c)(1)(B).

Share

Subscribe now

1. Where We Left Off

2. GST Trusts

3. Hanging Powers and Automatic Allocation

4. Incomplete Gift Powers

5. Conclusion

Where We Left Off

In the last generation-skipping transfer (GST) tax article, we discussed how annual exclusion gifts to irrevocable trusts may require allocation of GST exemption if not described in IRC Section 2642(c)(2). These transfers may or may not be subject to automatic allocation, but if not an affirmative allocation of GST tax exemption is needed to maintain a trust’s zero inclusion ratio (ZIR). This affirmative allocation requires the filing of Form 709.

Subscribe now

This is where the issue from the last article comes into play, because if Form 709 is not required there is often a reluctance to file it and instead to rely upon automatic allocation (if available). This especially becomes the case with certain “entry-level” trusts such as ILITs, or simple gifting trusts to children and descendants, that are designed to maximize annual exclusions. It is easy to establish such trusts, but the maintenance of such trusts is often glossed over during the drafting phase. And if these trusts are funded with assets with a value that exceeds the available annual exclusion(s) (which would invoke the requirement to file Form 709 anyway since the exception in IRC Section 6019(1) can no longer be met), the Crummey powers needed to generate such annual exclusions can create accounting nightmares.

If you have not done so, you are encouraged to read prior coverage of the types and nuances of Crummey powers as this information will be relevant to understanding this article. (A search tool is provided at the top of the main newsletter page for paid subscribers.) As covered in such articles, the common types of Crummey powers are:

• Hanging powers;

• Incomplete gift powers;

• IRC Section 2514(e) powers; and

• IRC Section 2642(c) powers.

As a reminder, Crummey powers are not the same as five-by-five powers. The former represents a one-time, lapsing right to withdraw triggered by a contribution to the trust that is a transfer of property by gift. The latter represents an annual right that typically applies to the principal of the trust that has already been subject to gift or estate tax, or an exception thereto (such as a sale to the extent of adequate consideration). Both powers, however, operate from the same lapse mechanism set forth under IRC Section 2514(e) whereby there is no gift from the powerholder to the other trust beneficiaries so long as the lapsed amount is limited to the greater of (1) $5,000, or (2) 5% of the value of the assets from which the power could have been exercised. A Crummey power rarely uses the 5% limitation since it can only be exercised up to the available annual exclusion for a holder (currently $19,000, reduced by any other prior calendar-year gifts to the holder), and 5% of that figure ($950) does not exceed $5,000.

That being said, it is this lapse limitation that presents the issue we will discuss today – whether Crummey powers can actually qualify for automatic allocation of GST tax exemption. As noted above and in the prior article, this becomes an issue where the settlor does not know Form 709 should be filed, or is reluctant to do so when there is no requirement to file under IRC Section 6019. It also reveals a significant gap for those who draft and implement trusts with Crummey powers, as it means an inability to adequately set expectations for the client can get them or their beneficiaries (and, thus, the drafter) in trouble.

GST Trusts

To start, we must know whether the transfers to the trust are direct skips or indirect skips. If the only current beneficiaries of the trust are skip persons, Treas. Reg. Section 26.2612-1(d)(2) treats the trust as a skip person. This is important because if the trust is treated as a skip person, then transfers to that trust will be direct skips. Such direct skips do not fall victim to the same automatic allocation issues highlighted below, as IRC Section 2632(b) provides for automatic allocation to direct skips unless there is an election out.

However, most trusts have a mix of non-skip persons and possibly skip persons as the beneficiaries holding current “interests” in the trust (as defined in Treas. Reg. Section 26.2612-1(e)). In such a case, the transfer would not be a direct skip. Instead, IRC Section 2632(c)(3)(A) classifies any transfer that is not a direct skip as an indirect skip so long as the transfer is made to a GST trust.

Under IRC Section 2632(c)(1), indirect skips are subject to automatic allocation unless there is an election out. However, the classification of a transfer as an indirect skip (and thus the availability of automatic allocation) is first determined by whether the transfer is to a GST trust. And under Treas. Reg. Section 26.2632-1(b)(2)(i), this automatic allocation is only available for indirect skips occurring after December 31, 2000.

Read more

One of the most complicated areas of estate and tax planning, which can apply at any level of wealth, is navigating the rules relating to required distributions from retirement assets. These assets can include traditional and Roth IRAs, as well as employer-sponsored plans such as the 401(k), 403(b), or 457 plan.

Subscribe now

Perhaps the most difficult application of these rules, especially after the SECURE Act (1.0 and 2.0), is what happens when an employee or owner who has contributed to such a plan or account dies. At this point myriad rules based on type and age of beneficiary, payout status for the plan or account, plan terms, and other elections can kick in. Keeping them straight can be difficult.

So, for those who want a quick onboard to these rules I recorded a ~15-minute video to cover them. This is not designed for mastery, but instead is designed to give you a resource to quickly absorb the foundational knowledge needed. The slides themselves are available for paid subscribers below (mainly to limit public access), but feel free to share the slides and video with the associates or other professionals within your firm or network.

Share

The Video

I’ve titled this the “shortest” video on these rules ever, but that is not intended to be indicative of a lack of quality nor a guarantee that it is indeed the shortest video ever. At the same time, I am purposefully light on a few areas that are easily read and digested such as determining the required beginning date, the four requirements for a see-through trust, and the documentation and administration timelines that apply after death. Instead, the focus here is on foundational knowledge for determining various payout periods - especially where there are multiple beneficiaries directly or by virtue of the see-through trust rules. We also discuss which beneficiaries “count” under the see-through trust rules along with some use cases for various forms of trusts (conduit, accumulation, and AMBT).

Slides (Paywall Applies)

Read more

ABOUT THE AUTHOR: Tim Harden is a CPA with Brady Martz, who works with estates, trusts, and individuals to provide tax saving strategies and compliance services. He has an extensive background in the field of trust, estate, and gift tax, including the areas of probate, asset protect, and complex trust and estate planning with tax compliance, including roughly 16 years as an attorney in this area prior to changing his focus to public accounting.

Introduction

At first glance, the rules for reporting depreciation for trusts and estates might not seem that important because a lot of trusts only own investment assets. However, there are two reasons why these rules are both relevant and, indeed, important. First, an increasing number of nongrantor trusts own interests in business entities that are taxed as S corporations or partnerships, from which the depreciation will flow through to the trust owner. This is due to the increasing frequency of estate planning techniques that have resulted in many transfers or sales of business interests to trusts to freeze their value at the time of the transfer for estate tax purposes. Many of these were structured as sales to grantor trusts, but as the population ages, the grantors die, and the trusts will become nongrantor trusts. In addition, in certain parts of the country, oil and gas trusts are popular and common, which opens the potential for depletion deductions.

Subscribe now

Further, the use of revocable living trusts has become more common in recent decades, with grantors transferring most if not all their assets to the trusts to avoid probate and provide for a more secure succession of ownership and management of businesses. The deaths of these grantors will also turn these into nongrantor trusts at some point soon, with a potential step-up in basis that generates new depreciation deductions. Thus, there could be depreciation deductions both for businesses and rental properties that were transferred to these revocable living trusts that must be analyzed and reported correctly. Second, the rules are specialized and do not necessarily give the results that would be assumed by the practitioner generally familiar with trusts.

Having established that it is important to understand the rules for depreciation deductions taken by trusts, we can begin to look at the framework for how the rules specifically apply. First, it is necessary to note that under Section 179(d)(4), nongrantor trusts and estates are not eligible for the Section 179 deduction, which otherwise would allow the deduction of the full amount of qualifying assets when they are placed in service. There is a possible workaround in this area for trusts and estates that own partnership (although not S corporation) interests, however, that we will discuss in Part Two of this article.

In terms of regular depreciation deductions, it is well established that under the Internal Revenue Code, trusts are entitled to take a deduction for depreciation. However, depreciation is not apportioned between the trust and the beneficiaries in the same manner as for items of income and expense. Instead, the beneficiary gets to take to the deduction based on a comparison between the distribution, if any, to the beneficiary and the accounting income of the trust. This can create surprising results, especially if the tax practitioner had been operating under the assumption that the depreciation would be allocated in the same manner as items of income and expense.

This two-part article will explain how the apportionment works, with examples, cover the application of Section 179, and then it will also explore the less frequently used “reserve” exception to this rule.

General Rules for Apportionment of Depreciation

Read more

1. Background

2. Present Interest Treatment

3. Safe Harbor of Rev. Proc. 2026-25

   1. Which Comes First? Filing, or Present Interest?

   2. GST Tax Traps

   3. The Service’s Justification

   4. Taxable Gifts as a Circular Definition?

4. Conclusion

Background

Without diving too deep into the details of creation and mechanics, one of the added benefits under OBBBA was the establishment of Trump accounts. These accounts are like an IRA, but for minors (under the age of 18) and can be funded with unearned income. There are generally five forms of contributions that are permitted to a Trump account under IRC Section 530A(c):

Subscribe now

• An initial $1,000 as an allocation of what would otherwise be a parent’s income tax liability for a child born between January 1, 2025 and December 31, 2028;

• A qualified general contribution from a governmental or charitable entity;

• An employer contribution (aggregated with and subject to the individual cap below);

• A complete rollover from another Trump account; and

• An individual contribution, from anyone, of up to $5,000 (per child, not donor, adjusted for inflation) annually.

It is this last type of contribution that has created some confusion, especially given the latest guidance set forth in Revenue Procedure 2026-25. This revenue procedure was published to provide guidelines on the gift tax treatment of contributions to a Trump account. However, as we will see below, these rules do not operate the same as for other types of contributions to a minor’s account such as a 529, UGMA, or UTMA.

Present Interest Treatment

Transfers to minors typically require a custodian, guardian, or similar adult or institution to take custody of and manage the funds on behalf of a minor since minors cannot enter into contracts. Thus, the minor’s access to the funds is typically delayed until age 18 or 21. Since the gift tax annual exclusion under IRC Section 2503(b) typically only applies to a present interest (i.e., an interest in property for which the donee’s possession or enjoyment is immediate and unrestricted), this delayed enjoyment would prevent such accounts from being present interests. Nonetheless, there is specific guidance for a variety of transfers for minors that permit present interest treatment such as Crummey powers (that can be exercised by a guardian on behalf of the minor), 529 plans, UGMA and UTMA accounts (see Rev. Rul. 59-537), and ABLE accounts (see Treas. Reg. Section 25.2503-3(a)).

A Trump account cannot be accessed until the child for whom the account is established reaches age 18, which would on its face create a future interest that does not qualify for the gift tax annual exclusion absent some specific statutory, regulatory, or other guidance. On this note, it is important to distinguish between the present interest requirement and the requirement to file a gift tax return in general. Under IRC Section 6019, a donor does not have to file a gift tax return for a calendar year during which all of their gifts meet certain requirements. One common filing exception is found in IRC Section 6019(1), whereby a gift tax filing can be avoided if no gifts exceed the available gift tax annual exclusions under IRC Section 2503(b).

Put differently, this means a gift of a future interest of any amount would have two concurrent effects. One, it would trigger a requirement to file a gift tax return. Two, it would use some of the donor’s applicable credit against gift tax, which is based on the lifetime applicable exclusion. This exclusion is the sum of the (1) basic exclusion amount (currently $15,000,000 for 2026, indexed for inflation starting in 2027), (2) the deceased spousal unused exclusion (DSUE) amount of the most recently-deceased spouse, and (3) any DSUE of a previously-deceased spouse (if someone is widowed twice or more) if applied before the death of a subsequent spouse as applicable credit against gift tax.

While this is dense legal background, it is presented to highlight that the present interest requirement is typically determined independent of the gift tax filing requirement. Otherwise, there would be no way to determine if there is an exception to the filing requirement to begin with for present interests that are all at or below the available annual exclusion(s). However, while this is the typical outcome the guidance of Rev. Proc. 2026-25 presents a safe harbor that is anything but typical.

Safe Harbor of Rev. Proc. 2026-25

The aforementioned safe harbor, for which we will explore the qualifiers below, is stated as follows:

If each of the requirements specified in section 4.02 of this revenue procedure is met for a calendar year in which a tax­payer makes contributions to one or more Trump accounts, each Trump account contribution made by the taxpayer during that calendar year will be treated as a com­pleted gift to the account beneficiary that is not a future interest in property and to which the annual exclusion applies for purposes of gift tax, GST tax and gift tax reporting.

In other words, meeting the safe harbor means that the transfer to a Trump account will be treated as a gift of a present interest. However, the safe harbor requirements under section 4.02 of the procedure do not appear to treat this present interest exception as being independently determined apart from the filing requirements themselves. To illustrate this, we will look at the safe harbor requirements – not necessarily in order.

Which Comes First? Filing, or Present Interest?

To start, we see the following requirement:

(5) Disregarding the Trump account contributions described in section 4.02(2) of this revenue procedure, no gift tax return is required to be filed, and no gift tax return is otherwise filed, for that cal­endar year by or on behalf of the taxpayer, whether for GST tax, portability, or other purposes.

In other words, if you already had to file a gift tax return notwithstanding the Trump account contribution on behalf of a child, then obviously you cannot use the safe harbor to avoid filing a gift tax return. But this presents a problem. Since the safe harbor in section 5 speaks in terms of “each of the requirements in section 4.02” having been met, this means perhaps that a Trump account contribution cannot be treated as a present interest gift if you are otherwise required to file a gift tax return.

Before examining this further, it is important to note that IRC Section 530A itself does not address the gift tax treatment of Trump account contributions. This can be contrasted with 529 plans, for example, that benefit from a specific statutory carve-out that not only treat them as gifts of present interests but that also permit up to 5 years’ worth of annual exclusion amounts to a contribution in one calendar year. At first glance, one might wonder if this difference is due to the fact that a 529 plan can be funded with a much larger amount than a Trump account (for which aggregate individual contributions are capped at $5,000 annually, adjusted for inflation). But if we look to another corollary – the Coverdell education savings account under IRC Section 530 – we see that these accounts, although capped at $2,000 per year, nonetheless benefit from statutory treatment as present interest by incorporating by reference the 529 account treatment under IRC Section 530(d)(3).

GST Tax Traps

Another hidden trap here is that the safe harbor also refers to the annual exclusion for “GST tax” purposes. As a result, this could also mean that having to file a gift tax return for the year also means that you must allocate GST tax exemption if an individual contribution is being made to a Trump account for a skip person (like a grandchild). And while a Trump account itself might be treated as a “trust” for GST tax purposes under the definition of IRC Section 2652(b), the account itself should be treated as a skip person under Treas. Reg. Section 26.2612-1(d)(2) since only a single skip person beneficiary holds all interests in the account. As a result, the transfer to a skip person would be treated as a direct skip regardless of classification as a present or future interest. But counterintuitively, this can create a situation where the GST tax annual exclusion is not guaranteed.

The trickle-down effect is that GST tax exemption would get automatically allocated to a Trump account contribution for a skip person if a gift tax return is filed, or that an election out would trigger GST tax liability. (As noted in a prior article, choosing to pay this GST tax could be an arbitraged way to reduce the gross estate – although the numbers here for a single contribution probably would not move the needle.) But if no gift tax return is required to be filed under the safe harbor, then the contribution should be treated as a nontaxable gift having an inclusion ratio of zero (i.e., the GST tax annual exclusion) under IRC Section 2642(c)(3). This would be the outcome regardless of treatment of the account as a “trust” since IRC Section 2642(c)(2) extends this treatment to a trust when the beneficiary is the sole beneficiary and is subject to gross estate inclusion for the account. Code Section 530A generally creates such treatment.

The Service’s Justification

As to why this filing-drives-present interest is perhaps the outcome, section 3 of the procedure states:

The Treasury Department and the IRS understand the concerns raised in public comments and recognize that the vast majority of individual donors to Trump accounts are unlikely to ever owe federal gift, estate or GST tax due to the lifetime basic exclusion amount of $15,000,000 and the corresponding $15,000,000 GST exemption amount.

Further clarification of this remark is provided later in this same section:

In addition, gift tax reporting compli­ance by these donors could dramatically increase the burden on the IRS to process gift tax returns for individual donors who are unlikely to ever be subject to gift, estate, or GST tax. Given the fact that nearly 6,000,000 elections to open Trump accounts have already been received, the number of gift tax returns filed annually could be expected to increase from roughly 300,000 to several million.

Taxable Gifts as a Circular Definition?

Given this background, let’s explore the other requirements. Requirement (1) of section 4.02 simply notes that the taxpayer (donor) is an individual, as would be the case anyway for an individual contribution to a Trump account. But requirement (2) paraphrased goes on to require that the only “taxable gifts” made during the year are cash contributions to a Trump account. This term “taxable gifts” is highlighted to emphasize requirements (3) and (4) of this section 4.02, as follows:

(3) The taxpayer’s total gifts during the calendar year to each individual who is an account beneficiary, including con­tributions to that account beneficiary’s Trump account, do not exceed the annual exclusion amount under section 2503(b) ($19,000 for 2026);

(4) Such contributions to Trump accounts made during the calendar year do not generate for that calendar year either a gift or GST tax liability, after applica­tion of the taxpayer’s remaining applica­ble credit amount against the gift tax, or remaining GST exemption… .

Since the term “taxable gifts” is applied after the subtraction of any available annual exclusions, this at least reveals that perhaps this treatment and outcome was not an accident. This is because the two subsequent requirements quoted above contextually create a presumption that the individual contributions to Trump accounts would be treated as future interests (and thus taxable gifts) but for the safe harbor, if satisfied. Otherwise, there would be no way that the condition in requirement (4) – that the gift generates gift tax or GST tax liability due to exhaustion of the exclusion and exemption respectively – could be satisfied.

And it is important to note that requirement (3) speaks only to whether the sum of individual contributions to the donee’s Trump account, and all other “gifts” (not taxable gifts) to the donee for the calendar year, exceed the annual exclusion amount. This does not define Trump account contributions as present interests, but merely sets the stage for the condition that if they are so treated then the usual non-filing exception requirement of IRC Section 6019(1) (of not exceeding the annual exclusion for any one donee) would apply.

Conclusion

At the very least, this revenue procedure creates an odd outcome whereby a required or even elective 709 filing for any given calendar year (such as for allocation of GST exemption, or a GST election, or even reporting a non-gift transaction to get the 3-year period running on a valuation) would automatically cause all Trump account contributions for the year to be treated as future interests that are not eligible for the gift tax annual exclusion. This itself could create some circular or retroactive outcomes. For example, if a Crummey power was also created in the same year by the same donor for a beneficiary of a Trump account then a gift tax filing for the year would increase the Crummey power to $19,000 while, in the absence of a required filing, the treatment of the Trump account contribution could shrink the Crummey power to $14,000 if the power is created after the date of contribution.

So if your practice is to file gift tax returns each year to affirmatively allocate GST tax exemption to such powers, then this revenue procedure counterintuitively will convert Trump account contributions into future interests to be reported on each such return. And in turn, special attention will need to be given to scenarios where a Crummey power or other present interest gifts are also made to a Trump account beneficiary in the same year when computing gifts and the annual exclusion.

In the grand scheme of their stated purposes within this revenue procedure, the Service has accomplished what they intended to do – preventing an influx of gift tax returns by donors who otherwise would not typically make any other gifts for a calendar year. But at the same time, the reduction of a burden for one form of taxpayer has increased the burden for taxpayers who might choose to make structured annual exclusion gifts. The coupling of the present interest requirement to the question of whether a gift tax return is filed to begin with seems, at the very least, counter to the weight of authority which independently makes this determination. In other words, a chicken-and-the-egg determination results when you compare other types of transfers (where the present interest treatment controls the requirement to file) versus Trump accounts (where the requirement or choice to file controls the present interest treatment).

Share

Subscribe now

1. Where We Left Off

2. Form 709, Schedule D, Part 2 Misreporting

3. Form 706, Schedule R, Part 1 Misreporting – or the Absence Thereof

4. Key Takeaways

Where We Left Off

While this has been a series on “advanced” generation-skipping transfer (GST) tax, this article will take a step back into more basic territory. But it reveals territory that is necessary to cross before moving onto more advanced topics, including a continuation of the automatic allocation rules at death that we discussed in the last GST tax article.

Subscribe now

This article is not intended to serve as a full recitation of the automatic or affirmative allocation rules, or the various elections or options relating thereto. However, the automatic allocation rules serve as a supporting cast because they can create recordkeeping nightmares. These nightmares start in IRC Section 6019, which sets forth the requirements as to when and whether a gift tax return must be filed on IRS Form 709 for the year. To paraphrase IRC Section 6019(1), if no gifts exceed the annual exclusion set forth in IRC Section 2503(b) (for gifts of present interests) then no gift tax return is required.

In other words, if the only gifts during the year are annual exclusion gifts (whether direct or in trust), no 709 would need be filed. And this is of no consequence for subsequent gift tax filings, because these annual exclusions do not get counted in taxable gifts and thus do not affect the calculation of the available applicable credit against gift tax.

There is a problem, however, when it comes to GST tax. Just because a gift qualifies for the annual exclusion does not mean that no GST tax exemption will be allocated. If the gift is a direct skip, then per IRC Section 2642(c)(1) the “nontaxable gift” (i.e., the portion qualifying for the annual exclusion) is granted a zero inclusion ratio and thus is not subject to allocation of GST tax exemption. But if the transfer is in trust for the benefit of an individual, IRC Section 2642(c)(2) states that this rule does not apply (even if the gift qualifies for the annual exclusion) unless the individual in question is (1) the sole trust beneficiary for life, and (2) will have the remaining undistributed trust assets included in their gross estate at death.

What does this mean? It means that transfers in trust that are subject to Crummey withdrawal rights nonetheless require allocation of the transferor’s GST tax exemption unless they meet the requirements of IRC Section 2642(c)(2). Structuring Crummey powers in this manner is more the exception than the norm, and can create accounting nightmares independent of the concerns set forth in this article. But if no gift tax return is filed for such Crummey gifts, it is possible that the automatic allocation rules could apply to such gifts (for gifts made after December 31, 2000). This is because automatic allocation applies for any trust that is a “GST trust” to the extent necessary to create a zero inclusion ratio under IRC Section 2632(c)(1). We will skip broader discussion of what exactly creates a GST trust for now, including elections, other than to point out that the flush language in the last sentence of IRC Section 2632(c)(2)(B) generally provides that a Crummey power in and of itself will not prevent a trust from being a GST trust (even though it could create an ETIP for a spousal Crummey power).

The outcome is that GST exemption potentially gets allocated to Crummey powers in non-filing years. And if a trustee and/or donor are not manually tracking these amounts and communicating them to the tax filer, the amount of GST exemption available for subsequent allocation may be overstated. Let’s explore the downstream implications.

Form 709, Schedule D, Part 2 Misreporting

The reconciliation of prior years’ and current year’s allocations of GST tax exemption is reported on Part 2 of Schedule D of Form 709. Lines 1-3 of this part are vital:

To start, line 1 reports the maximum allowable GST tax exemption for the year of filing. Per IRC Section 2631(c), this amount equals the estate tax basic exclusion amount for the year. In 2026, this amount is $15,000,000. (As an aside, while it seems difficult to incorrectly state this amount, I have seen it happen. One draft 709 I reviewed for gifts made in 2020 reported this amount as $1,000,000 – which has not been the exemption since 1998! This revealed the use of forms, or assembly software, that was dramatically outdated.)

A more-frequent source of errors is found in line 2. This line lists the GST tax exemption used for tax years before the current 709. It is common for preparers to simply carry over allocations reported on Part 2 of Schedule D from prior years. But simply carrying over allocations might disregard automatic allocations that occurred in non-filing years. As noted above, this can include Crummey gifts that were subject to automatic allocation but that nonetheless did not have to be reported on Form 709 under the filing exception of IRC Section 6019(1). The outcome can be two-fold:

• The amount of remaining GST tax exemption is overstated; and

• As a result, trusts that are believed to have a zero inclusion ratio (by virtue of allocating exemption in excess of the true available amount) may actually have an inclusion ratio greater than zero.

To address this possibility, it is a matter of good practice to include a statement of allocation explaining the use of GST tax exemption in non-filing years that precede the Form 709 in question. It is also important to note, however, that Crummey powers for the year 2000 or before would have required a gift tax return filing to allocate GST exemption to begin with. Otherwise, late allocation based on the current value of the trust is required (which can perpetuate the accounting nightmares alluded to above) unless relief can be sought under Rev. Proc. 2006-46 for non-filing years during which Crummey gifts to the trust occurred.

And, as mentioned in prior articles, timing of gifts matters. If a cash gift is made to an individual early in the year (in an amount less than the annual exclusion), then later that year a Crummey power is created by the same donor, the Crummey power may be limited to the unused annual exclusion with respect to the donor’s gifts to that individual. This can reduce the amount of GST tax exemption allocation required but, if this information is not available to the Form 709 preparer, it can also mean that the reported amount of allocation is inaccurate. (We will forego the broader issue of whether a gift tax return might actually have been required to be filed in what were assumed to be non-filing years.)

Form 706, Schedule R, Part 1 Misreporting – or the Absence Thereof

This issue cascades down to the allocation of remaining GST tax exemption at death, as introduced in the last article. This allocation takes place regardless of whether or not Form 706 is actually filed. And even if it is filed, this allocation takes place if Schedule R is omitted from Form 706. It is on this schedule that, as with the gift tax return, remaining GST exemption first gets reconciled and then allocated (whether automatically or affirmatively). And, it is where we see the same potential source of errors if Crummey gifts from non-filing (for gift tax) years were made that were subject to automatic allocation:

This puts the onus on the executor, and/or the Form 706 preparer, to be able to track down and reconcile the information needed to present an accurate remaining GST tax exemption figure after taking into account lifetime transfers (without input from the decedent since, it goes without saying, the decedent is not available to relay this information.) And even if no Form 706 is required to be filed under IRC Section 6018, this onus persists since it is this remaining figure that will be subject to the automatic allocation rules at death. As a reminder, this “final” automatic allocation kicks in at the due date (counting valid extensions) for Form 706 but is deemed to have occurred on the date of death as we will discuss in an upcoming article.

Again a statement may be required to explain disparities between (1) the GST exemption actually allocated (affirmatively or automatically) on Form(s) 709, and (2) any automatic allocation(s) not actually reported on Form 709. (As another reminder, affirmative allocation typically requires a complete Form 709 or 706 filing.) In addition to the concerns above, this also means that the executor must determine if and when lifetime transfers were made for which a gift tax return might have been required but that nonetheless was not filed. If automatic allocation did not apply to such transfers at the time of each unreported gift, late allocation may be required on the 706 itself.

Key Takeaways

Given how few 706’s are actually filed at our current basic exclusion of $15,000,000 per U.S. citizen or resident, the burden is increasingly being shifted to executors and/or trustees to determine if and when at least a final allocation of GST tax exemption might have occurred to a trust. Where 709’s cannot be found or are missing (especially for transfers occurring after the grandfathered trust cut-off date of September 25, 1985 to be discussed in subsequent articles), it becomes even more difficult to definitively determine the inclusion ratio for transfers in trust occurring during a decedent’s life or even as a result of their death.

And without intending for this to be an indictment of tax preparers of any background or qualification, the portions of Forms 709 and 706 dealing with the allocation of GST tax exemption often do not receive the attention they deserve. In fact, I am not alone in having observed the GST tax schedules being left completely blank on these forms even when transfers that are subject to allocation have been made. Such an outcome can also reveal a lack of attention to the presence or absence of vital trust-level elections from prior gift tax returns, such as elections in or out of automatic allocation or elections to treat a trust as a GST trust.

Education on “how” to review and/or prepare such returns is sorely needed, but this education is hard to come by. And while this newsletter attempts to tackle these issues, there is no substitute for real-world experience. This experience itself can be difficult to come by as well in a world where transfer tax filings are less frequent, and many who are pressed into service to prepare or review a 709 or 706 can find themselves feeling like Mike Ross from Suits when asked to file a patent. So, if you are a wealth transfer professional[1] and this is an area where you would like further education please reach out. (In fact, it is one reader’s question that prompted this article to begin with.) I am working on general and bespoke solutions to assist.

Share

Subscribe now

[1] This is not intended to serve as a solicitation for legal or tax services on my part. This is simply offering education to those who are licensed to benefit from such education.

1. Where We Left Off

2. Multiplication of Exclusions

3. Effects of Basis Adjustment under IRC Section 1014 on QSBS

   1. Step-Up, and IRC Section 1202(i)

   2. Step-Down in Basis

   3. No 1202(i) Floor Amount(s)

4. What’s Next?

Where We Left Off

As we enter this July 4^th weekend, it is hard to believe that it has been a year since President Trump signed the budget reconciliation bill originally known as “OBBBA” into law. While this Act introduced some new tax provisions that remain unclear even after a year, it also enhanced some long-standing tax benefits such as qualified small business stock (QSBS) that were confusing even before the Act.

Subscribe now

In the last QSBS article, we discussed how the original issue requirement for qualified small business stock can be broken when stock is transferred to or from pass-through entities. To recap, unless the original issuance is to the pass-through entity itself (S corporation or tax partnership) then a sale of stock does not permit pass-through gain to be excluded by the owners of the entity. While a tax partnership (that received original issue stock) can distribute the stock out to its partners without breaking the “chain” of original issuance, both this distribution rule and the pass-through gain rule disregard allocations or distributions that exceed the share that a partner would have received based on their interest in the partnership held at the time of original issuance.

Another transfer that does not break the “chain” of original issuance is a transfer at death under IRC Section 1202(h)(2)(B). However, this raises other questions and implications that must be considered for purposes of determining the gain exclusion of each recipient of stock. This article explores some of these issues.

Multiplication of Exclusions

A question that might arise is whether a transfer at death to multiple heirs would, in turn, force them to use the decedent’s gain exclusions set forth under IRC Section 1202(b)? Or, would each heir’s individual gain exclusion (an applicable dollar amount per issuer or, if greater, 10 times basis) be applied in a multiplicative manner?

As an example, let’s assume the decedent had 6 children – one of whom predeceased the decedent but had 2 children (grandchildren of the decedent). There is a per stirpital allocation of the decedent’s 6,000 shares of QSBS from Corporation A, and 9,000 shares of QSBS from Corporation B, to the descendants. This means each living child will receive 1/6^th of the shares of each issuer – 1,000 shares of Corporation A and 1,500 shares of Corporation B. And, the decedent’s two grandchildren will each receive 1/12^th of the shares – 500 shares of Corporation A, and 750 shares of Corporation B.

In such a case, IRC Section 1202(h)(1) specifies that each descendant will be treated as having acquired the stock in the same manner as the decedent (i.e., by original issue). It also provides that each descendant will be treated as having the decedent’s holding period for the stock. So, before we can even determine if gain is excluded we need to determine whether the applicable holding period requirements of IRC Section 1202(a) are met (assuming that the two corporations each meet the qualified small business requirements). This is where the wording of the Code section can create some uncertainty at first glance. In particular, IRC Section 1202(h)(1)(B) treats a transferee as:

…having held such stock during any continuous period immediately preceding the transfer during which it was held (or treated as held under this subsection) by the transferor.

Does the use of “immediately preceding” mean you can only tack the decedent’s holding period in a transfer at death? This is of no consequence if the original QSBS issuance was to the decedent themselves, but what if in turn the decedent had at some point acquired the QSBS in a transfer described in IRC Section 1202(h)(2) (by gift, at death of another, or from a partnership)? If you were to read “immediately preceding” in isolation, the natural conclusion would be that only the most recent transferor’s holding period would count. But this ignores the parenthetical “(or treated as held [by the transferor] under this subsection)” which means that holding periods all the way back to original issue should be tacked so long as the transfers have qualified under “this subsection” (IRC Section 1202(h)). An isolated interpretation of “immediately preceding” would mean a resetting of the holding period to a date later than the original issuance date, which does not seem consistent with the intent of how the QSBS principles are to be applied.

However, what IRC Section 1202(h)(1) does not expressly address or carry over are the per-issuer limitations on the eligible gain that can be excluded. The only implications of IRC Section 1202(h)(1) are that a transferee has the same acquisition date and holding period as the transferor(s) going back through the chain of transfers described in IRC Section 1202(h)(2). Arguably, if there was an intent to tack the decedent’s remaining limitations it would have been stated here. Instead, as we see under IRC Section 1202(b) the limitations (applicable dollar amount or 10x basis, per issuer in either case) apply to “the taxpayer.” Read together, a logical conclusion is that each of the 5 children and two grandchildren who inherit stock from the decedent in our example above would receive their own gain limitations after taking into account the applicable percentage based on (tacked) holding period.

Note also that the applicable dollar limit, and 10x basis, limitations apply on a per-issuer basis under IRC Sections 1202(b)(1) and (b)(4). If the inherited QSBS had been originally issued on or before July 4, 2025, this means the applicable dollar limit for each descendant would be $10,000,000 for their Corporation A shares and also, separately determined, $10,000,000 for their Corporation B shares. This is increased to $15,000,000 adjusted for inflation if the QSBS is issued after July 4, 2025. And, if greater than these applicable dollar amounts (after taking into account reductions for prior dispositions, but not including inflation adjustments to the $15,000,000 per issuer dollar limit once exhausted), each descendant can use their 10 times basis exclusion.

Of course, this raises the question – how is basis determined for this purpose? To answer this question, we must consider the effect of IRC Section 1014.

Effects of Basis Adjustment under IRC Section 1014 on QSBS

Read more

1. Background

2. Funding, in a Nutshell

3. Phase 1 Retitling

4. Presenting the Retitling Plan

5. What’s Next

Background

An article series last year explored some of the conceptual issues that surround the idea of “funding” the estate plan, especially the revocable trust. The central theory and proposal was that we should perhaps lead with funding. For attorneys and non-attorneys alike, this idea can seem too drastic of a change where traditionally the weight of service, compensation, and even standard of practice is weighted towards the creation and execution of documents.

To preface, this is not an indictment of a document-forward or a document-agnostic approach to estate planning. But to set the stage, many of us “know” that there is room for improvement when it comes to funding the revocable trust if and when one is created. Even just framing this as “improvement” might understate the issue. But knowing and doing are not the same, primarily because the process of funding for both estate planners and their clients has remained formless. This is a theme that will emerge throughout this article and series.

That being said, the common pushback to integrating funding is two-fold. One is the belief that the client would not be willing to pay for it. The other is a question of accountability, as taking the lead could mean that the attorney themselves is accepting responsibility and accountability for shepherding the funding process. But before getting swept up into the gut reactions to this idea, it is perhaps helpful to set the stage for what funding is and where it goes wrong. The problem is not always funding, but the relationship between funding and the benefits that promoted for tools such as revocable trusts.

Before jumping in, this is the first in a series of articles where (after painting an abstract picture) we explore practical steps in leading with funding, and how this can be an immense value-add that clients would pay for and which perhaps can assign accountability instead of accepting it. Throughout this series, we will assume that a revocable trust for a single client is being used or that either a joint revocable trust, or separate trusts, are being used for a married couple as part of a joint representation.

Funding, in a Nutshell

To set the stage, all estate plans will be “funded” at some point – at the latest after the death of the client. The problem with delayed funding is two-fold. One, from a timing perspective, this may invoke the probate process for what we defined as probate assets in the prior funding series. Two, it may reveal misalignment between beneficiaries of the revocable trust versus direct beneficiaries of what we termed nonprobate assets.

And funding does not stop there. The probate estate or its equivalent – the revocable trust – each serve as a “parking lot” for assets during a period of post-mortem administration. The assets in them will first fund the liabilities side of the balance sheet by wiping out valid claims, and taxes. Then, net assets and income will be distributed to the named or legally-determined recipients of these assets.

Effectively, this means we have two levels of funding:

• Transfers to a revocable trust, either during life or by alignment with transfers (other than by survivorship) taking effect at death; and

• Transfers after a property owner’s death from a revocable trust, from a probate estate, or even from a revocable trust by way of the probate estate, to the named heirs and beneficiaries.

A better way to approach funding (that I missed in the entire first article series) is perhaps to call it retitling. After all, a decedent’s death causes a probate estate to be formed for the assets titled in their individual name that are probate assets (or that are nonprobate assets but for which the estate is the beneficiary). Since these assets will have to be retitled out of the decedent’s name eventually, funding in its most basic form is retitling assets (or fractional interests therein) to a revocable trust during the property owner’s life. This could also take the form of changing beneficiary designations. And then, after a decedent’s death and the administration of the estate and/or revocable trust this means retitling assets into the names of the beneficiaries (whether individuals, or trustees of subtrusts for the benefit of such individuals).

This process can be burdensome depending on the types, and number, of assets. But retitling is a process that will eventually happen anyway. In effect, funding or its more sanitary label of “retitling” represents at least a partial pre-administration of the estate. This is important contextually, because a commonly-touted benefit of a revocable trust is that the assets retitled to the trust during life will avoid probate. But the only reason this is a benefit that can be touted is because the retitling is reflective of work that will eventually be performed when the client is deceased anyway. (And as an aside, the “accountability” one might fear for taking ownership of the funding process may nonetheless become unavoidable once probate avoidance as a core benefit is decided upon by the client.)

And the catch here is that the current approach to funding a revocable trust only addresses this first layer of retitling. While this pre-mortem retitling is arguably easier and less time-consuming than probate itself, it does not address the second layer of retitling to conclude administration of the revocable trust after death. And while this second layer is arguably easier and less time-consuming within a revocable trust itself as compared to a probate estate, it nonetheless can come as a surprise as it effectively serves as a private probate. The scope of this private probate gets exacerbated as asset mix, plan complexity, and even required filings for federal/state estate taxes (and even GST tax or portability) come into play. For families who were led to believe that the revocable trust could lead to streamlined administration of a decedent’s final affairs, the level of “streamlining” may not always align with expectations.

Again, this is presented not to judge. It is presented to compare reality to eventuality. It is also presented to scope the accountability layer even further. Often little credence is given to the job to be performed by the immediate successor trustee(s) who will take over the actual administration of the revocable trust itself, as their role often requires cooperation with (or even performance of some of the duties of) the executor.

In other words, probate avoidance is not administration avoidance. It is simply a streamlining of administration. And funding, when truly done effectively, approaches not just the first layer of retitling (settlor to revocable trust) but also the second layer of retitling (revocable trust to beneficiaries, or the trustees named on their behalf for irrevocable subtrusts).

Does this mean the drafting attorney needs to be doing all of the work of retitling in advance? NO! But what it does mean is that perhaps we should be more intentional about a plan for retitling. Many drafting attorneys at least create a skeleton plan for retitling in the first phase, that is usually circulated after the documents are executed. But, it is rare to create this plan on an asset-by-asset basis. Perhaps even more rare is a plan that also addresses the second phase of retitling during administration of the revocable trust.

So how can we explore moving from “funding” to a more comprehensive two-phase plan for retitling? We will explore some initial methodology first, and then jump to the existential tensions in service/compensation and accountability/liability.

Phase 1 Retitling

In an ideal world, the phase 1 retitling plan includes:

• The formal name/title for the trust itself;

• Each specific asset;

• The action (retitle, or change beneficiary designation) for each specific asset; and

• The responsible party for each specific action.

If we work backwards, we see that perhaps the most important point here is the responsible party. This has unexpected implications for the client, and attorney (creating the plan), alike. For the client, it helps work that would otherwise be formless become a bit easier to handle because they know who to contact and what to request (as determined within the plan itself). And for the attorney, it means that they do not completely shoulder the burden of accountability. The accountability can be shifted. For example, the attorney (or the client’s attorneys, in general) might “own” retitling for specific assets that require custom drafting such as deeds, assignments of business interests, a bill of sale for tangible personal property, or even a complex beneficiary designation instruction that would accompany a change in beneficiary form. Other professionals like the financial advisor or insurance agent may “own” retitling or beneficiary designation changes for financial assets and life insurance, respectively.

There could also be a hybrid, through which the attorney agrees to collaborate with the client on the appropriate forms. This could include bank accounts, and financial assets not managed by a financial advisor. This is the area where traditionally there has been a lot of pushback, as it often meant dedication of attorney or support staff time to sitting on hold with various call centers only to be stonewalled by a lack of authority to act on a client’s behalf. The thing is, this is again work that would have to be done anyway by the client, or eventually by their executor or trustee after their passing. So as part of the retitling process, the opportunity presented is perhaps to flag assets (especially accounts) for consolidation and liquidation which becomes its own separate value-add.

Note that on an asset-by-asset basis, there are several tax, creditor protection, and even succession options. These issues are covered in last year’s funding series. This series is about action, and assumes that the appropriate legal judgment (and drafting) behind each proposed “action” has taken place. But on that note, we need a way to build a plan. We also need a way to present that plan. Both of these propositions have, in the past, presented inefficiencies. This is where a variety of estate tech tools have popped up to assist with the process. At this point, if you are sick of hearing about AI you are not alone – I, too, have begun to treat the use of AI images and tools as a loss of credibility. But AI can be a solution here to address what is being called the “funding gap,” and I am similarly willing to stake my credibility on the use of an AI tool I have developed to present retitling plans in upcoming articles.

Presenting the Retitling Plan

The earlier you can present the Phase 1 (and perhaps even Phase 2) retitling plan(s), the better. Why? Because the retitling work is often left until after the plan is signed. Clients often have limited bandwidth for completing the estate plan and when presented with the triaging of (1) getting documents signed or (2) ensuring funding takes place, the common standard of practice is to ensure that (1) occurs even if it means sacrificing (2). However, as noted above the limitation on a client’s bandwidth is often related to the formless nature of the plan (and its presentation) itself. When you can put edges on it, that helps inspire action. And while planning is never truly “complete,” the illusion of “complete enough for now” is often what clients desire.

The problem as alluded to above is that where the touted benefits of the plan (especially probate avoidance) are reliant upon at least Phase 1 retitling, lack of funding means the plan cannot truly be complete. Ideally, this means the drafter is upfront from the beginning about the trade-off for probate avoidance – effectively a pre-probating of what would otherwise be the estate by going through the retitling/funding exercise. And perhaps if presented from the beginning and wrapped into the process, this makes it easier to handle especially if retitling ceases to be formless. In other words, while it is feared that a robust funding process would drive away clients who have limited motivation it can actually have the opposite effect.

Of course, this means the drafting attorney and/or support staff must spend more time entering and accounting for assets on an asset-by-asset basis. It also means that the client must spend more time organizing this information up front. But if this organization would have to eventually take place, this friction should not be triaged in favor of hastening the speed of engagement, drafting, and document execution. It also creates more opportunities for service and commensurate compensation outside of drafting, especially in an interactive way. Often a client can recall many of their significant assets from memory and communicate them, so recording this information in the initial meeting(s) can lower friction. Also, receiving this information from any financial advisors (or using an advisor’s information to confirm the accuracy of the assets communicated from the client) can be a vital way to solidify the advisory team.

And if asset information can be collected in real-time, perhaps it also benefits us to work with the client to build the funding plan in real-time on an asset-by-asset basis. As noted above, there are several paths and trade-offs that can come into play such as choices between leaving certain accounts titled in joint tenancy, or exploring whether the spouse should be the primary beneficiary of retirement benefits (with trust as contingent). Again this series is not about repeating the factors behind these choices, other than to note that the choices become an integral part of building the retitling plan and can perhaps be illustrated as options in parallel. But it is in these interactive value-adds that create form and edges around the estate plan that value is truly added. This value-add is also where additional fees can be generated, especially in a tech age where the time spent on drafting documents is being reduced.

What’s Next

At this point, I ask you to take your temperature as an exercise. Does the concept of deepening the conversation around a retitling plan excite you, or does it make you nervous? If the feelings are negative, you are not alone. Change is not fun (to put it lightly), and what this article series is proposing is a change in the standard of practice and service. But much like retitling would eventually have to happen anyway, I am here as the messenger to tell you that the change you fear is happening anyway. The advent of AI and estate tech has already shifted this curve in favor of those who can add value in essentially pre-administering estates and trusts, and it will continue to do so. If change is inevitable, it is up to you to determine when you will adopt it.

But as with clients who find it hard to take action on a formless plan, this article series is dedicated to creating edges that both you and the client can identify with. The problem of procrastination presents common ground for estate planners and clients. The issue becomes trading one form of procrastination for another as part of the traditional “triaging” between document execution and funding as presented above. So if nothing else, I hope this article series serves as a wake-up call not from a standpoint of fear but more from a standpoint of opportunity. Estate planning and death are never easy, but our job is to make them easier.

For those who wish to explore further adoption and changes (and perhaps contribute their own education and expertise on this subject that can vary wildly state-to-state and even vendor to vendor), please subscribe or bookmark this newsletter to stay in the loop on subsequent articles in this series. If you have anything (positive) to contribute, please reach out as well. Coming up, what we will cover next is the broad Phase 1 plan based on asset category by comparing the common approach to how it can be improved. From there, we will build out specific asset variances and explore ways to build and integrate Phase 2 retitling plans.

Share

Subscribe now

1. Where We Left Off

2. Tax Forms of Entity

3. Check-The-Box - Defaults and Options

4. Pass-Through Taxation, at a High Level

5. Conclusion

Where We Left Off

In the last article in this series, we discussed how the cap table could be an important organizational tool and maintenance item for families holding interests in (especially closely-held) business entities. The intent was to ensure that each owner, whether an individual, trust, estate, or even another entity has their interest tracked and logged in whatever form ownership is expressed for that particular entity. That could be a percent ownership, or a number of shares or units by class.

However, the utility of such information is not just confined to tracking for management purposes. Depending on the manner in which the entity is taxed, this information (and changes thereto, especially during a tax year) can be vital for income tax reporting itself. In this article we will explore the basics of how entities are taxed, and how certain types of entities can “choose” the manner in which they are taxed.

Subscribe now

To start, let’s explore the various forms of taxation that commonly apply for U.S. federal income tax purposes.

Tax Forms of Entity

Generally, entities will be taxed in one of three ways depending on certain default rules but also subject to certain elections:

• As a disregarded entity (owner of entity is taxed as if they directly owned the business assets);

• As a partnership (Subchapter K of the Code);

• As a C corporation (Subchapter C of the Code); or

• As an S corporation (Subchapter S of the Code).

By no means is this exhaustive of the taxation of entities, as there are several other forms or variations of taxation you could see such as RIC, REMIC, REIT, IC-DISC, etc. which are beyond the foundational scope of this article series. Special rules often apply to banks and insurance companies. You might also see entities obtain a determination for tax-exempt status under IRC Section 501, especially when organized for charitable purposes, but subject to certain rules for unrelated business taxable income and other potential excise taxes.

Prior articles have covered the taxation of C and S corporations extensively, but portions of this article below will briefly cover the default rules as relate to choice of state-law entity versus tax status. This brings us to the source of these default rules, known as the check-the-box rules.

Check-The-Box - Defaults and Options

The rules for business tax classification are largely contained within Treasury Regulations Sections 301.7701-1 through -4. The last regulation in this series covers business and investment trusts, which we will not get into for now. (Estate planning trusts and the taxation thereof have been partially covered in the extensive series in this newsletter on grantor trusts, and will also be analyzed in some upcoming coverage on the taxation and accounting rules for trusts and estates in general.)

Within Treas. Reg. Section 301-7701-2, we find the default classifications. In subsection (a) thereof, we see that:

A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.

Subsection (b) goes on to define the various forms of entities that are defined as corporations for federal tax purposes. Speaking in broad terms, this generally includes any entity that is formed by incorporation at the state level. However, it also includes an association as defined in Treas. Reg. Section 301.7701-3. We will cover associations soon, but for context we must look to the definition of “eligible entity” under Treas. Reg. Section 301.7701-3(a). Generally, any entity that is not defined as a corporation is an eligible entity and the significance of this status is that the entity can elect its form of taxation.

There is a catch, however. While an entity with one owner or member (other than a corporation) is treated by default as a disregarded entity as noted above, it cannot elect to be taxed as a partnership because a partnership is defined as requiring at least two owners or “members” under Treas. Reg. Section 301.7701-2(c). From this perspective it is important to note that the two or more owners or members must be different taxpayers in order to be a tax partnership. It is possible for a state-law partnership, or even an LLC, with multiple owners for state law purposes to be treated as having just one owner for tax purposes (and thus defaulting to disregarded entity status). This might be the outcome if, for example, a grantor owned 50% of a partnership and a grantor trust they established owned the other 50%. The same could hold true where other disregarded entities themselves come into play. Likewise, as discussed in a recent article this could also include a partnership or LLC in which 100% of the interests are community property.

At a high level, this means we find the following permutations by state-law entity and tax classification:

• Corporation: taxed as C corporation by default; can elect to be taxed as an S corporation if eligible

• Partnership: tax partnership by default (see possibility of single tax owner “partnership” above); can elect to be taxed as a C corporation (association) or S corporation

• LLC with single member (or partnership with one tax owner): disregarded entity by default; can elect to be taxed as a C corporation (association) or S corporation

• LLC with two or more members: tax partnership by default; can elect to be taxed as a C corporation (association) or S corporation

The elections can be made on IRS Form 8832 (if electing association classification) or on IRS Form 2553 (if electing S corporation classification). It is not possible to elect partnership classification, but a disregarded entity could become a tax partnership by adding one or more additional owners (that are treated as separate owners for income tax purposes).

So, what is an association? It is an entity other than a corporation that elects to be classified as a corporation. By default, this definitionally means that an association is taxed as a C corporation. However, as seen in our four permutations above any entity can elect S corporation classification if the entity meets the definition of a “small business corporation” under IRC Section 1361(b). This can be difficult for partnerships and LLCs that contain language permitting special allocations based on percent ownership, as the special allocations can violate the eligibility requirement of IRC Section 1361(b)(1)(D) that limits small business corporations to one class of stock.

If an entity other than a corporation wishes to elect to be taxed as an S corporation, does this mean it must first elect to be taxed as an association? Fortunately, the answer is no. Under Treas. Reg. Section 301.7701-3(c)(1)(v)(C), an eligible entity that makes a valid and timely election to be an S corporation is deemed to have first made the election to be classified as an association. Of course, this also means that a termination of the S election will cause the entity not to revert to its default classification but instead to classification as an association (as would be the case if an actual corporation that is taxed under the C corporation rules had its S election terminated).

Pass-Through Taxation, at a High Level

A hallmark of both tax partnerships and S corporations is pass-through taxation. At its most basic form, this means the entity does not pay any entity-level tax for either federal or state income tax purposes. However, practically all states have enacted a state income tax election whereby a partnership or S corporation can elect to have state income tax applied at the entity level (as if it was a C corporation). This generally is carried out as a workaround to the limitations on the deduction of state and local income tax under IRC Section 164(b)(7), as may be applied to an owner’s pass-through share of an entity’s net income that is taxed in that particular state.

On that note, the burden of taxation is applied to the partners in the partnership or the shareholders in the S corporation. This tax is calculated at the individual level by applying each owner’s share of the income, losses, deductions, and credits of the entity as if the owner incurred them directly. These items are not all netted out at the entity level and then passed through as a single item of net income or loss, because certain tax items might be treated differently between taxpayers. For this reason, you find rules on how items of tax significance are often separately stated between owners under IRC Sections 703 (for partnerships) and 1366 (for S corporations).

The ratio for sharing these items can vary between partnerships, under which it is called a distributive share, and S corporations which refer to each shareholder’s pro rata share. The key difference for partnerships is found under IRC Section 704(b) and the Treasury Regulations relating thereto, under which the distributive share defaults to the partner’s (percentage) interest in the partnership unless special allocations (having substantial economic effect) are made in accordance with the partnership agreement. In the case of a multi-member LLC, the term “partnership agreement” would include the operating agreement or company agreement. But with an S corporation all allocations and distributions must be pro rata per-share based on shares outstanding. As noted above, a partnership or LLC with these special allocations contained within its agreement may not qualify for the S corporation election because the special (non-pro rata) allocations can violate the single class of stock requirement for the S election itself.

S corporations can still be subject to the C corporation rules to the extent these rules are not superseded by the S corporation rules, and can special outcomes (and entity-level taxes notwithstanding pass-through entity status) that a partnership might not incur.

For example, an S corporation is still subject to the rule of IRC Section 311(b) whereby a distribution of appreciated property by the S corporation is treated as a deemed sale of the property for its fair market value. In the case of an S corporation, the gain recognized on such a deemed sale would get passed through to the shareholders, In addition, the built-in gains tax of IRC Section 1374 could apply if the entity had any operating history as a C corporation or association. This tax can be imposed for the first 5 years after the most recent S election if the entity was taxed as a C corporation before the election, and causes the entity to incur C corporation tax on the sale of any appreciated property to the extent of any net unrealized built-in gains that would have been incurred on the date of the S election if the property had been sold at that time. This is designed to limit opportunities to avoid double taxation that would otherwise be incurred by a C corporation on the sale of property by electing S corporation status, but in turn the tax itself would be treated as a loss allocable to shareholders under IRC Section 1366(f)(2).

Likewise, C corporations are subject to a 20% personal holding company (PHC) tax under IRC Section 541 if 60% or more of its “adjusted ordinary gross income” (defined in IRC Section 543(b)) is personal holding company income (generally, passive income from investments and other source) and it has 5 or fewer shareholders holding more than 50% of the stock (by value) for at least half of the tax year. If one hopes to avoid this outcome by electing S corporation status, they would run headlong into IRC Section 1375 which subjects excess net passive income to taxation at the entity level at C corporation rates if (1) the S corporations has any accumulated earnings and profits from a C corporation tax year and (2) more than 25% of the gross income is passive investment income. To be clear, these are independent penalties but they are tied together here to illustrate how C corporation history can persist for an S corporation.

Partnerships generally will not be subject to these same rules. In fact, an increase in basis to a partner’s interest by sale or by transfer at death can be shifted to the inside basis of that partner’s share of partnership assets by making an election under IRC Section 754. Such an outcome is not available for an S corporation, but can be manufactured at least in part by a liquidation of the S corporation. Where partnerships differ, however, is not in this treatment of assets but instead liabilities. Since the basis of property includes money borrowed to purchase that property (and the amount realized on sale is no less than the debt relief associated therewith), each partner of a partnership is treated as being on the hook (for tax purposes) of their share of partnership liabilities. As a result, if a partner’s interest is sold or liquidated this can cause the partner to be treated as if they received cash equal to their net debt relief. This phantom “cash” can cause gain to be incurred even if the actual consideration for the partnership interest was less than the partner’s basis.

Conclusion

While this discussion, including on pass-through entities, by no means approaches being comprehensive this should hopefully give you a solid foundation for determining tax classifications and outcomes for various entities. You are encouraged to also go back and read the articles on C and S corporations, starting here (the index needs to be updated but stay tuned for some interesting updates there).

Coming up, we will start exploring entity governing documents and their implications.

Share

Subscribe now

1. Where We Left Off

2. The QSST, and Grantor Trust Rules

3. The ESBT, and Grantor Trust Rules Plus Itemized Deduction Limitations

4. Conclusion

Where We Left Off

In the last grantor trust article, we discussed the utility and limitations of income tax “burn” payments by the grantor on behalf of the trust itself. The issues highlighted in that article are exacerbated where interests in pass-through entities, such as tax partnerships and S corporations, are held by a grantor trust.

Subscribe now

Managing S corporation stock at the trust level is notoriously difficult due to the limitations of “who” can be an S corporation shareholder under IRC Section 1361(b). As a refresher, shareholders are typically limited to 100 or fewer individual U.S. citizens or residents with limited exceptions. For trusts, these exceptions typically mean that a trust must be structured in one of three ways:

• As a trust all of which is treated as owned by an individual who is a U.S. citizen or resident under the grantor trust rules;

• As a qualified subchapter S trust (QSST); or

• As an electing small business trust (ESBT).

There are other small carve-outs such as for a trust that is created solely as a voting trust, or for a trust for which grantor trust status terminates due to the death of the deemed owner (which remains eligible for a period of 2 years after such termination). Likewise, a testamentary trust created under a will can be eligible for up to 2 years after funding. But at the end of any of these two-year periods, the trust in question must meet one of the core three structures above.

These structures and elections have some important overlaps with the grantor trust rules that are vital to the understanding of the grantor trust rules themselves. Much like the grantor trust rules can create deemed income tax ownership of trust assets, these structures can operate to treat one or more beneficiaries or the holder of a grantor trust power as the “shareholder” of the S corporation for purposes of the 100 (individual) shareholder limit.

Note also that while it seems intuitive that deemed income tax ownership of just the S corporation stock under the grantor trust rules would be the controlling consideration, the rules here (both IRC Section 1361(c)(2)(A)(i) and Treas. Reg. 1.1361-1(h)(1)(i)) require all of the trust to be treated as owned by an individual. Not only does this mean that one must be certain of 100% grantor trust treatment, but it also means that 100% grantor trust treatment that is aggregated between multiple individuals (possibly after taking into account treatment of spouses or family members as one shareholder under IRC Section 1361(c)(1)) may not be sufficient. Likewise, it means that deemed income tax ownership by another trust may not suffice unless in turn an individual is the 100% deemed owner of that trust (and even then this can create multiple factual pitfalls that are not clear in terms of interaction with various elections).

Circling back to the issue of deemed ownership, the other two options for S corporation ownership – the QSST, and ESBT – each require an election to achieve the related tax treatment and recognition of the trust as an S corporation shareholder. A recap of some of these rules and timelines can be found in prior overviews of the QSST and ESBT, respectively. But, these rules can have odd interactions with the grantor trust rules. We will explore each in turn, below, while also briefly exploring some new questions that might arise for ESBTs with respect to the new itemized deduction limitation applicable to non-grantor trusts under IRC Section 68.

The QSST, and Grantor Trust Rules

Read more