ARTICLE WHAT S IT WORTH TO YOU? A BRIEF EVALUATION OF THE 2016 GREENBOOK CONSISTENCY IN VALUATIONS FOR TRANSFER AND INCOME TAX PROPOSAL

ARTICLE WHAT S IT WORTH TO YOU? A BRIEF EVALUATION OF THE 2016 GREENBOOK CONSISTENCY IN VALUATIONS FOR TRANSFER AND INCOME TAX PROPOSAL Benjamin A. Cohen-Kurzrock On February 2, 2015, the Obama Administration released its General Explanations of the Administration s Fiscal Year 2016 Revenue Proposals. 1 In this proposal, the Obama Administration recommended enacting legislation requiring consistency in valuations for transfer tax and income tax purposes. 2 This consistency proposal is significant to taxpayers receiving property by gift or from a decedent s estate because it would affect the basis of the property received. 3 This Article evaluates this consistency proposal, assuming a client with a net worth or gift transfers sufficient to exhaust the applicable estate and gift tax credit. 4 Part I discusses the issue that this consistency proposal addresses by describing the traditional mechanics of Section 1014 and Section 1015 of the Internal Revenue Code (Code). Part II describes the Obama Administration s proposed changes to the current law. Finally, 2015 J.D., University of Houston Law Center. The Author would like to thank Professor William Streng, Vinson & Elkins Professor of Law at the University of Houston Law Center, for his invaluable feedback on this Article. 1. See The Greenbook and Tax Expenditures, U.S. DEP T OF THE TREASURY, http://www.treasury.gov/resource-center/tax-policy/pages/general_explanation.aspx (last updated Sept. 18, 2015). 2. DEP T OF THE TREASURY, GENERAL EXPLANATIONS OF THE ADMINISTRATION S FISCAL YEAR 2016 REVENUE PROPOSALS 195 96 (2015), http://www.treasury.gov/resource-center/taxpolicy/documents/general-explanations-fy2016.pdf [hereinafter 2016 GREENBOOK]; see Part III (offering a more detailed discussion of the proposal). 3. See Part III. 4. I.R.C. 2010(a), (c) (2015). For 2015, a decedent s estate may claim a credit of up to $5.43 million. See id. 2010(c)(3). 99

100 HLRe: OFF THE RECORD [6:1 Part III evaluates the appropriateness of the proposed changes. The Author concludes by recognizing that Congress codified a version of the consistency proposal when it passed the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, which President Obama signed on July 31, 2015. I. THE PROBLEM: TAX ARBITRAGE THROUGH INCONSISTENT VALUATIONS The Obama Administration s consistency in valuation proposal focuses on eliminating a minor idiosyncrasy in the rules for calculating the basis of property transferred by death or gift of the transferor. 5 There are two provisions of the Internal Revenue Code establishing the manner by which a taxpayer computes his basis in such property: (1) Section 1014 and (2) Section 1015. 6 Section 1014 instructs a taxpayer on the manner by which he should compute his basis in property acquired from a decedent. 7 Generally, a taxpayer takes a basis equal to the fair market value of the property acquired from the decedent at the time of the decedent s death. 8 Under Treasury Regulation Section 20.2031-1, a property s fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. 9 This fair market value should be identical to the value of the decedent s property at the time of his death for Section 2031 s gross estate calculation 10 5. The consistency proposal also discusses reporting obligations, but this discussion appears to be ancillary. Suffice it to say, Section 6034A imposes various reporting obligations on [t]he fiduciary of any estate or trust required to file a return under [S]ection 6012(a) for any taxable year.... Id. 6034A(a) (b). It also imposes a duty of consistency on [a] beneficiary of any estate or trust to which [Section 6034A(a)] applies.... Id. 6034A(c). This duty specifically requires a beneficiary to treat any reported item in a manner which is consistent with the treatment of such item on the applicable [estate s or trust s] return. Id. 6034A(c)(1). 6. The consistency proposal also addresses Section 1022. 2016 GREENBOOK, supra note 2, at 195. Section 1022 applied to the estates of decedents dying during 2010 if the decedent s estate made a timely election. I.R.C. 1022(a) (b) (repealed 2010). When applicable, Section 1022 computed a taxpayer s basis in the property received as the lesser of (a) the fair market value of the property at the time of the decedent s death, or (b) the decedent s adjusted basis in the property as increased by certain basis allocations. Id. Outside of this general description of Section 1022, this Article will not explore issues related to Section 1022 any further because Congress repealed Section 1022 and the typical audit window will close before any changes described in the consistency proposal take effect. Id. 6501(a) (2015). 7. See generally id. 1014. 8. Id. 1014(a). 9. Treas. Reg. 20.2031-1(b) (2015). 10. I.R.C. 2031(a) (2015); United States v. Cartwright, 411 U.S. 546, 551 (1973); Janis v. Comm r, 469 F.3d 256, 260 61 (2d Cir. 2006); United States v. Parker, 376 F.2d 402, 408 (5th Cir. 1967); Treas. Reg. 1.1014-1(a).

2015] WHAT S IT WORTH TO YOU? 101 It is, however, possible for a taxpayer who acquired property from a decedent to assign that property a fair market value that differs from the estate s fair market value. 11 This requires the taxpayer to challenge the executor s valuation of the property received by the taxpayer. 12 When this occurs, the taxpayer typically argues that the executor undervalued the property the taxpayer received and provides evidence of the real value. 13 To maximize the tax savings resulting from this type of challenge, it is beneficial for (1) the taxpayer s valuation to exceed the executor s valuation; (2) the statute of limitations for assessing tax on the estate s return to have run; and (3) the taxpayer and executor be different people or entities. 14 The Internal Revenue Service (Service) lacks any tool for enforcing a consistency rule if a situation satisfies all three of these conditions. 15 Section 1015, on the other hand, applies to property a taxpayer acquired by gift. Under this section, a taxpayer (gift recipient) determines his basis in such property based on whether the fair market value of the gifted property exceeds the donor s (gift giver s) basis in the property. If it does, the basis [of the gifted property] shall be the same [for the taxpayer] as it would be in the hands of the donor. 16 If the property s basis exceeds the fair market value, Section 1015 requires the taxpayer to take a dual basis: for the purpose of determining gain, the taxpayer s basis in the gifted property is the same as the donor s basis in such property; for the purpose of determining loss, the taxpayer s basis in the gifted property is the fair market value of the gifted property on the date of the transfer. 17 A taxpayer may increase his basis in gifted property by the amount of gift tax paid by the donor with respect to that property. 18 It is possible, however, for a taxpayer to challenge a donor s assessment of the fair market value of the gifted property in a manner similar to that seen in the Section 1014 arena. 19 11. RONALD D. AUCUTT, ESTATE TAX CHANGES PAST, PRESENT AND FUTURE 108 (2015), http://media.mcguirewoods.com/publications/estate-tax-changes.pdf; see Ford v. United States, 276 F.2d 17, 20 21 (Ct. Cl. 1960). 12. AUCUTT, supra note 11, at 108. 13. Id. 14. Id. 15. Id. 16. I.R.C. 1015(a) (2015). 17. Id. 18. Id. 1015(d). 19. See HOWARD M. ZARITSKY, TAX PLANNING FOR FAMILY WEALTH TRANSFERS: ANALYSIS WITH FORMS 1.03[1][b][i] (2015) ( [T]he Administration has determined that a significant number of taxpayers have felt free to determine the fair market value of property on the date of the gift and the donor s basis[] without regard to the basis and value reported on the donor s gift tax return. ).

102 HLRe: OFF THE RECORD [6:1 II. THE SOLUTION: A CODIFIED REQUIREMENT FOR CONSISTENT VALUATIONS The Obama Administration made a two-part proposal to remedy the minor loophole created by a taxpayer asserting a fair market value of transferred property that differs from the fair market value of the transferred property claimed by the transferor. 20 The first part of the proposal would require that the basis of the property in the hands of the recipient be no greater than the value of that property as determined for estate or gift tax purposes (subject to subsequent adjustments). 21 The second part of the proposal would require the transferor to provide the necessary valuation and basis information to the recipient and the Service. 22 To assist in accomplishing this two-part proposal, the Obama Administration plans to include a grant of regulatory authority to the Secretary of Treasury to provide details about the implementation and administration of [the consistency and reporting] requirements. 23 The two-part proposal would apply to transfers occurring the year after the proposal s enactment. 24 III. EVALUATION OF THE PROPOSED SOLUTION This is not the first time the Obama Administration has proposed requiring consistency in valuations for transfer and income tax purposes. 25 In fact, one can find versions of the current proposal dating back to 2009. 26 Because the Obama Administration expects this consistency proposal alone to generate significant tax revenue (between $1.87 and $3.237 billion) over the next ten years, 27 it is worthwhile to examine the potential benefits of and problems with the consistency proposal. 20. 2016 GREENBOOK, supra note 2, at 195. 21. Id. at 196. 22. Id. 23. Id. 24. Id. 25. This is also not the first time Congress considered enacting the Obama Administration s consistency proposal. In 2010, Senator Bernard Sanders and Representative Linda Sanchez sponsored the Responsible Estate Tax Act, which included statutory language for the consistency proposal, but that bill died in Congress. Responsible Estate Tax Act, H.R. 5764 & S. 3533, 111th Cong. 6 (2010). Later that same year, revised statutory language appeared as an amendment to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. Middle Class Tax Cut Act of 2010, S.A. 4727 to H.R. 4853, 111th Cong. 309 (2010). Almost a year later, Congress rejected another opportunity to enact the consistency proposal. See Sensible Estate Tax Act of 2011, H.R. 3467, 112th Cong. 5 (2011). 26. DEP T OF THE TREASURY, GENERAL EXPLANATIONS OF THE ADMINISTRATION S FISCAL YEAR 2010 REVENUE PROPOSALS 119 20 (2009), http://www.treasury.gov/resource-center/taxpolicy/documents/general-explanations-fy2010.pdf [hereinafter 2010 GREENBOOK]. 27. Compare id. at 130 ($1.87 billion), with 2016 GREENBOOK, supra note 2, at 297 ($3.237 billion).

2015] WHAT S IT WORTH TO YOU? 103 A. The Benefits of the Consistency Proposal The consistency proposal hopes to close a loophole in the current law by requiring the recipient of a transfer and the transferor to use the same value the fair market value determined by the transferor or his estate for a piece of transferred property. 28 Of course, there is widespread appeal for tax reforms that close loopholes exploitable only by wealthy individuals. This is especially true when those reforms could result in significant additional tax revenue. In the case of this consistency proposal, it is hard to imagine how anybody other than the wealthiest taxpayers would be upset by this consistency proposal as only the wealthiest taxpayers make estate and gift tax payments beyond the available credits. 29 Beyond this populist rationale, there is a legal foundation for the consistency proposal: Taxpayers should be required to take consistent positions in dealing with the [Service]. 30 The common law recognizes that all taxpayers are subject to a duty of consistency with respect to positions taken on the taxpayer s return, absent a provision that preempts this duty. 31 Traditionally, this duty applies if three conditions are present: (1) there is a representation or report by the taxpayer; (2) the Service relies on that representation or report; and (3) the taxpayer attempts, after the statute of limitations has run, to change the previous representation or report in a way that harms the Service. 32 The rationale behind this duty is that [t]he law should not be such a[n] idiot that it cannot prevent a taxpayer from changing the historical facts from year to year in order to escape a fair share of the burdens of maintaining our government. 33 At least one tax court applied this duty to recipients of property subject to a transfer tax and postulated that the 28. 2016 GREENBOOK, supra note 2, at 195. 29. CHYE-CHING HUANG & BRANDON DEBOT, TEN FACTS YOU SHOULD KNOW ABOUT THE FEDERAL ESTATE TAX 2 (2015), http://www.cbpp.org/files/1-8-15tax.pdf. 30. 2016 GREENBOOK, supra note 2, at 195. Interestingly, the Obama Administration relies solely on this legal foundation; it does not even allude to the populist rationale. Id. 31. Steve R. Johnson, The Taxpayer s Duty of Consistency, 46 TAX L. REV. 537, 538 44 (1991). Congress or the Service may preempt common law duties by enacting a statute or regulations that eliminates the duty or addresses the method and manner by which a taxpayer must take a consistent position. See Milwaukee v. Illinois, 451 U.S. 304, 313 14 ( [W]hen Congress addresses a question previously governed by a decision rested on federal common law[,] the need for such an unusual exercise of lawmaking by federal courts disappears. ). 32. Eagan v. United States, 80 F.3d 13, 16 (1st Cir. 1996); Herrington v. Comm r, 854 F.2d 755, 758 (5th Cir. 1988). 33. Janis v. Comm r, 461 F.3d 1080, 1085 (9th Cir. 2006) (quoting Estate of Ashman v. Comm r, 231 F.3d 541, 544 (9th Cir. 2000)).

104 HLRe: OFF THE RECORD [6:1 scope of the duty extended to any taxpayer whose specific economic interest was sufficiently identical to the taxpayer making the representation or report to the Service. 34 This extension of this duty, on its face, makes sense because most transfers for which Sections 1014 and 1015 apply are intrafamily transfers. Still, this new sufficient identity of interest test is subject to significant criticism, and it is unclear whether the court s holding could apply in a case in which the recipient did not participate in the valuation process. 35 Despite the criticism, at its core, the consistency proposal merely takes a step towards codifying the accepted principle that tax gamesmanship 36 is inappropriate. B. The Problems with the Consistency Proposal While it is admirable to limit the opportunities for tax gamesmanship, there are problems with the Obama Administration s consistency proposal that make it unwieldy. These problems stem, primarily, from the phrase subject to subsequent adjustments. 37 First, the phrase is unclear. While the Obama Administration probably intends this phrase to cover upward adjustments in the value of transferred property by the Service, it could also apply to basis increases for various taxes paid with respect to transferred property. 38 Second, subsequent adjustments to the value and basis of transferred property undermines the finality of these transfers. The harshness and cumbersomeness of this result is magnified if one considers a string of dispositions (by sale, gift, or bequest) by the original recipient of transferred property. In such a case, presumably, updated reporting information and adjustments to returns would be required along the entire string. This is simply untenable. 39 34. See Van Alen v. Comm r, 106 T.C.M. (CCH) 427 (2013). 35. ZARITSKY, supra note 19, at 106. 36. Van Alen, 106 T.C.M. (CCH) 427. 37. 2016 GREENBOOK, supra note 2, at 196. 38. See ZARITSKY, supra note 19, at 105 (noting that it is unclear how the consistency proposal deals with increases in basis for the gift tax and GST tax attributable to appreciation ). 39. The Joint Committee of Taxation (JCT) reviewed the consistency proposal in 2009 and recommended eliminating the subject to subsequent adjustments language for similar reasons. See STAFF OF JOINT COMM. ON TAXATION, DESCRIPTION OF REVENUE PROVISIONS CONTAINED IN THE PRESIDENT S FISCAL YEAR 2010 BUDGET PROPOSAL: PART ONE: INDIVIDUAL INCOME TAX AND ESTATE AND GIFT TAX PROVISIONS 133 36 (2009), https://www.jct.gov/publications.html?func=startdown&id=3573 (omitting the language in its discussion). The JCT recommended, instead, that the basis of property received by reason of death under [S]ection 1014 generally must equal the value of that property claimed by the decedent s estate for estate tax purposes. Id. at 133 (emphasis added). The JCT reasoned that the efficacy of the consistency proposal hinged on eliminating any possible relief mechanism for the recipient and transferor. Id. at 135. By precluding such

2015] WHAT S IT WORTH TO YOU? 105 Finally, enacting the Obama Administration s proposal to tax unrealized capital gains at death would accomplish the ends of the consistency proposal without the reporting and finality problems. 40 With respect to the duty of consistency argument, it is easy to imagine instances in which the recipient s and transferor s interests are not sufficiently identical. In fact, on a theoretical level, the recipient s and transferor s interests are adverse. The recipient of transferred property has an interest in assigning the highest possible fair market value to the property received to maximize the recipient s basis in that property. 41 In contrast, the transferor has an interest in assigning the lowest possible fair market value to the property transferred to minimize transfer taxes. 42 Binding the recipient to the transferor s assessment of the fair market value (albeit, subject to subsequent adjustment by the Service) without the recipient s participation in the valuation process seems contrary to the principles underlying the duty of consistency. IV. CONCLUSION On September 7, 2015, the Service published a Revenue Bulletin showing that the consistency proposal was enacted as part of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. 43 Specifically, Section 2004 of the Act amended Section 1014 of the Code and added Section 6035 to the Code. 44 It mandates that a transferee take a basis in property received by a decedent in an amount that does not exceed the final value determined for estate tax purposes. 45 The Act also addresses an estate s reporting obligations. 46 Given this change, the best strategy for an estate planning attorney, it seems, is to meet with all of the interested parties (the recipient relief mechanisms, Congress would encourag[e] a more realistic value determination in the first instance. Id. Interestingly, the Obama Administration s consistency proposal appears to dismiss this recommendation without explanation. See 2016 GREENBOOK, supra note 2, at 195 96. 40. 2016 GREENBOOK, supra note 2, at 156 57. 41. See I.R.C. 1014(a) (2015); id. 1015(a). 42. See id. 2031(a). 43. Notice 2015-57, 2015-36 I.R.B. 294 95, http://www.irs.gov/pub/irs-irbs/irb15-36.pdf. 44. Surface Transportation and Veterans Health Care Choice Improvements Act of 2015, Pub. L. 114-41, 129 Stat. 443, 454 56 (to be codified at I.R.C. 1014(f), 6035), https://www.congress.gov/114/plaws/publ41/plaw-114publ41.pdf. 45. Id. 46. Id. The Service indicated that it will provide guidance on the Section 6035 reporting obligations at a later date and stated that person s obligated to file a statement complying with Section 6035 should not file such a statement before the guidance is released. Notice 2015-57, 2015-36 I.R.B. 294 95, http://www.irs.gov/pub/irs-irbs/irb15-36.pdf.

106 HLRe: OFF THE RECORD [6:1 and transferor) to determine both the most accurate and tax efficient method for assessing the fair market value of the property that would be subject to a transfer tax.