February 25, 2016

Congress recently enacted IRC Section 6035. The purpose of 6035 is to have a consistent cost reporting basis so that income would not be understated by overstating the basis of an asset. In summary, the bill provides that for any federal estate tax return required to be filed, the executor or trustee must provide a statement to the Service, and to ALL persons ‘who hold a legal or beneficial interest in the property to which such return relates,” a statement identifying the value of each interest in such property as reported on the Form 706.

Thus, 6035 places the burden of basis reporting upon executors and trustees. In most simple estates this will not be a problem. But, if the estate held a controlling interest in any entity this could be a huge problem.   How does an executor or trustee adequately establish the value that is going to be reported to the beneficiary or beneficiaries? The regs on 6035 have not been released yet, so this issue is an unknown.

Suppose Mr. Jones owns 100% of ABC Company stock. He dies and, on his 706, the shares are valued at $10,000,000—the value of the 100% controlling ownership of the Company. He has four children and each gets a 25% interest. If the regs on 6035 state that the basis of the beneficiaries’ shares is merely pro-rata with what was on the 706, curious things can result.

For example, assume the beneficiary later sells, at Fair Market Value, his interest to trusts held by his children. Because of discounting, let’s say the Fair Market Value is $1,500,000. This means the sale will generate a $1,000,000 tax loss and the asset will be out of the estate of the beneficiary. The beneficiary will receive $1,500,000 over time at the AFR rate, of course. The market value of this note is probably $750,000.

This seems too good to be true. It really is a nonsensical result. It would seem, then, that the executor or trustee should have the interest transferred from the 706 appraised at its Fair Market Value and that this is the appropriate basis.

Forgetting the complicated scenario depicted above, the implications of Section 6035 have now saddled executors and trustees with the responsibility of documenting the tax basis apportioned to heirs and beneficiaries from a Form 706. Is this something they are equipped and prepared to do? Who will make this judgment call? It would seem the new Section 6035 is likely to be good news for appraisers!