[Federal Register Volume 64, Number 3 (Wednesday, January 6, 1999)]
[Proposed Rules]
[Pages 790-794]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-176]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-114841-98]
RIN 1545-AW57
Separate Share Rules Applicable to Estates
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations that provide that
substantively separate and independent shares of different
beneficiaries are to be treated as separate estates for purposes of
computing the distributable net income. These proposed regulations also
provide that a surviving spouse's statutory elective share of a
decedent's estate is a separate share. Further, a revocable trust that
elects to be treated as part of a decedent's estate is a separate
share. Section 1307 of the Taxpayer Relief Act of 1997 amended section
663 of the Internal Revenue Code by extending the separate share rules
to estates. These proposed regulations affect estates of decedents.
This document also provides notice of a public hearing on these
proposed regulations.
DATES: Written and electronic comments must be received by April 6,
1999. Outlines of topics to be discussed at the public hearing
scheduled for April 22, 1999, at 10 a.m. must be received by April 1,
1999.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-114841-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
114841-98), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the internet by selecting the ``Tax Regs''
option on the IRS Home Page, or by submitting comments directly to the
IRS internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in room 2615, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Laura
Howell, (202) 622-3060; concerning submissions of comments, the
hearing, and/or to be placed on the building access list to attend the
hearing, Michael L. Slaughter, Jr., (202) 622-7190 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
Prior to amendment by Section 1307 of the Taxpayer Relief Act of
1997, Pub. L. 105-34, August 5, 1997, (TRA 1997), section 663(c) of the
Internal Revenue Code (Code) provided that, for the purpose of
determining the amount of distributable net income in the application
of sections 661 and 662, in the case of a single trust having more than
one beneficiary, substantially separate and independent shares of
different beneficiaries (or classes of beneficiaries) of the trust
shall be treated as separate trusts. The application of the separate
share rule is mandatory where separate shares exist. Section 1.663(c)-
1(d) and H.R. Conf. Rep. No. 2014, 105th Cong. 1st Sess. 712-13 and fn.
18.
Section 1307 of TRA 1997 amended section 663(c) of the Code by
extending the separate share rule to estates. Prior to this amendment,
a distribution to an estate beneficiary in the ordinary course of
administration often resulted in the beneficiary being taxed on a
disproportionate share of the estate's income. The extension of the
separate share rule to estates promotes fairness by more rationally
allocating the income of the estate among the estate and its
beneficiaries thereby reducing the distortion that may occur when a
disproportionate distribution of estate assets is made to one or more
estate beneficiaries in a year when an estate has distributable net
income. Under the separate share rule, a beneficiary is taxed only on
the amount of income that belongs to that beneficiary's separate share.
In addition, section 1305 of TRA 1997 added section 645 to the Code
(originally enacted as section 646 and redesignated as section 645 by
the Internal Revenue Service Restructuring and Reform Act of 1998).
Under section 645, both the executor (if any) of an estate and the
trustee of a qualified revocable trust may elect to treat the revocable
trust as part of the decedent's probate estate for income tax purposes.
The legislative history for section 1305 provides that the separate
share rule applicable to estates will apply when a qualified revocable
trust elects to be treated as part of the decedent's estate.
Explanation of Provisions
The proposed regulations conform the current regulations to the
statutory changes. In addition, the proposed regulations address two
specific matters involving separate share treatment of interests in
estates: the treatment of the spousal elective share and the treatment
of an electing revocable trust under section 645 of the Code.
General Separate Share Rule
If an estate has multiple beneficiaries, substantially separate and
independent shares of different beneficiaries (or classes of
beneficiaries) are to be treated
[[Page 791]]
as separate estates only for purposes of computing distributable net
income. There are separate shares in an estate when the governing
instrument of the estate and applicable local law create separate
economic interests in one beneficiary or class of beneficiaries such
that the economic interests of those beneficiaries (e.g., rights to
income or gains from specified items of property) are not affected by
the economic interests accruing to another separate beneficiary or
class of beneficiaries. Thus, there are separate shares in an estate
when a beneficiary or class of beneficiaries has an interest in a
decedent's estate (whether corpus or income, or both) that no other
beneficiary or class of beneficiaries has in the decedent's estate. The
application of the separate share rule to estates is mandatory where
separate shares exist. The separate share rule requires that the
estate's income and deductions be allocated among the separate shares
as if they were separate estates. The section 661 deduction to the
estate and the section 662 inclusion in the gross income of the
beneficiary are limited by the distributable net income allocable to
each separate share.
These proposed regulations do not change the rules involving
specific gifts and bequests described in section 663(a).
Surviving Spouse's Elective Share
Most non-community property states have some form of elective share
statute which replaces common law dower and curtesy (the common law
protection for surviving spouses). Generally, an elective share statute
gives the surviving spouse the right to claim a share of the deceased
spouse's estate if the surviving spouse is disinherited or dissatisfied
with what the spouse would have received under the will or otherwise.
In most states the elective share consists of a fraction, ranging from
one-fourth to one-half of the decedent's estate. Elective share
statutes vary as to when the share vests and whether the share includes
a portion of the estate income, as well as whether the share
participates in the appreciation or depreciation of the estate's
assets.
Rev. Rul. 64-101 (1964-1 C.B. 77) addresses the Florida statutory
dower interest which, at the time of the revenue ruling, entitled the
widow to the dower interest and mesne profits thereon. The ruling holds
that the value of assets transferred to the widow as dower is not a
distribution to a beneficiary subject to sections 661(a) and 662(a) of
the Code. Instead, the transfer of assets is governed by section 102.
Rev. Rul. 71-167 (1971-1 C.B. 163) modifies Rev. Rul. 64-101 by
holding that the amount distributed to the widow representing mesne
profits is subject to sections 661(a) and 662(a) of the Code.
Therefore, an amount corresponding to the allowable deduction to the
estate under section 661(a) is includible in the gross income of the
widow under section 662(a).
Recently, two cases, Deutsch v. Commissioner, TCM 1997-470, and
Brigham v. United States, 983 F. Supp. 46, (D. Mass. 1997), have
addressed how to treat payments to the surviving spouse in satisfaction
of the spouse's elective share amount. In Deutsch, the surviving spouse
elected to take against the decedent's will as provided by the Florida
elective share statute. Under the statute, the surviving spouse was
entitled to 30 percent of the net estate based upon date of death
values, but was not entitled to any income of the estate, and did not
participate in appreciation or depreciation of the estate assets. The
Tax Court, noting Rev. Rul. 64-101, held that payments to the surviving
spouse in satisfaction of her elective share amount were not subject to
sections 661(a) and 662(a). Rather, the payments were governed by
section 102.
In Brigham, the surviving spouse elected to take against the
decedent's will as provided by the New Hampshire elective share
statute. Under the statute, the surviving spouse was entitled to one-
third of the personalty and one-third of the real estate. The court
held that the payments made to the surviving spouse in satisfaction of
her elective share amount were subject to sections 661(a) and 662(a).
Thus, the court held that all of the estate's distributable net income
was taxable to the surviving spouse because she was the only
beneficiary to receive a distribution for the year in question and her
distribution exceeded the amount of the estate's distributable net
income.
In light of the uncertainty concerning the proper treatment of
payments in satisfaction of a surviving spouse's elective share, and
also given that Rev. Ruls. 64-101 and 71-167 are outdated because dower
has been replaced by elective share statutes in most states, the
Internal Revenue Service and Treasury have concluded that regulatory
guidance is needed to provide uniform treatment.
These proposed regulations provide that the surviving spouse's
elective share constitutes a separate share of the estate for the sole
purpose of determining the amount of distributable net income in
application of sections 661(a) and 662(a). Therefore, only the income
that is (1) allocable to the surviving spouse's separate share for a
taxable year, and (2) distributed to the surviving spouse in
satisfaction of the elective share will be treated as a distribution
subject to sections 661(a) and 662(a). This approach results in the
surviving spouse being taxed on the estate's income earned during
administration only to the extent of the surviving spouse's right to
share in the estate's income under state law. Comments are requested on
whether there are situations in which an elective share or dower
interest would not be a separate share under the separate economic
interest test set forth in the proposed regulations.
Electing Revocable Trust To Be a Part of Estate
These proposed regulations provide that a qualified revocable trust
that elects to be treated as part of the decedent's estate constitutes
a separate share for the sole purpose of determining the amount of
distributable net income in the application of sections 661 and 662. A
separate proposed regulation project will provide further guidance
concerning qualified revocable trusts that are treated as part of an
estate.
Proposed Effective Date
These regulations apply to estates of decedents dying after the
date that the Treasury decision adopting these rules as final
regulations is published in the Federal Register.
Effect on Other Documents
When these regulations are finalized, Rev. Rul. 64-101 (1964-1 C.B.
77) and Rev. Rul. 71-167 (1971-1 C.B. 163) will be obsolete.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12886. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, this notice of proposed
rulemaking will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
[[Page 792]]
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any electronic and written comments (a
signed original and eight (8) copies) that are submitted timely to the
IRS. The IRS and Treasury specifically request comments on the clarity
of the proposed regulation and how it may be made easier to understand.
All comments will be available for public inspection and copying. We
especially request comments concerning the treatment of pecuniary
bequests (including formula pecuniary bequests) as separate shares.
A public hearing has been scheduled for April 22, 1999, beginning
at 10 a.m. The hearing will be held in room 2615, Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington, DC. Due to
building security procedures, visitors must enter at the 10th Street
entrance, located between Constitution and Pennsylvania Avenues, NW. In
addition, all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be admitted
beyond the immediate entrance area more than 15 minutes before the
hearing starts. For information about having your name placed on the
building access list to attend the hearing, see the FOR FURTHER
INFORMATION CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit written or
electronic comments by April 6, 1999, and submit an outline of topics
to be discussed and the time to be devoted to each topic (a signed
original and eight (8) copies) by April 1, 1999.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal author of these regulations is Laura Howell of the
Office of Assistant Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.663(c)-1 also issued under 26 U.S.C. 663(c).
Section 1.663(c)-2 also issued under 26 U.S.C. 663(c).
Section 1.663(c)-3 also issued under 26 U.S.C. 663(c).
Section 1.663(c)-4 also issued under 26 U.S.C. 663(c).
Section 1.663(c)-5 also issued under 26 U.S.C. 663(c).
Section 1.663(c)-6 also issued under 26 U.S.C. 663(c). * * *
Par. 2. Section 1.663(c)-1 is amended as follows:
1. The section heading is revised.
2. The first sentence of paragraph (a) is amended by removing the
language ``trust'' and adding the language ``trust (or estate)'' in its
place and removing the language ``trusts'' and adding the language
``trusts (or estates)'' in its place. The second sentence of paragraph
(a) is amended by removing the language ``trusts'' and adding the
language ``trusts (or estates)'' in its place.
3. Paragraph (b)(2) is removed.
4. Paragraphs (b)(3) and (b)(4) are redesignated as paragraphs
(b)(2) and (b)(3).
5. Paragraph (b) introductory text, is amended by removing the
language ``trusts'' and adding the language ``trusts (or estates)''
each place it appears.
6. Paragraph (c) and the last sentence of paragraph (d) are amended
by removing the language ``trust'' and adding the language ``trust (or
estate)'' in its place.
The revision reads as follows:
Sec. 1.663(c)-1 Separate shares treated as separate trusts or as
separate estates; in general.
* * * * *
Par. 3. Section 1.663(c)-2 is revised to read as follows:
Sec. 1.663(c)-2 Computation of distributable net income.
The amount of distributable net income for any share under section
663(c) is computed for each share as if each share constituted a
separate trust or estate. Accordingly, any deduction or any loss which
is applicable solely to one separate share of the trust or estate is
not available to any other share of the same trust or estate.
Par. 4. Section 1.663(c)-3 is amended by revising the section
heading and removing paragraph (f) to read as follows:
Sec. 1.663(c)-3 Applicability of separate share rule to trusts.
* * * * *
Sec. 1.663(c)-4 [Redesignated as Sec. 1.663(c)-5]
Par. 5. Section 1.663(c)-4 is redesignated as Sec. 1.663(c)-5 and a
new Sec. 1.663(c)-4 is added to read as follows:
Sec. 1.663(c)-4 Applicability of separate share rule to estates.
(a) General rule. The applicability of the separate share rule to
estates provided by section 663(c) will generally depend upon whether
the governing instrument and applicable local law create separate
economic interests in one beneficiary or class of beneficiaries of the
decedent's estate such that the economic interests of the beneficiary
or class of beneficiaries are not affected by economic interests
accruing to another beneficiary or class of beneficiaries. A separate
share should be allocated only the share of the estate's income and
deductions that the beneficiary (or beneficiaries) of such separate
share is (or are) entitled to (if any) under the terms of the governing
instrument or local law. The separate share rule does not affect rules
under section 663(a) concerning specific gifts and bequests.
(b) Examples of separate shares. Separate shares include--
(1) A surviving spouse's elective share;
(2) A revocable trust that elects to be part of the decedent's
estate under section 645;
(3) The residuary estate, or some portion of the residuary estate,
if the requirements of paragraph (a) of this section are met; and
(4) A gift or bequest of a specific sum of money or of specific
property that is paid or credited in more than three installments, if
the requirements of paragraph (a) of this section are met.
(c) Shares with multiple beneficiaries and beneficiaries of
multiple shares. A share may be considered as separate even though more
than one beneficiary has an interest in it. For example, two
beneficiaries may have equal, disproportionate, or indeterminate
interests in one share which is economically separate and independent
from another share in which one or more beneficiaries have an interest.
Moreover, the same person may be a beneficiary of more than one
separate share.
Par. 6. Newly designated Sec. 1.663(c)-5 is amended by:
[[Page 793]]
1. Revising the section heading and introductory text.
2. Redesignating the ``Example.'' as ``Example 1.'' and
redesignating paragraphs (a), (b), (c), (d), and (e) in newly
designated Example 1 as paragraphs (i), (ii), (iii), (iv), and (v).
3. Adding Example 2, Example 3, and Example 4.
The revisions and addition read as follows:
Sec. 1.663(c)-5
Examples.
Section 663(c) may be illustrated by the following examples:
Example 1. * * *
Example 2. (i) Facts. (A) Testator died domiciled in State X on
January 30, 1999, leaving an estate of $40,000,000 after debts,
expenses, and estate taxes, and survived by a spouse and three adult
children from a previous marriage. Testator's will directed the
executrix to pay the surviving spouse $1,000,000 in cash and divide
the residue, after payment of debts, expenses, and estate taxes,
equally among Testator's three children.
(B) The surviving spouse filed an election under State X's
elective share statute. The court determined that the surviving
spouse's election was valid and ordered the executrix to pay the
elective share. Under State X's elective share statute, a surviving
spouse is entitled to one-fourth of a decedent's estate after debts,
expenses, and estate taxes if the decedent had children. Further,
the surviving spouse is entitled to a proportional amount of the
estate net income and participates proportionally in appreciation or
depreciation of the estate's assets.
(C) The executrix elected the calendar year for the estate. On
June 30, 1999, the executrix distributed $5,000,000 to the surviving
spouse in partial satisfaction of the elective share. During the
1999 taxable year, the estate received dividend income of $2,000,000
and paid expenses of $50,000. For the 1999 taxable year, the value
of the estate neither appreciated nor depreciated. The executrix
made no other distributions during the 1999 taxable year.
(ii) Holding. Separate share treatment applies to each of the
three residuary bequests, and to the surviving spouse's elective
share.
(iii) Application. (A) After determining the income and expenses
for the estate, the executrix allocated a portion of the income and
expenses to each separate share based upon each share's percentage
of the estate. Thus, while the surviving spouse's elective share
initially constituted 25% of the estate, after the partial
distribution of $5,000,000 made on June 30, 1999, the elective share
constituted a smaller percentage of the estate. Accordingly, the
percentage of the estate's income and expenses allocated to the
elective share after June 30, 1999, was correspondingly reduced in
accordance with the executrix's determination of the proper
allocation of income and expenses to the elective share.
(B) For the 1999 taxable year, the estate is treated as having
distributed to the surviving spouse the distributable net income
that was allocated to the elective share. In accordance with section
662, the surviving spouse must include in gross income for the 1999
taxable year an amount equal to the distributable net income
allocated to the surviving spouse's separate share and distributed
to the surviving spouse for the 1999 taxable year. The estate will,
accordingly, be allowed a deduction under section 661 for the amount
of distributable net income allocated to the elective share and
distributed to the surviving spouse.
Example 3. (i) Facts. (A) Assume the same facts as in Example 2
except that Testator died domiciled in State Y leaving an estate of
$60,000,000 after debts, expenses, and estate taxes. Under State Y's
elective share statute, the surviving spouse is entitled to the date
of death value of one-third of the decedent's estate after debts,
expenses, and taxes. The statute also provides that the surviving
spouse is not entitled to any of the estate's income and does not
participate in appreciation or depreciation of the estate's assets.
Further, under the statute, the surviving spouse is entitled to
interest on the elective share from the date of the court order
directing the executrix to make payments.
(B) The executrix elected the calendar year for the estate.
During the 1999 taxable year, the estate received dividend income of
$3,000,000, and paid administration expenses of $60,000 and paid the
surviving spouse $1,000,000 of interest payments on the elective
share. Also, during the 1999 taxable year, the executrix distributed
$5,000,000 to the surviving spouse in partial satisfaction of the
elective share. The executrix made no other distributions during the
1999 taxable year.
(ii) Holding. Separate share treatment applies to each of the
three residuary bequests and to the surviving spouse's elective
share.
(iii) Application. The distributable net income of each child's
residuary bequest is $980,000 (a 33.33% share of estate income less
a 33.33% share of estate expenses). Because the surviving spouse was
not entitled to any estate income under state law, no income is
allocated to the spouse's separate share. The distribution in
satisfaction of the spouse's elective share does not consist of any
distributable net income and is not included in the spouse's gross
income under section 662. The $1,000,000 of interest payment to the
surviving spouse must be included in gross income of the spouse
under section 61. Therefore, the estate is treated as having
distributed to the surviving spouse $5,000,000 of amounts other than
1999 estate income. Accordingly, the estate is not allowed a
deduction under section 661 for the distribution made to the
surviving spouse. The taxable income of the estate for the 1999
taxable year is $2,939,400 ($3,000,000 (dividend income) minus
$60,000 (expenses) and $600 (personal exemption)). The $1,000,000
interest payment is a nondeductible personal interest expense
described in section 163(h).
Example 4. (i) Facts. (A) Testator died domiciled in State Z on
February 14, 1999, survived by a spouse and two children. Testator's
will contains a nonproportional funding fractional formula marital
bequest for the surviving spouse with a residuary credit shelter
trust for the lifetime benefit of the surviving spouse, and
remainder to the two children on the surviving spouse's death. The
date of death value of the estate is $1,650,000.
(B) The executrix elected the calendar year for the estate.
Under the fractional formula, the marital bequest constitutes 60% of
the estate and the credit shelter trust constitutes 40% of the
estate. Accordingly, the executrix claims a marital deduction of
$990,000 on the estate tax return for the amount passing to the
spouse under the fractional formula. On December 31, 1999, the
executrix made a partial proportionate distribution of $1,000,000,
$600,000 to the surviving spouse outright and $400,000 to the credit
shelter trust. As of December 31, 1999, prior to the distribution,
the value of Testator's estate had appreciated to $2,000,000.
(C) During the 1999 taxable year, the estate made no other
distributions, received dividend income of $20,000, and paid
expenses of $8,000.
(ii) Holding. Separate share treatment applies to the fractional
formula marital bequest and the credit shelter trust.
(iii) Application. (A) Because Testator provided for a
fractional formula marital bequest in the will, the income and any
appreciation in the value of the estate assets is proportionately
allocated between the marital bequest share and the credit shelter
trust share. Therefore, the distributable net income must be
allocated 60% for the marital separate share and 40% for the credit
shelter separate share.
(B) The distributable net income allocable to the marital share
is $7,200 (60% of estate income less 60% of estate expenses).
Correspondingly, the distributable net income allocable to the
credit shelter share is $4,800 (40% of estate income less 40% of
estate expenses). Because the $600,000 amount distributed in partial
satisfaction of the marital bequest exceeds the distributable net
income of $7,200 allocated to the marital share, the estate is
treated as having distributed to the surviving spouse $7,200 of 1999
distributable net income and $592,800 of other amounts. Similarly,
because the $400,000 distributed in partial satisfaction of the
amount payable to the credit shelter trust exceeds the distributable
net income of $4,800 allocated to the credit shelter trust share,
the estate is treated as having distributed to the credit shelter
trust $4,800 of 1999 distributable net income and $395,200 of other
amounts. Accordingly, the estate is allowed a deduction of $12,000
under section 661 for the 1999 taxable year. The taxable income of
the estate is $0, computed as follows:
Dividends.......................................... $20,000
Deductions:
Distribution to surviving spouse share........... $7,200
Distribution to credit shelter trust share....... 4,800
Expenses......................................... 8,000
[[Page 794]]
Personal exemption............................... 600
20,600
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(600)
(C) In accordance with section 662, the surviving spouse must
include in gross income for the 1999 taxable year an amount equal to
the distributable net income of the marital bequest share ($7,200)
that was distributed to the surviving spouse. The credit shelter
trust must include in gross income for the 1999 taxable year an
amount equal to the distributable net income of the credit shelter
trust share ($4,800) that was distributed to the credit shelter
trust.
Par. 7. Section 1.663(c)-6 is added to read as follows:
Sec. 1.663(c)-6 Effective date.
Sections 1.663(c)-1 through 1.663(c)-5 concerning the application
of the separate share rules to estates apply to estates of decedents
dying after the final regulations are published in the Federal
Register.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-176 Filed 1-5-99; 8:45 am]
BILLING CODE 4830-01-P
