Washington News

Each year, traditional IRA owners of age 73 and older must take a required minimum distribution (RMD). In nearly all cases, the RMD is calculated using the Uniform Table. Under the Uniform Table, distributions generally commence at age 73 at approximately 3.8% and increase each year based on the age of the IRA owner. This RMD must be taken by December 31 each year.

The majority of traditional IRA owners with larger IRA balances take the RMD during the months of October, November and December. Because many individuals with larger IRAs do not require funds immediately for living expenses, by delaying an RMD until the end of the year, they benefit from additional tax-free growth in the IRA.

Fortunately, the IRA charitable rollover will qualify for the donor's RMD. The IRS term for an IRA charitable rollover is a qualified charitable distribution (QCD). Your IRA custodian may also use this term.

There are five donor profiles for IRA charitable rollover gifts. The first are the convenience donors who appreciate the simplicity and ease of using this method for their end-of-year contributions. The second is the generous donor, who wants to give past the 60% of AGI deduction limit. The third is a major donor. This person may be a generous individual who is looking for a favorable opportunity to make a major gift. Fourth, the Social Security recipient may reduce taxes with an IRA rollover gift. Finally, a standard deduction donor will benefit from a direct IRA to charity gift.

Convenience Donor

Many IRA owners delay taking IRA withdrawals until October, November or December each year. As the individual approaches the end of the year, he or she will need to make decisions. If an IRA owner is actively making gifts to charity during the year, then it may occur to him or her that this is a good opportunity to make a gift.

Convenience donors may contact their IRA custodians to arrange for an IRA charitable rollover. There is no charitable income tax deduction, but also no inclusion in federal taxable income. It is simply a very convenient way to help their favorite charity.

Generous Donor

Some very generous individuals are already giving up to the 60% of adjusted gross income level. This is the maximum level under IRS rules to deduct cash gifts each year. Any gifts over this limit may be carried forward and deducted over the following five years. Some generous donors may also have a large IRA. Since they frequently live at a moderate level in proportion to their income and assets, they may not actually need all of their IRA.

If there is a desire to give more, they can give up to 60% of adjusted gross income from their regular assets and then make "over and above" gifts from their IRA. Some generous donors may in effect give nearly 100% of income per year through this method. Since the IRA rollover is not included in taxable income, it will have no impact on their regular income and other charitable gifts.

Major Donor

Board members, trustees and other major donors frequently have large IRAs. As the rules have continually become more favorable for IRAs and required withdrawals have been reduced, large IRAs will continue to grow. Over longer periods of time, there are occasional market dips, but the longer-term trend is positive and large IRAs will continue to increase in value.

For many professionals and business owners, the IRA may even become the vast majority of the estate. They have a need to do some "asset balancing" or there may be major future income tax problems. Therefore, it may be desirable for the major donor to give up to $105,000 in 2024 to charity from his or her IRA. This has the advantage of "balancing" the estate assets.

In addition, there may be income tax benefits. If the donor were to take the IRA distribution into his or her own personal income, there are several types of exemptions that are phased out at higher income levels. Thus, it may actually be preferable to make the gift directly from the IRA rather than making a charitable gift from regular income.

Social Security Donor

Social Security is subject to two levels of taxation. For donors who have income in excess of the first level, 50% of Social Security is taxed. For donors with income in excess of the second level, up to 85% of Social Security income may be subject to tax.

Withdrawing an amount from an IRA will potentially cause your income to increase from the 50% taxable bracket to the 85% Social Security taxable bracket. Even though the withdrawn amount is given to charity and deducted, there still is increased tax on your IRA. Thus, by making the transfer directly to charity, many Social Security recipients will save income taxes.

Standard Deduction Donor

Many seniors do not have a mortgage and their medical deductions are less than 7.5% of adjusted gross income (AGI). Thus, they may not have a sufficient level of deductions to itemize and choose instead to use the standard deduction.

If this donor withdraws $1,000 from his or her IRA and then gives it to charity, there is $1,000 of increased income with no offsetting charitable deduction, since the standard deduction is taken. Therefore, it will be preferable for all donors who are taking a standard deduction to make IRA rollover gifts directly to charity and avoid the additional income tax.

Children Pay Gift Tax on QTIP Termination

In Bruce E. McDougall et al. v. Commissioner; No. 2458-22; No. 2459-22; No. 2460-22; 163 T.C. No. 5, Clotilde McDougall passed away and the executor elected to qualify a residuary trust as a qualified terminable interest property (QTIP) trust under Section 2056(b)(7). The initial trust was created in 2011. In 2016, Bruce and his children, Linda and Peter, commuted the trust and its assets were distributed outright to Bruce. Bruce subsequently transferred the assets to other trusts for the benefit of the children in exchange for promissory notes.

Bruce, Linda and Peter each filed IRS Form 709 Gift Tax Returns for 2016 and claimed the reciprocal gifts required zero payment of gift tax. The IRS issued a notice of deficiency and claimed that the commutation of the QTIP trust caused the gifts from the father to the children and the transfer of the remainder interests by the children to the father as a taxable gift under Section 2511.

The Tax Court held that the commutation did not create a taxable gift by the father because there was no gratuitous transfer. However, the commutation of the QTIP trust did lead to taxable gifts by the children under Section 2511.

The Tax Court reviewed Estate of Anenberg v. Commissioner, No. 856-21, 162 T.C. (May 20, 2024). In that case, it was held that a termination of a QTIP trust did not result in a taxable gift by the surviving spouse to children. However, after the surviving spouse received the property, he or she could then engage in subsequent estate planning strategies.

Clotilde McDougall passed away in December 2011 within an estate of nearly $60 million. Her husband Bruce was her personal representative. Approximately $54 million was transferred to a residuary trust that paid all income to Bruce. Upon his death, the QTIP was divided "into equal shares, one share for each of [Clotilde’s] children who is then living and one share for each of [her] children who is then deceased with descendants then living."

By 2016, the QTIP trust value had more than doubled to over $110 million. Bruce, Linda and Peter agreed that the trust would terminate. The agreement stated, "The parties hereby agree that the Trust shall be commuted and the entire remaining balance of the Trust shall be distributed outright and free of trust to Bruce." The agreement stated that the gift of the remainder interests from Bruce to Linda and Peter, and from Linda and Peter to Bruce was a "reciprocal gift transfer."

Bruce, Linda and Peter filed IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Returns. The returns all stated that there was a deemed gift by Bruce to Linda and Peter and a transfer of the same interests by the children to Bruce as a reciprocal gift transfer.

In Anenberg, the Tax Court noted that the "QTIP fiction" was that the assets were in essence owned by surviving spouse. The commutation of a QTIP trust under Section 2519 did not constitute a taxable gift or a transfer of the property. Therefore, there was no gratuitous transfer by Bruce. In Anenberg, the IRS did not issue a deficiency against the holders of the remainder interest. However, the IRS had issued a deficiency against Linda and Peter in McDougall.

The court noted the QTIP fiction "does not apply for all purposes.". Therefore, because the two children obviously had substantial value as the remainder recipients, they had made a gift transfer to Bruce.

The children claimed there was a reciprocal gift. However, the termination of the QTIP trust did not include any gift by Bruce to the children. His subsequent transfer was to trusts in exchange for installment notes and therefore an exchange, not a gratuitous gift. The IRS noted if "Linda and Peter were to transfer their remainder interests to a third party, the transfers would clearly be a gift and Petitioners admit as much."

Therefore, the transfer by Linda and Peter of their remainder interests to Bruce constituted taxable gifts.

Editor's Note: While the age of Bruce was not specified, assuming that the 2016 QTIP value was $100 million, there may be substantial gift tax. If Bruce were age 85, under Section 7520 tables the approximate value of the remainder interests would be $75 million. With two 2016 gift exemptions of $5.45 million, there still would be a taxable transfer of about $64 million and gift tax of over $25 million. The final numbers will be determined by the parties and the Tax Court, but the potential gift tax is substantial.

IRS Final Regulations on Basis Consistency

On September 16, 2024, the Department of the Treasury published T.D. 9991; 89 F.R. 76356-76387, the final regulations that provide statutory guidance on basis consistency. The final regulations were similar to the proposed regulations (REG-127923-15) issued in March 2016.

Under Section 1014(f)(1), the basis of property acquired from a decedent is the final value for purposes of the federal estate tax return. Whether or not a final value has been determined, the executor files a statement required by Section 6035(a). These basis consistency rules are governed by Section 1014(f) and Section 6035, which requires a Form 8971 information return.

The basic issue addressed by the final regulations is a concern that the estate has an incentive to value assets at a low level to reduce estate tax, but the beneficiaries have an incentive to value the assets at a high value to reduce income tax on subsequent sale of the asset. Under Section 1014, the basis of assets acquired from a gross estate is the fair market value as of the date of death.

Reg. 1.1014-1(a) states "the purpose of Section 1014 is, in general, to provide a basis for property acquired from a decedent that is equal to the value placed upon such property for purposes of the federal estate tax." Courts have determined that there is a duty of consistency and a respect for basic fairness. Courts have stated that the "law should not be such an idiot" that it can allow the estate to claim a lower value and the beneficiary who later sells the assets to claim a higher basis. Under the consistency doctrine, the same value must be used for both the estate and subsequent income tax reporting.

In 2015, Congress added Sections 1014(f) and 6035 to address basis consistency issues. The Section 6035 reporting requirement is that executors and trustees report the basis on IRS Form 8971.

There were multiple concerns with the proposed regulations. Commentators inquired about the definition of a statutory executor or the definition of property that would and would not receive a basis adjustment. There was criticism of a provision that created a "zero basis rule" if the property was not reported on an estate tax return. There also was concern about the impact on beneficiaries if they subsequently sell or gift the property and there was a change in value for final estate tax purposes.

The final regulations clarify several issues. Reg.1.6035-1(c)(4) states property is received when a "beneficiary acquires such property when, under local law, title vests in the beneficiary or when the beneficiary otherwise has sufficient control over or connection with the property that the beneficiary is able to take action related to the property for which basis is relevant for Federal income tax purposes."

If there is a delay in valuation, the executor may now report on January 31 of the year following the acquisition of property by a beneficiary. The executor may report basis to a beneficiary and the beneficiary is not required to make subsequent reports. The elimination of the zero basis rule was in response to commentator claims that this was "onerous, unduly harsh, and unfair."

The IRS claimed it has regulatory authority to create the final basis consistency rules. It determined that the requirement for trustees to have subsequent reporting was permissible because they have a fiduciary duty to provide information to beneficiaries.

One of the potential issues for beneficiaries is that estate tax value may be adjusted after the beneficiary has received and sold an asset. This could subject a beneficiary to an income tax deficiency or potential penalty. The regulations include multiple examples on basis consistency for property passing to charity or a spouse, or for the determination of which property is excepted. There also are provisions to define the executor for purposes of assigning the reporting responsibility.

Editor's Note: The final regulations are quite detailed and will require careful analysis by attorneys and CPAs who are filing estate and subsequent income tax returns.

Applicable Federal Rate of 4.4% for October: Rev. Rul. 2024-21; 2024-41 IRB 1 (16 September 2024)

The IRS has announced the Applicable Federal Rate (AFR) for October of 2024. The AFR under Sec. 7520 for the month of October is 4.4%. The rates for September of 4.8% and August of 5.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2024, pooled income funds in existence less than three tax years must use a 3.8% deemed rate of return. Charitable gift receipts should state, “No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property.”