Disclosure on Estate Tax Return of Lifetime Sales to Trusts

Amy E. Heller (Weil, Gotshal & Manges LLP) reports for the October 2006 RPPT eReport on the newest draft of Form 706, issued by the I.R.S on August 16, 2006.  In Draft Form 706 Requires Disclosure of Lifetime Sales to Trusts she says that this form “adds a new category of lifetime transfers” that must be disclosed on the estate tax form.

[L]ine 12(e) of part 4 of the draft form asks an executor whether a decedent at any time during his or her lifetime transferred or sold an interest in a partnership, a limited liability company or a closely-held corporation to a trust that was in existence at the decedent’s death and that was (1) created by the decedent during his or her lifetime or (2) created by someone other than the decedent under which the decedent possessed any power, beneficial interest or trusteeship. If the answer to this question is yes, the executor is required to provide the EIN of the entity in which the interest was transferred.

As a result of new line 12(e), certain gratuitous transfers to trusts that are reportable on a gift tax return will need to be reported for a second time on the transferor’s estate tax return. More significantly, certain sales to trusts for which no gift tax return was filed will need to be disclosed on the seller’s estate tax return. For example, an individual’s sale of a partnership interest to his or her grantor trust for fair market value will need to be reported on the individual’s estate tax return, regardless of whether the sale was required to be reported on a gift tax return. ***

If new line 12(e) is finalized, practitioners who do not currently advise clients to report sales of interests in partnerships, LLCs or closely-held corporations to grantor trusts on gift tax returns may wish to consider doing so. Reporting these sales will help to close the statute of limitations on IRS challenges more quickly and may even reduce the risk of such challenges. If a sale is reported on one of the more than 99 percent of gift tax returns that are not audited and the transferor dies more than three years after the gift tax return is filed, the IRS will generally be precluded from raising valuation or other issues related to the sale on an audit of the transferor’s estate tax return. Furthermore, in the event that the IRS does successfully challenge a sale disclosed on a gift tax return, it may be possible to make adjustments to a client’s estate plan that would not be possible if the challenge arose after his or her death.

In fact, since this article was written, the draft of this form was finalized. The most recently form, revised October 2006, may be accessed here.