POST MORTEM ELECTIONS AND EQUITABLE ADJUSTMENTS: A BRIEF CHECKLIST

POST MORTEM ELECTIONS AND EQUITABLE ADJUSTMENTS: A BRIEF CHECKLIST

By Noel C. Ice

I. INTRODUCTION AND SCOPE OF OUTLINE.

A. TOPICS COVERED.

This is a very brief outline —a checklist really— of certain post mortem tax elections and equitable adjustments that the executor of a decedent’s estate should consider as a part of the administration process.

II. POST MORTEM ELECTIONS AND EQUITABLE ADJUSTMENTS.

A. ALTERNATIVE VALUATION DATE- IRC §2032.

IRC §2032 gives the executor the right to elect to value all of the property included in the gross estate as of the date which is six months after the decedent's death, if the property is still on hand at that time^[1]. However, if the property has been distributed, sold, exchanged, or otherwise disposed of, within this six month period, then the property is to be valued as of the date of such distribution, sale, exchange or other disposition.^[2] Furthermore, any interest which is affected by mere lapse of time is to be included at its value as of the date of death (instead of the later date) with an adjustment for any difference in its value as of the later date which is not due to the mere lapse of time.^[3]

IRC §2032(c) provides that the election may not be made unless the election will decrease the value of the gross estate, and the amount of federal estate tax. This amendment was designed to prevent estates utilizing the unlimited marital deduction from electing the alternate valuation date in cases where this produced a higher value, in order to increase the amount of the step up in basis under IRC §1014(a)(2).

B. QTIP ELECTION- IRC §2056(b)(7).

The executor has the right under IRC §2056(b)(7)(B)(v) to elect or not to elect a marital deduction for certain property which would otherwise constitute qualified terminable interest property under IRC §2056(b)(7)(B)(i). Whether or not the election is made may have a tremendous impact on the value of the remainder of the estate available for distribution. If the election is not made, it should be obvious that the recipient of the property which is liable for estate taxes will stand to lose, if only in the short run.

The executor may wish to make a partial election. The proposed regulations not only allow partial elections, but they even go so far as to state that a QTIP “trust may be divided into separate trusts to reflect a partial election that has been made or is to be made.”^[4] However, “If the trust is severed, it must be clear, by virtue of the duties imposed on the fiduciary either by applicable state law or by the express or implied provisions of the instrument governing the trust, that the fiduciary must divide the trust according to the fair market value of the assets of the trust at the time of the division.”^[5] It is important to note that a partial election cannot be an election as to a dollar amount (as such), but must relate “to a defined fraction or percentage of the entire trust or specific portion thereof (within the meaning of §20.2056(b)-5(c)).”^[6]

One thing is certain, the surviving spouse’s right to a qualifying income interest in the trust cannot depend upon whether or not the election is made, or the interest will be a nondeductible terminable interest, whether or not the election is made.^[7] However, if and to the extent that the QTIP election is not made, it ought to be permissible, and will usually be desirable, to provide that the nonelected portion will bear its pro rata share of estate taxes attributable to it.

Should the QTIP election be made at all? If the QTIP election is made in a case where the surviving spouse is so well off that the existence of the QTIP estate will not affect his overall spending or gift giving, then the surviving spouse's estate at death will be fully augmented by the QTIP property, plus appreciation and the compounded value of the income distributed. This will result in an increase in the overall estate tax liability of the combined estates on the death of the survivor. This is because, as a result of the QTIP election, the benefit of the lower marginal rates will only be available in the surviving spouse's estate, and will not be available in the estate of the first spouse to die. To reiterate, by electing the marital deduction on the death of the first spouse under the facts as described, the QTIP property, plus appreciation, will be stacked in the surviving spouse's estate to be taxed at a higher bracket than might have otherwise have been the case.

A wealthy spouse may not be able to give away any more property than she is already doing, without either incurring a gift tax or using up her available unified credit, and further, may not be able to spend the income or corpus of the QTIP. In such a case, making the election could be ill advised because of the loss of the graduated estate tax rates in the estate of the first to die. Admittedly, this loss will likely not exceed $125,000. Whether this is considered significant or not may be relative.

The time value of money only serves to make matters worse here, since the savings attributable to the estate tax bracket differential will be compounded if estate tax deferral is not elected. Under these facts, the life expectancy of the survivor is relevant as a tax savings factor insofar as it has a bearing on the likelihood of the spouse having a need for the property. More significant, however, is that, whether or not the QTIP election is made, the income from the QTIP trust will be taxable in the survivor’s estate (because it must be distributed in any event), but since the corpus will be reduced by the estate taxes paid (as a result of the failure to make the election), there will be an economic detriment in the fact that the size income stream will be reduced, and this detriment definitely is exacerbated by time. Therefore, the younger the surviving spouse, the greater the price for failing to make the election. On the other hand, if the income interest in the QTIP is disclaimed, and if the disclaimed interest passes in such a way that it will not be taxed in the survivor’s estate (a bypass trust might work here), then the life expectancy of the survivor becomes irrelevant. The life expectancy of the survivor becomes important in this setting only if there is a possibility that the spouse will (a) consume all or a portion of the QTIP property or the interest thereon, and (b) that such consumption will not be in lieu of consuming other assets which would otherwise have been taxable in the spouse’s estate.

Even if the estate tax bracket differential is ignored, the deferral^[8] of the estate taxes in the estate of the first to die confers no economic value unless the QTIP property or other property is either consumed or given away during the lifetime of the survivor. To illustrate, assume that the QTIP trust is $1,000,000.

i. If the QTIP election is made and the QTIP property is not consumed, and the existence of the trust does not cause the survivor to consume or give away his non-QTIP property at a faster or greater rate than otherwise, and if after x number of years the $1,000,000 grows to $2,000,000 as a result of appreciation and compounding of interest, then, at the death of the survivor, the estate tax on the $2,000,000 will be at the highest marginal rate. If this rate is 50%, then $1,000,000 can pass at the death of the survivor net of estate tax.

ii. On the other hand, if the QTIP election is not made and the income interest is disclaimed, and if the $1,000,000 is taxed at a 50% rate, then there will be $500,000 left. If this $500,000 doubles in value after the same x number of years as in the first example, there will still be $1,000,000 that can pass at the death of the survivor net of estate tax. Because the QTIP election was not made, the QTIP should not be taxable in the survivor's estate, if the trust was properly drafted. Either way the children or other beneficiaries end up with $1,000,000, illustrating that the time value use of money is not of particular economic value in an estate tax context.^[9] If this is the case when the estate tax bracket differential is not considered, then it should be obvious that significant estate tax savings can be had by paying the taxes up front in the first estate, so that there are two runs up the bracket ladder, provided the facts are as stated.

Not making the election may, however, result in cash flow problems. Furthermore, if the surviving spouse is able to spend or give away all or a portion of the QTIP estate, or if, by virtue of the QTIP, she is able to spend or give away more of her own property than would have otherwise been the case, then not making the election could result in needless taxes. To the extent that the spouse's life style is affected by the existence of the QTIP, so that more property is either consumed or given away than would have otherwise been the case, then, to such extent, the making of the QTIP election may mean that estate taxes will never be paid on this property. (Never paying taxes is one of the few things better than deferring them.)

Another reason to make the QTIP might include the intangible value to the spouse in knowing that the QTIP or other estate property passing to the spouse is available if needed, unreduced for estate taxes. Consideration should also be given to the value of obtaining a step up in basis for the QTIP at the death of the survivor. This step up will not be available if the QTIP election is not made.

Finally, one should consider whether or not the credit for previously taxed property under IRC §2013 (the PTP Credit) is available in the estate of the first spouse to die. If it is, it will be wasted if full advantage is taken of the QTIP marital deduction.

There is no pat answer to the question of whether or not the QTIP election should generally be made.

C. REDEMPTIONS OF STOCK UNDER §303.

Under IRC §301, redemptions of corporate stock are generally treated as if they were dividends. If the conditions of IRC §303 are met, the redemption of stock out of an estate will instead be treated as the sale of a capital asset.

The stock must be included in the decedent's gross estate for federal estate tax purposes, and the value of all of the corporation's stock which is included in the decedent's gross estate must exceed 35% of the adjusted gross estate. Furthermore, the redemption proceeds cannot exceed the estate, inheritance and succession taxes payable by reason of the death of the decedent, plus the amount of funeral expenses and cost of administration deductible for federal estate tax purposes. The generation skipping tax is treated as a death tax if it occurs at the same time as or as a result of the decedent’s death.^[10]

Note that the decedent need not have owned the stock at death. For instance, if the decedent made a transfer during lifetime which was subject to §2036, §303 could still apply.

Note that the shareholder redeeming the stock must actually be liable for the tax.^[11] Therefore, if the will provided that all of the taxes and expenses were to be paid by the residuary estate, and the stock is not a part of the residuary estate, §303 will not be available!

In meeting the 35% test, the estate may aggregate the stock in two or more corporations, if 20% or more in value of each corporation is included in the decedent’s estate.^[12] For purposes of the 20% test, the interest of a decedent’s spouse may be considered if the interest was held by the spouse and the decedent as joint tenants, tenants in common, or as community property.^[13]

The redemption is ordinarily required to place within 4 years of death^[14], however, if a §6166 election is made the 4 year period may be extended.^[15]

§303 is still important despite the enactment of that portion of the 1986 Tax Reform Act repealing the capital gains deduction, because even though the decedent's estate receives a step up in basis under IRC §1014, a redemption of stock which is treated essentially as a dividend will result in ordinary income to the extent of accumulated earnings and profits, without regard to the basis of the stock in the hands of the holder. A redemption that is not a complete redemption will ordinarily result in dividend treatment. §303 is an important exception to the general rule, and its importance is essentially undiminished by the repeal of the capital gains deduction.

To an extent, it may be possible during life to take a few simple steps in order to meet the 35% test. For instance, operating assets owned by the decedent individually and leased to the corporation could be transferred to it, thereby increasing the value of the stock as a percentage of the gross estate. Charitable contributions, if made during lifetime will reduce the size of the adjusted gross estate, but if the same contributions are made at death, these gifts will be includible.

D. PARTNERSHIP ELECTION TO INCREASE BASIS OF PARTNERSHIP ASSETS- IRC §§ 732(d) and 754.

Under the normal rules relating to partnership tax accounting, a partner’s income or loss for a partnership taxable year is not recognized until the end of the partnership taxable year. Although the partnership taxable year ordinarily closes with respect to a partner who sells or exchanges his entire interest in the partnership^[16] or whose interest is liquidated^[17], the death of a partner does not, in and of itself, close the partnership taxable year.^[18]

If the partnership year does not close, the decedent’s estate or other successor in interest will recognize income or loss at the end of the partnership’s tax year following the decedent’s death, based in part upon a period of time prior to the decedent’s death. This can result in a distorted relationship between the economic benefit normally associated with the ownership of the partnership interest and the income tax consequences thereof. For instance, distributions of income may have been made during the taxable year preceding the decedent’s death (reducing the value of the partnership interest at the date of death), but the successor in interest (and not the decedent) will be liable for the tax on this income. However, if the surviving spouse is the successor in interest (and the partnership year did not close), partnership income or loss for the year may be reported on the final joint tax return of the decedent and his spouse, thereby ameliorating the problem.^[19]

If the partnership terminates upon the death of a partner the partnership year closes on the date of termination.^[20] If, under the terms of an agreement existing at the date of death of a partner, a sale or exchange of the decedent partner’s interest occurs upon date of death, then the taxable year of the partnership shall close on that date with respect to the deceased partner.^[21] The rule is otherwise in a case where the death results in the liquidation of the partnership interest (as contrasted with a sale), since in the case of a liquidation of the interest, the partnership year does not close until the entire interest is liquidated.^[22]

Although the general rule under IRC §1014 is that the basis of property in a decedent’s estate is its fair market value at date of death, i.Treas. Reg. §1.742-1 states that such basis is to be increased by the estate’s share of partnership liabilities at date of death, and reduced to the extent the value is attributable to items of income in respect of a decedent. (IRC §1014(c) denies a step up in basis for property constituting income in respect of a decedent under IRC §691.)

Although the basis of the partnership interest in the hands of the successor partner will be stepped up, the basis in the underlying partnership assets will not change, in the absence of a special election. IRC §743(a) makes this explicit. However, IRC §743(b) provides that if the partnership makes a special election under IRC §754. then upon the death of a partner (or in the case of a sale or exchange of a partnership interest), the adjusted basis of the decedent’s interest in the partnership property shall be increased or decreased by the difference between the transferee partner’s basis and the adjusted basis of the partnership property.^[23] The election is to be made on a timely filed partnership return for the partnership tax year in which the death occurred.^[24] In the absence of approval from the District Director, the election, once made, is generally irrevocable.^[25] IRC §755 and the regulations thereunder, describe how the basis adjustment is to be allocated. Suffice it to say that accounting for and allocating the basis adjustment among the various categories of partnership assets can be very complex, which is one reason why the partnership may not wish to make the election.

If the §754 election is not made by the partnership, the successor in interest may be able to make an election under IRC §732(d) to adjust the basis of any property distributed to the distributee partner within two years of death, as if the §754 election had been made.^[26]

For an extended discussion of partnership interests in a decedent’s estate, see Post Mortem Tax Planning, by Jerry A. Kasner, Ch. 8, published by Shepard’s/McGraw-Hill, 1986.

E. DEFERRING TAX LIABILITY-IRC §§6161, 6166 and 2032A.

1. SPECIAL USE VALUATION- IRC §2032A.

If “qualified real property” passes to a “qualified heir,” from a decedent, then if certain other conditions are met, the executor may elect to value real estate used for farming or ranching, or in a closely held business, at its actual use value, rather than at its highest and best use. The decrease in value as a result of the election may not exceed, however, $750,000.

§2032A is a very complicated IRC section, made the more so by manifest IRS hostility to the use of the election.

There are a number of conditions which must be met before special use valuation is available. Some of these conditions are as follows:

Pre-Death

i. 50% or more of the adjusted value of the gross estate must consist of the adjusted value of real or personal property which on the date of the decedent's death was being used for a "qualified use" by the decedent or a member of the decedent's family, and was acquired from or passed from the decedent to a qualified heir of the decedent.

ii. 25% or more of the adjusted value of the gross estate must consist of the adjusted value of real property which meets the requirements set forth in paragraph i above, and in paragraph iii below.

iii. During the eight year period ending on the date of the decedent's death, there must have been periods aggregating five years or more during which the real property was owned by the decedent or a member of the decedent's family and used for "qualified use" by the decedent or a member of the decedent's family and there was "material participation" by the decedent or a member of the decedent's family in the operation of a farm or other business, and the property is designated in a special agreement with the IRS. If the decedent was receiving old-age benefits under Title II of the Social Security Act or was disabled, the eight year period shall end on the date such disability or retirement began.^[27]

iv. Such real property is designated in an agreement specified in IRC §2032A(d)(2).

For an excellent in depth discussion of IRC §2032A, see "Making Use of the Estate Tax Savings Available From IRC §2032A," by Clark S. Willingham, 1986 Advanced Estate Planning and Probate Course, sponsored by the State Bar of Texas, Professional Development Program, and BNA Tax Management Portfolio, 445-2nd- Section 2032A Special Use Valuation, by Steven E. Zumbach.

The election, once made, is irrevocable, however it no longer needs to be made on a timely filed return, if that return is the first return.^[28]

Post-Death

The Recapture Tax. If, within 10 years of the decedent’s death, a qualified heir either disposes of all or a portion of the qualified real property, or ceases to use it for a qualified use, then a recapture tax is imposed.^[29] (Under IRC §2032A(c)(7)(A) a two year grace period is permitted post death for commencing qualified use.) Further, if there are periods aggregating 3 years or more during any 8 year period after the decedent’s death and before the date of death of the qualified heir during which there is no “material participation” by the qualified heir or the qualified heir’s family, then a recapture tax is imposed.^[30]

IRC §2032A(g) provides that the Secretary shall prescribe regulations setting forth the application of §2032A in the case where the property is held by a partnership, corporation or trust. Treas. Reg. §20.2032A-3(f)(1) provides that where the property is indirectly owned through an entity (corporation, partnership or trust) there must be an arrangement calling for material participation in the business by the family member specifying the services to be performed. Holding an office in which certain material functions are inherent may constitute the necessary arrangement for material participation. Further:

“Where property is owned by a trust, the arrangement will generally be found in one or more of four situations. First, the arrangement may result from appointment as a trustee. Second, the arrangement may result from an employer-employee relationship in which the participant is employed by a qualified closely held business owned by the trust in a position requiring his or her material participation in its activities. Third, the participants may enter into a contract with the trustees to manage, or take part in managing, the real property for the trust. Fourth, where the trust agreement expressly grants the management rights to the beneficial owner, that grant is sufficient to constitute the arrangement required under this section.”^[31]

In the case of an eligible qualified heir, the material participation test is relaxed somewhat, and an active management test is substituted in its place.^[32] An eligible qualified heir means a qualified heir who is the surviving spouse of the decedent, or a person who has not attained the age of 21, is disabled (within the meaning of subsection (b)(4)(B)^[33]), or is a student.^[34] Active management generally means the making of management decisions of a business other than the daily operating decisions.^[35]

As a general rule, neither material participation nor qualified use may be satisfied vicariously. However, there are exceptions. Although there cannot be material participation through an agent,^[36] it has been held that the activities of a legally appointed conservator are attributable to the ward for purposes of satisfying the material participation requirements of §2032A.^[37] Further, as already noted, the material participation test can be satisfied by a family member.^[38]

The following terms are of paramount importance in applying §2032A.

Qualified Use. In addition to the other tests, the decedent or a member of his family, and the qualified heirs must be use the property for a qualified use, both to qualify initially and to avoid recapture. Qualified use merely means that the property is used as a farm for farming purposes or is used in another trade or business.^[39] The regulations however interpret the statute as requiring the existence of an active trade or business, and indicate that the owner must be “at production risk” as to the property.^[40] A cash lease to a non-family member will not qualify, unless it is based on production.

Note that qualified use must never cease after death, but that material participation need only take place during 5 out the 8 years following death. This is important because although both material participation and qualified use may be through a family member pre-death, the qualified use test may not be satisfied post death through a family member. This means that a post death cash lease (where the qualified heirs are not at production risk) to a family member will be treated as a cessation of qualified use, even though it can be used in the 5 out of 8 years post death material participation test. Qualified use is required at the point in time of the decedent’s death, in addition to material participation during the 5 out of 8 year period preceding death, disability or retirement.

Material Participation. Just what constitutes material participation has been a fertile ground for litigation with and rulings from the Service. Material participation is required by the decedent or a member of his family prior to death, and is also required in order to avoid the recapture tax after death. The regulations provide some help in interpreting this phrase, and offer two safe harbors.^[41] IRC §2032A(e)(6) provides that material participation is to be determined in a manner similar to the manner used for purposes of IRC §1402(a)(1) (relating to net earnings from self-employment). §1402(a)(1) and the §2032A regulations make it clear that the material participation test cannot be satisfied by an agent. Although there is no simple definition as to what constitutes material participation, the regulations suggest that the following factors will be considered: physical work, participation in management decisions, the existence of regular advice and consultation on the operation of the business, participation in a substantial number of management decisions, the regular inspection of production and the maintaining of a home on the farm.^[42]

Active Management. Active management is something less than material participation. The House report indicated that the phrase “active management” means making business decisions other than daily operating decisions.

Qualified Heir. The term "qualified heir" means a member of the decedent's family.^[43]

Member of Family. The IRC defines a "member of the family" as follows:

(2) Member of family. The term "member of the family" means, with respect to any individual, only --

(A) an ancestor of such individual,

(B) the spouse of such individual,

(C) a lineal descendant of such individual, of such individual's spouse, or of a parent of such individual, or

(D) the spouse of any lineal descendant described in subparagraph (C).

For purposes of the preceding sentence, a legally adopted child of an individual shall be treated as the child of such individual by blood.^[44]

Qualified Real Property. Qualified real property is real property located in the United States which was acquired from or passed from the decedent to a qualified heir of the decedent and which, on the date of the decedent's death, was being used for a qualified use by the decedent or a member of the decedent's family, provided the other tests are met.^[45]

Note that the application of the above rules can operate rather oddly. For example, if a man left a ranch in a QTIP trust for his wife, remainder to the man’s son, who was the wife’s step son, the wife would be a qualified heir, and the son would be a member of the family of the both his father and his step-mother. However, material participation during the 5 out of 8 year period preceding the son’s death, disability or retirement would be required before the son could use §2032A; so if the step-son failed to survive the step-mother for 5 years, §2032A would not be available in the son’s estate. The reason? Although the step-son is a member of the step-mother’s family, the step-mother is not a member of the son’s family.

2. DEFERRAL OF TAX UNDER §6161.

A 12 month extension of time to pay any federal taxes may be available under IRC §6161(a)(1) for reasonable cause.^[46] Upon the expiration of each one year period, another one year extension may be granted upon application and good cause shown.^[47]

Similar relief may be available under §6161(a)(2) and (b)(2), which allow a deferral of up to ten years and which are concerned only with the estate tax. §6161 is discretionary with the Internal Revenue Service. The standard for obtaining the 10 year extension used to be that of "undue hardship." In 1976, the phrase "undue hardship" was changed to "reasonable cause."

For an article on the effect of §§303, 6161 and 6166, see "Payment of Estate Taxes: §§303, 6161 and 6166" by Richard Z. Kabaker, found in the course materials for Estate Planning in Depth, 1986, an ALI-ABA course of study.

3. EXTENSION OF TIME FOR PAYMENT OF ESTATE TAX WHERE ESTATE CONSISTS LARGELY OF INTEREST IN CLOSELY HELD BUSINESS- IRC §6166.

If the value of an interest in a closely held business exceeds 35% of the adjusted gross estate, the executor may elect to pay all or a portion of the estate taxes in installments. Interest only can be paid for the first five years, with the tax being paid in up to ten annual installments thereafter. Interest is charged at only 4%. However, the 4% interest portion is only with respect to the tax on $1,000,000, reduced by the unified credit. The tax on $1,000,000, prior to the application of the unified credit is $345,800. In 1987, the unified credit is $192,800. Therefore, the 4% rate is limited to the first $153,000 of estate tax liability.

There are a number of other special conditions and tests which must be met before IRC §6166 will be available.

Passive assets cannot be considered in the application of the 35% test.^[48]

In the case of a sole proprietorship, only the assets of the business which are actually used in the enterprise will be counted for purposes of satisfying the 35% test.

An interest in a partnership will qualify for inclusion in the 35% test if either the partnership has 15 or fewer partners, or if the decedent held 20% or more of the capital interest.^[49] An interest in a corporation will qualify if either the corporation has 15 or fewer shareholders, or if the decedent held 20% or more in value of the voting stock.^[50] If a husband and wife hold an interest as community property, as tenants in common, as joint tenants, or as tenants by the entirety, they are treated as one person for purposes of the numbers of owners tests.^[51] Other provisions of §6166 provide for aggregation with certain members of a decedent’s family under certain circumstances and for certain purposes.

In order to qualify for §6166 treatment, the proprietorship, partnership or corporation must be an active trade or business.^[52]

Business may be aggregated for purposes of meeting the 35% test if 20% or more of the total value of each is included in the decedent’s gross estate.^[53]

F. choice of fiscal year- IRC §441.

Even after TRA '86, an estate may still elect a fiscal year other than a calendar year. This can be very advantageous, since it may be possible to make use of a lower income tax bracket by electing a short first fiscal year, before substantial income has been received. IRC §441.

G. Filing the Final Income Tax Return-Election to file a joint return- IRC §6013(a).

The decedent’s final income tax return is due at the same time that it would have been due had the decedent been alive, i.e., April 15 of the following year, in the absence of extensions. However, the decedent’s tax year ends with death, resulting in a short last tax year.^[54] The decedent’s estate has the right to file a joint return with the surviving spouse, pursuant to IRC §6013(a)(3). Whether this will be advantageous or not will depend on the facts.

H. ELECTIONS UNDER IRC §643(e).

The 1984 Tax Reform Act amended IRC §643 to allow an executor to elect to recognize gain or loss on a distribution of property to the residuary beneficiaries in the same manner as if the property had been sold to the distributees at its fair market value. There are many questions remaining to be answered as to exactly how and when new IRC §643(e) operates, but one thing is for certain, the executor is going to be put to some hard choices in the carrying out of his fiduciary duty to make or not make this election. Also for certain is that the beneficiaries will be economically impacted, for good or ill, by the executor's decision in this regard.

IRC §643(e) was originally enacted by the 1984 Tax Reform Act as §643(d) it was redesignated as IRC §643(e) by the 1986 Tax Reform Act. Although it is not readily apparent from reading the statute, IRC §643(e)(3) was not intended to give the executor an election as to whether or not to recognize gain, unless gain would not otherwise have been recognized.^[55] Therefore, for example, the election under §643(3) would not be available to an executor seeking to avoid having sale or exchange treatment apply to an “in kind” distribution in satisfaction of a pecuniary obligation under a will employing the "true worth" approach.

If property distributed in kind carries out DNI, Treas. Reg. 1.661(a)-2(f) purports to allow a step up in basis equal to the DNI, not to exceed the fair market value of the property at the time of distribution. This regulation has essentially been invalidated by the advent of IRC §643(e). Unless the executor elects to recognize gain on the distribution, the basis of the property in the hands of the beneficiary will be the date of death value under §1014, without an adjustment for the DNI component.^[56] If, however, the executor makes the §643(e)(3) election to recognize gain or loss, the beneficiary's basis will be adjusted accordingly.^[57]

A distribution from the residuary estate ordinarily will not be considered a taxable sale or exchange (although it would carry out DNI), since the beneficiaries own or are treated as owning the residuary estate from date of death.^[58] This is implied in IRC §643(e). However, here IRC §643(e)(3) clearly gives the executor an election whether or not to recognize gain or loss on such distributions. In fact, it may be that the election described in §643(e)(3) only applies to distributions out of the residuary estate which would otherwise not trigger sale or exchange treatment.

Beneficiaries having a share of the residuary estate are generally entitled to a share of each asset, in the absence of a direction in the will to the contrary. It is often more practical, however, to make nonprorata division. For example, instead of giving A and B (equal residuary beneficiaries) an undivided one-half interest in Universal Widgets, Inc., and Blackacre, both being assets of the residuary estate having equivalent value, A and B may prefer that A gets all of the stock in Universal Widgets, Inc., and B gets all of Blackacre. Although such a nonprorata partition has all of the attributes of a sale or exchange between A and B, each exchanging his undivided one-half interest in the one asset for the other's one-half interest in the remaining asset, the Service has made it clear in numerous private letter rulings that if state law or the governing instrument allow non pro rata distributions, sale or exchange treatment will not apply. If, however, sale or exchange treatment is desired, the §643(e) election could here be made to achieve that result.

There is nothing in the statutes that would clearly exclude a distribution of the right to income in respect of a decedent from DNI, unless the gift of the right to the IRD was specific however, prior to the enactment of §643(e), if the right to IRD carried out DNI in an otherwise tax free distribution (such as would ordinarily be the case in a residuary distribution), the basis in the right to the IRD would be stepped up by the amount of the DNI under Treas. Reg. 1.661(a)-2(f), and, to that extent, no income tax would be paid when the IRD was collected! This was in the too good to be true category, or at least so thought the Tax Court in Rollert Residuary Trust, 80 T.C. No. 30 (1983), aff'd 752 F.2d 1128 (6th Cir. 1985). See also Estate of Dean v. Commissioner, TC Memo 1983-276, 46 CCH TCM 184 (1983), which is in accord with Rollert, and notes the conflict between 661 and 691. The Rollert and Dean cases held that IRD would not carry out DNI. This required a torturing of the applicable IRC provisions in order to achieve a fair result.

IRC §643(e)(1) impliedly revokes Treas. Reg. 1.661(a)-2(f), by providing that the basis of any property received by a beneficiary in a distribution from an estate or trust shall be the adjusted basis of such property in the hands of the estate or trust immediately before the distribution, adjusted for any gain or loss recognized to the estate or trust on the distribution. §643(e)(2) provides that in the case of any distribution of property, the amount deductible under the DNI rules of IRC §661(a)(2) and IRC §662(a)(2) shall be limited to the lesser of the basis of the property in the hands of the beneficiary or the fair market value of the property. (This rule won't apply if an election under §643(e)(3) is made.)

There are some interesting possibilities associated with a §643(e)(3) election to recognize gain on a distribution of the right to receive payments of income in the future. However, the point to be made here is that in the absence of a §643(e)(2) election, or other triggering event, the beneficiary of the right to receive IRD will receive a zero basis in the property right (see Treas. Reg. §1.1014-1(c)(1)), which means that the distribution will carry out zero DNI, pursuant to §643(e)(2). This would seem to cure the problem perceived by the Tax Court in Rollert and Dean, since there is no longer the possibility of a free step up.

I. THE ELECTION TO TAKE A DEDUCTION AS AN INCOME TAX DEDUCTION OR AS AN ESTATE TAX DEDUCTION.

There are many items as to which the executor has the right to take either a deduction for income tax purposes on the income tax return of the estate, or to take the deduction under §2053 or §2054 on the estate tax return. An expense of administration is a common example of an instance where an item may be properly deducted on the Estate’s Form 1041 or the 706. A deduction under both sections cannot be taken.^[59]

Obviously (?), a decision to take a deduction on the estate tax return is of little utility if there is no estate tax to pay by virtue of the unlimited marital deduction or otherwise. In this connection, the executor should be mindful of the mechanics of marital deduction formula clauses under the will. Administration expenses not taken on the estate tax return, should, in theory, reduce, dollar for dollar, the amount passing under a credit shelter formula clause. See Estate of Newton B.T. Roney, 33 T.C. 801 (1960), aff'd, 294 F.2d 774 (5th Cir. 1961) Matter of Garofalo, 109 Misc.2d 811, 441 N.Y.S.2d 38 (1982) and Marital Deduction And Credit Shelter Dispositions And The Use Of Formula Provisions, by Richard B. Covey, United States Trust Company of New York, 1984, pages 29-31 and 123. Cf., Treas. Reg. §20.2056(b)-4(a).

The executor should be mindful of the mechanics of marital deduction formula clauses under the will. Administration expenses not taken on the estate tax return, should, in theory, reduce, dollar for dollar, the amount passing under a credit shelter formula clause.^[60]

The reason is that any deduction which reduces the size of the taxable estate for federal estate tax purposes will directly affect the size of the marital deduction under the formula clause (by reducing it), resulting in a corresponding increase in the amount that can pass tax free to the bypass trust. Contrariwise (even though the total dollars available for distribution may not have changed), if an income tax deduction is taken, the size of the taxable estate will increase correspondingly, and the formula marital gift will likewise increase to take up the slack. Either way, if formula clauses are involved, there will be winners and there will be losers, who will be economically affected by the executor's determination as to where to take the deduction.

For instance, to the extent that administration expenses chargeable to principal are not deducted by the estate, the amount available for funding a credit shelter gift will be reduced of necessity. This is because the estate is only allowed a marital deduction for the net value of the property passing to the spouse (adjusted for gains and losses, perhaps).^[61] If the will employs a formula clause, the marital deduction claimed would have to be net of such expenses. Therefore, if the property passing to the spouse were subject to reduction for administrative expenses, this would have to be reflected in the size of the marital deduction claimed. In practice, this means that charges to principal that are not deducted on the 706 reduce the credit shelter gift. Since the credit shelter gift is, in effect, the dollar amount left over after the marital deduction has been computed, the credit shelter gift must be reduced.^[62]

J. EQUITABLE ADJUSTMENTS.

It should be quite obvious that the making of the elections described above will have a substantial economic effect upon the share of the estate which ultimately inures to the benefit of a particular beneficiary. This puts the executor in a difficult position, since the making of the various elections may benefit one beneficiary at the expense of another.

If one beneficiary has benefited and another suffered as a result of a tax election, the question arises as to whether or not the fiduciary can, or in fact must, make an "equitable adjustment" to even out the effects of the election. If the executor may make such an adjustment, then this could make a determination of the marital deduction much more complicated and could possibly put it in jeopardy, under certain circumstances. The failure to insist upon an equitable adjustment might even be a gift, at least if the law were clear, which it is not. In any event, the point to be made is that this whole area is one in which great sensitivity is called for. Unfortunately, it is also an area which is still being developed in other jurisdictions, and has yet to be clearly recognized in our Texas cases.

See In re Estate of Holloway, 323 N.Y.S. 2d 534 (1971) In re Estate of Cooper, 186 So. 2d 844 (Fla. Dist. Ct. App. 1966) In re Warms' Estate, 140 N.Y.S. 2d 169 (1955) and Estate of Bixby, 140 Cal App 2d 326, 295 P 2d 68 (1956). For an excellent, comprehensive article on the problem of equitable adjustments, see Dobris, "Equitable Adjustments in Post Mortem Income Tax Planning: An Unremitting Diet of Warms," 65 Iowa L. Rev. 103 (1979), with a follow up entitled "Limits on the Doctrine of Equitable Adjustment in Sophisticated Post Mortem Estate Tax Planning," 66 Iowa L. Rev. 273 (1981). See also, Carrico and Bondurant, "Equitable Adjustments: A Survey and Analysis of Precedency and Practice," 36 Tax Lawyer 545 (1983), and "Equitable Adjustments," by Malcolm A. Moore, a part of the course materials for the 1986 ALI-ABA course of study Planning Techniques for Large Estates.

K. Generation skipping tax exemption- IRC §§2631 & 2632.

Each taxpayer is entitled to a $1 million exemption from the generation skipping tax. To the extent not utilized during lifetime, the exemption is available at death, but it will be up to the executor to make the allocation (or it will be made for him). The irrevocable allocation is made on a statement attached to a timely filed estate tax return Form 706. If the executor fails to make an allocation, the exemption remaining is allocated first to direct skips and second to trusts which are potentially subject to the GST and with respect to which the decedent is the transferor.

Since it is much more practical to have a trust with a zero inclusion ratio than it is to have a trust which is partially exempt and partially nonexempt, it may be that the Will ought to provide separate trusts which are either wholly exempt or wholly nonexempt. The bypass trust is a good candidate for allocation of the exemption, but the bypass trust alone will not ordinarily use up more than $600,000 of the $1 million exemption. In the typical A-B trust situation, the QTIP will be the only other property available for the allocation.

The QTIP will be includible in the estate of the survivor for estate tax purposes. This means that the spouse will ordinarily be the transferor under the rules generally applicable for determining the transferor of property for generation skipping tax purposes.^[63] However, for GST purposes, IRC §2652(a)(3) gives the executor the right to elect to treat all of the property in the QTIP trust as if the QTIP election had not been made, meaning, in effect, that the decedent, and not the spouse, is treated as the transferor, and therefore the decedent’s executor may allocate some of the decedent’s exemption to the trust. But what if the gross estate exceeds the amount of the available exemption? Since IRC §2652(a)(3), as amended by TAMRA, now requires that the election be made with respect to all of the property in the trust, it is not entirely clear that the §2652(a)(3) election can be made with respect to less than all of the property which qualifies for QTIP treatment. A strict reading of this new restriction, however, is that the election must be made with respect to all of the property in the trust, and not all of the QTIP property. Therefore, if more than one trust is created, one of which will have a zero inclusion ratio and one of which will not, then not only can the election be made with respect to one trust and not the other, but that is the result one would want anyway.

The TAMRA Committee Reports are enlightening on this subject:

“Valuation of property and allocation of GST exemption for purposes of computing inclusion ratio. * * * The bill clarifies the valuation and allocation dates of property for purposes of computing the inclusion ratio. Property transferred as a result of death is generally valued as of the time of distribution from the estate. If requirements prescribed by the Secretary are met [footnote 87- “It is expected that in appropriate circumstances the Secretary of the Treasury will require that property distributed from the estate be fairly representative of the appreciation or depreciation in the value of all property available for distribution. Cf. Rev. Proc. 64-19, 1964-1 C.B. 682.”], however the value of such property is its estate tax value. For property not transferred as a result of death, value is determined, and GST allocation made effective, when the allocation is filed.

* * *

“Treatment of single trust as multiple trust. * * * The bill provides that a single trust generally may not be treated as two separate trusts for purposes of the generation-skipping transfer tax. However, portions of a trust attributable to transfers from different transferors, and substantially separate and independent shares of different beneficiaries in a trust, shall be treated as separate trusts.

* * *

“Special election for qualified terminable interest property. * * * The provision clarifies that the election to treat property as if no QTIP election had been made must be made with respect to all the property in the QTIP trust. For example, if a spouse makes a QTIP election with respect to $1.4 million of a $2 million trust, he must elect with respect to the entire $1.4 million in order to make the generation skipping election. It is expected that the executor’s indication on a Federal estate tax return that separate QTIP trusts will be established will suffice to permit such trusts to be treated as separate trusts for purposes of this provision.”

If the QTIP trust exceeds the available exemption remaining, then a mechanism will have to be in place in the decedent’s Will that would allow the division of the QTIP into separate trusts, if a zero inclusion ratio is to be preserved, and if the bypass trust is to also have a zero inclusion ratio.

L. S CoRporation (Subchapter S) Elections. RESERVED.

M. DISCLAIMERS.

1. Requirements of Federal Law - IRC §2518.

a. The Disclaimer Must Be In Writing.^[64]

b. The Written Disclaimer Must Be Received By The Transferor Of The Interest Within 9 Months After The Transfer.^[65]

The transferor in the case of a decedent’s estate will usually be the executor, and the nine month period is measured from date of death.

The nine month period technically begins to run on the date the transfer creating the interest was made.^[66] This means, for example, that in the case of a future interest, the interest must be made when the interest is created and not when it vests.

There is a very important exception for transferees under age 21. The 9 month period does not begin to run until the transferee is age 21.^[67] Just think of the interesting issues this exception creates.

c. The Transferee Must Not Have Accepted The Disclaimed Interest Nor Any Of Its Benefits.^[68]

This is a difficult rule to interpret and can be a trap for the unwary.

d. As A Result Of The Disclaimer, The Interest Must Pass Without Any Direction On The Part Of The Disclaimant.^[69]

This rule poses problems if the disclaimant will be a trustee of a trust into which the property passes, or will have a power of appointment over the property following the disclaimer. Fortunately the final regulations treat the rule as being satisfied if the disclaimant trustee does not have discretion or the distribution standard is limited by an ascertainable standard.^[70]

e. The Interest Must Pass To Someone Other Than The Disclaimant, Unless It Passes To A Spouse Of The Decedent Transferor.^[71]

This is another trap for the unwary. The exception for a spouse allows a marital deduction gift to be disclaimed, even though the gift will pass to a bypass trust for the spouse.

2. Requirements of State Law - Tex. Prob. Code §37A.

Some of the state law requirements for a valid disclaimer include the following.

a. The Disclaimer Must Be In Writing, Acknowledged Before A Notary, Or Other Person Authorized To Take Acknowledgements Of Conveyances Of Real Estate.^[72]

b. The Written Disclaimer Must Be Filed With The Probate Court In Which The Will Has Been Probated Within Nine Months After The Death Of The Decedent.^[73]

If no administration is pending, the disclaimer is filed with the county clerk of the county of the decedent’s residence.

c. The Written Disclaimer Must Be Delivered In Person Or By Certified Or Registered Mail To The Legal Representative Of The Transferor Within Nine Months After The Death Of The Decedent.^[74]

d. A Person May Provide In The Instrument Of Transfer (E.g., Will) For The Disposition Of Disclaimed Interests.^[75]

e. The Disclaimer Must Be Irrevocable.^[76]

f. The Disclaimed Interest Will Pass As If The Disclaimant Had Predeceased The Decedent Unless The Will or Other Instrument Directs Otherwise.^[77]

g. The Disclaimant Must Not Have Accepted The Property Disclaimed.^[78]

The statute provides that acceptance shall occur only if the person making the disclaimer has previously taken possession or exercised dominion and control of the property in the capacity of beneficiary.

3. Disclaimer Clauses Under a Will.

Consider the issues addressed (albeit imperfectly perhaps) in the following tax clauses.

a. [if POUROVER="n"]Reserved. [endif][if POUROVER="y"]Disclaimer on Behalf of Maker: Maker’s executor is authorized to disclaim all or any portion of any bequest, devise or trust interest (or other disclaimable interest) provided for Maker under any will or trust or otherwise provided. In particular, such executor is authorized to exercise this authority in order to obtain advantageous results considering[if MARRIED="y"], in the aggregate, the taxes to be imposed on Maker’s estate and Maker’s [H/W]'s estate[endif][if MARRIED="n"] the taxes to be imposed on Maker’s estate[endif], even though this may cause some beneficiaries of the estate to receive less than they would otherwise have received. [endif]

b. Specific Property Not In Trust: Except where it has been specifically provided to the contrary elsewhere in this instrument, if any property which is not a part of the residuary estate and which is not held in trust is disclaimed by a beneficiary under this instrument, [if SPOUSEBEN="y"]other than Maker’s [H/W], [endif]such property shall pass to the then living descendants of the disclaimant, by right of representation, if any, and if none, then such property shall become part of the residuary estate.

[if SPOUSEBEN="y"]c. Specific Property Not In Trust Disclaimed By Spouse: Except where specifically provided to the contrary elsewhere in this instrument, if any property which is not a part of the residuary estate and which is not held in trust is disclaimed by Maker’s [H/W], such property shall become part of the residuary estate.

[endif]d. Residuary Property Not In Trust: Except where specifically provided to the contrary elsewhere in this instrument, if any property in the residuary estate which is not to be held in trust is disclaimed, such property shall pass to the then living descendants of the disclaimant, by right of representation, if any, and if none, then such property shall pass as if the disclaimant [if REVOCABLE="n"]died prior to the signing hereof by the Maker[else]predeceased Maker[endif].

e. Property In Trust: Except where specifically provided to the contrary elsewhere in this instrument, if a disclaimant disclaims all of his or her interest in all (or any portion) of any trust, the trust (or the affected portion) shall be administered and distributed as if the disclaimant died after having survived the event giving rise to the interest, such as[if REVOCABLE="n"] the signing hereof by the Maker[else] the death of Maker[endif], even if this results in the acceleration of a remainder interest or closes an otherwise open class, and even if this results in the removal of the property from the trust (which in many cases it would). Except where specifically provided to the contrary elsewhere in this instrument, if a disclaimant disclaims less than all of his or her interest in all (or any portion) of any trust, the trust (or the affected portion) shall be administered and distributed as if the disclaimed interest had been omitted from the terms of the trust.

f. Disclaimer of Specific Assets Out of a Trust or Residuary Estate: A beneficiary of a trust or of the residuary estate is entitled to disclaim all or an undivided portion of a specific item or items of property, in accordance with the foregoing rules. If the specific item disclaimed is sold or converted during administration, the disclaimer will extend to the proceeds of sale. A disclaimer of a specific item or items of property held by a trust shall result in such property being removed from the trust with respect to the disclaimant. If the disclaimed property would continue to be held in trust for the benefit of other beneficiaries in the event of the disclaimant’s death, and if the disclaimant retains interests in other trust property, the disclaimed property (or its proceeds) shall be segregated and held in a separate trust in which the beneficiary will have no interest, to the extent necessary to satisfy the preceding sentence. (A disclaimer from the residuary estate must, of necessity, be subject to the right, if any, of the fiduciary to to pay debts with or otherwise administer the property, prior to funding or other distribution, in the same manner as in the absence of a disclaimer.)

g. Qualified Disclaimer: If the disclaimer is expressly intended to be a qualified disclaimer under §2518 of the IRC,[if SPOUSEBEN="y"] and if the disclaimant is not Maker's [H/W],[endif] the disclaimed property or interest shall pass to someone other than the disclaimant without any direction on the part of the disclaimant, and the disclaimer will be deemed to extend to succeeding interests in the same property as necessary to achieve this end. If the disclaimed interest disappears (such as might be the case with a disclaimed power) and does not pass to the disclaimant, this shall be treated as passing to someone other than the disclaimant, unless this would cause the disclaimer to be disqualified.

h. Recipient Under 25: It is provided, however, that any distribution which is the result of a disclaimer and which would otherwise be distributed in fee simple and free of trust to a person who has not then attained the age of 25 years, or to a beneficiary who is under a legal disability, whether or not so adjudicated, shall instead be made subject to the contingent trust provisions applicable to distributions from the residuary estate.

(i) Disclaimer: If a beneficiary of any trust under this instrument makes a disclaimer, and if this beneficiary is a trustee under this instrument, this trustee shall have no discretionary power to direct the enjoyment of the disclaimed interest or to allocate enjoyment of that interest among members of a designated class (unless this power is limited by an ascertainable standard in the manner permitted by Treasury Regulations under Code §2518, including Treas. Reg. §25.2518-2(e)(1)(i))[if MARRIED="y"], but as to the disclaimed property or interest in property, the then acting co-trustee shall have the sole power to administer and distribute the disclaimed property. If there is no co-trustee then serving Maker appoints the next successor trustee under this instrument to act as co-trustee for this purpose.

N. U.S. Savings Bonds.

The unrecognized income from United States Series E and EE savings bonds may be reported on the decedent’s final income tax return, at the election of the executor.

If a cash basis decedent elected under IRC §454(a) to report the income from either Series E or EE United States Savings Bonds annually, no part of the interest is income in respect of a decedent.

If the §454(a) election was not made during life, the executor may make the election on the decedent’s final individual income tax return, and the interest will not be income in respect of a decedent.^[79] If the election on the final income tax return isn’t made, the interest earned to date of death will be income in respect of a decedent, and is therefore not reported on the final income tax return of the decedent. In this case, the taxpayer, whether it be the estate or the beneficiary, can elect to report all of the income earned both before and after death on the earlier of the maturity or surrender date. The portion of the interest earned prior to death is income in respect of a decedent and therefore the recipient can deduct the estate tax attributable to it.^[80]

Alternatively, if the §454(a) election was not made during life or on the decedent’s final income tax return, the cash basis recipient (the estate or beneficiary) may make the IRC §454(a) election to have the interest taxed annually. In this case the accrued but unrecognized income earned in previous years will be recognized and reported in the year of the election. This income is income in respect of a decedent and the IRC §691(c) deduction is available with respect to it.

If Series EE or E bonds are used to satisfy a pecuniary legacy, the transfer will be treated as a sale and any previously unrecognized income will be recognized by the estate.^[81] The income to date of death would be income in respect of a decedent.

Shocking though the notion may be, under Free v. Bland,^[82] it may be that community property can be left to a third party in fraud on the spouse, without recourse.

^[6]Prop. Treas. Regs. §20.2056(b)-7(b). Temp. Treas. Reg. §22.2056-1(b).

^[7]Prop. Treas. Regs. §20.2056(b)-7(c). See ex. (7).

^[8]Recall that unless the income interest is “disclaimed” there will be no deferral of the income from the QTIP. The mere failure to make the QTIP election, without more, will result in the inclusion of the income stream (and a reduced income stream at that) in the spouse’s estate, if not consumed.

^[9]This should be contrasted with income tax deferral which is of real economic value in other contexts. Also, if the QTIP election is not made, and if the income generated by the trust is taxed in the survivor’s estate, then there will be a loss of the interest on the money used to pay the tax. But if the income is either disclaimed or given away tax free using §2503(b) annual exclusion gifts, then, as it is hoped the example above illustrates, the economic result is a wash: after payment of estate taxes in the survivor’s estate, there will be at least as much property left as if taxes were paid only in the estate of the first decedent to die, assuming the property is not consumed in the interim.

^[18]IRC §706(c)(2)(A)(ii). Treas. Reg. §1.706-1(c)(3).

^[33]That is, the individual has a mental or physical impairment which renders him unable to materially participate in the operation of the farm or other business. IRC §2032A(b)(4)(B).

^[36]§1402(a)(1). Cf., Treas. Reg. §20.2032A-3(g).

^[37]Mangels v. U.S., 828 F.2d 1324 (Eighth Cir. 1987), Rev’g 632 F. Supp. 1555 (S.D. Iowa 1986).

^[38]A member of the family includes a lineal descendant of the parent of the individual. §2032A(c)(6)(B)(ii). §2032A(e)(2)(C). Treas. Reg. §20.2032A-3(e)(1).

^[52]See Rev. Ruls. 75-365. 75-366 and 75-367.

^[55].IRC §643(e)(4); provides that §643(e) does not apply to distributions described in IRC §663(a). §663(a) distributions would include gifts of specific property or of a specific sum of money. (Never mind that Treas. Reg. §1.663(a)-1(b)(1) states that formula pecuniary gifts aren't covered by §663(a).)

^[60]Estate of Newton B.T. Roney, 33 T.C. 801 (1960), aff'd, 294 F.2d 774 (5th Cir. 1961); Matter of Garofalo, 109 Misc.2d 811, 441 N.Y.S.2d 38 (1982); and Marital Deduction And Credit Shelter Dispositions And The Use Of Formula Provisions, by Richard B. Covey, United States Trust Company of New York, 1984, pages 29-31 and 123. Cf., Treas. Reg. §20.2056(b)-4(a).

^[62]Estate of Newton B.T. Roney, 33 T.C. 801 (1960), aff'd, 294 F.2d 774 (5th Cir. 1961); Matter of Garofalo, 109 Misc.2d 811, 441 N.Y.S.2d 38 (1982); and Marital Deduction And Credit Shelter Dispositions And The Use Of Formula Provisions, by Richard B. Covey, United States Trust Company of New York, 1984, pages 29-31 and 123. Cf., Treas. Reg. §20.2056(b)-4(a). But see Estate of Gordon P. Street, TC Memo 1988-553, 56 TCM, CCH Dec. 45,201(M).

^[80]Treas. Reg. §691(a)-2(b), Ex. (3); Rev. Rul. 64-104, 1964-1 C.B. 223; IRS Publication No. 559.