Section 645 Election to Treat Revocable Trust as Part of the Grantor's Estate - Final Regulations Provide Guidance
- A decedent's estate has several income tax advantages not available to a revocable trust. These include:
- The option to adopt a fiscal year for income tax purposes and thereby permit an executor to defer the reporting of income and plan for the use of deductible expenses.
- The ability to take advantage of the charitable set aside deduction under Internal Revenue Code ("IRC") §642(c).
- Recognition of loss upon the satisfaction of a pecuniary bequest with assets having a fair market value less than basis under Code §267(b).
- Not being subject to the active participation requirements of the passive loss rules for tax years ending less than two years after decedent's date of death.
- The Code §645 election was enacted by the Taxpayer Relief Act of 1997, P.L. 105-34, §1305(a). IRS rules for making the election were originally set forth in Rev. Proc. 98-13. In December 2000, the Service published Prop. Reg., §1.645(1) which contains alternate election and reporting requirements.
- These regulations, with generally pro-taxpayer amendments, were finalized on December 24, 2002 (T.D. 9032). IRS Notice 2001-26 provides that estates and revocable trusts of decedents who die after December 31, 1999 and before the effective date of final Code §645 regulations, may use either the election and reporting requirements under Rev. Proc. 98-13 or those in Prop. Reg. 1.645(1).
- The focus of this article is on the final regulations which provide easier and more flexible §645 election procedures and requirements.
V. Qualified Revocable Trust
- A Code §645 election is effective only if made with respect to a "qualified revocable trust" ("QRT").
A QRT is any trust (or portion thereof) "owned" for income tax purposes by the decedent under Code §676 because of a power held by the decedent, determined without regard to Code §672(e) (which treats a grantor as holding any power or interest held by his or her spouse).
A trust is not a QRT if it is treated as owned by the decedent because his or her spouse is granted the power of revocation. However, a trust is a QRT if it is treated as owned by the decedent because he or she had the power to revoke with the consent of the decedent's spouse.
- For estates not filing an estate tax return, the "applicable date" is the date that is two years after decedent's date of death.
VII. Election Procedures
- The straightforward election procedures are set forth in IRC Reg. §1.645.
- If there will be no Executor appointed, the QRT Trustee files the election. In this event, the election must include QRT Trustee's representation that there is no executor and to the trustee's knowledge and belief, one will not be appointed.
- The election is currently made on a statement attached to the initial Form 1041 of the estate, if there is an executor, and, if not, to the Form 1041 filed for the first tax year of the QRT taking into account the trustee's election to treat the trust as an estate under Code §645.
- The IRS has announced that it will publish a §645 election form (Form 8855) by June 24, 2003.
- The QRT and related estate are treated as separate shares for purposes of calculating distributable net income ("DNI"). Accordingly, if distributions are made from the QRT and/or the related estate, the DNI of the entity making the distribution would have to be determined.
- Distributions between the QRT and related estate shares will affect the computation of DNI. The following example is provided in IRC Reg. §1.645(e)(2)(iii)(B):
XI. Planning Strategies
- There are several circumstances in which a Code §645 election can prove beneficial. Some benefits can flow directly and immediately to the QRT beneficiaries. For example:
B is an individual beneficiary of a QRT for which a Code §645 election has been made. The QRT and related estate have a taxable year of December 1, 2002 through November 30, 2003. B receives a taxable distribution on December 15, 2002. Pursuant to Code §662(c), B will not have to report any income as a result of the distribution until 2003, and will have until April 15, 2004 to file an income tax return including the income from the distribution. If no election had been made, the distribution would have been taxable to the beneficiary in 2002, and the tax attributable to the distribution payable on April 15, 2003, just four months later. The election permits a deferral of the tax payment of sixteen months.