Code §642(h)(1) permits the capital loss carryover of an estate to be carried over to the beneficiaries succeeding to the estate property upon termination of the estate. What happens if the beneficiaries do not actually succeed to any property?
In a recent Chief Counsel Advice, the estate agreed with the IRS to turn over all of its assets to settle income tax liabilities of the decedent. The beneficiaries who would have received a distribution from the estate were thus barred from receiving anything. Nonetheless, they deducted capital losses of the estate. The Advice indicates that the beneficiaries should not be allowed the deduction.
Treas. Regs. § 1.642(h)-4 does provide an example of a beneficiary receiving a loss even though there were insufficient assets to actually distribute anything to the beneficiary. This is based on the premise that such a beneficiary would have gotten something but-for the loss, and thus suffered it and should receive the capital loss deduction. Nonetheless, the Advice indicated that there was no way the beneficiaries could receive anything pursuant to the settlement agreement, and thus they could not use this example. The Advice does not provide any details on the economics of the settlement – it would seem that if the losses were large enough that if they did not occur and the IRS liability could have been satisfied with something left over for the beneficiaries, then the beneficiaries suffered the loss at least in part and thus should get at least some of the losses. Such an analysis would seem to be required by the definition of beneficiaries in regard to a testate estate under Treas. Regs. § 1.642(h)-3(a) which definition includes persons who bear the burden of any loss for which a carryover relates. Thus, it would seem that an analysis should have been undertaken to determine if any amounts would have been left to the beneficiaries if the IRS was paid its liability in full, assuming that no losses had occurred. However, the Advice does not undertake this analysis and simply hangs its hat on the fact that the agreement existed so the beneficiaries could receive nothing and thus no losses would be allowed to them – end of story.
Treas. Regs. § 1.642(h)-3(b) provides a definition of a “beneficiary” for an intestate estate. That includes heirs and kin of the decedent under an insolvent intestate estate that receive nothing but would have received something if the estate was not insolvent. This concept, if applicable to a testate estate also, should allow a deduction here, at least in part, if the losses were large enough to have cost the beneficiaries part of what they otherwise would have received even after the IRS was paid in full. The Advice noted that the estate at issue above was a testate estate, so the intestate estate rule did not directly apply and would not be applied. More reasonably, the Advice should have used the intestate rule to inform it regarding the need to track the actual economics in the testate situation, but as noted, such an economic analysis was not undertaken.
Perhaps we may see more on this issue if the taxpayers decide to litigate the issue.