CCA 1047021: Estate beneficiaries could not claim unused capital loss carryovers after the estate transferred all property to the United States

Plain-English summary

Chief Counsel Advice considered whether an estate's residuary beneficiaries could use the estate's unused capital loss carryovers under IRC § 642(h)(1). The estate was insolvent under a settlement agreement that transferred all of its proceeds to the United States for unpaid federal income taxes, so no property could pass to the individual beneficiaries. The advice concluded that the beneficiaries were not succeeding to the property of the estate and therefore could not receive the carryovers. It distinguished an example in which beneficiaries received a share of a loss carryover because they could have received estate property if sufficient funds had existed.

Ruling snapshot

• Question: Could residuary beneficiaries claim the estate's unused capital loss carryovers when a settlement transferred all estate proceeds to the United States?
• Outcome: Advice given
• Key authorities: IRC §§ 642(h)(1), 1212, and 172; Treas. Reg. §§ 1.642(h)-3 and 1.642(h)-4.

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201047021
       Release Date: 11/26/2010
       CC:PSI:B02:JKeeney                               Third Party Communication: None
       POSTN-122853-10                                  Date of Communication: Not Applicable

UILC: 642.08-00

date: July 20, 2010

 to:   Associate Area Counsel, CC:SB:1:NEW:1
       (Small Business/Self-Employed)

from: Acting Chief, Branch 2
(Passthroughs & Special Industries)

subject: Request for Chief Counsel Advice

       This Chief Counsel Advice may not be used or cited as precedent.

       LEGEND

       Estate        = --------------------------------------------------------------------------------------------
                       -------------------------
       Decedent      = ------------------------------
       Administrator   -------------------
       Counsel         --------------------
       Date 1        = ----------
       Date 2        = ------------
       Date 3        = ----------
       Date 4          ----------
       Date 5          ----------
       a             = -----------------
       b             = -----------------
       Year 1        = -------
       Year 2          -------
       Year 3          -------
       Year 4          -------

       ISSUE

Whether, under § 642(h)(1), the beneficiaries of the Estate, none of whom will receive
any of the Estate’s property pursuant to a Settlement Agreement with the United States
arising from Decedent’s unpaid income taxes, should succeed to approximately $a of
the Estate’s unused capital loss carryovers.

More specifically, are these beneficiaries included within the phrase, “beneficiaries
succeeding to the property of the estate” under 642(h)(1)?

CONCLUSION

The Estate’s beneficiaries should not be entitled to any of the Estate’s unused loss
carryovers under § 642(h)(1).

FACTS

Decedent died on Date 1. Decedent’s will provided that Decedent’s spouse received
the entire residuary estate in trust for life, with the residue divided equally among
descendants of four named individuals at the spouse’s death. At the time of death,
Decedent had unpaid assessments arising from underpayments of income tax for the
taxable years of Year 1 through Year 4 for joint returns filed with the spouse. The
Administrator of the Estate entered into a Settlement Agreement dated Date 2 with the
United States, which was approved by a state court of appropriate jurisdiction on Date

3. Decedent’s spouse had died by the time of the Settlement Agreement, and the
   spouse’s executor consented to the Agreement.

The Settlement Agreement provided that the Estate was to be deemed insolvent and
that the United States was to receive all the proceeds of the Estate less outstanding
administrative expenses. Accordingly, under the terms of the Settlement Agreement,
none of the individual testamentary beneficiaries are entitled to receive any property.

Subsequent to the Settlement Agreement, on or about Date 4, the United States and
Administrator, as Administrator of the Estate, entered into a stipulation and consent
agreement, reducing to judgment in the amount of $b plus interest in favor of the
United States. This consent judgment represented the assessed federal income tax
liabilities for Year 2 through Year 3.

The Estate anticipates reporting approximately a $a capital loss carryover under § 1212
on its final income tax return for the taxable year ending Date 5.

The Estate has received a formal opinion from its tax counsel, Counsel, who concludes
that the allocation of the Estate’s unused carryover loss to the Estate’s beneficiaries is
not barred by the terms of the Settlement Agreement, by the fact that the Estate is
insolvent, or by the outstanding $b tax liability owed to the United States.

The Administrator of the Estate filed a summary motion with a state court seeking a
judgment directing the Administrator to issue Schedules K-1 (Form 1041), Beneficiary’s
Share of Income, Deductions, Credits, etc. to the Estate’s residuary beneficiaries
reporting their share of the estimated $b unused capital losses. The Department of
Justice, Tax Division, contacted CC:SBSE Area Counsel (1) regarding whether they
should file a motion to remove this matter from state court and place it into federal court
because a state court’s judicial declaration would violate federal rights and (2) whether
the underlying proposal to issue Schedules K-1 to the beneficiaries is correct.
CC:SBSE requested our assistance to determine whether the beneficiaries are entitled
to the Estate’s unused capital losses under § 642(h)(1).

Law & Analysis:

Section 642(h)(1) states that if on the termination of an estate or trust, the estate or trust
has a net operating loss carryover under § 172 or a capital loss carryover under § 1212
then such carryover or such excess shall be allowed as a deduction, in accordance
with regulations prescribed by the Secretary, to the beneficiaries succeeding to the
property of the estate or trust.

Section 1.642(h)-3(a) provides that the phrase “beneficiaries succeeding to the property
of the estate or trust” means those beneficiaries upon termination of the estate or trust
who bear the burden of any loss for which a carryover is allowed, or any excess of
deduction over gross income for which a deduction is allowed, under § 642(h).

Section 1.642(h)-3(b) provides that with reference to an intestate estate, the phrase
“beneficiaries succeeding to the property of the estate or trust” means the heirs and
next of kin to whom the estate is distributed, or if the estate is insolvent, to whom it
would have been distributed if it had not been insolvent.

Section 1.642(h)-3(c) provides that in the case of a testate estate, the phrase
“beneficiaries succeeding to the property of the estate or trust” means the residuary
beneficiaries (including a residuary trust), and not specific legatees or devisees,
pecuniary legatees, or other nonresiduary beneficiaries. However, the phrase does not
include the recipient of a specific sum of money even though it is payable out of the
residue, except to the extent that it is not payable in full. On the other hand, the phrase
includes a beneficiary (including a trust) who is not strictly a residuary beneficiary but
whose devise or bequest is determined by the value of the decedent’s estate as
reduced by the loss or deductions in question.

In the example to §1.642(h)-4, the decedent’s will leaves $100,000 to A, and the residue
of his estate equally to B and C. His estate is sufficient to pay only $90,000 to A, and
nothing to B and C. There is an excess of deductions over gross income for the last
taxable year of the estate or trust of $5,000, and a capital loss carryover of $15,000, to
both of which § 642(h) applies. A is a beneficiary succeeding to the property of the
estate to the extent of $10,000, and since the total of the excess of deductions and the
loss carryover is $20,000, A is entitled to the benefit of one half of each item, and the
remaining half is divided equally between B and C.

With respect to intestate estates, § 1.642(h)-3(b) specifically contemplates an insolvent
estate. However, the regulation does not distinguish degrees of insolvency. In the
present case, the Estate is testate. With respect to testate estates, § 1.642(h)-3(c)
states that the phrase include, “a beneficiary of a fraction of a decedent’s net estate after
payment of debts, expenses, etc.” This section does not distinguish a void net estate.

The Estate obtained a legal opinion letter stating that the Estate’s residuary
beneficiaries would be included within the phrase “beneficiaries succeeding to the
property of the estate” under § 642(h)(1). The opinion letter also stated that it was
made in the absence of any authority (other than the regulation itself) addressing the
application of that phrase in the context of no property passing to any beneficiary.
Therefore, the opinion letter concludes that this opinion has not been tested in either a
decided case or any published Internal Revenue Service ruling. In addition, the opinion
includes the observation that § 1.642(h)-3 indicates that the Department of the Treasury
contemplates that net operating loss carryovers survive the termination of an insolvent
estate likewise has not been tested in either a decided case or any published Internal
Revenue Service ruling.

Section §1.642(h)-3(a) states carryovers and excess deductions pass only to
“beneficiaries succeeding to the property of the estate or trust” who are “those
beneficiaries upon termination of the estate or trust who bear the burden of any loss
for which a carryover is allowed….” In the present case, the individual beneficiaries of
the Estate should no longer be considered beneficiaries after the Estate entered into the
Settlement Agreement to transfer all the proceeds of the Estate to the United States.
This is a distinguishable situation from that set forth in the allocation example.
Beneficiaries in that example received a loss carryover despite not receiving any
property, but could have received property if the estate had sufficient funds. Here, as a
legal matter, the individual beneficiaries could no longer receive anything. Any losses
incurred by the Estate were to the detriment of the United States rather than the
individual beneficiaries. Therefore, the Estate’s beneficiaries should not be entitled to
any of the Estate’s unused loss carryovers under § 642(h)(1).

This writing may contain privileged information. Any unauthorized disclosure of these
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call -----------------------of this office at (202) 622-3060 if you have any further
questions.