In Uncategorized on 12/08/2016 at 16:25

And She Also Got the Deduction

Judge Laro tells the story of Estate of Steve K. Backemeyer, Deceased, Julie K. Backemeyer, Personal Representative, and Julie K. Backemeyer, 147 T.C. 17, filed 12/8/16.

The late Steve farmed in Cass County, NE, and in the year prior to the year at issue, bought a lot of inputs, like seed, fertilizer, insecticide and diesel fuel, which would help him transform Cass County soil, rain and sunshine into corn and soybeans. Being a cash basis sole proprietor, the late Steve wrote off all the costs thereof on his Schedule F for that year.

In the next succeeding year, being the year at issue, but before he could use any thereof, the late Steve bought the farm. The inputs aforesaid turned up on the estate inventory, at cost. The late Steve had a bushelbasketful of receipts for all but $203 thereof.

The farmland and inputs passed to Julie via the family trust. Julie took the inputs as an in-kind distribution from the trust and promptly took up farming. And wrote off the inputs she had gotten against the income from the sales of corn and soybeans.

IRS yells a lot of things, but settles on tax-benefit rule: if you took a deduction in one year, but a fundamental change took place inconsistent with the premise upon which the deduction was taken, and no nonrecognition provision applies, that item is income in the next year. IRS says this is fundamental.

Yes it is. But Julie got a stepped-up basis in the inputs because of Steve’s death. And estate tax and income tax are two separate things.

Steve’s deduction of the inputs is OK even though he didn’t use them in the year he bought them. See my blogpost “The Field Pack Question,” 7/30/15.

And Julie’s deduction is OK, too.

“…neither Mr. Backemeyer’s death nor the distribution of the farm inputs to and their use by Mrs. Backemeyer was fundamentally inconsistent with the premises on which the initial section 162 deduction for tax year 2010 was based.  “A current event is considered fundamentally inconsistent with the premises on which the deduction was originally based when the current event would have foreclosed the deduction if that event had occurred within the year that the deduction was taken.’  Frederick v. Commissioner, 101 T.C. at 41.  Had Mr. Backemeyer died and Mrs. Backemeyer inherited and used the farm inputs in [year preceding death], the initial section 162 deduction would not have been recaptured for purposes of the income tax.

“The reason for this is that the estate tax effectively ‘recaptures’ section 162 deductions by way of its normal operation, obviating any need to separately apply the tax benefit rule.  When Mr. Backemeyer died, all of his assets, including the farm inputs, became subject to the estate tax, which operates similarly to a mark -to-market tax when the mark-to-market tax is imposed on zero-basis assets.” 147 T. C. 17, at pp. 26-27.

Requiring Julie to relinquish the deduction on the inputs would mean double taxation…estate and income.

While it may be beneficial for tax purposes, death is not generally recommended for tax planning purposes.

Judge Laro doesn’t state whether estate tax was actually paid, but the Section 1014 step-up doesn’t require that tax be paid.

IRS says that Julie is getting a double deduction, one on the 1040 MFJ she and Steve filed for Steve’s last full tax year, and one on her own the next year.

OK, says Judge Laro, but Congress has monkeyed with Section 1014 as recently as last year (2015), and presumably knows the laws they are amending. Wanna bet, Judge?

“It is hardly unforeseeable that taxpayers would attempt to deduct previously expensed inherited assets for which they received a stepped-up basis, yet at no point has  Congress acted to prevent it.” 147 T. C. 17, at pp. 30-31.

A classic tax benefit rule is recapture depreciation in Sections 1245 and 1250. But they don’t apply at death.

Finally, a nonrecognition statute blocks the tax benefit rule, and nonrecognition of stepped-up gain at death is a fundamental nonrecognition statute.

So no deficiency, except for the tax on the $203 Julie concedes. And that’s way below the radar for the substantial understatement chop IRS was looking for.


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