Deductions for Transfers for Public, Charitable, &
Religious Uses; In General Marital Deduction;
Valuation of Interest Passing to Surviving Spouse

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 20 [TD 8846] RIN 1545-AV45

TITLE: Deductions for Transfers for Public, Charitable, and
Religious Uses; In General Marital Deduction; Valuation of Interest
Passing to Surviving Spouse

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to the
effect of certain administration expenses on the valuation of
property that qualifies for either the estate tax marital deduction
under section 2056 of the Internal Revenue Code or the estate tax
charitable deduction under section 2055. The regulations distinguish
between estate transmission expenses, which reduce the value of
property for marital and charitable deduction purposes, and estate
management expenses, which generally do not reduce the value of
property for these purposes.

EFFECTIVE DATES: These regulations are effective on December 3,
1999.

FOR FURTHER INFORMATION CONTACT: Deborah Ryan, (202) 622-3090 (not a
toll-free number). SUPPLEMENTARY INFORMATION:

Background

On December 16, 1998, the Treasury Department and the IRS published
in the Federal Register (63 FR 69248) a notice of proposed
rulemaking (REG-114663-97) relating to the effect of certain
administration expenses on the valuation of property which qualifies
for the estate tax marital or charitable deduction. The proposed
regulations were issued in response to the decision of the Supreme
Court of the United States in Commissioner v. Estate of Hubert, 520
U.S. 93 (1997) (1997-2 C.B. 231).

Written comments responding to the notice of proposed rulemaking
were received, and a public hearing was held on April 21, 1999, at
which time oral testimony was presented.

This Treasury decision adopts final regulations with respect to the
notice of proposed rulemaking. A summary of the principal comments
received and revisions made in response to those comments is
provided below.

The proposed regulations set forth the substantive provisions as
applied to the estate tax marital deduction in §20.2056(b)-4(a). For
the estate tax charitable deduction, the proposed regulations (under
§20.2055-1(d)(6)) merely cross-reference the rules for the marital
deduction.

Several commentators suggested that the regulations under section
2055 should contain specific rules relating to the charitable
deduction, rather than just a cross-reference.

The Treasury and the IRS agree with this suggestion. The final
regulations contain rules under §20.2055-3 specifically addressing
the effect of administration expenses on the valuation of property
when all or a portion of the interests in property qualify for the
estate tax charitable deduction.

Several commentators stated that the distinction between estate
transmission expenses and estate management expenses was not clearly
made in the proposed regulations and requested more concrete
definitions of each type of expense. In response to these comments,
the final regulations characterize estate transmission expenses as
those expenses that would not have been incurred except for the
decedent's death.

Although the amount of these expenses cannot be calculated with any
degree of certainty on the date of the decedent's death, they are
expenses that are incurred because of the decedent's death. Estate
management expenses, on the other hand, are characterized in the
final regulations as expenses that would be incurred with respect to
the property even if the decedent had not died; that is, expenses
incurred in investing, maintaining, and preserving the property.
These are expenses that typically would have been incurred with
respect to the property by the decedent before death or by the
beneficiaries had they received the property on the date of death
without any intervening period of administration. In order to be
certain that all expenses are classified as either transmission
expenses or management expenses, transmission expenses are defined
to include all expenses that are not management expenses. Three
commentators stated that the different treatment accorded to estate
transmission expenses and estate management expenses under the
proposed regulations creates a new federal standard for allocating
expenses that may be contrary to the manner in which the expenses
must be charged under state law. However, the Treasury and the IRS
believe that the allocation of administration expenses based on the
distinction between transmission and management expenses provides
the most accurate measure of the value of the property which passes
to the surviving spouse or to the charity at the moment of the
decedent's death for federal estate tax marital and charitable
deduction purposes. Transmission expenses that are charged to the
property passing to the surviving spouse or to the charity reduce
the amount of that property as of the date of the decedent's death
because the expenses, as well as the transfer to the surviving
spouse or to charity, are a consequence of, and arise as a result
of, the decedent's death. In contrast, management expenses do not
generally reduce the amount of the property passing from the
decedent as of the date of the decedent's death because these
expenses are incurred in producing income and preserving and
maintaining the property between the date of the decedent's death
and the date of distribution. These expenses are the ongoing, year-
to-year expenses incurred in the investment, preservation, and
maintenance of property by property owners.

In response to other comments, the final regulations illustrate the
application of these rules to pecuniary bequests to the surviving
spouse. If, under the terms of the governing instrument or
applicable local law, the recipient of a pecuniary bequest is not
entitled to income earned until distribution, the income is not
included in the definition of the marital or charitable share. Thus,
the amount of the property passing to the surviving spouse or
charity for which a marital or charitable deduction is allowable
will not be reduced even if estate transmission or estate management
expenses are paid out of the income earned by assets that will be
used to satisfy the pecuniary bequest.

Two commentators requested guidance in applying the regulations to
estates that are intended to be nontaxable. Accordingly, the final
regulations add two examples, one involving a formula designed to
produce zero estate taxes and the other involving a pecuniary
bequest designed to utilize the applicable exclusion amount under
section 2010.

Many of the comments concerned the special rule of §20.2056(b)-4(e)
(2)(ii) of the proposed regulations. Under the special rule, the
value of the deductible property interest is not increased as a
result of the decrease in the federal estate tax liability that is
attributable to the deduction of estate management expenses as
expenses of administration under section 2053 on the federal estate
tax return. A similar rule would have applied for purposes of the
estate tax charitable deduction.

Several of these commentators argued that the special rule is
inconsistent with sections 2056(a) and 2055(c), because the value of
the property passing to the surviving spouse or charity should be
reduced only by the estate taxes actually paid. Thus, an estate
should be permitted the full benefit of deducting management
expenses on the federal estate tax return, including an increase to
the marital or charitable deduction based on the resultant decrease
in tax payable from the marital or charitable share.

Conversely, other commentators asserted that the special rule does
not conform with section 2056(b)(9). Section 2056(b)(9) provides
that nothing in section 2056 or any other estate tax provision shall
allow the value of any interest in property to be deducted for
federal estate tax purposes more than once with respect to the same
decedent. These commentators pointed out that if estate management
expenses paid from the marital or charitable share are deducted on
the federal estate tax return, and no reduction is made to the
allowable amount of the marital or charitable deduction, then the
same property interest is deducted twice in violation of section
2056(b)(9).

After considering these comments, the Treasury and the IRS have
eliminated the special rule of the proposed regulations. The final
regulations provide that estate management expenses attributable to,
and payable from, the property interest passing to the surviving
spouse or charity do not reduce the value of the property interest.
However, pursuant to section 2056(b)(9), the allowable amount of the
marital or charitable deduction is reduced by the amount of these
management expenses if they are deducted on the Federal estate tax
return.

The Treasury and the IRS believe that the principles which apply for
determining the value of the marital and charitable deductions
should also apply for determining the value of property that passes
from one decedent to another when calculating the amount of the
credit for tax on prior transfers under section 2013. Therefore, the
final regulations amend §20.2013-4(b) by adding a cross reference to
§20.2056(b)-4(d).

Effective Dates The regulations under sections 2055 and 2056 are
applicable to estates of decedents dying on or after December 3,
1999. The regulations under section 2013 are applicable to transfers
from estates of decedents dying on or after December 3, 1999.

Effect on Other Documents

The following publications are obsolete as of December 3, 1999:

Rev. Rul. 66-233 (1996-2 C.B. 428)

Rev. Rul. 73-98 (1973-1 C.B. 407)

Rev. Rul. 80-159 (1980-1 C.B. 206)

Rev. Rul. 93-48 (1993-2 C.B. 270)

Special Analyses

This rule is not a significant regulatory action as defined in
Executive Order 12866. Therefore, a regulatory assessment is not
required. It also has been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to
these regulations, and, because the regulations do not impose a
collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, these regulations were
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Deborah Ryan, Office of
the Assistant Chief Counsel (Passthroughs and Special Industries).
However, other personnel from the IRS and Treasury Department
participated in their development.

List of Subjects in 26 CFR Part 20

Estate taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations Accordingly, 26 CFR part 20 is amended
as follows:

PART 20--ESTATE TAX; ESTATES OF DECEDENTS DYING AFTER AUGUST 16,
1954

Paragraph 1. The authority citation for part 20 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 20.2013-4 is amended
by:

1. Removing "and" at the end of paragraph (b)(2).

2. Redesignating paragraph (b)(3) as paragraph (b)(4).

3. Adding a new paragraph (b)(3).

The addition reads as follows: § 20.2013-4 Valuation of property
transferred.

* * * * *

(b) * * *

(3)(i) By the amount of administration expenses in accordance with
the principles of §20.2056(b)-4(d).

(ii) This paragraph (b)(3) applies to transfers from estates of
decedents dying on or after December 3, 1999; and

* * * * *

Par. 3. Section 20.2055-3 is amended by:

1. Revising the section heading.

2. Adding a paragraph heading for paragraph (a).

3. Redesignating the text of paragraph (a) following the heading and
paragraphs (b) and (c) as paragraph (a)(1), and paragraphs (a)(2)
and (a)(3), respectively.

4. Adding a new paragraph (b).

The revision and additions read as follows:

§20.2055-3 Effect of death taxes and administration expenses.

(a) Death taxes. * * *

(b) Administration expenses--(1) Definitions--(i) Management
expenses. Estate management expenses are expenses that are incurred
in connection with the investment of estate assets or with their
preservation or maintenance during a reasonable period of
administration.

Examples of these expenses could include investment advisory fees,
stock brokerage commissions, custodial fees, and interest.

(ii) Transmission expenses. Estate transmission expenses are
expenses that would not have been incurred but for the decedent's
death and the consequent necessity of collecting the decedent's
assets, paying the decedent's debts and death taxes, and
distributing the decedent's property to those who are entitled to
receive it. Estate transmission expenses include any administration
expense that is not a management expense. Examples of these expenses
could include executor commissions and attorney fees (except to the
extent of commissions or fees specifically related to investment,
preservation, and maintenance of the assets), probate fees, expenses
incurred in construction proceedings and defending against will
contests, and appraisal fees.

(iii) Charitable share. The charitable share is the property or
interest in property that passed from the decedent for which a
deduction is allowable under section 2055(a) with respect to all or
part of the property interest. The charitable share includes, for
example, bequests to charitable organizations and bequests to a
charitable lead unitrust or annuity trust, a charitable remainder
unitrust or annuity trust, and a pooled income fund, described in
section 2055(e)(2). The charitable share also includes the income
produced by the property or interest in property during the period
of administration if the income, under the terms of the governing
instrument or applicable local law, is payable to the charitable
organization or is to be added to the principal of the property
interest passing in whole or in part to the charitable organization.

(2) Effect of transmission expenses. For purposes of determining the
charitable deduction, the value of the charitable share shall be
reduced by the amount of the estate transmission expenses paid from
the charitable share.

(3) Effect of management expenses attributable to the charitable
share. For purposes of determining the charitable deduction, the
value of the charitable share shall not be reduced by the amount of
the estate management expenses attributable to and paid from the
charitable share. Pursuant to section 2056(b)(9), however, the
amount of the allowable charitable deduction shall be reduced by the
amount of any such management expenses that are deducted under
section 2053 on the decedent's federal estate tax return.

(4) Effect of management expenses not attributable to the charitable
share. For purposes of determining the charitable deduction, the
value of the charitable share shall be reduced by the amount of the
estate management expenses paid from the charitable share but
attributable to a property interest not included in the charitable
share.

(5) Example. The following example illustrates the application of
this paragraph (b):

Example. The decedent, who dies in 2000, leaves his residuary
estate, after the payment of debts, expenses, and estate taxes, to a
charitable remainder unitrust that satisfies the requirements of
section 664(d). During the period of administration, the estate
incurs estate transmission expenses of $400,000. The residue of the
estate (the charitable share) must be reduced by the $400,000 of
transmission expenses and by the Federal and State estate taxes
before the present value of the remainder interest passing to
charity can be determined in accordance with the provisions of
§1.664-4 of this chapter.

Because the estate taxes are payable out of the residue, the
computation of the estate taxes and the allowable charitable
deduction are interrelated. See paragraph (a)(2) of this section.

(6) Cross reference. See §20.2056(b)-4(d) for additional examples
applicable to the treatment of administration expenses under this
paragraph (b).

(7) Effective date. The provisions of this paragraph (b) apply to
estates of decedents dying on or after December 3, 1999.

Par. 4. Section 20.2056(b)-4 is amended by:

1. Removing the last two sentences of paragraph (a).

2. Redesignating paragraph (d) as paragraph (e).

3. Adding a new paragraph (d).

The addition reads as follows:

§20.2056(b)-4 Marital deduction; valuation of interest passing to
surviving spouse.

* * * * *

(d) Effect of administration expenses--(1) Definitions--(i)
Management expenses.

Estate management expenses are expenses that are incurred in
connection with the investment of estate assets or with their
preservation or maintenance during a reasonable period of
administration. Examples of these expenses could include investment
advisory fees, stock brokerage commissions, custodial fees, and
interest.

(ii) Transmission expenses. Estate transmission expenses are
expenses that would not have been incurred but for the decedent's
death and the consequent necessity of collecting the decedent's
assets, paying the decedent's debts and death taxes, and
distributing the decedent's property to those who are entitled to
receive it. Estate transmission expenses include any administration
expense that is not a management expense. Examples of these expenses
could include executor commissions and attorney fees (except to the
extent of commissions or fees specifically related to investment,
preservation, and maintenance of the assets), probate fees, expenses
incurred in construction proceedings and defending against will
contests, and appraisal fees.

(iii) Marital share. The marital share is the property or interest
in property that passed from the decedent for which a deduction is
allowable under section 2056(a). The marital share includes the
income produced by the property or interest in property during the
period of administration if the income, under the terms of the
governing instrument or applicable local law, is payable to the
surviving spouse or is to be added to the principal of the property
interest passing to, or for the benefit of, the surviving spouse.

(2) Effect of transmission expenses. For purposes of determining the
marital deduction, the value of the marital share shall be reduced
by the amount of the estate transmission expenses paid from the
marital share.

(3) Effect of management expenses attributable to the marital share.
For purposes of determining the marital deduction, the value of the
marital share shall not be reduced by the amount of the estate
management expenses attributable to and paid from the marital share.
Pursuant to section 2056(b)(9), however, the amount of the allowable
marital deduction shall be reduced by the amount of any such
management expenses that are deducted under section 2053 on the
decedent's Federal estate tax return.

(4) Effect of management expenses not attributable to the marital
share. For purposes of determining the marital deduction, the value
of the marital share shall be reduced by the amount of the estate
management expenses paid from the marital share but attributable to
a property interest not included in the marital share.

(5) Examples. The following examples illustrate the application of
this paragraph (d):

Example 1. The decedent dies after 2006 having made no lifetime
gifts. The decedent makes a bequest of shares of ABC Corporation
stock to the decedent's child. The bequest provides that the child
is to receive the income from the shares from the date of the
decedent's death. The value of the bequeathed shares on the
decedent's date of death is $3,000,000. The residue of the estate is
bequeathed to a trust for which the executor properly makes an
election under section 2056(b)(7) to treat as qualified terminable
interest property. The value of the residue on the decedent's date
of death, before the payment of administration expenses and Federal
and State estate taxes, is $6,000,000. Under applicable local law,
the executor has the discretion to pay administration expenses from
the income or principal of the residuary estate. All estate taxes
are to be paid from the residue. The State estate tax equals the
State death tax credit available under section 2011.

During the period of administration, the estate incurs estate
transmission expenses of $400,000, which the executor charges to the
residue. For purposes of determining the marital deduction, the
value of the residue is reduced by the Federal and State estate
taxes and by the estate transmission expenses. If the transmission
expenses are deducted on the Federal estate tax return, the marital
deduction is $3,500,000 ($6,000,000 minus $400,000 transmission
expenses and minus $2,100,000 Federal and State estate taxes). If
the transmission expenses are deducted on the estate's Federal
income tax return rather than on the estate tax return, the marital
deduction is $3,011,111 ($6,000,000 minus $400,000 transmission
expenses and minus $2,588,889 Federal and State estate taxes).

Example 2. The facts are the same as in Example 1, except that,
instead of incurring estate transmission expenses, the estate incurs
estate management expenses of $400,000 in connection with the
residue property passing for the benefit of the spouse. The executor
charges these management expenses to the residue. In determining the
value of the residue passing to the spouse for marital deduction
purposes, a reduction is made for Federal and State estate taxes
payable from the residue but no reduction is made for the estate
management expenses. If the management expenses are deducted on the
estate's income tax return, the net value of the property passing to
the spouse is $3,900,000 ($6,000,000 minus $2,100,000 Federal and
State estate taxes). A marital deduction is claimed for that amount,
and the taxable estate is $5,100,000.

Example 3. The facts are the same as in Example 1, except that the
estate management expenses of $400,000 are incurred in connection
with the bequest of ABC Corporation stock to the decedent's child.
The executor charges these management expenses to the residue. For
purposes of determining the marital deduction, the value of the
residue is reduced by the Federal and State estate taxes and by the
management expenses. The management expenses reduce the value of the
residue because they are charged to the property passing to the
spouse even though they were incurred with respect to stock passing
to the child. If the management expenses are deducted on the
estate's Federal income tax return, the marital deduction is
$3,011,111 ($6,000,000 minus $400,000 management expenses and minus
$2,588,889 Federal and State estate taxes). If the management
expenses are deducted on the estate's Federal estate tax return,
rather than on the estate's Federal income tax return, the marital
deduction is $3,500,000 ($6,000,000 minus $400,000 management
expenses and minus $2,100,000 in Federal and State estate taxes).

Example 4. The decedent, who dies in 2000, has a gross estate of
$3,000,000.

Included in the gross estate are proceeds of $150,000 from a policy
insuring the decedent's life and payable to the decedent's child as
beneficiary. The applicable credit amount against the tax was fully
consumed by the decedent's lifetime gifts. Applicable State law
requires the child to pay any estate taxes attributable to the life
insurance policy. Pursuant to the decedent's will, the rest of the
decedent's estate passes outright to the surviving spouse. During
the period of administration, the estate incurs estate management
expenses of $150,000 in connection with the property passing to the
spouse. The value of the property passing to the spouse is
$2,850,000 ($3,000,000 less the insurance proceeds of $150,000
passing to the child). For purposes of determining the marital
deduction, if the management expenses are deducted on the estate's
income tax return, the marital deduction is $2,850,000 ($3,000,000
less $150,000) and there is a resulting taxable estate of $150,000
($3,000,000 less a marital deduction of $2,850,000). Suppose,
instead, the management expenses of $150,000 are deducted on the
estate's estate tax return under section 2053 as expenses of
administration. In such a situation, claiming a marital deduction of
$2,850,000 would be taking a deduction for the same $150,000 in
property under both sections 2053 and 2056 and would shield from
estate taxes the $150,000 in insurance proceeds passing to the
decedent's child. Therefore, in accordance with section 2056(b)(9),
the marital deduction is limited to $2,700,000, and the resulting
taxable estate is $150,000.

Example 5. The decedent dies after 2006 having made no lifetime
gifts. The value of the decedent's residuary estate on the
decedent's date of death is $3,000,000, before the payment of
administration expenses and Federal and State estate taxes. The
decedent's will provides a formula for dividing the decedent's
residuary estate between two trusts to reduce the estate's Federal
estate taxes to zero. Under the formula, one trust, for the benefit
of the decedent's child, is to be funded with that amount of
property equal in value to so much of the applicable exclusion
amount under section 2010 that would reduce the estate's Federal
estate tax to zero. The other trust, for the benefit of the
surviving spouse, satisfies the requirements of section 2056(b)(7)
and is to be funded with the remaining property in the estate. The
State estate tax equals the State death tax credit available under
section 2011.

During the period of administration, the estate incurs transmission
expenses of $200,000.

The transmission expenses of $200,000 reduce the value of the
residue to $2,800,000. If the transmission expenses are deducted on
the Federal estate tax return, then the formula divides the residue
so that the value of the property passing to the child's trust is
$1,000,000 and the value of the property passing to the marital
trust is $1,800,000. The allowable marital deduction is $1,800,000.
The applicable exclusion amount shields from Federal estate tax the
entire $1,000,000 passing to the child's trust so that the amount of
Federal and State estate taxes is zero. Alternatively, if the
transmission expenses are deducted on the estate's Federal income
tax return, the formula divides the residue so that the value of the
property passing to the child's trust is $800,000 and the value of
the property passing to the marital trust is $2,000,000. The
allowable marital deduction remains $1,800,000. The applicable
exclusion amount shields from Federal estate tax the entire $800,000
passing to the child's trust and $200,000 of the $2,000,000 passing
to the marital trust so that the amount of Federal and State estate
taxes remains zero.

Example 6. The facts are the same as in Example 5, except that the
decedent's will provides that the child's trust is to be funded with
that amount of property equal in value to the applicable exclusion
amount under section 2010 allowable to the decedent's estate.

The residue of the estate, after the payment of any debts, expenses,
and Federal and State estate taxes, is to pass to the marital trust.
The applicable exclusion amount in this case is $1,000,000, so the
value of the property passing to the child's trust is $1,000,000.
After deducting the $200,000 of transmission expenses, the residue
of the estate is $1,800,000 less any estate taxes. If the
transmission expenses are deducted on the Federal estate tax return,
the allowable marital deduction is $1,800,000, the taxable estate is
zero, and the Federal and State estate taxes are zero.
Alternatively, if the transmission expenses are deducted on the
estate's Federal income tax return, the net value of the property
passing to the spouse is $1,657,874 ($1,800,000 minus $142,106
estate taxes). A marital deduction is claimed for that amount, the
taxable estate is $1,342,106, and the Federal and State estate taxes
total $142,106.

Example 7. The decedent, who dies in 2000, makes an outright
pecuniary bequest of $3,000,000 to the decedent's surviving spouse,
and the residue of the estate, after the payment of all debts,
expenses, and Federal and State estate taxes, passes to the
decedent's child. Under the terms of the applicable local law, a
beneficiary of a pecuniary bequest is not entitled to any income on
the bequest. During the period of administration, the estate pays
estate transmission expenses from the income earned by the property
that will be distributed to the surviving spouse in satisfaction of
the pecuniary bequest. The income earned on this property is not
part of the marital share. Therefore, the allowable marital
deduction is $3,000,000, unreduced by the amount of the estate
transmission expenses..(6) Effective date. The provisions of this
paragraph (d) apply to estates of decedents dying on or after
December 3, 1999.

* * * * *

Deputy Commissioner of Internal Revenue
Approved:
Assistant Secretary of the Treasury

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