This article continues a series of articles on the Internal Revenue Code (“IRC”) §318 constructive ownership rules. Today, the topic is §318 estate attribution rules – i.e. attribution of ownership of corporate stock from estate to its beneficiaries and vice versa. Since this is a long topic, I will divide it into three articles. This article focuses on the §318 downstream estate attribution rules.
§318 Estate Attribution Rules: Two Types
There are two types of the IRC §318 estate attribution rules: downstream and upstream. The downstream attribution rules attribute the ownership of corporate stocks owned by an estate to its beneficiaries. On the other hand, the upstream attribution rules attribute the ownership of corporate stocks owned by beneficiaries to the estate. As I stated above, this article focuses on the first type – i.e. §318 downstream estate attribution rules.
§318 Downstream Estate Attribution: Attribution from Estate to Beneficiary
Under the IRS §318(a)(2)(A), corporate stock owned directly or indirectly by or on behalf of an estate is deemed to be owned proportionately by its beneficiaries. It is very important to understand that the actual disposition of estate property by the testator does not matter to the proportionate attribution of estate property between the beneficiaries. Thus, even if the will demands that all corporate stocks be inherited by only one beneficiary, the ownership of these stocks will be attributed to all beneficiaries in proportion to their respective interests in the estate.
Three questions arise with respect to the application of this §318 downstream estate attribution rule: (1) What stocks are considered to be owned by the estate? (2) Who is deemed to be a beneficiary of an estate? and (3) How does the proportionality rule work?
§318 Downstream Estate Attribution: Stocks Owned by Estate
Treas. Regs. §1.318-3(a) defines when an estate is deemed to be an owner of corporate stock for the §318 attribution purposes. It states that corporate stocks (as well as any other property) shall be considered as owned by an estate if “such property is subject to administration by the executor or administrator for the purpose of paying claims against the estate and expenses of administration.” This is the case even if the legal title to the stock vests immediately upon death in the decedent’s heirs, legatees, or devisees under local law. Id.
§318 Downstream Estate Attribution: Definition of a Beneficiary
I address the definition of a beneficiary for the §318 attribution purposes in more detail in another article. Here, I will only state the general rule.
Treas. Regs. §1.318-3(a) states that “the term beneficiary includes any person entitled to receive property of a decedent pursuant to a will or pursuant to laws of descent and distribution.” Hence, in order to be considered a beneficiary under §318, a person must have a direct present interest in the property of the estate or in income generated by that property.
§318 Downstream Estate Attribution: Proportionality
As in many other cases concerning attribution proportionality, there is very little guidance from the IRS and Treasury regulations concerning determination of a beneficiary’s proportionate interest in an estate. Hence, an attorney has a considerable freedom in determining the reasonable methodology with respect to the application of the proportionality requirement. It appears that one method may be particularly acceptable to the IRS: measuring the relative values of each beneficiary’s interest.
§318 Downstream Estate Attribution: No Re-Attribution
Similarly to many other IRC provisions concerning constructive ownership, §318 estate attribution rules contain a prohibition on re-attribution of stocks. Under §318(a)(5)(C), a beneficiary’s stock constructively owned by an estate through the operation of the §318 estate attribution rules cannot be attributed to another beneficiary.
§318 Downstream Estate Attribution: Example
Let’s conclude this article with an illustration of how the §318 downstream estate attribution rules actually work. The proposed hypothetical scenario is as follows: an estate owns 100 of the total 200 outstanding shares of X, a South Dakota C-corporation; A is entitled to 50% of the property of the estate and actually owns 24 shares of X; B owns 36 shares of X and has a life estate in the other 50% of the estate; and C owns 40 shares of X and only has a remainder interest in the estate after the death of B. Here is how the §318 estate attribution constructive rules would work in this case:
A actually owns 24 shares of X and constructively owns another 50 shares of X through his 50% beneficiary interest in the estate. In other words, A’s total ownership of X equals 74 shares.
B actually owns 36 shares of X and constructively owns another 50 shares of X through his life estate; his total number of shares of X equals 86.
Finally, C owns 40 shares of X only. He does not have any constructive ownership of any shares of X, because his remainder interest in the estate is not a present interest in the estate; hence, he is not a beneficiary of the estate.
Contact Sherayzen Law Office for Professional Help With §318 Downstream Estate Attribution Rules
The constructive ownership rules of §318 are crucial to proper identification of US tax reporting requirements with respect domestic and especially foreign business entities. Hence, if you a beneficiary of an estate or an executor/administrator of an estate that owns stocks in a domestic or foreign corporation, contact Sherayzen Law Office for professional help with §318 estate attribution rules.