United States Additional Estate Tax Return Under Code Section 2057

We ask for the information on this form to carry out the Internal Revenue laws of the United States. We need it to figure and collect the right amount of tax. Subtitle B, Estate and Gift Taxes, of the Internal Revenue Code, imposes a tax in some cases on qualified heirs when a section 2057(f) taxable event occurs with respect to a QFOBI.

The Form 706-D is used to determine the amount of the taxes owed. Section 6011 requires you to provide the requested information if the tax is applicable to you. Section 6109 also requires you to provide your taxpayer identification number (SSN). Routine uses of the information on Form 706-D include giving the information to the Department of Justice for civil and criminal litigation, as well as to cities, states, and the District of Columbia for use in administering their tax laws. If you fail to provide the required information in a timely manner, you may be subject to penalties and interest.

You are not required to provide the information requested on a form that is subject to the Paperwork Reduction Act unless the form displays a valid OMB control number. Books or records relating to a form or its instructions must be retained as long as their contents may become material in the administration of any Internal Revenue law. Generally, tax returns and return information are confidential, as required by section 6103.

The time needed to complete and file this form will vary depending on individual circumstances. The estimated average time is:

If you have comments concerning the accuracy of these time estimates or suggestions for making this form simpler, we would be happy to hear from you. You can write to the Tax Forms Committee, Western Area Distribution Center, Rancho Cordova, CA 95743-0001. Do not send the tax form to this office. Instead, see Where To File on page 1.

Purpose of Form

If an estate claimed a qualified family-owned business interest (QFOBI) deduction on Schedule T of Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, each qualified heir assumed personal liability for a portion of the reduction in estate tax resulting from the QFOBI deduction.

Section 2057 imposes an additional estate tax on a qualified heir when certain taxable events occur with respect to a QFOBI received by the qualified heir. The qualified heir uses Form 706-D to report and pay the additional estate tax. A qualified heir also uses Form 706-D to report certain nontaxable events.

Who Must File

Each qualified heir must file a Form 706-D to report:

• A taxable event. See Taxable Events below.
• An involuntary conversion or exchange of a QFOBI.
• A transfer to a family member.
• A qualified conservation contribution.
• The loss of U.S. citizenship if the QFOBI passes or is acquired or held in a qualified trust.

When To File and Pay

File Form 706-D and pay any additional tax due within 6 months after the taxable disposition, disqualifying act, or cessation of qualified use of the QFOBI, unless an extension of time has been granted.

Use Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation- Skipping Transfer) Taxes, to apply for an extension of time to file. Circle Form 706-D at the top of the Form 4768.

Make the check or money order payable to the United States Treasury and write Form 706-D and the qualified heir's social security number on the check or money order.

Where To File

File Form 706-D with the Internal Revenue Service office where the Form 706 for the decedent's estate was filed.

Statute of Limitations

The additional estate tax may be assessed until 3 years after the IRS receives notice that the qualified heir disposed of the QFOBI, qualified use ceased, or a disqualifying act occurred.

However, if the property was disposed of in an involuntary conversion or in an exchange, the tax may be assessed up to 3 years after the IRS receives notice that the property was replaced or will not be replaced. See section 2032A(f) for details.

Lien

If the estate elected to take the QFOBI deduction, section 6324B establishes a special lien against the QFOBI equal to the adjusted tax difference attributable to such an interest.

Definitions

Ownership rules. Ownership of the business interest may either be direct, or indirect through a corporation, partnership, or a trust. An interest owned, directly or indirectly, by or for such an entity, is considered owned proportionately by or for the entity's shareholders, partners, or beneficiaries. A person is the beneficiary of a trust only if he or she has a present interest in the trust.

For more information on ownership rules, see the Instructions for Form 706.

Qualified heir. A person is a qualified heir of property if he or she is a member of the decedent's family and acquired or received the QFOBI from the decedent.

If a qualified heir disposes of any QFOBI to any member of his or her family, that person will then be treated as the qualified heir with respect to that interest.

For the purpose of the QFOBI deduction, a qualified heir also includes any active employee of the trade or business to which the QFOBI relates, if the employee has been employed by the trade or business for a period of at least 10 years before the date of the decedent's death.

Member of family. The term member of the family includes only:

• An ancestor (parent, grandparent, etc.) of such individual;
• The spouse of such individual;
• The lineal descendent (child, stepchild, grandchild, etc.) of the individual, the individual's spouse, or a parent of such individual; and
• The spouse, widow, or widower of any lineal descendent described above.

A legally adopted child of an individual is treated as a child of that individual by blood.

Taxable Events

Section 2057 imposes an additional estate tax when there is a taxable event. A taxable event occurs if, within 10 years of the decedent's death and before the qualified heir's death, one of the following events occurs:

1. The qualified heir disposes of any portion of his or her interest in the qualified family-owned business, other than by a disposition to a member of the qualified heir's family or through a qualified conservation contribution under section 170(h);
2. The qualified heir ceases to meet material participation requirements (i.e., if neither the qualified heir nor any member of his or her family has materially participated in the trade or business for at least 5 years of any 8-year period (see page 2 for a discussion of material participation));
3. The principal place of business of the qualified family-owned business ceases to be located in the United States;
4. The qualified heir loses United States citizenship and neither a qualified trust was created nor was a security arrangement made. (See page 4 for more information.)

Note: For special rules for involuntary conversions and exchanges, see the instructions for Schedule B on page 3.

As under section 2032A, the 10-year recapture period may be extended for a period of up to 2 years if the qualified heir does not begin to use the property for a period of up to 2 years after the decedent's death. (See Two-Year Grace Period on page 2.)

Only one additional estate tax will be imposed with respect to any one interest in the qualified family-owned business. For example, if additional estate tax is imposed for early cessation of use of the QFOBI, a second additional estate tax will not be imposed for a subsequent early disposition of the same part of the QFOBI.

A sale or disposition, in the ordinary course of business, of assets such as inventory or a piece of equipment used in the business (e.g., the sale of crops or a tractor) would not result in recapture of the benefits of the QFOBI deduction.

Each qualified heir is personally liable for the portion of the recapture tax imposed with respect to his or her interest in the qualified family-owned business.

Thus, for example, if a brother and sister inherit a qualified family-owned business from their father, and only the sister materially participates in the business, her participation will cause both her and her brother to meet the material participation test.

If she ceases to materially participate in the business within 10 years after her father's death (and the brother still does not materially participate), the sister and brother would both be liable for the additional estate tax (i.e., each would be liable for the additional estate tax attributable to his or her interest).

Disposition to family member. If a transferee, who is a family member, enters into an agreement to be personally liable for any additional tax under section 2057, the disposition is nontaxable, and you should enter it on Schedule C. Otherwise, a disposition of an interest in property to a family member of the qualified heir is a taxable event, and you should enter it on Schedule A.

Material Participation

For this purpose, "material participation" is defined under section 2032A (special use valuation) and the related regulations. See, for example, Regulations section 20.2032A-3.

Under such regulations, no one factor is determinative of the presence of material participation. The uniqueness of the particular industry (e.g., farming, manufacturing, etc.) must be considered.

Physical work and participation in management decisions are the principal factors for consideration. For example, an individual generally is considered to be materially participating in the business if he or she personally manages the business fully, regardless of the number of hours worked, as long as any necessary functions are performed.

If a qualified heir rents qualifying property to a member of the qualified heir's family on a net cash basis, and that family member materially participates in the business, the material participation requirement is met with respect to the qualified heir for purposes of this provision.

If a qualified heir dies before the required period has passed, any material participation requirement ends for that heir's portion of the property, provided the heir received a separate or other undivided interest from the decedent.

If qualified heirs receive successive interests in specially valued property (e.g., a life estate and remainder interests) the material participation requirement does not end for any part of the property until the later of the expiration of the recapture period or the death of the last qualified heir.

In determining whether the required participation has occurred, disregard brief periods (e.g., 30 days or less) during which there was no material participation, as long as such periods were preceded and followed by substantial periods (more than 120 days) during which there was uninterrupted material participation.

Surviving spouse. A surviving spouse who received qualified real property from the predeceased spouse is considered to have materially participated if he or she was engaged in the active management of the business.

For additional details regarding material participation, see Regulations section 20.2032A-3(e).

Additional Estate Tax

The amount of the additional estate tax is equal to the applicable percentage of the adjusted tax difference attributable to the QFOBI deduction. The applicable percentage is based on the number of years that the qualified heir (or members of the qualified heir's family) materially participated in the trade or business after the decedent's death.

In addition, interest at the underpayment rate established under section 6621 for the period beginning on the date the estate tax liability was due under section 2001 and ending on the date such additional estate tax is due (section 2057(f)(2)(A)).

You may calculate this interest amount yourself, or you may have the IRS calculate it for you. If the IRS calculates the interest, there may be additional interest charged under section 6601 until the full amount is paid.

If you want the IRS to calculate the interest, you may estimate the amount of interest and pay it with the tax, following the Note below. This may avoid any additional interest.

Note: If you include interest with your payment, indicate the amount of interest paid on the dotted line for line 15. Do not include the interest in the entry space for line 15.

Applicable Percentage

Two-Year Grace
Period:
 
Commencement Date

No additional tax is imposed if the qualified heir begins using the property in a qualified use within the 2-year period after the decedent's death. The date on which the qualified heir begins to use the property in a qualified use is the commencement date.

The 10-year recapture period is extended by the period after the decedent's death and before the commencement date.

For example, if the decedent died February 28, 1999, and the commencement date is August 1, 2000, the recapture period would begin August 1, 2000, and end July 31, 2001.

How To Complete Form 706-D

You may only file Form 706-D for one qualified heir. If a disposition, cessation, disqualifying act, involuntary conversion or exchange, or nontaxable transfer involves more than one qualified heir, each must file a separate Form 706-D.

Complete Form 706-D in this order:

1. Part I;
2. Schedules A and B;
3. Part II;
4. Schedule C.

   Important: The qualified heir must sign the return.

Valuation

When computing the amounts to enter on Form 706-D, use the same values and estate tax that the executor reported on the Form 706 filed for the decedent. However, if the IRS has completed the audit of the estate tax return, use the agreed values and tax rather than the reported values and tax.

Schedule A. Disposition of Qualified Family-Owned Business Interest, Cessation of Qualified Use, or Disqualifying Act

How To Complete Schedule A

On Schedule A, list every QFOBI or portion thereof that the qualified heir disposed of, or discontinued use of, since the date of the decedent's death and for which a Form 706-D has not been previously filed. You must also report any disqualifying act regarding the QFOBI (i.e., the principal place of the qualified family-owned business is no longer located in the United States, or the qualified heir lost United States citizenship and the QFOBI property was neither placed into a qualified trust, nor was a security arrangement made).

Do not list any interests that have already been reported on a previously filed Form 706-D. In general, do not list property interests disposed of to family members of the qualified heir. These interests should be listed on Schedule C.

Column (A). Within each part, list and number the property interests in chronological order of disposition, cessation, or disqualification.

Column (B). Use the same description in column (B) that the executor used for the QFOBI on the Form 706 filed for the decedent's estate. Include in column (B) the schedule and item number where the QFOBI was reported on the Form 706.

Column (C). Report in column (C) the date that the qualified heir disposed of the QFOBI, the interest ceased, or a disqualifying act occurred.

Column (D). You only need to complete column (D) if you are reporting an involuntary conversion or exchange. If the qualified heir disposed of the QFOBI in an arm's length transaction, report the amount realized in column (D).

If the QFOBI is disposed of by the qualified heir in other than an arm's length transaction, report in column (D) the FMV of the QFOBI as of the date of its disposition.

If the qualified heir owned only a part of the QFOBI, report in column (D) the pro rata share of the amount realized or the FMV allocable to the part owned by the qualified heir.

Arm's length transaction. An arm's length transaction is a transaction where there is no bargain or gift element for affection or other reasons.

Amount realized. The amount realized is the sum of the money received plus the FMV of property (other than money) received. For the real property taxes that must be taken into account, see section 1001(b).

Fair market value. Fair market value (FMV) is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.

Column (E). Report in column (E) the value at the date of the decedent's death (or alternate valuation date, if applicable) of the QFOBI property that passed from the decedent to the qualified heir who disposed of the property, discontinued the qualified use, or incurred a disqualifying act. If you are reporting part of your total QFOBI, include only that pro rata share in column (E).

In general, use the value that the executor reported on the Form 706 filed for the decedent's estate. However, if the IRS has completed the audit of the estate tax return, use the agreed value rather than the reported value.

Schedule B. Involuntary Conversions or Exchanges

Involuntary conversions of qualified property (under the rules of section 1033) and exchanges of qualified property (under the rules of section 1031) are treated similarly when computing the additional estate tax on Form 706-D.

If you are reporting an involuntary conversion or exchange, you may not use the same Form 706-D to report any cessations or other dispositions that are not involuntary conversions or exchanges. Use a separate Form 706-D for the cessations or other dispositions.

You may report conversions and exchanges together on the same return.

Nontaxable Involuntary Conversions or Exchanges

If the qualified heir reinvests all of the involuntary conversion proceeds in qualified replacement property, or if the qualified heir exchanges qualified property solely for qualified exchange property, then there is no additional estate tax.

You should complete Form 706-D, even though there is no tax, to notify the IRS that the involuntary conversion or exchange took place. However, you need to complete only Part I, Schedule A, and Schedule B. Write nontaxable on line 15 of Part II.

Rules similar to those under section 2032A(e)(14), 2032A(h) and 2032A(i) are applicable. Also, see section 2057(i).

Partially Taxable Involuntary Conversions or Exchanges

If the cost of the qualified replacement property is less than the amount realized in the involuntary conversion; or if other property, in addition to qualified exchange property, is received in the exchange, the conversion or exchange is partially taxable. You should complete all of Form 706-D and determine the tax using Part II.

List on Schedule A the QFOBI that the qualified heir disposed of, discontinued use of, or with regard to which the disqualifying act occurred, regardless of whether he or she received replacement or exchange property for the interest. List on Schedule B only the replacement or exchange property the qualified heir actually received.

Qualified Replacement or Exchange Property

The term "qualified replacement property" means any property which is -

1. Acquired in an exchange which qualifies under section 1031, or
2. The acquisition of which results in the nonrecognition of gain under section 1033.

The period of the decedent's or family member's ownership, or material participation with respect to replaced or exchanged property is treated as the period of ownership, or material participation with respect to the qualified replacement or exchange property. This applies only to that part of the FMV of the replacement or exchange property (at the date of acquisition) that does not exceed the FMV of the replaced or exchanged property (at the date of disposition).

Note: The 10-year recapture period is extended under certain circumstances. See Two-Year Grace Period on page 2.

How To Complete Schedule B

Column (A). Make one entry for each item of qualified replacement or exchange property.

Column (B). Describe the qualified replacement property with enough detail so that the IRS can locate and value it. For more information, see the instructions to Form 706.

Column (C). For an involuntary conversion, enter the cost of the replacement property. For an exchange, enter the FMV of the replacement property.

Part II - Tax Computation

Line 1

Enter the qualified heir's share of the QFOBIs shown on line 4 of the decedent's Form 706, Schedule T.

Line 2

Enter the total reported value of the QFOBIs shown on line 6 of the decedent's Form 706, Schedule T.

Line 5

Multiply the amount of gross additional estate tax entered on line 3c by the qualified heir's percentage of QFOBIs entered on line 4 of this Form 706-D. The result is the qualified heir's share of the total reduction in estate tax.

Line 9

See the Applicable percentage table on page 2.

Line 10

Multiply line 8 by the applicable percentage entered on line 9. If you completed Schedule B, complete lines 11 through 15. If you did not complete Schedule B, skip lines 11 through 14 and enter the amount from line 10 on line 15.

Line 15

Enter the additional estate tax due.

Show, on the dotted line for line 15, interest at the underpayment rate established under section 6621 for the period beginning on the date the estate tax liability was due and ending on the date such additional estate tax is due.

Example. April Green died November 1, 2000. On the Form 706 filed for her estate, the executor elected to take a $675,000 QFOBI deduction based on her ownership of 100% of the stock in XYZ Corp. The estate tax value of the stock was $900,000. June Green, April Green's daughter and sole heir, received all of the XYZ stock from the estate, and managed the corporation. On June 30, 2002, June Green sold part of the stock to a nonqualified heir. The stock sold had an estate tax value of $200,000.

The following amounts should be entered on the Form 706-D filed by June Green to report the sale of stock:

Line 1. $900,000 (the qualified heir's share of the total QFOBIs as shown on line 4 of the Schedule T, Form 706).

Line 2. $900,000 (the total reported value of all the decedent's QFOBIs shown on line 6 of the decedent's Schedule T, Form 706.

Line 3c. $355,000 (gross additional estate tax).

Line 4. 100%

Line 5. $355,000 (quaIified heir's share of total reduction in estate tax).

Line 6. $200,000 from column (E), Schedule A of this Form 706-D (estate tax value of the QFOBI disposed of).

Line 7. 22.2%

Line 8. $78,810

Line 9. 100% as the applicable percentage (the recapture event occurred within 4 years of the decedent's death).

Line 10. $78,810, total additional estate tax.

Line 15. $78,810, additional estate tax due (there were no entries on lines 11 through 14).

Interest was not entered on the dotted line of line 15. June Green, the qualified heir, chose to have the Service compute the interest on the additional estate tax due.

Schedule C. Nontaxable Transfers

Disposition to family member. You may enter a disposition to a family member of the qualified heir on Schedule C only if you file this Form 706-D on time (including extensions) and attach an agreement by the transferee to be personally liable for any additional estate tax under section 2057(f) on the QFOBI received. For a format for such an agreement, see Form 706, Schedule T (section 2057(h)).

If you are not filing this Form 706-D on time, or if the transferee does not enter into the agreement, you must enter the disposition(s) on Schedule A instead of Schedule C.

Qualified conservation contribution. Enter a disposition made through a qualified conservation contribution under section 170(h). In general, the term qualified conservation contribution means a contribution -

1. of a qualified real property interest,
2. to a qualified organization,
3. exclusively for conservation purposes.

Attach a copy of the Form 8283, Noncash Charitable Contributions, that was filed.

As stated in the Instructions for Form 8283, if your donation qualifies as a qualified conservation contribution under section 170(h), attach a statement showing the FMV of the underlying property before and after the gift and the conservation purpose furthered by the gift. See Pub. 561, Determining the Value of Donated Property.

Loss of U.S. citizenship. A qualified heir who loses U.S. citizenship (and, in some circumstances, a long-term resident who ceases to be treated as such) may avoid additional estate tax by placing the qualified family-owned business assets into a trust meeting certain requirements, or by furnishing a bond in lieu of personal liability. See section 2057(g) for details.

Show in Schedule C if the qualified heir lost U.S. citizenship (or long-term residency), and such heir complied with the requirements of section 2057(g)). Attach a copy of the qualified trust agreement or evidence of the bond. See section 2057(f)(1)(C) for more information.

How To Complete Schedule C

See the instructions for completing columns (A) and (B) of Schedule A, beginning on page 2. Report the applicable dates in column (C).

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