Wills, Trusts & Estates Prof Blog

ATRA Tax Implications

Recently, Congress passed the American Tax Relief Act of 2012, or “ATRA”. The Act affects only already existing provisions, but has many new tax implications. Some of the provisions included in the act will positively affect estate planning. One of the areas affected by the Act is the maximum estate, gift and GST tax rate. The rate is now permanently set at 40%, which occurs on taxable estate worth more than $5,250,000. Moreover, ATRA set the tax-exempted amount for decedents’ estates at $5.25 million. ATRA has also given something for married couples to think about. The Act extended TRA 2010’s ‘portability’ provision, permitting married couples to transfer unused estate tax to the surviving spouse. ATRA has made many previous temporary provisions permanent. However, the change from temporary to permanent can significantly change estate-planning techniques.

See Lewis Saret, ATRA : An Unexpected Plus To Your Estate Planning --Part I, Forbes, Jun. 13, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.

The Most Generous States

One method of determining which states have the most charitable activity is to look at the percentage of tax returns claiming charitable deductions.

Maryland had the highest percentage of tax returns claiming charitable deductions with 40.1%.  This led to a total giving of $3.9 billion with a median contribution of $2,969.  New Jersey had the second highest percentage of tax returns with 36% and Connecticut third with 35.9%.  Utah, Minnesota and Virginia were close behind.

See Dan Caplinger, The 6 Most Generous States in America, The Motley Fool, May 29, 2013; see also Paul L. Caron, Percentage of Tax Returns Claiming Charitable Deductions, TaxProf Blog, June 2, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Terminating Irrevocable Bypass Trusts

Nowadays, trusts may be more trouble than they are worth.  For those wishing to terminate an “irrevocable” trust, one common situation where this is possible involves bypass trusts.

When one spouse dies, assets equal to their exemption from federal estate and gift taxes are typically placed into a bypass trust so the surviving spouse will have access to the earnings or principal.  When the surviving spouse dies, these assets bypass their estate and go straight to children, essentially preserving the first spouse’s exemption.

Trustees of a bypass trust can terminate the trust if it’s relatively small, uneconomical to maintain, or if it no longer serves a “material purpose” of the creator.  The trustees can then distribute the assets in kind to the surviving spouse.

See Ashlea Ebeling, How to Kill an Irrevocable Trust, Forbes, June 5, 2013.

Minnesota Gift Tax Implications

As I have previously discussed, effective June 30, 2013, the new Minnesota gift tax will impose a 10% tax on certain gifts made by Minnesota residents and those owning property in Minnesota.There are several retroactive implications of the new law. Any decedent who passed after December 31, 2012 will be subject to the following changes under this new tax. The new law indicates that any taxable gifts made three years before the decedents death must be taxed. Additionally, the new law will affect people who are not from Minnesotta who have an interest in a “pass through entity” with any tangible assets. Now, for estate tax purposes, non-residents must include their gross estate even if the tangible property is held in an s-corporation, partnership, or other pass through entities. The new tax also affects farms and small businesses by creating up to a $4 million dollar tax deduction for farms and small businesses meeting certain criteria. The details will be explained in a memorandum expected to come out soon. 

See Briggs and Morgan, Estate Planning After The Omnibus Tax Act Of 2013 (House File 677), Lexocology, May 29, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.

Minnesota Second State to Impose Gift Tax

Effective June 30, 2013, the new Minnesota gift tax will impose a 10% tax on certain gifts made by Minnesota residents and those owning property in Minnesota.  Individuals have a lifetime $1 million exemption from the gift tax. 

Minnesota also has a 16% estate tax.  Individuals “will be required to include Minnesota taxable gifts made within three years of death in their Minnesota taxable estate.”

The new law also subjects property held in pass-through entities to the estate tax.

See Mark W. Greiner, Karen Sandler Steinert & Cameron R. Seybolt, Minnesota Enacts Significant Changes to Minnesota Estate and Gift Tax Laws, Lexology, May 24, 2013.

PLR on Conversion of Trusts

Recently, a Private Letter Ruling has allowed taxpayers to convert two trusts into a unitrust. A man died leaving his three sons as the sole beneficiaries of Trust 1 and Trust 2 governed by state law. Both of the trusts were irrevocable. State law permits the trustee to transfer the trusts into a unitrust to delineate the trust income if five requirements are met. The Trusts trustee and beneficiaries deem that the Trusts meet the criteria for conversion under State law and agree to change the Trusts to a unitrusts. Following an agreement, trustee and beneficiaries ask for a ruling that will not disturb their GST tax status. Additionally, they request that the conversion will not cause a beneficiary to have made a bequest that classifies as a gift for tax purposes and will not subject the Trusts or the beneficiaries to capital gains.

PLR 201320009 held that so long as the trusts meet the five requirements for the unitrust and the beneficiaries agree the conversion will not change any interest in either trust. As a result, neither trust lose it’s GST status. Additionally, because there is not a shift in any beneficial interest none of the beneficiaries can be treated like they have made a gift for gift tax purposes. Finally, no gain or loss will be recognized for either trust because of the conversion.

See Lorraine E. Gardner, Private Letter Ruling IRS Rules On Proposed Conversion Of Trusts, Legacy UCLA , May 24, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Article on Marshall v. Commissioner

Eric Bennett Rasmusen (Indiana University Bloomington) recently published an article entitled, The Meaning of 'Value' for Gift and Estate Tax Donee Limitations in Tax Code 26 U.S.C. § 6324(B): An Amicus Brief for Marshall v. Commissioner, Wills, Trusts, & Estates Law eJournal, Vol. 9, No. 15 (May 30, 2013).  Provided below is the abstract from SSRN:

In 1995, J. Howard Marshall II made a gift to Elaine Marshall worth some $43 million at the time of transfer. The IRS assessed gift tax against his estate, which failed to pay. In 2008 the IRS assessed gift tax of $74 million against donee Elaine Marshall, which exceeds $43 million because of the interest accumulated since 1995 but is less than the $81 million the gift would compound to at 5% per year. Does the limitation on donee liability to “the value” of the gift imposed by 26 U.S.C. § 6324(b) mean to “the original amount of the gift”, or to “the value of the gift at the time of eventual tax payment”? The appellate courts are split on this. That is the issue in Marshall v. Commissioner, which is now before the 5th Circuit. This paper is an amicus brief in that case and, I hope, a good example of how economics can inform and simplify law.

10 Ways to Avoid Mistakes when Naming Life Insurance Beneficiaries

Designating life insurance beneficiaries can be tricky and mistakes are common.  Here are 10 things you can do to avoid making any mistakes when naming life insurance beneficiaries:

 

1. Instead of naming a minor child, name a trust or a reliable adult for the child’s benefit.
2. Don’t risk making a dependent ineligible for government benefits.
3. Have your spouse sign a waiver if designating someone other than your spouse in a community-property state.
4. Make sure the life insurance death benefits are not counted as a taxable gift.
5. Don’t assume your will trumps the life insurance policy.
6. Don’t forget to change the designated beneficiaries when circumstances change.
7. Choose the distribution method that matches your intentions.
8. Make sure the beneficiaries know they are beneficiaries.
9. Consider having the policy paid out in installments.
10. Name secondary and final beneficiaries to prevent the benefit from going into your estate.

See Naming Life Insurance Beneficiaries: 10 Ways to Screw Up, Fox Business, May 22, 2013.

New Gift Tax In Minnesota

Recently, the Minnesota Legislature passed a new tax bill that the governor is expected to approve. The bill will be adding a new state gift tax. If signed by the governor the new law will take effect on July 1, 2013. The law requires a 10% tax on gifts worth $1 million dollars over a person’s lifetime. The new law is stricter that the current Federal exclusions. Some Federal exclusions are not exempted from the state tax. When a Minnesota resident or non-resident dies all of the lifetime gifts will be assessed for gift tax purposes. Clients who wish to give a gift should consult with a financial advisor to understand the different tax implications. 

See Michelle L. Rehbein, Minnesota Legislature Adds New State Gift Tax And Expands Estate Tax Provisions For Nonresidents, Leonard, Street and Deinard, May 17, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.

Connecticut Rakes in Inheritance Taxes

Connecticut state officials estimated that they would collect about $150 million in inheritance taxes in 2012, but due to the death of an unprecedented amount of wealthy people, Connecticut will collect a staggering $428 million. 

This unexpected record amount is also due to an increase in gift taxes, a result of wealthy individuals making huge transfers in gifts before the higher federal gift tax rate increased from 35 to 40 percent on January 1, 2013. 

The wealthiest Connecticut residents to die in 2012 include Goldman Sachs investment partner Richard M. Ruzika, Standard Oil heir Lucie Cunningham Warren, and Wall Street investor Barton Biggs.

See Christopher Keating, Inheritance Windfall: Record-Breaking Year for Estate Taxes Helps Fuel Budget Surplus, Hartford Courant, May 11, 2013.

Take Advantage of Family Discounts Now

The Treasury Department has long maintained it has the authority under Internal Revenue Code § 2704(b)(4) to restrict or eliminate valuation discounts for transfers of interests in family-controlled entities, and Obama’s new budget proposal echoes this sentiment. 

Traditional planning techniques use “valuation discounts to enhance the transfer of wealth to heirs with little or no gift or estate tax consequences.”  The absence of the perennial proposal to restrict or eliminate intra-family valuation discounts in the Treasury Department’s “Greenbook” signals the likelihood of proposed § 2704 regulations.  Therefore, estate planners should promptly take advantage of valuation discounts before any regulations are enacted.

See Gordon A. Schaller & Scott A. Harshman, The “Death Knell” for Family Discounts?, Jeffer, Mangels, Butler & Mitchell, LLP, Apr. 24, 2013.

Billionaire Sumner Redstone Challenges The IRS on 1972 Gift Tax

In 1972, Billion Sumner Redstone apparently made a gift to his children but did not file a gift tax return. Now, 41 years later, the IRS is claiming that he owes them $1.1 million in taxes and penalties, plus interest. According to Bloomberg, this "case involves stock in the family's National Amusements Inc. received by Redstone's son, Brent, and his daughter, Shari, after the settlement of an intrafamily lawsuit." Some estate and gift taxes attorneys have alleged that this is unprecedented; however, the statute of limitations does not apply here because Redstone did not file a gift tax return  in 1972. Instead, Redstone argues that the transaction was not a gift at all. He argues that it was was transaction made in the ordinary course of business. According to Bloomberg, "the case is Redstone v. Commissioner, T.C., No. 008097-13."

See Richard Rubin, Billionaire Redstone Challenges IRS on Tax for 1972 Gift, Bloomberg, May 1, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.

Obama’s Budget Proposal Likely to Have Negative Effect on Charities

As I have previously discussed, President Obama’s budget proposal could have a huge impact on charitable donations.

For every donation to a nonprofit organization, taxpayers in the highest tax bracket currently receive a 39.6 percent tax deduction.  Obama proposes to cap the tax deduction for donations at 28 percent for all tax brackets.  Along with increased income taxes, capital gains taxes, and Medicare surcharges, this cap on tax deductions could provide an additional disincentive to donate.  Charities also worry about another budget proposal known as the Buffett Rule that would require those with an annual income over $1 million to pay a minimum tax of 30 percent.

This proposal comes during a period of stagnant revenue for the charitable sector.  One study shows “that the top 2.2 percent of taxpayers were responsible for 27 percent of all charitable giving.”  Providing disincentives for the top tax brackets to donate may have a devastating effect on the charitable sector and the needy who benefit from it. 

See Colleen O’Dea, Charities Fear Obama Budget Will Hurt Donations, Private Wealth, Apr. 19, 2013

State Gift and Estate Taxes Are Alive and Well

Even with the large federal unified credit, a taxpayer might still have to pay state estate taxes following their death. There are still 21 states with a state estate tax. The District of Columbia also imposes a state estate tax. The problem is that most of these do not have a large unified credit like at the federal level that excludes a good amount of income from taxation. For example, in New Jersey the exclusion limit is $675,000, in Rhode Island the limit is $910,725, and in New York the limit is $1 million. In each of these states, the top rate on income exceeding the exclusion is 16%.

remember, all of a person's assets are included in this amount. This could also include life insurance depending on who receives the policy and how the policy is owned. Furthermore, several states impose an inheritance tax, which is different from the estate tax. An inheritance tax is imposed on the beneficiaries after the distribution of property, with the exception of spouses is most states and children and relatives in some. The two states that impose an inheritance tax on Maryland and New Jersey. There are ways to reduce the amount that a person will pay in estate taxes. For example, a person could give deathbed gifts which are exactly what they sound. A person could technically give away enough money to decrease their estate to below the threshold amount, but that is not always the best. A better strategy might be to discuss things with an estate planning attorney in the person's state to figure out the best possible strategies. 

See Sandra Block, Retirement: State Estate Taxes Are Alive and Well, The Chicago Tribune, Apr. 16, 2013.

PLR Reinvigorates Incomplete Gift Non-Grantor Trusts

Recently, a Private Letter Ruling has allowed taxpayers to reduce state tax liability without compromising the benefits from their assets. Taxpayers receiving stable income from their stock portfolio or with unrealized capital gains can take full advantage of this Private Letter Ruling (PLR).

PLR 201310002 holds that the incomplete gift non-grantor trusts with a lifetime special power of appointment for a heath, education, maintenance, and support purpose is now permitted. In essence, the trust makes a transfer incomplete in two ways; through the remainder interest and the major interest without the hassle of the grantor trust status. Additionally, the ruling held the distribution committee does not have powers of appointment. As a result, the PLR should make using incomplete gift non- grantor trusts more useful to avoid state income tax for the upper middle class. The preferred jurisdiction to create these trusts is Nevada.

See Peter Meicher and Steven J. Oshins, New Private Letter Ruling Breathes Life Into Nevada Incomplete Gift Non-Grantor Trusts, Wealthmanagment.com, Apr. 16, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Article on Achieving Horizontal Equity Through Estate and Gift Tax Reformation of Valuation

John F. Coverdale (Professor of Law, St. John's University) recently published an article entitled, Of Red Bags and Family Limited Partnerships: Reforming the Estate and Gift Tax Valuation Rules to Achieve Horizontal Equity, 51 U. Louisvile L. Rev. 239 (2013). Provided below is the introduction to his article:

Imagine a primitive society in which people store gold nuggets in bags. Neither buyers nor sellers of nuggets care what color the bags are because the value of the nuggets is set solely by their weight and purity. The only time anyone cares about the color of the bag is at death, because for purposes of the estate tax, the government assigns nuggets stored in red bags a much lower value than nuggets stored in any other color bag. This means that decedents who have stored their nuggets in red bags will owe substantially less tax than those who have used any other color.

The red bag discount flies in the face of economic reality because the color of the bag does not change the value of the nuggets. It also violates the principle of horizontal equity, which requires that similarly situated taxpayers pay the same amount of tax. For any given level of revenues, the red bag discount means that the rate of tax levied on nuggets stored in any other color bag must be higher than it otherwise would be. This leads to gross inequity: those who are well-enough advised to store their nuggets in red bags will pay less than their fair share of the total tax and all others will pay more than their fair share.

In the United States today, family limited partnerships (“FLPs”) are the red bags. The minority and marketability discounts granted for estate and gift tax to interests in FLPs are as out of touch with economic reality and as unfair as the red bag discount of the hypothetical society.

To illustrate this point and see the inequities it engenders, consider the case of three taxpayers, each of whom has three children and owns $10 million worth of Google stock that she wishes to transmit to her children. Taxpayer A gives the shares directly to her children or leaves the shares to them in her will. Her gifts or estate will be valued at $10 million. Taxpayer B creates an FLP to which she contributes the stock and leaves the interests in the FLP to her children in her will. Her estate will be granted a marketability discount on grounds that an outsider buyer would not pay net asset value for interests in the FLP because the lack of a market for those interests makes them illiquid, and buyers prefer liquid assets. The discount will be granted even if the FLP immediately distributes the Google shares to the children or sells them for $10 million and distributes the cash to the children. Taxpayer C contributes her Google shares to an FLP and gives one-third interests in the FLP to each of her children. In addition to a marketability discount, she will be granted a minority interest discount on grounds that the value to an outsider of a one-third interest in an FLP is reduced by being a minority partner who has no control over the FLP. Again, the discounts will be granted even if the next day the FLP distributes the Google shares or sells them and distributes the cash.

Taxpayers A, B, and C each give their children stock worth $10 million, which they can easily and quickly turn into $10 million in cash. There is no difference in the value of what is transmitted and received in the three cases. Yet they are treated very differently for estate and gift tax purposes, in flagrant violation of the principle of horizontal equity. In a typical recent case, for example, a family limited partnership that held $1,163,015 in cash and marketable securities and no other assets was valued at only $788,059 for estate tax purposes after minority and marketability. The issue is not a small one. In 2004, over half of all the discounts on estate tax returns were claimed for FLPs.

These bizarre results are the product of the formalism with which the courts have approached the problem of valuing FLPs. They have focused on the Treasury Regulation’s definition of value as “fair market value,” that 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.” The “willing buyer” and “willing seller” in the definition, courts have insisted, are hypothetical persons who are unrelated to each other. On the basis of these definitions, courts have valued interests in FLPs by inquiring what an outsider would pay for them. They have concluded that an outsider would require a steep discount from the value of the assets, because he would own a minority interest in the FLP and because there is little or no market for interests in the FLP.

It is true that if an outsider were to purchase an interest in an FLP, he would require a discount for the reasons the courts give. In fact, however, interests in FLPs are never sold to anyone outside the family. They are “specifically designed to be given away during life or at death . . . .” Subsequently, they are either liquidated, redeemed, or transferred among family members. The holders of the interests are always related parties, not outsiders. What is bought and sold in transactions with non-family members are not the interests in the FLP but the underlying assets. For these reasons, “the notion of fair market value, premised on a voluntary arm’s-length exchange [between unrelated parties], is profoundly unrealistic” when applied to FLPs.

The reasons given in the organizational documents for the formation of FLPs often include liability protection, succession planning, and centralization of investment decisions. In a few cases, non-tax purposes may actually matter to the people who form the FLPs. Three-fourths of all the assets held by FLPs, however, consist of cash, marketable securities, and real estate, and “there is usually little reason to put marketable securities in an [FLP] except for the discounts.” My point, however, is not that FLPs should not give rise to discounts because they are tax-motivated. It is, rather, that placing assets in an FLP should not give rise to discounts because it has no more effect on value than placing gold nuggets in a red bag.

The IRS has made numerous attempts to curb this abuse, both by attributing the interests held by one family member to other family members in a manner similar to what this Article proposes and by applying various statutory provisions. One of its more interesting approaches involved finding a gift on creation of the family limited partnership. The courts have, however, frustrated all these efforts except in cases where the taxpayers were poorly advised or excessively greedy. The weight of precedent in this area is so great that it is extremely unlikely that these abuses can be curbed without legislation. 

This Article suggests legislation to bring estate and gift tax valuation of assets held by FLPs back in touch with economic reality. It proposes using family attribution to deny minority discounts for entities controlled by members of a family. It further recommends disallowing marketability discounts for family-controlled entities that do not conduct an active trade or business. These measures would restore a measure of horizontal equity to estate and gift taxes, in addition to making the tax system more economically efficient by eliminating the incentive to spend money to form, operate, and wind up entities that generally have little utility other than their ability to reduce taxes.

Part I provides essential background on the valuation of closely held businesses. Part I.A gives an overview of the process of valuing a business as a whole, focusing especially on how it applies in the estate and gift tax context. Part I.B explores control premiums and minority discounts. Part I.C examines the marketability discount. Part II.A discusses minority discounts as applied to FLPs and proposes legislation to disallow them through family attribution. Part II.B explores marketability discounts as applied to FLPs and proposes legislation to deny them where the FLP does not conduct an active trade or business.

CLE on Multistate Estate and Gift Planning

On Tuesday, April 23, 2013, the ABA is hosting a telephone seminar and audio webcast entitled Multistate Estate and Gift Planning. The telephone seminar and webcast is from 12 p.m. to 1 p.m. Eastern.  Topics will include: 

• Overview of which states have estate or gift taxes
• Determination of taxes based on domicile, location of assets, and location of beneficiaries
• How elective shares, bequests to a former spouse, community property, homestead protection, and prenuptial agreements can override estate planning documents
• State law restrictions on the ability to choose trusts (corporate or individual) executors, and others who will make investment, distribution or administrative decisions
• Deciding primary jurisdiction and which state's law applies
• And more! 

Please click here for more information. 

CLE on Charitable Giving Techniques

The ALI-CLE and the ABA Section of Taxation is co-sponsoring a live course and video webcast entitled, Charitable Giving Techniques, on Thursday-Friday, May 2-3, 2013 at the Washington Plaza Hotel in Washington D.C. Provided below is description of the event:

Acquire the knowledge to advise your clients not just on compliance with past and proposed new regulations, but also on how they can incorporate a range of incentives into their ongoing financial planning.

Taught by a distinguished national faculty of experts in the field, this annual course, comprising at least 12 full hours of instruction including one hour of ethics, is a comprehensive review of lifetime and testamentary charitable giving techniques, including a full discussion of recent statutory provisions. It addresses the technical, mechanical, and legal sides of the issues, with practical applications and “tips from the trenches.”

The first half of the first day offers two tracks at different levels of complexity, allowing you to attend the track that is right for you. One track serves as a crash course or refresher in the basic aspects of charitable giving techniques. The alternative morning track is for those looking for more advanced analysis. Following the Thursday lunch break, all registrants come together for the remainder of the course, which focuses on more challenging issues and is taught at an advanced level, thereby allowing the faculty and registrants to delve more deeply into important topics, such as:

• Use of private foundations, donor-advised funds, and supporting organizations
• Post mortem charitable planning
• Charitable giving tax pitfalls
• Life insurance
• Hot topics and case studies in planned giving
• Best practices in development – lessons learned

The faculty also spends a full hour discussing ethics problems that routinely challenge charitable giving practitioners. This course includes CLE ethics credits.

Article on Gift Tax Fundamentals

Mark Powell (Adjunct Professor of Law, Chapman University School of Law) & Andrea Kushner Ross (Attorney, California) recently published an article entitled, Fundamentals of Gift Tax, SSRN, (Nov. 1, 2012). Provided below is the abstract from SSRN:

A detailed overview of the US gift and generation-skipping transfer taxes.

CLE on Avoiding Common Pitfalls in Preparing 2012 Gift Tax Returns

It is not too late to register for the March 5, 2013 CLE entitled An Ounce of Prevention is Worth a Pound of Cure: Avoiding Common Pitfalls in Preparing 2012 Gift Tax Returns.  The teleconference and live audio webcast is from 1:00 p.m. to 2:30 pm ET.  

This program will address some of the common pitfalls in the preparation of the Federal Form 709, with a special focus on:

• Reporting issues related to GST tax allocations and compliance;
• Gift splitting;
• Transfers to Crummey trusts; and
• "Spousal access trusts."

In addition, this program will provide tips for addressing mistakes on prior returns and anticipating potential audit issues.

For more information or to register, please click here.