What Does All this Mean for Us in TN?

Ok, so it's been a little while.  But, if you haven't noticed, there has been a lot going on lately, and the life of a tax lawyer this time of year can be a little busy.

For those of you living under a rock, there is a new tax bill that has been passed by the Senate and is scheduled to be voted on by the House today.  There are lots of provisions, but I will focus on the transfer tax portions of the trust.

Under the new tax law -

1.  Everyone will be entitled to a $5,000,000 exemption from the estate tax.  This exemption will be "unified", which means that an individual can give away a combination of $5,000,000 during life or at death before paying any estate tax.  In 2009, a person could give away $3,500,000 at death, but only $1,000,000 during life.

2.  The rate of tax for any transfers in excess of $5,000,000 is $35%.  This is down from 45% in 2009.

3.  The estate tax exemption is "portable."  This means that if a person dies and does not use his or her entire $5,000,000 exemption, his or her spouse can use the unused portion.  Under prior law, it was possible to use both spouses exemptions, but it required relatively sophisticated planning.

4.  For an individual who died (or will die) in 2010, his or her estate has the option of no estate tax and a carryover basis, or an estate tax as outlined above and a stepped-up basis.

So, what does this mean for us in TN?  I think the two most important issues to consider for people in TN are the increased gift tax exemption and the portability of estate tax exemption.

1.  With a new $5,000,000 exemption from the gift tax, an individual could on Jan. 1, 2011 make a $5,000,000 gift and pay no federal estate tax.  This is a great result.  We must not forget, though, that TN has its own gift tax, and there is no exemption from the TN gift tax.   This means that a $5,000,000 gift would generate $463,400 of tax.  This is a pretty big pill to swallow, and most taxpayers will not want to pay this tax.

2.  Although the estate tax exemption will be portable, the $1,000,000 exemption from the TN inheritance tax is not portable.  Accordingly, in order to take advantage of both spouses' exemptions, it will still be necessary to create a bypass trust at the first death.

While the new tax act appears to be a great deal for the wealthy, it also creates some very interesting issues for people dying in TN.

End of Year Gifts

This is a good article about end of year gifting.

The federal gift tax rate for gifts in 2010 is (just) 35%, which is really low compared to historical rates.  Under current law, the rate increases to 55% on January 1, 2011.  Accordingly, for taxpayers whose net worth is sufficiently high that they will likely be subject to estate tax regardless of any law changes, taxable gifts this year could be a really good planning tool.  This is especially true for older clients or clients in poor health.

Of course, you should wait until the end of the year (read December 31) to make these gifts, because if you die before the end of year, then the gift tax paid will have been wasted.

States are in Favor of the Estate Tax

As I stated in a previous post, I was at the Southern Federal Tax Institute in Atlanta last week, which has a wonderful two-day estate planning program.  There were many interesting things said, but one of the things that caught my attention the most related to the reinstatement of the federal estate tax in 2011.

Prior to the Bush tax cuts, the federal estate tax code allowed each decedent a "state death tax credit," which was a credit against the decedent's federal estate tax liability.  The purpose of the credit was to give taxpayers a credit for any amounts paid in state death taxes.  (Although this was the purpose, the state death tax credit was a specific formula provided in the tax code and was not actually related in any real way to the amount of state death tax a decedent actually paid.)

Most states had a death tax (or inheritance tax or estate tax, etc.) equal to the state federal death tax credit.  Accordingly, the state death tax credit really just provided the states with some of the federal estate tax revenue, and did not actually reduce the total estate tax owed by a decedent.  For example, let's assume that a decedent owed $100 in federal estate taxes, not including the state death tax credit, and was entitled to a $20 state death tax credit.  Without the state death credit, the decedent would owe $100 to the IRS.  With the state death tax credit, the decedent would $80 to the IRS and $20 to the state where she died.  So, in both scenarios, the decedent was out $100.  The only thing that changed was where it went.

When the Bush tax cuts came in, the state death tax credit was repealed.  This meant that the death tax revenue for many states went away as well.  If the estate tax is reinstated next year as currently scheduled, the state death tax credit comes back too, which means that many states will start receiving estate tax revenue again.

I have always known that the return of the estate tax would benefit many states, but what I did not realize, and learned at SFTI, is that many states are actually lobbying Congress to allow reinstatement of the estate tax as currently scheduled.

WTH Is Going on with the Estate Tax?

As most everyone knows by know, there is no federal estate tax this year.  As part of the 2001 Bush tax cuts, the estate tax was gradually repealed starting in 2001 until complete repeal in 2010.  Because of the Congressional budget rules (of which I will spare you), the Republicans did not have enough votes to make the repeal permanent.  Instead, without further Congressional action, the estate tax is reinstated beginning next year. In addition, upon reinstatement, the federal estate tax exemption is only $1,000,000 per person (whereas it as $3,500,000 per person last year) and the top rate increases to 55%.

Most everyone thinks that we will have an estate tax next year, but that Congress will act and not allow the exemption to return to $1,000,000.  (Of course, this time last year, I counseled clients that there was no way Congress would allow the estate tax to be repealed for a year. So, frankly, no one really knows.)  But, the consensus also seems to be that it will be next year before Congress takes action.  First, nothing will take place before next month's elections.  Then, the universal belief is that the Republicans (who favor repeal) will make substantial gains in Congress this year.  Because of this, the Republicans will likely be able to strike a better deal by waiting until the beginning of next year when all their new people are in office, rather than trying to pass some lame-duck legislation before the end of the year.  Accordingly, it could be January, February or later before we get any Congressional action, and who knows, maybe nothing will happen.

SFTI

Sorry guys that I haven't posted in a few days.  I will be in Atlanta for the Southern Federal Tax Institute most of the week and I should learn about quite a few worthy topics to post about.

Valuation, Valuation, Valuation - Part 1

Not unlike the famous question, "What are the three most important things in real estate?", one could easily argue that the three most important things in estate planning are valuation, valuation and valuation.  The estate and gift taxes are taxes on the transfer of property.  Accordingly, it doesn't take a rocket scientist (or an overeducated lawyer) to see that the lower the value of the property being transferred, the less tax that will be paid.

Based on this simple idea, estate planning lawyers spend a lot of time trying to lower the value of property for transfer tax purposes without actually lowering the value.  As you might expect, the IRS doesn't like this very much, and many (and maybe most) of the tax cases in the estate and gift area over the past several years have involved valuation, and primarily a technique called family limited partnerships (FLPs).

It's actually a misnomer to call FLPs a technique.  An FLP is just a partnership like any other partnership, which just happens to be owned by members of the same family.  Many FLPs are operating businesses, like the family restaurant, hardware store or beauty salon.  Where FLPs got their (bad?) name, though, is where they do not hold operating businesses, but instead hold investments assets or other family assets that might not be typically held in a partnership.

The idea (and some might say abuse) goes like this - I will take my brokerage account that has a quantifiable value (and recently has been sinking like brick) of let's say $100.  I then form a partnership and contribute the account to the partnership.  Now, I don't own a brokerage account anymore.  Instead, I own an interest in a partnership that owns a brokerage account.  I have placed lots restrictions on this interest that I now own.  For example, I cannot get my money back without consent of the other partners and I can't sell the interest without consent of the other partners.  By placing these restrictions and others on my interest, such interest is now worth something less than $100.  So, when I make a gift of this interest to my daughters, I pay tax on the discounted value of the interest and not $100.  As these things typically go, a long time passes and the FLP makes a distribution or is dissolved, and then my daughters receive my original $100, but I paid tax on the lower amount.

So, now that you have the technique down, in Part 2 I will discuss some of the abuses and the IRS attacks on those abuses.

Mickey Mouse is in Support of the Estate Tax!

Read Abigail Disney's Op-Ed in the USA Today in support of the estate tax here.

How Much Do You Need to Know About . . .?

A recent conversation with a friend of mine made me realize that there are a lot of really complicated matters that go into estate planning.  Some of these include life insurance, investing, retirement planning, etc.  All of these items are very important and can be very complex.  Because they can be so complex, it is impossible to know everything about each of these topics.  But, it is important to know the basics.  So, I thought I would start a series entitled "How Much Do I Need to Know About ____________?

Look for entries in this series in the days to come and please let me know in the comments if there is any specific topic that you would like to learn about.

Beware of the Large Bequest

Over the past year, I (and every other estate planning lawyer) have spent a lot of time worrying about formula bequests based on the federal estate tax exemption.  As many of you know, one of the "basic" tenants of estate planning for married couples is to establish a bypass trust (or family trust or credit shelter trust, etc.) at the death of the first spouse equal to the federal estate tax exemption.  Because the estate tax has been repealed for 2010, there is no federal estate tax exemption for someone dying this year.  Accordingly, it can be very unclear how a formula based on such exemption would work for someone dying this year.  Depending on the terms of the bypass trust, an "incorrect" interpretation could have disastrous results.  Fortunately, the Tennessee legislature has passed a law that (for the most part) corrects this problem.

But, formulas and other large bequests are often used in other contexts and the potential problems with these bequests have not received as much discussion.  I have a client for whom I prepared a will several years back.  In that will, she had made several large bequests to friends and charities with the remainder passing to her son.  I received a call from her recently stating that because of the downturn in the financial markets she did not have enough funds to make these bequests and still leave anything to her son.  Accordingly, we removed these bequests from her will.

In my experience, this client is highly unusual.  Most clients are not aware enough of their wills to realize when they have a problem like this.  It is not uncommon to meet with a client to review a past will and have the client exclaim, "I didn't realize I had left so much to _____________."  Accordingly, we can't always rely on clients to inform us of these situations.  This problem typically is only discovered when the client decides to update his will for other reasons, which could be years later.  


On the other hand, estate planning lawyers do not have up to date financial information on each of their clients.  This, plus the fact that we have so many clients, means that it is unrealistic to expect the lawyer to be aware that a problem like this has arisen.  


So, what is the solution?


Frankly, there is not a good one.  I believe the best way to combat this problem is to provide as much client education as possible when a will is executed containing a large bequest or formula transfer.  Maybe if we emphasize it enough on the front-end, the client will realize when a problem arises and give us a call.  


In addition, we should really encourage our clients to check-in with us every few years for a quick update.  I tell all my clients that they should check in with me every two to three years to make sure their estate plan still accomplishes their goals.  If the client will send an updated financial statement, this "check-up" usually only takes a short (and inexpensive) phone call.  This is a relatively cheap and easy solution to a very big problem.  It is not pleasant to sit down with a family after a loved one has died and explain to them that the inheritance will not be distributed as they thought.

Estate Planning in a Low Interest Rate Environment

Deborah Jacobs at Forbes has a good article about five ways to take advantage of the current low interest rate environment.

Free Danny Tate?

I recently learned of the conservatorship case of Danny Tate.  I guess I have been living under a rock because it appears that I was the last one to hear about this case.  A quick Google search turns up numerous articles and blogs about Mr. Tate's plight.  I won't rehash the details of the story as it has been detailed by numerous others both in print and online.  In addition, I have no idea which side is right and which side is wrong on this matter.  On one side, it doesn't take much research to see that Mr. Tate has a pretty compelling case that he does not (at least currently) need a conservator.  It seems many of Mr. Tate's supporters blame the probate judge for appointing a conservator for Mr. Tate.  The probate judge involved in this case, however, has an excellent reputation and it is hard to believe that he would appoint a conservator where one was not needed.

Regardless of who is right and who is wrong, this case highlights the need for incapacity planning.  When preparing wills for clients, we also prepare powers of attorney for healthcare and finances to avoid the need of a conservator if a client becomes incapacitated.  It can be easy when preparing these documents to not put a lot of thought into who should serve in these roles and what the documents actually say (and do not say).  As the Tate case (and many other cases) highlights, the persons we choose to serve as powers of attorney can be just as important as the other planning we do.

Just last night I was watching an episode of The Good Wife, which despite its horrible Tammy Wynette-esqe title, is actually pretty good. In this episode, a husband and a wife were divorcing.  Just hours before the court appearance to finalize the divorce, however, the husband had a car wreck and went into a coma.  While the husband had changed his will to remove his soon to be ex-wife as the beneficiary, he had not changed his power of attorney.  So, while his ex-wife would not receive anything if he died (there was a prenuptial agreement waiving all statutory rights), as long as the husband was alive, the ex-wife had control of his $40 million estate!  

The moral of the story - check those POAs!!

How Long is Too Long?

In 2004, Tennessee adopted the Uniform Trust Code. At the same time, Tennessee amended its rule against perpetuities (RAP) to 360 years. This change to the RAP means that a trust can last for up to 360 years before being required to terminate.

Tax attorneys (like myself) love these so-called "dynasty trusts" because they allow taxpayers to avoid estate taxes. As long as the funds stay in the trust, they will not be subject to estate taxes. Accordingly, a trust lasting for 360 years could avoid estate taxes for more than 10 generations, which provides an unbelievable tax benefit.

But, do our clients really want trusts that last for 360 years?

I have found in my practice that clients really want to benefit the people they know - their children, grandchildren and sometimes great-grandchildren. Clients (and people in general) often have a hard time thinking about their heirs 360 years from now. A good way to think about this is to consider what was going on 360 years ago - or in the year 1650. This would have been more than 100 years before the Declaration of Independence. Consequently, it is impossible to know what will be going on 360 years from now.

I think the moral of the story is that sometimes as practitioners we can get caught up in the tax planning and forget the real goal - carrying out our clients' goals. I think most clients, if they answered honestly, would prefer their assets pass the to their children, grandchildren and great-grandchildren, even if it costs their heirs in the year 2400 a little extra in estate tax.

Fisk Art Sale

The court has ruled on the proposed sale by Fisk of its Alfred Stieglitz Art Collection to the Crystal Bridges Museum in Arkansas. The court found that it was impracticable for Fisk to comply with the "do not sale" condition placed on the collection by Georgia O'Keefe, but that the proposed sale (at least under the current terms) was not the best solution to carry out Ms. O'Keefe's intent. Accordingly, the court ordered the parties to submit new proposals for selling the collection.

See the Tennessean's coverage at the following link.

Retirement Plan Beneficiary Designations

I recently had a very interesting conversation with a client regarding the beneficiary designation for an IRA of a deceased parent. The IRA assets are custodied at a very well known and large institution. The beneficiary designation for the IRA was designed to limit the amount of estate taxes, and the designation should achieve that result.

Sounds great, right?

The only problem is that the custodian is refusing to honor the beneficiary designation. Why you might ask? No one really knows, other than the designation is relatively complex. At this organization (which unfortunately is not that atypical), it is impossible to speak with someone in the legal department. Accordingly, the only option is to move the IRA to another custodian who will honor the designation. But, this can be much harder to do than you might think for various reasons.

Accordingly, be very careful when drafting beneficiary designations to insure that the IRA custodian will accept them. Even the best drafted designation in the world will be of no use if the custodian refuses to carry it out.

"Pre-Funding" of GRATs

Ok, so my idea of doing a new blog regarding estate planning may have been a little ambitious, but I am fully committed now.

I had an interesting discussion a week or so back about the "pre-funding" of GRATs (Grantor Retained Annuity Trusts for the uninitiated). Many experts believe that Congress will significantly limit the effectiveness of GRATs either by requiring a minimum term of 10 years or requiring a taxable gift to be made upon the funding of the GRAT or most likely both. This change could occur very soon. Accordingly, for someone wanting to do a GRAT this year, it is important to create and fund the GRAT before this new law is passed.

But, what if you don't have the right asset to fund the GRAT right now? One option might be to go ahead and create and fund a GRAT right now with cash or some other asset. Then, two or three months down the road when you have the right asset to put in the GRAT, you can swap this asset for the cash. If done correctly, this should not have any effect on the ability of the GRAT to qualify under IRC Section 2702. If you plan to use this method, however, it is important that the grantor retains the right to substitute property of equivalent value.

This is a pretty creative way to protect yourself against this potential change in the law, even if you are not ready to fund a GRAT right now.