State of The Estate Tax

The federal estate tax exemption or the amount that is not subject to tax is $3,500,000 for an individual dying in 2009. The gift tax exemption is $1,000,000. The maximum federal estate and gift tax rate is 45%. Under current law there is no estate tax for individuals dying in 2010, but for 2011 and beyond the estate tax exemption will return to the pre 2000 amount of $1,000,000 per person. The gift tax exemption remains at $1,000,000 per person for 2010 and beyond. Beginning in 2011, the maximum federal estate and gift tax rate is 55%.

Most everyone believes that the current law will be changed before the year 2010 comes and there is no estate tax. The question is how the law will be changed and is there anything that can be done in 2009 to take advantage of certain provisions of the current law.

The “Certain Estate Tax Relief Act of 2009” (H.R.436) has already been introduced in the House. This bill would retain the current exemption of $3,500,000 indefinitely beginning in 2010. The rate of tax would remain at 45% (50% for large estates). This bill also contains other important provisions. On the positive side, the bill would repeal the carryover basis rules scheduled to become effective in 2010. One negative aspect of this legislation is the removal of the valuation discounts for transfers of non business assets to closely held entities such as Family Limited Partnerships.

Senate Democrats have recently offered their proposal which would set the exemption for both estate and gift tax purposes at $5,000,000 per person ($10,000,000 per couple) indexed for inflation. The estate and gift tax rate would be 35%. There are other proposed bills in Congress dealing with the estate tax. While the post 2009 estate tax law must be determined by our legislators, this may not happen this fall. It has been suggested that Congress may simply extend the law effective for 2009 to 2010 and deal with the broader issues later.

In the meantime, it may be wise to consider transferring non business assets to a Family Limited Partnership now. The discounts for lack of marketability and control are currently available, thus allowing a transferor to either pay less gift tax or transfer more property. While the final version of H.R. 436 could make the effective date retroactive, this seems unlikely since the current version has a prospective effective date.

Contesting A Will

It is not unusual to hear a disgruntled potential heir make a threat to challenge someone’s will. Such threats are easy to make, but usually unsuccessful. Feeling that one has not been treated fairly is not enough by itself to prevail in a will contest. A competent decedent has the right to leave their estate to anyone he or she chooses. A surviving spouse (and in some jurisdictions minor children) may under state law have the right to elect to take a higher percentage of the estate (usually 1/3) if greater than the percentage actually left to them, but this is not contesting the will.

Contesting a will is usually a lengthy and expensive endeavor and the contestant, assuming a sufficient connection or “standing”, also must have a valid legal basis to do so. The following reasons are generally accepted as the legal basis for challenging a will, although state law will vary as to the particulars.

The document offered for probate is not a legally enforceable will. Each state has its own formalities, but usually the will must either be in the decedent’s handwriting or witnessed by two adults and notarized. The document must also have been intended to be the decedent’s last will and not for example, a draft.

The decedent lacked the testamentary capacity to make a will. A person is deemed competent to make a will as long as they understand the composition of his or her estate and know the natural objects of their bounty regardless of any illness or other infirmity.

The decedent was unduly influenced by a person in a fiduciary relationship with the decedent who stands to gain from the will. If such a relationship is found to exist, the burden of proof often switches from the contestant to the proponent of the will (the executor).

Some or all of the will resulted from fraudulent representations or mistaken beliefs of the decedent. Fraud would result if the decedent were intentionally provided with false information. Innocent misrepresentations to or mistaken beliefs by the decedent though, would generally not invalidate a properly executed will.

It is usually advisable to consult an attorney when you think someone may challenge your will. The attorney can explain your state law to you in general and in particular the effect in your state of an “in terrorem” clause. Such a clause in your will attempts to limit challenges by providing that any challenger will be disinherited. Some states do not recognize such clauses as against public policy.

If you expect a will challenge you may also want to take such precautions as videotaping the signing of your will and where appropriate, obtaining documentation from a physician that in your doctor’s opinion, you are competent to make a last will and testament.

The Estate Plans of Michael Jackson and Steve McNair

All too often, celebrities and otherwise wealthy people create problems for their families by failing to take the opportunity to plan their estates. Anyone who fails to provide for their loved ones creates problems, but these problems become magnified for celebrities because of the publicity and wealth. Two recent very public deaths underscore the value of proper estate planning.

Although there will probably be litigation over Michael Jackson’s estate if for no reason other than its size, “The King of Pop” appears to have done all that he could to discourage such challenges. Michael’s will “pours” his assets into a trust. He probably did this to limit public access to his affairs since while one’s entire will is public information, the specific details of a trust are not. Michael’s will and trust specifically name his three children as his beneficiaries. His trust names certain of his siblings’ children as contingent beneficiaries. This is important for two reasons. First of all, there would be no incentive for someone else to claim they are a child of Michael Jackson. Secondly, it takes the intestacy laws of the State of California out of the picture.

Michael’s will attempts to limit the inevitable legal battle over his children by naming a guardian for the children (his Mother) and even a contingent guardian (Diana Ross). His will also contains language to the effect that he is intentionally omitting to provide for his former wife, Deborah Jean Rowe Jackson. These clauses can be important in any future litigation.

The heirs of former star quarterback Steve McNair will not be as fortunate as Michael Jackson’s heirs. McNair, killed in a recent murder-suicide apparently died without a will. NFL insiders are incredulous at this apparent oversight since pro football agents typically refer their clients to estate planning attorneys as a matter of course. If McNair died without a will, the state of his residence and not McNair will decide who gets his assets. The former All-Pro left a wife and their two minor sons. Reportedly, he had two other sons not with his wife One can expect a lengthy legal battle over the paternity of these children and the resulting disposition of the estate. If McNair left no will, he may also have failed to take advantage of some fairly simple estate tax saving opportunities, thus requiring his estate to pay the maximum amount of taxes.

No one should die without a will. The relative complexity of settling the estates of these two recently deceased celebrities will highlight the consequences of failing to do so

The Credit Shelter Trust

The Credit Shelter Trust, sometimes referred to as a “Bypass” or “AB” trust, is so important to any married person’s basic estate plan that it would be malpractice for any estate planner not to at least discuss this estate tax saving tool with his or her married clients. This trust, properly drafted and implemented, will insure that a spouse’s exemption from the federal estate tax will not be wasted.

By way of background, every U.S. citizen and most U.S. residents are granted a lifetime exemption from the federal estate tax. Although technically a credit, the amount of this credit exempts the first $3,500,000 of any one individual’s estate from taxation in 2009. Although future legislation is expected, the current law would exempt only $1,000,000 per person from taxation in 2011. In addition to one’s lifetime exemption,
gifts or inheritances to spouses are fully exempt from estate taxation.

A couple with a combined taxable estate of less than two times the applicable exemption ($7million in 2009, but $2million in 2011) would expect that their ultimate beneficiaries (usually their children) would pay no federal estate tax. Under current law though, this is not always the case. Assume Husband and Wife each have a taxable estate of $1million or a total of $2million. Husband dies in 2011 when the exemption is $1million. Husband leaves his entire estate to Wife and because of the unlimited marital deduction, no estate tax is due. Wife dies then with an estate of $2million. Since her estate has an exemption of only $1million, her beneficiaries are subject to a federal estate tax of approximately $500,000 ($1,000,000 taxable estate times 50% federal estate tax rate).

This happened because her husband wasted his exemption by leaving his entire estate to his wife. This could have been avoided by leaving an amount of his estate equal to the exemption to the couples’ ultimate beneficiaries, but for a lot of reasons this is not usually practical. The solution then is for the first spouse to die to leave the amount of the exemption to a credit shelter trust. The taxable estate of the second to die spouse then would not include this amount.

The language contained in a properly drafted Credit Shelter Trust is by necessity voluminous and complex. However, the trust is fairly simple to administer. In order to accomplish the goal of not wasting the first-to-die spouse’s exemption, the principal (generally up to the amount of the exemption) is left to the couple’s ultimate beneficiaries, for example the children. Typically they are not entitled to any of the principal until the second spouse passes away. The surviving spouse receives all of the income from the assets placed in this trust during his or her lifetime. The surviving spouse may also receive the greater of 5% of the assets or $5,000 each year. In addition, the trustee is usually granted the authority to make discretionary distributions of principal to the surviving spouse for his or her health, maintenance, support or education. The surviving spouse is almost always a co-trustee and under certain circumstances, the only trustee.

Practically, the spouse has almost complete access to the assets of the trust. Considering that it comes with a substantial tax benefit to the ultimate heirs, it does seem foolish not to employ this tax saving tool where appropriate.

The Irrevocable Life Insurance Trust

To most estate planners, basic estate planning would include a will, living trust (where applicable), credit shelter trust (if married), property power of attorney, medical power of attorney and living will. Reducing the federal estate tax beyond the credit shelter trust usually requires an irrevocable transfer of the ownership and use of assets to your loved ones .This strategy is generally appropriate only for the wealthy. The Irrevocable Life Insurance Trust (“ILIT”) though, has the potential to escape estate tax while retaining the ability to control the disposition of assets in the form of life insurance proceeds

Proceeds of life insurance policies owned or deemed owned by a deceased insured or payable to his or her estate can be subject to the federal estate tax depending on the size of the estate. You can avoid having the life insurance proceeds included in your taxable estate by naming someone else such as your spouse or children as the owner of the policy. For many people, this is not a practical solution. For example, this may not be in the best interests of your children if they are minors or otherwise not in a position to manage a large sum of money. Furthermore, the proceeds would be included in the beneficiary’s estate.

The ILIT may be an opportunity to have your cake and eat it too, in that you can provide who and under what circumstances receives the proceeds while escaping the federal estate tax on these proceeds. The trust and not the insured, spouse or heirs must own the policy, The insured must not have any of the powers of ownership such as the right to change the policy in any way. For new policies, the trustee is the original applicant and subsequent sole owner of the policy. The ownership of an existing policy can be transferred to the trust by completing an irrevocable assignment form provided by the insurance company designating the trust as the new owner and beneficiary of the policy. However, if the transferor insured dies within three years of the transfer of an existing policy (but not the purchase of a new policy), the proceeds will be taxable for estate tax purposes.

Like wills and other estate planning documents, sample ILITs can be obtained on the internet. It is highly recommended though to engage an attorney to draft an ILIT because certain legal issues may have to be addressed. For example, if an existing policy is transferred to an ILIT, the cash surrender value could be a taxable gift. A taxable gift can also occur to the extent the insured pays the premium for the insurance policy unless a “Crummey Power” is utilized.

In addition to these pitfalls, a well drafted trust can provide opportunities for the insured and his or her beneficiaries. For example, a “fail-safe” clause could provide protection from the estate tax should the insured die within three years of the transfer of an insurance policy to an ILIT. Also, it is customary to add a clause to the trust authorizing the trustee to either purchase assets from or lend money to the insured’s estate. This option provides the estate with liquidity while shielding the insurance proceeds from tax.

Any competent estate planning attorney can help you avoid the pitfalls and take advantage of the opportunities of an Irrevocable Life Insurance Trust.

Property Power of Attorney

Whether you use a will or a living trust no estate plan is complete without a property power of attorney. This is a legally binding document in which you give the authority to another person to make financial decisions for you. A property power of attorney is not to be confused with a medical power of attorney which gives another person to make medical decisions for you. This document will be the subject of a future discussion.

Why would you want or need a property power of attorney? If you become incapacitated to the extent you cannot handle your own financial affairs, you and your family will be glad you have designated someone of your choosing to do so. The alternative is a guardianship proceeding which is costly, time consuming and sometimes humiliating.

You may also want a power of attorney even if you are competent to handle your affairs simply for convenience. For example like most couples my wife and I have purchased, sold and refinanced several properties over the course of our marriage. With a properly drafted power, only one of us has had to attend the time consuming settlements necessary to accomplish these real estate transactions.

Powers of attorney are characterized several different ways. They can be general or specific. A general power of attorney grants your agent the authority to conduct all of your affairs. A specific power grants your agent the authority to act for you only in specific transactions, such as a real estate closing. Whether general or specific, powers can also be limited to a certain time, for example when you return from an overseas trip, or powers can be valid until you revoke it.

A durable power of attorney is designed to be effective before and after your incapacity. A springing power become effective only upon a determination (usually by one or even two doctors) that you are incapacitated to the extent you cannot handle your own affairs. In most cases you would want the power to be durable but not springing. Otherwise, you would not be able to avoid the trip to the courthouse for a determination that you are incapacitated.

Usually powers of attorney are not recorded as public information at the local courthouse. However, if the power relates to a real estate transaction, it may have to be recorded at the Recorder of Deeds Office. If a person has already reached the incapacity stage, one might want to record their power because they may no longer be competent to execute another.

Elderly people in particular may want to consider naming multiple individuals either as co or alternative agents. This would guard against the possibility that the single named agent predeceases the principal or becomes incapacitated themselves when the principal is no longer competent to name another.

Powers of attorney should be executed when you sign you sign your will. If you engage an attorney to create your estate plan he or she will include this important document. If you choose not to use an attorney, there are power of attorney forms readily available on the internet.

Medical Power of Attorney

Every basic estate plan should include a Medical Power of Attorney along with a Medical Directive to Physicians (“Living Will”). A Medical Power of Attorney is a legal document in which you (the “principal”) designate another person (the “agent”) to make health care decisions for you should you be unable to do so yourself. A Medical Power is not to be confused with a Property Power of Attorney in which you give another person the authority to make financial decisions on your behalf, another important estate planning document.

The Medical Power is a document which should be executed in addition to a Living Will. A Living Will is a document in which you direct health care providers to withhold or withdraw specified medical treatments should you be in an end stage or irreversible terminal condition. The Medical Power is more general in that it applies to more than the specified treatments and applies whether or not you are terminal.

Your Medical Power becomes effective when your physician certifies that you are incompetent to make your own medical decisions and lasts until you become competent. It applies to most decisions with the notable exception of commitment to a mental institution. With respect to the decisions made in your living will, you should specify in either or both documents whether you require your agent to follow your living will instructions or whether they are for your agent’s guidance only.

You can designate any competent adult, with the exception of your health care provider, as your medical agent. If your designated agent is either elderly or not local, you may want to designate a co-agent or alternative agent. In such a case, be sure to delineate their respective responsibilities.

Health care providers (physicians, hospitals, nursing homes, nurses and even physical therapists) will gladly provide you certainly with a Living Will and maybe a Medical Power of Attorney. These documents are also readily available on the internet. If you engage an attorney to plan your estate, he or she will also provide you with these documents.

New Proposed Regulations under Section 706 Address Varying Partnership Interests

On April 14, 2009, the IRS issued Proposed Regulations addressing the determination of partners’ distributive shares when a partner’s interest in the partnership changes during the partnership’s tax year (the “Proposed Regs”). The Proposed Regs would update existing regulations to reflect a 1997 amendment to Code Section 706(c) that added death of a partner to the list of events that close the partnership’s tax year with respect to a partner whose entire interest terminates. The Proposed Regs also consolidate, clarify, and in some cases restrict the methods available for dividing partnership income and other items between a partner whose interest terminates (or is reduced) and the partner or partners whose interests increase. The corresponding rules under current law are scattered among the Code, legislative history, regulations, rulings and other administrative pronouncements, and are collectively referred to as the “varying interests rule”. Finally, the Proposed Regs narrow the circumstances under which the tax year of a “disregarded foreign partner” must be taken into account in establishing a partnership’s tax year. This summary focuses on how the Proposed Regs affect the more commonly-encountered aspects of the varying interests rule.

Under current law, the default method for dividing partnership items between periods of different ownership involves an interim closing of the partnership’s books. This “interim closing” method divides the partnership’s tax year into two short periods –one before and one after the change in ownership. As an alternative, the partners may agree to use the “proration” method. That method prorates income and other items for the partnership’s full tax year between the pre-change and post-change periods based on the elapsed portion of the year or another reasonable method. The Proposed Regs retain a choice between these methods (as modified) and confirm that they apply to a full disposition, partial disposition, or other reduction of a partner’s interest. Under a new consistency requirement, the partnership must apply the same method and (if applicable) convention to all changes in partners’ interests during the same tax year.

Perhaps the most notable change to the varying interests rule is the requirement that a partnership using the proration method allocate “extraordinary items” among partners in proportion to their interests at the beginning of the day on which the item is taken into account. Thus, for example, gain from disposition of a capital asset (other than in the ordinary course of business) cannot be prorated over the partnership’s entire tax year but must be assigned to the date of recognition. The term “extraordinary items” also encompasses Section 1231(b) property, items arising from the discharge or retirement of debt, certain bulk sales, and other listed items. For purposes of this definition, Section 1231(b) property is identified by disregarding the requirement of a holding period, and is subject to an exception for sales in the ordinary course of business. If the Commissioner determines that proration of an unlisted item would result in a substantial distortion of income, then it too is considered an extraordinary item. Although many partnerships today voluntarily distinguish between operating and capital items in applying the proration method, the new “extraordinary item” requirement and the breadth of that defined term will greatly diminish the usefulness of the proration method as a planning tool. If this proposed rule becomes final, the proration method will mainly be useful to avoid the administrative burden associated with an interim closing of the books. In light of this and the new consistency requirement, it is likely that many partnerships will specify in the partnership agreement the method to be used in applying the varying interests rule.

Under the Proposed Regs, a partnership using the interim closing method may adopt a semi-monthly convention. In general terms, that convention calls for the interim closing to take place either at the end of a month (in cases where the ownership change occurs during the first 15 days of the following month) or on the 15th day of the month of change (in all other cases). In 1984, the IRS approved use of a semi-monthly convention in more limited circumstances. See IRS News Release 84-129 (December 13, 1984).

Certain “service partnerships” would enjoy a safe harbor in the Proposed Regs that allows use of “any reasonable method” to account for varying interests, provided that the resulting allocations are valid under Section 704(b). In general terms, this means that the allocations must either comply with the substantial economic effect test or reflect the partners’ interests in the partnership. For purposes of the safe harbor, a service partnership is one in which substantially all activities involve services in the fields of health, law, engineering, architecture, accounting, actuarial science, or consulting. Largely preserving an existing exception, the Proposed Regs provide that the new rules do not preclude changes in allocations among partners who were partners for the partnership’s entire tax year, provided that the change in interests is not attributable to a capital contribution or a return of capital, and further provided that the resulting allocations comply with Section 704(b) and corresponding regulations. Under Section 761(c) generally, such modifications to a partnership agreement may be made until the deadline for filing the partnership’s return (disregarding extensions).

In most cases, the Proposed Regulations are proposed to apply to partnership tax years that begin after the date of publication of final regulations (but not to partnership tax years that begin before January 1, 2010). Special effective date rules are provided for certain partnerships with foreign partners and for existing publicly traded partnerships.

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Contributed by Glenn Madere, Esq. Glenn Madere is the Editor of The Readable Code and Regs: Partnerships (Blue Bell, PA: Readable Press, 2009).

Dying Intestate

The previously posted WILL NOT is a tongue in cheek but unfortunately accurate account of what may happen if you die intestate (without a valid will). The following is a more detailed discussion of some of the consequences of failing to legally document your post mortem intentions.

The most important question is who will inherit your property. Without a will, the intestacy laws of the state of residence will provide the answer. While such laws provide an exhaustive list of potential beneficiaries, the statutory recipients may not be your intended beneficiaries. The first beneficiaries in order of priority will be your spouse and children. Generally, the surviving spouse will receive a stated monetary amount (for example $30,000) plus a percentage of the residue (for example one third). Your children will receive the rest.

Our sixteenth President, Abraham Lincoln, from all accounts a fine lawyer, inexplicitly died without a will. Under the applicable intestacy statute, his wife Mary and his 2 sons split the residue of his modest estate. Considering there was no government pension at that time and Congress stopped his salary on the day he died, one wonders if Abe would have preferred Mary to live on his entire estate and not just the portion provided her under the intestacy statute.

Howard Hughes also passed away intestate (a purported will was found to be a forgery). Unlike Lincoln, Hughes died without a surviving spouse or children. Under the intestacy law, his $2.5 billion fortune was divided among his 22 cousins, his closest relatives. One wonders whether Hughes would have wanted such a distribution especially considering his lifetime philanthropy. The administration of Hughes’s estate dragged on for more than 20 years, another consequence that could have been avoided with a valid will.

Some other common consequences of dying intestate are as follows:

A will is the proper document to name a guardian for those under your care. Without naming your successor, you trust a Court to name the right person.

Similarly, without a will, you trust the state legislature to name the proper person to administer your estate.

Finally, without a properly drafted will, you are forfeiting any legal tax savings on behalf of your beneficiaries.

You will find that hiring a lawyer to prepare a will is almost always cost effective. You should be able to find a competent lawyer to prepare a simple will for under $400. If for some reason you choose not to use a lawyer, you should at least take advantage of the many do it your self will kits available on the web.

When You Don't Have a Will...

LAST WILL NOT AND TESTAMENT

I, JONATHAN MORRIS, of Pennsylvania (maybe Florida), questionably of sound mind declare this to be my Will Not. I do not know where my prior Will is or even what it says but nevertheless I do not revoke any prior Wills and Codicils if they are found.

FIRST: Specific Bequests.

I will not give my tangible personal property to anyone in particular even though my grandson has spent hundreds of hours of quality time with me restoring my '62 "Vette" and even though it was understood between us that the car would be his at my death.

I will not make provision for the fact that without the knowledge of the rest of my family, I lent my daughter the sum of one hundred thousand dollars ($100,000) to pay off her husband's gambling debts. I am sure she and her husband will tell the family that it was our understanding that her share of my estate would be reduced by the amount of the unpaid loan.

I do though specifically bequeath a significant share of my estate to the lawyers that will be required to resolve the disposition of my estate.

SECOND: Residue.

If my wife survives me by thirty days I will not give all of the residue of my estate to her nor will I give all of the residue of my estate to my children. Instead I authorize the elected officials of my state of residence at my death to determine who gets the residue of my estate as I believe such elected officials are more qualified than me to make this determination.

Any portion of my estate passing to a minor shall become his or her property at age eighteen regardless of whether such beneficiary is mature enough to manage such property.

To the extent the residue of my estate passes to my children I assume that my living children will agree to give an equal share to the children of my deceased son.

THIRD: Spendthrift Provision.

To the extent allowed by law, the creditors of anyone receiving any portion of my estate may receive such portion rather than the beneficiary.

FOURTH: Death Taxes.

I authorize any and all taxing authorities to claim the maximum amount of taxes from my estate before distribution to my loved ones or from my loved ones as the case may be.

FIFTH: Administrative Powers.

My Executor shall have none of the customary powers necessary to administer my estate, unless specifically conferred by law or approved by the Court.

SIXTH: Guardian.

I will not appoint anyone in particular as guardian of the person of each minor child of mine even though I had the legal authority to do so at my death. Instead I trust a judge whom I have never met to appoint the right person.

SEVENTH: Executor.

I appoint the state legislature to determine who should administer my estate. My Administrator shall be required to post security in every jurisdiction.


NOT Executed ________________, 2009.