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“Estate tax” among other tax issues

As previously mentioned if Congress does nothing both the estate tax and generation skipping tax return like a bear in January 1, 2011 with a $1 million exemption per person and a 55% bracket. However, along with the death tax, there are other serious income tax changes that will occur if Congress does nothing; capital gain rates will increase from 15% to 20%; highest rates on ordinary income will rise to 39.6%; and certain dividends will be taxed at the higher ordinary income tax rates rather than 15%. Also certain trusts would incur a 3.8% Medicare surtax.

In light of Congress’ recent history we are very unsure that any tax change will occur prior to January even if you believe it’s for the good of the ailing economy. Thus, everyone should assume that change will not occur and make appropriate plans.

We cannot control when we die so we cannot control if the estate tax will be applicable (there is no estate tax or generation skipping tax in 2010). However, we can plan on selling certain assets to insure the current capital gain rates, and possibly move assets to more tax efficient mutual funds; also gifts of dividend paying stocks to lower bracket family members may be an option either by outright gifts or by sale to defective grantor irrevocable trust. Also a review should be made of tax-deferred annuities as an option as tax rates get higher (and don’t forget the higher tax rates beginning 2013 for certain individuals under the new Health Care Act).

Many decisions to be made.

As we know this past December the House of Representatives passed a bill to continue the estate tax law as in 2009 with a $3.5 million exemption; however, because of the healthcare discussions the Senate never reviewed that House bill. As we discussed in our blog throughout this year many Senators and Congressmen have proposed legislation for both higher exemptions and lesser rates and lower exemptions and higher rates. Congress has failed to act on any of these proposals.

Most recently, last week, Senators Kyle and Blanche tried to add their proposal of a $3.5 million estate tax exemption and a 35% tax bracket, adjusted for inflation, to the small business bill and it was rejected by the Democratic leaders.

At this point some believe there will be legislation in November and December but most believe that we better get ready on January 1 for a $1 million exemption and a 55% bracket. This will hurt many pocketbooks and affect a great deal of the estate plans.

When Mr. Duncan died in March of this year with a $9 billion estate not alot was heard on talk news or news articles that his heirs will pay no estate tax and save about $4 billion. That doesn’t count the many millionaires that died in the last six months with a great tax savings for their families.

However, now that a public figure  passed away, George Steinbrenner, many talk shows and news releases discuss that for the past 95 years we had an estate tax and in this year alone, 2010, there is no estate tax and this is the year that George Steinbrenner died with an estate of approximately $1.5 billion and his heirs saved about $800 million. Not only do the talk shows and news releases discuss the savings but also what was discussed was that on January 1, 2011, the estate tax comes back with only one million-dollar exemption and at a high rate of 55%. Only to show how ridiculous Congress was not to make any changes in December of 2009.

This caused many people to be aware of the estate tax situation and many comments are being made by those that are worried that on January 1, 2011, the estate tax comes back like a bear at only a one million-dollar exemption and 55% tax rate; and those that applaud the estate tax coming back on January 1 with such a roar.

The Senate is expecting to take up the small business lending bill this week. And now with this awareness and the public concern regarding the estate tax, as discussed above, maybe the Senate  will discuss the attachment to the bill that Democratic Senator Blanche Lincoln of Arkansas and Republican John Kyle of Arizona hope to attach to this lending bill. Both Senators plan to attach to the bill a change in the estate tax with a $5 million exemption indexed for inflation and a top rate of 35%.

Let’s see what happens this week.

The Obama administration has proposed in its 2011 federal budget a return of the estate tax 2009 rates with the exemption of $3.5 million per person and a maximum rate of 45% as was in existence in 2009.

In the meantime former Treasury Secretary Robert Rubin has joined with many other individuals and urge Congress to reinstate the estate tax before the August recess. Along with this movement an amendment to the small business jobs bill may be introduced by Senator Kyle to reverse the repeal of the estate tax.

On a procedural note, if someone dies while there is no estate tax, there is no United States Estate Tax Return (706) due. However we are waiting for a new return from the IRS regarding the basis adjustment in certain situations while there is no estate tax.

Interestingly at the state level, under the general reading of the Pennsylvania statute, there is no realty transfer tax due upon the filing of an assignment of a gas lease; however, recently the Pennsylvania Department of Revenue is raising objections to this exclusion. We’ll keep you informed as this unfolds as this will prove to be very interesting.

The estate tax law is still undecided. Many Representatives and Senators have proposed different bills from the repeal of the estate tax to much higher taxes on the wealthy. Look at the following variety of proposals: 

In April, Representative Mark Kirk (R. Ill.) proposed extending the repeal of the estate tax to December 31, 2015; also, in April, Representative Jim Jordan (R. OH.) proposed a repeal of the estate tax indefinitely along with cutting corporate tax rates plus other tax cuts.

Last month, in May, Representative Mike Thompson (D. Calif. ) proposed exempting farmland as long as farmland was still in use and not developed, with many co-sponsors. Question: Are gas leases and gas wells and pipelines considered development under that proposal?

This month Senator Blanche Lincoln (D. Ark. ) and Senator John Kyle (R. Arizona) proposed a $3.5 million exemption per person with a 45% bracket, and in 10 years the proposal would automatically establish a $5 million exemption per person with a 35% bracket.

On the other end of the spectrum, this month independent Senator Bernie Sanders ( Indep. VT.), along with three Democratic co-sponsors, proposed exemptions at 3.5 million per person with a 45% bracket (as in 2009), but estates with taxable assets between $10 million and $50 million would pay 50% rate, and estates in excess of $50 million would pay a 55% rate, and a further surtax of 10% for estate in excess of $500. Also, this is proposed to be retroactive to January 1 of 2010. Such retroactivity would cause a great deal of litigation by the many millionaires’ estates that have died since January and have incurred no estate tax under the current law. Such litigation would cause a couple of years delay to clarify the law for estate planners.

As we discussed previously, it should be interesting to see if any law regarding estate tax is passed prior to the end of this year; and of course if there is no change then, automatically, on January 1, 2011, the exemptions will be at $1 million per person with a 55% rate.

A Pennsylvania trial court finds that the state may seek repayment of a Medicaid overpayment from the son of a Medicaid recipient rather than from the Medicaid recipient’s estate. Maloy v. Dept. of Public Welfare (Pa. Commw. Ct., No. 1575 C.D. 2009, June 10, 2010). Charles Maloy was admitted to a nursing home and began receiving Medicaid benefits. His son, Charles Maloy II, became his guardian. As guardian, Charles transferred one-half of Mr. Maloy’s property to himself and took out two mortgages on the property. When the state discovered the transfer and the mortgages, it determined that Mr. Maloy was no longer eligible for benefits and that it had overpayed him. While the state was preparing its claim, Mr. Maloy died, so the state requested repayment from Charles. Charles did not dispute the overpayment, but argued that the state should request the overpayment from Mr. Maloy’s estate, not from him. The administrative law judge determined the state could seek repayment from Charles, and Charles appealed. The Pennsylvania Commonwealth Court affirms, holding that the state could seek repayment from Charles. The court finds that “not only is the collection of repayment from Charles II expressly authorized, but it seems entirely appropriate, given that it was his actions that led to the overpayment.”

Johnson Estate is  case dealing with joint bank accounts decided by the Orphans Court of Philadelphia. The Court found that there was no clear and convincing evidence that the joint bank account was not intended. Also the Court explained that the party seeking to eliminate the joint account has the burden of proof under the Pennsylvania Multiple Party Accounts Act, and that this burden of proof under the statute has changed the common law rule which provided that proof of a confidental relationship shifted the burden to the survivor of the account. The Court found that no confidential relatonship existed as there was a lack of evidence that the parties did not deal on equal terms as there was no evidence of overmastering of influence, or dependance on one side. 30, 2d Fiduciary Reporter 249.

In the Estate of Black,133 TC No.15, the Tax Court found for the taxpayer even though the family limited partnership did not conduct an active trade or business as the following factors where present: proportionate interests were distributed to the partnership contributors; the assets contributed were properly credited to the contributor’s capital account; it was a legitimate and significant nontax reason for formation of the entity; the decedent kept sufficient assets outside the partnership; and the partnership was administered correctly.

 In a Tax Court Memorandum, TCM 2010-2, the Tax Court held that gifts of interests to a family limited partnership did not qualify for the annual gift tax exclusion. The Court pointed out that the following are needed for such a transfer to enjoy the exclusion: the partnership would generate income at or near the time of the gifts; some portion of the income would steadily flow to the donees; and the portion of income flowing to donees can be readily ascertained.

The United States has taxed the transfer of wealth since colonial times. The basics of our current estate tax system began in 1916. As with all taxation there are always pros and cons as to whether there should be such a tax and how it should work. There has been many positions on this fiscal philosophy of taxing wealth transfers as to whether it changes individual behavior such as reduced savings, and stifling entrepreneurship, to mention a few. Many people have many different views; for example, a few like Judy Pigott and Bill Gates Sr. advocate higher estate taxes for the wealthy; however the majority of commentaries complain about the estate tax as it taxes the same monies twice (after income taxes) and advocate that it should be eliminated.

As most know since January 1, 2010, we have no estate tax but it will return on January 1, 2011. An important issue that has occurred in the past five months, while there has been no estate tax, is that there is a limited increase to basis to date of death value, and therefore the basis on many assets will be carried over from the decedent to the heir and this may cause potential lawsuits from unhappy heirs and IRS penalties. And, as history shows , every time the carryover bases issue has been discussed the record keeping for tax basis has been a big burden both for taxpayers and the IRS. Also, with no estate tax and because of the formula clauses in many estate plans which avoids losing estate tax exemptions, all of the assets may be distributed to the credit shelter trust and that may result with  disgruntled heirs with more lawsuits.

The above describes problems that are real. The inconsistencies are also real; the estate tax has been eliminated during these past five months, but regarding estate and gift tax filings of previous years, the current tax audits are tougher than ever especially with respect to valuation issues and use of entities such as family limited partnerships. Apparently someone in the Treasury Department is taking the position that the estate tax is important. Yet, because of inaction by the legislative branch, millionaires and one billionaire has died so far in 2010 without any estate tax.

The Hill publication reports that Senator Finance Chairman Baucus indicates a small business bill will occur very shortly and it will include a fix for the estate tax. House Majority Leader Hoyer said that they expect to work on the estate tax in the very near future, and Chairman of the House Ways and Means Committee Congressman Levin stated recently that he expects to enact a retroactive estate tax.

The next few weeks should prove very interesting with Congress tackling the taxation of wealth transfers.

These are odd times. There are numerous reports that the estate tax audits are tougher than ever especially with respect to valuation. This would indicate that the treasury is looking for more revenue. Yet in spite of this, Congress allowed the estate tax to terminate for 2010. Since there is no estate tax, it stands to reason that the government should be losing revenue. Estate tax returns declined from 121,715 filed in 2001, to 49,924 in 2007.  The decline occurred even though the taxpayers became wealthier during that time period. The obvious cause for the decreased filings is the increased exemption which rose from $675,000 in $2001 to $2,000,000 in 2007. Now that there is no estate tax there will be no filings for 2010 (unless an estate tax is enacted) and no government revenues.

In just one recent estate, inaction by Congress has cost the government approximately $4 billion in estate tax revenue.  Mr. Duncan, a Texas billionaire was the first billionaire to die this year.  His estate is valued at approximately $9 billion.   Add to this loss, the estate tax that would have been collected on all of the millionaires who died since January 1, 2010. Along with the revenue issue, Congress’s failure to act caused a multitude of problems with many taxpayer’s estate plans.  More likely than not, the majority of taxpayers did not modify their estate plans to include the new provisions necessary to avoid capital gains by heirs who liquidate inherited assets.  This topic is discussed in our previous blogs.

Such a substantial loss of tax revenue is inconsistent with the reported need by the current administration for more taxes to increase revenue for budgetary reasons. For example, Obama’s 2008 budget estimated that the treasury could raise $5.4 billion by taxing dividends and capital gains at 20% for individuals with income above $200,000 and families above $250,000. Yet Congress completely dropped the ball when it came to reenactment of the federal estate tax.  Congress’s inability to “get with the program” has now manifested a loss of $4 billion in tax revenue with the death of just one taxpayer.  Death without taxes…..the government’s losses keep mounting.  Let’s see what Congress does in the coming months.

An Iowa court of appeals held that a Medicaid recipient’s life estate in her house is part of her probate estate for the purposes of satisfying debt, so the house does not pass directly to her beneficiary under her will.  Escher v. Estate of Escher (Iowa Ct. App., No. 09-1198, April 8, 2010).

Decedent  entered into a real estate contract to sell her house to her sister-in-law. Decedent retained a life estate in the house and subsequently died.  Her will provided that the house be given to the sister-in-law who then stopped making payments on the contract.

The state filed a claim against Decedent’s estate for reimbursement of Medicaid payments made on her behalf. The executor moved to forfeit the real estate contract and return the house to the estate because the sister-in-law was no longer making payments. The trial court determined Decednet’s life estate was an asset that should be included in the probate estate.  As such, the sister-in-law was required to continue making payments. The sister-in-law argued that the house should be conveyed to her because it automatically transferred to her upon Decedent’s death.

The Iowa Court of Appeals held that the life estate is part of the probate estate for purposes of satisfying debt. According to the court, the sister-in-law did not have complete ownership of the property upon Decedent’s death due to the life estate interest which remained available as an asset to satisfy the Medicaid debt.