Articles & Blog

Year End Is Near- Gift Tax Exclusions

You may gift $13,000 to as many individuals as you like prior to the year end and such amount, including appreciation, will not be part of your estate for estate tax purposes upon your death. It doesn’t matter if death occurs one day after the gift or 10 years after the gift; there is no look back or contemplation death rule. The $13,000 (adjusted for inflation) exclusion renews every January 1 but any unused amount at year end does not carry over to increase the renewed exclusion. Therefore don’t waste the exclusion but use the exclusion by December 31.

Example, husband and wife have four children. Each may gift $13,000 per child or $52,000 in total per spouse and with both spouses the total gift would be $104,000 removed from their estate. Keep this in mind for your year end planning so you don’t waste the exclusion.

We will discuss the lifetime gift and estate tax exemption after we learn the results of the election which occurs today.

Annual Gift Exclusion

On June 4, 2012, the Tax Court issued the opinion in the case of Wimmer vs Commissioner (T.C. Memo 2012 – 157) allowing the annual exclusion for limited shares that were gifted of a family limited partnership stating that such gifts were present interests and not future interests. The assets of the partnership in that case consisted of publicly traded stocks which produced dividends. The Court distinguished the previous Hackl Case (118 TC 279) and the Price case (TC Memo 2010 – 2) stating that in Wimmer the general partner made distributions each year unlike the Hackl and Price cases.

Gift Tax Exemption

The gift tax exemption of $5,120,000 is due to expire on December 31, 2012, if Congress and the Administration does not extend the law. If they do not extend the law such gift tax exemption will revert to $1 million on January 1, 2013.

It is best to make a gift of assets that will appreciate over the years to eliminate the appreciation for estate taxation and utilize this large exemption. Many times appreciation may occur in non liquid assets such as closely held company stock or property. The problem is if the IRS disagrees with the value of property or closely held stock gifted and finds that the value is above $5,120,000 gift exemption, and if they are successful in court, there will be a 35% gift tax on the excess.

Some help has occurred very recently on March 26, 2012, where the United States Tax Court issued an opinion in the Wandry case (T C Memo 2012 – 88) where the taxpayer made a gift of an amount of LLC units so that the fair market value of units was a stated amount stating in their gift assignment that if the IRS is successful in determining that the valuation is greater than the valuation as provided by the taxpayer, then the number of gifted shares shall be reduced and adjusted accordingly so that the value of the number of shares is less than the exemption. The Court found for the taxpayer.

Utilization of the provisions of this case may be helpful in making gifts of closely held stock or other nonliquid assets subject to appraisal.

Family Limited Partnership upheld by IRS under section 2036

The Tax Court in Memo 2012-48 issued February 22,2012, found for the taxpayer in Stone vs. Commissioner.

Mr. and Mrs. Stone owned 740 unproductive woodland acres in Cumberland County, Tennessee and wanted to gift the properties to their 21 children and children’s spouses and grandchildren. They met with counsel and he suggested they form a family limited partnership to avoid many deed transfers and eliminate the potential for partition actions.

In 1997 Mr. and Mrs. Stone formed the limited partnership under state law and each of them received a 1% general share and 49% limited shares.  Their real property was then transferred to the partnership. The partnership provided that it would hold and manage the real estate for the family members and provide for the health education, maintenance, and welfare for the family members. The partnership also provided that the limited partners could dismiss the general partners with a 67% vote.  The real property was appraised.  Mr. and Mrs. Stone made gifts of limited partnership shares to their family from 1997 through 2000.  By the end of 2000 Mr. and Mrs. Stone each held 1% general share and the family members held the 98% limited shares.  During this time the property was not developed and remained unproductive.  Since there was no income, real estate taxes were paid in some years personally by Mr. Stone.

Upon the death of Mrs. Stone, the IRS argued that section 2036 applied to the transfer of the property to the partnership as it was testamentary in nature.  Consequently, the IRS believed that all of the property should be included in the federal estate tax return of the decedent.  Section 2036 provides that the full value of the transferred property will be included in the decedent’s gross estate if the following conditions are met: (1) a decedent makes an intervivos transfer of property;  (2) for other than a bona fide sale for adequate consideration;  and (3) retains certain rights or interests in the property which are not relinquished until death.   In Stone, (1) Both parties agreed that an intervivos transfer was made. (2) The Tax Court followed established law that “the bona fide sale for adequate and full consideration exception is met where the record establishes the existence of a legitimate and significant nontax reason for creating the family limited partnership and the transferors received partnership interest proportional to the value of the property transferred.” The Tax Court’s analysis separated this issue into two parts: (a) whether the transaction qualifies as a bona fide sale, and (b) whether the decedent received adequate and full consideration.  

The Tax Court considered the taxpayer’s motive in its determination of whether the transfer to the partnership was a bona fide sale.   The Tax Court found two nontax motives.  One motive was to create a family asset which would later be developed and sold by the family.  The second motive was to protect the land from partition actions. The IRS argued that the only motive was to simplify the gift giving process.  The IRS claimed that gifting and elimination of the need to execute numerous deeds is a testamentary purpose and not a legitimate and significant non-business motive.  The IRS asserted further that since the Stones were transferors of the property and controlling general partners of the family entity that there was no arms-length transaction and thus no bona fide transfer.  The Tax Court did not agree with the IRS.  The Tax Court held that the taxpayers’ desire to have assets jointly held and managed by family members, even standing alone, is a legitimate and significant nontax motive for purposes of section 2036(a) (citing Estate of Mirowski v. Commissioner, T.C. Memo. 2008-74.  The Tax Court further held that testamentary objectives interwoven with other nontax motives will not defeat the underlying legitimate and significant nontax motives. (Estate of Bongard v. Commissioner, 124 T. C. at 121.) The Tax Court also found other facts to support legitimate and significant nontax motives.  For example, the Stones were financially independent and did not depend on distributions from the partnership; the real property was actually transferred to the partnership by deed;  there was no commingling of personal assets and partnership assets; and although the Stones were over age 70 at the time of the transfers to the partnership, their health was good.  It was also recognized that the partnership interest received by the Stones was proportionate to the property contributed by them.   Since there were legitimate and significant nontax reasons and the transaction occurred in a manner by which unrelated parties would deal with each other, the Tax Court held that a bona fide sale did occur.   

Regarding the full and adequate consideration issue, the IRS argued that there is no full and adequate consideration where the interfamily transaction merely attempts to change the form in which the property is held.  (This has been referred to as  “recycling of value”.) (see Estate of Gore v. Commisssioner, T.C. Memo. 2007-169.)  The Court held that the “recycling” argument fails where it is established that there is a “legitimate and actual” nontax purpose for establishing the partnership. As a result the Court found that Section 2036 did not apply and found in favor of the taxpayer and against the IRS.

Gift Tax Exemption Update

President Obama’s recent budget proposal would bring the gift tax exemption back to $1 million from the current $5 million. Transferring assets that may appreciate will be important to avoid estate tax and generation-skipping tax in the future, and there may only be approximately 10 months left to utilize the current law with a large exemption. Obama is proposing to return to the $3.5 million estate tax exemption as in 2009, and the $1 million gift tax exemption and generation-skipping tax exemption and a 45% tax rate.

 Many people in wealth categories should seek estate planning advice in the very near future regarding this matter.

Special Needs Trust

In November of 2011, in the Watkins case (Watkins vs. Baron, volume 2, Third Series, Fiduciary Reporter, page 35) the Lackawanna County Court was presented with a Petition to approve a Special Needs Trust for the Petitioner to receive and administer settlement proceeds and the trust provided that it will serve to “supplement and not supplant” financial benefits for the Petitioner, and the trustee would have absolute discretion to provide for Petitioner’s needs other than basic support. The Trust Agreement also provided that it was intended to be exempt under the Omnibus Budget Reconciliation Act of 1993 (42 USC section 13906p (d)). The Trust Agreement further provided that it was irrevocable, and that upon the death of the Petitioner the remaining assets would be paid to the Department of Public Welfare of the Commonwealth of Pennsylvania up to an amount equal to the medical benefits provided by the Department. The Court found under the regulations of the statute that the trust contained assets for an individual under 65 who was disabled as defined by the statute, and that such trust was established for the benefit of the individual by a Court, and the trust contained a provision that the Department of Public Welfare will receive the amounts remaining in the trust upon death equal to the total amount of benefits paid by the Department. The Court approved the Petition and allowed the Special Needs Trust in accordance with the facts and the statute.

Estate Tax-Limited Partnership

The Tax Court Memo 2011 – 209 issued August 30, 2011, was an interesting case regarding the Estate of Turner. A limited partnership was created for the decedent and his wife and they transferred securities into the partnership. The Court found that management of securities is a legitimate nontax purpose if the assets involved required active management or special protection, or if it was stock of an operating business that required management. The Court found that the record failed to establish any meaningful activity of the marketable securities while in the partnership. The Court found that the decedent commingled personal and partnership funds and used partnership funds for personal gifts and personal bills. The Court found that the decedent, as general partner, had the right to amend the partnership agreement at any time without the consent of the limited partners. The Court found that the partnership was primarily testamentary and not for the active management of investments or business. In summary, the Court found that the transfer to the partnership was not for bona fide or adequate consideration as there were no significant nontax purposes and that the decedent expressly or implicitly retained the right to possess the transferred property as well as controlled which person would enjoy the transferred property. The Court included all the assets in the gross estate of the decedent under section 2036 of the Internal Revenue Code.

Life insurance held in an Irrevocable Trust.

A surprising case in taxpayer’s favor resulted in Turner vs Commissioner, TC Memo. 2011 – 209 (August 30, 2011). The trust document provided that the beneficiaries have “Crummey withdrawal powers” after each “direct or indirect transfer” to the trust. The trust gave each beneficiary the absolute right and power to demand withdrawal from the trust after each direct or indirect transfer to the trust. The Settlor paid insurance premiums directly to the carrier rather than to the trust and the trust to the carrier. The court held that the terms of the trust provided that the beneficiaries have the right to withdrawal whether the payments were direct or indirect and therefore the beneficiaries had the right to demand withdrawals from the trust after each indirect payment was made; thus even though the payments were indirect it did not affect the beneficiaries’ rights to demand withdrawal. The court found that these gifts were present interest gifts as it cited Crummey vs Commissioner and Cristofani vs Commissioner.

This decision is in favor of the taxpayer but we highly recommend that the insurance payment be made to the trust and the trust make the payment to the carrier, and the beneficiaries be notified of their withdrawal rights after each of the contributions to the trust are made.

Joint Accounts

Another recent interesting case in Pennsylvania regarding joint accounts follows the rule of law in the recent Supreme Court case of Estate of Novosielski , 992 A2d. 89 (2010), which reversed the lower Court stating there must be clear and convincing evidence before the statutory provision giving a last will primacy over the right of survivorship presumed by statute in Pennsylvania. In the case of Lanzetta Estate, Vol.1, Third Series Fiduciary Reporter p. 352 (July 2011), the Montgomery County Orphans’ Court found that the joint survivor of a bank account takes precedence over a last will were there is no clear and convincing evidence of a different intention. The Court cited Section 6304 of Title 20 of Pennsylvania Statutes, where it provides “any sum remaining on deposit at the death of a party to a joint account belongs to the surviving party or parties as against the estate of the decedent unless there is clear and convincing evidence of a different intent at the time the account is created.” The Court held that the only issue is the decedent’s intent at the time the account was created, and the statutory presumption that the decedent intended the joint survivor to take as a surviving party was not overcome.

Estate Tax possible debate

There are discussions to debate a new estate tax law in Congress after the debt ceiling debate is concluded.

Currently there is a $5 million estate tax exemption with a 35% rate until December 31, 2012, unless Congress extends. If Congress does not extend the law reverts to a $1 million exemption and a 55% rate. Some Democrats advocate a $3.5 million exemption and 45% rate and some Republicans suggest to keep the rate at 35%. The Administration’s 2012 budget proposal promotes a $3.5 million exemption and 45% rate. Some Republicans want the estate tax repealed altogether but that is unlikely. Yesterday Minnesota Gov. and Republican presidential hopeful Pawlenty said he would end the estate tax.

 It should provide an interesting debate if the issue is brought to the floor.