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If Congress does nothing to change the estate tax, on January 1, 2011, the federal estate tax law reverts to the 2001 law as it existed prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). As a result, the states will obtain the money they once received prior to EGTRRA. This is because EGTRRA repealed the state death tax credit which was fully phased out after 2004. This state death tax credit received by the states began in 1924 and survived with some adjustments until 2004. This credit was free money for the states and had no adverse effect on the residents of the states. Surprisingly, at the time of enacting EGTRRA there was no strong advocacy by the states and the credit was eliminated under EGTRRA.

In 2001, prior to EGTRRA, the state death tax credit was calculated as follows: an amount of $60,000 was subtracted from the taxable estate to obtain the adjusted taxable estate and with that figure the state death tax credit was calculated from a table as provided by the IRS. Generally an amount equal to the state death tax credit was distributed to the applicable state. Under EGTRRA the federal government reduced the estate tax rate but they receive more tax monies because of the elimination of the state death tax credit.

If Congress does nothing then on January 1, 2011, the states will receive this credit money again as the state death tax credit will be restored.

Congress adjourned yesterday and there will be no vote on adjustments to the estate tax nor extending the Bush income tax cuts until after the elections. This is no surprise. Here we are again wondering when Congress will give some guidance as to planning for income taxes and to individuals who would like to plan their estate. House Minority Leader John Boehner voiced his opinion that “a vote to adjourn is a vote to raise taxes”.

Currently we have no choice but to plan an estate assuming that the current law will stay intact and beginning January 1, 2011, we will have a $1 million exemption per person and 55% estate tax rate.

And the discussion continues. Many thought that adjustments to the estate tax law would have been made during the past nine months; but as we know nothing has happened. Another billionaire died in the meantime, John Kluge, and no estate tax has been incurred.

Very recently Senator McConnell and Senator Grassley introduced the Tax Hike Prevention Act which would provide a 35% estate tax rate and an exemption of $5 million per person and back to a step up in basis for assets inherited. There are some who propose to go further and eliminate the estate tax such as Republican Senate candidate Pat Toomey of Pennsylvania. He is pushing for the elimination of the tax as he complains that according to a recent study 1 million jobs have been lost in the United States because of this tax.

Let’s see where this new proposal (The Tax Hike Prevention Act) takes us. Maybe something will happen in November or December after the elections.

Discounts have always been a topic with estate and gift tax planning and below are a few recent examples of cases involving discounts:

In the Holman recent holding of the Eighth Circuit (No. 08-3774; Eighth Circuit, April 7, 2010), the Court found that the restrictions as contained in the limited partnership agreement should be disregarded. The Court found that the provisions of the Internal Revenue Code Section 2703 applied and refused to allow a discount for restrictions that a partner could only transfer interest to other family members or to trusts of family members. The statute only allows such restrictions if it is a bona fide business arrangement, and the Court found that it was not a bona fide business arrangement. The Court cited cases where similar restrictions were allowed because they were shown to be legitimate business purposes. As a result, the Court eliminated the discounts sought by the taxpayer applicable to those restrictions.

In a Tax Court Memo, Pierre vs. Commissioner (TC Memo 2010-106, May 13, 2010), the Court disallowed discounts where a single member LLC was formed and some shares were gifted to an irrevocable trust, and some shares were sold to the irrevocable trust on the same day. The Court found that the step transaction doctrine applied. The accounting ledger showed that only gifts occurred, and was inaccurate as it did not show that part was gift and part was loan. These transactions (gift and sale) should not have occurred on the same day but should have been separated.

Discounts were reduced in another Tax Court case, Ludwick vs Commissioner (TC Memo 2010-104, May 10, 2010), regarding partition, and the Court only allowed discounts for cost of the partition, including maintenance of the property for the time incurred during partition.

Discounts may also be a topic when Congress eventually tackles estate tax legislation. The Obama Administration has already raised issues of discount and valuation during the campaign and even more recently. Discounts have a dramatic effect on the amount of estate taxes being paid and, although this issue is not discussed a great deal by the proponents and objectors of the estate tax, this topic needs to be watched closely.

“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.”