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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.

The Supreme Court of Pennsylvania in the Novosielski decision on March 25, 2010 (J-3-2009), reversed the Superior Court and allowed joint ownership with survivorship rights to prevail over an inconsistent Last Will. The Court cited the Multiple Party Accounts Act which provides that a joint account enjoy the right of survivorship absent clear and convincing evidence to the contrary. The court followed cases defining clear and convincing evidence where it requires that the “witness testimony is so clear, direct, weighty and convincing as to enable the trier of fact to come to a clear conviction, without hesitancy, of the truth of the precise facts and issue.” The Court found that the Superior Court inappropriately engaged in fact-finding and that both the Superior Court and the Orphans Court followed erroneous paths “in their search for clear and convincing evidence of intent differed from the right of survivorship”.

In December of 2009 the Supreme Court of Pennsylvania, in the Estate of Slomski (987 A.2nd 141), reversed the Superior Court and allowed the agent of a power of attorney to change the beneficiary of a retirement plan of which the principal was the owner. The power of attorney expressly permitted the agent “to engage in retirement plan transactions”. This is the exact language from the Pennsylvania Durable Power of Attorney Act (20 PS 5602(a) (18)). Such language allows the agent “in general, exercise all powers, with respect to retirement plans that the principal could if present”.

The long awaited decision by the PA Supreme Court in Kilmer v. Elexco, et.al, (J-78-2009) is in.  Unfortunately for the property owners, the PA Supreme Court refused to invalidate gas leases which calculated the landowner’s royalty based on a “net-back” valuation method.  The “net-back method,” calculates royalties as one-eighth of the sale price of the gas minus one-eighth of the post-production costs of bringing the gas to market. Post-production costs refer to expenditures from when the gas exits the ground until it is sold. Essentially, the gas is valued when it leaves the ground at the wellhead by deducting from the sales price the costs of getting the natural gas from the wellhead to the market.  The net-back method is also defined in the Code of Federal Regulations at 30 C.F.R. § 206.151 as:

Net-back method (or work-back method) means a method for calculating market value of gas at the lease. Under this method, costs of transportation, processing, or manufacturing are deducted from the proceeds received for the gas, residue gas or gas plant products, and any extracted, processed, or manufactured products, or from the value of the gas, residue gas or gas plant products, and any extracted, processed, or manufactured products, at the first point at which reasonable values for any such products may be determined by a sale pursuant to an arm’s-length contract or comparison to other sales of such products, to ascertain value at the lease. 

The landowners claimed that the net-back method violated Pennsylvania’s Guaranteed Minimum Royalty Act found at 58 P.S. § 33.  That section states that:

A lease or other such agreement conveying the right to remove or recover oil, natural gas or gas of any other designation from lessor to lessee shall not be valid if such lease does not guarantee the lessor at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property. 

The Pennsylvania Supreme Court disagreed and reasoned that: “Although the plain language of the GMRA clearly provides that the lessor must receive a one-eighth royalty, it is silent regarding the definition of royalty and the method for calculating the royalty. To the dismay of both Landowners and Gas Companies, the GMRA does not use any of the terms suggested by the parties, such as “at the wellhead,” “post-production costs,” or “point of sale.” The absence of such language is not surprising given the state of the industry at the time the GMRA was enacted, when virtually all royalties to landowners were based on the sale of unprocessed gas from the producer to the pipeline companies at the wellhead.”  As a result of deregulation of the gas pipelines in the 1980’s, the value of gas at the wellhead and the point of sale are no longer the same.  Depending on the point in production where gas is sold, one landowner may receive larger royalties than a neighbor whose gas is sold after it is fully processed. The Supreme Court held that “The use of the net-back method eliminates the chance that lessors would obtain different royalties on the same quality and quantity of gas coming out of the well depending on when and where in the value-added production process the gas was sold.”  The Supreme Court was also unconvinced by landowners’ argument that the gas company would inflate post production costs in order to reduce the royalty owed.  It was noted that the gas company’s incentive is to keep costs at a minimum since it would still be obligated for seven-eighths of post production costs.

Now that the House of Representatives is somewhat less busy with the passage of the Health Reform Bill, that Chamber may in the near future visit the estate tax issue. As we mentioned since January 1 of this year there is no estate tax which is the first time in 95 years and there is a modified adjustment to tax bases which may cause capital gains in some situations for heirs.

Some have suggested that the estate tax be enacted and be retroactive to January 1 of this year, but many constitutional experts comment that such retroactivity may be unconstitutional. In a previous blog we mentioned that Senator Kyl suggested to enact an estate tax and the heirs of the estates of decedents who died after January 1, 2010, when there was no estate tax, have theoption to choose either (1) the law at the time of death with no estate tax and a partial increase in basis, or (2) the step up in basis and be subject to the new estate tax exemption and rate. (See last week’s blog as an example of why an heir may want to option for an estate tax and step up in basis, depending on the facts). This would appear to eliminate the argument of retroactivity. The acting Chairman of the House Ways and Means Committee, Representative Levin, last week suggested the same option to avoid any constitutional attack on the retroactivity.

If no changes are made to the estate tax law, then automatically on January 1, 2011, the estate tax will be back with only a $1 million exemption per person and a 55% top tax rate. Senators Kyl and Lincoln hope to see Congress enact a $5 million exemption and a 35% tax on estates worth more than that amount. But lawmakers will be at task to find a way to offset the 2009 estate tax revenue which  law provided a 45% top bracket on estates worth more than $3.5 million.

Any such legislation may take awhile. In the meantime, we suggest you contact your counsel and adjust your estate planning documents to make sure they are in compliance with the current law regarding the modified capital gains rules.

Many comments are made such as “it’s great that we have no estate tax.”

That may be true for the very wealthy but lets look at the following example with no estate tax and with limited adjustment to basis which is the current law.

Example: A surviving spouse, or unmarried individual, dies with assets consisting of real estate and stocks worth $3.3 million and with a tax basis of $1.0 million. The Last Will provides that the assets will be given to decedent’s daughter and the daughter subsequently sells the assets.

If death occurred in December 2009, there would be no federal estate tax because the federal exemption of $3.5 million exceeded the worth of the estate. There would be no capital gain on the subsequent sale by the heir of of lets say a sales price of $3.3 million because the basis in the hands of the heir is adjusted to the date of death value of $3.3 million. Thus, no federal estate or capital gains tax. Nice.

Suppose death occurred a few days after January 2010. There would be no federal estate tax as it has been repealed. The basis in the hands of the heir would be adjusted only by $1.3 million (the new basis adjustment rule); therefore, the basis in the hands of the heir would be $2.3 million (decedent’s basis of $1 million plus adjustment allowed of $1.3 million). The result would be a capital gain of $1 million. Not very palatable.

Currently there is no estate tax and no adjustment to basis as we previously discussed. This is causing many planning problems and also has other implications. For example, along with increased capital gains on subsequent sales by heirs because of limited basis adjustment that could cause many taxpayers to incur the Alternate Minimum Tax because higher capital gains could decrease the Alternate Minimum Tax Exemption and cause an Alternate Minimum Tax liability.

This past Thursday the House approved a $15 billion jobs bill for stimulating private-sector job creation which bill needs Senate approval and it does not appear any estate tax proposals are contained in this bill. Two weeks ago Senate Minority Whip Jon Kyl stated that the estate tax issue need be addressed before the Senate takes up futher legislation. His position at that time was not to make any estate tax legislation retroactive but rather allow the taxpayers to have an option of either electing current tax law or be subject to whatever new estate tax law occurs later this year. Some commentators are very upset that some legislators are trying hold up any jobs bill because of estate tax legislation. Let’s wait and see what happens in the Senate.

Recently acting chairman of the House Ways and Means Committee Sander Levin stated regarding estate taxes, “I think the main point is that we have to act…I think this interval is not helpful, people need to be able to plan.” It would appear that if the chairman of the powerful tax policy committee is thinking in that direction there may be some estate tax legislation this year. Let’s see what happens but don’t hold your breath.

As mentioned elsewhere in our website, there is no federal estate tax since January 1, 2010. Consequently, many estate plans will cause unintended results. If death occurs with no estate tax, the mechanics of a married couple’s estate plan which includes a marital trust and a credit shelter trust may cause distribution of all assets to the credit shelter trust. In certain circumstances, that may not fulfill the couple’s estate plan objectives. There may also be lost a basis adjustment resulting in subsequent capital gain. People should meet with their estate planning lawyer to review this situation. 

Many estate planners have been expecting Congress to enact an estate tax and make it retroactive to January 1 , 2010. Nobody knows when and if that will happen. Recent commentary speculates that Congress may enact the estate tax as part of a jobs bill. However, since nothing is certain, you should not delay reviewing your estate plans to be certain that all is in order following the recent change in law.

TO TAX….OR NOT TO TAX………THAT IS THE QUESTION!!! The Federal Estate Tax was repealed on January 1, 2010 for a one-year period pursuant to the tax law revisions made in 2001. The 2001 legislation also scheduled the Federal Estate Tax to be reinstated on January 1, 2011. However, it appears as though congress may reinstate the Federal Estate Tax early in the 2010 session. Over the last few weeks, many commentators have discussed whether federal estate tax legislation, when passed, should be applied retroactively to January 1, 2010. Retroactive application seems to be logical and fair. However, House Ways and Means Chairman Rangel seems to shy away from retroactivity. While Senate Finance Chairman Bacus promotes retroactive legislation. In order to avoid uncertainty, all are advised not to die until Washington makes up its mind whether or not to impose a tax on your estate.

This is the first time our country has not had a Federal Estate Tax since 1915. Legislation that was expected during the last few months of 2009 never occurred, and as a result…we have no estate tax for 2010.

 Several concerns remain:

• Inheritances are now subject to much higher capital gains when sold because the basis of assets inherited are  the same as in the hands of the decedent as there is no basis adjustment to date of death value with certain exceptions;
• Congress is intending to make a change this year which would install an estate tax and make it retroactive to January 1 and have an exemption from $2 million to $5million (or agree to 3.5million) and probably a 45% tax rate;
• If there is no change or new law this year then , under current law, 12 months from now, on January 1, 2011, the estate tax is reinstated with only a $1 million exemption and a 55% tax rate;
• Also affect to January 1, 2010, there is no generation skipping tax. But if you give a gift to a grandchild and they pass a law during 2010 installing the generation skipping tax and make it retroactive to January 1, 2010, a tax will have to be paid.

Somewhat confusing to plan for, but definitely don’t cash in your life insurance policies yet.

POWER OF ATTORNEY CAN CHANGE RETIREMENT PLAN BENEFICIARY. In a case decided on December 28, 2009, the Pennsylvania Supreme Court held that the principal’s Power of Attorney granting the agent the power to engage in retirement plan transactions authorized his agent to change the beneficiary of the principal’s retirement plan. (IN RE: ESTATE OF RONALD SLOMSKI v.THE THERMOCLAD COMPANY, et.al.J-68A-2009; J-68B-2009, DECEMBER 28, 2009). The principal in Slomski named his mother as agent in his power of attorney. Sixteen days before the death of the principal, the agent changed the beneficiaries of principal’s retirement account from his children to the principal’s siblings. The PA Supreme Court reversed the PA Superior Court noting that a principal can give authority to an agent to engage in retirement plan transactions by including the simple language “to engage in retirement plan transactions” in the power of Attorney (20 Pa.C.S. § 5602(a)(18)). 20 Pa.C.S. § 5603(q) provides that a power to “engage in retirement plan transactions” shall include, inter. alia., the power to exercise all powers with respect to retirement plans that the principal could if present. Since the principal in Slomski retained the right to change the beneficiaries of his retirement plan, the agent named in his power of attorney held the same power.