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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.

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.