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Minimize taxation of trusts

During 2014 a trust with taxable income above $12,150 will incur capital gains rate at 20 percent (15 percent plus a 5 percent surtax), whereas an individual will not pay the surtax until he or she acquires taxable income of $400,000. Also a trust will pay the Medicare tax of 3.8 percent on taxable income above $12,150, whereas an individual will pay that tax when their adjusted gross income exceeds $200,000. Therefore, a trust pays on capital gains on income above $12,150 at 23.8 percent, whereas if an individual has income under $200,000 then his or her rate on capital gains is 15 percent. Distributing capital gains from a trust (which has taxable income above $12,150) to an individual- beneficiary with AGI under $200,000 will obviously save tax dollars. In the right circumstances a certain amount of capital gains could be included as part of distributable net income and deducted at the trust level and be included in the beneficiary’s tax return with the use of certain provisions of the Pennsylvania Uniform Trust Act, the Pennsylvania Prudent Investor Act, and the Pennsylvania Uniform Principal and Income Act, in conjunction with US Treasury Regulations 1.643.

CHILDREN CAN BE HELD RESPONSIBLE FOR A PARENT’S MEDICAL BILLS

Approximately 29 states, including Pennsylvania, have laws making adult children financially responsible for the care and maintenance of their parents if their parents can’t afford to take care of themselves.  These laws have taken on new significance in law suits by third parties such as nursing homes and other health care providers.

Pennsylvania’s filial support law can be found at 23 Pa.C.S.A. § 4603. It provides that all of the following individuals have the responsibility to care for and maintain or financially assist an indigent person, regardless of whether the indigent person is a public charge: (i) The spouse of the indigent person; (ii) A child of the indigent person; and (iii) A parent of the indigent person.  There is no responsibility for financial support: (i) If an individual does not have sufficient financial ability to support the indigent person; or (ii) A child shall not be liable for the support of a parent who abandoned the child and persisted in the abandonment for a period of ten years during the child’s minority.

This law was enforced by the Pennsylvania courts in the case of Health Care & Ret. Corp. of Am. v. Pittas, 2012 PA Super 96, 46 A.3d 719, 721 (Pa. Super. Ct. 2012), reargument denied (July 18, 2012), appeal denied, 619 Pa. 706, 63 A.3d 1248 (2013).  In Pittas a son was held liable for his mother’s $93,000 nursing home bill.  Following treatment in a rehabilitation facility the mother moved overseas leaving a large portion of her medical bills unpaid. The nursing home sued the son who was one of three adult children. Both the trial court and an appeals court found the son responsible for his mother’s unpaid nursing home bill, rejecting his arguments that the courts should have considered alternate forms of payment, such as Medicaid, his mother’s husband or her two other adult children.

United States Supreme Court-Affordable Health Care Act

The recent opinion of United States Supreme Court held that closely held corporations enjoy religious freedom under the Religious Freedom Restoration Act of 1993 and such closely held corporations do not need to insure certain methods of contraception that would violate the sincere religious beliefs of the company’s owners. The Court stated that this religious freedom under the Religious Freedom Restoration Act extends to closely held corporations and not just proprietorships or partnerships, and the mandate imposed under the Affordable Health Care Act (Obamacare) for noncoverage of certain methods of contraception is in violation of the Religious Freedom Restoration Act of 1993. As a result, the Supreme Court did not need review the constitutionality issue under the First Amendment. The Conestoga case in our Third Circuit was reversed (as the Third Circuit found that the company was in violation of the Affordable Held Care Act), and the Hobby Lobby case in the Tenth Circuit was affirmed (as the Tenth Circuit found that the company was not in violation of the Affordable Held Care Act) . The Court stated that there are other ways in which Congress or the Department of Health and Human Services could equally ensure that every woman has cost-free access to all FDA approved contraceptives.

Valuation

Recently, the Tax Court issued an interesting case in the Estate of Richmond, T C Memo 2014 – 26, regarding valuation. The decedent owned 23.4% of a C Corporation that had been in existence for a very long time and held mostly marketable securities.

The Court found that the prevailing approach would be to value the shares under the net asset value theory, which was also the IRS’s position; rather than the taxpayer’s (the Estate) position of capitalizing the actual one year dividend.

With respect to the built-in capital gains discount, the Court agreed with the IRS and followed the precedent of the Tax Court and Second and Sixth Circuits and based the discount on the present value of the tax liabilities that the Corporation would recognize. The Court rejected the Estate’s argument that the Court should base the discount in accordance with the view of the the Fifth and Eleventh Circuits which calculates the discount on the tax liability as if the tax was immediately due and payable in full on the valuation date. The Court noted that the executors resided in Pennsylvania and New Jersey and the will was probated in Pennsylvania, thus an appeal would be to the Third Circuit. It would be interesting if the facts of the case resulted in a potential appeal to the Fifth or Eleventh Circuit; would the outcome of the Tax Court be different on the issue of the built in capital gains?

Also, the Company accountant prepared the valuations and the Court imposed the valuation misstatement penalty of 20% due to the fact that the accountant did not have appraiser certifications and the accountant did not explain the basis for their conclusions.

Federal Estate Tax Return for Spouses in 2011, 2012 and 2013

Last month the IRS opened a window to correct what could be a potentially costly error to families whom you serve. This pertains to a married individuals who died in 2011, 2012 and 2013, owning a business interest, gas lease (whether or not in production) or any other appreciable asset.  Undoubtedly,  business interests and tangible assets have value.  However, a recent gift tax audit involving one of our clients has confirmed absolutely that the IRS considers gas leases as having substantial value whether or not they are in production. If an individual who owns such appreciable assets  passes away leaving a surviving spouse, it is a common misconception that nothing needs to be done from an estate standpoint.  (This is especially prevalent in the context of non-producing gas leases since they have no value for Pennsylvania Inheritance Tax purposes.) The IRS takes a different view.

Even if the deceased spouse’s assets do not have a value which exceeds the federal estate tax threshold, this fact may change during the life of the surviving spouse. Assume that the deceased first spouse’s assets have a value of $3 million on the date of death. Obviously, no Federal Estate Tax or Pennsylvania Inheritance Tax is due. The misconception is that no action needs to be taken, including the filing of a form 706 Federal Estate Tax Return. However, if on the death of the surviving spouse the same assets have  a value of $7 million due to appreciation, there will be approximately $1.3 million of assets exposed to Federal Estate Tax (which is roughly 40%). This could have been avoided if the 706 was timely filed on the death of the first spouse and portability elected. If that were the case, the second spouse to die would have exemptions of approximately $10.6 million and no federal estate tax would be due. As you can see, there is a significant savings to the family.

A procedure is currently available to correct this error for individuals who passed away in 2011, 2012 and 2013. However, this opportunity will expire on December 31, 2014.

Pennsylvania Inheritance Tax Business Family Exemption

Effective July 9 of this year Pennsylvania allows an exemption from inheritance tax on transfers at death of a “qualified family-owned business interests” provided that it is transferred to a “qualified transferee”. A “qualified transferee” is a decedent’s spouse, lineal descendants, siblings and siblings’ lineal descendants, ancestors and ancestors’ siblings. The qualified transferee must continue to own the business for seven years after the decedent’s date of death. If the business ceases to be owned by a qualified transferee within such seven-year period, the inheritance tax will be due from the due date of the decedent’s death and interest shall be applied from that date. The qualified transferee must certify to the Department of Revenue, every year for seven years, that he or she continues to own the qualified business. A “qualified family-owned business interest” is a proprietorship or entity that has fewer than 50 full-time employees; a book value of less than $5 million; has been in existence at least five years prior to the date of death of decedent; and wholly owned by the decedent or by the decedent and his family who meet the definition of a qualified transferee. An entity may also be a “qualified family-owned business interests” provided that it must be engaged in a business which is not the management of investments or income-producing assets owned by the entity.

Older Adults Protective Services Act

There is an excellent case that discusses the workings of our Older Adults Protective Services Act under our Pennsylvania statutes. It is the case of “In the Interest of A. M. an Older Adult” from Chester County; Fiduciary Reporter, Vol. 3, Third Series 129. It discusses the statute, the spirit of the law and procedures to follow. If interested it is worth reading.

Digital vaults

People should be aware of the need to record their online passwords and login information so that upon their death none of their assets are lost because locations are unknown and cannot be found. They now have websites where you can login information and passwords in digital vaults. This should be a concern of many people drafting last wills and it might be worth it to review those websites.

Modification of an Irrevocable Trust

The Hendrickson Trusts (3 Fiduc. Rep. 3d 55) is an interesting case where the Superior Court in New Jersey applied Pennsylvania trust law as the trusts were governed by Pennsylvania law and allowed a change of trustee from a large bank, Wells Fargo, to a smaller trust department, The Philadelphia Trust Company. It reasoned that many changes have occurred since the appointment of the original trust department many years ago as it was subject to numerous mergers into a much larger bank and this affected performance of administration. The Court concluded that the modification was not inconsistent with the material purpose of the trust under Pennsylvania law
( 20 PS 7740.1 (b)).

The American Tax Relief Act of 2012

Estate Tax: The American Taxpayer Relief Act of 2012, enacted on January 1, 2013, is not an extension for another short period of time but rather now permanent. It permanently provides for a $5 million exclusion for estates of decedents dying after December 31, 2012, adjusted annually for inflation, with a maximum federal estate tax rate of 40%.

Portability: The Act also makes the estate tax portability provision permanent. Therefore, a deceased spouse’s unused estate tax exclusion amount may be used by the surviving spouse. The Act did not address any portability with respect to the generation-skipping tax exemption.

Gift Tax: The Act also provides a 40% tax rate and a permanent unified gift tax exemption of $5 million adjusted for inflation for gifts made after 2012.

Generation Skipping Tax: The Act also provides a 40% GST tax rate with a permanent $5 million GST exemption.

As we mentioned in previous articles the credit shelter trust is still needed in many situations to avoid any tax on the appreciation during the lifetime of the surviving spouse; to utilize the generation-skipping tax of the first spouse to die because the GST it is not portable; and such credit shelter trust would provide many other non-tax benefits.