Articles & Blog

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.

2013 Tax Increases

If Congress cannot agree in the next 40 days there will be significant changes in the federal tax law on January 1, 2013 as follows:

The current individual rates of 10%, 15%, 25%, 28%, 33%, and 35% will be replaced by 15%, 28%, 31%, 36%, and 39.6%.

The current long-term capital gain rate of 0% for taxpayers in the 10% and 15% bracket, and 15% for all other individuals will be replaced with 10% for individuals in the 15% bracket, and 20% for all other individuals.

Currently qualified dividends are taxed at 0% for taxpayers in the 10% and 15% brackets, and 15% for everyone else. This will be replaced with qualified dividends being taxed at 10% for individuals in the 15% bracket, and 20% for everyone else.

The former personal exemption phaseout and the itemized deduction phaseout will be reinstated. Current law has eliminated those phaseouts.

There will be a .9% Medicare hospital insurance tax regarding employment income, and the employee share of the Social Security payroll tax will increase from 4.2% to 6.2%.

The current estate tax exemption of $5,120,000 with a top rate of 35% will revert to a $1 million exemption and a top rate of 55% . The current gift tax exemption of $5,120,000 and a top rate of 35% will revert to a $1 million exemption with a top rate of 55%. The current generation-skipping tax of $5,120,000 and a top rate of 35% will revert to a $1.4 million exemption with a top rate of 55%.

Currently there is portability between spouses for estate and gift tax exemptions but that will be eliminated in 2013.

Hopefully Congress and the President can compromise and eliminate a great deal of the tax increases as described above.

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.