Articles & Blog

Estate Tax-Limited Partnership

The Tax Court Memo 2011 – 209 issued August 30, 2011, was an interesting case regarding the Estate of Turner. A limited partnership was created for the decedent and his wife and they transferred securities into the partnership. The Court found that management of securities is a legitimate nontax purpose if the assets involved required active management or special protection, or if it was stock of an operating business that required management. The Court found that the record failed to establish any meaningful activity of the marketable securities while in the partnership. The Court found that the decedent commingled personal and partnership funds and used partnership funds for personal gifts and personal bills. The Court found that the decedent, as general partner, had the right to amend the partnership agreement at any time without the consent of the limited partners. The Court found that the partnership was primarily testamentary and not for the active management of investments or business. In summary, the Court found that the transfer to the partnership was not for bona fide or adequate consideration as there were no significant nontax purposes and that the decedent expressly or implicitly retained the right to possess the transferred property as well as controlled which person would enjoy the transferred property. The Court included all the assets in the gross estate of the decedent under section 2036 of the Internal Revenue Code.

Life insurance held in an Irrevocable Trust.

A surprising case in taxpayer’s favor resulted in Turner vs Commissioner, TC Memo. 2011 – 209 (August 30, 2011). The trust document provided that the beneficiaries have “Crummey withdrawal powers” after each “direct or indirect transfer” to the trust. The trust gave each beneficiary the absolute right and power to demand withdrawal from the trust after each direct or indirect transfer to the trust. The Settlor paid insurance premiums directly to the carrier rather than to the trust and the trust to the carrier. The court held that the terms of the trust provided that the beneficiaries have the right to withdrawal whether the payments were direct or indirect and therefore the beneficiaries had the right to demand withdrawals from the trust after each indirect payment was made; thus even though the payments were indirect it did not affect the beneficiaries’ rights to demand withdrawal. The court found that these gifts were present interest gifts as it cited Crummey vs Commissioner and Cristofani vs Commissioner.

This decision is in favor of the taxpayer but we highly recommend that the insurance payment be made to the trust and the trust make the payment to the carrier, and the beneficiaries be notified of their withdrawal rights after each of the contributions to the trust are made.

Joint Accounts

Another recent interesting case in Pennsylvania regarding joint accounts follows the rule of law in the recent Supreme Court case of Estate of Novosielski , 992 A2d. 89 (2010), which reversed the lower Court stating there must be clear and convincing evidence before the statutory provision giving a last will primacy over the right of survivorship presumed by statute in Pennsylvania. In the case of Lanzetta Estate, Vol.1, Third Series Fiduciary Reporter p. 352 (July 2011), the Montgomery County Orphans’ Court found that the joint survivor of a bank account takes precedence over a last will were there is no clear and convincing evidence of a different intention. The Court cited Section 6304 of Title 20 of Pennsylvania Statutes, where it provides “any sum remaining on deposit at the death of a party to a joint account belongs to the surviving party or parties as against the estate of the decedent unless there is clear and convincing evidence of a different intent at the time the account is created.” The Court held that the only issue is the decedent’s intent at the time the account was created, and the statutory presumption that the decedent intended the joint survivor to take as a surviving party was not overcome.

Estate Tax possible debate

There are discussions to debate a new estate tax law in Congress after the debt ceiling debate is concluded.

Currently there is a $5 million estate tax exemption with a 35% rate until December 31, 2012, unless Congress extends. If Congress does not extend the law reverts to a $1 million exemption and a 55% rate. Some Democrats advocate a $3.5 million exemption and 45% rate and some Republicans suggest to keep the rate at 35%. The Administration’s 2012 budget proposal promotes a $3.5 million exemption and 45% rate. Some Republicans want the estate tax repealed altogether but that is unlikely. Yesterday Minnesota Gov. and Republican presidential hopeful Pawlenty said he would end the estate tax.

 It should provide an interesting debate if the issue is brought to the floor.

Pennsylvania recent case on realty transfer tax.

On March 29, 2011, in the case of Miller vs. Commonwealth of Pennsylvania, the Commonwealth Court of Pennsylvania agreed with the Order of the three-judge panel which provided that the trust in question was a “will substitute” under the Realty Transfer Tax Act, 72 PS section 8101-C3. Therefore the transfer was properly excluded from taxation.

In this case the trust was an irrevocable trust and provided that upon the death of the Settlors the property is automatically transferred to the beneficiaries, and the Settlors could exchange and otherwise dispose of the property and may live in and enjoy the residence in question.

Section 1102–C.3(8.1) of the Realty Transfer Tax Act provides an exclusion for “A transfer for no or nominal actual consideration to a trustee of a living trust from the settlor of the living trust…”.  The Act further provides the definition of a “living trust” as “Any trust, other than a business trust, intended as a will substitute by the settlor which becomes effective during the lifetime of the settlor, but from which trust distributions cannot be made to any beneficiary other than the settlor prior to the death of the settlor.” The Commonwealth argued that the trust is not a “will substitute” because it was not a revocable trust but rather an irrevocable trust.

The three-judge panel reviewed the definition of “will substitute” in the Restatement (Third ) of Property which basically provides that the property transfers to the beneficiaries upon the death of the donors while preserving lifetime rights to the donors. The panel found that trust was a “will substitute” and that there was no transfer tax regardless that the trust was irrevocable. The Commonwealth Court agreed with the Order of the three-judge panel.

However, it is important to note that if the irrevocable trust did not allowed the Settlors to reside in and enjoy the property and have control on the sale or exchange of the property, the results would have been different and realty transfer tax would be imposed. It is also important to note that this issue of realty transfer tax is different than the law regarding death tax as such a transfer to an irrevocable trust would not be excluded from inheritance tax or federal estate tax because the settlors have the right to enjoy the property.

Estate Tax- Credit Shelter Trusts and Marital Trusts

There are some estate planners suggesting that for clients with wealth  that credit shelter trusts and marital trusts are no longer needed because of the portability feature for the federal estate tax exemption of the new tax act effective January 1 of this year. They suggest transferring all assets to the surviving spouse and upon the surviving spouse’s death there would be available both the federal estate tax exemption of the second spouse to die along with the use of the federal estate tax exemption of the first spouse to die. However, regardless of this portability feature of the federal estate tax exemption, we continue to utilize credit shelter trusts and marital trusts for the following reasons.

1. Use of the portable exemption new legislation requires an election that must be made on a timely filed estate tax return of his first spouse to die which computes the amount of unused federal exemption that the surviving spouse will receive. If the election is not made the portable feature is lost. Also, the election is irrevocable. We don’t have this problem with credit shelter trust .

2. If we use the credit shelter trust the appreciation on the assets contained in that trust will not be subject to estate tax on the second spouse to die. Whereas, if the first spouse provides in his or her Last Will that all of his or her assets shall be distributed to the surviving spouse and then the surviving spouse uses the federal estate tax exemption of both the first spouse and the second spouse, all of the appreciation that occurred in the estate of the surviving spouse regarding the assets of the first spouse will be subject to estate tax at the death of the surviving spouse. This results in a large advantage lost.

3. There is no portability with respect to the GST tax. To preserve the GST exemptions for both spouses the deceased spouse must be a transferor and therefore the marital reverse Q-tip trust is needed.

4. Credit shelter trusts provide many nontax benefits such as asset management, creditor protection and guaranteed disposition to lineal descendents.

5. Portability will last for only two years unless it is extended by Congress. If it is not extended then we need redo all the estate plans regarding those that did not utilize a credit trust. Use of the credit trust will avoid this exhausting reconstruction.

Interesting Cases and Ruling

An interesting case is found at Groody Trust, Vol.1, Third Series, Fiduciary Reporter, p.108 Monroe County, Pa. This case discusses whether a Last Will changes the dispositive terms of a Revocable trust. After a review of all the facts the Court concluded that whichever document represented “the final expression of the decedent of his intention regarding payment…” is controlling. This case also contains an interesting factual discussion of whether a beneficiary transfers an interest in a trust or disclaims such interest.

In Cepko Estate ,Vol.1, Third Series, Fiduciary Reporter, p.115, Westmoreland County, Pa., at issue was a joint account which remaining funds was specifically bequeathed to decedent’s daughter and the Court found that the account was controlled under section 6303 of the Pennsylvania Multiple-Party Account Act and the funds were contributed by the decedent and used both at his direction and also properly by his agent (his spouse) under his power of attorney.

In Private Letter Ruling 20944002 the IRS refused to rule whether the assets of the trust are included in the estate of Settlor under section 2036 where taxpayer created an irrevocable trust which benefited himself along with his spouse and descendents. The trust was created under a state law which provided that creditors could not reach Settlor if it the trust is a self settled asset protection trust. All the proper provisions where in place as the trustee was not a related party, it was a grantor trust with a substitution clause, the trustee was prohibited from reimbursing the taxpayer for income taxes paid by the taxpayer with respect to the trust income, and the IRS determined that the gift was a completed gift. However, the IRS refused to rule regarding the issue of whether or not the property is included in Settlor’s gross estate under section 2036 because the trustee had discretion to distribute income and principal to the grantor. Thus, self settled trusts remain questionable with respect to section 2036 inclusion.

Recent Estate and Gift Updates

In Fisher,106 AFTR2d 2010- 6144 (DC Ind), the operating agreement of a limited liability company provided that the limit liability company had the first right of refusal if a child’s interest in the company were sold and payment would be made by promissory notes. The Court agreed with the Internal Revenue Service and applied section 2703 (a) which provides that the value of any transferred property is determined without regard to restrictions on the right to sell or use the property. The taxpayer urged the Court to apply the exception to this law stating that there was a bona fide business arrangement. The Court found that such exception was present under the facts of the case as the Court found that there was no business interests being preserved with the transfer restriction. The Court cited the Holman case (which case was discussed at our Blog a few months back).

In the Estate of Jensen, T. C. M. 2010-182, a dollar for dollar discount was allowed in decedent’s estate for built-in long-term capital gains. This may be appealed to the Second Circuit.

Under Revenue Procedure 2010-40 (IRB 2010-46), no inflation adjustment  occurred on January 1, 2011, for the federal annual exclusion and therefore it remains at $13,000.

New estate tax law for two years

Finally some direction for the estate tax law but still uncertainty after two years.

The President signed into law this past Friday the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. The following are a summary of changes with respect to the estate, gift and generation skipping tax, but only to last for two years and if not adjusted, then on January 1, 2013, will revert back to the law of 2001. The changes are as follows:

For the period from January 1, 2011, through December 31, 2012, the estate tax rate will be a maximum of 35% with a $5 million applicable exclusion per person.

The estates of decedents that died in 2010 have an option to (1) choose the estate tax at a top 35% rate and $5 million applicable exclusion and the elimination of the modified carryover basis rules of 2010, or (2) choose no estate tax and the modified carryover basis rules as have been in effect for 2010.

The law allows transferability of the applicable exclusion among spouses. Thus the surviving spouse may take advantage of any unused portion of the applicable exclusion amount of his or her spouse.

The gift tax is now reunited with the estate tax for two years with the top gift tax rate of 35% and an applicable exclusion of $5 million. This gift tax change is not retroactive to 2010; thus there is no option to change the 2010 law which provides for a $1 million exclusion and the top bracket of 35%.

Generation skipping tax is reinstated for two years similar to the estate tax with a $5 million exemption and a 35% top rate.

Estate Tax-Uncertainty

Now we have a “framework” for tax change as announced yesterday by the President who did not seem very happy that there was a compromise. Yet still a great deal of uncertainty.

We’re not certain exactly how the estate tax will end up but we should know within two weeks. More importantly, it was announced yesterday that the tax compromises, including the estate tax compromise, are only to last for two years. If that is the result we will continue to be uncertain as to future planning just as we are in 2010.