New Jersey Estate Planning & Elder Law Blog : New Jersey Estate Planning Lawyer & Attorney : Deirdre Wheatley-Liss : Fein Such Kahn & Shepard Law Firm : Elder Law, Tax Planning

USA Today has two stories running today - one Our view on death and taxes: Loopy estate tax policy highlights D.C. dysfunction, and the other Opposing view on death and taxes: End the 'death tax'.  Both totally miss the point that there is a tax as a result of death no matter which way you lean - an estate tax would be assessed immediately, or there will be capital gains taxes to pay for decades to come.

In the first article, they quote a US Senator: "Sen. Jim Bunning, R-Ky., bluntly put it, [George] Steinbrenner "was smart enough to die in 2010."  Really?   Smart enough to die this year?  I am sure Mr. Steinbrenner's family and friends appreciate your comments on their loss.  USA Today then describes why there is no estate tax in 2010, including the recent political battles, and supports an estate tax by saying:

It makes sense to tax inherited wealth, derived simply by having the right parents, at a higher rate than money acquired through hard work or investment. Advocates of repeal rarely say where else they'd get the money to make up the lost revenue, because the inevitable answer is it would come from taxpayers of lesser means.

Ahh, the famous "he who has more must share" argument.

On the flip side, in the second article Rep. Louie Gohmert, R-Texas, takes the position "[t]ime to end the death tax permanently.":

For anyone to reach his hand into a deceased person's pocket and steal is despicable. But, when someone dies and the government steals from the deceased, our laws legalize the theft.

He goes on to tell the story of the family farm that had to be sold to pay taxes.  

Ahh, the famous "how dare they" argument.

How how about a few actual facts to consider.

• The estate tax impacts around 2% or less of the entire US population (for in depth factual information about who pays the estate tax and how generated look at  the Tax Policy Center "Tax Policy Briefing Book" chapter on Wealth Transfer Taxes).  So for the other 98% of US taxpayers, consider the estate tax  a source of revenue to the federal government that you don't actually have to contribute to. 
• In 2009, an estimated less than 100 estates with family farms and small businesses were subject to tax - just 1.9% of all taxable estates.  There are current laws to defer taxation of farms and better ones have been proposed (see Family Farms to be Exempted from Estate Tax?)
• Estate taxes were estimate to generate $13.8 billion in 2009.  The federal government spends $x each year - if estate taxes don't generate part of the income, other taxes will.
• For more facts, look at Truths about the Estate Tax - Debunking the Popular Myths

And the most important, and most glaringly overlooked fact of all in BOTH USA Today articles - if there is no estate tax there is STILL a tax on inherited wealth.  That tax is the capital gains tax. Let's thing - if there is no estate tax all that appreciation on assets that has disappeared for 98% US taxpayers on a person's death will now potentially be subject to tax on the sale of assets.  An while an estate tax may seem harsh in light of the death of a loved one, consider the nightmare of finding proof of cost basis for assets purchased decades earlier.  For more information about the real realities of no federal estate tax, look at Federal Estate Tax "Death" in 2010 Creates Capital Gains Trap.

A thought - let's abandon rhetoric and look at creating good tax policy.

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Why is there an estate tax at all?  An interesting article in The Nation "The Plutocracy Prevention Act" explores the ideological underpinnings of the enactment of the federal estate tax in 1916.

A century ago this summer, Theodore Roosevelt gave his remarkable "New Nationalism" speech about the dangers of concentrated wealth and corporate power. After witnessing a decade of financial corruption and corporate malfeasance, Roosevelt called on the nation to "effectively control the mighty commercial forces which they have themselves called into being."

 Hmm, dangers of a "decade of financial corruption and corporate malfeasance" - sound familiar at all?  Madoff and BP come to my mind.

 The article goes on to provide why the estate tax was structured as it was:

Part of his vision was a "graduated inheritance tax on big fortunes, properly safeguarded against evasion and increasing rapidly in amount with the size of the estate." Congress instituted an estate tax in 1916 that was in place until last January. For most of the last century, the estate tax was a single tax rate. A person with $5 million was taxed at the same rate as someone with $5 billion.

While the author is using this history lesson to underscore their support for the newest estate tax legislation (see prior post "Estate Tax News From Washington") where there is a "billionaire surcharge" I find it interesting that the facts and circumstances that gave rise to the estate tax almost a century ago are so similar to those facing us today.

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A new estate tax reform solution has been proposed by Sen. Bernard Sanders, Tom Harkin and Sheldon Whitehouse billed  the Responsible Estate Tax Act.  According to Steve Leimberg, this newest estate tax proposal is structured as follows:

· Exempt the first $3.5 million of an estate from federal taxation ($7 million for couples). (According to their estimates, this would exempt 99.75 percent of all estates from the federal estate tax in 2011).

· Include a progressive rate structure so that the super wealthy pay more.

     o The rate for the value of the estate above $3.5 million and below $10 million would be 45 percent, the same as the 2009 level.

     o The rate on the value of estates above $10 million and below $50 million would be 50 percent.

     o The rate on the value of estates above $50 million would be 55 percent.

· 10 Percent Billionaire's Surtax: The proposal would impose a 10 percent surtax on the value of an estate above $500 million ($1 billion for couples).

· Close Estate and Gift Tax “Loopholes” requested in President Obama's Fiscal Year 2011 budget.

· Require consistent valuation for transfer and income tax purposes;

· Modify rules on valuation discounts;

· Require a 10-year minimum term for Grantor Retained Annuity Trusts (GRATS).

· Protect family farmers by allowing them to lower the value of their farmland by up to $3 million for estate tax purposes.

     Their bill would increase the ability of an estate to use the Special Use Valuation rule reduce the value of farmland for estate tax valuation purposes from its current $1 million to $3 million and index it for inflation.

· Benefit farmers and other landowners by providing estate tax relief for conservation easements.

     Their bill would provide tax relief to farmers and other landowners by amending estate tax rules for conservation easements through an increase in the maximum exclusion amount to $2 million and increasing the base percentage to 60 percent.

 

 

 

 

 

 

 

 

 

 

 

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Senators in Washington are stirring the pot about what to do about the federal estate tax, but as NASDAQ reports, no consensus is near. Options in play:

• Do nothing - The federal estate tax return in 2011 with a $1 million per person exemption and a 55% rate.  Sen. Casey (D. PA) commented "I think it would be a big mistake when everyone's yelling about spending and deficits to let a lot of very wealthy people get off the hook,"

 

• Obama Administration Proposal - Permanently fix the estate tax with a $3.5 million exemption and a 45% tax.  This would mimic the tax in place for deaths in 2009.  This would be a tax cut as the revenue from the 2011 tax law change is already in the budget, and the tax loss dollars would need to be replaced by other taxes.

 

• Lincoln-Kyl Proposal - Starts with the Obama administrations proposal in 2011 but then "gradually phase down to a 35% rate and a $5 million exemption level."  Note that one of the ways the estate tax reduction would be paid for is by eliminating the deduction of state estate tax paid, which would significantly increase the total tax due on deaths of New Jersey residents.

What is clear is that nobody involved with the discussions are currently having to deal with the uncertainties all of this has created in helping the actual taxpayers who wish to put a plan into place, or who have suffered deaths of family members in 2010.

 

Image: graur razvan ionut / FreeDigitalPhotos.net

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Jensen Law Offices has a great post summarizing the mechanics and usefulness of a Charitable Remainder Trust or CRT.  A CRT is one of those great tax techniques where you get to have your cake and eat it too.  

A CRT is a split gift between a charity and your family.  For example - you leave a portfolio in a trust where your children get 7% a year for their lives, and when the child dies, the charity gets the balance of the portfolio.  Your estate is entitled to a tax deduction (since NJ still has an estate tax, this is relevant in 2010 as well as 2011 and beyond when the federal estate tax reappears).  Your children get an income stream for live, and the charity has the reminder upon their deaths.

Note that when you have a taxable estate charitable giving at its most basic is taking dollars that your family would not have gotten anyway (because they had to go to taxes) and directing them to charity. With a CRT you are compounding this by getting the tax benefits and giving the family a stream of dollars.

 

Image: Salvatore Vuono / FreeDigitalPhotos.net

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Life estates are commonly used in elder law asset protection planning.  Mom owns a house worth $400,000.  She gives the house to her children(a "remainder interest"), and keeps the right to live in the house during her lifetime (a "life estate interest").  The gift of the remainder interest is "transfer" for Medicaid purposes, and starts the clock on the 5 year lookback period.  

The gift of the house subject to a life estate is a popular asset protection planning technique because it is easy to understand and less invasive to lifestyle than other transfer techniques. Making a gift of a remainder interest simply involves the attorney preparing a deed and associated real estate transfer documents.  There are no realty transfer tax consequences - realty transfer tax is not assessed in New Jersey for transfers without consideration (i.e.: a gift). Also, using a life estate technique not much changes from a practical perspective as the life estate holder (ie: Mom) continues to be responsible for all property taxes, maintenance and upkeep - and is still entitled to the Senior property tax rebate.  Perhaps most importantly, you don't spend your house, so it is emotionally easier to give away an interest in a house than to give away cash dollars that you may still want to spend.  For those who think they are at least 5 years away from a nursing home, a transfer of a house subject to a life estate can be a home run as the house tends to be the most valuable single asset.

But what happens from a tax perspective when the owner dies? (Assuming the death is not in 2010 when we have no federal estate tax - see my prior post on estate tax implications for deaths in 2010)

If you give away an asset and keep a life estate in that asset, the life estate acts like a "string" that pulls 100% of the value of the asset into your taxable estate.  From an estate tax perspective, this mean that (1) 100% of the value of the house is included in decedents taxable estate, and (2) the cost basis of the house is "stepped-up" to the value of the house on date of death (IRC 2036).  So, if Mom bought the house for $40,000 and it is now worth $440,000, Mom's estate includes the house valued at $440,000, and kids get the house with a $440,000 basis.  When they sell the house for $450,000 down the road, then they only have $10,000 of capital gain.  The $400,000 of appreciation that occurred during Mom's lifetime essentially disappears (you potentially pay estate tax instead).  If the total estate is less than $675,000 (New Jersey) or $1,000,000 (federal starting in 2011 - unless congress changes it), then there will be no estate tax due.  If there is a New Jersey estate tax, the rate ranges up to 16% on amounts over $675,000 - this is far less than the capital gains tax (15% federal plus 7.5% NJ) on $400,000 if Mom simply gave the house to the kids without keeping the life estate.  

In New Jersey we also need to contend with the Inheritance Tax if the remainder beneficiaries are not children - for example, Aunt gives her house to her nieces and nephews and retains a life estate.  The Inheritance Tax is a separate tax from the estate tax that is assessed against a beneficiary based on their relationship to the decedents - transfers to spouses and children are exempt, transfers to other family members are not.  For example, when Aunt dies, the life estate acts to make 100% of the value of the house subject to inheritance tax (NJAC 18:26-5 et seq).  So, nieces and nephews get the house, but they need pay an inheritance tax at the rate of 15%-16% with no exemption.  The inheritance tax is a credit to the estate tax, so you don't end up paying both taxes if the estate is subject to estate tax and the beneficiaries are not children or spouses.

The benefits of making  a transfer of a house subject to a life estate can significantly outweigh any estate tax or inheritance consequences in many situations.  The key is to get advise for YOUR situation to see if transfer of a house subject to a lift estate make sense to protect your assets from a Medicaid spend-down.

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My prior post was about the federal tax impact for single individuals who die in 2010 (unless Congress does as they have promised and create an estate tax retroactive to January 1, 2010 – we will have to wait and see if that happens and how it is constructed).

The news for single folks was not good. Mom dying with a $3.5 million estate in 2009 could leave it to son tax free. Mom dying with that same $3.5 million dollar estate, assuming the basis of her assets is $350,000, now creates a  federal capital gains tax of $277,500 for son (or $416,250 if he is in NJ).

The news for married folks is worse. In 2009 mom could leave $100 million (or whatever amount) to dad with no taxes whatsoever – there is an unlimited marital deduction from estate taxes (so long as your spouse is a US citizen). In 2010 only $4,300,000 will pass tax free to the surviving spouse.

The "death" of the estate tax creates a capital gains "trap" - and the “trap" catches assets passing to a surviving spouse that were never subject to tax under the estate tax.

What??? you say. How is it possible that by eliminating the estate tax you are creating a tax for widows and widowers? As I noted, due to the magic of Internal Revenue Code Section 1014, capital gains taxes disappear at death under the 2009 law. Section 1014 creates a “step-up in basis” by stating that when an estate is subject to estate taxes, the cost basis of inherited assets is the date of death value.  For example, mom bought stock for $10, and when she dies it is worth $100.  Dad  inherits stock and sells for $100.  His capital gains is $0 ($100 of value - $100 of basis =0).

However, in 2010 there will be no estate tax, and therefore no “step-up in basis”.  Instead, per Section 1022, Dad can apply $1,300,000 million plus $3,000,000 to add basis to the assets that mom has. How might this work? Let’s say mom has a $6 million estate, made up mostly of the family business she and dad still work in and some real estate. Assume mom has a $500,000 basis in the assets – all that appreciation has been due to increases in value over the years. If mom died in 2009, dad would get $6 million tax free. If mom dies in 2010, and dad sells everything since he doesn’t want to work without his life partner, he only has a basis of $4,800,000  ($500,000 of mom’s basis + $4,300,000 of allocated basis). Since he sold for $6 million, he has $1,200,000 of capital gains. He will owe the federal government $180,000, and if he lives in New Jersey, he will also owe the Garden State $90,000, for a total of $270,000. Remember, had mom died in 2009 when there was an estate tax in place, dad would have owed $0.

It bears repeating that all other concerns aside, this new tax regime where you need to track cost basis over a life time is a nightmare. How do you prove mom’s basis before she died was $500,000? Was every improvement tracked? What documentation will the IRS accept as proof? Will you have that documentation 30, 40, 50 years later?

My next post will address some planning opportunities (every cloud has a silver lining after all) that might exist in this new tax environment.

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Sigh ... I was really, really hoping I would not have to post about what happens to those who die in 2010 from a federal tax perspective.  However, since Congress couldn't seem to get its act together, here is the current 2010 landscape (with the caveat that Congress can act in 2010 and have a retroactive estate tax - but, we will have to see what happens when it happens).

Did you know that the "death" of the estate tax creates a capital gains "trap"?  And that "trap" catches the smaller estates, the ones that under current tax laws have no federal tax consequences on death. 

Assume you are single person with a $3.5 million estate (I will post separately about married couples).  Had you died in 2009, there would have been no federal tax consequences to your death.  If you die in 2010,  there will no federal estate taxes (same as 2009).  However, your heirs will have to pay capital gains taxes (see, there is always a catch).

What??? you say.  I thought death was tax free in 2010.  It is estate tax free, there won't be a federal estate tax.  There will, however, be federal and state capital gains taxes for deaths in 2010. Why??? you ask.  Well, there is a pesky little section of the Internal Revenue Code (1014) that says, essentially - when an estate is subject to estate taxes, the cost basis of inherited assets is the date of death value.  For example, mom bought stock for $10, when she dies it is worth $100.  Son inherits stock and sells for $100.  His capital gains is $0 ($100 of value - $100 of basis =0).  Section 1014 is a neat magic trick - it makes capital gains taxes disappear.  In tax parlance we call this a "step-up in basis".

However, in 2010 there will be no estate tax, and therefore no step-up in basis.  Let's take the same example where mom bought stock for $10, and when she dies it is worth $100.  Son inherits stock and sells for $100.  He now has a capital gain of $90 subject to tax ($100 of value - $10 of basis = $90).  He must pay federal capital gains tax on this amount (15%) and state capital gains tax (7.5% in New Jersey) for a total tax of $20.25 if he is in NJ - or $15 if he is in FL or another state without a state estate tax.  

Notice that when mom died in 2009 with an estate tax in place, son netted $100.  However, when mom dies in 2010 with no estate tax in place, son only nets $79.75. Lets add some zeros - son nets $1,000,000 if mom dies in 2009, but only $797,500 if she dies in 2010.  Now you see how no estate tax is not necessarily a good thing?!

The above is over-simplistic, but it makes the point that the "death" of the estate tax creates a capital gains trap.

One point of "relief" - your estate will be able to allocate $1.3 million to add basis to inherited assets (different rules apply for a surviving spouse) per code Section 1022.  To continue our example, mom's entire $3.5 million estate consists of stock she bought for $10 a share and is now valued at $100 a share.  Her cost basis in her estate is $350,000.  She dies, and the estate has an additional $1.3 million of basis - so the stock now has a total basis of $1,650,000.  Son sells the stock for $3.5 million, creating a capital gain of $1,850,000, which in return has son paying a federal capital gains tax of $277,500 (or $416,250 if he is in NJ).  Remember now, if mom had died in 2009 when there was a federal estate tax, son would have paid $0 in tax.

But the the so called "relief" is a trap too - how are you going to prove basis?  How do you know what mom paid for each stock share?  And if you do know, what about splits, mergers, stock dividends - what is her cost basis in all those?  Tracking basis for assets acquired over a person's lifetime, particularly when the person is now dead, is a nightmare.

Congress has "promised" to reinstate the estate tax to January 1, 2010 - and I think we all know what weight to give to Congresses promises.

My next post will address what happens if mom dies in 2010 survived by dad  (a spouse) - and the picture isn't rosy there either.

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 I had previously reported that a one-year extension of the federal estate tax seemed likely in an end of year defense spending bill.  Now, Hani Sarji reports that it is likely Congress won't act this year, but will act next year and reinstate the estate tax to January 1, 2010 in some form.

In Estate Tax Fix Fails, Repeal Likely - US Lawmaker (Dow Jones Newswires, 12/15/09), Martin Vaughan reported the following:

Rep. Earl Pomeroy (D., N.D.), said plans to include a temporary estate tax extension in end-of-year defense spending legislation have been dropped because of Senate opposition.

As a result, he told Dow Jones Newswires, the estate tax will be repealed on Jan. 1 as foreseen by current law, and replaced with an onerous capital gains tax that heirs would have to pay when they sold any inherited assets. . . .

It is regrettable that we're going to have this disruptive period without a permanent resolution," Pomeroy said.

But he said "the prospects are 100%" that Congress will come back next year and reinstate the tax, and make it retroactive to Jan. 1, 2010.

My issue with repeal and retroactive reinstatement is what happens to the person who dies before the reinstated law is passed?  From a planning perspective, I know Congress won't leave well enough alone, and the reinstated law will not be identical to the current law, which means that for the person who dies during the gap time will have lost an opportunity to fully plan their estate.  See a prior post on my other thoughts on retroactive estate tax reinstatement.

Image: Salvatore Vuono / FreeDigitalPhotos.net

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Even though the House passed a measure for a permanent extension of the estate tax at a $3.5 million dollar exemption per person, sources are reporting that the Senate is looking to push through a one-year extension by year end.  This would mean that the estate tax exemption would be $3.5 million per person in 2010, but still come back at a $1 million exemption in 2011.

Elder Law Answers reports that "Congressional watchers are coalescing around the prediction that the Senate will likely pass a one-year extension of the estate tax before year's end -- probably as part of a defense spending bill."  It cites in in-depth discussion at OMB Watch why the Senate won't likely move for a permanent resolution in the way of the House.  OMB Watch notes "The other option is for the Democratic leadership to tack a one-year estate tax extension onto a likely omnibus appropriations bill that insiders say Congress will pass before the end of 2009."

CNN Money concurs with the one year extension, advising "The Senate is likely to rally around a short-term fix and pass a one-year extension of the tax at 2009 levels by Dec. 31."  Hani Sarji at his blog reports that the House is now even expecting a one year patch, their recent legislation notwithstanding "'According to House Majority Leader Steny Hoyer, estate state tax fix may be temporary and may be attached to defense spending bill".

Why all this pressure?  Well, besides the financial incentive in certain circles for mom and dad not to survive 2010 intact, a permanent change to a $3.5 million exemption would actually add to the deficit.  CNN Money clarifies this point:

The House bill would increase the deficit by $234 billion over 10 years, according to the Joint Committee on Taxation. That's because even though current law would repeal the tax for one year, it reinstates it by 2011 at an exemption level of just $1 million, which would mean an increasing number of estates would be subject to the tax as years went by."

 $234,000,000,000.00 - That is a lot of zeros to be giving up at a time the government is broke.  So expect a push for the real question of estate tax reform, not a patch, into 2010.

 Photo courtesy Francesco Mariano

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Is the Federal Estate tax going away in 2010, being extended for 2010, or will there be total repeal?  Will Congress get around to addressing it this year (only 30 days left guys)?  Or will we be in total limbo?

I chuckled last week when fellow blogger David Schulman of South Florida Estate Planning Law quipped that "I'm Not Writing About Pending Estate Tax Legislation".  David rightly points out that until something concrete comes to pass, we estate attorneys might as well be reading tea leaves.

Not all bloggers feel that way it seems as this week I came across a blog specifically dedicated to federal estate tax legislation changes, aptly named "Future of the Federal Estate Tax".  Here you will get a summary of every piece of legislation being offered on the federal estate tax, with links to the bills themselves.  Blogger Hani Sarji also pulls together some of the latest commentary, included several op ed pieces that ran in the NY Times this weekend in response to last weekends opinion piece "Protect the Farm, Tax the Manor"

For me, I don't make law, I just try to make it work best for my clients.  I can only hope that Congress recognizes what a mess a one year repeal could be and takes responsible action before year end. (yes - I am aware that "Congress" and "responsible action" do not always go hand in hand).

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After a flurry of reports that Congress was going to address the estate tax this week, Derek Jenson posts this week that it is being postponed until at least after Thanksgiving.  Derek comments that this makes the one year extension of the current federal estate tax law (a $3.5 million exemption per person with a 45% rate) virtually a lock - because what else do they have time to do at this point?

Interestingly, Derek comments on how this "band aid" is only going to create more of an issue for congress.  

The 2010 extension is easy. It is a tax increase. What is difficult is raising the exemption and lower the rates for 2011. That will be a tax cut. [snip] It is not difficult to image that a year from now we will still not have a permanent estate tax bill and will be facing another one year extension or a return to the $1.0 million exemption."

Recall that under the current law, while there is no estate tax in 2010, the estate tax returns in 2011 with a $1 million exemption and 55% top rate - so the trade off for one year of no estate tax is potentially agreeing to keep the current level of $3.5 million exemption and 45% permanently (not that anything is ever truly permanent with tax and congress).  

According to the Congressional Quarterly, the cost of keeping the current rates over the next 10 years versus allow the estate tax to go away for 1 year and then come back in at lower levels (ie, if Congress does nothing) is a staggering $233.6 billion over 10 years.  We we are looking at extreme health care costs on top of an already bloated budget - perhaps a do nothing approach may net Congress more dollars in the end.

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The Huffington Post heralds "An Estate Tax Victory By Any Other Name".  Contributor Chuck Collins advises that the richest (billionaires, not mere millionaires) families in America have recently changed their strategy from calling for the death of the so-called "death tax" to the reducing the impact of the same.

The federal estate tax effects less than 2% of estates nationwide.  However, Collins reports that "Wealthy families, including 18 dynastic families such as heirs to the Mars candy family fortune, had spent millions in lobbying funds to save billions in future taxes."   Now, they have apparently changed this mission statement to their lobbyist not to "kill the death tax" but to mitigate its impact.

I understand how the estate tax seems categorically unfair.  However, it bears reminding that the estate tax stands in lieu of the capital gain tax when a person dies. When you die, you may have assets that have increased in value between when you bought them and when you died.  For example, you bought stock in Acme, Inc. at $10 a share and it is now $100 a share.  If you sell that stock, during your lifetime, you owe capital gains tax on the gain of $90.  

However, due to Section 1014 of the Internal Revenue Code, when you heirs sell that same inherited stock, their cost basis is $100 (the tax basis is "stepped-up" to the date of death value, and all that appreciation during your lifetime disappears, as does the governments opportunity to tax it.  

The cost for the the "magic wand'? - the existence of an estate tax that taxes your assets at death (assuming you have more than $3.5 million from a federal estate tax perspective).  The kicker is that capital gains tax rates are 15% presently, and estate tax rates 45%, so perhaps it is the rates that need to be looked at, not the existence of the tax.

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Under the present law the federal estate tax expires midnight December 31, 2009. For the next 365 days death is tax free - but, the federal estate tax comes back as of midnight December 31, 2010. Much has been blogged about the fact that Congress will act this session to change the federal estate tax law, but what if they don't?

Gideon Alper of Gay Couples Law Blog has an excellent post "Estate Tax Repeal in 2010 Not a Big Deal Because Congress Can Pass Retroactive Tax Amendment".  In it, he proposes that if Congress fails to act in 2009, they still have a chance to act in 2010, and can make the law retroactive to dates of death after December 31, 2009.

After all, there is quite a lot on Congress's plate for the remainder of the year: a war in Afghanistan, health care reform, to name a few. Gideon also takes a bit more cynical view noting that 2010 is an election cycle, and although the federal estate tax affects less than 2% of the United States population, it's a great issue for political fodder, and political fodder creates campaign contributions.

I have to disagree that from a planning perspective it would make not make much difference if the estate tax was "un-repealed" retroactively. I base this upon the fact that Congress can never leave well enough alone. I believe that the chance of them making the estate tax retroactive for deaths in 2010 in exactly the same way it currently applies in 2009 to be very small -- if they have to pass the Bill, why not tinker around with the tax code?  After all, there are some good estate tax proposals out there. For example, one looks to defer estate tax payments from working family farms until the family cashes out of the farming business (Family Farms to be Exempted from Estate Tax?").

New Jersey retroactively applied its new "de-coupled" estate tax in 2001. The existence at a New Jersey estate tax separate from the federal estate tax was announced in June 2001, and made retroactive to dates of death as of January  1, 2001. The problem of course, was exemplified by my client who died in March 2001, and never had the opportunity to create an estate planning documents tax effective under the New Jersey estate tax law, because the law did not exist at the time that he in fact died.

The root of the problem here is the political play of passing tax laws that expire --the supporters of the Bill get a "quick win", and it is generally left to another Congress to deal with unwinding of the transaction. The lack of certainty in the tax code creates a planning nightmare -  documents have to be drafted to incorporate the laws that exist today, the laws that are slated to exist in the future, and then best guesses as to what the law might actually be at some point in time in the future.

Congress created this problem -- it's incumbent upon them as responsible representatives of the citizens of this country to fix it -- this year. 

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The federal estate tax is applied to property as it passes from one generation to another.  Family farms have always been uniquely affected by the tax, as the family may have vast and valuable land holdings, but not much in way of liquid assets.  This can result in the property needing to be sold or mortgaged to pay the estate tax.

Legislation has been introduced in the House of Representatives that would exempt farms from the federal estate tax so long as the farm property passed to a family member and continues to be used as an agricultural operation (HR 3524).  It would also exempt land subject to a qualified conservation easement from the estate tax.

This bill make sense in that it is akin to section 1031 of the Code where if you sell real estate and buy different real estate it is not a tax realization event, as you are still invested in real estate.  Here, so long as you remain a family agriculture business, a death would not be a tax realization event.  Instead, the tax would be deferred until the property is sold or the agricultural business stops.  This makes sense from a timing standpoint as the timing of the tax would be when the dollars would be realized - you have cash, you can pay cash.  The question is, will a sensible proposal become law?  

To get a farmers perspective look to Estate tax proposal would help farm families from the California Farm Bureau Federation.

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Let's say that your father created a trust for the benefit of his second wife (not your mother) and his Will provided that his wife would receive all the income from the trust during her lifetime, and whatever was left over upon her death would pass to you. This is the common set up with a Qualified Terminal Interest Property (“QTIP”) Trust.  Let's also say a New Jersey estate tax is being generating by your father's estate. Do you have a right to challenge the New Jersey estate tax by virtue of being the beneficiary of the QTIP trust after your step-mother's death?

A recent New Jersey Tax Court case says "Yes". In Joanne LaBarbera v. Director, Division of Taxation Judge DeAlmeida, J.T.C. held on behalf of the Tax Court that the Plaintiff, the residuary beneficiary of a QTIP Trust, has standing to challenge an assessment of estate tax against the estate of the initial beneficiary of the trust. 

 

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I can't seem to stop reading about this "bailout" or No Banker Left Behind Act. It is like watching a car wreck in slow motion - you would do something if you could, but you don't have the power to stop it.

Then, I came across the below that I think offers a better way to look at a bailout. Apparently, Sweden found itself in a strikingly similar bank credit crisis back in 1992:

The country was so far in the hole in 1992 -- after years of imprudent regulation, short-sighted economic policy and the end of its property boom -- that its banking system was, for all practical purposes, insolvent.

Sound familiar?

From the NY Times' How Sweden Solved Its Bank Crisis:

But Sweden took a different course than the one now being proposed by the United States Treasury. And Swedish officials say there are lessons from their own nightmare that Washington may be missing.

Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

The article goes on to say that Sweden spent about the same percent of its GDP (4-5%) on is 1996 bailout of the banks, but took equity back so the out of pocket to the government (ie the taxpayers) was really only 2%.

I am thinking I am liking the Swedish plan much better than take all my money, do what you like, have no oversight, and no real change plan I see now - oh, and I really love that we have to do it NOW or life as we know it will end, when as we know it is already long past.

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Category: Estate and Inheritance Tax

Congress is again considering a permanent modification to the federal estate tax.

At present, US residents have a $2 million exemption from federal estate tax. That exemption is scheduled to increase to $3.5 million in 2009. There is NO federal estate tax in 2010, and the federal estate tax in re-instituted in 2001 with a $1 million exemption. (Doesn't congress just make the clearest laws).

The Senate recently voted 99-1 in favor or a proposal to fix the exemption permanently at the 2009 levels. This would be good as it would impose some certainty on planning, and remove the incentive for wealthy heirs to have the parents not survive past 2010 (the dark side to a 1 year repeal). Of course, this is merely a resolution, not a law, but it is interesting that it comes to the forefront again in an election year in the midst of a recession.

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Category: Estate and Inheritance Tax

As the Estate Tax Debate is likely to heat up as we head into the 2008 election season, I found the below articleNew Statesman - Death and Taxes from British political philosopher Martin O'Neill debating Great Britain's Inheritance Tax (which is structured similarly to our federal estate tax) excellent reading and very enlightening.

The Article begins "In a letter to his friend Jean-Baptiste Leroy in 1789, Benjamin Franklin famously opined that "in the world nothing can be said to be certain except death and taxes." Franklin was surely right about this, just as his judgment was sound in so many other matters - after all, this was the man who told us that "beer is living proof that God loves us and wants us to be happy". But it is astonishing how often passions become enflamed, and good sense goes out the window, when we encounter the heady mix of mortality and tax. "

It goes on to highlight some on the mis-perceptions about the British Inheritance Tax that are very similar to the many time unwarranted fears about the US estate tax:

(1) Most People Pay Nothing (or at any rate not very much...)At the current £300,000 threshold, only the richest 6% of estates pay anything. One common form of misjudgement is that many people who will not be affected IHT nevertheless think that they will be. A striking example of this kind of thinking comes from the U.S., where the Estate Tax threshold kicks in only at $2,000,000, or for the top 1% of estates. Nevertheless, Bush's attempt at repealing the estate tax enjoyed widespread public support among the less well off. Surveys found that 20% of Americans believed that they were in this top 1%, with a further 20% expecting to come into this bracket in the near future!

The emphasized text speaks for itself.

(2) Arguments About 'Double Taxation' are Bad Arguments:Perhaps the strangest,
and yet most pervasive, aspect of opposition to IHT is that many people say that
'double taxation' is intrinsically unfair. But, if this were true, then it would
be intrinsically unfair to levy any form of tax on the expenditure of post-tax
income.

The reality is that in a tax system that has parallel forms of taxation (federal, state, local), there is double taxation. Federal income tax supports the United States. Sales tax supports New Jersey. Real estate tax supports my local town. The reality is that all these governmental entities need funds to operate. And the estate tax REPLACES the capital gains tax for heirs due to the step up in basis that eliminates tax on appreciation in assets during lifetime (and all Americans benefit from this, not just those in the 1% that pays the estate tax).

(3) If not Inheritance Tax, then what?Inheritance Tax is a tax that falls disproportionately on the old (the typical case is of 60 year-olds inhering from 80 year-olds) and the rich. If we wish to repeal it, or raise IHT thresholds, then, unless we want to reduce government expenditure, the shortfall needs to be raised elsewhere. The chances are that it will be raised to a greater degree from those who are younger and poorer than those affected by IHT. Many of the opponents of IHT would be less sure of their position if questions about IHT were framed in a different way. Instead of "Would you like inheritance tax to be reduced?" the question should be "Would you like to replace inheritance tax with increased income tax or corporation tax?". Here again, thinking of IHT as part of a tax system, rather than in abstract isolation, helps to make the issues clearer.

This point is my main concern with the charge to repeal the estate tax. Assuming that government expenditures remain exactly the same, if the government takes in less revenue from elimination of the estate tax, where is it going to get the shortfall from? Likely you and me.

(4) Why Free Market Conservatives Should Love Inheritance Tax. Inheritance Tax is often seen as a policy of the Left rather than the Right, and it's certainly true that there are lots of good egalitarian reasons that support IHT. But this is only half of the picture. Those on the Right, and especially those who believe in the usual justifications for the free-market, should be just as enthusiastic as the staunchest socialist about the preservation of IHT. Here's why. Let us assume that we believe in the glories of the free market economy. If we give people responsibility, and set them on their own two feet, then they'll work hard and prosper. A free market in trade and employment gives us, let us suppose, a dynamic, innovative and thriving economy. It does this by incentivizing hard work, and letting economic rewards flow to those with the best ideas and the greatest capacity for hard graft.

But, if this is our vision of society, we surely must admit that the unearned windfall gains of inheritance tax distort this picture. Large inheritances distort the level
playing field which would allow the dynamic and innovative to prosper. If welfare payments cause listlessness and sap dynamism, then we can only assume that large unearned windfalls will do likewise. Indeed, these were precisely the sorts of arguments given by Teddy Roosevelt when he proposed an American federal
estate tax in 1906. As Andrew Carnegie (another proponent of IHT) put it "the
parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and leads him to lead a less useful and less worthy life than he otherwise would." One need hardly point out that neither Roosevelt nor Carnegie were approaching these issues from the left.

The solution? Inheritance tax can be used to fund education so as to create that level playing field and broad opportunities, or, perhaps, used to fund capital grants to young entrepreneurs. This is exactly the sort of scheme favoured by Bruce Ackerman and Anne Alstott, in their book The Stakeholder Society, where they advocate capital grants to each individual of $80,000 at the start of their working lives, funded by a progressive estate tax. One of the interesting features of this sort of scheme is that it is all about using the state to facilitate individual responsibility and to create opportunities, rather than simply doling out welfare. This is a much purer vision of a free market society than societies that are gummed-up and ossified by inherited advantage.

I took a tax theory class once long ago that echoed how the estate tax supports the capitalist society we are and is not merely a form of socialism. While I don't know if the government taking to give is realistic (I would rather save my own $80,000), the estate tax does support current government expenditures that could not exist without funding.

(5) Why the Left Needs To Be Less Defensive about Inheritance Tax. Just like the Democrats in the US, the Labour Party has tended to be somewhat defensive when reacting to proposals to abolish or reduce IHT. Rather than simply emphasizing that not all that many people pay IHT, Labour should be trying the difficult task of transforming public opinion on the issue. Perhaps the strongest arguments for IHT appeals to ideas of reciprocity and fairness that are very commonly shared.

Teddy Roosevelt took the view that "The man of great wealth owes a peculiar obligation to the State, because he derives special advantages from the mere existence of government." There would be no good in being wealthy if one could not enjoy stable property rights, the protection of the police, and the peace of a well-defended country, all of which need to be paid for. And individuals do not make their money in a vacuum, but by building on a broad history of innovation and development. This sort of reciprocity argument is also made by Bill Gates, Sr., father of the Bill Gates of Microsoft, in his book Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes. This sort of argument can get broad purchase with those of every political stripe, as is demonstrated by the fact that Roosevelt and Gates are hardly "soak the rich" firebrands or loonie lefties.

This point underscores the basic element of a progressive tax system - those who have more pay more because they have more disposable dollars (dollars not needed for the basics of food and shelter) for the community. Unless we go to a flat tax, a progressive tax system is what we have to work within.

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Category: Estate and Inheritance Tax

Courtesy of Elderlawanswers.com, the House has introduced a bill to modify the federal estate tax as follows:

With the estate tax set to expire in 2010, a bipartisan bill (H.R. 3170, click here. ) has been introduced in the U.S. House of Representatives that would increase the estate tax exemption by $250,000 every year from 2009, when the exemption is set to be $3.5 million, until 2015, at which point the exemption would have increased to $5 million. From 2015 on the exemption would rise at the rate of inflation.

The bill, introduced by Reps. Harry Mitchell (D-AZ) and Christopher Shays (R-CT),
would also create two tax rates: 15 percent for estates worth $25 million and
less and 30 percent for estates worth more than $25 million. Under current law,
the top tax rate will be 45 percent in 2009.

Earlier in the year, the U.S. Senate voted 51-41 to reaffirm its support for a budget resolution that establishes the current-law 2009 estate tax rules through 2012.

While this would simplify matters from a certainty viewpoint (it is very difficult to do planning for a tax code with an expiration date), my initial reaction is concern about the rates. When a person dies, capital gains are essentially eliminated through IRC Sec. 1014 where there is a "step-up" in basis - the heirs basis is date of death value; any gains accumulated during the decedent's lifetime are wiped out. If the estate tax rate of 15% is lower then the capital gains tax rate (currently 15%, but again scheduled to expire), the economic disincentive to sell stock during your lifetime continues. Perhaps if the desire is to lower the estate tax rate, it would make sense to have it match the capital gains tax rate so that death essentially becomes a realization event for tax purposes.

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