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

 2010 is the year of no estate tax.  It only goes to follow that the wealthiest of all Americans are rejoicing that they need not share their wealth with others, and can go back to counting their coins without worry about the government asking for their share, right?  Wrong.  It turns out that "34 Billionaires Are Giving Half of Their Fortunes Away" according to Time Newsfeed.

A a few week ago Bill Gates and Warren Buffet announced that they were going to solicit the very exclusive club they belong to, America's Billionaires, to donate at least 50% of their fortunes to charitable causes during their lives or after their deaths through The Giving Pledge.  The Giving Pledge is described as an effort to "invite the wealthiest individuals and families in America to commit to giving the majority of thier wealth to philanthropy."  You can even view pledges to see who has made the pledge so far.  Some names you will recognize

• Michael Bloomberg
• Warren Buffet (who is leaving 99% of his wealth to charities)
• Dian Von Fursetnberg
• Bill and Melinda Gate
• Barron Hilton
• George Lucas
• Ted Turner

You can even see what has motivated these people who have been blessed with success to give back.. George Lucas' passion is educational innovations.  Michael Bloomberg believes that "by giving, we inspire others to give of themselves, their money or their time."

Within the estate tax code has always been the concept that you can give it in taxes, or give it to charity.  Charitable gifts are not subject to tax.  The acts of these individuals inspires me to think "Why don't more people take charge of where their money is going on death and instead of leave it grumbling to the government, leave it to cause you believe in?."   Think of all the change if The Giving Pledge was not limited to only America's billionaires?  The Giving Pledge has inspired me to have more through discussions with my clients about trading tax dollars for philanthropy.

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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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In doing some client research I came across a great resource "State Death Tax Chart" published by the law firm McGuire Woods.  State death tax can be relevant no matter where you live, because it could apply to:

• Real estate you own in another state
• The consequences for beneficiaries who reside in another state
• Where you may want to consider relocating your residence to
• Questions about a parents estate who lives somewhere else in the country

The chart is updated through March 2010.

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The New York Times ran an article this week "Saying ‘No Thanks’ to a Bequest".  In the article, Deborah L. Jacobs explores how a disclaimer provision either included in an estate plan, or created after death, can achieve some estate tax savings in this environment of uncertainty about the federal estate tax this year or next.

In an estate plan a "Disclaimer" is when a beneficiary says "No, I don't want that part of my inheritance."  Now, why would a person not want an inheritance?  Well, for a spouse, a disclaimer is used more accurately to say "I don't want to take my inheritance outright, and therefore it should pass to a trust where I am a beneficiary." This trust could capture the exemption amount from federal estate taxes if and when the federal estate tax comes back.  A disclaimer creates flexibility in a period of uncertainty as the spouse doesn't have to decide now if it makes sense to fund the trust, they can wait and see what the tax laws are at the time the first spouse dies.

The article outlines how a disclaimer works, the benefits of disclaimers (flexibility being key) and some of the drawbacks (what if the spouse doesn't disclaim, or accepts the assets so they can't disclaim).  However, I think the article misses one key point about how using disclaimers to create trust can create inflexibility.  If a person sets up a trust in their Will and directs that it be funded (i.e.: put $1 million is this trust) instead of allowing it to be funded through a disclaimer (i.e.: I spouse disclaim $1 million which will now pass to a trust), then the trust can give a person a "Power of Appointment" over the trust.  

A "Power of Appointment" essentially allows a person to change who gets the trust funds and how after the death of the decedent.  This is incredibly powerful in using a trust.  A trust will last for years or decades after your death.  Unless you have a crystal ball, you don't know what will happen to your beneficiaries, or what the tax laws will be in the future.  By setting up a trust for your spouse and children, and giving your spouse a Power of Appointment, your spouse has the ability to change how your children eventually get your assets after your spouses' death.  For example, if a child has a health issue, your spouse can change the trust to leave more to that child, or to leave it to the child in trust instead of outright.  Without the Power of Appointment the child might get money that would negate other benefits he was receiving.

So how to balance the flexibility of a disclaimer with the flexibility of a Power of Appointment? In New Jersey, where we have a state level estate tax of $675,000, we recommend a "3-Part Will".

• Part 1 - An amount equal to $675,000 goes to a family trust with a power of appointment in favor of the surviving spouse
• Part 2 - An amount equal to the difference between (1) the federal estate tax exemption amount (if any) and $675,000 go to the spouse - the spouse can disclaim this amount to a family trust if it makes sense from an estate tax perspective
• Part 3 - The balance to the spouse  

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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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Depending on your passion, March Madness, Fashion Week or the Indianapolis 500 could be what you look forward to immersing yourself in every year. For estate planners, we look forward to the annual Heckerling Institute sponsored by the University of Miami School of Law.  For one week each January it is chance to go back to the classroom, and immerse yourself in what is working, what is not, a what is on the horizon for estate planning and tax law.

So next week I will be in Orlando as a student to refresh my knowledge, renew the creativity bank and reconnect with the theoretical of the law as opposed the practical day to day.  I will be tweeting updates to #heckerling and posting my thoughts about new and old techniques in the weeks to come.

This is a great opportunity to pick others minds, so comments about what you would like to know would be welcome.  I am sure lots of commentary will focus on what to do in our 365 days of estate tax repeal.

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 My two prior posts have been about the  federal tax impact for single individuals who die in 2010, and the federal tax impact for married individuals.  In summary the results for singles were not good, and for marrieds were worse – the "death" of the estate tax creates a capital gains "trap" for survivors.  While all this will be moot if Congress does as they have promised and create an estate tax retroactive to January 1, 2010, they haven’t acted yet, and as of January 1, this is the law.

What planning can be done in this environment?

Can you just say “whoo-hoo”; I’ll give everything to my children.  Hold on there – the federal estate tax is repealed in 2010, not the federal gift tax.  Each person still has a lifetime exemption of $1,000,000 – if you make gifts in excess of that in 2010, you will be subject to the federal gift tax at a rate of 35%.

However, the generation skipping tax (“GST tax”) is repealed in 2010.  The GST Tax essentially says that you can only leave up to $3.5 million to grandchildren without paying a separate tax of 55%.  The theory behind the GST Tax is that the government should share in the wealth at each generation.  If grandma leaves everything to granddaughter, the IRS might need to wait 75 years until tax can be collected again.  If assets go the children, the IRS might only have to wait 30 years to tax again.  So, in 2009 you could leave up to $3.5 million to grandchildren without GST tax. In 2010, you can leave everything to grandchildren without an additional tax.  For wealthy families, this could mean a huge amount passing to lineal descendants with the only tax cost(s) being capital gains (click here for an explanation of the 2010 capital gains tax trap for estates).

The estate plan you had in 2009 and will need again in 2011 won’t really make sense in 2010 unless they make the estate tax retroactive.  Do you need to go out and totally revise your plan? Not necessarily.  If you have a terminal situation however, it definitely bears looking at your current plan to make sure it addresses how to plan to minimize capital gains taxes instead of estate taxes.

Gifts to grandchildren may be a winning strategy in early 2010.  Also, for anyone who is terminally ill, a change of an estate plan to leave assets to grandchildren may be a winner as well (although if the estate plan isn’t changed, disclaimers may be able to be employed by the children to a similar effect).  And it will bear looking at the estate plan of anyone who is terminally ill.

Image: Danilo Rizzuti / FreeDigitalPhotos.net

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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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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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In reviewing the Obama administration's first 200 days, CNN Money correctly predicts that the next 200 days will bring and shift to taxes.  Regardless of where we end up on health care, where is all the money going to come from for all the hundreds of billions ($X00,000,000.00's) that have already been spent?
 

Some thoughts:

• New Health Care cost related taxes will be in the works - somebody will need to pay.  Could be reduction in itemized deductions for certain income earners, surcharge to income earners, additional taxes to insurers, or reduction of the tax free nature of employer provided benefits.
• Extend the estate tax for at least one year at the current levels of $3.5 million exemption per person and 45% maximum bracket.  They won't let the estate tax expire in 2010.  The question is if they will push one year, or just make it permanent at existing levels to not have to address again in 2010.
• Closing "Corporate Tax Loopholes" - This may be combined with a rate reduction.  The thought is the certain provisions make it less expensive to operate offshore.  The goal would be to make it more expensive to operate offshore, but create an incentive to operate, and thereby employ in the US, so the tax revenue effect may be flat.

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