Tax, Trusts & Estates Law Monitor : Estate Planning Lawyer & Attorney : Cole Schotz Meisel Forman & Leonard Law Firm : NJ, Mid-Atlantic Gift Tax & Trust Issues

Attached is an article from Tuesday’s New York Times, which details the story of Dan L. Duncan, a Texas billionaire, who died in March 2010, and as a result of the 2010 federal estate tax repeal, will be able to pass his multi-billion dollar fortune to his family estate and generation-skipping tax free. This is the type of story that may trigger a strong reaction from Congress to not only finally move on estate tax legislation, but potentially retroactively apply it.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

As many of us know, the Qualified Personal Residence Interest Trust, or “QPRT,” is a common estate planning tool. An individual contributes his or her residence to a trust, but retains the right to live in the residence for a term of years (e.g., 10 or 20 years). The contribution of the residence to the trust is a gift, but the gift is reduced by the value of the individual’s retained interest, so the gift is much less than the actual fair market value of the residence.

The creation of the remainder interest typically constitutes a taxable gift by the grantor of the trust. This can limit the utility of a QPRT if a client already has used his or her $1 million lifetime gift tax exemption, or if the value of the remainder interest would exceed $1 million. For example, a $10 million New York City apartment will generally create a remainder interest of greater than $1 million if transferred to a QPRT (the calculation depends, of course, on the QPRT term of years, the discount rate in effect, the client’s age, etc.). This client may not be able to create a traditional QPRT without triggering a gift tax.

One planning technique that a client at this level might wish to consider is a “zeroed-out QPRT.” With a zeroed-out QPRT, the individual retains certain rights (ie, a limited power of appointment) over the remainder interest so that the initial transfer of the property to the trust is not a gift at all.  In other words, the actuarial value of the remainder interest is not gifted away and remains in the grantor’s estate. But if the individual survives the term of the QPRT, the future appreciation in value of the residence will be removed from the individual’s estate. Only the actuarial value of the remainder interest at the beginning of the trust term should be includible.

Let us return to the above example of a $10 million New York City apartment and assume the client is 65 years old and creates a 15 year QPRT to own the property. The remainder interest is allocated to its own trust, and the client retains a limited power of appointment over it. Based on the current actuarial tables, the grantor’s retained interest will be worth approximately $6 million and the remainder interest will be worth approximately $4 million. There should be no gift at the time of transfer due to the grantor’s limited power of appointment over the remainder.

Now let us assume that the client survives the term, and when the client dies at 81, the property has a value of $17 million. On these numbers, the amount includible in the client’s estate should be only the original $4 million remainder. All of the appreciation in the property has occurred outside of the client’s estate.

One downside to this technique is that the donees will receive the property with a carryover basis and not receive a step-up (assuming the step-up rules apply). Since the estate tax is greater than the capital gains tax, this generally does not present an issue, though it is worth noting that the scheduled increase in capital gains rates will worsen the income tax effects of a sale of the property.

The zeroed-out QPRT is an interesting application that may be a worthwhile consideration for certain clients. Please contact us if you would like to discuss this technique.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

We wanted to continue to update you on new developments over the past few months in matters related to the estate tax.

• Despite reports stating that an estate tax deal was imminent, on May 18, Senate negotiators said that an agreement regarding estate taxes was on the verge of collapse after a majority of the Democratic caucus expressed concerns about voting for an expensive tax cut for wealthy families. Senate Finance Commissioner Max Baucus (D-Mont.) said “there is no agreement on the estate tax in either substance or process. None whatsoever.” Lobbyists said they believed the deal would have resulted in a top tax rate of 35 percent with a $5 million exemption level for individuals ($10 million for couples), with both figures indexed for inflation. They also believed it would have eliminated the chances of a retroactive estate tax increase.

• We previously wrote about bills being filed in both the Florida House and Senate in February, 2010 to impose a Florida estate tax on non-residents who own real or personal property in Florida and who reside in states that tax Florida residents who own property in those states. If enacted, the law would have been effective July 1, 2010. Both bills died in committee on April 30.

• In New York, an amended version of a bill was recently introduced to amend the estates, powers and trusts law to deal with certain formula clauses in Wills and trusts for estates of decedents dying in 2010. The amended bill provides, in essence, that for decedents dying in 2010, a formula clause in a dispositive instrument providing for a bequest of the maximum amount that can pass free of federal estate or GST taxes, shall be construed with respect to the law in effect for decedents dying on December 31, 2009. While we encourage all clients to review their planning documents in light of repeal, this bill could serve as a backstop for those clients who have documents drafted with formula clauses that are not applicable as a result of the estate tax repeal.

• A similar bill was introduced in the New Jersey Senate on May 20 to clarify the interpretation of certain formula clauses in Wills and trusts executed before 2010.
   

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The IRS and New Jersey Division of Taxation have extended this year’s tax return filing deadline for residents of 12 New Jersey counties due to the flood emergency in the state.  Residents of these counties now have until May 11, 2010 to file their returns.

See the IRS Press Release on this topic by clicking here.

See the NJ Division of Taxation announcement by clicking here.

The extension applies to residents of Atlantic, Bergen, Cape May, Essex, Gloucester, Mercer, Middlesex, Monmouth, Morris, Passaic, Somerset, and Union counties.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

There have been a number of new developments related to federal and state level estate taxes over the past few months.

• House passes 10 year minimum term for GRATs. On March 24, 2010, the House passed the Small Business and Infrastructure Jobs Tax Act of 2010 which contains a provision instituting a 10 year minimum term for GRATs and a requirement that the remainder interest for GRATs be greater than zero. As we have detailed in prior blog posts, short term GRATs are an effective estate planning tool to transfer significant wealth to younger generations estate and gift tax free. If enacted into law, the use of GRATs will be severely limited. The bill now goes to the Senate for consideration. If you have been considering implementing a GRAT, you should move forward quickly before it is too late.
• NJ estate tax extended to non-residents? A bill was introduced on February 8, 2010 in New Jersey seeking to extend the New Jersey estate tax to non-residents who own real or tangible property in New Jersey. Currently, the New Jersey estate tax only applies to New Jersey residents.
• Florida estate tax on non-residents? Bills were filed in both the Florida House and Senate in February, 2010 to impose a Florida estate tax on non-residents who own real or personal property in Florida and who reside in states that tax Florida residents who own property in those states. If enacted, the law would be effective July 1, 2010.
• Federal estate tax repeal. We are three months into the one year estate tax repeal and there are no new significant developments. It remains pure speculation at this point whether the repeal will be replaced with a new estate tax law and if so, will the new law be retroactively applied so that the repeal is treated as if it never existed, or whether the repeal will run its course for 2010 and 2011 will bring a reinstated estate tax with much lower exemption amounts ($1 million federal exemption and generation-skipping transfer tax amounts).

We of course will be following all of these developments closely and will post updates if and when the status of the above matters change.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

It is fairly common for foreigners to invest in US real estate. Before doing so, however, they should consider the income, gift and estate tax implications of such investments and possible tax structuring (entities, trusts, etc.) to minimize exposure.

A foreigner may purchase US situs real estate directly and own the property or properties in his or her individual name, though this creates income tax reporting and withholding issues. In addition, if the foreign owner then dies, his or her US situs real estate is subject to US estate tax, often an unpleasant surprise for the surviving family members. This tax result is exacerbated because, generally speaking, foreigners do not get the benefit of a unified credit.

Example: Charles, a Japanese citizen, buys a New York City rental apartment valued at $2 million. He dies 10 years later when the property is worth $4 million. Absent other circumstances, Charles’ US situs property is subject to US estate tax. Assuming a 45% tax rate and no exemption, federal estate tax of $1.8 million will be due nine months from Charles’ date of death. New York estate tax would be additional. (Note that the federal estate tax is currently repealed, so these figures in this example apply only if/when the federal estate tax is re-enacted).

There are a number of steps that foreigners and their families should consider if faced with the situation of a foreign decedent owning US property, including:

Treaty relief.  If the US has an estate tax treaty with the decedent’s home country, the decedent may be entitled to a greater unified credit. A common treaty provision gives a nonresident alien decedent a unified credit equal to a fraction of the unified credit available to US persons. The fraction is equal to the percentage of the decedent’s US situs property over the decedent’s worldwide property. The greater unified credit permitted under a treaty can mitigate the estate tax exposure.

Post mortem QDOT.  A surviving spouse (often an nonresident alien too) can create a qualified domestic trust (“QDOT”) and transfer to it inherited US situs real estate. With a proper structure and a QDOT election in place, property passing to a nonresident alien spouse will qualify for the estate tax marital deduction. The effect of this is to defer the estate tax until the death of the surviving spouse, though it does not avoid the estate tax altogether.

Pre-death planning. There are any number of steps that could be taken prior to death to avoid US estate tax. Some common considerations include (1) annual exclusion gifts of interests in the property which will qualify for the gift tax annual exclusion, (2) transferring the real estate to a US corporation, since the shares of a US corporation – considered intangible assets whose situs is the domicile of the owner – are not subject to estate tax in a nonresident alien’s estate, or (3) transferring the real estate to another entity, the ownership of which will not be subject to US estate tax. Before taking any of these steps, the property owner should look into the income tax considerations (including FIRPTA), gift tax considerations, and reporting requirements that can be quite onerous. These approaches also should be considered for a surviving spouse’s portion of jointly owned property.

Conclusion. When a foreigner dies owning US situs real estate, the executor or surviving family members can consider a number of steps to reduce the US estate tax exposure.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

For the first time in almost 100 years, a federal estate tax does not exist.  On January 1, the federal estate and generation skipping transfer taxes were eliminated, but only for one year.  Click here to read about the current legislative uncertainty.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The following letter was recently distributed to clients and friends of Cole Schotz:

Dear Clients and Friends:

Due to Congressional inaction in the final weeks of 2009, the Federal estate tax has been repealed for individuals dying in 2010 and the generation-skipping transfer (“GST”) tax has been repealed for generation-skipping transfers made in 2010. However, current law provides that the estate tax and GST tax will be restored as of January 1, 2011 with only a $1 million applicable exclusion and a $1 million GST exemption, indexed since 1998 for inflation, as compared to the $3.5 million applicable exclusion and GST tax exemption that had been in effect in 2009. The Federal gift tax remains in place (though at a lower tax rate) with a $1 million exemption and will not change except as to certain specialized trusts.

It was widely anticipated in the tax and estate planning community at large that Congress would take action before the end of 2009 to prevent this result. Therefore, virtually all tax professionals determined that it was unnecessary for clients to undertake a review of their estate planning documents prior to the end of 2009. Since Congress did not act, however, it is important for you to be aware of this situation which will likely be resolved in one of the following ways:

1. Congress could pass legislation which reinstates the estate tax and GST tax with specified exemption amounts that would be retroactive to January 1, 2010;
2. Congress could pass such legislation that would be effective as of a later date; or
3. Legislation will not be passed in 2010, in which case, there would be no estate or GST tax in effect until January 1, 2011, when those taxes would be reinstated with a top estate and GST tax rate of 55%, an applicable exclusion amount of $1 million and a GST exemption of $1 million, indexed since 1998 for inflation.

Of course, other scenarios are always possible as Congress’ action or inaction is impossible to predict. We will closely follow all discussions in Congress, review all proposed bills, and advise you when legislation has been enacted. We also will post updates to our tax blog (www.taxtrustsandestateslawmonitor.com) on these matters as they break.

While the prevailing view is that Congress will address these issues and retroactively restore the estate and GST taxes effective as of January 1, 2010, there is no guarantee that this will occur. Therefore, it is important that you are aware that the current state of the law, with repeal in place, could create unintended results as to how your assets will pass at the time of your death and could result in adverse tax consequences. Whether your particular situation is impacted and, if so, in what manner, depends on the particular wording in your Wills, Trusts and other estate planning documents and on your family and financial circumstances.

Examples of only a few of the situations that could produce unintended results include (i) an allocation of assets between the children of a current or prior marriage and a surviving spouse and (ii) an allocation of assets between children and grandchildren, where such allocations are based on tax concepts that were in effect when your Wills were executed but are no longer in effect under current law. In both of these cases, assets may be distributed in a way that you did not intend. The potential tax consequences that could result if the repeal stays in effect are literally too numerous to mention here, and must be explored on an individual basis.

Another change that applies only in 2010 relates to the tax basis of inherited assets. Under the law in effect prior to 2010 and again in 2011, the tax basis of inherited assets generally changes to the value of those assets on the date of the decedent’s death. Under the law now in effect, however, the basis in inherited assets remains the same with two limited exceptions: (i) up to a $1.3 million increase in basis will apply to assets passing to beneficiaries on a decedent’s death and (ii) up to an additional $3 million increase in basis will apply to assets passing to a surviving spouse.

Given that the potential tax and distribution impact could be significant, we suggest that you contact a member of our Tax, Trusts and Estate Department to review the effect of this change in law on your estate plan, whether or not we drafted your estate planning documents.

Best wishes for a happy and healthy new year.

Very truly yours,

Cole, Schotz, Meisel, Forman & Leonard, P.A.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

To the surprise of most estate planning practitioners, the arrival of January 1, 2010 brought with it a federal estate tax repeal. Congress was unable to compromise prior to year end on legislation that would have either maintained the status quo ($3.5 million applicable exclusion amount and a 45% estate tax rate) or implemented new exclusion amounts and/or tax rates.

As a result, the following rules apply in 2010:

• There is no federal estate tax;
• There is no generation-skipping-transfer (“GST”) tax;
• While the gift tax exclusion amount remains fixed at $1 million, the gift tax rate drops to 35%; and
• The basis step-up for inherited assets is eliminated. In its place, beneficiaries will inherit assets with the basis of the decedent (assuming the asset has appreciated). There are two exceptions: (i) there will be a $1.3 million increase in basis to assets passing to beneficiaries on a decedent’s death and (ii) there will be an additional $3 million increase in the basis of assets passing to the decedent’s surviving spouse.

The prevailing belief among estate planners is that Congress will act soon to re-institute the estate tax and make it retroactive to January 1, 2010. If Congress fails to act in 2010, the federal estate tax will be reinstated by law on January 1, 2011 with a $1 million applicable exclusion amount and a $1.2 million GST exclusion.

This is a brief summary of the major estate tax changes as a result of the repeal. We will be blogging frequently on this topic as developments unfold. Please also look for a letter we are mailing out to our clients and friends explaining some of our concerns regarding the repeal, a copy of which will be posted to the blog shortly.

• Email This
• Print
• Comments
• Trackbacks
• Share Link