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

2009 has been an interesting year for estate planners. The arrival of 2009 brought an increase in the applicable exclusion amount to $3.5 million (from $2 million in 2008), meaning taxpayers with proper planning could shield this amount from the imposition of federal estate taxes. 2009 also brought the scheduled estate tax repeal for a one year period beginning on January 1, 2010 that much closer.

Notwithstanding the fact that we are now less than seven months away from a temporary estate tax repeal, there is a prevailing belief among estate planners that Congress will change the law before 2010 preserving some form of the estate tax, especially in light of the economic meltdown and the federal deficit.

In fact, numerous bills have already been introduced in Congress detailing estate tax parameters for 2010 and beyond. With respect to the applicable exclusion amount, three separate House bills have been introduced with exclusion amounts equal to $2 million, $3.5 million and $5 million, respectively.

For the most part, the estate tax rates in these bills are set at the current 45% estate tax rate, and some impose surtaxes on estates in excess of $10 to $25 million.

Other important items are addressed in these bills as well. For example, there is a mention of unifying the gift and estate exemptions, meaning if this were part of the new law (we believe unlikely at this point), the $1 million lifetime gift exclusion amount would be increased to equal the estate tax exclusion amount. This certainly would expand the ability of a taxpayer to implement more lifetime transfer planning.

Some of the bills include the concept of making the estate tax exclusion portable for couples, meaning for example if a husband does not utilize his full exclusion, his wife could utilize not only her exclusion, but his as well.

Finally, there is language in one bill which would restrict the use of valuation discounts typically applied to the ownership of closely held non-business family entities. These discounts are an integral part in transferring wealth to the next generation.

We will be keeping a close eye on estate tax legislation throughout the year and will report to you the new estate tax law as soon as it is passed.
 

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Intra-family loans offer a conservative way of using interest rate arbitrage to achieve guaranteed estate tax benefits. The technique can be a powerful tool in today’s uncertain economic climate.

Intra-family loans take advantage of the spread between IRS prescribed interest rates and the interest rates available in the capital markets. For example, in July 2009, the “applicable federal rate” prescribed by the IRS for a three year note is 0.82% and a jumbo CD can be found with an interest rate of 4%.

Consider this example: Client creates a new irrevocable, generation-skipping tax exempt grantor trust for the benefit of his family. He makes a gift of $1 million and then loans the trust $9 million in exchange for a three year promissory note bearing interest at the applicable federal rate of 0.82%. The trust takes the $10 million and simply invests it in a jumbo CD as described above. The trust will receive interest income of $400,000 per year and have to pay out $82,000 per year in interest on the promissory note, a net gain of $318,000 per year, which accrues to the trust income, gift and estate tax-free. In three years, the trust will have accumulated $954,000 on a tax-free basis. At that time, the trust can repay (or refinance) the note.

The market downturn of 2008-2009 has wreaked havoc with many estate plans as transferred assets have lost value or failed to meet investment expectations. Intra-family loans are a conservative method for achieving estate tax benefits in today’s economy. Readers who are interested in intra-family loans should contact their tax attorney.
 

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Earlier this month, the New Jersey Appellate Division, in Hadfield v. Lillo, held that a decedent’s ex-spouse was not entitled to the proceeds of a life insurance policy where the decedent, after obtaining a divorce, failed to change the beneficiary designation of a life insurance policy on his life. This case represents a fairly straightforward interpretation of New Jersey’s “revocation on divorce” statute.

NJSA 3B:3-14, amended in 2005, provides that a divorce revokes any revocable dispositions made by a divorced individual to his or her former spouse in a governing instrument (which includes a life insurance policy), except as otherwise expressly provided. Prior to the amendment, the statute simply provided that if after executing a will the testator divorces, the divorce revokes any dispositions of property to the ex-spouse under the decedent’s will only.

The decedent in Hadfield was divorced prior to and died after the 2005 amendment. The ex-spouse argued that the amended version of the statute should not apply because it was not in effect at the time of the divorce. The court rejected this argument and retroactively applied the amended statute after reasoning the ex-spouse had no vested right in the insurance since the decedent could have changed the beneficiary designation at any time.

The law is similar in New York. Under NYEPTL 5-1.4, a divorce revokes the former spouse’s rights not only under a will but also by beneficiary designation of an insurance policy. The statute, by way of recent amendment, specifically references the beneficiary designation of a life insurance policy.

A shortcoming to the statutes is that life insurance frequently is owned by a spouse’s irrevocable insurance trust and the irrevocable trust is designated as the beneficiary. The statutes highlighted above deal with the revocation of revocable dispositions made by a divorced individual. As a result, absent specific language in an irrevocable trust to the contrary, a divorce will not revoke the designation of the irrevocable trust as the beneficiary and will not terminate an ex-spouse’s rights under the trust. It is also important to note that the state level revocation upon divorce statutes do not apply to ERISA governed retirement plans, such as IRAs, 401(k)’s and other employer-provided plans, a rule which adds confusion to this area.

A life changing event such as a divorce should always result in an extensive review of one’s estate plan.
 

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