Dedon on Estate Planning

Gift Tax and the Statute of Limitations

A U.S. Tax Court decision filed March 6^th, Dickerson v. Commissioner, regarding a waitress who won $10 million in a lottery, is extremely relevant for gift tax law.  The waitress tried to shift the winnings to family members without incurring a taxable gift.  The IRS disagreed, claiming there was a gift, and the Tax Court concurred.

The relevance is not so much the facts of the case, since few of us win lotteries, but rather the procedural aspects of the case.  The waitress won the lottery in 1999 but did not file a gift tax return until 2007.  In 2008, the IRS asserted that gift tax was owed.  The Tax Court heard the case in 2010, which resulted in its decision last week.

The legal importance is that there is no statute of limitations on gifts if a gift tax return is not filed.  Further, the gift tax return needs to provide the necessary information, such as asset appraisals, to put the IRS on notice of the substance of the gift.  Absent filing a gift tax return, or filing the proper return, the statute remains open and transactions that taxpayers may think have been closed remain vulnerable to IRS challenge.

In 2011 and 2012, when numerous taxpayers are taking advantage of the $5 million exemption amount (now $5,120,000) while it exists, Dickerson highlights the importance of properly making the gift and documenting it.

Income Deduction of Estate Planning Fees

With April 15^th approaching, it reminds us of the need to file our income tax returns. When preparing estate planning documents, clients often ask, "are these estate planning fees deductible?"

The cost to do a simple Will, Power of Attorney and Medical Directive are personal expenses and not deductible. However, a portion of the cost to prepare a comprehensive estate plan, involving a revocable trust to avoid probate and a marital and credit trust to reduce or eliminate estate taxes, is deductible.

How do you distinguish between the personal expense allocable to the non-deductible planning and the deductible expense attributable to the tax planning and the property preservation? It depends on each case and the fee charged, but it is likely 60% to 75% of the total fee is deductible. These fees are analogous to advisory fees paid to a financial planner. Of course, how this applies to your own tax return and the 2% miscellaneous deduction rule, is for you and your CPA to sort out.

Planning to Use Exemption Amounts

Set forth below is an article published last week in VA Business Magazine pertaining to how a married couple can each use their $5,120,000 gift exemption while the opportunity lasts, and yet still benefit from the assets.

Download Va bus mag art 2-16-12

 

 

Let the Games Begin

President Obama’s 2013 Budget proposal was released this week. As expected, there are restrictions on estate and gift tax strategies that have been useful during 2011 and 2012. A couple of the proposals are repeats from his prior recommendations. These include eliminating 2-year rolling GRATS and valuation discounts between family members.

Most significantly, the President desires a $3.5 million estate tax exemption and a $1 million gift and generation skipping tax exemption. Thus, for 2013, as during 2009, a married couple can protect $7 million upon death, and can gift $2 million during their lifetimes. The estate tax rate would be 45%. These proposed limits would dramatically reduce the current advantages available to wealthy taxpayers, which allow for a $5 million exemption amount upon death or for lifetime gifts. As relatively bad as the Obama proposal is for estate planning purposes, if Obama and Congress fail to agree on estate legislation in 2012, in 2013 the death and tax exemption amounts will be only $1 million per person and a 55% tax rate.

What does it all mean? A lot of uncertainty, but for wealthy taxpayers considering asset transfers, act this year.

Substantiating Charitable Deductions

Taxpayers who claim income tax deductions for charitable contributions must request and obtain the written acknowledgement from the charity that the contribution was made. It is due by April 17, 2012, the time the income tax return is filed. Failure to have the required substantiation from the charity can void the tax deduction. Below is a sample letter.

　

CHARITY NAME

____[Date]_______

　

[Name of Donor]

[address]

 

Dear ____________:

Thank you very much for donating $_________ to Charity during 2011. This letter acknowledges your generous donation. No goods or services were received by you in consideration of this gift. Therefore, the full amount is deductible to the extent allowed by the Internal Revenue Service regulations.

Thank you for your support.

Sincerely,

 

___________________________________

_____________________, [Title]

Charity

The More Things Change, The More They Stay The Same

On January 10^th, PricewaterhouseCoopers hosted a webinar pertaining to potential tax legislation in 2012. The panelists concluded that, despite a number of tax provisions that will expire, a huge deficit, and a continuing clamor for significant tax reform, it is unlikely there will be major legislation during this election year. Rather, it is very likely that, in 2012, taxpayers will face the same planning uncertainty they did in 2010; namely, the next year looming with a $1 million gift and death tax exemption.

Thus, Congress will act (or not) sometime between Thanksgiving and New Years. In 2012, however, in contrast to 2010, there are additional pressures which do not bode well for the continuation of this year’s $5 million gift and estate tax exemption, such as a lame duck Congress and a scheduled $450 billion cut in defense spending. There could also be a new President. Absent other cuts or tax increases, the tension between reduced spending or increasing taxes or both, will continue to dominate the debate.

Business Owners and 401(k) Compliance

Attached is an article I wrote that was recently published in the Virginia Business Magazine pertaining to 401(k) plans and common employer compliance failures. According to an IRS study, 64% of the plans audited are not in compliance, causing problems for businesses and potential personal liability for Board members.

Download Va bus mag art 1-4-12

Happy New Year

The end of the year and the start of a new one is the traditional time for retrospectives and predictions. In the estate world, the dominate theme in 2011 was the extraordinary asset transfer opportunities available to the wealthy. Specifically, the right to give $5 million ($10 million for a married couple) to children or other beneficiaries in a Dynasty Trust and thereby avoid estate tax on those assets and their appreciation forever. Using a Dynasty Trust also provides asset protection advantages so that the transferred assets remain in the bloodline in perpetuity.

These transfers also could be discounted for transfer tax purposes, so that the transferred assets are worth only 60% to 70% of their underlying value. The gifts could be leveraged to allow for even greater asset transfers, through techniques that benefit from low interest rates, such as GRATs or a "gift and sale to an Intentionally Defective Trust." (See the prior December 6, 2010 Post, where a number of articles about these techniques are cited.)

In short, the stagnant economy, low interest rates, and advantageous gift and estate tax laws, combined for a banner year for wealthy taxpayers doing estate planning.

Will this optimal estate planning environment continue in 2012? Most everyone expects the dismal economy and low interests rates to continue. The $5 million exemption amount also is scheduled to remain during 2012. However, there is a remote possibility that tax legislation later in 2012 could retroactively reduce the exemption amount for all of 2012 (emphasis on "remote"). Thus, it is likely that, until 2013 when the exemption amount falls to $1 million, the $5 million exemption remains.

In the Obama administration and Congress’ sights for 2012, however, is legislation to eliminate discounts on intra-family transfers; limiting Dynasty Trusts to only 90 years; and eliminating some of the advantageous transfer strategies, such as 2-year GRATs.

On balance, 2012 starts with the same advantages that applied in 2011. So those who wanted to act but failed to do so still have the opportunity to transfer significant assets estate and gift tax-free, at least early in 2012 and perhaps up to December 31, 2012. Not all asset transfer strategies, however, may survive the entire year.

Crummey Is Still Crummy

Clients have asked about the recent Tax Court memorandum decision, Estate of Turner v. Commissioner, T.C. Memo. 2011-209, where the Court held that contributions to an irrevocable trust to pay life insurance premiums qualified for the annual exclusion even though the taxpayer paid the premium directly to the insurance company and the beneficiaries never received notice of the premium payment. (The primary issue in Turner centered on a family partnership created for estate planning purposes, but that is the subject of another post.)

The Crummey withdrawal right, annual exclusion gifts and the payment of insurance premiums to an Irrevocable Life Insurance Trust, is irrelevant to many. But for those who have irrevocable trusts to hold life insurance so that the death benefit is not in their estates, the Crummey withdrawal right is extremely important.

The Crummey withdrawal right, named after a taxpayer in a 1968 case, stands for the proposition that the payment of an insurance premium for a policy owned by an irrevocable trust qualifies for the annual exclusion only if it is a "present interest." A present interest means an immediate right to withdraw the contributed premium. But when the premium is paid to a Trust, there typically is no immediate right. The Crummey withdrawal right gives the beneficiary the right to take out his or her share of the insurance premium. For example, if the premium paid to the Trust is $10,000, and the Trust has two beneficiaries, the trust would have explicit language giving each beneficiary the right to withdraw $5,000. If the beneficiaries waived the withdrawal right (as expected), the Trustee then pays the insurance company the premium.

Traditionally, the taxpayer had to make the premium payment to the Trustee and the beneficiaries needed to be aware of the right to withdraw the premium. The rationale being, how else could there be a right to withdraw the money if funds were not in the Trust and the beneficiaries did not even know about it?

This background takes us to the Turner case. The Court stated that the taxpayer could pay the insurance company directly and the beneficiary did not need to know about the withdrawal right. Under Turner, the law was satisfied because the Trust had language allowing for the right to withdraw the payments. If the Turner case was the law, it would avoid the huge inconvenience that taxpayers face in complying with the Crummey right each year. Turner may also rescue many taxpayers who are supposed to comply with the Crummey right but do not.

But does Turner provide that relief? On one hand, it is a Tax Court decision. However, it is a memorandum decision issued by the Tax Court, not a Tax Court opinion, and there is a difference in precedential value. Further, it is unlikely the IRS would acquiesce in Turner. So until there is an acquiescence or the decision is affirmed by one or more Circuit Courts, taxpayers would be well advised to stay the course and continue to put up with the inconvenience of the Crummey letter and payment to the Trustee. My guess is the IRS will continue to litigate this issue.

The All Important “Ascertainable Standards”

I have written in the past about designing Trusts for children. Indeed, you can see under the "Most Popular Posts" section of my blog, a post devoted to the subject.

In planning for children, the question always comes up: upon the death of the second parent, how do I protect the children so that they have what they need but not so much it saps the children’s motivation to lead a productive life? As the prior posts describe, most Trusts address this objective with "ascertainable standards." Ascertainable standards provide parameters for Trustees to utilize in deciding what is appropriate for the Trust beneficiaries. When a client names an institutional Trustee or a third party Trustee, these standards protect the independent Trustee so that the beneficiary cannot compel extravagant distributions. At the same time, those standards ensure the beneficiary receives necessary distributions and the Trustee is not acting arbitrarily.

Ascertainable standards are also important for estate tax purposes. Sometimes the client creates a "Dynasty" Trust for the child’s lifetime where the child is the beneficiary and also is named as the sole Trustee. Despite serving in these dual roles, the Trust assets would not be taxed in the child’s estate upon the child’s death if the Trust is governed by ascertainable standards. In other words, provided the client trusts the adult child to spend Trust assets wisely, the child can serve as beneficiary and the sole Trustee and avoid estate tax inclusion at the child’s death. However, if the Trust does not have ascertainable standards, these estate tax advantages are lost. (By the way, these same ascertainable standards allow the client to name a surviving spouse as the beneficiary and Trustee without triggering tax in the surviving spouse’s estate.)

So what are ascertainable standards? As described in prior posts, they are defined as "health, maintenance, support and education." These terms, ostensibly common and innocuous, have deeper meaning in the Trust world. These terms are accepted by the Courts and IRS as providing sufficient guidelines for Trustees in administering Trusts. On the other hand, when drafters stray outside of these four words, the tax advantages may be lost. Such was the case in a recent Tax Court decision, Estate of Chancellor v. Comm’r, T.C. Memo. 2011-172, where the IRS argued that the inclusion of the word "welfare" jeopardized the advantages of the Trust because "welfare" was not an ascertainable standard. Although the IRS ultimately lost and the Tax Court did not subject the Trust assets to estate tax in the beneficiary’s estate, it required a Tax Court case to reach that conclusion. Chancellor teaches us that clients and their attorneys are well advised to stay within the well accepted "health, maintenance, support and education" standards in designing their Trusts.