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The Trusted Adviser

June 2010 | Volume 3 • Number 6

Update from ATG Trust Company

In 1972 the federal estate tax was effective for estates over $60,000. Through much iteration it eventually rose to an exemption limit of $3,500,000 in 2009. In 2010 it is unlimited. Then in 2011 it goes back to the 2001 rules of a $1,000,000 exemption. Or, maybe it won't.

There is serious talk now about repealing the repeal of the estate tax retroactively. Simply put, this is taxing the dead but waiting until they are dead to tell them about it. Politics aside, this is a difficult issue to fully discuss with clients, partly because estate planners are split on just what is the right thing to do.

Let's start with presuming the repeal is effective for all of 2010 and then reverts to the 2001 limits, as the law reads today. What to do?

Some rushed to get a qualified terminable interest property (Q-TIP) in place before December 31, 2009, to lock in the then $3.5 million exclusion, believing Congress will not let this go untouched as it scrambles for revenue. But that is history.

One scenario says take no action: Wait it out and see what happens next year. The problem with that is the law of unintended consequences. Many typical "A/B trust" estate plans read that the estate should be set up so that the marital portion, going to or directly for the surviving spouse's benefit, should be the (paraphrasing) "least amount that would cause no federal estate tax to be paid" but in much more eloquent verbiage.

As of today that "least amount" would be zero. That means everything goes to the family trust. Depending on the terms of the family trust, that could be devastating to the surviving spouse, especially in a second marriage situation where relying on the kindness of the children may be less than prudent planning. It seems doing nothing is potentially tempting fate. At the very least, it seems prudent to review your standard "A/B trust" language and consider contacting those clients potentially in this boat to apprise them of the potential.

Other Changes

In addition to estate tax issues, a lot has changed in 2010.

There is no more automatic step-up in tax basis. Instead, the basis of property acquired from a decedent will be the lesser of the decedent's adjusted basis or the property's fair market value on the decedent's date of death. Under this rule, it is possible that the cost basis of property will be steppeddown. The beneficiaries of an estate now need to know what the decedent's cost basis was. Good luck with that.

There are two exceptions to the carryover basis rules. You can allocate up to $1,300,000 to various assets owned by a decedent, increasing the cost basis of those assets.

And another $3,000,000 of basis increase can be allocated to properties passing to a spouse or to a special "qualified terminable interest property" trust for the spouse (often called a "Q-TIP" trust or a "marital" trust).

New Focus on Capital Gains

Assuming the new carryover basis rules stay in effect, there are some things to consider for the very old and terminally ill. Rather than an estate tax issue in 2010, it is a potential concern as to which beneficiaries get which assets, especially highly appreciated ones.

Planners need to consider the amount of capital gain tax that would be assessed if the property were sold in 2010, the relative tax brackets of potential beneficiaries, whether the inherited asset would likely be sold by the recipient, and, in the case of a spousal bypass trust, whether the property would qualify for the spouse's basis adjustment. It could also affect how any charitable legacies are funded.

Also, for the very ill or aged it has always been wise to consider sellingdepreciated assetsprior to death to at least capture the loss for future generations.

Gift Tax Changes

The federal gift tax was not repealed but now has a lower 35% rate of tax, down from the 45% rate in 2009. Under 2010 law, each person may give away during lifetime as much as $1 million in cash or other property without generating any gift taxes. Any gifts that exceed this amount will be taxed at 35%. The annual exclusion remains at $13,000.

Generation-Skipping Tax

The federal generation-skipping transfer tax (GST) has been repealed for the 2010 tax year. But it comes back in 2011. Under the old law you could give away during lifetime or at death up to $3.5 million (the "GST exemption") without imposition of the generation-skipping transfer tax. Any gifts to grandchildren or great-grandchildren (and to certain other persons two or more generations younger than the person making the gift) in excess of the GST exemption would have been subject to the GST tax, which was equal to the highest marginal estate tax bracket (45% in 2009). This is reinstated in 2011, and the available GST exemption will be reduced to its former level of only $1,000,000 (although this amount will be indexed for inflation) and with a 55% rate of tax.

The chart below illustrates the rate changes:

 

 

Year	Lifetime Gift Tax Exemption	Total Gift and Estate Tax Exemption*	Generation-Skipping Tax (GST) Exemption	Gift, Estate, and GST Taxes/Top Rates
2009	$1 million	$3.5 million	$3.5 million	45%
2010	$1 million	Unlimited	Unlimited	35%
2011	$1 million	$1 million	$1 million	55%

Filing Requirements

For 2010 decedents with estates in excess of $1.3 million or that acquired certain property by gift within threes years of death, executors are required to file an information return that is due with the decedent's final income tax return. So, this information return is basically due by April 15, 2011. The IRS has not released a form yet, but failure to file the return is subject to a penalty of $10,000 — so be on the lookout.

Magically Appearing Tax Liens

If we were holding assets in a significant estate, say $1,000,000 or more, where the beneficiary was someone other than a surviving spouse, and the decedent died in 2010, we would be thinking long and hard before making distributions. If the rules are repealed retroactively there could be estate tax liens (or other arising tax consequences) that would simply appear by a pen stroke of Congress. The best receipt and refunding agreement ever will not help if the money is simply gone. Caution is advised, friends.

How Do the Tax Liens Appear?

We asked one of our legal researchers to sum it up. It seems odd that the words "whim" and "tax lien" would be used together, but there you have it. It could be a thorny issue for real estate title insurance as the last sentence of the quote below points out:

 

 

 

 

"The consequences of retroactive estate taxes will be determined first and foremost by the language of the Congressional action. The exemption limit and any special provisions to ease the burden on taxpayers caught without sufficient liquid assets will be at the whim of Congress. Conservative estate planners should prepare for Congress to simply impose tax liabilities enforceable through standard federal tax liens. Estate taxes are imposed under Title 26, Chapter 11 of the U.S. Code. Unpaid estate taxes are enforceable by special estate tax liens under 26 USC &§ 6324(a) against the taxpayer's gross estate. The gross estate generally consists of "the value at the time of [the taxpayer's] death of all property, real or personal, tangible or intangible, wherever situated." 26 USC &§ 2031(a) (2006). The lien lasts for ten years from the date of the decedent's death. 26 USC &§ 6324(a)(1). Although the circuits have disagreed, the Seventh Circuit has held that the ten-year limitation is durational, so the lien expires after ten years regardless of whether the government files suit; a suit that is not concluded within ten years becomes moot because the lien expires. See United States v Cleavenger, 517 F2d 230 (7th Cir 1975); see also United States v Davis, 52 F3d 781 (8th Cir 1995); United States v Potemken, 841 F2d 97 (4th Cir 1988). Tax liens "arise automatically and secretly" by operation of law at the moment a decedent dies. Cleavenger, 517 F2d at 234; see 26 USC &§ 6324(a). Therefore, the government does not need to make any filing or recordation of the lien. Cleavenger, 517 F2d at 232. Timely paying the tax avoids enforcement of the lien. In the event that Congress retroactively imposes 2010 estate taxes, absent other provisions, liens will arise automatically upon every estate of every decedent subject to estate taxes. If not successfully enforced within ten years of each decedent's death, these liens will expire. Depending on what Congress does or does not do, a title commitment on property of a decedent dying after 2010 may require inclusion of exceptions for death taxes such as: Federal and [Illinois, Indiana, or Wisconsin] estate taxes that may be charged against the estate."

Planning Opportunity for Gifts

Uncertainty can mean opportunity. Clients might be able to save taxes, even if a retroactive law is passed.

Before January 1, 2011, or a new law is enacted, suppose a grandparent makes a gift, for example, of $10 million to a trust for the spouse of the grandparent with the grandchildren as remainder beneficiaries. Because this is a spousal gift there is no gift tax on the transfer. But, using careful language, the spouse should be able to disclaim the gift, meaning it would pass to the grandchildren under the terms of the trust. That would make this a taxable gift as of the date of the gift to the trust. The trick is to not make the disclaimer until the rules are clear so timing is everything. Of course, the spouse should not accept any distributions from the trust prior to making a decision about a disclaimer.

If no retroactive law is passed or it is and then found unconstitutional (as some scholars think) and the spouse effectively disclaims, gift tax at 35% is imposed instead of the 45% under old law or 55% in 2011. Since the generation-skipping tax disappeared in 2010, there is no GST; the resulting tax, after using the unified credit, is $3,150,000.

If Congress retroactively enacts the estate and GST rules as they were in 2009, the higher rates would apply and the total tax due on a disclaimer would be $5,322,500, over $2,000,000 more than initially planned. So, the spouse just does not disclaim. A gift tax return is filed in 2011 treating the trust as qualifying for a marital deduction. No tax is due and the trust is in effect for the spouse.

States' Rights

Let's not forget than any federal retroactive estate tax law could also affect what states that impose an estate tax might do. We have heard nothing of changes in that arena for Illinois but it is prudent to be mindful, especially with the budget deficits states are facing.

Opportunities to Connect with Clients Abound

Every time the death tax rules change it really does feel like the "Attorney, CPA and Trust Officer Full Employment Act" has been signed. But you know the real job here is educating your clients on what to do in order to protect them, their families, and their hard earned wealth from a variety of potential traps, including taxes they can legally minimize or avoid.

Most of our trust clients are not here because of tax planning. Most are here because they need someone they can turn to, someone who has their best interest at heart and is not in the business of selling products to them. That is you, and us, together.

So, despite the upheaval these tax rule changes cause, let's all say a hearty "Thanks!" to our friends in Washington for giving us a reason to reconnect with our clients and help them through this.

 

 

 

 

 

 

THE TRUSTED ADVISER is published by Attorneys’ Title Guaranty Fund, Inc., P.O. Box 9136, Champaign, IL 61826-9136. Inquiries may be made directly to Mary Beth McCarthy, Corporate Communications Manager. ATG®, ATG® plus logo, are marks of Attorneys’ Title Guaranty Fund, Inc. and are registered in the U.S. Patent and Trademark Office. The contents of the The Trusted Adviser © Attorneys' Title Guaranty Fund, Inc.

[Last update: 6-29-10]