Michigan Estate Planning Law Blog : Michigan Estate Planning Lawyer & Attorney : TJ Wall Law Firm : Southeast MI Wills, Trusts & Probate Issues

Joe Paterno's transfer of homeownership to his wife in July most likely was not an attempt to shield assets before a sexual-abuse scandal hit Pennsylvania State University's football program.  Instead, the move by the legendary coach more likely was made to take advantage of expiring estate tax rules, lawyers said.  Mr. Paterno switched ownership of his ranch-style home in State College, PA from joint ownership with his wife, Susan, to her full ownership on July 21 in a $1 transaction, according to documents filed in Centre County, PA.

A New York Times story suggested that the move could have been an effort to shield the home from future lawsuits that may arise from the child abuse scandal that was first revealed early this month. But attorneys familiar with Pennsylvania law said that the property already was protected from creditors because it was jointly owned and therefore couldn't be subject to creditors of only one of the spouses. The only way that the house, valued at $594,484, could be exposed to creditors is if both Mr. Paterno and his wife were targeted in a lawsuit, lawyers said.

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Congress has passed and President Obama has signed into law the deal extending the Bush tax cuts that he struck with Congressional Republicans. The legislation restores the estate tax for two years at a 35 percent tax rate, with estates up to $5 million exempt from paying any tax ($10 million for couples). If Congress does not change the law in the interim, in 2013 the estate tax will revert to what it was scheduled to be in 2011 -- a 55 percent rate and a $1 million exemption. The $801 billion tax-cut bill makes several other significant changes to wealth transfer taxes:
 

•The new $5 million estate tax exemption and 35 percent rate are retroactive to January 1, 2010. The heirs of those dying in 2010 will have a choice between applying the new rules or electing to be covered under the rules that have applied in 2010 -- no estate tax but only a limited step-up in the cost basis of inherited assets. This will benefit the heirs of tens of thousands who died in 2010 with relatively modest estates and who would have been subject to capital gains tax on inherited assets above a certain threshold.

•The law makes the estate tax exemption "portable" between spouses. This means that if the first spouse to die does not use all of his or her $5 million exemption, the estate of the surviving spouse could use it.

•The law unifies the estate, gift and generation-skipping transfer tax exemptions at $5 million. (For 2010 there is no generation-skipping tax, while the gift tax exemption has been $1 million for a number of years.) A 35 percent tax rate will apply to gifts or transfers over the $5 million threshold. (There is no change in the $13,000 annual exclusion amount for gifts.) These high exemption levels mean that "[t]he rich will have a two-year window in 2011 and 2012 to protect huge amounts of their estates from taxation for generations," wrote estates attorney Kevin Staker on his Estate Tax News Blog.

But that window is open even wider than was previously assumed because of an additional loophole for the wealthy in the new law. Although taxpayers have until December 31, 2010, to transfer funds outright to grandchildren and avoid the generation-skipping tax, there's the risk that the grandkids will squander the sudden influx of cash. As Forbes blogger Janet Novak explains in a recent post, "the money doesn't (as most planners had believed) have to be distributed outright to the grandkids to qualify for the 0% rate. Instead, according to the fine print in the tax deal, it can be put in a trust for them, [noted estate planning lawyer Jonathan] Blattmachr says. That means, he explains, that money can be taken from an existing multigenerational trust, declared subject to the 2010 GST tax, and deposited in a new trust for grandkids' benefit, with the GST tax now pre-paid at a 0% rate." Novak says Blattmachr has been telling his estate planning attorney peers, "Cancel your ski trip or trip to Hawaii. This is a once-in-a-lifetime opportunity."

The generous estate tax provisions were the main sticking point for progressive Democrats. A vote in the House on an amendment to increase the estate tax, including lowering the exemption to $3.5 million, was defeated by a vote of 233 to 194. After some minor changes to the bill were made, it passed the House by a 277 to 148 margin, after having been approved overwhelmingly by the Senate 81 to 19.

The site Politico quotes one senior House Republican aide as saying, "I'm trying to remember something that we passed under Bush that was this good." The new tax law presents previously unavailable planning opportunities, especially for the well-off. 

Just click on the following link to read the full legislation, titled the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010" as originally introduced.
 

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New York Yankees owner George Steinbrenner is the fourth known U.S. billionaire to die during 2010, according to Forbes magazine. Why is this significant? Because there is no estate tax in 2010, meaning that the U.S. Treasury has lost billions in tax revenues unless Congress acts between now and the end of the year to reinstate the tax retroactively.

Steinbrenner was worth an estimated $1.5 billion, meaning his heirs could save as much as $600 million in taxes because he died this year. Steinbrenner's wealth -- mostly consisting of the Yankees, a new stadium and a regional cable network -- could pass to his wife tax-free even if the estate tax were in effect, but this year she might have an incentive to disclaim (or turn down) any bequest, which would allow the assets to pass to Steinbrenner's four children free of federal tax. (But Steinbrenner's family would have to pay a huge capital gains tax if it were to sell any highly appreciated assets, since along with the disappearance of the estate tax, there is no "step-up" in the cost basis of inherited assets during 2010.)

The other billionaires to die in 2010 are Janet Morse Cargill of the family that founded Cargill Inc. (net worth: $1.6 billion), Texas pipeline magnate Dan Duncan ($9.8 billion), and California real estate mogul Walter Shorenstein ($1.1 billion). By rough calculation, their deaths in 2010 have cost the government some $6.5 billion.

Motivated by the billion-dollar estates passing to heirs tax-free, Sen. Bernard Sanders (I-VT) and four co-sponsors have introduced a bill that would return the estate tax to the 2009 exemption level of $3.5 million but add a progressive tax rate structure that would start at 45 percent, rise to a top level of 55 percent, and add a 10 percent surtax on billionaires. The proposal would be retroactive to the start of 2010.

The Responsible Estate Tax Act (S. 3533), introduced on June 24, 2010, is cosponsored by Sens. Sherrod Brown (D-OH), Al Franken (D-MN), Tom Harkin (D-IA), and Sheldon Whitehouse (D-RI). According to its sponsors, the proposal would bring in at least $264 billion over a decade while exempting 99.7 percent of Americans from paying any estate tax. The retroactivity provision would likely face a court challenge from heirs of wealthy individuals such as Steinbrenner.

"At a time when we have a record-breaking $13 trillion national debt and an unsustainable federal deficit, people who inherit multimillion- and billion-dollar estates must pay their fair share in estate taxes," three of the senators said in a letter accompanying the bill's release.

The year without an estate tax is a creature of the Bush tax cuts. Under the provisions of a tax-cut bill enacted in 2001, the value of estates exempt from the tax gradually went up over the past eight years while the tax rate on estates was reduced. During 2010, according to the 2001 law, the estate tax disappears entirely, only to be restored in 2011, potentially, at a rate of 55 percent on estates of $1 million or more, which is where things stood before the 2001 change.
 

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Happy New Year!  I hope you enjoyed the Holidays with your family and close friends. Well, despite my last post about the pending estate tax legislation, there is currently no tax on the estates of those dying during 2010! Although Congress may reinstate the tax retroactively in 2010, perhaps as part of broader tax reform, this is not a certainty. Burned by their near-universal conviction that Congress would act to preserve the tax before it expired on December 31, 2009, experts are now wary of predicting what lawmakers will do. 

If Congress fails to act, a few thousand very wealthy families will have reason to celebrate, while tens of thousands of taxpayers of more modest means will pay capital gains on inherited assets thanks to the end of the basis step-up and the start of modified carryover basis rules. In addition, executors will face confusing administrative burdens, and married couples with credit shelter trusts may want to revise their plans, at least for 2010. And if Congress does change the law retroactively, extensive litigation over inheritances is almost guaranteed.

The chief tax counsel for the House Ways and Means Committee estimates that while extending the 2009 estate tax law would have affected about 6,000 estates, 71,400 estates could face new capital gains taxes with the estate tax gone. According to the Center on Budget and Policy Priorities, "at least 62,500 of these are estates that would not owe any estate tax if the 2009 rules were continued and that thus would be adversely affected by estate tax repeal. Farm and business estates would constitute a disproportionately large share of this group." (Small farms and businesses are the groups whose interests opponents of the estate tax have claimed they are defending.)

The Perils of Going Retroactive

Senate Finance Committee Chairman Max Baucus (D-MT) has pledged to try to restore the estate tax retroactively in 2010. This would undo the capital gains increase, but it could also create fertile ground for lawsuits by those whose family members die between January 1, 2010, and the date when any retroactive law is enacted.

"I can guarantee this: if they succeed in getting retroactive in hiking the death tax from zero to 45 percent, there are going to be lawsuits," said Dick Patten, president of the American Family Business Foundation, which opposes the estate tax. "Its going to be messy, its going to be noisy." (For an excellent discussion of the mess that a lapse in the estate tax could create, see this article by Forbes.com. "Beneficiaries will deal with uncertainty for years," warns one tax expert.)

 What to Do?

In the meantime, estate planning attorneys and their clients are trying to figure out what to do. Particularly vulnerable are married couples with credit shelter trusts that are designed to allow both spouses to take advantage of their respective estate tax exemptions. With the estate tax gone, the wording of these trusts could be interpreted as completely bypassing the surviving spouse when the first spouse dies, meaning a surviving spouse would get nothing without claiming an elective share. (For commentaries, click here and here.)

Along with the estate tax, the generation-skipping transfer tax also disappears in 2010. Some wealthy individuals may bet that Congress won't extend the law retroactively and therefore make large gifts to grandchildren.

"Ten years ago, there was a lot of gallows humor about repeal when everybody said it would never happen," said Rep. Richard Neal (D-MA), chair of the House Select Revenue Subcommittee. "Now, one of those never-happen moments has happened, and nobody's laughing."

For more on the implications of the disappearance of the estate tax, see the Future of the Estate Tax blog.

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On Thursday, December 3, the House of Representatives passed the "Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009" (H.R. 4154) sponsored by Rep. Earl Pomeroy (D-ND) by a vote of 225-200. The bill makes permanent current estate tax provisions of a 45 percent estate tax rate and a $3.5 million per-person exemption. There is no provision for indexing for inflation. The bill also maintains the so-called “step-up in basis” tax rules. Similar action is not expected in the Senate, where a one year extension of current law is considered more likely. To read a record of the proceedings, visit: frwebgate.access.gpo.gov/cgi-bin/getpage.cgi

As I have been advising my clients for the last few years, if Congress takes no action whatsoever, the estate tax is scheduled to enter one year of full repeal in 2010 followed by a return of the estate tax in 2011 with a much lower exemption amount ($1 million) and a much higher maximum tax rate (55%). I am optimistic, however, that logic will prevail (despite the fact that we are dealing with D.C. politics) and our current $3.5 million exemption will be extended for at least the short term.

Two important points I want to stress: (1) The federal estate tax is all-encompassing and is levied upon a deceased person's worldwide gross estate (any and all assets that the individual owned or had an interest in as of the date of death, i.e. real estate, cash, stocks, bonds, life insurance proceeds, patents, etc.); and (2) In a married couple scenario, the present $3.5 million exemption is not "automatic" for each spouse; proper planning must be implemented to take advantage of this "double exemption" opportunity.   

Our firm will continue to closely monitor these developments and will certainly alert any clients whose plans may need attention as a result thereof. 

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