Tennessee Estate Planning Law : Tennessee Estate Planning Lawyer & Attorney : Bryan Howard : Howard & Mobley Law Firm : Nashville, Chattanooga, Memphis

Unconfirmed rumors are circulating that the Super Committee may propose to reduce the current $5 million gift tax exemption to $1 million, potentially effective as early as November 23, 2011. It seems unlikely to me, but the rumor could be based upon “leaks” from insiders who are familiar with the Super Committee deliberations.

A lot of our clients have already made their $5 million gifts. Others are taking their time and studying their options. A couple of our clients who were studying their options are now mobilizing to complete their gifts prior to November 23, 2011. 

If you are concerned about a potential law change but will not be able to complete your gift by November 23, 2011, there is one technique that you should consider. An inter vivos QTIP trust would allow you to beat the law change, if there is one, yet provide you with the flexibility to unwind the transaction if there is no law change. Assume that Husband makes a $4 million gift to a marital trust that benefits Wife for her lifetime and then continues in trust for the benefit of their children. If the Super Committee does not change the law, and the gift tax exemption remains in place until December 31, 2012, the marital trust will be liquidated and the assets will be distributed to the wife. The couple will then decide how to best use their $5 million gift tax exemption. If this course is followed, Husband will need to file Tennessee and federal gift tax returns on April 15, 2012 (or October 15, 2012 with an extension), and make QTIP elections on both returns.

Alternatively, if the $5 million gift tax exemption is eliminated as of November 23, 2011, the QTIP trust will stay in place and the husband’s federal gift tax return for 2011 will not make a QTIP election.   The Tennessee gift tax return for 2011 will still make a QTIP election in order to avoid paying Tennessee gift taxes for 2011.

The QTIP plan will allow the husband to utilize his gift tax exemption but does not allow the wife to utilize her exemption. If the wife establishes a similar $4 million trust for the husband, there is a danger that the reciprocal trust doctrine will eliminate all of the proposed benefits from the transaction. In theory, the separate trusts for the husband and the wife can have different provisions that will avoid the application of the reciprocal trust doctrine. However, it is my opinion that there is still some risk if they each establish trusts that benefit the other, especially since the two trusts will be created very near in time to each other. Accordingly, I do not recommend the establishment of QTIP trusts by both spouses.

I am very skeptical about Congress closing the gift tax window as of November 23, 2011. Nevertheless, you might as well consider acting before that date if you are committed to making a gift anyway. An inter vivos QTIP trust is one method for hedging your bets.

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The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 authorized portability of the federal estate and gift tax exemption for married couples. This means that if one spouse dies without having used his or her entire exemption, the survivor may use it.

Portability has been widely hailed as a great estate planning benefit. The benefit is that the first spouse to die can leave everything to the survivor rather than having to create a credit shelter trust. 

Our view is that the benefit of portability is overrated; furthermore, it creates a trap for the unwary. We are not advising any of our married clients to plan on using portability.

The foremost reason that we do not favor portability is because the statute that created it also required the law to expire on December 31, 2012. President Obama and many members of Congress have indicated that they would like to extend portability beyond this sunset date; however, we have learned that it is foolhardy to plan on the assumption that future tax laws will be consistent with sensible statements made by politicians. 

Even if portability is made “permanent” by future legislation, there are many pitfalls to using portability. First, there is no inflation adjustment. For example, assume a married man dies this year and leaves his entire $5 million estate to his wife. When the wife dies, she will be able to use her husband’s unused exemption, but without any adjustment for inflation. If the husband had placed the $5 million in a credit shelter trust instead of transferring it to his wife, appreciation of the value of the trust during his wife’s remaining lifetime would have also escaped estate taxes.

The Tennessee inheritance tax exemption is not portable. If you fail to use the exemption in the estate of the first spouse to die, it will be lost forever. This will result in higher Tennessee inheritance taxes for the survivor’s estate.

Those who plan to establish trusts that last for the lifetimes of their children and beyond, are concerned about generation-skipping transfer tax exemption. The GST exemption is not portable. However, if the first to die establishes a trust and allocates GST exemption to the trust, the trust will be exempt from generation-skipping taxes for up to 360 years.

In order to claim portability, the estate of the first spouse to die must file a timely federal estate tax return. I predict that a lot of surviving spouses who are not otherwise required to file an estate tax return will fail to file timely returns in order to claim portability. 

There are numerous portability issues associated with the remarriage of the surviving spouse. It will likely take years for regulations and court cases to fully flesh out these issues. All things considered, we recommend that you disregard portability as a planning tool, at least until the law is made permanent.

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See below for a helpful tax tip from the IRS.

Taxpayers sometimes need tax returns from previous years for loan applications, to estimate tax withholding, for legal reasons or because records were destroyed in a natural disaster or fire. If your original tax returns were lost or destroyed, you can obtain copies or transcripts from the IRS. Here are 10 things to know if you need federal tax return information from a previously filed tax return.

1. There are three options for obtaining free copies of your federal tax return information – on the web, by phone or by mail.
2. The IRS does not charge a fee for transcripts, which are available for the current and past three tax years.
3. A tax return transcript shows most line items from your tax return as it was originally filed, including any accompanying forms and schedules. It does not reflect any changes made after the return was filed.
4. A tax account transcript shows any later adjustments either you or the IRS made after the tax return was filed. This transcript shows basic data, including marital status, type of return filed, adjusted gross income and taxable income.
5. To request either transcript online, go to www.irs.gov and use our online tool called Order A Transcript. To order by phone, call 800-908-9946 and follow the prompts in the recorded message.
6. To request a 1040, 1040A or 1040EZ tax return transcript through the mail, complete IRS Form 4506T-EZ, Short Form Request for Individual Tax Return Transcript. Businesses, partnerships and individuals who need transcript information from other forms or need a tax account transcript must use the Form 4506T, Request for Transcript of Tax Return.
7. If you order online or by phone, you should receive your tax return transcript within five to 10 days from the time the IRS receives your request. Allow 30 calendar days for delivery of a tax account transcript if you order by mail.
8. If you still need an actual copy of a previously processed tax return, it will cost $57 for each tax year you order. Complete Form 4506, Request for Copy of Tax Return, and mail it to the IRS address listed on the form for your area. Copies are generally available for the current year and past six years. Please allow 60 days for actual copies of your return.
9. The fee for copies of tax returns may be waived if you are in an area that is declared a federal disaster by the President. Visit www.irs.gov, keyword “disaster,” for more guidance on disaster relief.

Visit www.irs.gov to determine which form will meet your needs. Forms 4506, 4506T and 4506T-EZ are available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

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The FDIC has published a brochure explaining the amount of FDIC insurance for various situations including revocable trusts, irrevocable trusts, and entities such as corporations and LLCs.

Revocable trusts can easily qualify for $1,250,000 of coverage, and may qualify for even higher coverage in very narrow circumstances. Irrevocable trusts generally are limited to $250,000 of coverage. Likewise, entities are limited to $250,000 of coverage. The good news is that it is easy to expand the amount of coverage well beyond $250,000 by setting up accounts in the names of trusts and entities.

A lot of my clients add the names of their children on various accounts in order to expand FDIC coverage.  These arrangements have gift tax risks and may distort the client's overall estate plan because the accounts will belong to the children after the client dies. 

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In a recent case, Estate of Ina Ruth Brown, the Tennessee Court of Appeals upheld the validity of a contract to execute Wills. These contracts are most often used in second marriages when at least one of the spouses has children from a prior marriage.

The contract typically works as follows: Each spouse agrees to bequeath certain property to the survivor with the understanding that the survivor will bequeath the property to the children of the first spouse to die following the survivor’s death.

Following the execution of the contract, the husband and wife each execute Wills which are consistent with the contract. After the first spouse dies, the children of the surviving spouse sometimes persuade the surviving spouse to change his/her Will in a way that totally disinherits the stepchildren. That is exactly what happened in the Brown case.

After Mrs. Brown died, her son probated her Will, which left everything to him.  Mr. Brown’s children filed a Will contest.  The children should have filed a claim for breach of contract against the estate of Mrs. Brown rather than a Will contest.  Nevertheless, the Court of Appeals granted to Mr. Brown’s children the property they were entitled to receive based upon the contract.  Even though Mr. Brown’s children were ultimately successful, it took them 8 years and significant legal fees to protect their rights.

Estate planning for spouses in second marriages is challenging. Each spouse wants to benefit their spouse and benefit their children from the prior marriage. The best solution is to transfer separate assets to the spouse and children upon the first spouse’s death. When there are not enough assets to take care of the spouse and the children, various approaches are used to enable the property to benefit the surviving spouse during his/her lifetime with the property to pass to the children upon the surviving spouse’s death. All of these techniques inevitably create tension between the stepparent and the stepchildren.

I have prepared contracts to make a Will for several couples, though only after investigating other solutions and with a warning to my clients that such contracts are a challenge to enforce by the children of the first spouse to die.

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One year ago, I wrote about interest rates reaching an all-time low. They dipped a little more late last year, then increased before heading lower again. Now, they have reached another all-time low.

The 7520 Rate for transactions in October of 2011 will be 1.4%. This represents a 30% decrease from the September rate of 2%.  

Grantor retained annuity trusts (“GRATS”) and charitable lead annuity trusts (“CLATS”) work well when the Section 7520 Rate is low. Installment sales to grantor trusts and intra-family loans also work well when interest rates are low. These transactions use different interest rates than the 7520 Rate, but these rates are also near the all-time low.

One of my clients is currently evaluating a sale to a grantor trust in exchange for a private annuity. Private annuities work better in a low interest rate environment. I seldom recommend private annuities because they work best in terms of reducing estate taxes when my client dies sooner. This particular client is not expected to live beyond 3 years, though he has at least a 50% chance of living at least one year. This 50% threshold is required in order to use the IRS actuarial tables.

The low interest rate environment is not good for charitable remainder annuity trusts (“CRATS”) and qualified personal residence trusts (“QPRTS”). Even though low interest rates are not favorable for QPRTS, some of my clients are establishing QPRTs to take advantage of the current low values of residential real estate. One of my clients will be establishing two QPRTs for her Florida vacation home before the end of September in order to take advantage of the higher rates.

You should consider acting now to take advantage of the opportunities presented by the record low IRS interest rates and the $5 million federal gift tax exemption that is in effect for 2011 and 2012. 

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Everyone’s lifetime gift tax exemption increased significantly this year. Several of our clients who plan to take advantage of this opportunity have already made their $5 million gift.

Other clients are taking their time and considering their options before making their gift. Some have given $440,000 and plan to give the rest in 2012. The reason for a gift of $440,000 is because this is the amount above which the rate of Tennessee gift taxes increases from 7.5% to 9.5%. If you are planning to give more than $440,000, you should consider splitting the gift between 2011 and 2012 in order to minimize Tennessee gift taxes.

One of our clients has become concerned about the political rhetoric regarding a potential repeal of the Bush-era tax cuts for millionaires. To my knowledge, this rhetoric has not been specifically directed to the $5 million gift tax exemption. However, President Obama’s plan to reduce our deficit proposes a return of the estate tax exemption to 2009 levels in 2013. In 2009, the gift tax exemption was only $1 million.

If the President’s plan gains traction, it could be passed with an earlier effective date. There is some possibility, albeit remote, that the $5 million gift tax exemption will not stay in place until December 31, 2012.

Our client had planned to make a gift of $440,000 in 2011 and $4,680,000 in 2012. You will notice that the two gifts add up to $5,120,000. There is a CPI inflator on the $5 million gift tax exemption for 2012. The official number will be announced later this year; however, based upon inflation that has occurred to date, the exemption has been estimated to rise to $5,120,000 for 2012.

Our client has decided to reverse the gifts and make a gift of $4,680,000 in October of 2011 and $440,000 on January 1, 2012. Our client will still get the benefit of running up the Tennessee gift tax rate brackets twice. Our client is taking the risk that any change to the gift tax exemption that occurs during 2012 will not be made retroactive.

The one negative from accelerating the majority of the gift tax to 2011 is that our client will be required to pay the majority of the Tennessee gift tax on April 15, 2012, rather than April 15, 2013. Accelerating the payment of approximately $430,000 in gift taxes by one year will cost the interest that could have earned between April 15, 2012 and April 15, 2013. Since interest rates being paid on fixed-income investments are so low right now, our client has decided that accelerating the payment of the Tennessee gift tax is cheap insurance against a potential law change.

If you know that you want to make a $5 million gift prior to December 31, 2012, you should consider accelerating a substantial portion of the gift to 2011. In addition to hedging against a potential adverse law change, accelerating the gift could have other benefits. If you choose to make a gift of an asset with depressed values, such as real estate or stock, the asset might appreciate in value, which would enhance the value of the gift.

Other benefits from accelerating the gift include income from the property as well as your payment of income taxes on the income. Once you make the gift, income from the gift will belong to your donee. Almost all of our clients who are making large gifts are making the gifts to a grantor trust. This means that the donor will continue to pay income tax on the income from the gift even though they will not receive the income. Paying income tax on income that you do not receive further reduces your taxable estate.

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Estates of decedents who died in 2010 were given a very valuable option. They can elect to not be subject to estate taxes and have carryover basis for income tax purposes. Alternatively, they can elect to be subject to estate taxes yet receive a stepped-up basis for the assets owned by the decedent.

Those who choose to be subject to the estate tax system are required to file a Form 706 by September 19, 2011 if the estate is larger than $5 million. The IRS has just announced that these estates may obtain a six-month extension of the time to file to March 19, 2012 by requesting an extension on Form 4768.

Those who choose to be in the carryover basis system will be required to file a Form 8939. Originally, the IRS said that Form 8939 would be due on November 15, 2011. That deadline has been extended until January 17, 2012.

One of the reasons the IRS extended these dates is because of their delay in providing the appropriate forms. We only recently received the Form 706 and the accompanying instructions. We have yet to receive Form 8939.

All of the estates with whom we are working know which system they plan to elect. All of the estates under $5 million are electing the estate tax system so that they can have stepped-up basis for income tax purposes without having to file Form 8939. These estates do not have to file any forms to make this election. Only 1 of the estates that were above $5 million are choosing the estate tax system. The rest are choosing the carryover basis system. The 2 month extension until January 17, 2011 is very welcome news for these estates, especially since we have yet to see the Form 8939.
 
If you are uncertain of the best tax system, you should file the Form 4768 no later than September 19, 2011. This will buy you 4 months of time to make the decision. You will not be precluded from electing the carryover basis system if you file the Form 4768.

If you file Form 4768, you should also request an extension of time for payment of any estate taxes that would be owed. If you eventually file a Form 706 and owe taxes, the extension of time to pay will cause you to owe interest during the interim. However, late payment penalties will be avoided, and the interest rate is very low.
 

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A previous blog discussed the Mitchell case, in which long-term leases substantially reduced the estate tax value of certain real property. A very significant issue did not have to be decided by the Court because the IRS stipulated that the property gifted by the decedent as well as the property still owned by the decedent at the time of his death would receive fractional interest discounts.

Six days before he died, Mr. Mitchell gave a 5% interest in his beachfront property and his ranch to a trust for his sons. The IRS stipulated before trial that the 5% gift of the beachfront property would receive a 32% fractional interest discount and the 5% gift of the ranch would receive a 40% discount.

The IRS also stipulated that the 95% interests in the beachfront property and the ranch that were owned by the decedent at the time of his death would receive fractional interest discounts of 19% and 35%, respectively.  The combined fractional interest discounts saved more than $1 million of estate taxes.

Numerous court decisions have recognized significant fractional interest discounts. In my experience, discounts of 25% to 35% are typical.  These court decisions influenced the decision by the IRS to concede the discounts in the Mitchell case.

The decedent’s revocable trust devised the 95% interest to the very same trust to which he had gifted a 5% interest just 6 days before his death. Therefore, the trust for the sons received a 100% ownership of the property. However, by dividing the transfer of the property to the sons’ trust into two separate portions, Mr. Mitchell significantly reduced his estate taxes.

Mr. Mitchell's estate was fortunate to receive the discounts since he made the gift after he became very ill due to cancer. Some prior cases have disallowed otherwise valid discounts for deathbed gifts. Ideally, the gift should be made at least one year before death and certainly before a diagnosis of a terminal illness.

Whenever you plan to make a gift of real estate, you should consider giving part now and part later (or part to one donee and part to another donee). Further, if you are planning to devise real estate through your Will, you should consider giving a small percentage interest in your lifetime and the remainder through your Will.  Now is an excellent time to make a gift due to depressed real estate values and the temporary $5 million federal gift tax exemption.

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