This is the third article in a series discussing various tax planning opportunities that should be considered in the wake of the recent elections.  For the prior articles see:

Postponing Sales Until 2017; and

Should you Accelerate Charitable Gifts to 2016?

President-Elect Trump has made it clear that he intends to repeal federal estate taxes.  In light of the Republican majorities in the House and Senate, prognosticators believe that estate tax repeal will occur in the near future.  Assuming that estate taxes are repealed, there are numerous questions.

First, when will the repeal occur?  The last time that estate taxes were repealed in 2001, the repeal did not actually occur until 2010.  If there is a repeal with a delayed effective date, you will still owe taxes if you are unfortunate enough to die before the repeal becomes effective.

The second issue is whether repeal will be permanent.  Federal estate or inheritance taxes have been repealed four times in the past (1802, 1870, 1895, and 2010).  Each time the tax was repealed, it was later reenacted in a different form.  The most recent reenactment actually occurred in 2001, by the same Congress that repealed the tax for 2010.  They actually voted for the tax to reappear in 2011!  Based on history, I do not expect that repeal will be permanent.  It is easy to imagine a day when the 99.9% who will not have to pay the tax again decide that it is fair for our wealthiest taxpayers to pay a tax upon death.  Of course, this is grossly unfair to the 0.1%, but it was unfair every other time that estate taxes were enacted.

The third issue is whether the revenue loss from estate tax repeal will be replaced, in whole or in part, by a loss of stepped-up basis, or, even worse, capital gains tax upon death.  Under current law, the income tax basis of assets gets changed to the fair market value of the assets owned upon death.  The asset can be sold by one’s heirs soon after death without paying capital gains tax.  If stepped-up basis is removed, the tax will need to be paid when assets are sold after death.  When the tax was repealed in 2010, stepped-up basis was removed, though there was a limited amount of basis step-up granted.  Unlike estate taxes, which currently only are paid by 0.1% of decedents, stepped-up basis benefits the families of all decedents who own appreciated assets.

A more troubling possibility is a capital gains at death tax system, which is used in Canada.  This system would impose a capital gains tax on the built-in gains on assets owned at death.  If you lose stepped-up basis, at least you can postpone the date upon which the tax will be incurred.  If taxes are imposed at the time of death, the ability to postpone the tax will be lost.

Several clients have asked us whether they should alter their estate planning in light of the proposed repeal of estate taxes.  In my opinion, it is premature to alter your estate planning based upon the assumption that you will die in a year in which estate taxes do not exist.  As a general rule, if there are sensible strategies to remove assets from your taxable estate, I recommend that you implement these strategies.  As always, you should favor strategies that are flexible so that you can take advantage of future opportunities.

This is the second article in a series discussing various tax planning opportunities that should be considered in the wake of the recent elections.  The prior article discussed postponing sales until 2017.

There are at least three aspects of President Elect Trump’s tax plan that favor accelerating charitable gifts to 2016.

First, income rates will likely go down in 2017.  If you can make a gift in 2016 and reduce your taxes by 40% of the amount you give, this is likely a bigger savings than you will receive in future years.

Second, Trump proposes to cap itemized deductions at $200,000 per year.  This limitation will significantly reduce the benefit of making charitable gifts for certain taxpayers.

Third, Trump proposes to impose a capital gains tax on transfers of appreciated property to a private foundation.  It is unclear whether he intends for this rule to apply to lifetime gifts or just to testamentary gifts.  However, if this tax only applies to testamentary gifts, it could be easily avoided by making a deathbed gift.

Today, I met with a couple who are considering making a substantial charitable gift sometime between now and the first quarter of 2018.  These clients expect to receive substantial income in 2017.  I called my client’s CPA and she ran the numbers based on a hypothetical 2017 tax system consistent with Trump’s proposed plan.  The conclusion is that the clients will get significantly more tax savings by making a gift in 2016.  The gift will consist of some cash and appreciated securities given to a private foundation and some cash given to a donor advised fund.  The private foundation and the donor advised fund will allow my clients to make the gift now and pick the actual charities that will receive the funds later.  Giving part of the gift to a donor advised fund will allow the clients to save more taxes as compared to giving everything to the private foundation.

I have learned from experience that significant changes in Washington create tax planning opportunities.  Tax laws always change significantly when the party affiliation of the President flips.  It might seem prudent to wait for the laws to change before making major decisions.  However, waiting for certainty may result in foregone opportunities.

In the last few days, I have received numerous calls from clients about various tax issues that are impacted by the results of the election.  I plan to write a series of articles detailing the types of issues that my clients are confronting.

The first decision involves the timing of the sale of a significant asset.  One client was planning to sell real estate in December.  Another client was planning to sell his business in December.  These clients both contacted the buyer about postponing the sales until January of 2017.  They are hoping that income tax rates will be lower for sales in 2017.  If rates are reduced in 2017, will be the rate decrease be made retroactive to January 1, 2017?  There is precedent for making this type of a change.  However, there is also precedent for making a change effective during the middle of a year.  Postponing sales until January seems like a sensible strategy, though waiting longer might provide a better result.

In 2008, Kelley Cannon murdered her husband.  She was later convicted of first degree murder and is currently serving a lengthy prison sentence.  While serving her sentence, she has attempted to benefit financially from her husband’s death by claiming a share of his estate and an insurance trust that he had established.  Paul Gontarek and Kelly Caissie, two attorneys in our firm, recently convinced the Tennessee Court of Appeals to rule against Mrs. Cannon based upon the Slayer Statute.

The Slayer Statute prevents a killer from inheriting from the victim.  For this statute to apply, proof of the killing must be established by a preponderance of the evidence (i.e., more likely than not).  Independent proof of the killing should be unnecessary since Mrs. Cannon’s criminal conviction required proof beyond a reasonable doubt, which is a much more difficult standard.  Nevertheless, it took 8 years and two trips through the Davidson County Probate Court and the Tennessee Court of Appeals to invoke the Slayer Statute without a second murder trial.  Paul and Kelly convinced the Court of Appeals to apply a legal doctrine known as Collateral Estoppel, which permits the Court to recognize the criminal conviction as proof of the killing.

The Court reached a sensible result and allowed the decedent’s three children to inherit the entire estate and insurance trust.

Last week, the IRS issued proposed regulations that will significantly reduce valuation discounts for gifts or sales of interests in family limited partnerships, family limited liability companies, and closely-held corporations.  It will take years and several court cases to determine the overall effect of the regulations.  My best guess is that the regulations will reduce the valuation discount for a typical family limited partnership gift or sale from approximately 35% to approximately 5% or 10%.

These regulations were issued pursuant to a statute that was enacted in 1990.  The reason the IRS waited so long to promulgate these regulations is because they preferred for Congress to change the law.  They have given up on Congress.  The regulations may eventually be ruled to be invalid for exceeding the statutory authority that was given to the IRS to promulgate these regulations.  Nevertheless, my advice is to plan as if the proposed regulations will be valid when issued as final regulations.  Trust me.  You don’t want to pay the legal fees to overturn the validity of IRS regulations.

When will the regulations become final?  We do not know for sure.  The IRS will hold hearings on the regulations on December 1, 2016.  Generally, it takes several weeks or months to finalize the regulations after the public hearings. The IRS will undoubtedly receive vociferous complaints from different groups around the country.

In summary, any planning transactions involving gifts or sales of family limited partnerships, family limited liability companies or closely-held corporations should be completed prior to December 1, 2016.

Effective January 1, 2016, the Tennessee inheritance tax has been repealed, based on a law that was enacted in 2012.  The repeal does not help individuals who died in 2015.  They are still subject to the tax.  It only helps families of decedents who die this year or later. 

What is the effect of the repeal?  First of all, the maximum estate tax rate for decedents who are above the federal estate tax exemption (currently $5,450,000) will only be 40%, rather than approximately 46%.  Even though this represents a significant reduction, I see little impact on whether you implement strategies to avoid federal estate taxes.  40% is still a steep rate and most of our clients want to take reasonable measures to minimize or eliminate the federal estate tax. 

The repeal will affect the design of documents prepared for our married clients.  For many years, our documents have created two credit shelter trusts, a typical credit shelter trust (often referred to as a “Family Trust”) for the amount of the Tennessee inheritance tax exemption, and a second trust (sometimes referred to as a “Tennessee QTIP Trust” or a “Tennessee GAP Trust”) equal to the difference between the federal estate tax exemption and the Tennessee inheritance tax exemption.  In 2015, this formula resulted in $5,000,000 going to the Family Trust and $430,000 going to the Tennessee QTIP Trust.  Fortunately, we can now place the entire federal estate tax exemption, currently $5,450,000, in the Family Trust and will not need a Tennessee QTIP Trust.

Do you need to modify your current documents that contain Tennessee QTIP Trust provisions?  In most cases, the answer is no.  The funding language for the Tennessee QTIP Trust will not apply since there is no Tennessee inheritance tax.  Feel free to modify your documents if it bothers you to have unnecessary language in your Will; however, my advice is to wait until you need to make a change for other reasons. 

A few surviving spouses have asked us whether they can eliminate a Tennessee QTIP Trust that was established by a spouse who died prior to 2016.  Unfortunately, it is not possible to merge the Tennessee QTIP Trust into the Family Trust.  The Tennessee QTIP Trust will still avoid federal estate taxes upon the surviving spouse’s death.  Thus, as a general rule, my advice is to maintain the Tennessee QTIP Trust.  If the surviving spouse’s estate has declined below the federal estate tax exemption, then it might be acceptable to liquidate the Tennessee QTIP Trust in whole or in part. 

The repeal of the Tennessee inheritance tax is a welcome change.  Most individuals do not need to make any adjustments to their estate planning documents or planning in light of this change.

Unfortunately, one of my clients is entering the last stages of her life.  Her deductible medical expenses this year have been substantial due to home healthcare and hospice care.  I checked with her CPA and confirmed that a portion of her IRA can be converted to a Roth IRA for a modest income tax cost.  I talked to her brother, who has her power of attorney, and recommended that he convert a portion of the IRA to a Roth IRA. 

The conversion will eliminate future income taxes for my client’s children on future distributions from the Roth IRA.  The future savings for the children, one of whom lives in a state with a state income tax, will far exceed the incremental 2015 income taxes that my client will pay. 

An ancillary benefit is that my client has a taxable estate for federal estate tax purposes.  The incremental income taxes will be deductible for federal estate tax purposes (or will reduce her taxable estate if she unexpectedly lives beyond April 15).  This effectively reduces the incremental income taxes by 40%.  Assume for example, that $100,000 is converted at a tax cost of $15,000.  The net cost after factoring in the estate tax deduction of 40% will only be $9,000.  The future tax rate for my client’s children will far exceed 9%. Thus the overall taxes will be reduced. 

In summary, a late-in-life Roth IRA conversion may save substantial income taxes for your children.  Make sure that you have a durable general power of attorney which authorizes your agent to make a Roth IRA conversion.

I am currently working with an elderly client named John who is the beneficiary of a $6 million trust established by his father.  Upon his death, half of the trust will be distributed to his daughter; the other half will be distributed in equal shares to the children of his deceased son.  The trust owns a lot of stocks that were transferred to the trust upon his father’s death in 1989.  These stocks have a very low basis in comparison to the current fair market value of the stocks.  The trust is exempt from GST taxes and will not be subject to estate tax or GST tax upon his death.  Because the trust will not be subject to estate or GST tax, there will not be any change in the basis in the stocks of the trust upon his death. Therefore, when the daughter and grandchildren eventually sell the stocks, they will incur substantial capital gains taxes.  John would like for his daughter and grandchildren to receive a higher basis in the stocks, if that is possible. 

One approach is for the trust to distribute low-basis stocks worth approximately $3.4 million to John.  Since he already owns assets of $2 million, the distribution would give him a combined estate of $5.4 million, which is below the current federal estate tax exemption of $5.43 million.  His Will distributes his estate consistently with the trust.  Therefore, distributing assets out of the trust to John will not change the ultimate beneficiaries of the assets.  Because the stocks will be in his estate, they will receive a stepped-up basis upon his death. 

The danger with this approach is that the stocks will appreciate, which could result in estate taxes being owed upon John’s death.  Another danger is that the federal estate tax exemption could be decreased by future law change.  For example, the President has proposed a decrease of the exemption to $3.5 million. 

In order to accomplish John’s goals, while hedging against the appreciation and legislative risks, I have proposed the following solution:

Step One – The Trustee of the trust will establish a new trust that is identical to the 1989 trust, except that John will have a power in his Will to appoint a portion of the trust assets to creditors of his estate.  The amount that can be appointed will equal the maximum amount that does not result in estate taxes being payable.  The power of appointment will apply in sequential order to the most highly appreciated assets. 

Step Two – The Trustee of the 1989 Trust will distribute approximately $4 million in appreciated assets to the new trust.  Tennessee law allows the transfer of assets between trusts for the same beneficiaries in certain circumstances.  This process is referred to as “Decanting.”

The power of appointment will have the following consequences upon John’s death.  John does not have any creditors, therefore, there is very little risk that he will exercise his power of appointment in favor of creditors.  Even though the power is virtually meaningless, the Internal Revenue Code requires the amount that could be appointed to be included in John’s estate for estate tax purposes.  However, since the amount that can be appointed is limited to the amount that will not cause estate taxes, no estate tax will be owed.  Once the formula amount is determined, the Trustee will then determine which assets had the most appreciation and, thus, which assets are subject to the power of appointment.  These assets will receive a stepped-up basis upon John’s death.  His daughter and grandchildren would then be able to sell those assets without any capital gains (except for appreciation that may occur following John’s death).  Based upon the current disparity between basis and fair market value of the stocks in the trust, there would be approximately $2.7 million of additional basis gained by this technique.  John’s daughter lives in California (which has state income taxes on capital gains), while the grandchildren live in Tennessee.  Based upon the maximum federal and state income tax rates, the increased basis could reduce future income taxes by as much as $800,000.

Your $5.43 million federal estate exemption is a very generous gift that Congress has provided to you.  You should look for opportunities to leverage the exemption to give your heirs a higher basis for income tax purposes.

Two of my clients have already contacted me about the renewal form sent to them by the Tennessee Department of Revenue regarding the exemption of their LLC from Tennessee franchise and excise tax.  If your LLC (or limited partnership) is exempt from Tennessee franchise and excise tax, it is very important to fill out this form each year.  You do not have to pay anything to renew the exemption. 

The most common exemption is obligated member entity (“OME”).  The OME exemption applies when the members waive liability protection.  If you are relying on this exemption, check the obligated member entity box and all the boxes on Schedule F.  Additionally, if any new members have been admitted, they must sign an Amendment to the Articles of Organization that waives liability protection and file it with the Tennessee Secretary of State. 

The two most common other exemptions for our clients are the family owned non-corporate entity (“FONCE”) and the farming/personal residence exemptions.  My recommendation is to allow your CPA who prepares the tax return for the LLC to complete the form, if you are relying on either of these exemptions.  There is information from the LLC’s federal income tax return (Form 1065) that will be needed. 

Not all LLCs are exempt from franchise and excise taxes.  Generally, these LLCs operate a business or own commercial real estate.  Even though not exempt, the earnings from an LLC operating a business may not be subject to tax if they are treated as self-employment income by the owners of the LLC for federal income tax purposes.  No application for exemption is filed to claim this benefit.

In summary, you can avoid an unpleasant tax bill for your LLC if you or your CPA annually renews the exemption of your LLC from Tennessee franchise and excise taxes.

A recent case, In re: Estate of Lois Whitten, illustrated a tricky area of the law for creditors’ claims against an estate.

When you probate a Will, the Court publishes a Notice to Creditors. Creditors have 4 months from the first publication of Notice to file their claims against the Estate. In order to benefit from the 4 month statute of limitations, the Executor must search the Decedent’s records and send a copy of the Notice to any likely creditors. The 4 month deadline also applies to any creditors that the Executor should not have expected after searching the Decedent’s records. If the Executor fails to send a copy of the Notice to a creditor whom the Executor should have known about, then the creditor has 1 year from the date of death to file a claim.

Instead of sending the Notice to Creditors in Whitten, the Executor sent a letter to the creditor with a check. The letter stated “This pays her bill in full. If not, please do not cash the check but return it to me.” The creditor rejected the check and returned it to the Executor. Six months after the Notice to Creditors had been published, the creditor then filed a claim against the estate for a larger amount. Had the Executor included the Notice to Creditors with the letter, this claim would have been disallowed. However, the court allowed the claim because the Executor did not send the required Notice.

Lessons from this case:

1. If you are a creditor of someone who dies, file your claim promptly (especially if your claim is such that the Executor may not discover it).

2. If you are an Executor, send all potential creditors a copy of the Notice to Creditors.