Two Statutes of Limitation to Watch Out For With Creditors' Claims

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.

IRS Issues Portability Regulations

The Tax Relief Act of 2010 added a provision that allows a surviving spouse to use any unused estate tax exemption from his or her deceased spouse. So far, this is only available if both spouses die between January 1, 2011 and December 31, 2012. There is widespread optimism that portability will be extended by future legislation.

The IRS published regulations on June 15, 2012 dealing with numerous issues regarding the regulations. There are two noteworthy items that affect short-term planning.

First, if your spouse died on or after January 1, 2011, the rules for filing your spouse’s estate tax return have been relaxed under certain circumstances. If your spouse’s estate is not required to file an estate tax return because the value of the estate is below the filing threshold, you generally do not have to report values of assets passing to the surviving spouse or to charity. You only need to report the description, ownership, and/or beneficiary of the property together with sufficient information to establish your right to the marital or charitable deduction. This means that you are not required to obtain a full-blown appraisal of these assets. However, you must use “due diligence” to estimate the fair market value of the gross estate. You are allowed to identify a range of values with the Executor’s “best estimate” rounded to the nearest $250,000. This is welcome news because expensive appraisals can be avoided. You still have the issue of determining the fair market value of the assets for purposes of establishing the income tax basis of the asset and may choose to obtain appraisals anyway.

The other good news is that the regulations made it clear that gifts by the surviving spouse first use up the unused estate tax exemption from his/her spouse (“DSUE”). If your spouse died over the last eighteen months and left you some DSUE, you should consider making a gift prior to year-end. First, we don’t know that portability will be extended. Second, if you remarry and your next spouse dies before you have used your DSUE, you will lose the DSUE from your first spouse.

Tax Relief Act of 2010 - Part 2 - Estate Tax/Carryover Basis Election for 2010 Decedents

This is the second article of a series dealing with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). For the first article, see: Part 1 – Charitable IRA Rollovers

The Act retroactively reinstated estate taxes to apply to decedents who died in 2010. However, the Act provided two relief provisions. First, the federal estate tax exemption for 2010 decedents was $5 million. Second, the Act allows executors to elect the carryover basis regime for 2010 decedents if that regime is preferable to the estate tax regime.

We represent several estates that plan to elect the carryover basis regime. The carryover basis regime may result in future income taxes; however income taxes are less than estate taxes. Most estates of $10 million or more will elect the carryover basis regime. This is because the estate tax regime would result in estate taxes, either now or upon the death of the surviving spouse. Estates of unmarried decedents with more than $5 million will generally elect the carryover basis regime.

Estates worth $5 million or less will stay with the estate tax regime. They will not owe any federal estate taxes and all assets owned by the estate will receive a stepped-up basis.

The Executors for married decedents whose estates were between $5 and $10 million will have to analyze the two regimes. When the available basis step-up of $4.3 million is enough to increase the basis of all assets to date of death value, the estate should elect the carryover basis regime. When the basis step-up is not enough to eliminate all pre-death gains, the executor will need to analyze whether future income taxes to be incurred on pre-mortem appreciation will be more than future estate taxes to be incurred upon the death of the surviving spouse.

The analysis of future income taxes and future estate taxes requires a crystal ball. Income taxes might be avoided if the surviving spouse gives appreciated assets to charity or holds them until death. Estate taxes might be avoided if the surviving spouse makes sufficient gifts or if the $5 million federal estate tax exemption is extended until the year of the spouse’s death.

The Act did not specify how or when to make the election to be subject to the carryover basis regime. The Act specified that the Form 706 for decedents subject to the estate tax regime does not need to be filed until September 17, 2011. I expect guidance from the IRS clarifying that the carryover basis election can also be made as late as September 17, 2011.

Your Will Does Not Dispose of All of Your Assets

Some people mistakenly assume that their Will controls the disposition of all of their assets. There are several ways that your assets pass to someone outside of your Will.

Assets that are owned as tenants by the entirety with your spouse or joint with right of survivorship will pass to the other owner or owners by operation of law.

A large number of assets pass by beneficiary designation. Common examples are bank accounts, retirement accounts such as 401(k) plans and IRAs, and life insurance. See the enclosed article from Fidelity regarding important considerations in your choice of beneficiary designation.

If you transfer ownership of your assets to a trust before you die, the trust will dictate how the assets pass upon your death. A number of my clients have transferred all or a portion of their assets to a revocable trust or an asset protection trust.

Under Tennessee law, your spouse is entitled to elect against your Will and receive a share of your estate, year’s support, exempt property, and homestead. As a general rule, your spouse will elect to receive these benefits when they are better than the Will.

Even if your Will does not direct your Executor to pay your debts, your creditors will file claims against your estate and will be paid prior to the beneficiaries named under your Will.

Even if your Will does not direct your Executor to pay your tax obligations, the IRS and the State of Tennessee have priority over the beneficiaries of your Estate regarding the payment of income, inheritance, estate and generation-skipping transfer taxes, including interest and penalties. They have a “secret” lien against all of the assets of your Estate. If the Executor of your Estate fails to pay your tax obligations, the IRS and the State of Tennessee will be able to collect taxes from your Executor (to the extent that the Executor has distributed assets to the beneficiaries) or from the beneficiaries of your Estate (to the extent that they received assets from your Estate or from other methods such as beneficiary designations).

Because there are so many ways to receive assets that are not dependent on the terms of your Will, it is very important to make sure that you account for all of these potential non-testamentary transfers when planning for the disposition of your assets.

Disclaimer of Joint Brokerage Account Reduces Looming Estate Tax

 I currently represent an 88 year old widower whose wife died less than 9 months ago. The wife’s estate is approximately $1.6 million. The husband’s assets, including a $1 million brokerage account that had been owned jointly with his wife, are worth approximately $1.8 million. Because the husband’s estate exceeds $1 million, his estate will owe more than $300,000 of estate taxes if he dies after January 1, 2011 and Congress does not change the tax laws prior to his death.

In an effort to reduce or eliminate his potential federal estate tax liability, I have recommended a disclaimer of the husband’s one-half survivorship interest in the brokerage account. If the husband chooses to file a disclaimer, his children will receive one-half of the brokerage account now, rather than following his death. Under federal law, the disclaimer will not be treated as a gift by the husband. This means that no federal gift or estate taxes will be charged on the $500,000 passing to his children.  The disclaimer will reduce his federal estate taxes by more than $200,000.

Tennessee treats a disclaimer of a joint brokerage account as a gift. The husband will have to pay $36,000 of Tennessee gift tax on April 15, 2011. Upon the husband’s death, the inheritance taxes imposed on his estate will be reduced by $36,000 as a result of the disclaimer. Therefore, the net effect of the disclaimer is to accelerate the payment of $36,000 from 9 months after the husband’s death to April 15, 2011.

The husband has a modest lifestyle and feels comfortable that he will have sufficient assets for his remaining lifetime after he executes the disclaimer. He also likes the idea of getting assets to his children sooner.

If we knew that Congress would change the federal estate tax exemption to $2 million or more prior to the husband’s death, it would be unnecessary to make the disclaimer. Unfortunately, the disclaimer must be filed within 9 months after the death of the wife. Congress has been in a stalemate for more than 9 years regarding the “estate tax fix.” Because the 9 month deadline will occur in a few weeks, the husband will have to make the disclaimer decision prior to finding out whether Congress changes the law.

Who Will Pay Your Mortgage After You Die?

 It is very typical for a Will to direct the Executor to pay the Decedent’s valid debts. When my clients own real estate encumbered by a mortgage, they often want the successor owner of the real estate to continue paying the mortgage. For these clients, I place a provision in their Wills giving the Executor the discretion to continue paying the mortgage until the successor owner takes over the payments.

When the successor owner of the real estate is also the residuary beneficiary of your estate, it may not matter whether your estate or the successor owner pays the mortgage. If your estate pays the mortgage, the residuary estate passing to the successor owner will be less. Nevertheless, it provides more flexibility for the successor owner if you allow the mortgage to remain in place. The successor beneficiary can pay off the mortgage early if there is not a need to maintain the mortgage.

Things are not as easy when the successor owner of the real estate is not the residuary beneficiary of your estate. Now it makes a big difference as to whether your estate or the successor owner pays the mortgage.

If you decide that you want the successor owner to pay the mortgage, there is another consideration. The bank may file a claim against your estate and require the Executor to pay the mortgage. Depending upon whether the successor owner was jointly liable on the debt, your estate may have a claim against the successor owner to pay at least a portion of the debt. If you do not want your Executor to be in the position of having to sue the successor owner of the house, you should condition any bequest to the successor owner on their agreement to assume the mortgage. If you take this approach, the bequest to the successor owner will be reduced to the extent, if any, that your estate is required to make payments on the mortgage.

There are 2 methods by which the successor owner can acquire the property.

First, when you own the property, your Will simply devises the property to the successor owner. You can make the devise conditional on the devisee’s assumption of the mortgage.

Alternatively, when you own the property as tenants by the entirety with your spouse or jointly with right of survivorship, the successor owner will acquire the property by operation of law. Your Will cannot require the successor owner to assume the mortgage. However, if your Will makes a bequest of other assets to the successor owner, this bequest can be conditioned upon the successor owner’s assumption of the mortgage. If the bequest is less valuable than the mortgage, the successor owner might forfeit the bequest rather than assume the mortgage.

In summary, you need to decide who you want to pay your mortgage and draft your Will accordingly.

Where Is Your Original Will?

I recently met with a couple for whom I prepared Wills in 2006. They want to make a change to their Will because a member of their family died unexpectedly. When they went to their lockbox, they were unable to find their original Wills. Fortunately, they still have the ability to sign new Wills.

What would have happened if one of my clients had died and the survivor was unable to find the Will? It is likely that we could have probated a copy of the Will. Tennessee law allows a Court to probate a copy of the Will when there is credible testimony that the Will has been lost and that there was no intention to revoke the Will. I have successfully probated copies of Wills on 6 or 7 occasions. Every time that I have probated a copy, no one objected and a close family member was able to give credible testimony about the Will being lost.

You should assume that your heirs will be unsuccessful in probating a copy of your Will. When the original Will cannot be found, there is a strong presumption under Tennessee law that the Will was revoked. There have been numerous cases where the Court refused to probate a copy of a Will. If the Court refuses to probate the copy, the Court will choose an administrator to manage your estate and distribute your assets according to the intestate succession laws of Tennessee.

Due to the problems caused when your original Will cannot be located, it is very important that you keep your original Will in a lockbox or other safe location. You also need to make sure that one or more trustworthy persons knows the location of your original Will.

Revocable trusts do not have the same problem. The Trustee does not have to produce the original Trust Agreement in order to carry out its duties. This is another potential benefit of a revocable trust.
 

Sales By 2010 Estates May Be Taxed As Short-Term Capital Gains

Short-term capital gains are taxed at a significantly higher rate than long-term capital gains. In 2010, the maximum rates are 35% for short-term capital gains and 15% for long-term capital gains. In 2011, the maximum rates will increase to 39.6% and 20%.

Prior to 2010, gains from sales of assets by an estate were automatically treated as long-term capital gains, regardless of when the decedent bought the asset. For decedents dying in 2010, this rule does not apply. It is now necessary to determine when the decedent bought the asset. If the asset is sold within a year after it was acquired, the gain will be short-term.

Tax on pre-mortem gain can be eliminated by allocating the decedent’s basis increase to the property. Every decedent has $1.3 million of basis increase that may be allocated by the Executor. Married decedents potentially have an additional $3 million of basis increase that can be allocated.

The basis increase can not be used to eliminate post-mortem gains. Assume the decedent bought a stock for $200,000 on November 1, 2009. The decedent died on March 31, 2010 when the stock was worth $260,000. If the Executor sells the stock for $300,000 on October 15, 2010, there will be a short-term capital gain of $100,000. The pre-mortem gain of $60,000 can potentially be eliminated if the Executor chooses to allocate a portion of the decedent’s basis increase to this particular asset. The basis increase cannot be used to wipe out the $40,000 post-mortem gain.

The gain could be converted from short-term capital gain to long-term capital gain if the Executor waits to sell until November 1, 2010.

Children Born Out of Wedlock Must Act Quickly to Preserve Inheritance Rights

I recently read that 43% of the 91,000 babies born in Tennessee in 2008 were born out of wedlock. Babies with unwed parents are now so common that the social stigma from yesteryear has largely disappeared.  Nevertheless, there are still circumstances where the law discriminates against children born out of wedlock.

When someone dies without a Will, the state of Tennessee decides who will inherit the person’s estate. The laws governing this process are known as "Intestate Succession." When the decedent has no surviving spouse or descendants, the property is distributed to the decedent’s parents or descendants of the parents if they are deceased, i.e., brothers, sisters, nieces and nephews. If the parents are deceased and have no then living descendants, then the property is distributed to descendants of the decedent’s grandparents (i.e. aunts, uncles, first cousins, second cousins, third cousins). Children born out of wedlock frequently claim to be a member of the class who inherits from an intestate decedent.

The Cleo Snapp case is the most recent of several Tennessee cases that have treated children born out of wedlock as creditors of the estate. Tennessee law requires creditors to file a claim against the estate within 1 year of the decedent's death if they want to receive a share of the estate. Furthermore, if the executor notifies the creditor that they need to file a claim, they have only 4 months after receiving the notification. If the creditor does not file a timely claim, they forfeit their share of the estate.

The problem presents itself when inheritance rights flow through the potential inheritor's father. There is no requirement for filing a claim when your “blood” relationship to the decedent is through your mother.

When a potential inheritor files a timely claim, he or she must still prove the identity of their father by clear and convincing evidence.

The paternity issue most often arises when there is not a Will, but can also arise when there is a Will which does not clearly specify who inherits the decedent's estate.

Higher Taxes in 2011 Impact Fiscal Year Elections by Estates

When someone dies, their estate becomes a separate taxpayer for income tax purposes. Estates are allowed to choose their tax year. We generally recommend that estates elect the longest fiscal year available, which is the end of the month preceding the one-year anniversary of the decedent’s death. For example, the latest fiscal year that can be elected for a decedent who dies in April of 2010 is March of 2011. The reason that we generally elect a fiscal year is to postpone the time when income taxes will be paid on income earned by the estate.

Revocable trusts are also allowed to make the same fiscal year election, though they are required to make a separate election (referred to as a Section 645 election) with the IRS.

Federal income taxes will be increasing for tax years beginning after December 31, 2010. The maximum rate for dividends will increase from 15% to 39.6%. The maximum rate for capital gains will increase from 15% to 20%. The maximum rate for rents and interest income will increase from 35% to 39.6%.

As a general rule, the estate or revocable trust pays taxes on capital gains and taxes on other income is paid by the beneficiaries to the extent the income is distributed, or paid by the estate or revocable trust if the income is retained.

If the estate retains the income, the estate will benefit from making a fiscal year election. If the estate or revocable trust intends to make distributions to the beneficiaries, and the beneficiaries are in a high income tax bracket, the estate or revocable trust may want to avoid a fiscal year election for decedents who die in 2010.  The fiscal year election would cause the beneficiaries to pay higher taxes because the income will be taxed on their 2011 federal income tax returns.

There is a corollary problem for estates that already have fiscal years. If the estate is terminated in 2011 or later, the income will flow out to the beneficiaries in 2011, when it is likely to be taxed at a higher rate. Conversely, if the estate is terminated by December 31, 2010, the income will be taxed to the beneficiaries based on the lower 2010 rates. It is not always possible to accelerate the closing of an estate. However, if there are just a few minor details, it may be possible for the beneficiaries to assume responsibility for the final details in order to allow the estate to close.

2010 Estates are Challenging to Administer

Our firm is assisting Executors and Trustees with the administration of several estates and revocable trusts of decedents who have died during 2010. Administering these estates has presented numerous challenges.

The first problem is that we do not know whether federal estate taxes will be reinstated retroactively. We are advising the Executors that there are two different sets of laws that could apply, either the law that is currently on the books, or another law that has not yet been written. We are guessing that a retroactive law, if one is enacted, will be similar to the law that existed as of December 31, 2009; however, there are no guarantees.

If there is no federal estate tax, this is great news for most of our estates. However, the price to be paid for having no federal estate taxes is carryover basis. I was not practicing law in the late 1970’s when the prior version of carryover basis was the law, but have been forewarned by various practitioners who were practicing during that time period. Carryover basis is even worse than I had imagined.

We are advising Executors to assume that carryover basis is the law. This means that the Executor needs to ascertain the cost basis of the decedent’s assets unless the total value of the assets is less than $1.3 million, or is less than $4.3 million if the decedent was married and leaves at least $3 million of assets to the spouse or a qualified marital trust. Fortunately, most publicly traded securities held in brokerage accounts now list the cost basis. Determining the cost basis of various other assets such as furniture, artwork, real estate and interests in closely held businesses is not so easy.

One revocable trust has a large holding in a single stock. The stock has performed well since the time of the decedent’s death and the Trustee would like to sell a substantial portion of this position. However, the decedent’s basis in the stock was very low and the beneficiaries do not want the Trustee to sell and incur a large capital gains tax. If carryover basis is repealed and stepped-up basis is restored, everyone will be delighted to sell the stock. By the time the law is settled, the value of the stock may have declined precipitously.

Another revocable trust makes a large charitable bequest that will only occur if federal estate taxes are reinstated retroactively. Neither the charity nor the alternate takers can make plans until the law is settled.

Another estate holds significant real estate holdings. The Executor would prefer not to sell the real estate in the current market. Sales are not necessary if there are no federal estate taxes, but sales will be necessary if federal estate taxes are reinstated retroactively. Waiting until the law is settled may be too late to raise money in time to pay taxes if that becomes necessary.

There are numerous income tax planning issues that must be addressed due to carryover basis and all of its complicated rules. There are also carryover basis strategies that should be considered prior to death when you know that death is imminent but have at least a few days to make changes. I plan to discuss these strategies in a future article.

Because of the Tennessee inheritance tax, Executors still have to obtain date of death values, and perhaps alternate valuation date values, for all assets owned by the decedent. This means that Executors for estates of 2010 decedents have more to do than ever before.

 


 

So you want to be an Executor

You should carefully consider your answer if a friend or family member asks you to serve as his or her executor.

Most first time executors underestimate the number of tasks that must be completed by an executor. There is potential liability if something bad happens. For example, the beneficiaries want you to keep a certain asset and the value of the asset suddenly declines for reasons beyond your control.

Executors have to make difficult decisions. What is best for the estate as a whole may not be the best for particular beneficiaries. Finally, beneficiaries can be challenging to deal with. Beneficiaries often view the executor as preventing them from receiving their inheritance.

Keith Keisling sent me the following poem which summarizes some of the potential headaches faced by an executor.

THE EXECUTOR

I had a friend who died and he,
On earth so loved and trusted me,
That ere he quit this earthly shore,
He made me his executor.
He tasked me through my natural life,
To guard the interests of his wife,
To see that everything was done,
Both for his daughter and his son.
I have his money to invest,
And though I try my level best,
To do what wisely, I’m advised,
My judgment oft is criticized.

His widow once so calm and meek,
Comes, hot with rage, three times a week,
And rails at me, because I must,
To keep my oath appear unjust.
His children hate the sight of me,
Although their friend I’ve tried to be,
And every relative declares,
I interfere with his affairs.
Now when I die I’ll never ask,
A friend to carry such a task,
I’ll spare him all such anguish sore,
And leave a hired executor.

---Today and Tomorrow, Edgar A. Guest
(Chicago: Reilly & Lee Company, 1942)