Happy Birthday – The Estate Tax Turns 100

Wishing a happy 100th birthday to the Estate Tax!

In 1916, Congress instituted the estate tax to boost U.S. revenues just in case we joined the fight in World War I. At the time, the top rate was 10% and the exemption was $50,000, which meant it affected less than 1% of estates. Proponents of the tax thought it was a reasonable way to raise money while its opponents in Congress thought it was a matter best left to the states.

The U.S. had imposed temporary taxes on estates to pay for earlier conflicts but they were always repealed. The reason this one lasted was the hope that it would preclude the establishment of an aristocracy in America by preventing concentrations of wealth. Presidents Theodore and Franklin Delano Roosevelt were both proponents, as well as Andrew Carnegie, despite the size of their own estates. One particularly extreme view was that of Senator Huey Long of Louisiana. He wanted to confiscate all fortunes that were greater than $8 million.

Now, the estate tax is 40% on assets owned at death above the exemption amount. For 2016, the exemption amount is $5.45 million. It’s estimated that only about 4,400 people will have taxable estates this year.

Deadline to Amend Retirement Plans to Reflect Windsor Decision Approaching Fast

The deadline to amend retirement plans to reflect the Windsor decision is approaching fast. As of September 16, 2013, the IRS requires qualified retirement plans to treat a same-sex spouse as a spouse for plan purposes. In April of this year, the IRS specified that amendments to qualified plans are required by the end of 2014 if the plan’s definition of marriage is inconsistent with the Windsor decision.

DOMA Section 3 was enacted in 1996 and defined marriage between one man and one woman as husband and wife. In 2013, the Supreme Court decided, in U.S. v. Windsor, that Section 3 of DOMA was unconstitutional because it deprived same-sex spouses of equal protection. Revenue Ruling 2013-17 provided that taxpayers may rely on Windsor retroactively “with respect to any employee benefit plan or arrangement or any benefit provided thereunder only for purposes of filing original returns, amended returns, adjusted returns, or claims for credit or refund of an overpayment of tax concerning employment tax and income tax with respect to employer-provided health coverage benefits or fringe benefits that were provided by the employer and are excludable from income” under Code Sec. 106, Code Sec. 117(d), Code Sec. 119, Code Sec. 129 , or Code Sec. 132 based on an individual’s marital status.

In an IRS Notice, the IRS provided further guidance on the effect of Windsor on qualified retirement plans and plan amendments. The Notice stated that a plan must be amended in certain situations, including if its terms with respect to the requirements of Code Sec. 401(a) define a marital relationship by reference to Section 3 of DOMA or are otherwise inconsistent with the outcome of Windsor. The deadline for adopting such amendments is generally December 31, 2014. Because the deadline to file amended returns is only two weeks away, retirement plans that have not already done so should change the terms of their plans so they are consistent with Windsor. Also, plans that have already amended their terms should make sure that they comply with any subsequently issued guidance.

Edging Towards the Fiscal Cliff

On December 31, 2012, the temporary tax cuts instituted during the Bush presidency are due to expire. Most members of Congress don’t want to let that happen; many would like to extend the cuts until a new tax plan can be developed. Republicans want the historically low tax rates from the Bush years to continue. Democrats also want the low tax rates to continue—for most Americans. For the wealthy, Democrats argue, the Bush tax cuts should end. As a result of this difference of opinion, Democrats and Republicans are reaching an impasse—one that brings America ever closer to what pundits are calling the “fiscal cliff.”

The phrase provides a chilling description of what might happen if members of Congress are unable to reach an agreement. If the tax cuts are allowed to expire, taxes will increase by $4 trillion dollars, and government spending will be cut significantly. Allowing the Bush tax cuts to expire could have a disastrous result on securities markets at home and abroad, and yet, that outcome seems increasingly likely, as neither party seems willing to budge.

In fact, some Congressional members from both sides of the aisle are beginning to express the belief that allowing the tax cuts to expire might not be so bad for their respective political parties. That of course, moves the welfare of the American citizen to the back seat. Congress could come back in 2013 and enact new tax cuts. Whomever wins the White House could claim he was responsible for the new tax cuts. It would be a political windfall. Even if that process took all year, the cuts could apply retroactively to January 1, 2013. As a result, the scheduled 2013 tax increases would only exist on paper, and would be wiped out by subsequent cuts. It’s not clear, however, that such a plan would stop Wall Street from reacting: according to the Congressional Budget Office, allowing the tax cuts to expire could plunge the already ailing U.S. economy into a recession in the first quarter of 2013.

For some politicians stepping off the “fiscal cliff” is looking like an increasingly attractive option. It would allow both parties to avoid compromise, and the newly elected president could come to Congress with his new plan.

Members of Congress may be willing to allow the Bush tax cuts to die for another reason: it won’t force them to raise taxes. Voting to increase taxes is never popular in the polls, but if the Bush tax cuts are allowed to die, taxes will increase automatically, generating nearly $4 trillion in revenue. Congress could use some of that money to reduce the deficit, and could give the rest back to voters in the form of new tax reductions. That approach might look good to voters, but is it best for the economy? Unless Democrats and Republicans meet a consensus, the “fiscal cliff” might be inevitable.

An alternative approach would be a short-term extension of the Bush tax cuts, which could potentially buy time for Congress to cut spending and work on a new tax plan. That approach is endorsed by the Republican-controlled House of Representatives, but it is unlikely to pass through the Democratic-controlled Senate, which is pushing for tax rates for the wealthy to expire. Whether that happens largely depends on the outcome of the election.
 

Hugh Hefner – the Quintessential Tax Planner

Kudos to Hugh Hefner. In case you haven’t heard, the 84 year old entrepreneur just announced his engagement to an attractive 24 year old. Now, I know you presume that this is the natural outcome when two people fall in love, but I suspect there may be ulterior motives.

We all know that Hugh is, from all appearances, a pretty wealthy guy. I can only conclude from this most recent nuptial announcement that he is also an incredibly gifted tax planner.

I am not sure the ink was even dry on the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 before the perennial purveyor of porn jumped into action. You see, included in Congress’s extension of the Bush tax cuts was a brand new provision in the estate tax law dealing with “portability” of the estate tax exemption. Beginning in the year 2011, the estate tax exemption increases to $5 million. In addition, the executor of a decedent’s estate can elect to transfer his or her remaining $5 million exemption to his or her surviving spouse.

Hugh gets his own $5 million exemption. We all know how young and spry he is, and based upon his lifestyle, we can only presume that Hugh thinks he is going to live to age 150. His naïve yet enchanting young wife, who has never been faced with the pressure of modern day life being married to a multi-millionaire, may well succumb to the physical stress of the relationship and meet an untimely demise during either 2011 or 2012. If this is the case, Hugh will be entitled not only to his own $5 million estate tax exemption, but to the exemption of his recently deceased spouse as well. Brilliant!

This creative tax reduction “technique” provides a unique new market for the acquisition of “portable estate tax exemptions.” Let’s presume, for a moment, that we have a wealthy unmarried client (call her “Ms. A”) with no foreseeable intent to marry in the future. We explain to Ms. A that if she agrees to marry someone, and if her new husband then predeceases Ms. A, she could receive the benefit of her deceased husband’s unused $5 million estate tax exemption. Ms. A decides that this is worth looking into, so we find a lost soul with no assets, no reasonable life expectancy, and the need for some quick cash. Ms. A and her intended “spouse” would enter into a premarital agreement providing that he waives all claims against Ms. A’s estate, agrees to accept no support from Ms. A and agrees never to communicate with Ms. A again (even though the marriage would last “until death do us part”). Ms. A could then create a trust providing for monthly nominal payments to the new husband during his lifetime (an inter-vivos QTIP). The husband would agree under the prenup to sign a will giving his $5 million estate tax exemption to Ms. A.. At the new husband’s death, the trust would revert back to Ms. A or her intended beneficiaries.

What a plan! This would give Ms. A an additional $5 million of exemption to use in connection with gifts to children or other intended beneficiaries, resulting in a $1,750,000 tax reduction at her death.

If you think this whole arrangement might be comical, let me tell you what’s really comical: Congress thought that portability meant simplification, but instead they created a new quagmire and more confusion among tax advisors. When will they learn?
 

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