Death of the Death Tax?

On January 10, 2017, Rep. Kristi Noem (R-S.D.) introduced H.R. 631, the “Death Tax Repeal Act of 2017.” While this bill resembles a similar bill that failed to become law in 2015, with the 2016 elections, the political landscape in Washington has changed considerably. In brief, H.R. 631 provides that:

  • The estate tax will be repealed for descendants dying on or after the date of enactment.
  • The generation-skipping transfer (GST) tax is repealed for GST transfers occurring on or after the date of enactment.
  • The gift tax is retained with its current lifetime exemption of $5.49 million, but its tax rate is reduced to 35% (down from 40%). The gift tax exemption amount will continue to be adjusted annually for inflation.
  • The special “anti-freezing” tax rules, also known as Chapter 14, are retained, presumably to maintain the overall effectiveness of the current gift tax system.
  • The estate tax will continue to be imposed on principal distributions from pre-existing qualified domestic trusts (also known as “QDOTs”) with respect to non-citizen decedents dying before the date of enactment, but only for the 10-year period following the date of enactment.

Notably absent from this bill is any reference to a change in the current system in which the tax basis of an appreciated asset received from a decedent’s estate is “stepped-up” to the fair market value of such asset on the decedent’s date of death. This system effectively eliminates the capital gains on the pre-death appreciation of the value of such inherited assets. In earlier reports, many speculated that this rule would be changed either to a carryover basis system (where inherited assets would retain the same tax basis of the decedent), or even the “Canadian system” (whereby capital gains would be immediately recognized on the appreciated assets of a decedent, with such a tax payable shortly after death).

H.R. 631 is unlikely to pass simply as a stand-alone piece of legislation. Rather, as Congress begins to assemble a larger tax reform bill later in 2017, many tax experts feel that it’s likely that such legislation will include provisions that will repeal the current estate tax rules. Whether the tax basis rules will be changed, and whether a tax reform bill ultimately passes, will ultimately depend upon the political and fiscal realities that arise as the legislative process moves forward.

If the New England Patriots can win the Super Bowl from 25 points down, then anything can happen in 2017!

Win Olympic Gold – And Pay for It

Olympic gold metals are assessed for income tax, but the real cost could be the estate taxes.

Every time the Olympics come around, there’s dozens of articles and posts about how Olympic medals are subject to income tax. The IRS considers all prize winnings, such as gambling or game show prizes, to be income and thus taxable. Olympic medals get lumped into this group (as do the cash bonuses they come with). Luckily for the athletes, their medals are valued at the time they are earned, essentially the value of the materials. A gold medal from Rio is estimated to be worth $564, a silver medal is estimated at $305, and a bronze medal has little intrinsic value. Since Olympic medalists generally treat their sport as a profession the value of the medal and related bonuses are likely to be offset with a deduction for the significant expenses that most athletes incur.

What people may fail to consider is the effect the medals will have on the Olympian’s estate taxes. Property in an estate is valued at the date of death, not the original value. And though Olympic medals have little intrinsic value, their sentimental value makes them worth far more. In 2013, one of Jesse Owens’ medals from the 1936 Olympics in Berlin sold for $1.47 million, the highest price ever paid for a piece of Olympic memorabilia. A boxer from Ukraine, Wladimir Klitschko, sold his medal for $1 million. Even a medal from an athlete who isn’t as well known may be valued upwards of $30,000. These values are included in a deceased Olympian’s estate and are potentially taxable.

Michael Phelps broke a 2100 year old Olympic record by winning 13 individual gold medals over the course of four Olympics (not to mention his 28 medals total.) The medals are worth quite a lot on the open market, even if Phelps is only initially taxed on their intrinsic value. When he dies, his estate will likely need to hire a specialized appraiser to determine the value and even then, it will only be an educated guess. Of course, since Michael Phelps is superhuman, he may never die, which would make this whole process simpler.

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.

IRS Expands Relief for Missed Portability Elections for Surviving Spouses

On January 27, 2014, the IRS issued Rev. Proc. 2014-18 which provides a remedy for estate representatives who did not elect to combine the deceased spouse’s unused exclusion amount with the surviving spouse’s exclusion amount in a timely manner. As an example, assume the first spouse died in 2012 with an estate of $2,120,000. The Applicable Exclusion Amount (“AEA”) for 2012 was $5,120,000. Assume that his estate uses $2,120,000 of the deceased spouse’s AEA which leaves $3,000,000 remaining as the Deceased Spouse’s Unused Exclusion (“DSUE”). The executor of the estate can elect to combine the $3,000,000 DSUE amount with the surviving spouse’s AEA (currently 5,340,000 for 2014), giving the surviving spouse a total federal estate tax exclusion in 2014 of $8,340,000.

The relief provided by Rev. Proc. 2014-18 gives certain estates which did not file a federal estate tax return on a timely basis to now file a Form 706 Federal Estate tax return and make a delayed portability election.

Prior to January 27, 2014 the only option to remedy a late return was to request a private letter ruling with the Internal Revenue Service to seek permission to file a late return and pay a significant user-fee ($2,000 to $10,000). It is no longer necessary to seek private letter ruling or pay any user fees.

This relief is also available for the surviving spouse of a same-sex marriage. However, this relief is not available for domestic partners who are registered but not married in a state or county that had authorized same sex marriage.

If you are the surviving spouse and your spouse died after December 31, 2010 and prior to January 1, 2014 you should review this situation with your estate planning attorney and accountant to determine if filing of Form 706 Federal Estate Tax Return and making a portability election is possible and would be appropriate for you. The Federal Estate Tax return with the delayed portability election must be filed by December 31, 2014.

If you have any questions, feel free to contact any of the estate planning attorneys with the firm.

Michael Jackson’s tax bill: Off the Wall? Bad? Can they ‘Beat it’?

Michael Jackson spent over forty years singing, dancing and "weird-ing" his way to owning the title "King of Pop". Michael was six years old when he debuted as part of the Jackson 5 in 1964 and was 24 when he dropped the album "Thriller" and the ground-breaking videos for "Beat It", "Billy Jean" and "Thriller". Michael recoded 13 number-one singles and won 13 Grammy Awards during his prolific career and "Thriller" remains the best-selling album of all time. Sadly, Michael died of acute propofol and benzodiazepine intoxication on June 25, 2009. He was 50 years old.

An estate tax return was due for the estate of Michael Jackson on March 29, 2010 (which was probably extended to September 29, 2010). This return listed the assets owned by Mr. Jackson at the time of his death and included valuations on each asset. As you can imagine, Mr. Jackson’s estate probably owned some things that many of us will own when we die: bank accounts, automobiles, real estate, etc. Mr. Jackson also owned some things that were unique to his celebrity status and his profession: recording rights, rights to his likeness and image, his endorsement deals with Pepsi and other corporate sponsors, etc.

The Internal Revenue Service has charged the Jackson estate with undervaluing the assets on the estate tax return, as the estate reported a taxable estate of $7 million. The IRS has sent the estate a tax deficiency notice for $702 million ($505.1 million in taxes and $196.9 million in penalties). The primary arguments surround the estate’s valuation of Mr. Jackson’s likeness and image (valued by the estate at $2,105 and by the IRS at $434 million) and the value of some of Mr. Jackson’s recording contracts owned by "MJ/ATV Publishing Trust Interest in New Horizon Trust II" (valued at $469 million by the IRS and not listed on the estate tax return.)

Most of the audits we come across on estate tax returns feature disagreements over the valuation of assets. When filing these returns, it is often wise to obtain a written appraisal of real property and business interests and then discuss the valuations of these assets (for return purposes) with a tax professional. The IRS has provided a good deal of guidance when it comes to properly valuing assets, following this guidance may save the taxpayer’s family from the headaches (and financial costs) of an IRS audit and appeal.

It is uncommon that the IRS disagrees with tax assessments by over $900 million, as is the case with Mr. Jackson’s estate. It will be interesting to see how the arguments over the value of Mr. Jackson’s assets plays out on TMZ and it will be equally interesting to see the justifications used by the estate and the IRS regarding the valuation of Michael’s likeness.

Two final notes about Michael Jackson: First, today would have been his 55th birthday, so happy birthday Michael. Second, it looks like he has got some new music on the way:

http://www.youtube.com/watch?v=76VC2Dsy1SU

James Gandolfini’s estate: Disaster or well-executed plan?

I recently read an article about the “disasterous” estate tax planning done by the attorneys for late James Gandolfini. The article pointed out that the actor left the majority of his $70 million estate to his children, family and friends; while “only” leaving his wife 20%. The crux of the article was that, by allowing 80% of assets to pass to people other than his spouse, the estate will unnecessarily pay tax on about $50 million. (The $50 million that would have otherwise been passed tax-free if Mr. Gandolfini had left everything to his wife). The tax bill is reportedly going to be in the neighborhood of $30 million.

$30 million is a substantial check to write to the government; but to assess whether the estate plan is a “disaster”, we need to dig a little deeper. James Gandolfini was married twice and he had a child with each wife: Michael, born in 2000, and Liliana, born in 2012. He met his second wife in 2006 and they were married in 2008. Mr. Gandolfini’s mother was a lunch lady and his father a mason and custodian. He did not land his first acting job until he was 26 and his life changed forever when he landed the role of gangster Tony Soprano in 1999 then became a millionaire many times over at the age of 40.

James Gandolfini’s life was far from ordinary, but the issues that his attorneys had to deal with in preparing his estate plan were very common: multiple marriages, children with different spouses and the unique challenges presented by first-generation wealth. It is not uncommon or “disastrous” for people to pass assets to their loved ones knowing there will be an estate tax to pay as a result, due to the unique nature of the beneficiaries and the assets. What is important is that potential taxes are laid out ahead of time to allow the individual to make informed decisions. Sometimes it is worth the tax bill for someone to pass assets outside of the “traditional” family map of everything-to-the-surviving-spouse.

In Mr. Gandolfini’s case, he chose to establish trusts for the benefit of his children at his death so that he could provide for the children’s well-being immediately and so that he could have some control over how (and when) assets are distributed. He also chose to leave substantial amounts to his sisters and friends. These choices cost the estate tens of millions of dollars in taxes, but that may have been a choice Mr. Gandolfini made. Only he and his lawyers know if the result was “disastrous” or exactly as planned.

It is worth noting that Mr. Gandolfini could have left the assets in trust for his wife’s benefit, then provided for the distribution of these assets to his beneficiaries on upon her death. This strategy is fairly common. In this case, however, Mr. Gandolfini’s surviving spouse is only 45 years old and that hypothetical distribution to the kids may not take place for thirty or forty years. Mr. Gandolfini may also have been advised to transfer some of his assets during his lifetime, at this point it is not clear whether any sort of plan was in place.

Properly executed planning documents can help parents protect their children from themselves and from creditors and predators. Our firm will be hosting a seminar to discuss the planning challenges that families face when planning for minor children. We will talk about the red flags that parents should be looking out for and then discuss the legal and financial variables that emerge when we add a child to the mix. The seminar will be held from 7:30-9 AM on July 25, 2013. To register for this seminar, please contact us at events@samuelslaw.com or 503-226-2966. Space is limited, so be sure to contact us soon.

How the Estate Tax Brought Down the Defense of Marriage Act

Today the U.S. Supreme Court ruled that Section 3 of the Defense of Marriage Act (“DOMA”) violates the Equal Protection clause of the 5th Amendment to the U.S. Constitution.  The opinion of the court in United States v. Windsor, written by Justice Kennedy, states that “DOMA seeks to injure the very class New York seeks to protect. By doing so it violates basic due process and equal protection principles applicable to the Federal Government.”  The decision marks a historic moment in the national debate over same-sex marriage and will likely be the focus of much discourse.  But there is one important issue that may otherwise fall through the cracks: this was a case about the federal estate tax.

Edith Windsor met her wife Thea Spyer in 1963 and the two became engaged four years later, never knowing whether they would legally be able to wed.  They registered as domestic partners in 1993 in their home state of New York and were finally married in Toronto, Canada in 2007.  Ms. Spyer passed away in 2009 and left her entire estate to Ms. Windsor.  If Ms. Spyer had been a man, the entire bequest to Ms. Windsor would have passed tax free, under the marital deduction to the federal estate tax.  However, when Ms. Windsor filed for the marital deduction, the Internal Revenue Service disallowed it, saying that under DOMA Ms. Windsor and Ms. Spyer were not in a recognized marriage and could not have the benefit of the marital deduction.  The IRS assessed a $363,053 tax on Ms. Spyer’s estate, she paid the tax, and sued the government for a refund.  Today, Edith Windsor not only gets the satisfaction of having her 44 year relationship finally recognized by the federal government, but she also gets a refund of the estate tax paid in 2009, plus interest. 

Many questions remain that will be sorted out in the coming days, months (and probably years) – by the courts, Congress, and the Executive Branch. For couples in same-sex marriages (currently recognized by 12 states, and the District of Columbia) however, in addition to federal tax consequences, today’s ruling provides access to a significant number of federal law benefits. These benefits include Social Security survivor benefits, benefits under federal employee health plans, and veteran’s benefits. 

Oregon Inheritance Tax Return Filing Deadline Extended for Some 2010 Estates

 — But Not The Tax Due Date

As a result of Congress passing the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 in December 2010, the Oregon Legislature had to act expeditiously to determine which 2010 federal tax changes Oregon would adopt. As part of this review the 2010 Oregon Inheritance Tax return (“OIT return”) filing requirements for some 2010 decedents were changed to follow the federal filing requirements. Thus, if a decedent died after December 31, 2009, and before December 17, 2010, with property taxable in Oregon and a federal estate tax return is required, the due date for the OIT return is extended to the same date the federal estate tax is due.

Generally, this means that for 2010 decedents who died before December 17, 2010 with gross estates valued over $5 million, the extended filing deadline is September 19, 2011, for an OIT return (Form IT-1), plus six additional months if a timely extension request is applied for. For 2010 decedents with gross estates under $5 million, the 2010 OIT return remains due nine months after the date of decedent’s death. For 2010 decedents dying after December 16, 2010, the filing requirements remain unchanged and the OIT returns are due nine months following the date of decedent’s death.

Because of the revenue shortfalls, the Oregon Legislature did not extend the Oregon Inheritance Tax due date. Oregon Inheritance Taxes remain due and payable nine months after the date of the decedent’s death. Also, any penalties and interest must be calculated based on nine months after the date of the decedent’s death irrespective of the filing extension. The filing extension provision, tax due date, penalty and interest changes are contained in Section 33 of SB 301. (http://www.leg.state.or.us/11reg/measpdf/sb0300.dir/sb0301.en.pdf)

The Governor signed SB 301 on March 9, 2011, but it will not become law until the 91st day after the close of the legislative session. After SB 301 becomes law, Section 33 will be retroactive to estates of decedents who died after December 31, 2009. A representative from the Oregon Department of Revenue has confirmed that the Department will currently follow the intent of the new law and allow the filing deadline extension for 2010 returns.

If you are working with an estate that may be eligible for this filing extension, consider contacting the Oregon Department of Revenue to confirm the estate’s eligibility for these changes. Please note these changes in the law do not address the filing deadline for estates over $5 million that elect not to pay any federal estate tax and instead elect a modified carryover basis and file the Form 8939 information return in lieu of the federal estate tax return.
 

The Accidental (Tax-Free) Billionaire

Dan Duncan was the son of an oil-field roughneck. From humble beginnings, Mr. Duncan started his own oil and gas business in 1968 with $10,000 and a truck. Over the years, Duncan grew that business into a prosperous venture which is now known as Enterprise GP Holdings L.P., a publicly traded company (Ticker EPE). At his death on March 28th of this year, Duncan had an estimated net worth of $9 billion and was ranked No. 74 on Forbes list of the world’s richest individuals. It appears that Duncan is the first American billionaire to pass his wealth free of the estate tax since the modern estate tax was originally imposed in 1916.

As we have previously discussed in WealthLawBlog, the federal estate tax is on a one-year hiatus in 2010. In 2009, the first $3.5 million in net worth was exempt from the estate tax, with a top tax rate of 45%. In 2011, the estate tax returns with only a $1 million exemption and a top rate of 55%. Hence, if Duncan had died three months earlier or nine months later, his estate would have been liable for billions in federal estate taxes. 

However, Duncan’s death is not entirely tax free. One quirk in the 2010 estate tax law is an anomaly referred to as “carryover basis.” Generally, under the modern estate tax regimen, while estates are subject to the estate tax, the assets that are subjected to the tax receive a “step-up” in their tax bases equal to the value of such assets as of the decedent’s date of death. This means that the heirs receiving these assets can sell those assets and pay capital gains taxes on only the appreciation in the value of those assets exceeding the stepped-up bases. In 2010, assets receive no step-up in basis except for a limited step-up of $3 million for assets passing to a surviving spouse and $1.3 million for assets passing to other heirs.

In the case of Duncan’s estate, except for these limited exceptions to the step-up basis rule, Duncan’s heirs will inherit the assets in Duncan’s estate with carryover tax bases. If the Duncan heirs sell these assets, then they will pay capital gains taxes on the difference between the sale price of the assets and Duncan’s original basis. Based upon the presumption that much of Duncan’s estate consists of his company shares with a very low basis, the ultimate capital gains taxes payable by Duncan’s heirs could be substantial. Nevertheless, even if the taxes are paid at the increased capital gains rate for 2011 of 20% (increasing to 23.8% in 2013), these taxes are certainly much less than the estate tax rates of 45% to 55%. 

The bottom line: death and taxes are still inevitable. It’s only their timing and severity that varies.

The Bridge is Out! Senate Fails To Compromise on Estate Tax Fix

As reported in a recent article in TheHill.com, bipartisan negotiations over a potential compromise relating to the federal estate tax have broken down. According to Senate Minority Whip Jon Kyl (R-AZ), Senate Democrats are not allowing any legislation to reach the Senate floor which is not supported by a majority of Senate Democrats.

President Obama has previously proposed that the estate tax be continued at 2009 levels, with a total exemption from the estate tax of $3.5 million (potentially $7.0 million for a married couple) and with a top bracket of 45%. While the terms of the failed compromise were not released publicly, it has been reported from a number of sources that the compromise would begin at President Obama’s proposed levels, but then the exemption would increase over a number of years to $5 million with a 35% top bracket. In order to make the reduction deficit neutral, the Senate proposal would have also allowed individuals to prepay the estate tax during their lifetime at a rate of 35%. Presumably, this prepayment proposal would have been accomplished through some type of a “prepayment trust,” in which taxpayers would transfer assets to an irrevocable trust and pay the estate taxes in the year of transfer.

If Congress takes no further action on the estate tax (a possibility which I have discussed in a previous WealthLawBlog article), the estate tax will remain “repealed” for the balance of 2010, but then will return on January 1, 2011 with an exemption of only $1 million and a top bracket of 55%. Some Senators have stated publicly that they are in support of a reduced estate tax exemption. For instance,

Sen. Bernard Sanders (I-Vt.) recently stated: “The idea that we would make significant exemptions within the estate tax to give more tax breaks to the top three-tenths of 1% is nauseating. I will do everything I can to stop that.”

With approximately 11 “legislative weeks” for Congress to accomplish a “fix” to the estate tax, it seems to me that two things are becoming increasingly likely. First, the estate tax will likely remain “repealed” for the balance of 2010. Second, as the champagne flows and 2011 is ushered in, the “new” estate tax will return with the $1 million-55% parameters.