Estate Tax Abyss

For more than 32 years, I have counseled clients on planning for federal estate tax and Oregon inheritance tax. Throughout that time, numerous legislative changes have occurred: taxes have increased and decreased; effective dates have come and gone; and clients have changed their strategies to fit the evolving landscape in our tax laws. Never, however, have we been confronted with the lack of certainty over estate tax laws that we now face, due to the ineptitude and irresponsibility of the United States Congress.

Back in 2001, as part of the initial Bush administration tax plan, the federal estate tax exemption was scheduled to gradually increase over a nine year span. In the tenth year (2010), the federal estate tax exemption became unlimited. In other words, for those dying in 2010, there is currently no federal estate tax.

In addition, the tax benefit commonly known as “step-up in tax basis” was repealed for the year 2010. Under the old rules, the tax basis in assets inherited by beneficiaries became the fair market value of the assets as of the decedent’s date of death. In 2010, tax basis in inherited assets is called “modified carryover basis,” which is the lower of the date of death value or the decedent’s tax basis, meaning that no step-up to date of death value is achieved.

There are two significant exceptions to this rule. First, a decedent’s estate is entitled to increase the basis in assets owned by the decedent at death by an amount equal to $1.3 million. Second, with respect to assets passing to a surviving spouse or to a trust for the surviving spouse that qualifies as a QTIP Trust, an additional $3 million step-up is available.

In 2011, the entire house of cards falls. Because of a sunset provision enacted as part of the original law, deaths in 2011 and thereafter are treated as though the 2001 law had never been enacted. In other words, inherited assets receive a full step-up in basis, but decedents are only entitled to a $1 million federal estate tax exemption.

Basically, this means anyone dying in 2010 would completely avoid federal estate tax, but carryover basis (subject to the exceptions discussed above) would apply. If, however, that person survived until 2011 or thereafter, he or she would only be entitled to a $1 million estate tax exemption, with the remainder being taxed at significant rates.

During the past 10 years, we all thought Congress would act responsibly and change these laws so that “estate tax Armageddon” would never occur. Indeed, when the 2001 law was passed, it was anticipated that changes would occur well before the year 2010. Yet the year 2010 is now upon us with no foreseeable change in the law, and we find ourselves scratching our heads in anticipation of what Congress will or will not do.

As recently as last December, there were as many as nine separate bills, either in the drafting stage or pending before Congress, intended to fix the estate tax law and avoid the current quagmire. None of those bills passed both Houses.

So here we are with no relief in sight. There is conjecture that Congress will act during the first quarter of this year to correct this problem, most likely through establishing an estate tax exemption somewhere between $3.5 million and $5 million per individual, with the reinstatement of stepped-up basis. However, there is a growing probability that this will not occur.

Given the recent election results in Massachusetts, it may be more difficult for Congress to pass comprehensive estate tax legislation. Many pundits have agreed that if legislation does not occur quickly, then it may not occur at all this year. Some Democrats, who see the situation in 2011 as a tremendous opportunity to increase taxes without new legislation, may be willing to simply let the Bush 2001 tax cuts die a quiet death and reinstate the law as it existed in the year 2000. The pundits go on to argue that if people complain because the estate tax exemption would then only be $1 million and the tax would increase to a maximum 55 percent rate, the Democrats could simply say, “Blame it on the Republicans – it’s their law.”

But let’s presume Congress does something soon. In fact, Congress may have already acted by the time this article is published. Many legal scholars argue, however, that any legislation, if made retroactive to January 1, 2010, will be subject to scrutiny because of the potential unconstitutionality of a retroactive increase in estate taxes.

If indeed that is the case, and Congress avoids retroactivity by passing a law that is effective only for deaths occurring after enactment, then what happens to those who died between December 31, 2009 and the new effective date? Do they have no step-up in basis other than the amounts identified for 2010? Do they avoid federal estate tax? Do they have the right to choose which set of laws they want to follow? These questions, together with a host of others, remain unanswered.

Exacerbating the entire situation is the Oregon inheritance tax, which currently provides for a fixed $1 million exemption, a maximum rate of 16 percent, and the presumption of a full increase in basis. The Department of Revenue has recently taken the position force, but Oregon will follow the federal rule in 2010 and move to carryover basis.

If the feds act to change the law and Oregon does not reconnect to the federal income tax changes, then we could have stepped-up basis for federal purposes and carryover basis for Oregon purposes. So beneficiaries would have to keep two depreciation schedules-one for Oregon and one for federal purposes. This issue has not yet been resolved.

There are a myriad of other problems that are much more technical, going well beyond the scope of this article.

The real question, however, concerns how our clients deal with this problem now. In many typical estate plans for our married clients, we have prepared wills and revocable living trusts which fund a marital share and a bypass amount (normally the amount of the unused estate tax exemption). If the bypass share equals the unused exemption, then under the 2010 “Armageddon law,” this could result in the entire estate going to the bypass share. If the will provides, for instance, that the bypass share goes to children of the first marriage, then the 2010 law would result in the surviving spouse being disinherited.

After thorough investigation and analysis of the problems presented by the current federal estate tax law and how those problems interface with the Oregon inheritance tax, the Firm’s estate planning group has developed a number of different options available for clients who are concerned that their estate plans may be affected. Although these rules affect married couples most profoundly, they also have a significant impact on single individuals.

It is impossible for us to review the thousands of wills we have prepared over the last 30-40 years to determine which clients may or may not be affected by these unanticipated changes in the law. As a result, if you are concerned about how the law may affect your estate planning documents, we urge you to call the office, make an appointment, and evaluate whether and to what extent any changes might be required in your estate plan.

Please understand that Congress has the ability to enact legislation to fix this problem retroactively, assuming that is constitutional. If this is the case, then your estate plan is probably unaffected. However, there is no guarantee this will happen.

If you have questions regarding how this law affects your estate planning documents, please call our office and we will analyze your documents and provide recommendations. As always, we will do everything we can to ensure that your interests are protected.

Buying A Foreclosed Rental Property? New Laws Make It Tricky

In 2009, both the U.S. Congress and Oregon’s legisla­ture passed new laws protecting residential tenants in properties where a lender is foreclosing. As a result, any buyer at the foreclosure sale must investigate the status of tenancy at the property and give significant notice before possessing it.

Although this may not be an issue in multi-family housing where tenancies are usually preserved, it could be a big problem in single family dwellings and smaller “plexes” where the goal is to obtain property free of tenants.

Federal law

The federal law is 12 USC 5201 et seq. and is known as the Protecting Tenants at Foreclosure Act of 2009. This statute applies in the case of a foreclosure on a federally-related mortgage loan on any dwelling or residential real property. A federally-related mortgage loan is one secured by a lien on residential real property where there is a structure for occupancy of from one to four families, or a manufactured home. It must be made by a lender whose deposits or accounts are insured by any agency of the federal government. Also it applies if the loan is made, insured, guaranteed, supplemented, or assisted in any way by any officer or agency of the federal government, or in connection with a housing or urban development program administered by any officer or agency of the federal government. It also applies if the loan is intended to be sold to the Federal National Mortgage Association, the Government National Mortgage Association or the Federal Home Loan Mortgage Corporation. Last, it applies to loans made by a creditor as defined in the Consumer Credit Protection Act.

Under the federal act, the buyer at a foreclosure sale will take the property subject to the rights of a bona fide tenant. Those rights can be terminated on 90 days’ notice, but only if the tenant is holding without a lease or with a lease terminable at will, or if the purchaser intends to use the residence as the purchaser’s primary residence.

So if you buy at a foreclosure sale and there is an existing tenant under lease for a year, you will not be able to remove that tenant before the end of the lease term unless you intend to live in the residence yourself. A bona fide lessee will not include the borrower, the borrower’s child, the borrower’s spouse, or the borrower’s parent. Nor will it include a lease for substantially less than fair market rent. Nevertheless, this could pose a substantial obstacle to you if you plan to buy a foreclosed residential rental property.

Oregon law

But it doesn’t stop there: there are a number of Oregon laws that were passed in 2009, which also protect tenant rights. Under House Bill 3004 and Senate Bill 952, the purchaser at a foreclosure sale must give the tenant 30 days’ notice before evicting and that notice cannot be given more than 30 days before the first date set for the sale. However, the tenant can obtain a longer time period for notice.

If the tenant gives the trustee under the trust deed a copy of the rental agreement or lease at least 30 days before the first date that was set for sale, then the purchaser at the foreclosure sale cannot commence a foreclosure until 60 days’ notice has been given to the tenant.

But, if the tenancy is month-to-month or week-to-week, and the tenant gives notice of the rental agreement to the trustee not less than 30 days before the first date set for the foreclosure sale, then the tenant is only entitled to 30 days’ notice before an eviction.

However, even if the tenancy is for longer than a month-to-month term, the purchaser may be able to remove the tenant on 30 days’ notice, if the purchaser intends to occupy the residence as the purchaser’s primary residence. So it is critical for any purchaser to ask the trustee if any notices of existing leases or rental arrangements have been provided by tenants.

More requirements

House Bill 3004 adds a requirement that a trustee have a website to post true copies, or links to true copies, of amended notices of sale. Oregon Senate Bill 628 modified the warning notice to require that information on how the borrower can consult with a housing counselor and get information on federal loan modifications is included. Also, it must provide a deadline for submitting a request for a loan modification and places timing burdens on the beneficiary to review the application in good faith and respond.

Senate Bill 239 requires filing an affidavit of the service of the notice with regard to loan modification programs. And if that notice is not sent, the grantor of the trust deed will have the opportunity to redeem the property.

Oregon Senate Bill 952 now adds a requirement for a notice to tenants to advise them of their risk of being forced to move out and of their right to notice and other rights. It is not clear what effect a failure to timely give this notice will have.

The message of the new federal and state statutes is that the road to acquiring residential rental properties through foreclosure is a dangerous one. It should not be traveled without carefully reviewing not only the status of the property, but the terms of the tenancies of all of the occupants and the notices that were sent out in connection with the foreclosure.

It is no longer possible to simply serve all tenants with foreclosure notices and eliminate their rights at the sale. There are many traps for the uninformed. We can help you each step of the way.

Distributing Wealth (Part Three in a Three-Part Series)

For more than 82 years, our firm has helped businesses and families build, protect, and distribute wealth. In this third of a three-part series, I’ll explore several key important areas to consider when distributing wealth, especially if you own a small or medium size business.

1. See the Big Picture

Distributing your wealth, both during life and after death, presents both challenges and opportunities. However, the process cannot take place in an isolated or capricious manner. Rather, look to your overall values, family circumstances and responsibilities. Through careful planning, the proper distribution of wealth can meet responsibilities, protect your family, promote charitable causes and ultimately create a legacy.

2. Be Charitable

Gifts to charity, both during life and after death, present excellent tax, as well as intangible benefits. During life, charitable gifts are generally deductible for income tax purposes up to 50 percent of your adjusted gross income. If property other than cash, such as stock or real estate, is given to a charity, the amount of the deduction is generally equal to the fair market value of the donated property. Charitable gifts made as part of the distribution of your estate are also deductible for purposes of estate or inheritance taxes. In cases of gifts of non-cash property, the tax rules can be complex. Therefore, it’s important that you obtain professional advice before making such gifts.

3. Splitting Gifts with Charities

A charitable remainder trust (CRT) can be an excellent vehicle to accomplish both charitable and non-charitable benefits at the same time. In a typical CRT arrangement, money or other property is transferred to a privately- created trust, then the donor or a beneficiary designated by the donor receives income from the trust for a predetermined period. The trust then terminates, and the remaining assets in the trust are distributed to the charity.

Upon a lifetime transfer of the money or property to the CRT, the donor receives a partial income tax deduction. In addition, the asset is removed from the estate, reducing subsequent estate taxes. Once property is transferred to the trust, any sale of the property by the trust is exempt from income taxes. CRT’s are a great opportunity for you to convert highly appreciated assets to a predictable stream of income without paying income taxes on the sale of that asset.

4. Proactive Planning with Life Insurance

Life insurance can be a very effective tool for providing your estate and heirs with liquidity for support or to pay debts or estate taxes. However, many people are unaware that owning life insurance directly in your own name will cause the life insurance to be included in your estate for estate and inheritance tax purposes.

A common solution for this problem is to form a trust – commonly known as an irrevocable life insurance trust, or ILIT – to own the life insurance policy. “Gifts” to the ILIT are typically made on an annual basis in amounts sufficient to pay insurance premiums. At death, the proceeds of the life insurance are not included in your estate for estate tax purposes. These proceeds can then be available to the estate or its beneficiaries.

Often, the ILIT is funded with a second-to-die life insurance policy, as estate and inheritance taxes are generally payable at the death of the surviving spouse.

5. Make Lifetime Gifts Wisely

In addition to estate taxes, the Federal tax code imposes a gift tax on gifts made during your lifetime. However, the gift tax has two exemptions. The first exemption is a $1 million lifetime exemption, whereby gift tax is not payable until one’s cumulative gifts during life exceed $1 million. This exemption is on a per-person basis, meaning that a married couple can give away a total of $2 million during their lives.

The second exemption is the annual gift exclusion whereby yearly gifts up to the exclusion amount – currently $13,000 – are not subject to gift tax and also do not reduce the $1 million lifetime exemption. For example, with a $14,000 gift to a child, the first $13,000 would be exempt, but the final $1,000 would reduce the $1 million exemption amount to $999,000.

6. Gifts of Business Interests

Giving business interests to family members can present great opportunities along with complex challenges. When less than a controlling interest in a business is given, the estate and gift tax laws recognize that the transferred interests are typically valued using various valuation discounts. These discounts arise both because such interests generally have little control with respect to the operations of the business, and also because they have little resale marketability. With these discounts, larger shares of the business entity can be transferred.

However, if you choose this route, you should plan the gifting of business interests very carefully as the IRS may scrutinize the manner in which the gift value was determined. You should consider hiring a professional business appraiser to substantiate the value of the gifted interest.

7. The Estate Tax in Flux

The Federal Estate Tax is in flux. Please see the Estate Tax Abyss article by my law partner Stephen Kantor in this newsletter to learn more about this important issue.

Notwithstanding the unpredictable nature of the federal estate tax, Oregon and Washington both have state-level inheritance tax systems. Oregon has an inheritance tax exemption of $1 million per person, and Washington’s exemption is $2 million. Therefore, for some individuals, state-level tax planning may be necessary in addition to federal estate tax planning.

Building, protecting, and distributing wealth requires careful planning. This three-part series has discussed many of the key issues relating to this planning process. You can access the first two parts of this series on our firm’s website at www.SamuelsLaw.com.

An American Trial Lawyer In Europe: A Sabbatical Revisited

From its source high in the Black Forest, the Danube River winds its way east toward Vienna, Budapest and eventually the Black Sea. At the point where it crosses the border into Austria, it passes Passau, a beautiful baroque city on the banks of the Danube in that corner of Germany where the Czech Republic, Austria and Germany all meet.

In Europe, the University of Passau is regarded as having one of the best schools of international law. So when I was invited to spend my sabbatical at the University of Passau giving a series of lectures on the American jury system, I was excited and honored by the opportunity.

Germany, like virtually all European countries, does not use the jury system. Instead, a case is tried with a panel of judges (usually, three to five on the panel). In fact, the American jury trial, the bedrock foundation of our American justice system, is in many ways a mystery to Europeans.

As Americans, we grow up with the jury system. We see it on TV shows like Perry Mason and coverage of real life trials like O.J. Simpson. We watch juries in the movies from Henry Fonda as the hold-out juror in Twelve Angry Men to Richard Gere as the tap-dancing defense attorney in Chicago. In fact for Americans, it is difficult to imagine a justice system where one was not entitled to a jury of his peers. Plus, we all know relatives, friends and neighbors who have served on juries and have stories to tell.

Preparing these lectures on juries was a task I relished. Here was an opportunity to share one of the great pillars of Anglo-American jurisprudence.

As I walked into the lecture hall in the middle of campus for my first lecture, I was pleased to see it was filled with upper classmen and faculty members who appeared eager to learn about a system they had only seen in the movies. It turned out that this was an interested and inquisitive audience.

My lectures traced the origin of the jury system in England from about the year 1215 through the American Revolution and up to modern day practice. I explained jury duty and how jurors are just ordinary people, summoned to perform their civic duty and selected by the attorneys for the parties.

I was able to explain how attorneys in a jury trial present their case in an adversarial process, where each side has its chance to call witnesses and cross-examine witnesses on the other side. This is a dramatic departure from the European system in which the presiding judge selects and calls the witnesses and asks virtually all of the questions. The students were fascinated to learn how the American trial lawyer considers not only the facts and the law, but also how to most effectively present the case using just the right tenor and mood to fit the client, the claim, and the evidence.

The students and faculty who attended were also intrigued by our system of pretrial discovery. Europeans don’t do discovery. They have no such thing as depositions or document production, all of which are so routine in our civil litigation system.

Instead under the German system the court prepares the case for trial and asks virtually all of the questions. When they appear at trial, the parties have no idea apart from the allegations in the pleadings just exactly what the other side’s witnesses will say.

And, unlike our system, there is no opportunity for the lawyer to ask those penetrating and revealing questions in cross examination. Why not? Because there is no cross examination.

At first the 90 minutes I was allotted for each lecture seemed like it would be more than adequate. In fact, I was worried that I wouldn’t have enough material to fill all 90 minutes. Little did I know that the students and faculty would be so enthusiastic in their response and that questions would last until well beyond the allotted time.

After one lecture, a woman approached me and told me that she had driven from Munich some two hours away. Someone from the law school had called her and told her that she needed to hear what I had to say, so she drove the two hours in order to take in my lecture.

It is the custom for German university students to knock politely on the desk with their knuckles to applaud a professor at the end of a lecture. After my last lecture, I was very pleased to receive a prolonged and resounding knocking or “Klopfen” as a sign of heartfelt appreciation. But really the pleasure was all mine.

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