February 2011 Archives

February 24, 2011
Posted by Sanger & Manes, LLP

The Hidden Minimum Required Distribution Rules Dangers in Drafting a See-Through Trust (Part 2)

A see-through trust, if drafted properly, may serve as a useful planning vehicle. It allows an IRA to distribute IRA amounts to the trust ratably over the expected remaining life of the designated beneficiary (and still comply with the 401(a)(9) minimum distribution rules). It also allows a trustee to use his or her discretion as to how much of those IRA assets the trust will actually pass on the beneficiaries. This stands in direct opposition to the "conduit trust" which also, under 401(a)(9), allows IRA amounts to be distributed ratably over the expected remaining life of the designated beneficiary, but requires the amounts to flow directly from the IRA to the beneficiary (i.e., no trustee discretion; all amounts directly from IRA to beneficiary).

But drafting a valid see-through trust is not easy. To qualify as a valid see-through trust, the trust must provide for an "identifiable individual designated beneficiary". For example, what if the IRA provides that the designated beneficiary is a subtrust for daughter. The subtrust provides that the trustee shall distribute income and principal to daughter for her health, education, maintenance and support until she reaches age 35, when daughter may receive income and principal without restrictions. In this case, daughter may qualify as a identifiable individual designated beneficiary, allowing the IRA to distribute the IRA amounts ratably over daughter's lifetime (a good tax result). But what if the subtrust gives the daughter a general power of appointment should the daughter fail to reach age 35. Who is the designated beneficiary now? The answer is, we cannot identify one. The daughter could appoint anyone in the world, and so we cannot name a specific identifiable individual designated beneficiary and we do not have a valid see-through trust. Under 401(a)(9), the IRA must now distribute all IRA amounts to the trust not later than the end of the fifth anniversary of mother's death (a bad tax result). Since we botched the see-through trust, the full amount of the IRA is taxable far earlier than if drafted correctly.

But the IRS has approved of a possible way around this mess. More on this to come in Part 3...

February 21, 2011
Posted by Sanger & Manes, LLP

The Hidden Minimum Required Distribution Rules Dangers in Drafting a See-Through Trust (Part 1)

Estate planning practitioners are likely familiar with the See-Through Trust, and its advantages. Let's say wife dies after husband, and either rolled-over his IRA, or had one of her own. Say further that wife dies leaving all her property (including the IRA) to their two children, in trust. The beneficiary of the IRA is the trust (intended to qualify as a See-Through Trust). The trust says the trustee shall distribute all trust property to the beneficiaries for their health, education, maintenance and support. Question: how frequently must the IRA make distributions to the trust to satisfy the IRC Section 401(a)(9) minimum distribution rules? There exists one of two possible answers: either (a) ratably over the life of the "designated beneficiary"; or (b) not later than the end of the year containing the fifth anniversary of the participant's (wife's) death. Since you believe the trust qualifies as a See-Through Trust, you probably think the IRA administrator may distribute the IRA benefits ratably over the lives of the children and still satisfy 401(a)(9)? But can you really? More to come on this....

February 17, 2011
Posted by Sanger & Manes, LLP

Gamblers- The IRS Knows About Your Winnings, But How Do You Prove Your Losses?

How you ever won a big jackpot at the casino? Well, if that jackpot was worth at least $1,200, you know that along with your winnings, the casino will issue you a W-2G, which notifies the IRS of your big payday. You might not care about that, except that most of us don't walk away from the casino right after winning the big jackpot. Typically, we play a little more, and maybe even by the end of the day have more losses than winnings, or certainly less winnings than the $1,200+ of which the IRS now has notice. The Internal Revenue Code allows a taxpayer to deduct gambling losses from gambling winnings on an annual basis. But Internal Revenue Code requires a taxpayer to prove his or her gambling losses. How do you prove gambling losses? The IRS has traditionally accepted a daily log or journal kept by the taxpayer detailing the gambling activity of the day. But how many people really keep a daily journal on their gambling activities?

We have a suggestion: get a casino issued "players card" and use it every time you play the slots. Not only do you earn points towards casino freebies, by using the card you allow the casino to electronically track your gambling winnings and losses. This should serve as excellent evidence when proving your gambling losses to the IRS.

February 16, 2011
Posted by Sanger & Manes, LLP

ABA Comments on Draft Form 8939

As discussed in previous entries, the IRS recently released a draft Form 8939, for decedents who died in 2010 and wish to elect no estate tax (which comes with no basis step-up in assets (with limited exceptions)). Only estates of very wealthy 2010 decedents will likely wish to file a Form 8939. The IRS has still not issued instructions to the form. On January 31, 2011, the ABA sent the IRS a detailed comment letter on the Form 8939, and the IRS, in turn, responded to the comments. Commentators requested clarity on the due date of the form (the IRS hinted at a 9/19/11 due date). The ABA questioned whether the act of filing the Form 8939 constituted making the election (the IRS responded that it did, and that it preferred an executor complete the form rather than simply checking a box to make the election). Finally, the ABA asked whether the IRS would consider allowing estates to make a "protective election" out of the estate tax in the event an IRS audit adjustment subsequently made the election more advantageous. The IRS appears disinclined to do so. More to come soon on the Form 8939.

February 11, 2011
Posted by Sanger & Manes, LLP

What is the Value of My Estate When I Divide My Property into Fractional Interests at Death?

On January 31, 2001, the US Tax Court decided the case of Estate of Adler v. Commissioner (TC Memo 2011-28). The case involved a scenario where a father executed a grant deed transferring five one-fifths interest in property for each of his five children. The deed, however, expressly stated that the father reserved unto himself the full use, control, income and possession of the property during his lifetime. Generally, for the purposes of calculating the estate tax, the IRC requires the inclusion of the full value of the property if the decedent retained possession and enjoyment of the property for life. A property divided into fractional interests, however, typically reduces the value of the property below its fair market value (due to a lack of control and marketability of the minority interests). The Tax Court held the property's value at the decedent's death was its full fair market value, with no discount for the division into five one-fifth interests. The Tax Court concluded by inferring that had the decedent not controlled the disposition of the entire property at death, a discount may have been appropriate.

February 10, 2011
Posted by Chris Manes

Dividends Before And After Death

Let's say Chris (again) dies on January 5, 2011. He has an estate plan with a typical Bypass/QTIP trust arrangement for his second wife, Suzy, remainder to his children from his first wife, along with a pour-over will. The children get the principal of the Bypass and QTIP when Suzy dies. Needless to say Chris' children and Suzy despise one another. Suzy also dies in 2011, and under her estate plan all her property goes to her children from a prior marriage.

Chris owned stock in IBM, and on January 1, 2011, the company declared a dividend of $30,000 payable to Chris. IBM doesn't set a required payment date for the dividend, but the actual payment occurs on January 10, 2011, five days after Chris died. Predictably (again), litigation ensues. Chris's children claim the $30,000 should be allocated to "principal," which means it goes to them as remaindermen. Suzy's children claim the receipt was "income" due to Suzy, which goes to them under her estate plan. Who wins (assuming both sides have competent lawyers familiar with the P&I statute)?

The answer is found in Probate Code §16350 and §16346(c). Suzy's income interest began on Chris's date of death. The dividend was declared prior to that date, and deemed payable on the date of declaration under the Probate Code. Accordingly, the dividend is allocated to principal. Chris's children, not Suzy's children, get the cash.

But let's say that IBM makes the dividend declaration on January 1, 2011, with a required payment date set as January 10, 2011, five days after Chris died? The result - the opposite. Suzy's children get the cash. §16346(c).

February 10, 2011
Posted by Chris Manes

Unpaid Periodic Rent - Income or Principal?


Let's say Chris dies on January 5, 2011. He has an estate plan with a typical Bypass/QTIP trust arrangement for his second wife, Suzy, remainder to his children from his first wife, along with a pour-over will. The children get the principal of the Bypass and QTIP when Suzy dies. Needless to say Chris' children and Suzy despise one another. Suzy also dies in 2011, and under her estate plan all her property goes to her children from a prior marriage.

Chris is owed unpaid periodic rent of $100,000 due on January 1, 2011. The $100,000 of rent is paid on January 10, 2011, five days after Chris died. Predictably, litigation ensues. Chris's children claim the $100,000 should be allocated to "principal," which means it goes to them as remaindermen. Suzy's children claim the receipt was "income" due to Suzy, which goes to them under her estate plan. Who wins (assuming both sides have competent lawyers familiar with the P&I statute)?

The answer is found in Probate Code §16346(a). Suzy's income interest began on Chris's date of death. Accordingly the rental income, because it accrued before her income interest began, is allocated to principal. Chris's children, not Suzy's children, get the cash.

February 4, 2011
Posted by Chris Manes

Electing 2011 Estate Tax Treatment For 2010 Estates


Intuitively, you would think the IRS would require an affirmative election for a fiduciary to obtain 2011 estate tax treatment for 2010 estates. But the IRS is neither intuitive nor a fool. The Service realized that there would be hundreds of thousands of estates that would want 2011 tax treatment, while only a handful (literally) that would prefer 2010 rules (namely those estates over the $5,000,000 threshold). Putting the affirmative burden on "normal" estates would result in hundreds of thousands of forms for the IRS to process. So the IRS did the prudent thing and made 2011 treatment the default.

Thus, if a fiduciary of a 2010 estate wishes to operate under the 2010 law, with no estate tax and (largely) no basis step-up, he must complete a new form, Form 8939, and file it with the IRS. For the rest of us, the vast majority of estates of decedents who died in 2010 but who wish to operate under the 2011 rules, the fiduciary doesn't need to make an affirmative election on the Form 1041. The IRS will treat those estates by default under 2011 rules.

February 4, 2011
Posted by Chris Manes

What Happened To My Stepped Up Basis? How The New Estate Tax Rules Work

By now, most practitioners know of the significant changes to the estate tax provided in the 2010 Tax Relief Act. We know now that for decedent's dying in 2010, the decedent's estate must choose from one of two options. Option (1) allows an executor to operate under the 2010 law, which provides for no estate tax but also provides for no step-up in basis (although a fiduciary is permitted to assign a limited amount of basis to specific assets). Option (2) allows a fiduciary to operate under the 2011 law, which reinstates the estate tax (and the basis step-up), but only taxes estates valued above $5,000,000. For fiduciaries of decedents dying in 2010 with estates valued below $5,000,000, there appears little reason not to simply operate under the 2011 law (i.e., no estate tax since the estate is less than $5,000,000 plus a full basis step-up). For the Steinbrenners of the world, it's a different matter, and more thought will have to be put into it.

But how does the fiduciary in a normal (i.e., non-George Steinbrenner) estate plan elect to operate under the 2011 rules? Are the deadlines for the election? Do you have to file a Form 706 even in a small estate to get the stepped up basis using 2010 rules?

More about that shortly.