Articles Posted in Estate Tax

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Summer allows us a little break in our Palm Springs law office, and it also allows us to take a break from our blogs. But as Fall is now upon us (and it is gorgeous outside, trust me), it’s time to get back to business. We get a a lot of questions about the probate process here in California (something our Firm gets involved in regularly), and how it may differ when the deceased was not a US citizen/ resident.

Before We Describe the Probate Process, Remember, Your Estate Will Save Time and Money if You Put Your House in a Trust While You’re Living

California probate is a both time consuming (think 8 months to over a year to complete…) and costly (the family of a deceased will have to pay attorneys approximately 3% of the value of the property being probated in California…plus extra costs as well associated with the estate tax return of the estate and even potentially other costs). On the other hand, property placed into a valid trust (under California law) does not have to go through probate, which generally saves the estate thousands of dollars and speeds up the process by which the heirs receive the property considerably. Sanger and Manes drafts trusts for Canadians owning Palm Springs area real estate (and all of California property generally).

If the Canadian Decedent Did Not Use a Trust or WIll which Constiutes a Valid Trust or Will Under California Law, What Happens to the US Real Estate When the Canadian Dies?

Just like if an American dies owning US real estate, no trust means a probate is required. Probate means a court proceeding whereby the court must decide who owns the property now that the former owner has passed away. Typically (although not always), the decedent will have at least had a will (probably back in Canada). So we, as US attorneys, will attempt to have the Canadian will accepted by the US court. Will it be? Not necessarily. Each state in the United States provides for its own requirements which a valid will must contain. For example, one requirement under California law is that a valid will must be signed by two witnesses who were present to witness the execution of the document by the testator and who also witnessed each other sign the document. So what if a Canadian will had one only witness? Certainly that document could be ruled invalid by the California court, and the deceased could be viewed as dying without a will (or dying “intestate”).

What are Impications of Dying Intestate?

Under California law, if the Canadian decedent is viewed as dying intestate, either because he or she had no will or trust (or the will he or she had was not viewed as valid under California law), the decedent’s property in Cal will be transferred to his or her next living heirs at law, in equal measures. So if a husband died intestate, the property would all go to his wife. If his wife had predeceased him, it would go to his children in measures- all by the rules of intestate succession.

I always tell my Canadian clients if their desire is to leave their property to someone other than the children in equal measures (like to just one child of three who really enjoyed the US house, or to a brother instead of any of the children), then at least get a California will for the California property to ensure it goes where the deceased wanted it to go (you can have confidence the California will will be honored by the California court, unlike the Canadian will). Of course, I still prefer a trust above all else.

We’ll talk about the various steps in the probate process in Part II of this series.

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As 2012 draws nearer to a close, we should all keep in mind that the opportunity for maximum estate and tax planning may also be drawing to a close. What are we talking about? Let’s look at the estate and gift tax changes which are scheduled to change at the end of 2012:

1) The $5,000,000 lifetime estate and gift tax exemption amount (actually $5,120,000) in 2012 is scheduled to revert to $1,000,000 in 2013.

2) The highest estate tax rate is 35% in 2012, which is scheduled to revert to 55% in 2013.

There’s no guarantee the estate/gift tax exemption will be $1,000,000 in 2013, or that the highest rate of estate tax will be 55% in 2013. But these are what’s scheduled, and absent an agreement from Congress, this is what we’re getting,

So how we can take advantage of what is scheduled to occur?

Suggestion 1- Make Gifts This Year (2012)

Obviously we’re talking about very wealthy people here. But if you have millions of dollars, you want to take advantage of every dime of that high $5,120,000 2012 exemption before it goes away. How do you do that? Recall that the estate tax exemption and the gift tax exemption basically operate in unison. So what the affluent person can do now is make a gift (let’s say to a relative but it could be to anybody). So the affluent individual makes a gift to his daughter (that’s probably who would inherit much of his estate anyway) in 2012 in the amount of $5,120,000. Now the wealthy individual has lowered his estate by $5,120,000 by giving that amount to the person to whom it was going to go to upon his death anyway. And because he did it in 2012, with a high estate/gift tax threshold, he was able to do it with no tax consequences. Imagine, on the other hand, if he didn’t make the gift in 2012, but instead held on to the money and then passed away in 2013. Upon his death the $5,120,000 still goes to his daughter (under the Will), but under this scenario (with only $1,000,000 in the estate tax exemption in 2013), $4,120,000+ is subject to the estate tax (which is taxed at maximum of 55% in 2013= over $2,000,000 in estate tax). So by not making the gift to daughter in 2012, the wealthy individual’s estate lost over $2,000,000 to the IRS.

Suggestion 2- If you Have Loans Outstanding to Family Members in 2012- Consider Forgiving Them (This Year)

Somewhat in line with Suggestion 1, if you are an affluent individual who has loans outstanding to you children, consider forgiving the loans (and making them gifts to your kids). Again, for the affluent, 2012 is potentially a very good year to make gifts to family members.

Suggestion 3- Put the Gifts For the Family Members into a Trust First

Again, it’s a good year for gifts to individuals who would inherit from you anyway. Why put the gifts in a trust 1st? Well, for starters, if the individual’s daughter has trouble with creditors (or if the individual’s daughter gets divorced and we don’t want the ex-husband getting any of the gift) those gifts (to the family members) are protected (unlike the outright gift). Also, this allows the wealthy individual to pay the tax on the growth (the interest/income component) instead of the daughter.

Other really interesting gift opportunities exist when gifting an interest in an LLC or partnership, where the gifts can actually be well above the $5,120,000 and still exempt (due to the discounting of interests in entities due to lack of marketability and for minority interests).

Last Question- Any Chance 2012 Gifts of $5,000,000+ Will Be Deemed Not Exempt in Later Years?

This is the question of the clawback. $5,120,000 is the exemption amount in 2012, but will the IRS retroactively deem that the $5,000,000 gift of 2012 was not entitled to the full exemption? There is no indication this will occur (although some practitioners do worry about it). For now, we say gift away, at least for the rest of 2012!!!

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A district court has now granted the IRS permission to issue a summons to the State of California Board of Equalization, as part of a gift tax enforcement initiative to detect transfers of real property between nonspouse relatives that weren’t reported on gift tax returns. California now joins Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin, as states where the state governments must turn over records about property transfers to the IRS. If you transferred property to nonspouse relatives and did not complete the appropriate gift tax return, the State of California may be on the verge of telling the IRS all about you.

Gift Tax Background
Intra-family transfers of property are extremely common. Remember that in 2011, decedents can exclude up to $5 million of their estate before having to pay estate tax on the remainder. Likewise, in 2011 individuals can “gift” up to $5 million and not pay a tax on the gift amount (the Internal Revenue Code therefore “unifies” the estate tax and the gift tax.) However, any individual who makes gifts to any one donee during a calendar year above the $13,000 annual exclusion must file a gift tax return (an IRS Form 709). A return must be filed even if no tax is payable (due to the $5 million lifetime exclusion).

When the IRS issues a Summons to the State of California, what Information can it Gather about You?
With a summons served upon the state of California, the IRS can uncover transfers of real property to nonspouse family members. How? Property transfers in California generally constitute a “change in ownership” so that the county assessor may reassess a property for property tax purposes. Absent a change in ownership, the state may only increase a California property owner’s taxes by 2% per year. In order to claim an exclusion from the change in ownership reassessment rule, California taxpayers must file Forms BOE-58-AH (Claim for Reassessment Exclusion for Transfer Between Parent and Child) or BOE-58-G (Claim for Reassessment Exclusion for Transfer Between Grandparent and Grandchild). These forms are filed with the local county assessor’s office. California property owners are generally very diligent about completing these forms, because they do not want their property reassessed for fear of considerably higher property taxes. The state of California maintains a statewide database of the information garnered from these forms. And now the IRS has access to the Forms BOE-58-AH and BOE-58-G filed by California transferors of property (to relatives) seeking to avoid a reassessment of the property.

California tells the IRS of the Property Transfer, now the IRS is Looking for The Transferor’s Form 709
The rest is relatively simple. The state of California allows the IRS to review the Forms BOE-58-AH and BOE-58-G, and the IRS simply follows up by seeing whether that individual completed a Form 709 (and paid gift taxes, if appropriate). IRS survey results concluded that at least 50% and up to 90% of individuals who transferred property to nonspouse family members failed to file a Form 709.

California residents- if you transferred property since 2005 to a nonspouse family member, and you should have filed a Form 709 and didn’t (and didn’t pay the appropriate gift tax, if any), go file it now. Because there is a very good chance the IRS is going to find this out anyway, and the penalties of their discovering your lack of compliance will be much worse if you have not already rectified the situation.

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Answer: The government can hold the executor personally liable for taxes the decedent owed to the IRS where because the executor pays creditors and beneficiaries, the estate lacks the funds to full-pay the IRS. Example: A decedent has unpaid taxes of $12. The decedent’s estate has $10 in total assets. The executor distributes $3 to the estate beneficiary, and then pays the remaining $7 to the IRS. The law requires the executor to pay claims owed to the United States before paying most of the other of the decedent’s debts. For purposes of the law, “debts” includes distributions to beneficiaries. Because the executor blundered when he distributed $3 to the beneficiary before paying/applying all $10 of estate assets to the IRS on account of the $12 of unpaid taxes, the executor is PERSONAL LIABLE to the IRS. In our example, the executor is personally liable for the amount of $3 (the amount he paid to the beneficiaries instead of paying the IRS). Note that the executor is not liable for the $5 of taxes remaining unpaid after (i.e. $12 owed the IRS minus the $7 of estate assets paid to the IRS), because the estate only had $10 from the outset, so the government could not expect the executor to pay more than $10. Since the estate had $10, and paid $7 to the IRS, the executor is personally responsible to pay $3 to the IRS. You will find the law at Section 3713 of title 31 of US Code (note §3713 is not an Internal Revenue Code section). There exist two important caveats to the general rule of an executor’s personal liability, discussed in our next post.

Answer: No. Example: A decedent has unpaid taxes of $12. When the decedent died, the assets were worth, $20. The economy suffered a depression and the estate assets dropped in value to $7. The executor pays the $7 to the IRS, leaving $5 of unpaid taxes. The executor is not personally liable to the IRS for the $5 because the law (§3713) only imposes personal liability where the executor paid other creditors or made beneficiary distributions which left the estate with insufficient funds to pay the entire $12 of taxes.

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Answer: Yes. IRC §2203 defines “executor” as the duly appointed executor or administrator, or if none has been appointed, then any person in actual or constructive possession of any property of the decedent.


Answer: Except is explained in Part III to-be-published next week, the answer is “no”. The executor is not personally responsible for the decedent’s unpaid taxes. The executor’s duty to pay the decedent’s taxes is in his representative capacity, using the decedent’s estate assets, and not the executor’s personal assets. Thus, if the decedent’s unpaid taxes total $12, and the estate assets total $10, and the executor pays the $10 to the IRS, the executor in his personal capacity is not liable for the $2 of unpaid taxes; the executor’s personal assets are not liable for the $2 of the decedent’s unpaid taxes. However, a foolish or ill-advised executor could find himself personally liable and his personal assets taken by the IRS by a non-IRC provision: §3713 of 31 U.S. Code. See also Cal. Rev & Tax Code §19516.

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Why do individuals wish to transfer assets to family limited partnerships? The answer is simple: if the assets are held by the family limited partnership, then they’re not held in the estate (i.e, less amounts subject to the estate tax). IRC Section 2036 provides generally that an individual’s gross estate includes property the decedent transferred during his life if he retained for life the possession or enjoyment of the property, or the right to the income from the property. But no inclusion is required if the transfer was a bona fide sale for an adequate and full consideration in money or money’s worth. And further, the transferee (the family limited partnership) must be respected as legitimate. The family limited partnership must be run as a legitimate business, with annual meetings, regularly maintained books and records, and active business activities.
In Estate of Erma v. Jorgensen ((2011, CA9) 107 AFTR 2d ¶ 2011-793 ), a decedent transferred marketable securities to her family limited partnership which held passive investments only and did not maintain books and records. Further, while still alive, the decedent wrote personal checks from the family limited partnership accounts. Before the US Tax Court, the estate claimed that the transfers of securities were bona fide sales for full and adequate consideration (the family limited partnership interest), and that they should not be included in her estate under IRC Section 2036. The Tax Court disagreed, and the Ninth Circuit affirmed the decision of the Tax Court (citing it appeared the amounts transferred to the family limited partnership could be accessed for the personal needs of the decedent at any time).
The key lesson, as noted by the Ninth Circuit: transfers to family limited partnerships are subject to heightened scrutiny; careful planning and attention to detail are a must.

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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). We think that only estates of very wealthy 2010 decedents will likely wish to file a Form 8939. But where is the final Form 8939? How can we file it if it does not exist? On March 31, 2011, the IRS issued the following statement: “Form 8939 is not due on April 18, 2011, and should not be filed with the final Form 1040 of persons who died in 2010. New guidance that announces the form due date will be issued at a later date and Form 8939 will be released soon after guidance is issued.” While that provided some relief for practitioners left completely in the dark about how to file a nonexistent Form 8938 by the filing deadline, it still leaves us all waiting for the final Form 8939. We don’t have much more to add, except that we are all…still waiting.

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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.

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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.

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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.