Articles Posted in Estate Tax

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congress-e1521771059150-300x231The tax legislation passed by Congress last year is something of a 1950s pop love song to businesses: sweet but not very deep.  It will likely have little impact on Canadians unless they own and operate a US company.  Typically, Canadians invest in US assets, particularly real estate, rather than run US operations.  The tax package has little to offer in that regard.  But one change does make a difference.  The new law doubles the US estate tax exemption amount.  Given the size of the increase, the US estate tax now leaves all but the wealthiest Canadians untouched.  However, this situation is temporary, making long-term estate planning for Canadians with US property tricky.

Canadians And US Estate Taxes

Canadians who own US assets (typically a vacation home) have traditionally been paranoid about US estate taxes.  It’s understandable.  The US estate tax rate has lurched between 35% and 65% in recent history, with a current rate of 40%.  Before 2003, when the exemption amount was $2 million or less, the estate of a Canadian with a valuable vacation home in the US could easily get hit with a significant estate tax.  Still, the anxiety was always exaggerated, given the favorable treatment Canadians receive under the US-Canada Tax Treaty.  This is especially true after 2010, when the exemption shot up to $5 million, with annual upward adjustments.

How The Treaty Works

The Treaty provides Canadians with the most favorable estate tax treatment of any US tax treaty.  Besides mitigating double taxation by providing for a deduction for Canada’s equivalent of an estate tax (the “deemed disposition” tax), the Treaty allows the estates of Canadians to benefit from the exemption amount available to US citizens.  The exemption is prorated based on the ratio of the value of taxable US assets to the value of the worldwide assets owned by the decedent.  To use simple numbers, if a Canadian died in 2011 when the exemption was $5 million, and his total assets were $5 million, with a vacation home located in the US worth $2.5 million, the estate would apply a percentage of the exemption amount equal to the US asset value over the total asset value. Result: a $2.5 million exemption against a US estate worth $2.5 million.  Accordingly, the estate would owe no estate taxes. Continue reading →

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One of the perennial questions my Canadian clients ask me is how they should take title to their US real estate, usually a vacation home.  My answer is, it depends on a number of considerations, but the right choice probably involves a revocable trust specially drafted to hold US real estate.  But in any case, some thought has to go into the decision.  Thousands of dollars may be at stake if the wrong method of title is used.  The choice shouldn’t be made casually while signing escrow papers, which regrettably often happens.

The best way for Canadians, and foreign nationals in general, to hold US real estate depends on their plans for the property, its value, the owner’s age and net worth, whether the property has appreciated since it was purchased, the expectation of rental income, and what issues loom large for the owner (avoiding probate, escaping the US estate tax, selling the property with a minimum of capital gain, limiting personal liability).  Let me go over the basics.

  1. The Probate Issue.  A probate in Canada can’t transfer real property located in the US to the decedent’s heirs.  Neither a California court nor the local county recorder will recognize foreign court orders when it comes to US real estate.  So, if you are a Canadian and you own a vacation home in California in your individual name (or both the names of you and your spouse), when one of you dies you will have to probate the real property (the exception is property held in joint tenancy, discussed below).  Another probate will be required when the surviving spouse dies if the spouse hasn’t sold the property.  Probate is the process whereby a court oversees and orders the transfer of assets from a decedent to the decedent’s heirs.  Like any court process it tends to be time consuming, public, and involves significant attorney’s fees.  It isn’t the end of the world to have to probate US real property, but most Canadians are justified in trying to avoid it.
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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).

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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.

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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).

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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.


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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.


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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.