2010 - And What To Do About Estate Plans?
Estate planners never thought this would happen - no estate or GST tax in 2010! When the 2001 Act became law, its provisions for a one-year repeal of the estate and GST taxes plus addition of a modified version of carryover basis for income tax purposes, were thought to be a possible problem that Congress would "fix" in due course. As we know, none of the possible fixes were enacted.
So here we are in 2010, a mid-term election year to boot, with no clear indication as to where the Federal estate tax, or lack of same, is headed. Yes, we still have the Federal gift tax with a continuing lifetime exemption of $1 million, and for this year, a 35% rate on taxable gifts not covered by the exemption. And then, under the 2001 Act, January 1, 2011 will see another blow to clients with substantial wealth - the return to the pre-2001 Act $1 million estate tax exemption equivalent and the 55% estate tax rate!
I attended the annual Heckerling (U. of Miami School of Law) Institute on Estate Planning in Orlando last week - a special year to attend this outstanding institute, given the 2010 uncertainty. Aside from the client contact opportunities (generally not deemed a mandate by speakers at Heckerling) of this year of no estate or GST tax, there was little definitive guidance or agreement among speakers as to what to do. Most speakers referred to 2010 as the "estate and GST tax gap" year - which, of course, assumes either (1) Congress will act sometime this year to "fix" the situation, or that January, 2011 will come and Congress will not have acted. In sum, many clients may not have to do anything right now; but no doubt some should and hopefully will through the efforts of proactive estate planning counsel.
We have the familiar problem, which has been discussed for years as the estate tax exemption equivalent rose from $1 million to the 2009 level of $3.5 million per estate, with marital deduction and bypass trust formula clauses. That is, in applying those clauses from year to year, is the client's wishes satisfied? And now how do such clauses work in 2010 when, at least for now, there is no estate tax? In addition, there is the opportunity - which may neither last nor actually be available with possible retroactive legislation - for major gifts at a 35% rate of gift tax. And, of course, there is the issue of dealing with the generation skipping transfers area when there is no GST tax - perhaps.
At least it would seem prudent to review with many clients, perhaps not all, their existing goals, financial situation, and the risk issues in 2010, perhaps preparing some form of modification of Wills and living trusts to at least reflect in writing the intentions of the client. Probably, while the Commonwealth of Virginia and the State of Florida have legislation being considered, we should not assume that state legislatures will be of much help. Lawyers would do well to review their estate planning files to determine whether the clients' intentions are clearly reflected, with perhaps a view to seeking court interpretation of documents should a client die during the "gap period".
No doubt all of this will be the subject of many articles and much analysis by commentators; however, it is on the individual client level that we must act if deemed appropriate. And to add to the confusion, there is the whole array of problems in a modified carryover income tax basis situation, including the ability to apply stepped up basis for appreciated assets for $1.3 million of basis adjustment and, with respect to spouses, another $3 million of basis adjustment (not asset value).
And The Courts Keep Issuing Opinions - Three (3) More in the FLP/FLLC Area!
My last three (3) newsletters dealt with judicial decisions of significance in the FLP/FLLC area the past few months. First, the 9/7/09 newsletter was titled "Step Transaction/Indirect Gift Attacks on FLPs", reviewing Holman, Gross, Linton and Heckerman - all cases dealing with the IRS use of IRC Sec. 2511 and the income tax doctrine of "step transaction" to torpedo entities and the claimed valuation discounts for gift tax purposes. Next, on 10/18/09, I posted a newsletter titled "The 'M & M' Court Decisions on FLPs", which reviewed the IRS Tax Court estate tax case victory in Malkin and the taxpayer victory in the Murphy U.S. District Court case (Arkansas). And, by the way, the Tax Court estate tax case of Miller and the District Court (Texas) case of Keller were summarized in the September 9th newsletter as well. And, finally, my 11/24/09 newsletter reviewed the 8th Circuit Court of Appeals decision in Estate of Helen Christiansen, affirming the Tax Court and providing definite "legs" to the use of defined value formula clauses in gift and estate tax planning.
But the courts have kept at it, i.e. issuing more opinions in the FLP/FLLC area. Below I refer to several additional decisions, including Petter, Black and Price - Petter being another defined value formula clause victory for the taxpayer in a gift tax case, Black an outstanding estate tax victory in the 2036(a) area, and, finally, Price involves the denial of gift tax annual present interest exclusions. Below is a brief summary of each of these cases, all of which are well worth studying in detail.
1. Anne Petter v. Commissioner, T.C. Memo. 2009-260 (12/7/09), a gift tax case, was another rebuff by the courts of the IRS argument that defined value formula provisions are against public policy, in that there is less incentive for the Service to audit and raise valuation issues where the "asset allocation provision" would merely reallocate assets to a charitable beneficiary. Bessemer Trust's Steve Akers wrote an excellent article on Petter for LISI, Estate Planning Email Newsletter - No. 1578 (1/24/10), offering specific tips and suggestions for effective use of defined value formula provisions at least as a backstop to the valuation appraisal for pass-through entity equity interests.
2. Estates of Black v. Comm'r, 133 TC No. 15 (12/14/09): Judge Halpern stated, in an important statement in this opinion, the following "Therefore, we agree with petitioner that these cases, like Estate of Schutt,present a unique set of circumstances that, on balance, require a finding that Black LP was formed for a legitimate and significant nontax purpose, i.e. to perpetuate the holding of Erie stock by the Black family." The "buy and hold" philosophy and good reasons for it formed the basis for finding that the 2036(a) "bona fide sale for adequate and full consideration" exception was present (even though there were some gifts by the Blacks during lifetime that should have required consideration of Secs. 2036(a)(1), (2), as seen in the 2008 Mirowski case - see my May 1, 2008 newsletter archived on my site).
a. Erie Indemnity Company ("Erie") was a fast-growing, multi-line insurer, and Samuel P. Black, Jr. was one of its first, and among its most productive, employees. The Black family's wealth largely was based on its significant holdings of Erie stock, which eventually became a public company. There were definite, credible reasons for preserving the family's Erie stock holdings, including the Senior Black's concerns about dissipation of the stock, intentionally or otherwise, by his son and two grandsons who would receive stock from certain trusts. In addition, the Black family Erie holdings could well become a "swing vote" in shareholder disputes involving members of the founding family of Erie.
b. So in his '90s, in 1993, Mr. Black formed an FLP, Black LP, utilizing the services of Stacy Eastland, then of Baker Botts in Houston. Baker Botts' nationally renowned tax litigator John Porter handled the Tax Court case that arose out of Black LP gifts and the estates of both Senior Blacks. The Black Estates won this case hands down! With the strong real and significant non-tax purposes established and the court concluding there was a "bona fide sale" involved in forming, funding and operating Black LP, Judge Halpern then found, citing Estate of Schutt, T.C. Memo. 2005-126, and Estate of Bongard,124 TC 95 (2005), that there was "full and adequate consideration", the other test to be satisfied, stating:
1 - The Black LP partners received interests proportionate to the value of property contributed to the entity.
2. The respective contributed assets (Erie stock), i.e. by the Senior Blacks, their son, and their son as trustee of his two sons' trusts, were properly credited at FMV in the transferors' capital accounts.
3. Distributions from Black LP (millions of dollars) involved proper negative adjustments to distributee capital accounts.
4. There was a legitimate and significant non-tax reason for formation of Black LP, i.e. the "buy and hold" (and control) philosophy of the Senior Mr. Black.
c. In this case, Judge Halpern also stated: "A family limited partnership that does not conduct an active trade or business may nontheless be formed for a legitimate and significant non-tax reason."
d. But Query? - Were the facts in Black, as in Murphy and Mirowski, so good that most,if not all, of our clients will not be able to match them? However, at least these three (3) cases provide guidance for effective planning where, on balance, it is determined that the FLP/FLLC plan makes sense and that it has a reasonable chance for success.
3. Price v Commissioner, T.C. Memo. 2010-2 (January 4, 2010) - following and applying the Hackl case of some years ago, present interest gift tax exclusions under IRC Sec. 2503(b) were denied to the husband and wife donors in this gift tax case. Hackl v. Comm'r, 118 TC 279 (2000), affirmed, 335 F.3d 664 (7th Cir. 2003). In Price, the managers' total discretionary control over distributions and the substantial restrictions on transferring interests by donees were most significant to the court. Thus, to cure the downside risk here, perhaps (1) mandatory distributions of some sort should be required (although this may adversely affect discounts), and/or (2) use of a "put right" tied to the exclusion amounts might work (again adverse effect on discounts perhaps), and/or (3) use of a "Crummey/Cristofani" lapsing withdrawal power by the donee could be of help. In any event, it is clear that the Service will continue to raise this gift tax exclusion issue in cases.
CPE Efforts.
In February, February 17th, I will present "Achieving Success and Avoiding Tax Litigation with FLPs and FLLCs" at a morning meeting of the Santa Cruz County Estate Planning Council. Thereafter, the same topic will be presented at the March 18th noon meeting of the San Mateo County Bar Association - Estate Planning Section.
Beginning in May and likely continuing through December, internet webcast CPE provider, CPE Link will sponsor several web courses I have authored, including those on "Hot Topics in Estate Planning", "Valuation Discount Planning" and "Planning with Pass-Through Entities". See www.cpelink.com.
I am working on webcast courses for presentation by WesternCPE, www.westerncpe.com, and in December will be presenting two (2) resort conference courses for that organization in Las Vegas. Also, as part of CPA Vern Hoven's Federal Tax Update team of authors, I am working on the Estate & Gift Tax Chapter of the 2010 FTU Manual.
Thanks for reading the Newsletter, and I hope you enjoyed it. Another issue will be posted in a few weeks, or as earlier developments occur.
Owen Fiore
