Recent Developments Affecting Estate Planning
Stanley M. Johanson
University Distinguished Teaching Professor and
James A. Elkins Centennial Chair in Law
The University of Texas School of Law
Austin, Texas
Probate, Trust and Estate Section
Dallas Bar Association
Dallas, Texas
May 23, 2017
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TABLE OF CONTENTS
I.The Federal Estate Tax—What Happens Now?
A.The one constant with respect to transfer taxes has been constant change...... 1
B.Will the estate tax be repealed?...... 1
C.What about the gift tax?...... 1
D.And what about the “new basis at death” rule?...... 2
E.What do we (and our clients) do in the meantime?...... 2
F.Trusts will remain the linchpin in estate planning...... 3
G.Account transcript in lieu of estate tax closing letters...... 5
II. Section 401—Qualified Plans and IRAs
A.Inherited retirement benefits: Five-year payout limit except for spouses?...... 6
B.Community property IRA—beneficiary is someone other than spouse ...... 6
C.Testamentary trust was a valid look-through trust...... 7
D.No look-through trust here; court order did not cure financial advisor’s error...... 8
E.Waiver of 60-day rollover requirement: Treasury makes it easier...... 9
F.Waiver of 60-day rollover requirement granted to W but not to H...... 9
G. Penalty waived for underpaid tax on early IRA distributions...... 9
III.Section 671—Grantor Trust Rules
A.Grantor trust modified to add reimbursement clause...... 10
B.GRATs modified to add missing language...... 10
IV.Section 1014—Basis of Property Acquired From a Decedent
A.Proposed regulations answer some questions and raise others...... 10
B.New focus: Income tax planning...... 11
V.Section 2033—Property In Which Decedent Had an Interest
A.Estate expert’s lowball valuation dismissed--conflict of interest...... 13
VI.Section 2053—Administration Expense Deduction
A.Graegin loan: $71.4 million deduction for $10.7 million loan? No way!...... 14
B.After settlement with IRS, no increase in Section 2053 deduction...... 15
VII.Section 2055—Charitable Deduction
A.Syndicated conservation easement transactions are “listed transactions”...... 15
B.Post-death redemption plan reduced amount passing to charity...... 16
VIII.Section 2056—MaritalDeduction
A.QTIP election in connection with portability election—how do you spell relief?!!.....16
B.Extension of time to make portability election granted...... 18
C.Marital deduction for same-sex couples...... 18
IX.Section 2704—Lapsing Rights and Restrictions
A.Long-awaited proposed regulations published, but where do they stand now?...... 19
X. Texas Legislative Developments
A.Overview...... 20
B.Uniform Power of Attorney Act...... 20
C.Partition of Tenancy in Common—Uniform Partition of Heirs’ Property Act...... 22
D.Miscellaneous probate matters...... 22
E.Trust Code...... 23
F.Rule Against Perpetuities: Life in Being Plus 300 Years??? No way!...... 23
G.Guardianship—the term “ward” would disappear...... 23
H.Reporting financial abuse of elderly persons...... 23
I.Multiple-Party Accounts...... 23
J.New forms for Anatomical Gifts and Medical Power of Attorney...... 24
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I. The Federal Estate Tax—What Happens Now?
A. The one constant with respect to transfer taxes has been constant change. It all began with the Tax Reform Act of 1976, which “unified” the federal estate tax and gift taxes, increased the estate tax exemption from $60,000 to $175,625, introduced the first (mercifully short-lived) version of the generation-skipping transfer tax, repealed (for a few years) the “new basis at death” rule, and made other significant changes (and some insignificant changes—remember the orphan’s deduction?). ERTA 1981 increased the estate tax exemption to $600,000, introduced the unlimited marital deduction, and gave us QTIP trusts. The Tax Reform Act of 1986 increased the exemption, reduced the maximum estate & gift tax rate, and gave us the current version of the generation-skipping transfer tax. In 1990, we were introduced to the Special Valuation Rules of Chapter 14. EGTRRA 2001 (the “Bush Tax Act”) repealed the estate tax under the Budget Reconciliation procedure’s “sunset” rule—a slow-burning fuse. After an estate-tax-free year in 2010, in 2012 Congress made the exemption “permanent” at $5,000,000 (with annual CPI adjustments).
1.And those are just the highlights! These same Acts, and sundry statutes in between, made more-than-tinkering changes to our transfer tax laws on an almost annual basis.
2.And here we are again—maybe!
B.Will the estate tax be repealed? The Trump administration released its tax reform plan on April 26, 2017—a one-page summary. The plan calls for repeal of the estate tax. In a briefing on the plan, Economic Council Director Gary Cohn clarified that repeal of the estate tax would be effective immediately, rather than being phased out.
1,Well… even with the Republicans holding both houses of Congress, they have only 52 senators, and it would tax 60 votes to override a likely Senate filibuster. (On the other hand, several Democrat senators will be up for reelection in states that went for President Trump.) A filibuster could be avoided if Republicans took the Budget Reconciliation route (as with the Bush Tax Act in 2001), producing a “repeal” that (thanks to the “Byrd rule” in the Senate) would expire in ten years.
2.State estate tax laws can be a concern even for Texans regardless of what happens at the federal level. New Jersey has repealed its estate tax (effective in 2018), but 20 states and the District of Columbia have estate or inheritance taxes. (In Oregon, for example, the estate tax exemption is $1,000,000, and progressive tax rates begin at 10 percent. And don’t smugly assume that those state death taxes are of no concern to us Texans. The situs rule raises a concern for any Texan who holds an interest in real property in one of those states. In most of these states, for real property owned by a nonresident the exemption is prorated. This means that absent planning, a vacation property in Oregonor some other state can produce a substantial estate tax.
C.What about the gift tax? Repeal of the estate tax would no doubt include repeal of the generation-skipping transfer tax. But would the federal gift tax also be repealed? The summary plan made no reference to the gift tax.
1.As important as the gift tax is as an adjunct to the estate tax, it may be even more important as a means of shoring up the progressive structure of the income tax.Recall the Economic Growth and Tax Relief Reconciliation Actof 2001 (EGTRRA), which via Senate's budget reconciliation procedurewas structured to repeal the estate tax effective January 1, 2010 (for one year!). The Joint Committee on Taxation persuaded Congress that repeal of the gift tax would lead to substantial downward adjustments of income tax revenue. As a result, while EGTRRA gradually increased the estate tax exemption to $3,500,000 (in 2009), the gift tax exemption was capped at $1,000,000.
2.Some examples that might arise in a world with no gift tax (and no gift tax returns to report transactions).
a.Client owns Acme common stock with a cash basis of $10,000 that is now valued at $100,000. If Client sells the stock, he incurs capital gain of $90,000 which (under the current rate of 23.8 percent) would generate $21,420 in income tax. Client instead gives the stock to Mother, who has modest income aside from social security. Mother sells the stock,incurs capital gain of $90,000, but pays little or noincome tax thereon.
b. Client gives income-producing assets, generating income of $40,000/year, to 22-year-old Daughter. The income is taken off the top of Client's income tax base (currently taxed at 39.6 percent—not to mention state income tax in many states) and is taxed to Daughter at much lower rates. Five (old and cold) years later, when Daughter has begun earning substantial income, she gives the assets back to Client.
(1)At least in the Clifford Trust days (10-year-and-a-day trusts—remember those?—repealed in 1986), Client had to wait 10 years to get the property back.
3.This subject is discussed at length (and with concern) in Soled, The $250 Billion Price Tag Associated With Gift Tax Repeal, 154 Tax Notes 429 (Jan. 23, 2017). As the title of Professor Soled's article suggests, repeal of the gift tax would have a whopping adverse effect on income taxrevenues.
D.And what about the “new basis at death” rule? A Trump administration is hardly likely to repeal the “new basis at death” rule—at least for most Americans. However, on the campaign trail Trump proposed a capital gain tax for assets held at death and valued at more than $10 million. How in the heck would that work? Would there be a step-up in basis for the first $10 million—and if so, how would assets be selected for the step-up? We of course have no clue, and neither does anybody else.
E.What do we (and our clients) do in the meantime? Daily Tax Reports (12-28-16) had a choice quote from Cynda Ottaway, president of ACTEC: “You’ve got to say, ‘keep your plan in place and stay healthy,’ because you don’t know what’s going to happen.” Digging further into history, also helpful is a quotation attributable to Oliver Cromwell, the 17th Century British revolutionary: “put your trust in God; but keep your powder dry." Bottom line: wait and see. If planning decisions must be made in the interim, it will be important to build as much flexibility into the plan as possible.
1.Did Benjamin Franklin have it wrong? It was Benjamin Franklin, in a 1789 letter, who wrote that “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.” Death, yes; income taxes, yes; but death taxes can hardly be said to be certain.
a.The annual Short Course on Estate Planning given by the Center for American and International Law (formerly the Southwestern Legal Foundation) in Dallas, at which I have lectured for 50 years, was scheduled this year for the first week in February. We decided to postpone the course because none of the speakers had a clue as to whether anything we might say would have any relevance six months later.
2.For the short run (and possibly for the long run—we just don’t know), clients assuredly should shelve plans for that proposed installment sale to a defective grantor trust or any other sophisticated planning transaction. (And this is yet another reason to not text while driving.)
3.Should you consider changing your practice to another area? Not to worry! There is a good likelihood that, whatever Congress does, you will be busier than you are now! Think back on all of the changes that I mentioned at the beginning of this outline, and how they affected your practice. Virtually every time Congress has made changes in the transfer tax area—especially when the rules are “simplified,” things tend to get more complicated, meaning more work for estate planners in revising existing wills and trusts (and doing it again a couple of years later).
F.One thing that won’t change: Trusts will remain the linchpin in estate planning.
1.Trusts for spouses remain important. A “bypass” trust that gives the spouse a life income interest and limited invasion powers over trust principal will continue to be important even if there are not going to be any estate taxes to bypass. It must be conceded that clients really like two page “I love you” wills: "to my [spouse] if he survives me, otherwise to my children in equal shares"—or perhaps “to my descendants per stirpes.”
a.One concern is that if the spouse later becomes incapacitated, the result will be a costly and cumbersome guardianship administration. If instead the estate was left in trust—with the spouse serving as trustee for as long as he or she is able and so inclined—a guardianship administration will be avoided.
b.Another concern is the risk of financial abuse. In Financial Abuse: the Silent Epidemic, Barron’s (Nov. 12, 2016), it was estimated that one out of five older citizens has been financially exploited, and that in 70 percent of the cases a child was the suspected perpetrator. Settling assets in a trust shields the assets from being exploited—unless, of course, that bad-apple child is the trustee!
c.A trust settlement assures that the remainder interest on the spouse’s death will pass to the children, rather than to that dreaded second husband, that trophy second wife, or that too-solicitous caretaker.
(1)As for caretakers, c.f. Texas Family Code §123.102 (triggered by alleged instances in which Caretaker whisked Patient to a justice of the peace, married him, disappeared, and then reappeared after his death wearing black—she’s a widow, after all), authorizing a suit to challenge a marriage on the ground that the decedent lacked sufficient mental capacity to enter into the marriage if (1) the marriage occurred within three years of death and (2) the action is filed within one year after death.
d.A trust can (and should!) give the spouse a special testamentary power of appointment, the power to appoint the trust property (e.g.,) “outright or in further trust to such one or more of my descendants as survive me.” Professor Ed Halbach (University of California) has noted that a power to appoint also gives the power to disappoint, and tends to insure filial devotion: If an elderly mother or grandmother has a special testamentary power to appoint assets worth $2 million, how likely is it that she will be alone at Thanksgiving?
2.Trusts for children and other descendants. Another problem with that two-page will:If the children may succeed to more than a modest amount, there are very real advantages in creating trusts for the children's benefit rather than giving them outright ownership. Moreover, each child can be the trustee of his or her own trust, giving the child the power to make management and investment decisions (just as an outright owner would make) while also giving various advantages.
a.Covering the contingency of divorce. In today’s world, over one-half of all marriages end in divorce. In Texas, only community property is subject to equitable ("just and right") division in a divorce proceeding. The judge cannot divest one spouse of title to his or her separate property and award it to the other spouse. Granted, if property is bequeathed outright to a child, it is the child's separate property because acquired by gift, devise or descent. However, under Texas law all property on hand at the time of divorce (or death) is presumptively community property. To keep its separate property status, the property cannot be commingled with community property, and good records must be kept; otherwise it may not be possible to establish separate ownership so as to overcome the community presumption by the required clear and convincing evidence.
A trust (even a trust with the child as trustee) is a useful vehicle for segregating inherited property and keeping it separate.
b.Creditor protection. If the child is in a profession or line of work in which malpractice actions are a concern (and, in today's litigious society, that includes just about everybody!), property left to a child in a trust can be given spendthrift protection, meaning that no creditors can reach the child's interest in the trust—even if the child declares bankruptcy.
c. In-law protection. Even if the child’s marriage is solid and the likelihood of divorce is remote, parents may be concerned that the child’s spouse might take some action that puts the child’s inheritance at risk. (Several Texas lawyers have told me that, in explaining the pros and cons of trusts for clients’ children, this is the scenario that catches the clients’ attention.)
Example 1: Donna, having inherited $750,000 from her parent’s estate, carefully places the inherited funds in a Paine Webber investment account. Donna has the account titled in her name as her “sole and separate property,” to segregate the assets from her and her husband Steve’s other assets. Donna and Steve have been married five years, their marriage is solid, and they have a young child. Steve has decided to start a business, and has negotiated a $575,000 loan from First State Bank. Steve tells Donna that the bank won’t make the loan unless Donna co-signs the note (or, perhaps, unless the loan is secured by Donna’s Paine Webber account), and Steve asks her to co-sign.
Stop the camcorder! What is Donna going to tell Steve? “Sorry, Steve; I know this is important to you, but I’m not going to help you out by signing the note”? It’s fair to say that Donna is in a rather dicey situation—as is her inheritance.
Need I continue the story? Donna co-signs the note. A year later, Steve’s business folds after the borrowed funds have been expended in leasing an office and purchasing supplies. Donna, having co-signed the note, is personally liable. There goes Donna’s inheritance.
Example 2: Same facts, except that the $750,000 that Donna inherited was left in a trust of which Donna is the trustee. The trust contains a spendthrift clause. Again, Donna co-signs Steve’s note. She is personally liable on the obligation, but the trust assets cannot be reached because of the spendthrift clause.
Example 3: Same facts as in Example 2, except that Steve, instead of attempting to borrow money from the bank, asks Donna, as trustee, to either (i) loan the funds to Steve or (ii) invest trust funds in his business. Here, Donna has no choice but to point out that, in view of her fiduciary duties as a trustee, (i) a loan to a relative would constitute impermissible self-dealing, and (ii) investing trust funds in a start-up company would be an imprudent investment not within the “prudent investor” standard.