Federal Update for Estate Planning Professionals. The View from Washington: Selected Legislation, Guidance and Cases. Queen s University of Charlotte

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1 Federal Update for Estate Planning Professionals The View from Washington: Selected Legislation, Guidance and Cases Queen s University of Charlotte Estate Planners Day May 21, 2015 A. Christopher Sega Venable LLP Washington, D.C. acsega@venable.com (202)

2 LEGISLATIVE DEVELOPMENTS Estate Tax Repeal. On April 16, 2015, the House of Representatives passed The Death Tax Repeal Act of 2015 (H.R. 1105) ( House Bill ). The House Bill, introduced by Rep. Kevin Brady (R-TX), passed by a vote of , with seven Democrats crossing the aisle to vote for repeal of the estate tax. The House Bill sits with the Senate. Even if the Senate passes the House Bill (or a version of it), President Obama has promised a veto. The House Bill would repeal estate and generation-skipping transfer (GST) taxes for decedents who die and generation-skipping transfers made on or after the date of enactment. The House Bill includes a transition rule to alleviate the estate tax burden on those who die prior to the date of enactment. For example, in the case of assets placed in a qualified domestic trust or QDOT for the decedent s non-citizen spouse, the current estate tax would not apply to: (1) distributions from such trust before the death of a surviving spouse made more than 10 years after the enactment date, and (2) assets remaining in such trust upon the death of the surviving spouse, even if the decedent funding the trust died before the date of enactment. The House Bill reduces the top gift tax rate to 35% and also provides that a transfer in trust will be deemed to be a taxable gift unless the trust is treated as wholly-owned by the donor or the donor's spouse. The lifetime exemption for gifts remains unchanged from present law ($5 million, with a cost-of-living adjustment for calendar years beginning after 2011). The adjusted lifetime exemption amount in 2015 is $5.43 million. The House Bill stands in stark contrast to the proposals President Obama made in his State of the Union address and in the Administration s Fiscal Year 2016 budget (see discussion below). For example, the President s proposal would eliminate the tax-free basis step-up by treating the transfer of appreciated assets upon death or a gift (except to charity) as a taxable event thus triggering capital gains tax on unrealized appreciation. The House Bill retains present law rules for determining the income tax basis of assets acquired by gift or from a decedent. The President s proposal would also restore the estate tax rates and lifetime exemption amount to those that were in effect in 2009 and would severely curtail some popular tools for shifting asset appreciation to future generations. The Joint Committee on Taxation scored the House Bill at a revenue loss of $269 billion over ten years. ABLE Accounts. On December 16, 2014, the Senate, following the House, passed the Achieving a Better Life Experience Act of 2014 ( ABLE Act ). Created under Code Section 529A, the Able Act allows states to establish accounts similar to Section 529 college savings plans for persons with disabilities, but only if the disability occurred prior to age 26. Funds in ABLE accounts will not be counted in determining eligibility for public benefit programs like Medicaid and SSI (first $100,000 for SSI). Funds may be -2-

3 used for health, education, housing, personal support and other care needs. The annual account contribution cannot exceed the federal gift tax exclusion (currently $14,000, but indexed for inflation). The maximum amount in an account will be the same as for Section 529 plans. Contributions are not tax-deductible, but income grows tax-free. There is a Medicaid payback for any funds remaining after the beneficiary dies. These vehicles may be used in connection with a disabled individual s special needs planning. Expansion of Section 529 Plans. The Senate Finance Committee approved an expansion of the Section 529 Plan that would include among the allowable expenses, the purchase of laptop computers, internet access and related services for college students. The bill has now gone to the full Senate. Note, that the President s State of the Union Address proposed to eliminate the advantages of these plans for new contributions. Estate Tax Statistics Nugget. In calendar year 2012, the last year for which statistics are available, there were only approximately 5,500 taxable estates. These taxable estates reported a net estate tax of approximately $8.5 billion. Although the exemption is slightly larger in 2015, the net amount of estate tax is expected to be measurably higher because of the improving economy. TAX ADMINISTRATION The Green Book In the Administration s General Explanations of the Administration s Fiscal Year 2016 ( Green Book ), the Obama Administration proposes changes to the tax law that include the following items. 1. Reduce the estate tax exemption to $3.5 million and the gift tax exemption to $1 million. Increase the estate and gift tax rate to 45%. Retain portability. 2. Change to a Canada-style deemed realization on appreciated assets at death. Individuals would retain a $250,000 exclusion for gains on a principal residence, as well as gains on tangible personal property (other than collectibles). Everyone would receive an additional $100,000 in gains exemption, indexed for inflation. Both would be portable. Deferrals under Section 6166 (or its equivalent) would continue and capital gains tax would be deductible for estate tax purposes. The capital gains tax would increase to 24.2%, plus the 3.8% tax on net investment income. Transfers to spouses and charity would be exempt from the tax, although both would take a carryover basis. 3. Intentionally Defective Grantor Trust or IDGT sales would be included in the settlor s estate, reduced by the consideration received. Toggling off grantor trust status would result in a taxable gift, again reduced by the consideration received. 4. Grantor Retained Annuity Trusts or GRATs must have a remainder of some value with a minimum 10-year term. Tax-free exchanges between the grantor and his GRAT would be eliminated. Front-loading GRATs (decreasing annuity -3-

4 GRATs) as a means of eliminating the inclusion in the out years would also be prohibited. A GRAT could not last for period that exceeds the grantor s life expectancy, plus 10 years (again, as a foil to avoiding estate tax inclusion for long-term GRATs). Each GRAT must have a minimum remainder value of 25% or $500, GST Tax Trusts would have limited perpetuities period of 90 years, thereby limiting the duration of the GST tax exemption. 6. Eliminate the so-called Health and Education Trust (or HEET Trust). The administration would limit the GST tax exception under Code section 2642(c) to those transfers made directly to the medical provider or educational institution for the benefit of a skip person. Transfers to a trust created for paying such expenses would not be GST tax exempt. 7. Modify the annual exclusion and Crummey rules by imposing a $50,000 annual limit per donor for any non-present interest gifts. This limit is NOT in addition to the $14,000 annual exclusion. [R]ather, this would be a further limit on those amounts that otherwise would qualify the annual per-donee exclusion. The quoted language was introduced in the Obama Administration s 2016 Fiscal Year Plan. The 2015 Fiscal Year Plan suggested that the $50,000 limit would be in lieu of the Crummey requirement for qualifying a contribution as a present interest gift. TAX ADMINISTRATION Internal Revenue Service Procedures Getting to Appeals with a Pending Information Request. In a memo to its estate and gift tax examiners, Appeals directed that a case should not be sent to Appeals in certain cases where the taxpayer has refused to provide information the agent has requested. Unless the taxpayer has stated that there is no additional information, the agent should close the case and issue a statutory notice of assessment. The IRS s new policy is designed to prevent taxpayers, who for strategic reasons, have refused to provide the requested information. The IRS based this new policy on its desire not to have factual items introduced at an Appeals conference. Appeals s 270-Day Rule. In a new Internal Revenue Manual policy, effective September 2, 2014, IRS Appeals has notified the field that it will not accept an estate tax audit case that has fewer than 270 days remaining on the statute of limitations period. MEMORANDUM FOR SB/SE EXAMINATION EXECUTIVES. Control Number: SBSE Expiration Date: August 28, Impacted IRM: IRM CASE LAW 1. In Smoot v. Smoot, F.Supp.3d, 115 AFTR 2d , TNT Doc , No. 2:13-cv (S.D. Ga. March 31, 2015), a U.S. district court held that the executor could, under Code Sec. 2206, recover from the decedent's former wife the estate tax attributable to life insurance proceeds that were paid to -4-

5 her. The court denied prejudgment interest, attorney fees, or recovery of the former wife's share of taxes on non-life insurance assets she had also received. 2. In Rafer v. Meyer, N.W.2d, 219 Neb 219 (2015), the court held that trust cannot waive a trustee s fiduciary duty to keep beneficiaries informed about the status of life insurance policies held in a trust and to act in good faith in the best interests of the beneficiaries. An ILIT trustee is not protected from his obligation to maintain the policy, even though the trust agreement stated otherwise. The Nebraska Supreme Court so held in reversing and remanding for decision the lower court s grant of the trustee s motion to dismiss. The case is a classic example of bad facts making bad law. In the facts of the case, the trustee (the settlor s attorney) never met with his client to explain the trust provisions, gave a false address resulting in the insurer s lapse notice never being received, and the insurance agent never remitted the initial premium to the insurer. 3. In Mikel v. Commissioner, T.C. Memo , the US Tax Court held that a trust provision requiring a beneficiary to submit any dispute over interpretation of the trust to an Orthodox Jewish arbitration panel (the beth shin) did not invalidate the beneficiary s withdrawal rights. Thus, contributions to the trust qualified for the gift tax annual exclusion as a valid Crummey power. In his decision, Judge Lauber rejected the IRS s position that the arbitration clause would render the Crummey withdrawal right illusory. He so held on the theory that the withdrawal right would not be viewed by a state court as subject to the arbitration requirement. Therefore, the arbitration clause would not limit the beneficiary s withdrawal right. 4. In Heers v. Parsons, 2015 BL , B.A.P. 9th Cir., No. NV (4/15/15), an attorney inexperienced in probate law incurred a nondischargeable debt for being 13 months late in filing a decedent's estate tax return. The lawyer took on the role of an estate's administrator even though she was not competent to perform the work, U.S. Bankruptcy Judge Randall L. Dunn wrote April 15 in a split decision for the U.S. Bankruptcy Appellate Panel for the Ninth Circuit. The estate was assessed $440,000 in interest and penalties for filing a tax return 13 months late. The probate court surcharged the administrator for the interest and penalties. The administrator then filed for bankruptcy, which was met by a complaint seeking to have the debt declared nondischargeable as a defalcation while acting in a fiduciary capacity under Section 523(a)(4) of the Bankruptcy Code. Based on the probate court's decision and uncontested facts, the bankruptcy judge found the debt not discharged. An appeal was rejected in a 2-1 decision that turned on an interpretation of the U.S. Supreme Court's 2013 decision in Bullock v. BankChampaign N.A. Writing for the court, Judge Dunn said Bullock means there is neither a strict liability nor a no fault basis for a nondischargeable debt for defalcation while acting in a fiduciary capacity. Dunn said it remains not so clear where to draw the line. Judge Dunn added that the administrator consciously and recklessly disregarded the risks of filing a late tax return. She was grossly negligent, the judge said, and thus the debt was not discharged. -5-

6 IRS GUIDANCE In PLR (November 14, 2014), the IRS made a significant expansion to the so-called estate administration exception for self-dealing between disqualified persons and a private foundation. The IRS has long accepted transactions that occur in connection with the administration of a decedent s estate from direct and indirect selfdealing. See Treas. Reg (d)-1(b)(3). The typical transaction involves the decedent leaving assets to her private foundation, subject to an option held by the decedent s family. The family would then exercise the option, purchasing the decedent s assets for a promissory note. The decedent s estate would then distribute the promissory note to the foundation in satisfaction of the decedent s charitable bequest. The transaction permits the family to purchase their inheritance, rather than receive after estate tax. In the facts of this ruling, the IRS extended this exception to a promissory note issued to the marital trust created for the decedent s surviving spouse. The note was issued in connection with an option exercised by the family (and the family limited liability company) in a transaction between the family (or LLC) and the marital trust. On the surviving spouse s death, the note was to pass out of the marital trust to the decedent s private foundation. The IRS ruled that this transaction would not be treated as proscribed indirect self-dealing. Allowing the transaction to occur before the surviving spouse s death presents both estate tax and business planning opportunities. It reduces the surviving spouse s estate, while allowing the family to purchase the optioned assets at a lower value. See also PLR (November 28, 2014). -6-