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Estate Planning Newsletter_Jan_Feb_2015

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Estate Planning Newsletter_Jan_Feb_2015

  1. 1. Estate Planning Update January/February 2015 1 Planning Thoughts Achieving a Better Life Experience Congress sent a tax extenders bill to President Obama in December, which he signed into law on December 19, 2014. The Tax Increase Prevention Act of 2014 [TIPA, P.L. 113-295] provided for a one-year retroactive extension of most of the provisions that had expired 11½ months earlier, for the 2014 tax year. Now the extenders have expired again, and further action by Congress will be needed to restore them for 2015. At this writing it is uncertain whether that will be the traditional stand-alone extenders legislation or part of a broader tax reform effort. For those advising the elderly affluent, the restoration of the “charitable IRA rollover” may have been the most important provision, though it came so late in the tax year that the restoration may have gone underutilized. According to the Joint Committee on Taxation, the one-year “tax cost” of allowing those over age 70½ to directly transfer up to $100,000 from their IRAs to charity will be $239 million, and the ten-year cost will be $384 million. Evidently, the JCT assumes that in the absence of this provision, a substantial amount of charitable gifts simply won’t be made, and so more taxable income will be generated. TIPA also included the Achieving a Better Life Experience Act [ABLE], a permanent expansion of IRC Sec. 529 savings accounts for the benefit of disabled young people. The purpose is to encourage private savings to support disabled individuals in a manner that supplements, but does not supplant, other benefits that may be provided by private insurance, Medicaid, the supplemental security income program, or the beneficiary’s employment. Qualified ABLE Programs A new section has been added to the Tax Code, IRC §529A, Qualified ABLE programs. ABLE programs will need to be established in each of the states, as with Sec. 529 college savings plans. ABLE accounts will be available only to residents of the state establishing the program [§529A(b)(1)(C)]. A disabled person is limited to a single ABLE account [§529A(b)(1)(B)], except that creating a successor account for rollover purposes is permitted. Contributions to an ABLE account generally must be made in cash [§529A(b)(2)]; Estate Planning Update January/February 2015 This Issue: Planning Thoughts ..............1 Cases and Rulings ...............2 Washington Talk ..................3 Upcoming Events ................5 First National Bank 14010 FNB Parkway Omaha, NE 68154 800.538.7298 www.firstnationalwealth.com
  2. 2. Estate Planning Update January/February 2015 2 an exception allows for the rollover of funds to another ABLE account for the same beneficiary or an eligible individual who is a family member of the beneficiary [§529A(c)(1)(C)]. As with 529 college savings plans, there is no deduction for making a contribution to an ABLE account. Investment changes are limited to twice each year [§529A(b)(4)]. More than one donor may contribute to an individual’s ABLE account, but the aggregate of such contributions may not exceed the amount of the gift tax annual exclusion in any calendar year ($14,000 in 2015) [§529A(b) (2)(B)]. The beneficiary of an ABLE account must have become disabled or blind before reaching age 26 [§529A(e)(1)]. Amounts accumulated in 529A ABLE accounts generally will not be counted for purposes of means-testing eligibility for federal programs. However, amounts distributed for housing expenses will not be disregarded for the supplemental security income program. In the event that the ABLE account balance exceeds $100,000, SSI benefits may be suspended, but Medicaid benefits will not be [TIPA Division B, Sec. 103]. Tax Treatment In contrast to a conventional special needs trust, which has the same broad goals as an ABLE account, these accounts offer the potential for freedom from income tax. No taxes are imposed upon the investment earnings of ABLE accounts [§529A(a)]. Similarly, there are no income taxes on distributions for qualified disability expenses [§529A(c)(1)(B)]. Qualified disability expenses are defined quite broadly. They include “education, housing, transportation, employment training and support, assistive technology and personal support services, health, prevention and wellness, financial management and administrative expenses, legal fees, expenses for oversight and monitoring, funeral and burial expenses,” and any other expenses as may be provided in future Regulations [§529A(e)(5)]. On the other hand, distributions not used for qualified disability expenses are taxable to the beneficiary, and a 10% penalty tax applies as well [§529A(c)(3)]. The distribution may not be treated as a taxable gift [§529A(c) (2)]. There is a price to pay for the tax favors accorded to the ABLE account. At the death of the ABLE account beneficiary, the state may make a claim on the account up to the total medical assistance paid for the beneficiary after the establishment of the account [§529A(f)]. Prognosis Once ABLE programs are established by the states, the ABLE accounts will have the advantage of simplicity coupled with tax freedom. However, some observers believe that the low annual limit on contributions coupled with the clawback of state benefits will make ABLE accounts less attractive than the alternative of conventional special needs trusts. The JCT apparently does not agree, as it scored the provision as reducing tax revenue by a whopping $2 billion over the next 10 years. The assumptions behind that score were not available, but, presumably, the baseline is that the earnings on the amounts contributed would otherwise have been taxed at the donor’s top tax rate. For the sake of unpacking this projection, assume that in one of the next ten years, the amount of lost revenue is $200 million and assume further that the avoided tax rate was 40%. That implies that $500 million worth of income from ABLE accounts avoided the income tax in that year. How large would the aggregate of ABLE accounts have to be to generate that much income? If the rate of return that year were 10%, the principal amount would have to be $5 billion. With contributions limited to $14,000 per year, how many accounts would be needed to reach $5 billion? If we assume five years of contributions, that suggests total per account contributions of $70,000, which means that more than 70,000 such accounts would have to be established. This example ignores the probability that ABLE funds already will have been spent for the disabled beneficiary to some extent, so, in fact, the JCT must have thought hundreds of thousands of these accounts will be established. Cases and Rulings Relying upon an incompetent attorney does not excuse late filing of estate taxes. Janice C. Specht et al. v. U.S., No. 1:13-cv00705 Virginia Escher died on December 30, 2008, at age 92, with an estate worth some $12.5 million. Her cousin, Janice Specht, was named executor of the estate. She had no experience at being an executor, never had owned stock, and, in fact, never had been in an attorney’s office. Nevertheless, she accepted the job. Ms. Escher’s lawyer was Mary Backsman, who had 50 years of experience in estate planning. Ms. Specht retained Ms. Backsman as the estate’s attorney. Backsman did not reveal that she was battling brain cancer at the time. Specht knew that a substantial estate tax was going to be due, and she knew the due date. She also knew that shares of UPS stock would have to be sold to raise the needed cash. Specht followed up with Backsman concerning progress on administering the estate, and
  3. 3. Estate Planning Update January/February 2015 3 she was assured that everything was fine. The assurances continued after Specht received notices from the probate court that estate accountings had not been timely filed. When the deadline for the estate tax went by, Backsman reported that she had filed for an extension, but she had not. Additional irregularities piled up, but Specht did not act. Fourteen months after the estate tax should have been paid, Specht obtained a new attorney, who filed an estate tax return within 90 days. IRS assessed some $1.1 million in penalties and interest, which the estate paid. The estate, in turn, sued Backsman for malpractice, a suit that was settled about a year later. Now the estate seeks a refund of the penalties and interest, because the estate had relied upon the advice of counsel. No such relief is available, the Court holds, even if the attorney involved were incompetent. Specht had many warning signs of trouble. Her failure to act sooner amounted to willful neglect of the problem. The disability of the attorney did not render Specht disabled. The Court noted that, in view of the malpractice action against Backsman, the State of Ohio had refunded the late penalty and interest on its estate taxes. “It is truly unfortunate that the United States did not follow the State of Ohio’s lead,” the Court concluded. • • • Estate tax values may not be based upon hypotheticals. Estate of Natale B. Giustina et al. v. Comm’r, CA-9, No. 12-71747 Erminio Giustina and two of his brothers entered the lumber business in Oregon in 1917. Over time they purchased lumber mills and substantial timberlands. However, by 1988 the lumber mills had been sold, and the family business was limited to managing the timber. Erminio’s two sons, Natale and Ehrman, ran the business for many years, and then their sons took over management. The partnership agreement governing the business limited transferability of ownership interests, and provided that only general partners had the power to sell the company’s timber or property. At his death in August 2005, Natale owned a 44.128% limited partnership interest. The estate hired experts to appraise the value of that interest, and that figure, $12,995,000, was reported on the estate tax return. The IRS believed that $33.5 million was closer to the mark. At trial the estate defended its value by capitalizing the cash flows that could be expected from the company in the coming years. The IRS expert took that approach as well, but also asserted that the liquidation value of the company was $150 million and offered a final valuation that blended the two figures. The Tax Court agreed that there was a 25% chance that the firm would be liquidated, and assigned that probability to the asset- based element of the calculation. The Tax Court’s final figure for estate tax determinations was $27,454,115. Despite the fact that this was double what the estate had reported on the estate tax return, the Court held that the estate had acted in good faith and relied upon qualified experts. Accordingly, the accuracy-related penalty was not assessed [Estate of Natale B. Giustina et al. v. Comm’r, T.C. Memo 2011-141]. On appeal, the Ninth Circuit rejects the Tax Court’s methodology as clear error. “Although the Tax Court recognized that the owner of the limited interest could not unilaterally force liquidation, it concluded that the owner of that interest could form a two-thirds voting bloc with other limited partners to do so, and assigned a 25% probability to this occurrence. This conclusion is contrary to the evidence in the record.” The Court outlined the nearly preposterous chain of events needed to get to a sale, and concluded that the sale was too speculative. Accordingly, the decision was reversed and remanded for a determination of value based only upon the capitalization of cash flows, and ignoring the theoretical liquidation value of the firm’s holdings. • • • Reformation of a charitable trust is approved. Private Letter Ruling 201450003 At his death, Grantor’s revocable trust became irrevocable, providing life income for his mother and another beneficiary with the remainder passing to charity. As such, the trust does not qualify for an estate tax charitable deduction. Within 90 days of the date that the estate tax was due, the estate’s executor sought a reformation of the trust, transforming it to a charitable remainder unitrust in order to secure the deduction. The IRS agrees that this will work. The original trust included a “reformable interest” that was ascertainable and severable from the noncharitable interests. It would have qualified for the charitable deduction before enactment of IRC §2055(e)(2). Furthermore, on the facts presented, the value of the qualified interest will be within 5% of the reformable interest. Washington Talk The Congressional tax-writing committees had new
  4. 4. Estate Planning Update January/February 2015 4 leaders, beginning in January. Paul Ryan (R-Wis.) will chair House Ways and Means, and Orrin Hatch (R-Utah) will helm Senate Finance. After his selection, Ryan said: “We will work together to fix the tax code, hold the IRS accountable, strengthen Medicare and Social Security, repair the safety net, promote job-creating trade agreements, and determine how best to repeal and replace Obamacare with patient-centered solutions.” 2014 was a difficult year for the IRS, with hearings into the inappropriate targeting of conservative groups, the loss of Lois Lerner’s e-mails, the discovery of those e-mails in November, and a major cut in funding. 2015 promises more of the same. • The new chair of the House Ways and Means Oversight Committee, Peter J. Roskam (R-Ill.), has demanded all of the Lerner e-mails and will be looking closely for comments that suggest political bias. • Jason Chaffetz (R-Utah), incoming chair of the House Oversight and Government Reform Committee, is expected to follow up on that Committee’s report on the IRS targeting of conservatives, released just before Christmas. • The new Chair of the Senate Finance Committee, Orrin G. Hatch (R-Utah), has been quite vocal in his criticism of the targeting, the missing e-mails, and the IRS’ efforts in writing new Regulations for exempt organizations. A round of Senate hearings may mean another set of appearances by top IRS officials. • The IRS has identified some 2,500 e-mails from the White House concerning taxpayer information. Some of these requests may have been inappropriate, even illegal. So far, the IRS has refused to turn over those e-mails for outsider review. This could prove to be a whole new area of investigation in 2015. A new voice for repealing the federal estate tax joins the House Ways and Means Committee. Rep. Kristi Noem (R-S.D.) has first-hand experience with the estate tax. When her father died in a farming accident in 1992, she had to leave college to return home to help run the family ranch. The family had no money in the bank but lots of land, machinery and cattle. “All of a sudden, I owed the federal government hundreds of thousands of dollars because a tragedy happened. That’s unfair,” Noem has said. Although the $5.43 million federal exemption provides better protection than her family experienced in 1992, it’s not enough to protect most family agricultural operations, according to Noem. She favors complete repeal and was a co-sponsor of the “Death Tax Repeal Act of 2013.” “As a lifelong farmer and rancher, I will be a strong voice for the agriculture industry on the panel,” she said. Members of the Senate Finance Committee will be organized into five bipartisan working groups to explore tax reform issues and come up with solutions. The subjects for study are individuals, infrastructure, savings and investment, business, and international. Each group will have a Republican Chair and a Democratic Vice Chair. The plan parallels the earlier effort by the House Ways and Means Committee, which had 11 working groups. Their report did not lead to legislation; perhaps this time it will be different. H.R. 5872, the American Solution for Simplifying the Estate Tax Act of 2014, an optional alternative to the estate tax, was introduced by Rep. Andy Harris (R–Md). Taxpayers could elect out of having their estates owe federal estate tax by choosing instead to be subject to a 1% income tax surtax for the rest of their lives. The surtax would apply to modified adjusted gross income, which would include tax-exempt interest income. The surtax would have to be paid for at least seven years before the estate tax waiver would become effective. According to the Congressional findings included in section 2 of the bill, such a change is expected to be revenue neutral. The goal is to eliminate all the complexity that tax planning injects into estate planning. On the other hand, the bill would impose carryover basis on estates electing the surtax, which would bring its own set of complexities into the planning picture. In the estate and gift area, President Obama’s 2015 budget includes most of the proposals from earlier budgets, including: • return to the 2009 transfer tax regime; • require consistent values for income tax and transfer tax purposes; • have a minimum ten-year term for grantor-retained annuity trusts; limit the duration of dynasty trusts; and • extend the lien when estate taxes on a closely held company have been deferred. The new wrinkle in this year’s budget proposal is an attempt to rein in the use of Crummey powers over irrevocable life insurance trusts. A new type of transfer would be defined, which would include transfers to trusts and pass-through entities and restricted transfers that can’t be immediately liquidated by the donee. Such transfers would be capped at $50,000 per year, even if total gifts to individual donees do not exceed the annual exclusion.
  5. 5. Estate Planning Update January/February 2015 5 Upcoming Events Cannon Estate Planning Teleconferences Tuesday, February 24, 2015 Protecting an Inheritance from Spousal and Creditors’ Claims If you are interested in attending, please contact Katie Nedrow at knedrow@fnni.com or 402.602.3305. This article does not constitute legal, tax, accounting or other professional advice. Although it is intended to be accurate, neither the publisher nor any other party assumes liability for loss or damage due to reliance on this material. Each individual’s tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation. Investment products are: Not FDIC Insured · May Go Down in Value · Not a Deposit · Not Guaranteed By the Bank · Not Insured By Any Federal Government Agency Banking products provided by First National Bank of Omaha. We would like to serve you and your clients. For more information on First National Bank and our services, please contact Tom Gaughen at 402.602.8724, or visit www. firstnationalwealth.com. 14010 FNB Parkway Omaha, NE 68154 800.538.7298 www.firstnationalwealth.com We would like to serve you and your clients. For more information on First National Bank and our services, please contact Tom Gaughen at 402.602.8724, or visit www. firstnationalwealth.com. 14010 FNB Parkway Omaha, NE 68154 800.538.7298 www.firstnationalwealth.com

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