United States: Wealth Management Update - January 2014

January Interest Rates for GRATs, Sales to Defective Grantor Trusts, Intra-Family Loans and Split Interest Charitable Trusts

The January § 7520 rate for use with estate planning techniques such as CRTs, CLTs, QPRTs and GRATs is 2.2%, which is a 0.2% increase from last month. The December applicable federal rate ("AFR") for use with a sale to a defective grantor trust, self-canceling installment note ("SCIN") or intra-family loan with a note having a duration of 3-9 years (the mid-term rate, compounded annually) is 1.75%, which is a 0.10% increase from the December rate.

The relatively low § 7520 rate and AFR continue to present potentially rewarding opportunities to fund GRATs in January with depressed assets that are expected to perform better in the coming years.

Clients also should continue to consider "refinancing" existing intra-family loans. The AFRs (based on annual compounding) used in connection with intra-family loans are 0.25% for loans with a term of 3 years or less, 1.75% for loans with a term between 3 and 9 years, and 3.49% for loans with a term of longer than 9 years.

Thus, for example, if a 9-year loan is made to a child, and the child can invest the funds and obtain a return in excess of 1.75%, the child will be able to keep any returns over 1.75%. These same rates are used in connection with sales to defective grantor trusts.

Tax Court Refused To Admit Appraisal into Evidence when Taxpayer Failed To Qualify the Appraiser as an Expert Witness

In Tanenblatt v. Commissioner, the Tax Court made clear that it would not allow a taxpayer to circumvent the Federal Rules of Evidence or the Court's own rules of procedure by compelling the IRS to "stipulate" that an appraisal attached to a petition was submitted into evidence.

Diane Tanenblatt died in February 2007 owning a minority interest in a limited liability company, whose principal asset was real estate in midtown Manhattan. The decedent's executors filed an estate tax return that reported the fair market value of the minority interest as $1.788 million, based on an appraisal that applied consecutive discounts of 20% for lack of control and 35% for lack of marketability, resulting in a combined discount of 48%.

On audit, the IRS applied consecutive discounts of 10% and 20% for lack of control and lack of marketability, resulting in a combined discount of 28% and claimed that the fair market value of the interest was $2,475,882, increasing the taxable estate by $687,882 and resulting in an estate tax deficiency of $309,547.

The decedent's executor filed a petition in Tax Court and attached a new appraisal, which valued the minority interest at $1,037,796. Based on the new appraisal, the executor claimed a deficiency of zero and an overpayment of estate tax entitling the estate to the refund.

At trial, the IRS called its own expert witness. The IRS's expert accepted the net asset value of the LLC provided in the taxpayer's original appraisal. However, he applied consecutive discounts of 10% for lack of control and 26% for lack of marketability (33.4% combined) and concluded that the fair market value of the interest was $2,303,000.

The Tax Court's opinion focused on the procedural defects in the Petitioner's attempts to enter the appraisal into evidence. Before trial, the Petitioner moved to compel the Service to "stipulate" that the new appraisal was submitted into evidence. This was an attempt to avoid the regular procedure by which the taxpayer must serve a copy of the written appraisal report on the IRS at least 30 days before trial, call the appraiser to testify as an expert witness, and have the witness identify the report before it can be received into evidence. Failure to follow the procedure resulted in the appraisal being deemed an unadmitted allegation in a complaint, which cannot be relied upon as evidence.

The Petitioner filed no response to the Service's motion to exclude the appraisal. When asked whether the Petitioner was relying on his own motions with respect to stipulating the appraisal into evidence, counsel candidly responded: "Probably, Your Honor, because right now my client's in a fee dispute with the appraiser, so right now I cannot get the appraiser to come in and testify."

Besides failing to properly admit the new appraisal into evidence, the executor never sought to enter into evidence the original appraisal filed with the estate tax return.

Despite being unable to rely upon the estate's appraisal report as evidence, the Court addressed Petitioner's argument that the estate's interest was an "assignee interest" rather than a member interest. The Court found that the value of an asset received by an estate must be based on what the decedent owned at death, not the nature of the interest transferred to the estate. The Court accepted the IRS expert's classification of the interest as a membership interest.

As a result of the Petitioner's failure to provide expert testimony which could serve as a basis for finding that greater discounts were in order, the Court accepted the discounts applied by the IRS expert witness and the resulting value of $2,303,000.

Although the issue was not raised at trial, at least one commentator has noted that the IRS may have valid objections to any claim by Tanenblatt's estate that expenses associated with obtaining the second appraisal are properly deductible as litigation expenses under Section 2053. While in most instances such fees would be properly deductible, in this case no appraisal was admitted into evidence at trial.

Income Tax Is Payable on Proceeds from Surrender of a Life Insurance Policy Used To Repay a Loan against the Policy

In a recent income tax case, the Tax Court affirmed the principal that the proceeds received from surrender of an insurance policy in excess of the policyholder's investment in the policy are taxable as income. This is the case even if almost all of the proceeds were used to repay a loan against the policy.

The taxpayers in Brach v. Commissioner were the owners of an insurance policy that allowed the policyholder to borrow up to the entire cash value of the policy. When the taxpayers became unable to pay the premiums or make loan repayments, they had to cancel the policy. The termination resulted in a gross distribution of about $65,903, which, after repayment of the loan, was reduced to $3,786. Taxable income on the distribution, however, was over $33,125 (the difference between the cash value and the taxpayers' investment of $32,778 in the policy). The taxpayers' failure to report the income resulted in a deficiency of $6,949 and an accuracy-related penalty of $1,390.

The Court rejected the position taken by the taxpayers that the surrender of the policy gave rise to "cancellation of indebtedness income" which, in light of the fact that the taxpayers were insolvent, was not includible in gross income by virtue of Section 108(a)(1)(B)(7) of the Internal Revenue Code.

Instead, the Court cited Section 72, which provides that an amount received in connection with a life insurance contract which is not received as an annuity generally constitutes gross income to the extent that the amount received exceeds the investment in the insurance contract. In this case, surrendering the policy entailed repayment of the loan. In contrast to repayment, "discharge of indebtedness" occurs when "the debtor is no longer legally required to satisfy his debt either in part or in full." Therefore, the taxpayers' debt obligation was satisfied rather than discharged.

Despite the clear rejection of the taxpayers' reporting, the Court found that imposition of a 20% penalty for underpayment was not appropriate. The taxpayers were relatively inexperienced in tax matters. They sought advice from a qualified professional, provided their adviser with all relevant information, and reasonably believed the adviser was competent to prepare their return. They had no reason to question the professional advice they received. Therefore, the underpayment fell within the exception under Section 6664(c)(1) which provides that an underpayment is not subject to penalty if the taxpayer establishes that there was reasonable cause for the underpayment and the taxpayer acted in good faith.

This case is illustrative of the Tax Court's willingness to consider all the facts, including a taxpayer's level of sophistication when deciding whether there was good faith reliance on expert advice. It is not clear that the Court would have held the same way had the taxpayers been better versed in tax matters or had they failed to disclose important information to their tax adviser.

New York Considers Raising Estate Tax Exemption, Reinstating Gift Tax, Eliminating GST Tax and Closing the Resident Trust Loophole

On November 14, 2013, the New York State Tax Reform and Fairness Commission presented its final report to the Governor containing various recommendation for reforms that would make New York's tax system "simpler and fairer and to help reduce the tax burden faced by New Yorkers and businesses." Among the various proposals was a wholesale reform of New York's estate tax system.

Current New York law allows for an estate tax exemption of $1 million, which is based on the federal estate tax law as it existed on July 22, 1998. The exemption amount is equal to the maximum state death tax credit at the time. New York has not had a gift tax since 2000, and New York's generation-skipping transfer tax is applicable only to taxable distributions and taxable terminations occurring at the same time as, and as a result of, the death of an individual.  

The Commission's report recommends increasing the estate tax exemption amount to $3 million, which would result in almost three-quarters of estates being exempt from the tax. In addition, the proposal would simplify the tax by no longer linking it to the federal estate tax as of a particular date.  

On December 10, 2013, the New York State Tax Relief Commission (separate body working in cooperation with the Tax Reform and Fairness Commission) recommended raising the estate exemption amount to $5.25 million, indexed for inflation, and lowering the tax rate to 10%. This would exempt nearly 90% of all estates from tax.

Both Commissions cited concerns that if reforms are not enacted, middle-class households will be subject to estate tax because of the increasing value of assets, such as real estate, and the current low threshold. In addition, a higher estate tax threshold would protect family farms and small businesses and reduce incentives for wealthy New Yorkers to move to other states in order to avoid paying estate tax.

In addition to recommending a higher estate tax exemption, the Tax Reform and Fairness Commission recommended two options for reinstating a state-level gift tax. The first and preferred option would subject gifts above a certain threshold to gift tax at rates consistent with the state estate tax. A second option would be to require estates to add back the value of gifts above a certain threshold in calculating estate tax. Either option would prevent taxpayers from reducing or avoiding estate tax by making lifetime gifts. Reinstating a gift tax is projected to generate approximately $150 million in annual revenues.

In an effort to curb the loss of income tax revenue resulting from Delaware Incomplete Gift Trusts, the Tax Reform and Fairness Commission also recommended "decoupling" from federal treatment of such trusts and treating them as grantor trusts for New York income tax purposes.

In contrast to these other proposals that would reinstate gift tax and impose additional fiduciary income tax on trusts, the Tax Reform and Fairness Commission recommended repealing the state-level generation-skipping transfer ("GST") tax. Less than 50 GST tax returns are filed per year in New York. The Commission's report notes that the tax generates less than $500,000 per year in revenue, and eliminating it would help to streamline New York State tax law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.