With the recent expansion of Blank Rome's Los Angeles office and the addition of a San Francisco office, the Private Client Group has planted its flag on the West Coast. On February 1, 2014, William Finestone joined our group in Los Angeles. Bill is a member of the American College of Trust and Estate Counsel ("ACTEC"), is included in "Best Lawyers in America," and has been recognized as a "Southern California Super Lawyer" by Los Angeles Magazine. With the addition of Bill, members of our group are admitted to practice in California, New York, Connecticut, Pennsylvania, New Jersey, Florida, Virginia, the District of Columbia, and Maryland.
This estate and tax planning newsletter discusses certain concepts and techniques that we hope may be of interest to our clients and friends.
- Transfer Tax Changes. The American Taxpayer
Relief Act of 2012 (the "2012 Act," passed in 2013) made
permanent the major changes made in 2010 in the law regarding gift,
estate, and generation-skipping transfer ("GST") taxes
(collectively, "transfer taxes").
- Gift Tax. The tax-free "annual exclusion" amount remains $14,000 per donee in 2014. The cumulative lifetime exemption increased from $5,250,000 in 2013 to $5,340,000 in 2014 (inflation adjustment). The tax rate on gifts in excess of $5,340,000 remains at 40%.
- Estate Tax. The estate tax exemption (reduced by certain lifetime gifts) also increased from $5,250,000 in 2013 to $5,340,000 in 2014, and the estate tax rate on the excess value of an estate also remains at 40%. All of a decedent's assets (other than "income in respect of a decedent," such as IRAs and retirement plan benefits), as well as a surviving spouse's half of any community property assets, will have an income tax basis equal to the fair market value of those assets at the date of death ["stepped-up (or down) basis"]. In this regard, securities brokers still are required to retain basis records and report the income tax basis of securities to the IRS. Accordingly, be sure to advise your broker of your basis in securities received by gift or inheritance.
- GST Tax. For 2014, the GST tax rate also remains at 40% and the lifetime exemption also has increased (inflation adjustment) from $5,250,000 in 2013 to $5,340,000 in 2014. Paragraph 5 includes more information about the GST tax.
- Portability of Estate Tax Exemption. The 2012
Act also made permanent the temporary "portability" rules
introduced in 2010 that provide for the transfer of a deceased
spouse's unused estate tax exemption ("deceased spousal
unused exclusion amount" or "DSUEA") to a surviving
spouse (without inflation adjustments). Thus, if a
2014 decedent's taxable estate is less than $5,340,000, the
DSUEA can be used by the surviving spouse with respect to both gift
taxes and estate taxes (but not GST taxes).
Portability is not available if either spouse is a nonresident
alien. Portability may allow some couples to forgo a more complex
estate plan while still taking advantage of both spouses'
transfer tax exemptions. Portability must be irrevocably
elected on a timely filed (including extensions) estate tax return,
even if a return is not otherwise required to be
A typical estate plan for a married couple generally has provided for the establishment of several trusts at the death of the first spouse: An "Exemption (or "Bypass" or "Credit Shelter") Trust"; a "Marital Trust," in California where joint trusts are common, a "Survivor's Trust," and possibly a "Generation Skipping Tax Exempt Trust." One of the reasons for the Exemption Trust is to use the deceased spouse's estate tax exemption to the fullest extent possible. Under the new portability law, however, if one spouse dies and leaves assets to persons (other than the surviving spouse and charity) in an aggregate amount less than the basic exclusion amount ($5,340,000 in 2014), the surviving spouse may be able to use the DSUEA as well as the surviving spouse's own exemption.
This portability provision may eliminate the need to create an "Exemption Trust" at the first spouse's death. For example, if this year the first spouse to die leaves all of his or her assets to the surviving spouse, no part of the deceased spouse's exemption is used because of the marital deduction available for assets passing to a surviving spouse at the first spouse's death. Unless the surviving spouse remarries and survives his or her new spouse, he or she will have an aggregate exemption of (i) $5,340,000 ("DSUEA") and (ii) his or her own inflation-adjusted $5,340,000 exemption ($10,680,000 total in 2014). Similarly, if in 2014 the first spouse to die leaves $1,000,000 to his or her children, the surviving spouse will have an aggregate exemption of $9,680,000 (the remaining $4,340,000 "DSUEA" in addition to his or her own inflation-adjusted $5,340,000 exemption).
In many cases, however, we will advise our clients to continue to use an Exemption Trust as part of their estate plans for both tax and non-tax reasons. State tax considerations may also impact the use of Exemption Trusts.
Federal tax reasons include the following: (i) The DSUEA is not indexed for inflation; (ii) eliminating estate tax on any appreciation of Exemption Trust assets at the surviving spouse's death, regardless of the value of the surviving spouse's assets; (iii) allowing for an allocation of the deceased spouse's GST exemption to the Exemption Trust;* (iv) the surviving spouse could remarry, survive his or her second spouse and be limited to using the unused exemption of his or her second predeceased spouse if any (a DSUEA thus may inhibit remarriage); and (v) an estate tax return must be filed timely to qualify for portability.
Non-tax reasons include the following: (i) Limiting (or eliminating) the ability of the surviving spouse to direct the disposition of the deceased spouse's assets on the surviving spouse's death; (ii) restricting the surviving spouse's right to use principal (perhaps only for health, support, and maintenance); (iii) providing creditor protection (creditors generally cannot reach the assets in an irrevocable trust established by another person); and (iv) providing professional management if desired.
Exemption Trust disadvantages include the following: (i) Annual costs for the preparation of Exemption Trust income tax returns and maintaining separate records for the Exemption Trust; (ii) the possible loss of a further stepped-up basis on the surviving spouse's death; (iii) lack of surviving spouse ability to change the estate plan to adapt to changed circumstances, unless as is often the case the surviving spouse has a limited power to change the Exemption Trust distribution provisions; (iv) lack of ability to offset capital gains and losses realized by the surviving spouse and the Exemption Trust; (v) Exemption Trust assets generally cannot be used to implement further estate planning techniques; (vi) the surviving spouse cannot use the $250,000 exclusion from capital gain upon the sale of a residence held in the Exemption Trust; and (vii) the possible need to accelerate taxable distributions from retirement accounts.
Planning Tip. If the reasons for establishing an Exemption Trust are not significant, but you nevertheless want to provide for the possible establishment of an Exemption Trust in case your spouse decides that it is advisable to do so, your estate plan can provide for distribution of your estate to your spouse, but include a provision that would allow your surviving spouse to "disclaim" all or a portion of his or her inheritance and have the disclaimed assets allocated to an Exemption Trust ("Disclaimer Trust"). The surviving spouse would make his or her decision to disclaim during the nine-month period following the first spouse's death. The only difference between a Disclaimer Trust and an Exemption Trust established by the first spouse is that the surviving spouse cannot have a power to provide for distribution of the assets of a Disclaimer Trust in a manner different from the first spouse's distribution plan.
- Income Tax Changes. Many income tax changes
were made by the 2012 Act, effective January 1, 2013. The following
is a brief summary of those changes taking into account 2014
- the highest tax rate is increased from 35% to 39.6% for incomes in excess of $457,600 (was $450,000) (joint return), $432,000 (was $425,000) (head of household), and $407,650 (was $400,000) (single)—these
- the social security tax increased from 4.2% to 6.2%;
- the alternative minimum tax ("AMT") exemption amounts have been increased and are to be adjusted for inflation (retroactive to 2012);
- the maximum tax rates for long-term capital gains and dividends remain increased from 15% to 20%; and
- the itemized deduction and personal exemption "phase-outs" were reinstated with adjusted gross income thresholds of $305,050 (was $300,000) (joint return), $279,650 (was $275,000) (head of household), and $254,200 (was $250,000) (single), which thresholds will continue to be adjusted for inflation annually. These "stealth tax" provisions effectively increase marginal tax rates for those affected.
- Revocable Trust. The revocable trust is a valuable estate planning technique for both single and married clients, used primarily to avoid the inconvenience and extra costs of a probate administration of an estate upon death (multiple probate administrations would be required if you own property in other states). The same estate tax savings techniques available by Will can be employed via the revocable living trust. Many of the post-death income tax advantages previously available to probate estates have been eliminated, thus making the revocable trust even more attractive for wealthier clients.
- Annual Gift Program. A lifetime gift-giving
program could reduce overall transfer tax costs considerably. By
receiving lifetime gifts, donees will benefit from all future
appreciation of and income generated by the transferred property
free of transfer taxes. This year, every individual may transfer
cash or other property worth $14,000 (or $28,000
for married couples) to each of as many donees as the donor selects
without incurring any gift or later estate tax. An inflation
adjustment applies when that adjustment would increase the annual
exclusion amount by $1,000 (e.g., from $10,000 in 2001 to $11,000
in 2002, to $12,000 in 2006, to $13,000 in 2009; and to $14,000 in
2013). Donors may make these gifts (known as "annual
exclusion" gifts) outright or via custodianships or trusts,
although careful planning is needed if trusts are to be used. For
example, it is very important to assure that any trust for a
grandchild contains special provisions so that gifts made to that
trust are exempt from the GST tax (discussed in paragraph 5). In
addition, no gift taxes are imposed if you pay a donee's
tuition or medical expenses (payments must be made directly to the
school or health care provider), and you may prepay tuition under
Even if a gift is not "tax-free" as described above, if your aggregate gifts do not exceed the $5,340,000 lifetime gift tax exemption amount (or $10,680,000 for married couples), no gift tax will be payable at the time of the gift. Taxable gifts in excess of the $5,340,000 lifetime exemption will accelerate transfer tax payment, but an overall tax savings may result because your gift tax dollars generally will not be subject to estate taxes at death. Paying gift taxes now, however, may result in an unnecessary tax payment if estate taxes would not be payable at death under new legislation; the possibility of estate tax repeal should be considered. Certain valuation advantages (such as "minority" discounts) that might be unavailable at death often are possible under current law in connection with lifetime gifts (e.g., see paragraph 13). Finally, the low interest rates currently in effect make this a very good time to loan funds to younger generations, and may make certain types of gifts via trust particularly attractive.
- Life Insurance. Life insurance proceeds are generally exempt from income tax. In addition, all estate tax on life insurance proceeds may be avoided on the death of the insured through proper planning: Insurance proceeds can be available free of estate tax to the surviving spouse, but by designating other family members or a trust for their benefit as owners and beneficiaries, estate taxes can be avoided in both spouses' estates. "Joint life" (or "survivorship" or "second to die") policies make life insurance planning affordable for many more people. You should consider the ownership and beneficiary designations for any newly acquired life insurance carefully before the policy is purchased. You also should review the ownership and beneficiary designations of your existing policies; your revocable living trust or Will does not generally control distribution of life insurance proceeds. "Split-dollar" life insurance plans now are subject to much more stringent rules; we suggest that you review with an insurance professional or with us any "split-dollar" life insurance programs in which you currently participate or in which you contemplate participating. Finally, recent economic activity may have caused your life insurance policies to experience financial problems; you may wish to contact your insurance professional to discuss the current status of your policies.
- GST Tax. The GST tax generally imposes an additional transfer tax (at the 40% estate tax rate) on property transferred to grandchildren and other younger beneficiaries by lifetime gift or at death, and whether outright or via trust. Certain techniques are available to avoid or substantially reduce this GST tax. One technique involves making "tax-free" gifts as described in paragraph 3 via an "annual exclusion" gift program to grandchildren (either outright or via trust) and by paying a grandchild's tuition and medical expenses (remember, direct payments to the school or health care provider are required). Another technique involves use of your lifetime GST exemption to establish a "dynasty" trust (which can invest in life insurance policies or other property) to enable a substantial amount of property to pass to grandchildren, great-grandchildren, and later generations free of any estate or GST tax. The GST exemption for 2014 is the same as the $5,340,000 unified estate and gift tax exemptions. Whereas use of the gift and estate tax "exemptions" is automatic, use of the GST exemption is elective. In view of the voluntary GST exemption allocation rules, we generally recommend that clients who make gifts to trusts from which a grandchild or other younger beneficiary may receive distributions file gift tax returns (even if not required) in order to specifically elect whether to allocate or not allocate GST exemption to those trusts.
- Marital Deduction; Noncitizen Spouse. The vast majority of married couples combine the estate tax "exemption" granted to each person with the unlimited marital deduction to assure that no estate taxes are payable until the death of the surviving spouse. The unlimited marital deduction generally is available for gifts and bequests to spouses; those gifts and bequests can be outright transfers or can be made via trusts (although not all types of trusts will qualify for the marital deduction). Severe restrictions, however, are imposed on the ability to defer estate taxes if the surviving spouse is not a United States citizen (the surviving spouse's residence is not a factor). Under these rules, property passing to a noncitizen surviving spouse must be held in a special type of trust (a "qualified domestic trust") in order to qualify for the marital deduction. In addition, although gift taxes on gifts to noncitizen spouses generally cannot be deferred via the marital deduction, in 2014 you may make "annual exclusion" gifts (discussed in paragraph 3) of a maximum of $145,000 (rather than $14,000) to your noncitizen spouse (subject to annual inflation adjustments). As discussed in paragraph 1-D, portability is not available if either spouse is a nonresident alien. You should review your estate plan now if either spouse is not a U.S. citizen.
- Estate Planning for Nonresident Aliens. The
estate of a nonresident alien ("NRA") (a noncitizen who
is not a U.S. resident) has only a $60,000 (not $5,340,000) estate
tax exemption available. U.S. donees of gifts from NRAs or foreign
estates in excess of $100,000 [or $15,358 in 2014 (inflation
adjusted) from a foreign corporation or partnership] must report
these gifts to the IRS on Form 3520. Several interesting planning
opportunities may exist for an NRA. An NRA may avoid transfer taxes
completely by structuring his or her holdings so that no U.S.
"situs" assets are owned directly (for example, U.S.
"situs" assets may be held by a wholly-owned foreign
corporation, although U.S. real estate presents special income tax
issues). If your spouse is not a U.S. citizen, you may wish to
defer estate taxes by use of a "qualified domestic trust"
(discussed in paragraph 6). Lifetime gifts by an NRA of U.S.
"situs" intangible personal property (such as stock or
partnership interests) are not subject to U.S. gift taxes, even
though these items might be subject to U.S. estate taxes if owned
by the NRA at death. An NRA also may wish to establish a trust to
hold property for U.S. resident children or other family members to
provide them with tax-free income and arrange for the trust
property to pass to other family members free of transfer
A U.S. taxpayer who expatriates can be subject to severe tax penalties unless that taxpayer has a net worth of less than $2,000,000 and average annual income of less than $157,000 (subject to annual inflation adjustments). The tax penalties can be deferred on an asset-by-asset basis if an election is made (interest and security are required). In addition, transfer tax is imposed on the receipt by U.S. taxpayers of any amounts in excess of $14,000 (adjusted for inflation) from an expatriate described above.
- Community Property v. Joint Tenancy. California law allows a form of ownership between spouses called "Community Property". For income tax purposes, both "halves" of appreciated community property receive a "step-up" in basis upon the death of either spouse. Because only one-half of the basis of property held in joint tenancy receives a basis "step-up" at the death of the first spouse, we generally recommend that legal title to appreciated assets owned jointly by spouses and not held in a revocable living trust be held as "community property" rather than as "joint tenants." California now recognizes "community property with right of survivorship" as a form of legal title for real estate.
- Charitable Tax Planning. There are several techniques available to transfer significant wealth to intended beneficiaries in a tax-favored manner and at the same time benefit charity. This is particularly true in connection with a sale of highly appreciated assets; a charitable remainder trust can be used to advantage in these circumstances. You also may be able to arrange to receive a lifetime annuity in exchange for cash or appreciated property, or even for agreeing to transfer your residence to a charity at your death (or at the death of the surviving spouse). You also may be able to transfer property to your descendants without (or with reduced) transfer taxes by establishing a charitable lead trust (these are particularly advantageous in a low interest rate environment as currently exists). The income tax benefits of donating partial interests in tangible personal property items (such as works of art) are currently restricted. The popular "Charitable IRA Rollover" rules expired on December 31, 2013, and as of this writing have not been extended for 2014. Wealthier taxpayers may be interested in a private foundation or a donor-advised fund established at a public charity, such as a community foundation. The IRS has developed two web pages that may be of interest to these taxpayers: "Life Cycle of a Private Foundation" deals with private foundations(http://www.irs.gov/Charities-&-Non-Profits/Private-Foundations/Life-Cycle-of-a-Private-Foundation ); and "Life Cycle of a Public Charity" deals with public charities http://www.irs.gov/charities/charitable/article/0,,id=122670,00.html).
- "Buy-Sell" Agreements/Options. A "Buy-Sell" or option agreement (whereby a family member or business associate has the obligation or option to acquire assets at an established price) can be used to advantage to restrict ownership of a business, to establish the value of an asset for estate tax purposes, and to provide a market for the asset to allow owners to plan for liquidity. This estate planning device is subject to restrictions, but some of these restrictions do not apply to agreements made before October 9, 1990. You therefore should be very careful if you wish to modify "Buy-Sell" or option agreements made prior to October 9, 1990. Employer-owned life insurance generally now is subjected to income taxation, although insurance used to fund a Buy-Sell Agreement is exempt from income taxation, provided that certain written notice and consent requirements are met in advance.
- Employee Benefit Plans and IRAs. Assets in pension and profit-sharing plans, IRAs, and other retirement plans (other than Roth plans) can be subject to severe taxes at death. You should review your plan benefits to determine whether you can avoid or postpone these taxes and whether your plan benefits are coordinated with your estate plan; your revocable living trust or Will generally does not control disposition of these benefits. Plan proceeds still can be the most advantageous to use for charitable gifts at death, including transfers to charitable remainder trusts and to establish charitable gift annuities.
- Subchapter "S" Corporations. The use of Subchapter "S" corporations has become somewhat less popular because of the increased use of limited liability companies ("LLCs"). Care must be taken, however, with respect to existing Subchapter "S" corporations. For example, upon the death of a Subchapter "S" corporation shareholder, Subchapter "S" corporation status can be lost unless the decedent's shares pass to a qualified shareholder in a timely manner. All Subchapter "S" corporation shareholders therefore should assure that their estate plans allow for the continuation of Subchapter "S" corporation status. Subchapter S corporations also might be used to reduce payroll taxes imposed on their owner-employees.
- Family Limited Partnerships and Limited Liability Companies. A "family limited partnership" ("FLP") or "family limited liability company" ("FLLC") can be an excellent estate planning vehicle for clients who own valuable assets. A FLP or FLLC can be advantageous if a family member encounters creditor problems in the future. Gifts of FLP or FLLC membership interests to your beneficiaries or to trusts for their benefit can qualify for the gift tax "annual exclusion" (discussed in paragraph 3) if properly drafted, and the value of those gifts can reflect the "discounts" available for minority and nonmarketable interests. "Discounted" values also can be used in connection with sales to desired limited partners or LLC members, including family members or trusts for their benefit. Some recent IRS challenges to these entities have been successful, however, so all administrative and operational details must be respected; some recent Court decisions have focused on the actual organizational and operational aspects of the family entities. The tax benefits anticipated at the time of the formation of the entity should be available at the donor's death if the entity is organized for a significant non-tax business purpose and operated strictly in accordance with the provisions of the governing instrument and applicable state law, the donor has retained enough assets outside the entity to satisfy the donor's personal financial needs, and the donor is not a general partner or LLC manager. We continue to urge all clients who have implemented FLPs or FLLCs to review those entities now.
- Durable Financial and Health Care Powers. It has become more important to plan for the risk of lifetime incapacity. A Durable Power of Attorney can provide for lifetime asset management, especially if your estate plan does not include a revocable living trust. An Advance Health Care Directive permits you to designate someone to make health care decisions on your behalf if you become unable to do so, and also can be used to make known your desires that artificial life-prolonging measures be or not be employed on your behalf. Appropriate health care documents for your children (both minors and adults) also should be completed. In California, a Durable Power of Attorney for Health Care signed prior to 1992 probably is ineffective today. The California Secretary of State has established an Advance Health Care Directive Registry, and will issue an identification card to each registered person and respond to inquiries by health care providers. A registration form can be obtained at http://www.ss.ca.gov/ahcdr/index.htm. In addition, you should consider executing an appropriate Authorization for use and disclosure of health information that otherwise would be protected and thus unavailable under the federal Health Insurance Portability and Accountability Act ("HIPAA").
- Same-sex Marriages; Registered Domestic Partnerships. On June 27, 2013, in United States v. Windsor, the United States Supreme Court held that Section 3 of the Defense of Marriage Act ("DOMA") is unconstitutional. The case arose in connection with a New York statute that recognized same-sex marriages. On the same date, in Hollingsworth v. Perry, the Supreme Court held that the proponents of California Proposition 8 did not have judicial standing to intervene in a case to argue in favor of the constitutionality of Proposition 8, which a United States District Court had previously declared unconstitutional. The Hollingsworth case paved the way for California same-sex marriage. We will follow up on the impact of these decisions and subsequent IRS pronouncements regarding them in a later letter.
- Deposit Insurance. The FDIC bank deposit insurance limit is $250,000 per account. Generally, all retirement accounts of a single "participant" at a particular bank are insured up to $250,000. All accounts held by a revocable trust are insured on a "per settlor per beneficiary" basis. For example, a single revocable trust established by a married couple that provides that, on the death of the first spouse, the assets will remain in the trust for the benefit of the surviving spouse for life, and that on the death of the surviving spouse, the assets will be divided into equal shares for their three children, will be insured while both spouses are living for $1,500,000 at each bank in which the trust maintains accounts (husband is treated as having three $250,000 beneficiaries, and wife is treated as having three $250,000 beneficiaries). This rule will apply regardless of the relationship between the trust creators and the beneficiaries; previous law provided for this protection only to certain close family members. For more information about FDIC insurance for revocable trusts, see http://www.fdic.gov/deposit/deposits/insured/ownership4.html.
- Foreign Bank Account Reporting. The Treasury Department is actively pursuing taxpayers who fail to report their foreign bank and securities accounts (including foreign fund accounts maintained outside the U.S.) on IRS Form 8938 as required by the Foreign Account Tax Compliance Act ("FATCA"). Filing this Form 8938 does not relieve U.S. taxpayers (including non-resident U.S. citizens and dual citizenship individuals) from the separate obligation to electronically file a Foreign Bank Account Report ("FBAR" Form TD F 90-22.1) by June 30 each year to report an interest in, or a signature authority over, any financial account in a foreign country if the aggregate value of those accounts exceeds $10,000 at any time during the calendar year. These two forms must be filed even if the accounts earned no income. IRS Form 8938 must be filed with a U.S. resident's income tax return if total foreign financial assets aggregate $50,000 at year-end or $75,000 at any time during the year (single or married filing separately) or $100,000 at year-end or $150,000 at any time during the year (joint return). Severe penalties are imposed and criminal prosecution is possible for failure to comply with either of these filing requirements. Finally, the IRS has renewed the offshore voluntary disclosure program that expired on September 9, 2011, with some changes.
The attorneys in the Private Client Group have extensive experience in implementing cutting-edge estate planning techniques to take advantage of these unique opportunities and challenges.
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.