Understanding and Manipulating Estate and Gift Taxes – Part II

As an Estate Planning practitioner, I always considers the impact that estate, gift, generation-skipping transfer, and inheritance taxes will have on an Estate Plan. After all, clients frequently inquire about tax impact during consultation and beneficiaries usually wonder not only if taxes will result from their inheritance but also who will bear the burden of paying said taxes. Generally, the individual making the gift bears the responsibility of paying any taxes on the transfer during life or at death. The first part in this two-part series Understanding and Manipulating Estate and Gift Taxes focused on understanding the basics of the Estate and Gift Tax. This second part will explore one sanctioned way to manipulate the Estate and Gift Tax.

The Internal Revenue Code (“Code”) levies an estate tax on the value of the assets of an estate exceeding the Applicable Exclusion Amount (“AEA”) at the rate of 40%. In 2023, each U.S. citizen / resident has an AEA of $12.92 million, meaning that an individual can transfer up to $12.92 million either during life or at death without worrying about incurring a gift or estate tax on the transfer. For those whose estates exceed the AEA, Code Section 2056 offers relief in the form of an unlimited deduction for property other than terminable interest property passing to the surviving spouse. Again, the Code provides a save for even terminable interest property if it meets the requirements of Code Section 2056(b)(7) – the “Qualified Terminable Interest Property” (“QTIP”) Trust. To receive the unlimited marital deduction for property passing to a surviving spouse through a properly structured QTIP Trust, the decedent’s fiduciary needs to file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return and elect QTIP treatment thereon. That election comes at a price though because it forces inclusion of the value of the QTIP Trust in the surviving spouse’s estate at the surviving spouse’s death, pursuant to Code Section 2044.

The surviving spouse’s estate bears the burden of paying tax on those assets, notwithstanding that the surviving spouse cannot control ultimate disposition of those assets. The decedent spouse can decide what happens to those assets upon the death of the surviving spouse. Further, the QTIP Trust need not include any distributions of principal to the surviving spouse, yet the Code includes that principal amount in the surviving spouse’s estate. Thankfully, the Code contains some balance. Code Section 2207A allows the decedent spouse’s estate the right to recover the amount by which inclusion of the QTIP Trust in the surviving spouse’s estate increased the total taxes due on the surviving spouse’s estate.

Let’s return to our example from last week. If you recall, Howard and Bernadette each had an estate of $25 million. Howard structured his plan to create a Family Trust with his remaining AEA, let’s assume that it was $12.92 million because he died in 2023 with his AEA intact. The remainder ($12.08 million) went into a Marital Trust for Bernie’s benefit. Let’s change the facts such that Bernie’s trust qualified for the QTIP election, thereby resulting in no taxes due upon Howard’s death. Now, let’s assume that Bernadette dies in 2023 without having used any of her AEA. She, too, has $12.92 million that she can shield from estate taxes. The $12.08 million remainder of her estate will be subject to tax at a rate of 40%, resulting in a tax liability of $4,832,000 ($12.08 *.40) …but wait! We forgot to include the principal of the QTIP Trust in our calculation of tax for Bernadette’s estate. Thus, Bernie’s estate would total $24.16 million ($25 million plus $12.08 million QTIP less $12.92 AEA) resulting in a total tax liability of $9,664,000 ($24.16 * .40). Not such a great result for her beneficiaries since they will not benefit from the assets in the QTIP Trust. Code Section 2207A, however, changes that result and allows Bernadette’s estate to recover the $4,832,000 amount by which the taxes increased because of inclusion of the value of the QTIP Trust in her estate. Thus, Bernie’s beneficiaries do not bear the burden of taxes on property from which they do not benefit and her estate recovers from the person or persons receiving the property that was included in Bernadette’s estate. This right to recover provides a more equitable result for Bernie’s beneficiaries who are in the same position as if Bernie never benefitted from the QTIP Trust.

Treasury Regulation Section 20.2207A-1(a)(1) explains that the recovery is from the “person receiving the property.” Thus, in our example, if Howard’s kids, Halley and Neil, received the QTIP Trust upon Bernie’s death, Bernadette’s estate could recover from the children. Let’s change the facts such that Halley and Neil were the children of both Howard and Bernadette. In that case, perhaps Bernadette’s fiduciary has no concerns about recovery because the beneficiaries are the same. Code Section 2207A(a)(2) allows a waiver of the right of recovery in either the Will or the Trust of the surviving spouse. This waiver allows the surviving spouse to determine whether their estate should recover any resulting taxes or whether the estate should forego such recovery.

If the beneficiaries of the QTIP Trust are the same as the surviving spouse’s beneficiaries, it’s more tax efficient for the surviving spouse to waive the right of recovery. If the statute of limitations for the estate to recover from the beneficiaries based upon the surviving spouse’s estate’s statutory rights under Code Section 2207A expires, then that results in a gift, likely unintended.  

Understanding and Manipulating Estate and Gift Taxes

After that title, who doesn’t want to read this post? Any practitioner in the Estate Planning world considers the impact that estate, gift, generation-skipping transfer, and inheritance taxes will have on a plan. Clients inquire about tax impact during consultation and beneficiaries wonder not only if taxes will result from their inheritance but also who will bear the burden of paying said taxes. Generally, the individual making the gift bears the responsibility of paying any taxes on the transfer during life or at death. Certain provisions of the Code may change that result. This first part in a two-part series will focus on understanding the basics of the Estate and Gift Tax.

Let’s start with the basics. The Internal Revenue Code (“Code”) levies an estate tax on the value of the assets of an estate that exceed the Applicable Exclusion Amount (“AEA”) at the rate of 40%. In 2023, each U.S. citizen / resident has an AEA of $12.92 million, meaning that an individual can transfer up to $12.92 million either during life or at death without worrying about incurring a tax on the transfer. For most of the population, that’s enough to remove the worry of estate tax from their mind. For some of the population, however, that’s not enough. Thankfully, in addition to the AEA, Section 2056 of the Code provides an unlimited deduction for property passing to the surviving spouse. Thus, married individuals may pass an unlimited amount of assets between one another during life and at death. Section 2056(b)(1) prohibits the deduction, however, for property passing to the surviving spouse that qualifies as a “terminable interest” meaning that the spouse’s interest in the property will terminate or fail on the lapse of time or occurrence of an event or contingency, or will terminate upon the failure of an event or contingency to occur, and upon such termination the interest will pass to someone other than the surviving spouse.

You may be wondering what that means. Let’s review an example. Assume that Howard and Bernadette have been married for several years but have no children together. Howard has children from a prior relationship, Halley and Neil. Over the years as an astronaut, Howard has amassed an estate of $25 million. Bernadette has her own assets of $25 million from her successful job as a microbiologist at a pharmaceutical company. Howard and Bernadette live a lavish lifestyle, flying all over the world to visit their friends, Sheldon and Amy, now living in Switzerland, along with their friend, Raj, and his wife Riva, living in India. After his death, Howard wants to make sure that Bernadette can continue this lifestyle but also wants to ensure that his children have adequate funds as well. He wants to pay as little as possible in taxes but worries that if he gives Bernadette everything outright that she will spend it all or fail to leave his children any of his wealth.

With these competing interests in mind, Howard makes an appointment to see his attorney who suggests that he structure his estate plan to create a Family Trust that will consist of his unused AEA with the remainder going into a Marital Trust for Bernadette’s benefit. The terms of the marital trust allow the Trustee of the Trust to make distributions of income or principal for Bernadette for life for her health, education, maintenance, and support. Howard does not want Bernadette to alter the plan and therefore excludes both a limited power of appointment and a general power of appointment. At Bernadette’s death, the assets in the marital trust will pass to his children, Halley and Neil. Howard likes the plan and signs it.

A few months later, Howard dies unexpectedly. Bernadette sees her attorney who advises her that Howard’s attorney structured the plan improperly. Howard’s estate cannot avail itself of the unlimited marital deduction for the assets passing to her in the marital trust. The attorney explains that Bernadette’s marital trust consists of a terminable interest, but an inappropriately structured terminable interest. He indicates that the Code allows a decedent spouse to leave assets in a trust for the benefit of a surviving spouse during that spouse’s life and obtain the benefit of the unlimited marital deduction provided that said trust has been properly structured and that Bernie’s trust was not. The lawyer goes on to advise Bernadette that two types of marital trusts will produce an unlimited marital deduction. The first is one in which the surviving spouse has a life estate coupled with a general power of appointment. While Bernie’s marital trust gave her a life estate, it did not contain a general power of appointment. The second is a trust that meets the requirements set forth in Code Section 2056(b)(7).

Code Section 2056(b)(7) requires the trustee to distribute all income from the trust to the surviving spouse. In addition, the trust gives the surviving spouse the power to make any unproductive property income-producing. Finally, no payment may be made to any other person during the surviving spouse’s lifetime. If the trust meets these requirements, it will qualify as a “Qualified Terminable Interest Property” (“QTIP”) Trust and allow the decedent spouse’s estate an unlimited marital deduction for the assets passing to the trust. The decedent spouse’s fiduciary need only file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return and elect QTIP treatment thereon, and that forces inclusion of the value of the QTIP Trust at the surviving spouse’s death in the surviving spouse’s estate, pursuant to Code Section 2044.

The surviving spouse’s estate bears the burden of paying tax on assets that the surviving spouse cannot control. In fact, the surviving spouse may have never had the benefit of any distribution of principal, yet it’s the principal amount included in that surviving spouse’s estate. This realization undoubtedly has frustrated many a surviving spouse. Adding insult to injury, the decedent spouse controls disposition of the assets upon the death of the surviving spouse. Talk about a homerun for the decedent spouse and a recipe for a tense relationship between the surviving spouse and the stepchildren. If only there were a solution… we should be shouting “Code Section 2207A.” It provides relief to the surviving spouse’s estate.

What It Means to Disclaim

Many of us dream about suddenly inheriting assets from a long-lost uncle. No doubt, some have experienced that new-found wealth and were overjoyed when it occurred. Sometimes, however, that wealth may not be desirable. Some clients have assets that exceed the amount they could spend in their lifetime, will have an estate tax issue, and additional assets only compound that. Others may prefer that the assets go elsewhere. This article examines the basics of disclaimers and how some situations require the more complex “double disclaimer.”

Internal Revenue Code (“Code”) Section 2518 describes the requirements necessary for a “qualified disclaimer.” If the disclaimer meets the statutory requirements, then the Code treats the disclaimant as having predeceased the decedent and imposes no gift tax on the transfer to the second beneficiary. This preserves the disclaimant’s Applicable Exclusion Amount (“AEA”) and the assets pass to the next named beneficiary or beneficiaries without additional tax liability. For the disclaimer to work; however, the disclaimant needs to follow the rules of Code Section 2518 precisely. A disclaimer needs to meet the following requirements pursuant to Code Section 2518:

  1. The refusal must be in writing,
  2. The refusal must be received by the transferor of the interest (or the representative or legal title holder) within 9 months of the later of the date on which the transfer creating the interest is made or the date the recipient attains age 21,
  3. The disclaimant must not have accepted any of the benefits of the property, and
  4. The interest must pass without direction by the disclaimant either to the decedent’s spouse or someone other than the disclaimant.

Nothing in the Code, the Treasury Regulations, nor any Internal Revenue Service guidance allows an extension on the 9-month deadline for a disclaimer. It matters not if the disclaimant were sick or had extenuating circumstances. That deadline is firm. Further, it doesn’t matter if an individual doesn’t know about their interest in the assets until well beyond the 9-month timeline. A lack of knowledge changes nothing. Let’s look at a quick example:

Granny’s Will leaves Blackare to Jose. The Will provides that if Jose predeceases Granny, Blackacre goes to Jose’s daughter, Lola. Blackacre has a value of $5 million. Jose has sufficient assets from his vast holdings and does not need  Blackacre. Jose has made several lifetime gifts and has already used his AEA. He wants Blackacre to go to Lola because she has always enjoyed vacationing there. If Jose accepts Blackacre, then gives it to Lola, that results in a taxable gift on $5 million resulting in a gift tax liability of $2 million. If Jose disclaims timely without accepting any benefits from Blackacre, then Blackacre will pass to Lola as though Jose predeceased Granny. Granny’s Will provides that Blackacre passes to Lola if Jose predeceased Granny. Allowing Blackacre to pass in this manner accomplishes Jose’s wishes and saves Jose $2 million.

While the above example is simple, that’s not always the case. If you want to consider a disclaimer, you need to map out how the property will pass after the disclaimer. The Estate Planning documents may complicate that process and the disclaimant cannot direct what happens if the Estate Plan varies from the disclaimant’s wishes. For example, above, if Jose preferred that Blackacre pass to his daughter, Gabriela, rather than to Lola, he could not disclaim and direct that the property pass to Gabriela. That would violate Code Section 2518. Instead, he would need to accept Blackacre and then gift it to Gabriela. He would incur the resulting gift tax of $2 million. In some complex situations, it may still be possible to achieve the desired result. Executing a disclaimer requires you to understand how the property will pass after the disclaimer. A double disclaimer may allow you to alter the course a bit. Let’s look at another example that highlights that principle:

Grandpa had a trust that left all his assets to his surviving spouse, Granny. Pursuant to the terms of Grandpa’s Trust, if Granny disclaimed, the property would be held in a Family or Bypass Trust for the benefit of Granny and their children, Lucia and Jose. At Granny’s death, the Trust Agreement directs distribution of the assets outright to Lucia and Jose. If Lucia or Jose predeceases Granny, the property would go to their descendants, if any, or to Grandpa’s descendants.

Granny decides she doesn’t want Blackacre and wants it to go to their children immediately without using any of her AEA. First, Granny needs to execute a qualified disclaimer of the property. That disclaimer sends Blackacre to the Bypass or Family Trust for her benefit and the benefit of Lucia and Jose. (Remember, even though Granny would benefit from the Bypass Trust, this meets the requirements of a qualified disclaimer because she is the decedent’s spouse.) Next, Granny would execute another qualified disclaimer, this time of her interest in the Bypass Trust. The second disclaimer treats Granny as having predeceased Grandpa. This allows Blackacre to pass directly to Lucia and Jose. In fact, if desired, the family could go one step further. Let’s say Granny only wanted Lucia to get Blackacre and Jose agreed to that plan. After Granny executed the first disclaimer sending Blackacre to the Bypass Trust and the second disclaimer of her interest in the Bypass Trust, Jose could disclaim his interest. Since Jose has no children, the terms of the trust would send Blackacre to Lucia. Remember, it’s imperative to chart the course of the disclaimed property to know where it will go.

Of course, if Granny wants to get the property just to Lucia, she’d have to rely on the expectation that Jose will disclaim after Granny does. Jose would be under no legal obligation to do so.

Disclaimers represent yet another way to achieve client goals. Sometimes they can be quite tricky and require thought to achieve the desired outcome. Sometimes more than one disclaimer might be necessary to accomplish the preferred result. Remember to chart the post-disclaimer course of the asset prior to disclaiming. Once you are confident that the disclaimed property will pass as intended, it’s imperative to follow Code Section 2518 exactly. Even a small misstep will invalidate the disclaimer and make the transfer a gift.

Should In Re Gregory Hall Trust Change the Way We Think About Amending Trusts?

Revocable Trusts lay the foundation for many an Estate Plan. They serve various functions, like avoiding probate, planning for incapacity, protecting beneficiaries, and providing continuity after death. Revocable Trusts provide the grantor with flexibility by giving the grantor the right to change the trust during their lifetime. Well-written trusts contain explicit instructions regarding the steps that the grantor needs to follow to amend, revoke, or change the trust. If a Revocable Trust lacks those specific instructions that can lead to questions regarding the grantor’s intent and ultimately, litigation, which benefits no one. Let’s look at a recent Michigan case, In re Gregory Hall Trust, No. 361528 (Mich. Ct. App. Mar. 16, 2023), that underscores the importance of clear instructions in the trust agreement.

Gregory Hall created a Revocable Trust that he subsequently amended and restated. The amendment and restatement indicated that his three children, Kenneth, Cheryl, and Michael, would split the residue of the trust after Gregory’s death. The amendment and restatement indicated that Gregory could amend the trust “by an instrument in writing delivered to the Trustee.” The trust provided no instruction regarding whether Gregory needed to sign the instrument or whether any other formalities typically required for trust amendment were necessary. A few years later, Gregory prepared a spreadsheet, the contents of which remain unknown. Several years after the amendment and restatement, but just weeks after preparing the spreadsheet, Gregory conveyed his home worth $500,000 to Kenneth. A few years later, Gregory created another spreadsheet reflecting the value of his overall estate, approximately $6 million, and reflecting conveyance of the home to Kenneth. After Gregory died, Kenneth argued that the house was a gift to him and that entitled him to 1/3 of the residue of the trust. Kenneth’s siblings indicated that the home was an advancement and argued for reduction of Kenneth’s 1/3 share of the residue by the value of the home.

After Gregory’s death, all three children became co-Trustees of the Trust. Cheryl and Michael petitioned the court for limited supervision of the Trust to resolve the advancement issue. Kenneth failed to cooperate during discovery and violated several of the court’s orders relating to discovery during the proceeding. Ultimately, the lower court found in favor of Cheryl and Michael and entered a default judgment against Kenneth as a discovery sanction. Kenneth appealed and the higher court affirmed the lower court’s decision. Kenneth’s egregious behavior concerning the documents and related electronically-stored information requested during discovery despite numerous reprimands from the lower court convinced the higher court of the correctness of the lower court’s decision. For those interested, here’s a link to the case detailing Kenneth’s bad acts: In re Gregory Hall Trust.

For purposes of this article, though, the discovery issue isn’t the most compelling part of this case. It’s that the lower court found that the second spreadsheet created by Gregory met the statutory definition of a contemporaneous writing as applied to trusts. The statute provides that an advancement includes property given by the testator during life if “the testator declared in a contemporaneous writing that the gift is in satisfaction of the devise or that its value is to be deducted from the value of the devise.” Based upon this statute, the court considered the transfer of the home an advancement rather than an intervivos gift. While the court never made an express finding that the spreadsheet was a declaration, their decision permits us to infer that the spreadsheet was a declaration for purposes of application of the statute. The court remained silent regarding the length of time between the amendment and restatement and creation of the second spreadsheet, but perhaps the first spreadsheet prepared just weeks before the transfer convinced the court that the second spreadsheet merely confirmed the contents of the first.

The court never disclosed whether Gregory’s Will or Revocable Trust contained language regarding an advancement but maybe it didn’t matter. Perhaps this case demonstrates the willingness of a court to apply statutes broadly to achieve the desired result in a matter. If nothing else, In re Gregory Hall Trust provides valuable lessons on the importance of clear instructions in the trust agreement regarding what constitutes an amendment, as well as how to effectuate such an amendment. Further, the trust agreement should have clear instructions regarding what constitutes an advancement. As In re Gregory Hall Trust demonstrates, these things are too important to leave to chance.

Organ Donation at Death: Witnessing a Walk of Honor in the Hospital

Organ donation saves lives, even as the donor loses theirs. April is National Donate Life Month. It’s designed to encourage people to register to be organ donors and to talk to their families about it. But few people outside of hospital staff see the process in action.

I’ve recently been spending a lot of time in the Cardiac Intensive Care Unit of a local hospital. A friend had a heart attack, coded and was revived. This is heavy stuff, experiencing a life and death situation. Luckily my friend had done advance medical directives, estate planning and funeral planning. You definitely want to have all of those things in place when a medical crisis hits.

The Walk of Honor

While keeping vigil at the hospital, I noticed a crowd of nurses and other staffers lined up along the corridor in the ICU. What was going on?

One of the ICU patients who was not going to survive was about to be taken to have their organs harvested. The hospital personnel had gathered for a Walk of Honor. They were there to salute this person’s gift of life. I joined the silent crowd.

A team of what seemed like a dozen medical personnel wheeled the patient through the unit. The person’s ebbing life was still supported with multiple IV drips and a portable vital signs monitor. All eyes focused on the crowd moving this person to organ harvesting surgery. Silent tears welled in the eyes of many. I put my hand over my heart.

This hospital’s staff does this Walk of Honor salute with every patient who opts to donate their organs.

One Organ Donation Story

Connie Diamond received a life-saving liver transplant. During National Donate Life Month, she wanted to share her story through this letter she wrote to the family of the donor.

Dear Donor Family,

When I awoke in the intensive care unit after the transplant surgery, I remember the nurse asked me, “How do you feel?” I said, “I feel grateful,” and I cried tears of joy.

After numerous diagnostic tests, a team of transplant specialists placed me on the transplant list over a year ago. My liver deteriorated to end stage liver failure due to a non-alcoholic auto immune disease called Primary Biliary Cirrhosis. I had complications which resulted in several hospitalizations. Transplant was my only viable treatment, my only hope.

In May, I was given the green light by the transplant team to relocate to Arizona for several months to be readily available for an organ donor match. I flew out to Arizona immediately, by myself, packing a bag big enough to fill with hope, optimism, positivity, and determination. I lit prayer candles. I opened the window coverings so I could see the sunrise on a new day of hope for a donor liver. I kept my cellphone fully charged and placed it on my chest as I slept. I met some special people who had transplants and were recovering. They became my angels while I waited for “the call.”

I am a 70-year-old youthful grandma and proud adoptive, single mother of accomplished twin girls, now age 34: Lauren, a registered nurse, and Jennifer, an honor student in Chemical and Biological Engineering. I also have a precious granddaughter, Maggie, 9 years old, my swim buddy and joy of my life!

While I waited for an opportunity for a transplant, I prayed and maintained a positive attitude. I readied myself to be physically and mentally strong. A driving force that kept me holding on was my wish to be able to attend my daughter Lauren’s wedding in California. August 2, “the call” came and I knew the angels were circling. I made a miraculous recovery and was discharged in record time. Less than two weeks later, on September 10th, I walked my daughter down the aisle with her dad.

I count my blessings every day, and every day think of you and your loved one who gave me this gift of life. I once had a vibrant career and I was forced into retirement, but now I feel like I have more to do in this life, a bigger purpose, and I feel compelled to give back.

With every beat of my heart, I live in gratitude for this precious gift of life from a beautiful loving soul and family. May you have solace in knowing that your loved one’s organ saved my life.

Make Your Wishes Known

National Donate Life Month (NDLM) was established by Donate Life America and its partnering organizations in 2003. Observed in April each year, National Donate Life Month helps raise awareness about donation, encourage Americans to register as organ, eye and tissue donors, and to honor those that have saved lives through the gift of donation. 

If you decide to become an organ donor, talk to your loved ones about what it means to you to make this life-giving choice. They are going to be the ones who have the final say once you are terminal.

The Joy in Joint Trusts

Married individuals may decide to create a joint trust to address their Estate Planning needs.  Joint trusts make sense in community property states (Illinois is not a community property state) because those states consider assets accumulated during the marriage as community assets and require that both spouses have equal management rights with respect to the community assets.  Joint trusts may provide benefits in separate property states as well by eliminating the need for separate trusts for each spouse.  In a typical joint trust, each spouse decides what will happen with their respective contributive share of trust assets upon their death.  They retain control of the assets during their life, just as they would were their assets in separate trusts.  A joint trust is nothing more than two separate trusts governed by one document instead of two.  Clients often prefer joint trusts because they have familiarity with joint property.  Typically, the trust has three property schedules, one for each grantor and one for their community or joint assets.

Spouses in second marriages find these trusts useful because they allow the survivor to have continuing access to assets or wealth that the couple accumulated together while maintaining some separateness thereby allowing the spouses to split whatever remains at the second death however they like.  Of course, joint trusts for second marriages require careful drafting and consideration.  For example, naming the surviving spouse as sole trustee after the death of the first spouse could cause issues.  If the surviving spouse fails to seek competent counsel upon the death of the first spouse, that only exacerbates the issue.  Unfortunately, sometimes a surviving spouse continues to view and use all the assets of the joint trust as their own because they had unrestricted access to the assets during the life of the now-deceased spouse.  Occasionally, the surviving spouse fails to realize that, as the Trustee, they have fiduciary duties to the remainder beneficiaries and a duty to follow the terms of the trust, even if against their self-interest.

A recent Michigan case, In re James M. Kurtz Protection Trust, Docket No 360605 2003 Westlaw 2618498 (Mich Ct App Mar 23, 2023) (unpublished), highlighted some of the issues that arise in a joint trust situation when the surviving spouse lacks competent counsel or fails to retain counsel altogether.  James and Barbara Kurtz created a joint trust naming their respective children from prior marriages as equal residuary beneficiaries after the death of both of them.  The joint trust contained provisions preventing revocation or amendment by the surviving spouse after the death of the first spouse.  The joint trust also gave the surviving spouse the right to withdraw principal.  After Barbara died, however, James purported to restate the joint trust.  He eliminated the children as beneficiaries and named his newly created “protection trust” as the sole residuary beneficiary.  In his capacity as trustee, James made distributions from the joint trust to himself and then used those assets to fund the protection trust.  James named one of his sons as the sole beneficiary of the protection trust.  James died and Barbara’s children initiated a lawsuit challenging James’ actions, including his restatement of the joint trust, his withdrawals from the joint trust, and the creation of the protection trust.  The lower court invalidated the restatement, the withdrawals, and creation of the protection trust.  James’ son appealed.

The appellate court considered both the provision prohibiting amendment of the joint trust as well as the provision allowing the surviving spouse the right to withdraw principal from the trust.  The court determined that one of the main purposes of the trust was to “ensure the children of one settlor would not be posthumously disinherited following the death of that settlor” which was exactly what James did.  By removing assets from the joint trust and putting them in the protection trust, James effectively disinherited Barbara’s children, which frustrated the goal of the joint trust.  The appeals court found that although James had the right to withdraw assets from the joint trust for his own use and benefit, the withdrawals that he made were not for that purpose.  The court determined that the withdrawals that James made were solely to fund the protection trust which was improper.  The court of appeals affirmed the lower court’s rulings with respect to the restatement of the joint trust and withdrawals therefrom.   The higher court indicated that James had the power to create the protection trust, but the terms of the joint trust prohibited unfettered access to the assets thereby preventing him from using joint trust assets to fund the protection trust.

The James case highlights some of the pitfalls that may trap the unwary practitioner with respect to joint trusts and provides several important lessons.  First, even though all the assets are in the joint trust at the first death, it’s important to retain counsel to review the terms of the trust and help guide the trustee through the administration of the joint trust after the death of the first spouse.  Second, it’s vital to follow the terms of the joint trust precisely in making distributions from the trust.  Third, the joint trust need not be irrevocable upon the first death, although the contributive share attributable to the decedent spouse should be irrevocable if protecting the plan is important.  If you want to discuss whether a joint trust is right for you or want to better understand the terms of your joint trust, reach out to discuss.

The IRS’ Annual Warning: The 2023 Dirty Dozen

Each year the Internal Revenue Service (“IRS”) publishes its “Dirty Dozen” list of the most notorious tax scams from the year. The list alerts taxpayers and professionals alike of the most commonly used tax cons during the last year. The scams run the gamut from promoting taking incorrect credits to produce large refunds to misusing international accounts. Let’s dive in!

Perhaps unsurprisingly, five of the twelve scams making their way onto the Dirty Dozen focus on technology and information grabs. The first comes in the form of fake communications from individuals posing as employees of legitimate tax and financial organizations such as the IRS, state departments of revenue, or other similar organizations. Communications arrive in the form of a text, called “smishing” or an email called “phishing” and ask the taxpayer to provide personal information which allows the scammer to steal the identity of the taxpayer. The IRS always initiates contact through mail, not email or text. Tax professionals need to worry about the second of the Dirty Dozen: “spearphishing” which is a phishing attempt targeted at a specific organization. Tax professionals who have suffered a data breach find themselves at greater risk for spearfishing. A successful spearfishing attempt gives the scammer access to client data allowing the thief to file fraudulent tax returns, among other things.

The third on the list involves scammers who offer their services to create a profile for the taxpayer on IRS.gov and prepare tax returns. The online account gives access to valuable tax information about the taxpayer and requires no assistance for creation. The IRS encourages each individual taxpayer to establish their own account. Anyone with access to the account could misuse the information found in the account. Related to the fake online accounts are fake professional preparers who take the number four spot on the list. While many wonderful preparers exist, watch out for anyone who refuses to sign on the dotted line, who charges a fee based upon the amount of the refund, or who neglects to provide their IRS Preparer Tax Identification Number (“PTIN”). Taxpayers should only sign a completed return and should create an IRS account themselves.

Any list of fraudulent schemes would be incomplete without mentioning social media, which is the fifth and final of the technology-related scams. The IRS notes that social media sites circulate inaccurate and misleading information. Some of it relates to common tax documents like Form W-2, or other forms intended to be used by a small group of individuals. The schemes encourage folks to submit false, inaccurate information to secure a refund. The IRS warns that those things that sound too good to be true generally are.

Two separate tax credits make the Dirty Dozen list. The first or number six on the list relates to the Employee Retention Credit (“ERC”). Those promoting the scam encourage individuals who do not qualify for the credit to file for it anyway. The IRS has discovered radio and internet ads regarding the ERC. First, most people do not qualify for this credit and second, the scam gives ne’er-do-wells an opportunity to collect taxpayer information under the guise of a refund that the scammers know the taxpayers cannot receive. The other tax credit scam giving us number seven on the list relates to the fuel tax credit. Here again, the credit has limited application; however, unscrupulous return preparers and promoters entice taxpayers to claim the credit thereby receiving a larger refund. Unfortunately, the taxpayer doesn’t qualify for the refund and will be subject to interest and penalties once discovered. The IRS has indicated an increase in the promotion of filing for refundable credits.

Fraudulent “Offer in Compromise” (“OIC”) mills sit at number eight on the list. The IRS offers OIC to people unable to pay their tax liabilities as a way to settle their debt. They play an important role in our system and require that the taxpayers desiring to avail themselves of such settlement meet certain qualifications. Mills promoting the OIC mislead taxpayers into thinking that they have a valid OIC with the IRS when they do not which often costs the taxpayers thousands of dollars.

The IRS grouped together three separate schemes all with international implications under the “schemes with international elements” umbrella that resides in spot number nine. Of note, the first scheme under spot nine involves use of offshore accounts and digital assets. United States (U.S.) citizens should avoid placing their assets in other jurisdictions for the sole purpose of preventing the IRS from reaching their assets. The IRS has made identifying these accounts and assets a top priority for several years. The second scheme under spot nine involves U.S. taxpayers contributing to foreign individual retirement accounts to avoid payment of taxes. The taxpayer then improperly claims an exemption from U.S. income tax on gains, earnings, and distributions from the foreign account based on the tax treaty with the host country. Finally, the third scheme under spot nine is some U.S. business owners with foreign business interests claim deductions for amounts allegedly paid as “insurance” even though the arrangement lacks many of the attributes of legitimate insurance. The IRS plans to challenge the purported benefits obtained from these transactions and impose penalties. Rounding out the top ten, the IRS warns taxpayers of bogus tax avoidance strategies such as “micro-captive insurance arrangements” and “syndicated conservation easements.”

Bogus charities pose a tremendous issue, especially when a natural disaster or crisis strikes. Number eleven on the list relates to scammers that set up fake organizations to receive contributions from unsuspecting taxpayers. These scams are particularly egregious in nature because they take advantage of tragedy and people’s generosity. The individuals running the fake charities collect personal information and exploit the taxpayers further. Remember that charitable deductions count only if given to qualified tax-exempt entities recognized by the IRS when accompanied by contemporaneous written acknowledgment.

The last of the Dirty Dozen involves two separate schemes aimed at high-income taxpayers. The first involves the use of a Charitable Remainder Annuity Trust (“CRAT”). A CRAT often involves the transfer of appreciated property to the CRAT. When used incorrectly, taxpayers claim that the transfer to the CRAT provides a step-up in basis as if the property were sold. Promoters and advisors sell taxpayers on this and the subsequent elimination of ordinary income and/or capital gain on the later sale of appreciated property from the CRAT. This misapplies the rules under Internal Revenue Code Sections 72 and 664. In reality, when a CRAT sells appreciated assets, those gains flavor distributions to noncharitable beneficiaries of the CRAT. The second relates to monetized installment sales. With these transactions, scammers find taxpayers seeking to defer gains on the sale of appreciated property. For a fee they facilitate a purported monetized installment sale for the taxpayer. An intermediary purchases appreciated property from a seller in exchange for an installment note. The note typically provides for payments of interest only, with a balloon payment of principal at the end of the term. The seller receives most of the proceeds, but improperly delays the recognition of gain on the appreciated property until the final payment on the installment note, often years later.

The IRS encourages taxpayers to be wary, avoid sharing data, and to report fraudsters who promote these schemes as well as those who prepare improper returns. Taxpayers need to protect their sensitive information and exercise caution and common sense both during tax time and throughout the year. Some of the scams listed in this article have been around for a time while others are new to the list this year. The Dirty Dozen serves as a good reminder to protect confidential information and to stay safe out there.

How Tax and Non-Tax Considerations Impact Estate Planning- Part II

When most folks think about Estate Planning, they focus on who gets what along with who distributes what. In some cases, clients consider their taxes, but that often occurs only when their estate will exceed the Applicable Exclusion Amount (currently $12.92 million in 2023). Comprehensive Estate Planning focuses on the foregoing but encompasses much more. The first part of this two-part series explored the various tax considerations and the impact of state law on Estate Planning. This second part will focus on the non-tax aspects of Estate Planning.

A Revocable Trusts creates the foundation for an Estate Plan by providing numerous benefits. Revocable Trusts allow the grantor of the trust to maintain control of their assets while alive and provide privacy after death. To understand how that works, it’s important to understand what happens in the absence of a Revocable Trust. Normally, a Will determines the distribution of your assets upon your death and allows you to select an individual or company to make the disbursements. Nearly everyone understands this aspect of Estate Planning. The Will also allows for nomination of a guardian to care for minor children. If you do not have a Will, then your state’s intestacy laws will govern distribution of your assets at your death. There’s no guarantee that the state’s distribution pattern matches yours. Further, state intestacy laws may appoint a stranger to handle these important tasks. Finally, a court proceeding will determine who will care for your minor children. Again, without your input, the court may select someone whom you would not want caring for your children. It’s easy to see how a Will or intestacy laws lack flexibility and fail to meet certain needs.

Regardless of whether you have a Will or your state’s intestacy laws determine property division and distribution of your assets upon your death, the individual in charge must petition the court for permission to transact the business of your estate through a probate proceeding. Depending upon the laws of your state, probate can be a lengthy, costly, and public process. If you want to avoid probate and maintain your privacy, a Revocable Trust serves as a Will substitute and provides the opportunity for you to do that. With a Trust, you transfer the assets to the Trust during your lifetime and manage them as the Trustee. You avoid probate altogether by using a Trust because the Trust doesn’t die, only the individual dies. The Trust contains provisions regarding what happens upon the individual’s death and vests a successor Trustee with the power to make distributions from the Trust without court oversight. The Trust also protects against incapacity by giving a successor Trustee the power to make distributions from the Trust for your benefit should you become incapacitated. Due to cases of fraud, institutions more readily recognize a successor Trustee acting on your behalf than an agent under your Property Power of Attorney. Thus, a Revocable Trust provides several great non-tax benefits to individuals desiring to have privacy and continuity in their Estate Plan.

In addition to the above benefits, using a Revocable Trust provides a way to protect your beneficiaries. Certain types of beneficiaries, for example, minors, those with special needs, or who have creditor issues require assistance in receiving and managing an inheritance. Consider the individual who plans to rely upon state intestacy laws for distribution of their estate. Those laws make no exceptions based on the type of beneficiary receiving the assets. This means that a minor, special needs beneficiary, or spendthrift could end up receiving funds outright. Outright distribution could have disastrous consequences for any special needs beneficiary by making them ineligible for the benefits that they were receiving. Outright distribution causes issues for a minor child by requiring a guardianship for such child to receive the assets. A spendthrift will squander any funds left outright. As mentioned above, the distribution pattern may or may not match your intended plan of distribution. Creating a comprehensive Estate Plan, consisting of a Revocable Trust, Will, Property Power of Attorney, Health Care Power of Attorney, Living Will, and a Health Insurance Portability and Accountability Act (“HIPAA”) Authorization avoids these consequences and gives the individual the ability to account for their own specific circumstances, be it a desire for privacy, protecting a particular beneficiary, or planning for incapacity.

Revocable Trusts also protect blended families. If either spouse has children from a prior marriage, establishing a trust allows that spouse to make distributions to those children on their death and/or create a trust for the surviving spouse that will be distributed to the children from the prior marriage upon the surviving spouse’s death. None of this is possible through the laws of intestacy. Finally, Revocable Trusts often contain provisions that help account for changes in circumstances through the inclusion of Trust Protector language. A Trust Protector may exercise certain powers to amend or change the Revocable Trust when the situation warrants it. For example, if tax consequences changed drastically and operating the trust as originally intended would be economically inefficient or cause undesired tax consequences, the Trust Protector can amend the Trust to provide a better result for the beneficiaries.

Estate Planning involves more than just who gets what when and who gives it to whom. It requires consideration of taxes applicable to an individual during life and to that individual’s estate at death. It also requires understanding the nature and character of assets in that individual’s estate as well as state law governing the title and disposition of assets. Finally, several non-tax considerations impact the shape of the plan as well. Privacy, continuity, and protection for certain beneficiaries, including those with special needs, minors, and spendthrifts all influence the plan. A comprehensive Estate Plan takes shape during life and grows and evolves as do your needs. I can help demystify these confusing concepts and guide you to a plan that accomplishes your goals in a tax-efficient manner.

How Tax and Non-Tax Considerations Impact Estate Planning- Part I

When most folks think about Estate Planning, they focus on who gets what along with who distributes what. In cases in which an individual’s estate is not expected to exceed the Applicable Exclusion Amount, currently $12.92 million, taxes may simply be an afterthought. Comprehensive Estate Planning, though, encompasses much more than the foregoing. This is the first part in a two-part series that explores the various considerations, both tax and non-tax, for Estate Planning. When focusing on the tax aspects of Estate Planning, one considers the income, gift, and estate tax at both the federal and state level. At the federal level, we have a unified estate and gift tax system applicable to everyone. At the state level, taxes vary widely. Some states may impose estate, gift, inheritance, or income taxes. States diverge in the type of property they recognize and their property and sales tax rates as well, all of which should impact the planning undertaken.

If you live in a state that imposes an income tax, it’s important to understand what types of income your state taxes. Individuals at or nearing retirement prefer states that exclude Social Security benefits from taxation and that provide exemptions for other common forms of retirement income, such as private pensions or Individual Retirement Accounts (“IRAs”). These states generally have lower property and sales taxes that allow their residents to make the most of every dollar, which has become increasingly important as interest rates and food costs continue to rise.

Eight states, including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming do not impose a state income tax. This protects a resident’s income from diminishment because of state income tax liabilities. Of those eight states, Florida, Nevada, Tennessee, and Wyoming impose neither an estate tax nor an inheritance tax. Nevada provides another advantage with a median property tax rate of just over $572 per $100,000 of home value. Unfortunately, Nevada has a combined state and local sales tax rate of 8.23%. Wyoming provides both a low combined state and local sales tax rate (5.22%) and a median property tax rate of $605 per $100,000 of home value.

Arizona, Alabama, Colorado, and South Carolina impose a state income tax, but none impose an estate or inheritance tax. Arizona, Alabama, and South Carolina all exempt Social Security benefits from state income taxes. Colorado exempts Social Security benefits from taxation at the state level if the retiree has attained the age of 65. South Carolina allows taxpayers aged 65 and over to exclude up to $10,000 of retirement income versus $3,000 for those under the age of 65. South Carolina also allows seniors to deduct $15,000 of other taxable income as well. Colorado’s combined state and local sales tax rate comes in at 7.77% and its median property tax rate is $505 per $100,000 of home value. South Carolina bests Colorado slightly with a combined state and local sales tax rate of 7.44% but has a slightly higher median property tax rate of $566 per $100,000 of home value. Alabama taxes IRA and 401(k) distributions but offsets that with a lower median property tax rate than nearly any other state in the nation at $406 per $100,000 of home value. Its average combined state and local sales tax rate is a bit high at 9.24%, but it allows anyone over the age of 65 to exempt the state portion of property taxes and allows lower-income residents an exemption from all property taxes on their principal residence.

Most states impose a tax on capital gains ranging between 2.9% in North Dakota to 13.3% in California. Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, and Wyoming do not tax capital gains. Of the states on the list that do not impose a tax on capital gains, New Hampshire stands alone in imposing a state income tax. Although it does not impose a state income tax, Washington recently passed legislation imposing a tax on capital gains at a rate of 7%. The legislation included a $250,000 standard deduction.

In addition to considering the potential estate, gift, inheritance, income, sales, and property taxes imposed by a state, individuals need to consider the types of ownership acknowledged in their state. For example, Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin all have community property. In addition, Alaska, Florida, Kentucky, South Dakota, and Tennessee allow their residents to elect into community property status for property held in a community property trust. In general terms, community property states consider the fruits of the labor of either spouse to belong to the community of their marriage, requiring equal access to the assets by both spouses. Community property provides a significant tax advantage by allowing a step-up in basis for all of the community property at the death of the first spouse, rather than just the decedent spouse’s assets, as would be the case in separate property or common law states. Community property states impose no restrictions on the distribution of the decedent spouse’s share of the community property, unlike separate property states.

While common law states do not permit residents to create community property, they provide other protections to a surviving spouse not found in community property states in the form of elective share rights. Typically, the surviving spouse may elect against the will of the predeceasing spouse to receive an intestate share of the estate. This amount depends upon many factors but often ends up around 1/3 of the “estate.” In some common law states, the spouse may elect against an augmented estate, which includes non-probate assets such as those found in a revocable trust. In other states, the survivor may only elect against the probate estate.

About one-half of the separate property states recognize “tenancy-by-the-entirety” or “TBE.” TBE requires unity of the interests of time, title, interest, possession, and marriage. Illinois, Indiana, Kentucky, Michigan, New York, North Carolina, and Oregon recognize TBE ownership for only real property. Alaska, Arkansas, Delaware, Florida, Hawaii, Maryland, Massachusetts, Mississippi, Missouri, New Jersey, Oklahoma, Pennsylvania, Rhode Island, Tennessee, Vermont, Virginia, and Wyoming all extend it to personal property as well. TBE property requires both spouses to encumber or sell the property and provides certain creditor protection if the creditor is only a creditor of one spouse. Understanding the protections and limitations of TBE ownership helps shape an estate plan in the separate property states that recognize that type of ownership.

As this article makes clear, Estate Planning involves more than just who gets what when and who gives it to whom. It requires consideration of taxes applicable to an individual during life and to that individual’s estate at death. It also requires understanding the nature and character of assets in that individual’s estate as well as state law governing the title and disposition of assets.

Funeral Contracts Should be Avoided

In an effort to make things easier for their loved ones, people sometimes enter into prepaid funeral contracts. The idea is that you pay for all of your own funeral and burial or cremation expenses in advance. When you pass away, your family notifies the service and the service handles everything.

When you enter into the contract you will have the opportunity to make specific choices with regard to the details of your funeral and burial or cremation. The service is legally compelled to deliver in accordance with the terms of the contract.

A Closer Look
This may sound like a simple solution on the surface. However, there are significant problems with these prepaid funeral contracts. For one thing, there are companies with unscrupulous intentions. These services are required by law to place payments into trusts or insurance policies. This doesn’t always happen. When the assets remain in hand, the people behind the service can abscond when the time is right.

Short of flat-out robbery, prepaid funeral services can take advantage of clients in other ways. Shortchanging would be one of them. For example, you could pay for a casket of a certain quality in advance. A far inferior product could ultimately be delivered. Or, you may pay for a certain number of limousines of a particular size. An entirely different assemblage of vehicles may arrive. Floral arrangements may come up short of the mark, and other shortcuts may be taken.

If you were to enter into a prepaid funeral contract in one area of the country and die elsewhere, you may ultimately receive nothing for your money. The contract could be tied to services provided by specific local entities.

Avoid the Middle Man
When you enter into a prepaid funeral contract you are paying someone to make arrangements that could be made directly. As a result, you are paying more for the actual products and services because the intermediary must make a profit. This is why prepaid funeral services exist. Because of the middle man you are overpaying from the start. You are also surrendering the opportunity to earn interest on the money that you have set aside for your final arrangements.

Viable Alternative
Instead of entering into a prepaid funeral contract, you could place adequate resources into a payable-on-death account. You name a trusted heir as the beneficiary. All of your heirs should be aware of this arrangement. After you pass away, the beneficiary assumes ownership of the resources in the account. Probate is not a factor, so the assets are immediately available to cover your final expenses. If you discuss your preferences with your beneficiary in advance, he or she will carry out your specific wishes when the time comes.

If you go this route there will be no surprises. Everything will go according to plan as you leave behind a turnkey, risk-free postmortem situation.