For Clients, Community, Advisers.  President Obama’s 2013 budget gives us some insight concerning what might happen if he is reelected and his 2013 budget (or any of its broad concepts) are adopted.

• LIFETIME EXCLUSION FROM ESTATE TAX:  The law would essentially revert to that which was in place in 2009.  That is, the current Republican endorsed $5.12 million exemption which is in force in 2012 would become $3,500,000 per individual ($7,000,000 per couple).  The estate tax on amounts over $3,500,000 would be 45% instead of 35%.  Of course, if Congress does nothing before January 1, 2013, the exemption will become $1 million and the rate will be 55%.
• TARGET:  GRANTOR TRUSTS.  For many years, irrevocable grantor trusts have been used as a sophisticated estate planning technique to reduce the size of an individual’s estate while avoiding income tax.   It’s a “have your cake and eat it, too” type of transaction.  These trusts come in all sizes and flavors.  They are often used to pass a business interest to another generation without payment of income and deferral of estate tax.  The administration’s proposal eliminates the key benefits of grantor trust transactions.  These have been around for many years.  They have been an important tool in our toolbox.  The administration seeks to take away this key tool.
• QUALIFIED GRANTOR ANNUITY TRUST:  Sam Walton made the GRAT famous.  He transferred billions of dollars of Wal-Mart stock to his family at very little transfer tax cost.  Describing how a GRAT works is beyond the scope of this brief article.  The proposed legislation prohibits the “zero’d out” GRAT which is the tool that Walton used.  It is an important technique for transferring property that increases in value over a short time to others.  It keeps the growth in value outside the donor’s estate.  The administration has been after this technique since Obama came in to office.
• VALUATION DISCOUNTS.  To value property for gift or estate tax, an appraiser will take into account its marketability and whether or not the interest transferred is that of a majority interest or that of a minority interest.  If the interest or parcel has limited marketability, a marketability discount of 5-25% can be applied.  If a minority interest is transferred (such as a minority interest in a business), a minority interest discount of 5-35% can be applied.  It is not uncommon for us to see combined discounts of 35% to 45%.  Over the years, some taxpayers have become very aggressive.  As a result, the IRS has also become aggressive in challenging discounts.  Here, the administration seeks to cut back the discounts.  However, the 2013 budget does not specify exactly how they seek to do this.

There are a few additional points which are somewhat esoteric and beyond the scope of what I believe clients and advisers want to read in a short article.  The administration also seeks to cut back the use of dynasty trusts and the use of trusts which length exceed the traditional rule against perpetuities.

In 2012, it’s anyone’s guess as what is going to happen in the political area.  As a result no one can predict what, if anything, will be passed and signed when it comes to the estate tax and gift tax.  This area has been a political football since before George Bush left office.  My only prediction is that it will continue to be.  As a result, as lawyers and planners, we need to be proactive on our clients’ behalf.  And our clients need to be diligent in ensuring that their plans are reviewed on a continuing basis and are up-to-date.

Are Living Trusts Created Just For Tax Benefits?

For Professional Advisors.  Lawyers and advisors around the country are getting some push back from their clients when they recommend Revocable Living Trusts (RLT). The issue seems to be that their clients perceive RLTs to only be good as tax planning tools.

With the federal estate tax exemption currently set at $5 million per individual and $10 million per married couple, some perceive a reduced need for such trusts.

But there are many important benefits to the RLT beyond tax protection.

Keeps You in Control

With a properly drafted RLT, a client can not only control who inherits his assets, but also how those assets are disbursed and under what circumstances.

The Grantor (your client) can set up rules or stipulations in the trust that must be met before assets are inherited by beneficiaries. The Trustee, chosen by your client, manages those assets according to your client’s wishes.

Some clients want the Trustee to have a lot of control, particularly when beneficiaries are minors or are financially inexperienced.  Others want the Trustee to exercise less control, particularly when the beneficiaries are mature adults.  We encourage our clients to keep beneficiary assets in trust for Protection and Privacy.

Protection and Privacy

Even properly drafted, a simple Will is essentially no more than a letter to a probate court judge. It informs the judge of the decedent’s wishes about what he or she wanted done with personal property and other assets, but the court can rule differently.

Court hearings and documents filed in a probate case are public record, meaning that if all your client had was a Will, then his personal worth and any records of family infighting over the estate could make the headlines. An RLT is executed outside of a probate court’s venue, keeping the entire matter private and out of public view.

After death, the RLT continues to offer protection to the client’s heirs. If left in the name of trust, assets are shielded from the beneficiaries’ creditors, lawsuits and divorce settlements. It also helps protect your client’s children from “accidental” disinheritance when a surviving spouse remarries.

Reduction in Stress

Probate can last many months to several years, depending on the size and complexity of your client’s estate. Administering a trust can often take less than a year.

Ask your clients how much grief and anxiety they are willing to let their heirs endure after their death due to poor planning. An RLT can dramatically reduce the wait time for an estate to be settled, allowing beneficiaries to move forward with their lives much sooner and receive the assets your client wanted them to enjoy and benefit from.

Have you experienced push back from a client when you propose a revocable trust?  Please let me know by post a comment.

Revocable Living Trusts are flexible tools. If you think you have a client that may need one as part of his or her plan, we would be delighted to talk to both of you about its benefits.

In recent years, have you made a gift of real estate to your children or grandchildren or, for that matter, anyone? If you have, you need to read this article.

The Law.  Transfer of real estate (or anything of value) from one person (donor) to another (donee) for less than fair market value is considered a gift for gift tax purposes. This is considered a separate tax system from our income tax system. Any gift in excess of $13,000 per year (per donee) must be reported to the IRS on a gift tax return (Form 709). From 2001 until 2011, the lifetime gift tax exemption was $1 million.  Beginning in 2012, every individual has a lifetime gift tax exemption of $5 million. So, gifts of less the $5 million will be tax-free!  (The value of the gift is based on the date of the gift not the date the return is filed). 

The IRS Program.  The Internal Revenue Service (IRS) has discovered that many gifts of real estate have gone unreported to the IRS.  This is potentially a loss of significant revenue for the IRS.  As a result, the IRS has initiated a project where they are reviewing real estate transactions in large metropolitan areas against gift tax returns filed.  This can be an innocent trap for an unknowing family.  Unfortunately, the IRS will not reduce taxes, penalties and interest for taxpayers who claim ignorance of (an admittedly little known and less understood) law.  Further, and most importantly, if the taxpayer files the back returns before the IRS catches up to them, serious penalties and problems can be avoided (though not necessarily entirely).  This is not a time or place to bury one’s head in the sand or play the audit lottery!

Take Action.  If you made a gift of real estate at any time in the past (or an interest in a land trust or any significant gift of any type of property at all) and the gift was not reported to the IRS on Form 709, you need to consult with a knowledgable estate and gift tax attorney to ascertain: whether or not you have to file, what if anything you have to do, and what, if any, are the potential consequences.  There is no statute of limitations.  Failure to file a gift tax return could affect your heirs significantly upon your death.  As a result, this is a subject that requires immediate attention.

A gift tax return can be filed at any time.  There may or, in many cases, may not be tax due.  The IRS has three years to audit the return once appropriately filed.  Otherwise, if it is filed in accordance with various IRS rulings concerning appropriate valuation, appraisal and disclosure, the values on the return are deemed accepted by the IRS.  Thus, the return needs to be filed by an experienced estate and gift tax attorney.

If you have made a gift – particularly of a real estate interest – and have not reported it to the IRS, pick up the phone and get advice about what to do – now.

For Clients, Advisors and Community. 

Senate Bill 0397 was passed on December 16, 2011 as Public Law 97-0636.  It provides mostly for technical changes in the Illinois Income Tax Law.  At the end of the legislation it provides for an increase in the lifetime exclusion from the Illinois Estate Tax.

For individuals dying prior to 2012, the lifetime exclusion from the Illinois Estate Tax was $2,000,000.  Thus, a couple could shelter $4,000,000 from the tax.

The change in the Illinois Estate Tax Exemption is recited on the last two pages of a 292 page statute.  It provides that for individuals dying in 2012, the lifetime exclusion from the estate tax will be increased to $3,500,000 and will be increased to $4,000,000 for individuals dying on or after January 1, 2013.  Thus, for this year, a couple can shelter $7,000,000 from the Illinois Estate Tax.  (For reference purposes, for this year, each individual can shelter $5,000,000 from the Federal estate tax or $10,000,000 per couple).  The fact that the Federal and state exemption limits are different is known as “decoupling”.

The legislation did not change the rates on the estate tax which range from 8% to 16%.

I am surprised that the General Assembly and the Governor have taken this step given the state’s precarious financial condition.  Once would think that they would be looking for every revenue source they could.

I just returned from attending the University of Miami Law School’s Heckerling Institute on Estate Planning.  Two themes were dominant in the presentations and workshops.  The first is that the laws and regulations which govern most estate plans today are quite volatile and require regular attention and review.  Hence, regular review of the estate plan is required.

Second, it is noteworthy that there is no gift tax in Illinois.  Thus, a lifetime gift of property completely removes the property from the estate tax base for state estate tax purposes.  This gives me the opportunity to remind  our readers that there is an 11 month opportunity to make substantial gifts (up to $5,000,000) and completely avoid the estate tax (both state and Federal).  Without action from Congress (in an election year!), the window will close on December 31, 2012.  If you have thought of transferring a business interest or other large interest to your children, don’t wait.

For Clients, Advisors and Community

Our society is increasingly mobile.  Many of our clients have multiple residences.  They spent the spring and summer months in the Chicago area but spend the late fall and winter in warmer climates – Florida, Arizona, California, Hawaii and other locations.

In a sometimes desperate chase for increased revenue, Illinois (and other states) have recently passed often significantly increased taxes on income and on estates of decedents.  Many of these states have also passed increased taxes on business and have developed climates unfriendly to business.  I hear often from my Illinois clients that they want to relocate to escape the high taxation in this state and move or retire to states with lower taxes like Florida and Wyoming.  Many are of the belief that you can change your domicile and therefore the jurisdiction in which you are taxed by spending the majority of time and simply getting a drivers’ license and registering to vote in a new state.

It’s not that simple.  Each state has its own rules for determining whether an individual is subject to income or estate tax in a given state.  And, the determination can be different for husband and for wife! 

There are basically two approaches to this question. Illinois and California and a few other states have adopted an approach that states that a resident is one who is in the state for other than a temporary or transitory purpose during the tax year or whose domiciled in the state but absent from the state for a temporary or transitory purpose during the year.

In order to make a determination these states look at various factors which may include the amount of time spent in another states versus the amount of time spent in Illinois; the location of the spouse and children; the location of the principal residence; the state that issued a driver’s license; the state of voter registration; state where professional licenses are; location of banks; location of medical, legal and accounting professionals and state where social ties and/or permanent work assignments.

New York and other states take a different approach.  There are two prongs to the New York test.  The first asks if the individual is domiciled in New York.  Domicile is subject to a “five factors” test.  They are:  home, active business involvement, time, near and dear items and family.  Time is probably the most important element.  But, there is also an alternate “residency” test to be passed as well.  An individual is taxed in New York if he or she maintains a permanent place of abode in New York and spends more than 183 part or full days there during a taxable year.

As one can readily  see, these tests can be very subjective. If you’re planning to flee the jurisdiction to reduce your tax bill, be sure you do it the right way and consult an expert who is familiar with the particular rules involved.

For Clients, Advisors & Community

In an earlier article, I discussed what a civil union is and how Illinois law affects spouses in a civil union under the new law.

There is a major disconnect, however between the Illinois civil union law and Federal law.  Illinois recognizes civil unions.  Because of the Defense of Marriage Act (DOMA) (defining marriage as a union between a male husband and a female wife only), Federal law does not generally recognize the civil  union.  (There is currently extensive litigation concerning DOMA.  It might or might not be struck down by the Supreme Court.   The Obama administration has taken the position that it will no longer defend DOMA.  For purposes of this article, we  assume that DOMA is still the law of the land.)

Income Tax:  A couple whose union in registered under Illinois’ civil union law should be able to file a joint income tax return, at least in Illinois.  However, that’s not the case.  No joint filing is allowed for unmarried couples under Federal law for filing Form 1040.  The Illinois tax is based on the adjusted gross income of the Federal 1040. So, there is no benefit to a civil union for individual income tax purposes.

Estate Tax: In the eyes of the Federal law, a couple united under Illinois’ civil union law is not married.  So, they cannot take advantage of the unlimited marital deduction that allows a spouse to leave upon his or her death, an unlimited amount of money to the surviving spouse, free of estate tax.  This would allow deferral of any estate tax to the death of the second spouse to die.  (I should comment, however, that for 2011 and 2012, at least, this affects only individuals whose gross estates exceed  $5,000,000).   As a result, spouses of a civil union have the risk of paying estate tax at the first to die where this would not be the case if they had a traditional marriage.  This is a very big deal because it will cost tax money at the death of the first partner to die and could cause significant reduction in the inheritance available to the survivor!

Gift Tax: The same is true with the gift tax.  Each spouse may make an unlimited amount of  gifts to his or her spouse during his or her lifetime.  Since Federal law does not recognize the  spouse under an Illinois civil union, there is no unlimited gift tax marital deduction.  (Again the same comment regarding the $5,000,000 lifetime exemption applies).

Qualified Pre-Retirement Survivor Annuity (QPSA): Many retirement plans require that the automatic beneficiary of the employee’s retirement plan account is the “spouse”.   This law was designed to protect spouses.  Many plans also require that if the employee names a beneficiary other  than the spouse, written spousal consent is required.  This is a Federal law.  Although there has been no firm guidance,  most practitioners think that the QPSA will NOT apply to an employee who has entered into a civil union.  Hence, it  is very important that the employee have a carefully drafted beneficiary designation which makes his or her intentions known concerning the beneficiary of his or her retirement plan benefits.

Social Security Benefits: Here is an area where an anomalous result will be most interesting to seniors.  Once again, Federal law does not, at the present time, recognize Illinois civil unions.   These aspects of the law can bring about an interesting result.  An example explains it:

Art was married to Beverly.  Art died at age 70.  Beverly continues to receive the survivor portion of his social security benefits.  Two years later, Beverly meets Charlie, a widower age 73.  They are thinking about moving in together and getting married.  Beverly knows that if she marries Charlie, she will lose about $1,500 per month in the survivor benefits she is receiving from social security.  However, after consulting us, Beverly and Charlie realize that if they enter into a civil union (where they get most of the benefits under Illinois law), Beverly will continue to receive the survivorship social security benefits from her deceased spouse because Federal law does not recognize the Illinois civil union as a “marriage”.  The difference in  planning could be significant!  Here, the couple is far better financially by choosing the civil union route.

There are many different considerations in choosing a civil union as opposed to a traditional marriage.  Sometimes the results can be surprising.  Couples contemplating a civil union need counsel so that they fully understand the consequences of their actions before taking that big step.

For Clients, Business Owners and Professional Advisors

I conducted my annual estate planning seminar for financial professionals yesterday.  There was some discussion about Illinois’ dirty little secret. It’s called the Illinois estate tax. It may affect you and your family.

Take a minute and do a quick calculation. Total up the value of:

• Your interest in your home
• Your life insurance policies (the death benefit)
• Your retirement plan accounts
• Your other investments and Illinois based

How much is the total? If it’s more than $2,000,000, then your estate will be subject to the Illinois estate tax! The tax is 8% at $2,000,000 and rises to 16% over $10,000,000. Many individuals are surprised to learn that their families might be subject to this tax.

Illinois has chosen to “decouple” from the Federal tax scheme which – at least for the next two years – grants a $5,000,000 exemption per person from the Federal  estate, gift and generation transfer tax. 

There are legitimate ways of  avoiding the Illinois estate tax for married couples. However, it may require planning separate and apart from the Federal estate tax.

This is an important topic that is part of a thorough estate plan review.  Many families have wills and trusts that may be outdated or that have not addressed Illinois’ “Dirty Little Secret”.  They should be reviewed at an early date.