Portable Estate Tax Exclusions

One new concept in the 2010 Tax Act is in Section 303 of the Act which specifies that when a spouse dies the surviving spouse can elect to carry over to his or her estate the unused unified credit. Thus if H dies with a $5 Million estate and leaves it all to the wife, the Executor can elect to have it apply to her estate when she dies. But there is a curve ball in here. The act uses the term, “last such deceased spouse of such surviving spouse”. Let’s say that spouse one died and had $4 Million left over and then surviving spouse remarries. Spouse Two dies leaving a $5 Million estate to Spouse two’s children. Suddenly surviving spouse has no portability of that $5 Million. Thus, her estate loses that. And we don’t know the effect if spouse one dies in 2011 or 2012 and then the surviving spouse dies in 2013 with a $1 Million exclusion.

When Homes are a Home

Phil Driscoll owns two homes. One in Cleveland Tennessee and a lake home outside of Cleveland Tennessee. Phil Driscoll is an ordained gospel minister. Phil Driscoll Ministries paid for both homes and it was excluded from his income under the Pastor’s Housing allowance under Section 107 of the Internal Revenue Code of 1986. The IRS felt that to be a bit greedy and assessed him with additional income and fraud penalties. Rev. Driscoll took the IRS to tax Court. The IRS argued that the use of the word “home” in Section 107 refers only to one home. Rev. Driscoll countered that in Section 7701(m) the Code provides that singular may include plural. Further, the legislative history did not forbid that interpretation. For those reasons the Tax Court ruled in Driscoll, et ux v. Commissioner, 135 TC 27 (2010) that both houses were homes for the purposes of Section 107 and both could be excluded from income. It was a split and narrow decision, but one that shows two things: (1) The IRS Code does by its own design create issues such as this and (2) That statutory language brings in Legislative History when Courts attempt to resolve these types of issues. This case is a big win for Pastors, but more importantly, it makes very clear another point, that when faced with a case where the IRS is taking a narrow reading of the law, one needs to look at the entirety of the Code to see if there is definitional assistance elsewhere and look to the Legislative History to make sure you have either neutral support or positive support from that history.

To Gift or Not to Gift that is the Question

With the reunification of gift and estate tax tables starting in 2011, it might be worthwhile to make gifts at the new $5 Million levels before Congress reduces it. With gift splitting, this means that a married couple could give up to $10 Million to the next generations. The issues: (1) What if they lower the exclusion rate after 2012 to say $2.5 Million and the couple dies in say 2013. Does that mean that the $5 Million already given away is now subject to estate taxes? Under the strict language of the Code that’s a possible conclusion. But what if Mom and Pop’s assets are below the amount of the Tax can the IRS go after the assets given away? That’s more complicated. That goes into the issue of transferee liability. If you receive something subject to a transfer tax and that tax isn’t paid, normally the tax follows the asset. But in this case, the gift tax was paid by the unified credit exclusion and just because that exclusion changed does not make that asset a transferred asset in my view. However, it is something to be concerned about. As we near the end of 2012, it may very well be good to go ahead and make gifts. (2) Liquidity. Ma and Pa may want to limit gifts to ensure liquidity to them. And the only gifts that will work are outright gifts without any retained ownership of them. (You can make gifts in trust for other people, just not yourself-if you did, keep the beneficial interest it would trigger an estate tax on your death). So, folks need to plan what their needs will be long term before such a gift. (3) Vermont residents may be some gift tax issues. So, check with your local attorneys to be sure that you are not running afoul of a state gift tax liability.

The $5 Million Estate Tax Exemption

Beware, the $5 Million exemption is Federal only. You need to look at your state laws to see if there is a State Estate tax and what the exemption amount is. Many states decoupled from the Federal Estate tax. So, let’s say pops dies in 2011 owning $10 Million in property. He leaves it all in a credit shelter trust. Let’s assume that he lives in a state with a State Estate Tax, he’s going to be subject to that tax (perhaps as much as 20% in some states) on $4 Million. With the new Act allowing the wife to tack on the Husband’s Federal Estate Tax exemption, it is better to make the Family Trust limit be the $1 Million amount with the rest being put in a qualified terminable interest trust (QTIP) for Moms. That way when Mom dies, it she can add together the exemptions and delay the estate tax in the estate. Many states do not have a gift tax, so if Mom and Dad are willing to make huge gifts in 2011 and 2012, and trust their kids (a huge assumption), this could be a strategy especially early in 2011 before such laws are enacted to close that “loophole”.