While it is not unusual for family members to fight over a deceased relative’s estate, it is rare to see a will contest result in a criminal prosecution. But that is exactly what has played-out this summer in a Manhattan courtroom as Anthony Marshall and his attorney, Francis Morrissey, are being tried for defrauding the estate of Marshall’s mother, socialite Brooke Astor, out of millions of dollars that prosecutors say Mrs. Astor had intended to go to numerous charities.
Mrs. Astor, who died in 2007 at age 105, was diagnosed with Alzheimer’s disease in 2000. Known as “the First Lady of Philanthropy,” Mrs. Astor had executed numerous wills over the years designating a significant portion of her estimated $187 million estate to go to a charitable trust. Marshall, her only child, was slated to receive in excess of $20 million.
Prosecutors allege, however, that Marshall decided that sum was insufficient to support his and his wife’s extravagant lifestyle. So, in early 2004 – and notwithstanding that his then 102 year-old mother had been suffering with Alzheimer’s for at least four years -- Marshall brought in a new attorney to draft a “Codicil” (e.g. an amendment) to Mrs. Astor’s will. The attorney (a well-known Manhattan trusts and estates attorney) drafted the Codicil without having met Mrs. Astor, and met with her for only about 15 minutes during the will execution ceremony. Nonetheless the attorney (who allegedly pocketed $1.7 million in legal fees) testified that Mrs. Astor was in fact competent to sign the will at that time, notwithstanding her advanced age and her prior Alzheimer’s diagnosis.
Regardless whether this case results in any convictions, the tawdry affair has been a boon to the tabloids, but an embarrassment to Mrs. Astor’s family and many of the professional advisers who participated in the events in question. The attorney who drafted her final will in 2004 has been criticized for apparently giving little consideration to Mrs. Astor’s obviously deteriorated mental condition and advanced age. Given that he was brought to the scene by a beneficiary who stood to gain millions from the change in the will, the attorney had a duty to conduct sufficient due diligence to determine Mrs. Astor’s capacity to sign a new will. It seems especially damaging to the attorney’s credibility that he stood to earn almost $2 million for his work on what appears to have been a fairly simple Codicil to the will.
Despite her millions, Mrs. Astor does not appear to have been well-served by her advisers. The current criminal case, as well as the previously well-publicized guardianship dispute between her son and grandson, revolves around Mrs. Astor’s mental competency and her ability to manage her affairs. Imagine that instead of relying upon a will-based estate plan that while she was in her 70’s or 80’s – and when there was no question regarding Mrs. Astor’s competency -- Mrs. Astor had executed a living trust agreement that included a “Disability Panel” designated to determine her mental capacity on an ongoing basis. The Disability Panel would have likely included her personal physician, her son, and one or more other close friends or relatives. As Mrs. Astor’s Alzheimer’s became more acute, the Disability Panel would have sprung into action to shift legal control of Mrs. Astor’s affairs from herself to her personally-designated successor Trustees. Once the panel had declared her “disabled” – which almost certainly would have occurred prior to the 2004 Codicil – it would have been virtually impossible for Mrs. Astor’s son to enrich himself by arranging for Mrs. Astor to modify her estate plan as provided by the 2004 Codicil.
You certainly don’t need Mrs. Astor’s millions to design an effective estate plan that incorporates comprehensive disability planning as well as death planning. But, you do need to work with an attorney who is as focused on planning for lifetime disability issues as on death planning.
Monday, October 5, 2009
Friday, September 11, 2009
New York's New Power of Attorney -- A Radical Change
On January 27, 2009, Governor Patterson signed into law a bill that radically overhauled the traditional New York “short form” statutory Power of Attorney (“POA”). The law, which went into effect on September 1, 2009, requires greater formality for signing the new POA than was required under the prior statute.
Some of the changes incorporated in the new statute include:
• A requirement that the designated agent or agents execute an acknowledgment of appointment that is contained within the POA in the presence of a Notary Public. The agent’s need not sign the POA at the same time that the principal signs, but the POA will not be deemed valid, and therefore cannot be used, until the agent has duly executed the acknowledgement.
• A requirement that the POA include a written notice to the agent explaining the scope of the agent’s fiduciary responsibilities. The POA also includes a warning to the agent that the agent may be liable for a breach of his or her fiduciary responsibilities.
• To limit perceived abuses by agents in making gifts of the principal’s assets to themselves or third persons under the prior statutory form, the new law requires that in any circumstance where the principal wishes to authorize an agent to make gifts of the principal’s assets, in addition to signing the new POA form, the principal must execute an optional document called the “Statutory Major Gifts Rider” (“SMGR”). The principal will need to carefully review the SMGR to determine which types of gifting authority, if any, that the principal wishes give the agent. In order for the agent to have each type of gifting authority, the principal must initial the corresponding section. For example, the principal must specifically initial a provision authorizing an agent to change beneficiary designations for life insurance policies and retirement plans if the principal desires that the agent have such authority. In addition, the principal must sign the SMGR, and his or her signature must be notarized and witnessed by two people not appointed as an agent.
• An optional provision for designation of a “monitor” to oversee the agent’s actions.
• Authorization to provide “reasonable compensation” to the agent for his or her services.
• Specific directions for revoking the POA.
• Expansion of the class of “financial institutions” that are required to accept the POA absent “reasonable cause.” Previously, the term “financial institutions” was limited to banks, but it now includes securities brokers, securities dealers, securities firms and insurance companies.
Many concerns remain among attorneys regarding how the new form will work in practice, and whether the new POAs will be readily accepted by financial institutions. As events unfold, we will keep readers informed regarding the effectiveness of the new POA
Some of the changes incorporated in the new statute include:
• A requirement that the designated agent or agents execute an acknowledgment of appointment that is contained within the POA in the presence of a Notary Public. The agent’s need not sign the POA at the same time that the principal signs, but the POA will not be deemed valid, and therefore cannot be used, until the agent has duly executed the acknowledgement.
• A requirement that the POA include a written notice to the agent explaining the scope of the agent’s fiduciary responsibilities. The POA also includes a warning to the agent that the agent may be liable for a breach of his or her fiduciary responsibilities.
• To limit perceived abuses by agents in making gifts of the principal’s assets to themselves or third persons under the prior statutory form, the new law requires that in any circumstance where the principal wishes to authorize an agent to make gifts of the principal’s assets, in addition to signing the new POA form, the principal must execute an optional document called the “Statutory Major Gifts Rider” (“SMGR”). The principal will need to carefully review the SMGR to determine which types of gifting authority, if any, that the principal wishes give the agent. In order for the agent to have each type of gifting authority, the principal must initial the corresponding section. For example, the principal must specifically initial a provision authorizing an agent to change beneficiary designations for life insurance policies and retirement plans if the principal desires that the agent have such authority. In addition, the principal must sign the SMGR, and his or her signature must be notarized and witnessed by two people not appointed as an agent.
• An optional provision for designation of a “monitor” to oversee the agent’s actions.
• Authorization to provide “reasonable compensation” to the agent for his or her services.
• Specific directions for revoking the POA.
• Expansion of the class of “financial institutions” that are required to accept the POA absent “reasonable cause.” Previously, the term “financial institutions” was limited to banks, but it now includes securities brokers, securities dealers, securities firms and insurance companies.
Many concerns remain among attorneys regarding how the new form will work in practice, and whether the new POAs will be readily accepted by financial institutions. As events unfold, we will keep readers informed regarding the effectiveness of the new POA
Sunday, September 6, 2009
Buy-Sell Agreements: Planning for a Business Owner's Death
In 1968 high school friends Sam and Larry started their plumbing supply business, Drainco Plumbing Supply, Inc., with the modest goal of providing a nice life for their growing families. Through hard work and good business sense, by 2009 Drainco Plumbing Supply – which now employs 35 people, including one of Sam’s sons and one of Larry’s daughters – has grown to be worth $10 million.
But Sam and Larry’s success comes with strings attached. Like most owners of successful closely-held businesses, the value of their business interests is by far their largest asset. Since the asset is illiquid, a premature death can prove disastrous, as the owner’s estate will need to pay what might be a substantial federal and New York State estate tax – in cash -- within nine months of the owner’s death. If there is insufficient cash to pay the tax, either the estate will need to sell the deceased owner’s interest in the business at a “fire sale” price, or pay the tax late with substantial penalties and interest. Tax issues aside, without planning a partner’s unexpected death may create a situation where the remaining owner is now a partner with the deceased owner’s widow, who may well have no experience with, or interest in, the business.
To ensure the preservation of the equity of their business as well as their legacy, business owners must plan ahead for the inevitable day when they will “leave” the business – whether vertically or horizontally!
All closely-held businesses should have a formal plan to ensure the preservation of the business upon an owner’s death. The Buy-Sell agreement is the planning tool used to provide the “road map” to address various contingencies such as the death, disability, or retirement of an owner, and those circumstances (if any) when an owner can sell their interests in the business to a third party.
Sam and Larry need to take time from their busy schedules and sit down with their attorney, accountant and insurance professional to devise a strategy to address the various life events that are part of any solid Buy-Sell agreement. A fundamental component of any Buy-Sell agreement is inclusion of a mechanism to provide for the disposition of an owner’s business interest upon death. A common scenario would be for Sam and Larry to purchase life insurance on each other’s life in a cross-purchase arrangement, with a death benefit equal to at least the value of each owner’s interest in the business. Since closely held businesses are often difficult to value, Sam and Larry are well-advised to use a business valuation specialist to determine the business’s actual value so that the appropriate amount of insurance can be purchased.
In a cross-purchase agreement, each owner is contractually obligated to purchase from the deceased owner’s estate (or trust, if applicable) the deceased owner’s interest in the business. In the event of Sam’s death, the business would need to be valued to determine the value of Sam’s interest in the business at the time of his death. Larry would use the life insurance proceeds from the policy he owns on Sam’s life to purchase Sam’s interest in the company from Sam’s widow, Sarah. If the life insurance is insufficient to pay the full amount of Sam’s interest in the company, the agreement should provide a mechanism – typically in the form of payments over a period of years pursuant to a promissory note, secured by Sam’s stock – to pay the balance of the purchase price to Sarah.
To help prevent a scenario where too much of the purchase price must be paid for via installment payments, it is critical that the owners’ assess their company’s value periodically, and increase the amount of life insurance on each other’s lives if feasible.
In businesses with three or more owners, it may be unwieldy to use a cross-purchase arrangement, as each owner would need to own a policy insuring the life of each other owner. An alternative to the cross-purchase arrangement is a redemption agreement in which the business entity (i.e., the corporation, LLC, etc.) is the owner of the insurance policies insuring the lives of each owner. Upon the death of an owner, the entity uses the life insurance on the deceased owner’s life to purchase from his or her estate the deceased owner’s business interest. For example, assume Drainco Plumbing Supply has a third shareholder, Kurt, with each shareholder owning 33 1/3 of the company stock. Upon Sam’s death, Drainco Plumbing Supply would purchase Sam’s stock from his estate. Larry and Kurt will now each own 50% of the remaining issued and outstanding stock in Drainco.
A third alternative is the hybrid, or wait and see arrangement. In a hybrid Buy-Sell agreement, the corporation has the first “option” to purchase a deceased shareholder’s stock. If the corporation does not exercise the option, then the remaining owners will have the option to purchase the deceased owner’s stock. If the individual shareholders do not exercise the option, then the corporation will typically be required to purchase the stock.
The hybrid agreement has gained greater usage over the past few years, as it affords greater flexibility to address the different tax impact of a corporation’s purchase of an owner’s stock as opposed to a purchase by the individual shareholders. Regardless of the structure used for the agreement, competent tax assistance is a must to ensure the best results.
But Sam and Larry’s success comes with strings attached. Like most owners of successful closely-held businesses, the value of their business interests is by far their largest asset. Since the asset is illiquid, a premature death can prove disastrous, as the owner’s estate will need to pay what might be a substantial federal and New York State estate tax – in cash -- within nine months of the owner’s death. If there is insufficient cash to pay the tax, either the estate will need to sell the deceased owner’s interest in the business at a “fire sale” price, or pay the tax late with substantial penalties and interest. Tax issues aside, without planning a partner’s unexpected death may create a situation where the remaining owner is now a partner with the deceased owner’s widow, who may well have no experience with, or interest in, the business.
To ensure the preservation of the equity of their business as well as their legacy, business owners must plan ahead for the inevitable day when they will “leave” the business – whether vertically or horizontally!
All closely-held businesses should have a formal plan to ensure the preservation of the business upon an owner’s death. The Buy-Sell agreement is the planning tool used to provide the “road map” to address various contingencies such as the death, disability, or retirement of an owner, and those circumstances (if any) when an owner can sell their interests in the business to a third party.
Sam and Larry need to take time from their busy schedules and sit down with their attorney, accountant and insurance professional to devise a strategy to address the various life events that are part of any solid Buy-Sell agreement. A fundamental component of any Buy-Sell agreement is inclusion of a mechanism to provide for the disposition of an owner’s business interest upon death. A common scenario would be for Sam and Larry to purchase life insurance on each other’s life in a cross-purchase arrangement, with a death benefit equal to at least the value of each owner’s interest in the business. Since closely held businesses are often difficult to value, Sam and Larry are well-advised to use a business valuation specialist to determine the business’s actual value so that the appropriate amount of insurance can be purchased.
In a cross-purchase agreement, each owner is contractually obligated to purchase from the deceased owner’s estate (or trust, if applicable) the deceased owner’s interest in the business. In the event of Sam’s death, the business would need to be valued to determine the value of Sam’s interest in the business at the time of his death. Larry would use the life insurance proceeds from the policy he owns on Sam’s life to purchase Sam’s interest in the company from Sam’s widow, Sarah. If the life insurance is insufficient to pay the full amount of Sam’s interest in the company, the agreement should provide a mechanism – typically in the form of payments over a period of years pursuant to a promissory note, secured by Sam’s stock – to pay the balance of the purchase price to Sarah.
To help prevent a scenario where too much of the purchase price must be paid for via installment payments, it is critical that the owners’ assess their company’s value periodically, and increase the amount of life insurance on each other’s lives if feasible.
In businesses with three or more owners, it may be unwieldy to use a cross-purchase arrangement, as each owner would need to own a policy insuring the life of each other owner. An alternative to the cross-purchase arrangement is a redemption agreement in which the business entity (i.e., the corporation, LLC, etc.) is the owner of the insurance policies insuring the lives of each owner. Upon the death of an owner, the entity uses the life insurance on the deceased owner’s life to purchase from his or her estate the deceased owner’s business interest. For example, assume Drainco Plumbing Supply has a third shareholder, Kurt, with each shareholder owning 33 1/3 of the company stock. Upon Sam’s death, Drainco Plumbing Supply would purchase Sam’s stock from his estate. Larry and Kurt will now each own 50% of the remaining issued and outstanding stock in Drainco.
A third alternative is the hybrid, or wait and see arrangement. In a hybrid Buy-Sell agreement, the corporation has the first “option” to purchase a deceased shareholder’s stock. If the corporation does not exercise the option, then the remaining owners will have the option to purchase the deceased owner’s stock. If the individual shareholders do not exercise the option, then the corporation will typically be required to purchase the stock.
The hybrid agreement has gained greater usage over the past few years, as it affords greater flexibility to address the different tax impact of a corporation’s purchase of an owner’s stock as opposed to a purchase by the individual shareholders. Regardless of the structure used for the agreement, competent tax assistance is a must to ensure the best results.
Saturday, August 29, 2009
Uncivil Society?
There is something rotten in the air. Spend a few minutes listening to talk radio, surfing the political blogs, or watching cable news, and it is undeniable that hatred and anger is on the rise, and seemingly spiraling out of control. Both the extreme right and the extreme left share in the blame. But just as much at fault are our political "leaders" who stand by silently (or even worse, offer encouragement) when some nut-job spouts hateful rhetoric.
Just a few days ago, video surfaced from yet another Town Hall meeting, this time hosted by Wally Herger, a non-descript Congressman from California. An audience member proudly announces that he's a "proud right-wing terrorist" and goes on to spout the typical anti-government nonsense. So does the esteemed Representative chastize this creep for his hate-mongering? Does he report him to the FBI? To the contrary, Herger praises the self-proclaimed "terrorist," saying, "Amen, God bless you," and then telling the audience, "there is a great American."
Looking back on our history, it seems we are heading back to the days of the "Know Nothing" party from the 1840's and 1850's. There's little room for reasoned and rational political discourse, just a lot of noise and sound bites designed to frighten those too lazy or ignorant to think for themselves. And if we insist on electing lightweights the likes of Wally Herger to positions of power, we only get what we deserve.
Just a few days ago, video surfaced from yet another Town Hall meeting, this time hosted by Wally Herger, a non-descript Congressman from California. An audience member proudly announces that he's a "proud right-wing terrorist" and goes on to spout the typical anti-government nonsense. So does the esteemed Representative chastize this creep for his hate-mongering? Does he report him to the FBI? To the contrary, Herger praises the self-proclaimed "terrorist," saying, "Amen, God bless you," and then telling the audience, "there is a great American."
Looking back on our history, it seems we are heading back to the days of the "Know Nothing" party from the 1840's and 1850's. There's little room for reasoned and rational political discourse, just a lot of noise and sound bites designed to frighten those too lazy or ignorant to think for themselves. And if we insist on electing lightweights the likes of Wally Herger to positions of power, we only get what we deserve.
Sunday, August 23, 2009
Health Care -- Facts and Lies
I have no idea if the health care legislation proposed by President Obama would be truly effective, and those who are skeptical may be correct that the plan would do little if anything to improve our health care system, lower costs, or achieve either objective.
But the hysteria seen in the Town Halls and on talk radio would be laughable if it weren't so dangerous -- and disingenuous. Having counseled seniors and baby boomers regarding end-of-life issues for the past 15 years, my experience is that all clients have an opinion regarding their preference for end-of-life care, and they are eager to sign living wills and health care proxies to effectuate their personal desires. The proposed legislation provides a forum for discussing end-of-life care for those who haven't addressed this issue previously, and would help avoid another Schiavo fiasco.
Also, those railing against "rationing" under any new system are either blind to the fact -- or consciously ignoring the truth -- that under our present hodgepodge system, rationing already occurs. Anyone who has dealt with an insurance company in trying to obtain approval for a course of treatment that the insurer considers outside the standard protocol recognizes this reality.
Having for the past decade served on the Board of a not-for-profit hospital, I have seen first-hand that our present system too often rewards procedures -- that is, payment-for-testing -- rather than successful outcomes. It is analogous to the situation in the legal field, where billing by the hour provides a perverse incentive for the attorney by rewarding inefficiency and punishing a successful result achieved expeditiously.
To be fair, I do believe that some type of tort reform should be part of any health care overhaul, and I fault the Democrats for not showing sufficient courage to incorporate tort reform in the proposed bill.
I don't profess to have the answers for our health care system. But I do know that what we have in place today is unmanagable and unsustainable, and far too many people remain uninsured. Given how far the United States lags behind other industrialized nations in terms of both costs and outcomes, there is no question that change in some manner is long overdue.
But the hysteria seen in the Town Halls and on talk radio would be laughable if it weren't so dangerous -- and disingenuous. Having counseled seniors and baby boomers regarding end-of-life issues for the past 15 years, my experience is that all clients have an opinion regarding their preference for end-of-life care, and they are eager to sign living wills and health care proxies to effectuate their personal desires. The proposed legislation provides a forum for discussing end-of-life care for those who haven't addressed this issue previously, and would help avoid another Schiavo fiasco.
Also, those railing against "rationing" under any new system are either blind to the fact -- or consciously ignoring the truth -- that under our present hodgepodge system, rationing already occurs. Anyone who has dealt with an insurance company in trying to obtain approval for a course of treatment that the insurer considers outside the standard protocol recognizes this reality.
Having for the past decade served on the Board of a not-for-profit hospital, I have seen first-hand that our present system too often rewards procedures -- that is, payment-for-testing -- rather than successful outcomes. It is analogous to the situation in the legal field, where billing by the hour provides a perverse incentive for the attorney by rewarding inefficiency and punishing a successful result achieved expeditiously.
To be fair, I do believe that some type of tort reform should be part of any health care overhaul, and I fault the Democrats for not showing sufficient courage to incorporate tort reform in the proposed bill.
I don't profess to have the answers for our health care system. But I do know that what we have in place today is unmanagable and unsustainable, and far too many people remain uninsured. Given how far the United States lags behind other industrialized nations in terms of both costs and outcomes, there is no question that change in some manner is long overdue.
Friday, August 21, 2009
Focusing on the Results, not the "Documents"
For the past decade I've been fighting the same fight: namely, getting clients to stop thinking of their estate plans in terms of the type of documents they need -- e.g., "I need a will," or "I need a trust" -- and instead shifting the focus onto the client's goals and objectives. Once the goals and objectives have been thoroughly discussed between the attorney and the client, then an effective estate plan can be designed to meet the client's needs. The various legal documents are simply tools in the lawyer's toolbox for meeting the clients objectives. The attorney's real value is in helping the client understand the implications of the planning as it fits the client's particular family and financial situation, and then in crafting the appropriate planning tools to realize the client's desires.
Here's an analogy: assume you are hiring a contractor to build a house. Do you simply tell the contractor to start building the house as he sees fit, but to be sure to use only Phillips head screwdrivers a Husqvarna electric saw, etc.? Of course not; you would surely have a blueprint of the house prepared by an architect or similarly qualified source, and would rely upon the contractor to use appropriate tools to get the job done right.
Well, in a "traditional" estate planning scenario, clients seem to assume that they know the appropriate "tools' to use for the planning, rather than relying upon the attorney to use his or her professional expertise to select the proper planning tools. Just as absurd, in traditional estate planning, experience tells me that the attorneys all too frequently fail to provide adequate counseling to the clients to structure an appropriate estate plan for that particular family; instead, the attorney acts as a mere "scrivener" in producing a "word processed" estate plan.
Here's an analogy: assume you are hiring a contractor to build a house. Do you simply tell the contractor to start building the house as he sees fit, but to be sure to use only Phillips head screwdrivers a Husqvarna electric saw, etc.? Of course not; you would surely have a blueprint of the house prepared by an architect or similarly qualified source, and would rely upon the contractor to use appropriate tools to get the job done right.
Well, in a "traditional" estate planning scenario, clients seem to assume that they know the appropriate "tools' to use for the planning, rather than relying upon the attorney to use his or her professional expertise to select the proper planning tools. Just as absurd, in traditional estate planning, experience tells me that the attorneys all too frequently fail to provide adequate counseling to the clients to structure an appropriate estate plan for that particular family; instead, the attorney acts as a mere "scrivener" in producing a "word processed" estate plan.
Sunday, August 16, 2009
The Federal Estate Tax: Coming Down to the Wire
Back to blogging after time for some travel (business and pleasure) and catching up at work. As August reaches the half-way point (and it's finally hot), it's time to take stock of the state of the federal estate tax law. While healthcare reform is dominating the news, when Congress returns from the August recess, estate tax reform will almost certainly be on the agenda.
In 2009, the federal estate tax exemption is $3.5 million. That is, upon death every person can pass $3.5 million of assets to non-spouses free of federal estate tax. Assets in excess of $3.5 million are subject to tax at a rate of 45%. Many states, including New York, have separate state estate taxes; New York only permits $1,000,000 of assets to pass to heirs free of estate tax.
Under both state and federal law, an unlimited amount of assets can pass from a deceased spouse to his or her surviving spouse under a rule known as the unlimited marital deduction. However, upon the second spouse's death, all of that spouse's assets in excess of $3.5 million are taxable, including assets inherited from the first spouse to die. Essentially, a direct transfer of assets to a surviving spouse results in the "forfeiture" of the estate tax exemption of the first spouse to die.
Preserving the exemption for the first spouse to die is rather simple. An amount equal to the estate tax exemption (e.g., $3.5 million) can be funded into a credit shelter trust for the benefit of the surviving spouse and, if desired, other beneficiaries such as descendants. The surviving spouse can be the Trustee of the credit shelter trust; the spouse can be entitled to income from the trust, and principal distributions of any amount can be made to the surviving spouse or other beneficiaries for "health, education, maintenance and support." Maintenance and support are very broad terms and essentially mean that distributions of principal may be made for any need to support the beneficiaries' needs, including vacations, homes, cars, and the like. If that isn't enough, the credit shelter trust may be drafted to grant the surviving spouse a "5 x 5" power that permits the spouse to invade the principal of the trust for any purpose in an amount not to exceed the greater of $5,000 or 5% of the trust principal (typically valued as of December 31 of the prior year).
But all that may change dramatically come 2010 if Congress does not act. Under the existing estate tax legislation passed in June 2001, the federal estate tax is repealed for one year only; that is, assets of any amount may be passed upon death to both spouses and non-spouses free of federal estate tax. A downside of the existing law is that while the estate tax would be repealed in 2010, the current unlimited "step-up" in basis for inherited assets will also be repealed, with only $1.3 million of assets to be eligible for a full step-up in basis ($4.3 million if there is a surviving spouse), with any "excess" assets to be transferred at a "carryover" basis.
This rule has been tried once before in the mid-1970s and was quickly repealed as unworkable. Imagine trying to determine the basis of old AT &T stock purchased 50-years ago that has since split multiple times and been spun-off into numerous successor companies. The complexities of trying to determine cost basis of a decedent's assets will surely drive-up the costs of estate settlements and lead to howls of protest.
So with all the uncertainty, what's Congress likely to do? Given the timing, the current assumption is that while Congress wrestles with a long-term solution, it will extend for at least one year the current $3.5 million estate tax exemption, along with the unlimited step-up in basis.
Two of the most likely long-term proposals include:
1. "Freezing" the exemption at $3.5 million with a maximum tax rate of 45%, but also indexing the exemption for inflation; the proposal would also "reunify" the estate and gift tax credits (currently the lifetime gift exemption is $1 million), and permit "portability" of the estate tax exemption from one spouse to the other. However, the proposal would place limits on "valuation discounts" for planning vehicles such as "family limited partnerships" that are frequently used by high-net worth individuals to minimize estate and gift taxes.
2. Making permanent the exemption level at $2 million, indexing that level for inflation, and establishing progressive tax rates of 45 percent for estates valued between $2 million and $5 million; 50 percent for estates valued at $5-to-$10 million; and 55 percent for estates valued over $10 million. This proposal also includes reunification of the estate and gift tax exemptions and "portability" between spouses.
As Congress tackles this issue this fall, I'll keep my readers posted as to breaking developments.
In 2009, the federal estate tax exemption is $3.5 million. That is, upon death every person can pass $3.5 million of assets to non-spouses free of federal estate tax. Assets in excess of $3.5 million are subject to tax at a rate of 45%. Many states, including New York, have separate state estate taxes; New York only permits $1,000,000 of assets to pass to heirs free of estate tax.
Under both state and federal law, an unlimited amount of assets can pass from a deceased spouse to his or her surviving spouse under a rule known as the unlimited marital deduction. However, upon the second spouse's death, all of that spouse's assets in excess of $3.5 million are taxable, including assets inherited from the first spouse to die. Essentially, a direct transfer of assets to a surviving spouse results in the "forfeiture" of the estate tax exemption of the first spouse to die.
Preserving the exemption for the first spouse to die is rather simple. An amount equal to the estate tax exemption (e.g., $3.5 million) can be funded into a credit shelter trust for the benefit of the surviving spouse and, if desired, other beneficiaries such as descendants. The surviving spouse can be the Trustee of the credit shelter trust; the spouse can be entitled to income from the trust, and principal distributions of any amount can be made to the surviving spouse or other beneficiaries for "health, education, maintenance and support." Maintenance and support are very broad terms and essentially mean that distributions of principal may be made for any need to support the beneficiaries' needs, including vacations, homes, cars, and the like. If that isn't enough, the credit shelter trust may be drafted to grant the surviving spouse a "5 x 5" power that permits the spouse to invade the principal of the trust for any purpose in an amount not to exceed the greater of $5,000 or 5% of the trust principal (typically valued as of December 31 of the prior year).
But all that may change dramatically come 2010 if Congress does not act. Under the existing estate tax legislation passed in June 2001, the federal estate tax is repealed for one year only; that is, assets of any amount may be passed upon death to both spouses and non-spouses free of federal estate tax. A downside of the existing law is that while the estate tax would be repealed in 2010, the current unlimited "step-up" in basis for inherited assets will also be repealed, with only $1.3 million of assets to be eligible for a full step-up in basis ($4.3 million if there is a surviving spouse), with any "excess" assets to be transferred at a "carryover" basis.
This rule has been tried once before in the mid-1970s and was quickly repealed as unworkable. Imagine trying to determine the basis of old AT &T stock purchased 50-years ago that has since split multiple times and been spun-off into numerous successor companies. The complexities of trying to determine cost basis of a decedent's assets will surely drive-up the costs of estate settlements and lead to howls of protest.
So with all the uncertainty, what's Congress likely to do? Given the timing, the current assumption is that while Congress wrestles with a long-term solution, it will extend for at least one year the current $3.5 million estate tax exemption, along with the unlimited step-up in basis.
Two of the most likely long-term proposals include:
1. "Freezing" the exemption at $3.5 million with a maximum tax rate of 45%, but also indexing the exemption for inflation; the proposal would also "reunify" the estate and gift tax credits (currently the lifetime gift exemption is $1 million), and permit "portability" of the estate tax exemption from one spouse to the other. However, the proposal would place limits on "valuation discounts" for planning vehicles such as "family limited partnerships" that are frequently used by high-net worth individuals to minimize estate and gift taxes.
2. Making permanent the exemption level at $2 million, indexing that level for inflation, and establishing progressive tax rates of 45 percent for estates valued between $2 million and $5 million; 50 percent for estates valued at $5-to-$10 million; and 55 percent for estates valued over $10 million. This proposal also includes reunification of the estate and gift tax exemptions and "portability" between spouses.
As Congress tackles this issue this fall, I'll keep my readers posted as to breaking developments.
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