Prepared February 25, 2004
We are all aware that, as a result of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“Tax Act”), the applicable credit against Federal estate tax is growing. The following is the schedule of exclusions over the next six (6) years:
Years Dollar Amounts:
2004, 2005 $1,500,000
2010 No estate tax
As part of the Tax Act, Congress has shown a preference towards testamentary transfers (transfers taking place at death), as opposed to transfers of assets by gifting. This bias is evident by the fact that the applicable exclusion against gift tax remains at $1,000,000, while the applicable exclusion against estate tax moves higher, until 2010.
Also, as a result of the Tax Act, and the limitation it has put on the State Death Tax Credit, many states have imposed their own estate tax which would be assessed on resident decedents dying within the state, regardless of the Federal estate tax due. In New Jersey, the estate tax is assessed on all assets not transferred to a spouse in excess of $675,000.
As a result of these tax laws, one should review one’s Will to determine whether they contain mandatory By-Pass Trusts which were designed to take maximum advantage of the Federal estate tax exclusion. If a Will does contain a mandatory By-Pass Trust, a potentially inadvertent tax consequence will be discovered by your Executor or Executrix, since the State of New Jersey will assess your estate a tax on any amount over $675,000 going into the By-Pass Trust, and the State of New York will assess your estate a tax on any amount over $1,000,000 going into the By-Pass Trust. For example, if a By-Pass Trust is funded with $1,500,000, the New Jersey estate tax due would be $64,400.
As a result of the new tax laws, we are recommending that Wills contain Disclaimer Trusts, as opposed to mandatory By-Pass Trusts. A Disclaimer Trust allows a surviving spouse to elect how much, if any, of the deceased spouse’s assets should be put into the By-Pass Trust. In addition, since the Federal exemption amount is continuing to increase, this then permits the surviving spouse to gauge the consequences of funding the Trust, in light of the tax law which exists at the time of the first spouse’s death. Flexibility is more important than ever in these years of uncertainty.
Two recent court cases: Estate of Albert Strangi and the Estate of Albert J. Hackl have ruled against a taxpayer with regard to a common and popular estate planning technique regarding family limited partnerships and/or limited liability companies. As a result of the court cases discussed below, we are recommending that clients who have family members as owners of a family limited partnership and/or limited liability company reevaluate the company documents to determine whether or not there is a possibility that transfers of minority interests may be either pulled back into the parent’s estate by the IRS, as a result of the parent retaining too much control over the company, or that the transfer may not be considered a present interest gift and therefore not considered as part of one’s annual exclusion amount (i.e. $11,000).
In Strangi, (which is currently on appeal) a family created a family limited partnership into which all of the assets of the surviving parent were transferred through the use of a power of attorney. The family limited partnership agreement authorized the general partner to make all decisions regarding distributions of income and principal, including the right of dissolution. Since the parent through a power of attorney retained the primary control factors mentioned above, the court cited Section 2036 of the Internal Revenue Code which indicates that if a decedent retained substantial control over an asset which he transferred prior to his death, then the asset should be deemed to be included in his estate for estate tax purposes. Second, the Strangi family, in transferring all as opposed to some of the decedent’s assets into the partnership, allowed the court to conclude that there was no legitimate business purpose in connection with the family entity, and that it was in fact a “sham” designed solely to avoid taxes. Finally, since the parent controlled all decisions without independent oversight, the court concluded that there was no fiduciary duty to respect the rights of the minority owners.
In Hackl, the decedent’s limited liability company owned two tree farms, as well as cash and securities. Although the decedent and his wife gifted minority interests of the company to their children, the Tax Court found that since the children could not cause their interests in the company to be liquidated or sold to a third party without their parents’ (the managers) consent, and since the parents control the distribution of profits, the children’s interest did not constitute ownership of an asset which had substantial economic benefits and was, therefore, not a present interest qualifying for the annual exclusion.
Finally, a federal law entitled the Health Insurance Portability and Accountability Act became effective in 2003 which severely restricts how medical information is disseminated and to whom it may be disseminated.
The Act requires that any third party who wishes to obtain health information which falls under the definition of “protected health information” under the Act must have authority, in writing, making specific reference to this Act, in order to obtain this information. We are therefore adding provisions to all of our new Health Care Powers of Attorney, and recommend that clients with existing Health Care Powers of Attorney consider executing new ones, which create a waiver for the release of such information. Obviously, without having access to proper health care information, one’s health care agent named in a proxy cannot make educated decisions regarding your health care.