Estate of Confusion: Estate Tax Aspects of Obama's Tax Deal with the Republicans

By now, most everyone knows that Obama has reached a tentative deal with the Republicans to extend the Bush tax cuts for two more years.  From an estate tax standpoint, this deal is extremely generous to taxpayers.  Under the deal, the estate tax exemption would be $5 million for each individual, and $10 million for couples.  In addition, the applicable estate tax rate would be 35%.  However, the proposed legislation's terms would expire in 2012, just in time for the next presidential election.

Not surprisingly, Obama has received a lot of criticism from the Democrats for what is perceived as a tax cut that will only benefit the extremely wealthy. Even for those who support lowering the estate tax, however, this deal cannot be viewed as an overwhelming victory.  The proposed legislation's 2012 sunset provision signals continuing uncertainty for taxpayers, making it impossible for them to effectively plan their business and financial affairs.

To learn more about the near "full scale rebellion" which the deal has sparked within the Democratic party, follow this link to a recent Boston Globe article:  "Obama chides Democrats, calls tax deal unavoidable".  Also, if you would like to keep up to date with all of the new estate tax developments, visit the "Future of the Federal Estate Tax" blog.  As always, if you have any questions or you would like to share your point of view please do not hesitate to leave a comment or contact me directly.

A Simple Tip for Avoiding Estate Tax

It is not uncommon for a married couple to own most of their significant assets jointly.  Jointly held property will pass to the surviving spouse upon the first spouse's death without going through probate.  Couples who own their home jointly as tenants by the entirety also enjoy protection from creditors.  Joint ownership, however, can be extremely detrimental from an estate tax perspective, because it can subject the property to estate tax more than once.  Fortunately, some alternative arrangements exist that provide the benefits of joint ownership without the negative estate tax consequences.    

Joint owners will be liable for estate tax on their jointly-held assets upon the death of the first joint owner, and again upon the death of the second joint owner.  Pursuant to the federal internal revenue code and Massachusetts state law, if a married couple owns property as joint tenants or as tenants by the entirety, one-half of its value will be included in the estate of the first spouse to die.  If the surviving spouse does not transfer the property prior to his or her death, its entire value will be included in his or her estate as well.  Consequently, the couple will end up paying estate tax on 150% of the asset's value, whereas they would only be taxed on 100% of its value if just one of them owned the property.

The estate tax consequences can get even uglier if the joint owners are not married.  The asset's entire value will be included in the estate of the first joint owner to die unless the other joint owners can establish they made a contribution to purchase the asset.  Consequently, two unmarried individuals owning an asset jointly can incur estate tax on its entire value twice:  Once when the first joint owner passes away, and again when the second joint owner passes away.  In other words, two unmarried joint owners can end up paying estate tax on 200% of the value of their jointly owned asset.

Fortunately, individuals can enjoy all of the benefits of joint ownership without all of the negative estate tax consequences by transferring their assets to a carefully drafted trust.  Assets in a trust can be passed to descendants without going through probate.  The trust can also be drafted to provide certain creditor protection features which are similar to a tenancy by the entirety .  In addition, the trust's creators can name themselves as trustees, and thereby retain control over the assets transferred to the trust during their lifetimes.

In writing this post, I do not wish to suggest that people should change the ownership structure of their assets without consulting with a qualified lawyer.  Each taxpayer's situation is unique, therefore a technique that is appropriate for a certain individual may produce disastrous results for someone else.  If you have any questions about the estate planning techniques discussed in this post, please don't hesitate to leave a comment or contact me directly.  

Estate Planning for Same-Sex Married Couples

Regardless of what your position is on the same-sex marriage issue, it is a legal reality here in Massachusetts.  In 2003, the Massachusetts Supreme Judicial Court issued its decision in Goodridge v. Department of Public Health, declaring that same-sex couples have the right to marry under the Massachusetts Constitution. Massachusetts law, however, directly conflicts with Federal Defense of Marriage Act, which expressly provides that "marriage means only a legal union between one man and one woman".  

This dichotomy between state and federal law creates numerous transfer-tax concerns.  For instance, under Massachusetts and federal law, spouses may transfer unlimited assets amongst each other during lifetime and upon death without incurring any gift or estate tax liability.  Because same-sex marriage is not recognized under federal law, however, same-sex couples can only make limited transfers amongst each other without incurring federal transfer-tax liability.  Same-sex couples are also subject to certain disadvantages with respect to taxation of jointly held assets.

To be sure, the Goodridge decision has provided numerous benefits for same-sex couples.  Same-sex married couples now enjoy spousal rights under intestacy laws and the elective share statute, priority rights to administer the estate of a deceased spouse who dies intestate, and the right to own their residence as tenants by the entirety.  However, same-sex couples are still subject to severe limitations from a transfer-tax perspective, which will persist until some changes are made to the federal law.     

2010 Year-End Gifting Opportunities

A lot of people know that the estate tax has been repealed for 2010 only, however relatively few people know that the Generation Skipping Tax ("GST") has been repealed for 2010 as well.  The GST is designed to prevent individuals from 'skipping' a generation of estate taxes by transferring assets to their grandchildren in lieu of leaving the assets to their children.  The way it works is to impose a tax upon transfers to relatives more than one generation younger than the donor, in addition to any applicable gift and estate taxes.

Individuals who make generation skipping gifts in 2010 rather than waiting until the GST tax comes back into effect in 2011 can realize substantial transfer-tax savings.  Assume an individual wants to make a $1 million gift to his grandchildren and all of his or her GST exemption has already been used.  The gift tax rate in 2010 is 35% and there is no GST tax, however in 2011 the gift tax rate is scheduled to rise to 55% and the GST tax is scheduled to come back into effect at a rate of 55%.  Consequently, if the individual makes the $1 million gift in 2010, he or she will pay $350,000 in gift tax and no GST tax.  If said individual makes the $1 million gift in 2011, however, he or she will pay $550,000 in gift tax, $550,000 in GST tax, and an additional $302,500 as gift tax on the GST tax.  In the final analysis, our individual saves $1,052,500 in taxes if he or she makes the gift this year instead of waiting until 2011.

There are some potential drawbacks, however, to making generation-skipping gifts in 2010.  A donor could make a gift to his grandchildren now, incur a gift tax liability, and then die during 2010.  To guard against this, however, the donor could simply transfer the assets to a revocable trust which will become irrevocable on December 31st, 2010, when it is clear that the donor will survive the year's end.  There is also the threat that Congress may pass a law applying the GST tax retroactively to transfers made during 2010.  In my opinion, however, the chances Congress will promulgate a retroactive GST tax are very slim and are steadily decreasing the closer we get to the year's end.

Obviously, this type of gifting strategy is only appropriate for certain taxpayers.  It can only benefit taxpayers with substantial assets who have the potential for incurring considerable estate tax liability.  Consequently, I would only recommend this strategy for clients who need to implement a gifting plan, or who already have a gifting plan in place.

If you feel that you or one of your family members could benefit from making year-end generation skipping gifts, feel free to contact me with any questions.   As always, I encourage readers to post their comments and questions.  Also, readers can call me at my office at no cost to discuss their questions about the GST, and other estate planning and elder law matters.

The content provided is designed to stimulate discussion and does not constitute legal advice. 

Welcome to My Estate Planning and Elder Law Blog

My name is Nick Keramaris, and I am a Massachusetts attorney specializing in estate planning and elder law.  This blog will discuss developments in elder law and estate planning, as well as various related areas of law.  My goal is to inform readers about these important legal practice areas in an interesting and straightforward fashion.  Of course, questions and comments are welcome and encouraged.  Now let's have some fun!