No Federal Estate Tax, but What About Your State?

As a reminder, we in MA have a $1,000,000 estate tax. Our trusts and wills account for this. If you have any questions, always feel free to email or call the office.


By: Paul Sullivan
The New York Times

The first quarter is nearly over, and the federal government has made no move to reinstitute the estate tax. So dying today seems free, right?

There is just one problem: If you live in one of 20 states with a state estate tax, you could find your existing estate tax plans causing more harm than good.

State estate taxes are not new. They had just been a secondary element in the course of figuring out the much higher federal estate tax.

Now, the issue is sorting through wills written to maximize the old federal exemption from estate taxes — $3.5 million in 2009. In states with their own estate taxes, some of these provisions could distribute money and incur taxes in ways the deceased never expected — or maybe not if the federal estate tax is reinstated. As Jerry Weihs, director of advanced planning at Sun Life Financial, said: “We’re in a state of ambiguity.”

AUTOMATIC MISTAKES The biggest issue with the state estate taxes is wills that contain so-called formula clauses. Many wills were redrafted in the last decade to take into account the increasing federal estate tax exemption. Instead of rewriting the will every few years, clauses were put in to reflect the rising exemption amount.

Two commonly worded clauses for estates that left money in trusts could cause problems. “If the clause says you leave the applicable exclusion to your kids and the rest to a second spouse, that could now mean leaving nothing to your children since there is no applicable exclusion in 2010,” said Sharon Klein, head of wealth advisory at Lazard Wealth Management. “The other issue is if you leave the maximum that could pass free of federal tax to your children and the rest to a second wife, then it is skewed toward the kids, and the wife is disinherited.”

So far 12 states have introduced legislation to remedy this, but the proposals vary. New York, for example, looks at the intent of the will on Dec. 31, 2009, but this applies only if there is a surviving spouse. A formula clause that splits assets between nieces and charity will not function as intended. Florida’s solution could be even more contentious: it allows a judge to interpret the intent of the deceased, if a trustee or a beneficiary challenges the will.

UNEXPECTED TAXES A formula clause can also cause another costly problem. If it was written to send as much money as possible free of federal estate taxes to a credit shelter trust, the estate could pay an unexpected amount in state estate taxes.

That is because estate plans were often written so that the maximum amount that would not incur federal estate taxes would be passed to one set of heirs and the rest to a surviving spouse tax-free. In New York, which has a $1 million state exemption, the estate would have paid $229,200 in state estate taxes on the difference between the New York exemption level and the $3.5 million federal exemption.

Today, the entire estate could pass free of federal taxes. This could lead to an unexpectedly high state tax bill, said Stephen Akers, associate fiduciary counsel at Bessemer Trust. He said the tax on a $25 million estate in New York would be $3,466,800.

“In retrospect, it could be wise to pay that,” Mr. Akers said. “You might be able to avoid the federal estate tax on that much money.” But that is a big if, and it depends on whether Congress decides to make a new estate tax retroactive.

MARRIAGE PROBLEMS The absence of a federal estate tax also raises the question of whether an estate can finance a qualified terminal interest property (QTIP) trust. Such trusts hold assets left to a surviving spouse free of tax until the second spouse dies. The glitch is that a QTIP trust was typically selected when filing the federal estate tax return.

Mr. Akers said several states like Connecticut, Massachusetts and Pennsylvania have a state QTIP election and others are working on it.

In theory, people living in these states could end up far ahead of where they otherwise would have been, he said. If someone left his estate in a state QTIP trust, the surviving spouse would not have to pay estate taxes on it when she died. This is because the estate tax for the surviving spouse comes into play only if a marital deduction is allowed when the first spouse dies. Since there is no federal estate tax return to file, the marital deduction is not an option now.

Mr. Akers said this had not been tested, but it was a better option than leaving assets outright to a spouse, which would certainly be taxed when the spouse died.

Ms. Klein said she was advising clients to set up QTIP trusts, where allowed, as a hedge. By filing extensions to the estate tax returns, you could have up to 15 months to make the election, at which point the estate tax landscape should be clearer.

SNOWBIRD TRAP More jarring to retirees who escape to Florida in the winter may be a bill under debate in that state’s legislature. It proposes to tax property owned by non-Florida residents who are residents of states with state estate taxes.

This is a radical change for Florida, which has long enticed wealthy residents because it had no income or estate taxes. The proposal, on the surface, is a battle between states: Florida wants its cut of any estate tax collected by another state on Florida property. (As proposed, people who live in states without an estate tax will be exempt.) But where it would affect nonresidents is in the legal costs to make sure Florida gets its cut.

And there are also immediate costs of Congressional inaction: changing your will to reflect your state estate tax is not free. “There are going to be significant expenses for what may well be a temporary situation,” Mr. Weihs said.

Tax Secrets of the Wealthy: Solve your business succession problem

Just in case the last article was not enough, here is another article on business secession planning. There are lots of options, but only if you plan. If we can be of any assistances, please do not hesitate to contact us.

Tax Secrets of the Wealthy: Solve your business succession problem
Marco Eagle
By: Irv Blackman

Own a family business? Want to transfer it to your kids? Then you’ll love this article. It’s about an old IRS letter ruling that is one of my favorites. It might be labeled “the lazy man’s way to plan your business transfer.” The ruling shows you how to take advantage of some favorable tax law while avoiding pitfalls. Good stuff!

There is a bit of a problem to using the technique: You see, you must drop dead before your family can enjoy the benefits of Letter Ruling 9116031.

But wait, the ruling has one redeeming quality. Really! First, the facts.
Joe, his wife Mary and their children owned all the stock in a family business. Joe died in 1990 and Mary inherited all of his stock. (Note: Mary’s tax basis — for computing capital gains — is the fair market value (FMV) of the stock on the day Joe died. For example, if the FMV was $1 million and she sold it for $1 million, there would be no capital gains tax.) Mary immediately sold all of her stock back to the corporation.

Here’s the general rule: When you or any member of your family sells stock back to your corporation (called a redemption), the redemption is usually taxed as a dividend — a tax disaster.

But there is a special tax-saving exception for a family member who has owned the stock for 10 years or more: If he/she divests all interest in the company (including any position as an officer or director), the redemption is treated as a sale (gets favorable capital gains treatment, instead of being a dividend). Since Mary sold all (stock she owned before Joe died and stock she inherited from him) of her remaining interest in the corporation, the purchase by the corporation of her shares was considered a bone fide sale (redemption) and not a dividend — a big tax victory.
When all the smoke cleared, not only had Mary escaped a big dividend income tax bill, but she has succeeded in effectively transferring the business to her children. How? Since the kids now owned all the remaining issued and outstanding stock, they owned 100 percent of the business. To sum it up: Mary walked off with a near-tax-free capital gain, (the price paid to Mary for the stock was a bit more than the exact FMV of the stock inherited from Joe) while the kids walked off with the business. A fantastic tax result.

Here’s some more good stuff about succession planning. Over the years, we have used the above ruling dozens of times with real-life clients and have nicknamed the strategy “The little guy redemption technique.” Here’s why. We use it when the seller is (1) in a very low or zero income tax bracket; (2) the stock price is (by a sort of rule-of-thumb) $600,000 or lower and (3) the seller is not worth enough to have a potential estate tax problem.

For example, the last one we did was for $380,000 for Dad No. 1, who owned 5 percent of the stock. The corporation redeemed all the stock paying the full $380,000 with a note payable over 10 years with interest at 6 percent on the unpaid balance.
Simple! Effective. Really a nice little flow of spendable cash for Dad No. 1, whose total net worth was only $800,000.

Let’s change the facts, just a bit.

Dad No. 2 (a real client from New York) is in the highest income tax bracket and estate tax bracket. Tax heaven would be to transfer his interest in the corporation (valued at $3 million) tax-free to his kids.

Dad No. 2’s succession plan must be centered around a strategy called an intentionally defective trust (IDT). An IDT is a tax-saving machine. It’s tax-free to Dad No. 2. Best of all the “buyer” of the stock (Dad’s kids) do not pay a single penny for the stock. Instead, the kids get the stock tax-free as a beneficiary of the IDT.

The lesson to be learned. Never, but never sell your stock to your kids, unless you are a little guy (as spelled out above). If transferring the stock of your family business to one or more of your children will be a tax burden to (a) you or (b) the children or (c) (in most cases) both, it is a must to find out just how much the family will save in taxes using an IDT. The rule of thumb: The savings are over $600,000 for every $1 million of the stock’s price. In real life, Dad No. 2 and his kids saved $1,920,000 in taxes (on a stock price of $3 million).

State receives $13 million from single estate

Here is a reminder about state estate taxes. While this article is from Vermont, don’t forget that Massachusetts imposes a significant estate tax for estates valued above $1 million (which can include Life Insurance!). In these current economic times, we do not expect that any state to eliminate or even reduce this revenue source. Careful planning, however, can reduce or eliminate this tax for your heirs. The choice is often whether you will engage in ‘voluntary philanthropy’ (like naming a charity as a beneficiary) or ‘involuntary philanthropy’ – meaning the State will take a chunk. Careful planning can help make these choices.

Burlington Free Press
By Terri Hallenbeck, Free Press Staff Writer

MONTPELIER — As lawmakers were stretching the last nickels and dimes to pull together the 2010 state budget last week, an unlikely thing happened: A $13 million windfall blew through the door.

That’s how much the state received in estate tax from one person’s estate last month.

“That’s a very unusual, large, one-time estate tax,” said Tax Commissioner Tom Pelham. He is precluded by law from identifying the estate’s owner. Somewhere in Vermont, someone died last year who was worth something on the order of $80 million to $100 million.

For the state, the $13 million in unexpected revenue is like an inheritance from a long lost relative and couldn’t have come at a better time. Various revenue that fund state spending have shrunk in the last year because of the ailing economy, forcing program cuts and layoffs.

As they put the last pieces of the 2010 budget together, legislators found the estate-tax money a welcome bandage to stop the bleeding. They earmarked $1.5 million of it for college scholarships that would otherwise have gone unfunded. The rest will be used as insurance in case revenue takes another dive in June. If the revenue doesn’t materialize, the money could help spare various state special funds from being cut and could give the state the first step out of a $67 million hole in the 2011 budget.

Because of that one estate, estate tax revenue was up $13.6 million above what economists had predicted in May, said state Finance Commissioner Jim Reardon. Other revenue continued to lag, he said, and the estate tax windfall left state $11.6 million over the expected General Fund revenue mark.

“Relying on a large settlement to balance your books is not the greatest position to be in,” he said, “but a worse position is not to balance your books.”

Estate taxes of that size are rare, said Joseph Bilodeau, a certified public accountant with Bilodeau Wells & Co. in Essex Junction. He estimated that a person’s estate would have been worth about $80 million to yield a $13 million tax bill. Many people with such a sizeable estates donate at least a portion to charity, making it tax-free, Bilodeau said.

Reardon said the state’s economist estimated the estate could have been worth $100 million, depending on whether all the assets were held in Vermont.