Why is This Topic Important to Wealth Managers? This blogticle serves as a reminder and review of the treatment of deceased estates from 2010 (making an a section 1022 election).

Estate Tax

The IRS recently published guidance [1] with regard to the time and manner in which the executor of the estate of a decedent who died in 2010 elects, pursuant to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, [2] (TRA), to have the estate tax not apply and to have the carryover basis rules in section 1022 apply to property transferred as a result of the decedent’s death.

Generally, subtitle A of title V of the Economic Growth and Tax Relief Reconciliation Act of 2001, [3] (EGTRRA) enacted section 2210, which made chapter 11 (the estate tax) inapplicable to the estate of any decedent who died in 2010 and chapter 13 (the GST tax) inapplicable to generation-skipping transfers made in 2010.

On December 17, 2010, TRA became law, which reinstated the estate and GST taxes.  However, section 301(c) of TRA allows the executor of the estate of a decedent who died in 2010 to elect to apply the Internal Revenue Code (IRC) as though section 301(a) of TRA did not apply with respect to chapter 11 and with respect to property acquired or passing from the decedent (within the meaning of IRC section 1014(b)).  Thus, TRA allows the executor of the estate of a decedent who died in 2010 to elect not to have the provisions of chapter 11 apply to the decedent’s estate, but rather, to have the provisions of section 1022 apply (Section 1022 Election).

Even though an executor may elect out of the estate tax under TRA, the provisions of chapter 13 (GST tax) nonetheless continue to apply.  Nevertheless, TRA, provides that the applicable tax rate for each GST occurring during 2010 is zero.  [4]

TRA also retroactively repealed section 2511(c), which treated each transfer in trust during 2010 as a gift unless the trust was treated as wholly owned by the donor or the donor’s spouse.  Because of this retroactive repeal, this section does not apply even if a Section 1022 Election is made.

GST

The GST tax was retroactively reinstated by TRA and applies to the estates of all decedents who died after December 31, 2009, regardless of whether a Section 1022 Election is made.  The GST tax is computed by multiplying the taxable amount by the applicable rate. [5]

Under the TRA the maximum federal estate tax rate for purposes of computing the GST tax on such a transfer is deemed to be zero which, when multiplied by any inclusion ratio, will result in an applicable rate of zero.  As under the law applicable to GSTs occurring prior to 2010, the only way to achieve a zero inclusion ratio for the transfer is to make a timely allocation of GST exemption to the transfer.

Next week’s blogticles will discuss planning opportunities.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

[2] See section 301(c) TRA, P.L. 111-312 (124 Stat. 3296)

[3] P.L. 107-16.

[4] Section 302(c) of TRA.

[5] IRC Section 2602.

Why is This Topic Important to Wealth Managers? This blogticle discusses one area that is well known to many wealth managers. However, this reexamination of a topic is designed to provide a refresher to wealth managers. Here we discuss the three year bring-back rule.

With certain exceptions, there is a general rule with respect to estates which requires that any property transferred by gift within three years prior to the transferor’s death has to be included in the gross estate of the deceased transferor, at its date-of-death value (even though the transferor may have had no ownership interest or retained rights of any kind when she died). [1] This rule is sometimes referred to as the “three year rule” or the “bring-back rule”.

The 3-year “bring-back” rule is applicable with respect to dispositions of retained interests in property which otherwise would have been includable in the gross estate.[2] All of these sections involve transfers of property as to which the transferor retained some form of continuing interest or right, which, if still retained when the transferor dies, is deemed sufficient to require the inclusion of the property in the gross estate of the transferor:

• §2036 -  Transfers with certain life interests retained
• §2037 -  Transfers with a reversionary interest retained
• §2038 -  Transfers with a right retained to alter, amend or revoke the transferee’s beneficial interest
• §2042 -  Transfers of life insurance policies with an incident of ownership retained

Under I.R.C §2035, if an insured individual transfers an insurance policy to a trust or another individual, even though the insured may no longer retain any incidents of ownership, if he dies within the 3-year period following the transfer, the entire policy proceeds will be includable in the insured’s gross estate, effectively defeating the major objective of the having the death benefits payable outside the estate.

For the most part, this problem can be eliminated by establishing a trust with a new policy (i.e., never owned by the insured). This, of course, may not be a viable alternative when an existing policy is involved. While consideration might be given to cancellation of an existing policy and replacement with a new one, such a course of action should be based more upon the non-tax aspects of a policy change (e.g., premium costs, contractual terms, quality of carrier, etc.) than purely the tax risk of §2035, the 3-year bring back rule.

In situations where a decision is made to establish an irrevocable life insurance trust with a policy to be newly issued, the §2035 problem (the 3-year rule) can usually be avoided by simply having the policy applied for by, and initially issued to, the trust as owner. If this is properly accomplished, the insurance proceeds will not be includable in the insured’s gross estate even if he should have the misfortune of living less than three years thereafter.

The critical factor in assuring the inapplicability of I.R.C. §2035 (the 3-year rule) is that the grantor/insured not have possessed at any time anything that might be deemed an incident of ownership with respect to the policy.

Generally it is the IRS’ position that reapplication by third party owner after decedent initially applied for the insurance within three years of death does not present a three year rule problem. Central to the position is the notion that an application for insurance (as long as money is not submitted with the application) is only an offer to contract. There being no contract between the parties, decedent never held any incidents of ownership.[3]

Tomorrow’s blogticle will continue to discuss issues surrounding wealth management.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

[2] For example, under I.R.C. §§ 2036, 2037, 2038, or 2042.

[3] See Technical Advice Memorandum (TAM) 9323002.

Why is this Topic Important to Wealth Managers? This blogticle presents discussion on international estate planning considerations for non-resident aliens generally. We have provided this information for wealth managers with international clients who may have estate tax issues to contend with.

A now deceased individual who at the time of death was neither a resident nor citizen of the United States may nonetheless be subject to U.S. estate tax if at the time of death he or she owned property in the United States. In such a case, although the U.S. estate tax is applicable, only property located in the United States is includable in the gross estate and subject to tax.

An important distinction is made between who is subject to income tax and estate tax. For estate tax purposes, a nonresident alien is a person who is neither a domiciliary nor a citizen of the United States. Thus, an alien who dwells in the United States, but whose domicile remains elsewhere, is classed as a nonresident alien.[1]

Domicile here is used in the traditional sense. In other words, domicile generally requires presence and an intention to remain permanently.

For example, consider a decedent who lived in the United States six years before he died. However, he always intended to return to his native Netherlands, the location of his family and close friends, at the earliest opportunity. This man’s domicile was the Netherlands and therefore he had died a nonresident alien and was not subject to the traditional citizen or resident alien estate tax regime.[2]

The gross estate of a nonresident alien includes that part of his property which is situated in the United States at the time of his death.[3] For purposes of determining what property is situated in the United States, any property which the decedent has transferred, by trust or otherwise, which would be taxable within the provisions of Code §§2035 through 2038 (relating to termination of certain property interests within three years of death, transfers with retained life estate or to take effect at death, and revocable transfers), is deemed situated in the United States if it was so situated either at the time of the transfer or at the time of death.[4]

For a decedent who at the time of death was a nonresident alien, property is considered located in the United States if it falls into any of the categories listed below:

• Real property located in the United States.
• Tangible personal property located in the United States. This includes clothing, jewelry, automobiles, furniture or currency. Works of art imported into the United States solely for public exhibition purposes are not included.
• A debt obligation of a citizen or resident of the United States, a domestic partnership or corporation or other entity, any domestic estate or trust, the United States, a state or a political subdivision of a state or the District of Columbia.
• Shares of stock issued by domestic corporations, regardless of the physical location of stock certificates.[5]

When considering inbound international estate planning issues one question that should be addressed is if the decedent is a citizen or resident of one of the several countries with which the United States has an estate tax convention (treaty). This is because provisions of the applicable treaty may override the normally applicable Internal Revenue Code provisions. The United States is a party to estate or gift tax treaties with the following countries: Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Norway, Republic of South Africa, Switzerland, and the United Kingdom.

One final but very important point to note is that proceeds of insurance on a nonresident alien’s life are not includible in his gross estate.[6]This is true even though the proceeds are paid to a resident beneficiary.

For additional information on this subject see AMAFX: U.S. Estate and Gift Tax Consequences for Non-U.S. Citizens.

Tomorrow’s blogticle will discuss the qualified domestic trust.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] See Est. of Jan Willem Nienhuys, 17 T.C. 1149 (1952).

[3] IRC §2103.

[4] IRC §2104(b).

[5] Treas. Regs. §20.2104.

[6] IRC §2105(a).

Why is this Topic Important to Wealth Managers? This blogticle represents part three of five in a series on the unified estate and gift tax as well as the portability of the spousal credit. Most wealth managers are aware of the new changes to the federal estate and gift tax structure with the unification and increased exemption amount of five million dollars. This week we discuss the estate and gift tax in detail so that wealth managers are well prepared to address client planning needs.

The Marital Deduction

A 100-percent marital deduction generally is permitted for estate and gift tax purposes for the value of property transferred between spouses.[1] Transfers of ‘‘qualified terminable interest property’’ are eligible for the marital deduction. ‘‘Qualified terminable interest property’’ is property: (1) that passes from the decedent; (2) in which the surviving spouse has a ‘‘qualifying income interest for life’’[2]; and (3) to which an election applies. [3]

In other words, the marital deduction allows spouses to deduct unlimited amounts for property that passes from a decedent to his or her surviving spouse. [4]

Portability of the DSUEA

Fittingly, as Benjamin Franklin notes there are two certainties in life; death and taxes.[5] Eventually the surviving spouse too will die and a tax on the combined estate will be imposed. Nevertheless, the Tax Relief Act of 2010 introduces a new estate tax concept for 2011 and 2012—the deceased spouse unused exclusion amount (DSUEA). Essentially, the DSUEA allows a surviving spouse to utilize the unused exclusion amount of the first spouse to die.

Under the provision, any applicable exclusion amount that remains unused as of the death of a spouse who dies after December 31, 2010 (the ‘‘deceased spousal unused exclusion amount’’), generally is available for use by the surviving spouse, as an addition to such surviving spouse’s applicable exclusion amount.[6]

If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last such deceased spouse. A surviving spouse may use the predeceased spousal carryover amount in addition to such surviving spouse’s own $5 million exclusion for taxable transfers made during life or at death.

A deceased spousal unused exclusion amount is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise is required to file an estate tax return.

The applicable exclusion amount is the sum of two components: the basic exclusion amount and the DSUEA. The basic exclusion amount for estates of decedents dying in 2011 and 2012 is $5 million. The second part of the equation, the DSUEA, is the amount of the first-to-die spouse’s exclusion amount that is not used by that spouse’s estate. Note that a surviving spouse’s DSUEA is equal to the unused exclusion amount of the surviving spouse’s last deceased spouse.

Tomorrow’s blogticle will continue our weeklong series on the gift and estate tax.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] A ‘qualifying income interest for life’’ exists if: (1) the surviving spouse is entitled to all the income from the property (payable annually or at more frequent intervals) or has the right to use the property during the spouse’s life; and (2) no person has the power to appoint any part of the property to any person other than the surviving spouse.

[3] See generally IRC Secs. 2056 & 2523.

[4] IRC Secs. 2056 & 2523.; AMAFX-AUS Main Library. The Federal Estate Tax.

[5] Benjamin Franklin. Letter to Jean Baptiste La Roy 1789. “But in this world nothing can said to be certain except death and taxes.’

[6] See generally IRC Sec 2010(c)(4).

Why is this Topic Important to Wealth Managers?  Discusses the Estate and Generation Skipping Transfer Tax with regards to the new Obama Tax Cuts.

The recent Obama Tax Cuts reinstated the estate and generation skipping transfer taxes effective for decedents dying and transfers made after December 31, 2009.  As was discussed earlier this week, the estate tax applicable exclusion amount is $5 million for decedents dying in calendar years after 2011, and the maximum estate tax rate is 35 percent. Furthermore, the generation skipping transfer tax exemption for decedents dying or gifts made after December 31, 2009, is equal to the applicable exclusion amount for estate tax purposes ($5 million for 2010).

For a general background on the Generation Skipping Transfer Tax, see our November 1^st Blogticle entitled: Life Insurance and the Generation—Skipping Transfer Tax

Although technically the generation skipping transfer tax is applicable for 2010, the generation skipping transfer tax rate for transfers made during 2010 is zero percent. After this year, the generation skipping transfer tax rate equals the highest estate and gift tax rate in effect for such year (35 percent in 2011 and 2012), notwithstanding the exclusion amounts.

Moreover, under the new law, a recipient of property acquired from a decedent who dies after December 31, 2009, generally will receive fair market value basis (i.e., “step up” in basis). [1]

Election for decedents who die during 2010

In the case of a decedent who dies during 2010, the new law generally allows the executor of such decedent’s estate to make an election whereby the estate would not be subject to estate tax, and the basis of assets acquired from the decedent would be determined under the modified carryover basis rules. [2]

Portability of unused exemption between spouses

Under the new law, any applicable exclusion amount that remains unused (including those used in the calculation of the generation skipping transfer tax), from the death of a deceased spouse, beginning next year, is available for use by the surviving spouse, in addition to such surviving spouse’s applicable exclusion amount.  A surviving spouse may use the unused amount in addition to such surviving spouse’s own $5 million exclusion for taxable transfers made during life or at death for a total of $10 million.

Extension of certain filing deadlines

The new law also provides for the extension of filing deadlines for certain transfer tax returns. Specifically, in the case of a decedent dying after December 31, 2009, and before the date of enactment, the due date shall not be earlier than the date which is nine months after the date of enactment to file and pay the estate tax

Sunset provision

Under the bill, the sunset of the new law of applies to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, 2012.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts and how they relate to wealth managers.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] For determination of modified basis carryover, see 26 U.S.C. § 1022.

President Obama’s tax compromise introduces a new estate tax concept for 2011 and 2012, the deceased spouse unused exclusion amount (DSUEA).  Essentially, the DSUEA allows a surviving spouse to utilize the unused exclusion amount of the first spouse to die.  The new law raises an important planning question: Is the bypass (credit shelter) trust obsolete as an estate planning device? Also: Do existing bypass trusts need to be amended in light of the new law?

In general, under the new estate tax, an estate’s exclusion amount, referred to as its applicable exclusion amount, is the sum of two components: the basic exclusion amount and the DSUEA. The basic exclusion amount for estates of decedents dying in 2011 and 2012 is $5 million. The second part of the equation, the DSUEA, is the amount of the first-to-die spouse’s exclusion amount that is not used by the that spouse’s estate. Note that a surviving spouse’s DSUEA is equal to the unused exclusion amount of the surviving spouse’s last deceased spouse.  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of Obama’s tax agreement, including its estate tax provisions, in Advisor’s Journal, see Obama Tax Agreement Faces Stiff Resistance in Congress (CC 10-112) and Obama Tax Agreement Passed by House (CC 10-117).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes.