Florida Probate, Trust & Estate Blog : Florida Probate Lawyers & Attorneys : Clark Skatoff Law Firm : FL Wills, Trusts & Inheritance : Palm Beach, Broward County, Boca Raton

Title: Pressing the “Do Over” Button: Strategies for Modifying Wills and Trusts after Formation

Presenter: Joshua S. Rubenstein

                Mr. Rubenstein opened his presentation discussing a few current events that weren’t expected such as the European debt crisis, the Asian spring, and the Yankees failing to reach the World Series. He noted that you cannot anticipate all changes and issues that may arise in the future.   Clients often make bad decisions regarding their estate plans, and lawyers sometimes make mistakes. In addition, people are living longer than ever before which raises the question, so how long does a person have to wait to inherit? There is an increase in litigation, and trust beneficiaries often few trusts negatively. Mr. Rubenstein divided the presentation into four different sections in discussing how to address some of these issues:  I) Tax Considerations Underlying Modifications: Income and Transfer Taxes, II) Retroactive Modifications, III) Prospective Modifications, and IV) Special Considerations with Respect to Litigation Settlements. 

I) Tax Considerations

                In describing the tax consideration’s underlying modifications, he noted the current low income tax rates, which he only expects to increase.  Historically income tax rates are as high as 90% for the top rates as opposed to the current 35-40% income tax rates and 15-28% capital gains rates.   He also discussed the various forms of taxation for different entities and how gifts, legacies and distributions from estate/and or trusts are generally tax exempt, except for income in respect of a decedent, distributable net Income, and gifts to employees.   The most common deductions are charitable, businesses, and administration expenses which are all subject to substantial limitations. He also noted many states and municipalities impose income tax rates, while eight states levy no income tax. 

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Many clients have or are considering using an irrevocable life insurance trust to minimize estate taxes. Assets properly held in irrevocable trust are not subject to estate tax. Annual gifts can be made to the trust to pay life insurance premiums, subject to beneficiaries’ rights of withdrawal of such assets, known as a “Crummey” withdrawal right.   

Most life insurance trusts are drafted to give the beneficiaries the right to withdraw the asset put into the trust. This is intended to ensure the gift qualifies for the annual gift tax exclusion amount as codified in Internal Revenue Code section 2503(b). (The annual exclusion amount is currently $13,000 per person per year.) This withdrawal power is known as a “Crummey” power after the seminal case on the subject Crummey v. Commissioner, 397 F.2d 88 (9th Cir 1968). 

Best practice, is to gift the insurance premium amount into the trust and have the trustee give to the beneficiaries a notice or right to withdraw, known as a crummey letter or crummey notice. But, what happens when the premiums are paid straight to the insurance company and no crummey notice or crummey withdrawal power is sent?

In the recent Tax Court case of Estate of Turner v. Comm'r, T.C. Memo. 2011-209 (Aug. 30, 2011), the IRS challenged the availability of the annual exclusion for amounts used to pay policy premiums directly, among other items. The IRS asserted two arguments to prevent the policy premium payments from being treated as annual exclusion gifts:

1. First, since premium payments were not made to the trust, the beneficiaries had no meaningful rights to withdraw such amounts and therefore it was not a present interest gift qualifying for the annual exclusion amount.
2. Second, since the beneficiaries did not receive notice of the gifts, they did not know of their legal right to demand distributions and the gifts should not qualify as a present interest gift available for the annual gift tax exclusion. 

In a monumental victory for the taxpayer, the Tax Court held that both IRS arguments had no impact on the annual exclusion for gift tax purposes. First, it provided that since the trust allowed for withdrawals for direct or indirect distributions, the manner of payment of the premium was not determinative as to whether the gift qualified for the annual exclusion. Secondly, the Tax Court determined the lack of any crummey notice or crummey withdrawal right for the gift did not affect the beneficiary’s legal right to demand a withdrawal.

While it is still advisable clients follow best practices in the funding of life insurance trusts, this case does provide some comfort in circumstances where such advice is not followed (although it should be noted the terms of your trust may change the result). Furthermore, the IRS and other courts have not conceded to this interpretation, so clients not implementing best practices do so at their own peril. If you need any advice on an estate planning or tax issue, please contact Jeffrey Skatoff or Craig Dreyer at (561) 842-4868.  

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Many clients have or are considering using an irrevocable life insurance trust to minimize estate taxes. Assets properly held in irrevocable trust are not subject to estate tax. Annual gifts can be made to the trust to pay life insurance premiums, subject to beneficiaries’ rights of withdrawal of such assets, known as a “Crummey” withdrawal right. 

Most life insurance trusts are drafted to give the beneficiaries the right to withdraw the asset put into the trust. This is intended to ensure the gift qualifies for the annual gift tax exclusion amount as codified in Internal Revenue Code section 2503(b). (The annual gift exclusion amount is currently $13,000 per person per year.) This withdrawal power is known as a “Crummey” power after the seminal case on the subject Crummey v. Commissioner, 397 F.2d 88 (9th Cir 1968). 

Best practice, is to gift the insurance premium amount into the trust and have the trustee give to the beneficiaries a notice or right to withdraw, known as a crummey letter or crummey notice. But, what happens when the premiums are paid straight to the insurance company and no crummey notice or crummey withdrawal power is sent?

In the recent Tax Court case of Estate of Turner v. Comm'r, T.C. Memo. 2011-209 (Aug. 30, 2011), the IRS challenged the availability of the annual exclusion for amounts used to pay policy premiums directly, among other items. The IRS asserted two arguments to prevent the policy premium payments from being treated as annual exclusion gifts:

1. First, since premium payments were not made to the trust, the beneficiaries had no meaningful rights to withdraw such amounts and therefore it was not a present interest gift qualifying for the annual exclusion amount.
2. Second, since the beneficiaries did not receive notice of the gifts, they did not know of their legal right to demand distributions and the gifts should not qualify as a present interest gift available for the annual gift tax exclusion. 

In a monumental victory for the taxpayer, the Tax Court held that both IRS arguments had no impact on the annual exclusion for gift tax purposes. First, it provided that since the trust allowed for withdrawals for direct or indirect distributions, the manner of payment of the premium was not determinative as to whether the gift qualified for the annual exclusion. Secondly, the Tax Court determined the lack of any crummey notice or crummey withdrawal right for the gift did not affect the beneficiary’s legal right to demand a withdrawal.

While it is still advisable clients follow best practices in the funding of life insurance trusts, this case does provide some comfort in circumstances where such advice is not followed (although it should be noted the terms of your trust may change the result). Furthermore, the IRS and other courts have not conceded to this interpretation, so clients not implementing best practices do so at their own peril. If you need any advice on an estate planning or tax issue, please contact Craig Dreyer or Jeffrey Skatoff at (561) 842-4868.  

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In a dramatic change from previous law, the Florida Legislature has enacted Florida Statute section 732.615 to allow the reformation of a will. Previously under Florida probate law, a trust could be reformed for a mistake of fact or law, but a will could not. The new statute allowing the modification of wills is effective as of July 1, 2011 and reads as follows:

732.615 Reformation to correct mistakes.—Upon application of any interested person, the court may reform the terms of a will, even if unambiguous, to conform the terms to the testator's intent if it is proved by clear and convincing evidence that both the accomplishment of the testator's intent and the terms of the will were affected by a mistake of fact or law, whether in expression or inducement. In determining the testator's original intent, the court may consider evidence relevant to the testator's intent even though the evidence contradicts an apparent plain meaning of the will. 

Previously, if a will was ambiguous, a Florida court could allow a reformation since the primary intent was to ascertain the intent of the testator. However, in some circumstances a mistake did not involve ambiguity, but instead involved a mistake of fact or law. One such example is where a bequest was for $10,000 instead of $100,000. In such cases, courts were previously barred from introducing evidence to determine the true intent of the testator, even if it was obvious what the testator’s true intent was from evidence other than the will. 

New Florida Statute section 732.615 will give support for beneficiaries who were deprived of an inheritance or part of an inheritance under a will when it was clear from other evidence that the decedent’s intent was not properly reflected in the will.  If you have any questions, or we can help you with an estate planning or probate matter, please contact Craig Dreyer or Jeffrey Skatoff at (561) 842-4868.

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On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Act).  The 2010 Act provides for extension of the Bush tax cuts from 2001 and 2003 until 2012, as well as a variety of other tax reductions.   Here are the some of the highlights.

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With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRA), estate planners were on notice that there would be no estate tax in 2010.  Unfortunately, very few estate plans have been drafted to take into account this one-year repeal.

Prior to the passage of EGTRA, the estate tax rate was 55%, and the exemption amount was $675,000.  During the decade, the estate tax rate was gradually lowered to 45% by 2009, and the exemption amount was gradually raised, to $3.5 million by 2009.  Under EGTRA, there is no estate tax in 2010.  In 2011, however, the estate tax springs back with a vengeance - a 55% estate tax rate, and an exemption amount of only $1 million.

For deaths that occur in 2010, the repeal is important because the level of federal estate taxation can control bequests in a will or trust.  For a married couple with a taxable estate under the pre-2010 law, the goal was to take advantage of the estate tax exemption amount to the maximum extent possible, while leaving the remainder of the estate to the surviving spouse (directly or in a marital trust).  A standard will or revocable trust would establish two trusts for this purpose.  The first is the Family Trust, into which the maximum estate tax exemption amount would be allocated.  The second trust would be the Marital Trust, into which the balance of the estate would pass, free of estate tax.  A will or revocable trust would contain an allocation clause to fund each trust.  For example:

I give to the Marital Trust the smallest pecuniary amount that, if allowed as a federal estate tax marital deduction, would result in the least possible federal estate tax being payable by reason of my death, with the remainder to the Family Trust.

If there is no estate tax, this allocation clause could fairly be read as allocating none of the estate to the Marital Trust, and all of the estate to the Family Trust.  If the Marital Trust and the Family Trust have the same disposition plan, same beneficiaries and same trustees, there is likely no problem.  Such would often be the case in a first marriage / common children situation.

If there are children from a first marriage and a second spouse, the Marital Trust and the Family Trust will often look quite different.  For example, although only a surviving spouse can be a beneficiary of a Marital Trust while alive, the Family Trust may or may not include the surviving spouse as a beneficiary.  Or, if the surviving spouse is a beneficiary of the Family Trust, there may be more severe limitations on distributions.  Sometimes, a surviving spouse will control who gets the assets in the Marital Trust upon death, while a Family Trust would not typically contain such a provision.

A surviving spouse who receives a Marital Trust of zero as a result of the spouse passing away in 2010 will have some recourse - the elective share, which would allocate to the surviving spouse a portion of the overall estate.  (The elective share in Florida is 30%.)  The elective share, however, may be less than what the passing spouse may have intended to pass to the surviving spouse.  Moreover, the expense of claiming the elective share could be considerable - especially when property is located both inside and outside of Florida.  In other words, the surviving spouse could be significantly harmed by the obsolete allocation clause.  The beneficiaries of the Family Trust may also have cause to complain, given the chaos which will have been unleashed on their situation.  

Whether estate planning documents drafted after the passage of EGTRA in 2001 which do not take into account the 2010 estate tax environment create malpractice for the drafting attorney is an open question.  Certainly any person with an outdated estate plan should seek review and guidance at once. 

How Should Obsolete Estate Planning Documents be Fixed?

One way to fix an estate plan's funding formula will be an override provision.  For example, the following clause could be added after the funding formula.

Notwithstanding the foregoing, not less than 50% of the residuary estate shall be allocated to the Marital Trust.

OR

Notwithstanding the foregoing, not less than $2 million of the residuary estate shall be allocated to the Marital Trust.

There are likely a number of ways in which to protect an estate plan from the situation that Congress has placed the American public.  The important point is to do something.

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In a startling display of Congressional ineptitude, Congress allowed the estate tax to expire as of January 1, 2010.  Before the trust fund babies trade in their Porches for Lamborghinis, realize that Congress may successfully enact an estate tax for 2010, and make it retroactive to January 1, 2010.  Although such retroactivity is likely to pass scrutiny, the results of any court  test are not likely to be resolved for years.  Here's why:

Assuming our hypothetical deceased passes away on January 1, 2010, the estate tax return is due nine months from the date of death.  Therefore, the estate tax return is due to be filed by October 1, 2010.  Assuming that prior to October 1, 2010 the Federal government enacts a new estate tax retroactive to January 1, 2010, the executor of the estate is likely to file the estate tax return showing zero estate tax liability, and include a disclosure statement that the estate is challenging the retroactive nature of the estate tax.  (To avoid interest and penalties while taking such a position, an executor should consider an estate tax deposit.) 

The audit of the estate tax return is not likely to conclude for eighteen months after filing the return, which takes us to April 1, 2012.  Assuming that the audit results in the IRS assessing the full estate tax, the estate has 90 days from the receipt of the IRS Notice of Assessment to file a Tax Court Petition.  Assume that the estate files its Tax Court Petition within one month, which takes us to May 1, 2012.

A Tax Court case typically takes approximately one year to resolve (although some tax court cases go on for many, many years).  Lets assume one year, so now we are at May 1, 2013.

Assume the Tax Court rules in favor of the IRS and upholds the retroactive estate tax.  The estate appeals the Tax Court ruling to a Court of Appeals.  The appeal may take approximately one year to resolve, depending on which circuit the appeal lies.  Lets assume one year, which takes us to May 1, 2014. 

Assume the Court of Appeals rules in favor of the IRS.  The estate seeks review by the Supreme Court.  Even if the Supreme Court refuses to hear the case, that process can take approximately two months to play out.  So now we are at July 1, 2014. 

For the "test case" to challenge the retroactivity of the estate tax back to January 1, 2010 (assuming Congress enacts such a statute), the results may not be known for over four years! 

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The Congressional Budget Office has just released an Issue Brief on Federal Estate and Gift Taxes, setting forth the revenue that the estate and gift tax raises, how such revenue is affected by the various proposals for estate and gift tax reform, and a detailed explanation of the various reform proposals.  

Among the highlights:

• Estate and gift tax receipts have averaged about 1.5% of federal tax revenue over the last few years
• Larger estates pay a significant portion of the estate tax.  In 2007, taxes on gross estates valued at more that $20 million were 36% of total estate tax revenue, and taxes on estates valued at more than $10 million accounted for 55% of total estate taxes.
• A permanent repeal of the estate tax would cause a revenue loss of approximately $500 billion between 2010 and 2019.
• Under current law, the 55% rate with a $1 million exemption is set to be reinstated in 2011 without a new law being put in place.  This is the rate structure that was in place in 2001.  If the federal government puts the 2009 rate structure in place for 2010 and beyond (45% rate with $3.5 million exemption), the loss in revenue as compared to doing nothing would be approximately $233 billion. 

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We are often asked whether Florida imposes an inheritance tax or estate tax on the estates of deceased persons.  Thankfully, there is no Florida inheritance or estate tax.  There are estate taxes that Florida residents need to be aware of:  the Federal estate tax, and the estate taxes that other states might impose.

The Federal estate tax, through the end of 2009, is imposed at a rate of 45%, after taking into account a $3.5 million exemption.  As of the writing of this entry, the estate tax is scheduled to be eliminated for 2010, only to be reinstated in 2011 at a rate of 55% and an exemption level of $1 million.  Please read about the estate tax fix.

Residents of Florida who own real estate in states that impose a state estate tax could be subject to such taxes in the absence of good planning.  Those states with a state estate tax include many of the states where Florida residents have migrated from, including Connecticut, Delaware, Illinois, Maryland, Massachusetts, New Jersey, New York, Ohio, and Rhode Island.   

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When large taxable estates are involved in litigation, estate tax issues can be tricky. This problem is most pronounced where one outcome of the litigation would result in less estate tax being paid. For example, if an adult child is the beneficiary of the last will, but a charity is the beneficiary of a prior will, and the child and the charity are litigating over which is the valid will, how much estate tax will ultimately be owed is unknown.  

If the charity prevails, because bequests to a charity are free of estate tax, the estate owes nothing. If the child prevails, the estate might owe estate tax on the bequest.  Estate taxes are due and payable nine months from the date of death, or interest and possibly penalties could apply. Most complex estate litigation would still be pending nine months after death.

If the maximum amount of estate tax is paid to the Internal Revenue Service, the estate may have some difficulty getting the money back if the charity prevails. If the estate pays less than what it would owe if the child prevails, interest and penalties may apply.  

In order to stop the possible imposition of interest and penalties, yet still allow for an easy return of funds should the estate not owe the tax, the Internal Revenue Code, Section 6603, allows a taxpayer to submit a deposit. The estate tax return would be filed as if the charity were to prevail, showing no tax owing, with adequate disclosure of the litigation.  Simultaneously, the estate would place on deposit with the IRS an amount that would equal the tax were the child to prevail.  

Under Revenue Procedure 2005-18, a deposit is automatically returned upon request, normally with interest.  A payment is not returned so easily, and the IRS could refuse to make the payment refund or could delay the return of the payment for an extended period of time, complicating the closure of the estate. 

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Recent attempts to fix the impending repeal of the estate tax and subsequent re-enactment at higher rates have been reported by the New York Times, in Carl Hulse's article, Estate Tax Is Expiring, but Death Won’t Last.  

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRA), the estate tax rates and exemption amounts have been sliding lower, from a top rate of 55% and an exemption amount of $1 million in 2001, down to a top rate of 45% and an exemption of $3.5 million in 2009. This change has reduced the number of taxable estates by 90%, some commentators have estimated.

Under current law, in 2010, the estate tax vanishes. Due to budgeting rules in place in 2001, Congress was required to reinstate the 2001 estate rules for the year 2011 and beyond. So, in 2011, current law would take us back to a 55% estate tax rate and an exemption amount of only $1 million. This change would ensnare hundreds of thousands of estates annually that are currently free of estate tax.

Practitioners in the estate field have been assuming that Congress would at some point during 2009 (and certainly well before the week before Christmas) enact a new statute preserving the estate tax in 2010, and reducing the otherwise draconian rate and exemption structure scheduled to go into effect on January 1, 2011. Professor Edward J. McCaffery's, The Politics of Estate Tax Reform, has an explanation of the politics behind the estate tax.   

What happens to the estates of those who pass away in the first part of 2010, before a new estate tax law is put into place later in 2010? For those of you thinking that such estates will pass without estate tax, such a result is doubtful. This situation has happened before, with a retroactive rate increase that was imposed on persons who passed away prior to the passing of the rate increase.

Provided that the retroactive application of a statute is supported by a legitimate legislative purpose furthered by rational means, judgments about the wisdom of such legislation remain within the exclusive province of the legislative and executive branches . . . .
To be sure, . . . retroactive legislation does have to meet a burden not faced by legislation that has only future effects . . . . “The retroactive aspects of legislation, as well as the prospective aspects, must meet the test of due process, and the justifications for the latter may not suffice for the former” . . . . But that burden is met simply by showing that the retroactive application of the legislation is itself justified by a rational legislative purpose.

United States v. Carlton, 512 U.S. 26, 30 (1994)

In other words, if Congress wants to raise money by raising taxes retroactively, the Supreme Court is not going to stand in its way.

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