The Qualified Domestic Trust

As stated in our previous post, the unlimited marital deduction is disallowed for distributions to non-citizen spouses. There is an exception to this disallowance however. A Qualified Domestic Trust (QDOT) can be created whereby property can pass to the non-citizen surviving spouse and qualify for the marital deduction. The QDOT can be created post-death provided that the property is transferred to the trust or is irrevocably assigned prior to the estate tax return due date.

The Unlimited Marital Deduction

There is no estate tax liability for assets passing from a deceased spouse to the surviving spouse. Both Ohio and federal provide for an unlimited marital deduction for the transfer of property between spouses. This is based upon the view that the husband and wife are one economic unit.

The marital deduction applies to transfers during lifetime and at death. The deduction is only for U.S. citizens regarding property passing from one spouse to the other (the citizenship requirement is to ensure that the government can ultimately collect the estate tax from the surviving spouse's estate). This is one reason that estate planning attorneys want to confirm that husband and wife are both U.S. citizens (especially with Ohio's close proximity to Canada).

Technically, the marital deduction simply defers the estate tax and does not avoid it. While an outright bequest of decedent’s entire estate to a spouse will eliminate estate tax at the decedent’s death, the surviving spouse’s estate will be taxed on all of the assets transferred from decedent (that is unless the surviving spouse consumes or gifts away the assets). As a consequence, the marital deduction simply defers the tax to the second estate.

What Happens to the Exemption for Generation-Skipping Transfer Tax in 2011?

We are already Mid-November and nothing has happened legislatively regarding the federal estate tax exemption. Although the Generation-Skipping Transfer (GST) Tax is independent of the federal estate tax, legislative changes to the exemption amounts would likely occur at the same time. Since 2004, the GST exemption equaled the estate tax applicable exclusion amount. In 2009, the GST exemption was $3,500,000. In 2010, the GST was repealed, and in 2011 the tax will be back with an exemption amount of $1,060,000,indexed for inflation.

The GST tax is imposed on asset transfers to "skip persons". "Skip persons" are generally grandchildren and later descendants of the donor, if the donor's child, who is the parent of the donee is living.

The government's concern of generation-skipping transfers is best shown by example.

Rich Guy-àGuy's son-àGuy's grandson-àGuy's great grandson

V V V

First Estate Second Estate Third Estate

In the normal case, you would have 3 separate estates from which the government could tax. However, where Rich Guy's estate is placed in trust with son and grandson having right to income with principal going to great grandson, Rich Guy gets similar result and 2 generations of estate tax skipped.

Will the federal government act in the short term to change the GST exemption amount or will it go back to its 2001 level?

A Lunch with the Ladies of the Grandview Civic Welfare Club

I have waited months and months for the motivation to return from my blog hiatus. As it turns out, my inspiration is a 90 year old club in Grandview, Ohio. Yesterday, I had the privilege to speak to the members of the Grandview Civic Welfare Club. A perk of being a male speaker for an all-ladies club is gaining admission to one of their meetings. (They meet the second Wednesday of each month at the Grandview Heights Public Library). What did I observe? A concise and relevant meeting of a group that prides itself on helping the communities of Grandview and Marble Cliff. The club was recognized last month by Mayor Ray DeGraw when he presented the group with a proclamation, declaring October 13 as "Grandview Civic Welfare Day" in the city. While a proclamation is nice and well-deserved, these members appear to be motivated by serving their community. There is also the fun aspect. If you are ever at the Grandview Heights Public Library's lower level and hear laughter, chances are it’s the Grandview Civic Welfare Association.

Capitalizing on Low Home Values – Meet the Qualified Personal Residence Trust (QPRT)

Most of us have witnessed the highs and lows of investing and understand that timing is everything. This is also evident in the real estate market where the US housing prices continue to struggle. In some circumstances, the stagnant housing market may present an opportunity for one to plan for the purpose of lowering their ultimate estate tax liability. Through the use of a Qualified Personal Residence Trust (QPRT) the grantor can transfer the title of the real estate to the trust and retain the right to continue to use the residence for a term of years with the remainder transferring to children or other beneficiaries. Assuming that the grantor survives the term, the residence will not be included in the donor’s estate for estate tax purposes. At the end of the term, the residence will be distributed to the beneficiaries, or may remain in further trust for the benefit of those beneficiaries. If the grantor outlives the term, the grantor may agree with the beneficiaries or with the trustee to continue to use the residence, so long as the grantor pays fair market rent for this use. The payment of fair market rent avoids a challenge by the IRS that the grantor’s continued enjoyment of the residence draws the residence back into the donor’s estate for tax purposes.

The transfer of the residence to the QPRT is considered a gift by the grantor for gift tax purposes; however, the gift is of a future interest in the property and thus reduces the value of the gift significantly. The grantor uses some of his lifetime federal gift tax exclusion amount or may even incur some gift tax liability now, to save more on estate tax later. If the grantor survives the term of the QPRT, the value of the house, plus any appreciation from the date it was transferred, passes to the children with no additional estate tax.

Example

John transfers a $1 million residence to his QPRT, retaining the right to live in the residence for a eight-year term. The value of the present gift to the remainder beneficiaries might be only 50%, or $500,000. If John survives the eight-year term, the residence will not be included in his estate for tax purposes, nor will any of the appreciation in value of the residence occurring after the initial transfer. If, after eight years, the residence has appreciated in value to $1.5 million, John has succeeded in transferring this amount to his beneficiaries at the same tax cost as a transfer of only $500,000.

To read more about this topic see an article titled, Low home values shine favorable light on personal residence trusts by Robert Celaschi, appearing in Business First's Estate Planning Section, March 19, 2010.

Nonprofits Under the Gun

This morning, the Columbus Dispatch perhaps provided a valuable service to people involved in nonprofits. The article Charities up against IRS deadline also likely caused some hand wringing among these same people who probably finished their cup of coffee and dashed off to their computer to see if their nonprofit was on the list of charities in danger of losing their tax-exempt status with the IRS. The statistics from the article came from the National Center for Charitable Statistic website. The website is a very good source and is now marked as one of my "favorites". I imagine the website might be running a little slow today due to a large amount of traffic. The Dispatch article indicates that approximately 8,900 charities have a filing requirement with most of those having a filing deadline of Monday, May 17.

The good news is that gives most charities enough time to become compliant. If the charity's gross receipts are less than $25,000, all it needs to do is file a Form 990-N (e-postcard) that consists of eight easy questions. If the charity's gross receipts are over $25,000, a Form 990 return is required to be filed. It is possible to get an extension on filing the Form 990.

How to Avoid Guardianships (and When Not to)

Here is a link to a recent article that I wrote for the Columbus Bar Association, appearing in April 2010's Columbus Bar News Bytes.

Recommended Website: GuideStar

We regularly come across websites or web-based products that we find highly useful. One particular website that we have used for years is GuideStar. This website covers nonprofit organizations like no other. The site permits you to search for nonprofits by name and/or location. The information that you can access depends on whether you pay for a premium subscription. With a premium subscription, you can access the organization's IRS form 990, find out about executive compensation, and much more. Even without a premium subscription, it is a valuable tool. We receive the GuideStar Newsletter via email and it frequently contains useful information.

Trust Mills Beware

For many years, estate planning attorneys, bar associations and the Ohio Legislature have warned citizens to beware of Trust Mills. Now the Ohio Supreme court has sent a message to Trust Mills to beware of operating in Ohio. A Trust Mill is a company that has agents pushing a “one-type fits all” trust form for a substantial price. Trust Mills often focus on the elderly with scare tactics such as brochures and mailings warning that even modest estates will be consumed by estate taxes and probate fees. In most instances, the victims of Trust Mills never speak with an attorney.

The Ohio Supreme Court in its decision, Columbus Bar Assn. v. Am. Family Prepaid Legal Corp., imposed a $6.4 Million civil penalty against a California Trust Mill operating in Ohio. The penalty is also against the two owners of the Trust Mill, American Family Prepaid Legal Corporation. The Supreme Court decision does a very good job of laying out how these companies operate.

The American Bar Association (ABA) has a report on the decision, Court Fines 2 Cos. $6.4M for Unauthorized Law Practice, Bans Them From State. The Columbus Dispatch reported on the decision, Companies that duped thousands of Ohio senior citizens fined $6.4 million. The Associated Press has an article, $6.4M fine in Ohio for illegal practice of law.

Movement to Eliminate Ohio’s Estate Tax is Under Way

The Ohio chapter of Americans for Prosperity is pushing forward with its proposal to repeal Ohio’s estate tax. Ohio assesses a tax on residents’ estates valued at $338,333 or more. The group successfully certified its petition with the Ohio Attorney General’s office and the Ohio Ballot Board. The group now needs to collect 120,683 valid signatures of registered Ohio voters by the end of the year to have the legislature consider its proposal.

If you are an opponent of the Ohio estate tax, you may want to contact the Ohio chapter of Americans for Prosperity to sign the petition and/or to volunteer to circulate the petition.

U.S. Continues to Uncover the Methods Used by Wealthy Tax-Evaders

In our last post, we addressed that the IRS was receiving an overwhelming number of disclosures from wealthy taxpayers, regarding income earned, but not reported, on offshore accounts. The U.S. continues to aggressively pursue the people who use these schemes to avoid paying income tax and the financial institutions that have willingly assisted and advised on how to set up these accounts.

The identities of many of these account holders have been revealed through the government’s civil and criminal cases against the Swiss bank, UBS. The bank turned over the names of 250 account holder as part of a criminal settlement. The number of names is about to grow significantly due to a separate settlement in a civil case against UBS, where it is expected that the bank will turn over thousands of names of U.S. account holders. This revelation makes for a large number of nervous tax-evaders. The bank unsuccessfully argued that it could not provide the account information due to Swiss privacy laws.

The IRS has been pursuing charges against the account holders revealed to it by the bank in the criminal settlement. There have been at least four guilty pleas to date. These cases have revealed in detail the elaborate schemes set up by wealthy U.S. residents with the assistance of UBS and Swiss lawyers. A recent Wall Street Journal (WSJ) article, UBS Tax Crackdown Widens to Hong Kong, identifies a California resident who opened a Swiss bank account with UBS in the name of a Hong Kong entity. The Californian moved more than $1 million from a Los Angeles business to the offshore account. The details of these schemes will continue to be revealed as the U.S. investigation spreads.

IRS Offering Clemency for Taxpayers Secreting Offshore Accounts

U.S. Taxpayers are required to declare on an annual basis income earned from foreign financial accounts by the filing of IRS Form TD F 90-22.1. For years, offshore accounts in certain countries have made it possible for these taxpayers to park money outside of the U.S., concealing that income from the IRS. It is estimated that billions of dollars in income tax revenues is lost every year to undisclosed offshore accounts.

While the IRS has urged compliance by implementing “amnesty” programs in the past, none has had the response of the current disclosure program commenced in March of this year. The disclosure program, which is currently scheduled to end on September 23, 2009, asks the taxpayer to volunteer information by following the procedure set out in IRS IRM 9.5.11.9 in exchange for avoiding substantial civil penalties and criminal prosecution.

According to a recent Wall Street Journal (WSJ) article, Tax Evaders Flock to IRS to Confess Their Sins, the volume of wealthy taxpayers filing for relief as a result of the Offshore Voluntary Disclosure Initiative has overwhelmed the IRS. An example provided in the WSJ article, helps explain the dramatic response. Under the disclosure program, a taxpayer with offshore accounts in the amount of $1 million that earns $50,000 in annual income for a six year period might end up paying $386,000 plus interest. A non-disclosing taxpayer might incur a $2.3 million penalty in addition to criminal prosecution.

It is not just the reduced penalties that are causing the influx of confessors. Recent federal court decisions have authorized the IRS to request information from foreign-based financial institutions.

If you are interested in learning more about the Offshore Voluntary Disclosure Initiative, there is a IRS Frequently Asked Questions (FAQ) release, recently modified on July 31, 2009.

Stepped-Up Basis to be Replaced by Carry-Over Basis

When you purchase an asset, the purchase price becomes your tax basis for that property. If you later sell that asset, your tax basis is used to determine your capital gain or loss for tax purposes.

If you receive property by gift, you take the donor’s basis. For example, Mr. Smith purchases ABC stock for $10 a share. Mr. Smith’s basis is $10 a share and if he sells the stock, his gain or loss would be based upon his $10 tax basis. Mr. Smith, instead of selling his ABC stock, gives his son the stock. His son’s basis is also $10 per share. This is sometimes called a “carry-over” basis, because Mr. Smith’s tax basis carries over to his son.

One benefit of inheriting property from a decedent is receiving a “stepped-up” basis. Pursuant to Internal Revenue Code (IRC) §1014, the basis of property inherited from a decedent is generally the fair market value of the property at the decedent's death, as opposed to the decedent’s cost to acquire the property. For example, Mr. Smith leaves his ABC stock to his son in his will. At the time Mr. Smith passes away, the value of the stock is $25 per share. Although Mr. Smith’s basis was $10, his son’s basis is stepped up to $25.

The benefit of the “stepped-up” basis will not be with us much longer, barring a legislative change. This is because the “stepped-up” basis under IRC §1022 will not apply to decedents’ estates with a date of death after December 31, 2009. Instead, IRC §1022 provides that the property acquired from a decedent shall be treated as transferred by gift. Therefore, when an heir sells the asset, he will be responsible for paying capital gains tax on all the gains that had accrued since the decedent originally acquired the asset.