Ronald Morton's Elder Law Blog

How Will 2010 Executors Handle Carryover Basis?

The following was posed in Crescendo eNotes January 18, 2010, and I though it would be of interest to readers of this blog:

As the first decedents pass away in 2010, executors and their advisors are now faced with great uncertainty. IRS Form 706 Estate Tax Returns will be due in nine months, although nearly all executors request an automatic extension of six months. Therefore, for individuals who pass away in January of 2010, estate tax returns are likely to be filed in April of 2011.

Attorney Conrad Teitell testified before the Senate Finance Committee on estate taxes on November 14, 2007. He explained that there are extraordinary differences in the level of estate taxation for the years 2008, 2009, 2010 and 2011. Estate taxes for taxable estates would be moderate in 2008, lower in 2009, zero in 2010 and very high in 2011.

On January 12, 2010, Mr. Teitell again wrote a letter to Chairman Max Baucus (D-MT) and Ranking Member Charles Grassley (R-IA). He noted, "Estate planning is serious business and not a game. Yet a retroactive change in the 2010 estate rules would literally make estate planning a role of the dice." To read the Conrad Teitell letter click here.

Mr. Teitell proposed two actions. First, he suggests that "the carryover basis rules be repealed retroactively." Second, he recommended that changes in estate tax laws be prospective. If the existing law is unchanged, 2010 estates will not be subject to estate tax, but also will not benefit from carryover basis. There is a $1,300,000 exclusion for each decedent and a $3,000,000 exclusion for a surviving spouse, but most assets in excess of these amounts will have a carry-forward basis.

Mitchell Gans is a respected estate commentator and teaches at Hofstra University School of Law. He published an article this week that discusses the constitutionality of a retroactive estate tax law. Mr. Gans "would favor a retroactive approach."

However, he is concerned that under United States v. Carlton, 512 U.S. 26 (1994), the retroactive estate tax compromise may not be upheld. While Carlton is a precedent for allowing retroactivity (similar to the Sec. 2057 rule that was imposed and upheld in Carlton), Professor Gans suggests that a retroactive estate tax could be determined to be a "new" tax. If so, the court may distinguish Carlton and determine that the new tax can not be retroactively imposed.

Professor Gans suggests that Congress should pass a contingent income tax that will be effective for 2010 if a retroactive estate tax is not upheld. He advocates that if "the estate [tax] were determined to be unconstitutional," a legatee would then be required to pay income tax on the inheritance.

Editor's Note: As estates now are entering the probate process during 2010, the situation becomes even less clear. As was discovered by executors in 1976 when there was another attempt to eliminate carryover basis, most estates will have great problems in establishing or proving basis for many assets (after a great outcry from executors and estate planners, the 1976 carryover basis law was repealed retroactively in 1980). But with two or three Democratic Senators dramatically behind in the polls and thus unwilling to vote for an estate tax compromise, it seems unlikely that Sen. Baucus and Sen. Reid will be able to gather the 60 votes necessary to pass an extension of the 2009 estate exemption and tax rate. As a result, the whole picture may remain unclear for most or all of 2010.

Will 2010 Estate Tax Be Retroactive?

The Dow Jones Newswire here is quoting Rep. Rangel, Chair of the House Ways and Means Committee, as saying that he does not favor retroactive estate tax legislation. The same article quotes his Senate counterpart, Sen. Baucus, Chairman of the Senate Finance Committee, saying he wants retroactivity.

Perpitrator of Ponzi Scheme Targeting Seniors Sentenced 90 Years

A San Juan Capistrano man convicted last year of bilking 124 elderly investors of more than $11 million in a Ponzi scheme was sentenced to 90 years and eight months in prison today.  Jeffrey Gordon Butler, 51, was convicted in June of 694 felony counts of stealing from elderly investors through the illegal sale of unqualified securities and filing false tax returns.  The judge sentenced Jeffrey Butler to consecutive terms in prison on dozens of counts after he heard emotional victim-impact statements last month from victims who said they lost most of their retirement savings to a man they had trusted.  He is unlikely to live long enough to be eligible for parole. 

Seniors to Receive Refund from Inappropriate Annuity Purchases

Minnesota’s Attorney General and Great American Financial Resources announced a settlement over disputed sales of deferred annuities to seniors in the state by Great American subsidiaries.  The agreement covers 2,000 policies placed by Great American Life Insurance Company and its affiliates, Annuities Investors Life and Loyal American Life, with an estimated value of about $50 million, according to the state’s AG, Lori Swanson.  The settlement allows seniors who bought annuities from the companies to submit refund claims. It also requires the companies to improve its suitability review procedure to assure annuity sales to seniors are appropriate. 

Unfortunately the ability Seniors in Mississippi to effectively pursue a remedy from being sold an inappropriate annuity product is limited by the absence of a rule permitting class actions, and the change in Mississippi Rule of Civil Procedure 20, which makes it much more difficult for parties to join litigation into a single suit where it can be efficiently prosecuted by a group of similarly situated plaintiffs. 

Seniors and their loved ones should be wary of individuals trying to sell them deferred annuities.  While there is an appropriate place and strategy for the use of these products, often the primary motivation is simply to earn the salesman a commission. Annuities are complicated contracts and Seniors need to make sure they understand what they are agreeing to before investing, and possibly making it inaccessible when they may need it most, their money in such vehicles. 

VA Delays

60 Minutes recently produced a story exposing the delays that Veterans are experiencing in claiming VA benefits. The story suggests that one of the VA's motives in such delay in awarding benefits is the fact that if the applicant dies prior to an award, no benefits are awarded retroactively.  The claim just ends.  "Deny, delay and hope that I die" is how one veteran interviewed explained his perception of the VA's the strategy.  Our office has noticed a greater delay in Aid and Attendance benefits over the past year, which is consistent with 60 Minutes report.  While I have attributed this delay to a greater number of veterans seeking the A&A benefits which were previously seldom known, and centralization of the application process which is now handled at one of 3 regional offices rather than at the local VA office, they cynic in me can't help but wonder if there is not a deliberate intent to delay claims of individuals who are, by definition elderly and feeble, usually suffering from multiple health problems, and as such have a greater likelihood of dying while their application is pending than would the general population. 

Mississippi Long Term Care Cost Sees Dramatic Increase

Long-term care represents 32.1 percent of total Medicaid spending according to a recent report. As costs rise, the program is raising serious budget problems for numerous states, including Mississippi.

Total Medicaid expenditures for long-term care increased 3.8 percent in 2008 reaching a total of $106.4 billion. Medicaid is a federal/state partnership to provide health care services to the nation's poor.  In Mississippi, the 3/4 of the cost of the program is paid with Federal dollars. 

Institutional long-term care spending by the Medicaid program increased 2.9 percent in fiscal year 20908 to $61.0 billion according to the recent report issued by Thomson Reuters. Medicaid nursing home expenditures increased 4.1 percent to $49 billion.

The largest total Medicaid expenditures for long-term care services. The total expenditures exceeded $18.4 billion.  Mississippi saw spending for nursing home care increase by 86.1 percent, the highest rise in the nation. 

Mississippi's Medicaid Time Bomb

Sid Salter has an excellent editorial and summary of the Medicaid funding issues facing our legislature this session in today's Clarion Ledger.  The bottom line is that the healthcare reform that is most likely to pass in the next several weeks will insure a large number of the currently uninsured by expanding Medicaid eligibility.  It is predicted that such an expansion will increase Medicaid recipients in Mississippi from the current 20% to 35%, and Mississippi's only real choice for getting the extra money to pay for that increase (even with the $3 to $1 federal match) will be to increase sales tax, income tax, or both. 

Now, I seem to recall the President saying repeatedly that increased coverage is not going to increase the taxes of anyone making less than $200,000 per year.  I guess it's a good thing people in that income range don't buy things that are subject to sales tax. 

Planning after "Repeal" of the Estate Tax

From its inception, the 2001 tax act was scheduled to repeal the federal estate tax and generation skipping transfer tax (GSTT) for one year beginning January 1, 2010. This should come as no surprise. What is surprising, however, is the fact that the 2001 tax act has now played out and repeal, at least temporarily - and unless reinstated retroactively - is upon us. This post explores how we got here (which may be instructive as to what will happen in the future) as well as some of the planning implications of no federal estate tax or GSTT for at least some part of 2010.

How Did We Get Here?
On June 7, 2001, President George W. Bush signed into law the much-heralded Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), designed to provide significant tax relief, including "permanent" relief from the federal estate tax (with its then $675,000 exemption and maximum 55% tax rate).

As we know, EGTRRA steadily lowered the maximum estate tax and GSTT rate to 45%, while increasing the exemption amounts to $3.5 million in 2009 and eliminating federal estate tax and GSTT altogether in 2010. However, as a result of a Senate rule that limits laws with a negative fiscal impact to 10 years (the so-called Byrd Rule), from inception EGTRRA contained a "sunset" provision. Under this provision, as of January 1, 2011, the law is scheduled to revert back to pre-EGTRRA law as if EGTRRA never existed. In other words, the federal estate tax and GSTT exemption will become $1 million (it was scheduled to increase under prior law) with a maximum rate of 55%.

What Will Congress Do Now?

No one knows with certainty what Congress will do to remedy this situation but several key Congressmen have stated publicly that they will attempt to pass estate tax legislation early in 2010. One of them, Senator Max Baucus, Chairman of the Senate Finance Committee, has said that swift action is necessary to prevent "massive, massive confusion."

Furthermore, many in Congress have expressed the desire to make such legislation retroactive to January 1, 2010. If Congress purports to make these tax charges retroactive to January 1, there are sure to be numerous lawsuits over the constitutionality of such retroactivity and, in all likelihood, these challenges would not be resolved until after years of litigation culminating in a Supreme Court decision. Where would that leave clients who die in the interim?

Cynics, however, note that these same Congressmen were unable to pass a one-year patch that would have eliminated the confusion in the first place. They also suggest that it is in the best interest of both Democrats and Republicans to do nothing and let EGTRRA sunset - and their argument has gained traction recently.

The argument is as follows: Democrats have incentive to do nothing because this law was passed by a Republican Congress and signed by a Republican President - they have no responsibility for the insanity caused by the sunset. Republicans, alternatively, are incentivized to do nothing because they have steadfastly argued for total repeal of the "death tax," and this cry - at least in 2001 - resonated with the American people. Their argument is that Democrats had the opportunity to permanently end the "death tax" and chose not to. In what potentially will be a significant mid-term election, many in Congress will likely use their position on the "death tax" in an attempt to ensure reelection.

Modified Carryover Basis
Under our current estate tax system, subject to some exceptions, assets owned at death receive a basis "step-up" to their fair market value at the time of death. Therefore, if your client dies owning Walmart stock that he or she bought for $10,000 many years ago, for example, the beneficiaries could sell the stock at its fair market value of, say, $10 million, and pay little or no income tax. The only tax the beneficiaries would have to pay would be on the difference between the sale price and the fair market value at death. (Of course, the stock would also be subject to estate tax at the client's death.)

Under EGTRRA, along with repeal of the estate tax and GSTT in 2010, a beneficiary receives property with an adjusted basis equal to the lesser of the decedent's basis or the asset's fair market value on the decedent's date of death. Thus, EGTRRA eliminates the automatic "step-up" to the date of death value but retains the "step-down" for depreciating assets.

To offset this loss of the step-up in basis, EGTRRA provides that the executor (or other person responsible for the decedent's property) may allocate a $1.3 million "aggregate basis increase" on an asset-by-asset basis up to the particular asset's fair market value at the date of the decedent's death. Assets left to a spouse may receive an additional $3 million "spousal property basis increase," also asset-by-asset, up to the particular asset's fair market value at the date of the decedent's death.

Lifetime Powers of Appointment
Under current law, for purposes of the basis step-up, a surviving spouse owns property in a marital trust over which that spouse has a lifetime or testamentary power of appointment. However, for purposes of the $3 million spousal property basis increase, only a QTIP trust is eligible and EGTRRA treats property in a QTIP trust over which the surviving spouse has a lifetime power of appointment as not owned by that spouse. Thus, if the surviving spouse has a lifetime power of appointment over the QTIP trust the executor (or other person responsible for the decedent's property) cannot allocate the spousal basis increase to marital trust property. Alternatively, the executor can allocate the spousal property basis increase to QTIP property over which the surviving spouse has only a testamentary power of appointment.

The Impact on Existing Estate Plans

Residuary Marital Trust Formula Funding Clauses
Under a typical living trust or will, the document creates at least two trusts, a credit shelter (aka bypass or Family) trust and a marital trust. Often, the living trust or will language divides the decedent's property into the two trusts through what is known as a residuary marital trust formula funding clause, as follows: the amount of the decedent's property that will pass to the credit shelter trust equals the "maximum amount that can pass free of federal estate tax;" the balance of the decedent's assets pass to the marital trust.

If the client created this estate plan when the federal exemption was significantly lower, and in particular if the client dies in 2010, this common estate planning language will cause the unintentional over-funding of the family trust and under-funding of the marital trust. Where the family and marital trusts contain identical beneficiaries and dispositive provisions, this over-funding of the family trust and under-funding of the marital trust will have no significance. However, if the family and marital trusts contain different beneficiaries and/or different dispositive provisions, this may cause unintended and undesirable consequences to the client.

For example, with second or subsequent marriages, and in particular where there are children from a prior marriage, the client often limits the surviving spouse's rights to the income from the marital trust, while the children from the prior marriage are often the beneficiaries of the credit shelter trust. If the client dies in 2010, all of the client's assets will pass to the credit-shelter trust, and the marital trust - i.e., the surviving spouse - will receive nothing! This is certainly not what the client wanted and it will not provide the state's statutory minimum to the surviving spouse. With few or no assets left to the surviving spouse, he or she may resort to a lawsuit against the trust or estate for the statutory minimum, thereby increasing legal fees and wreaking havoc with the estate plan.

Conclusion
Since most estate planners did not anticipate EGTRRA playing out into 2010, many clients' estate plans fail to take into consideration the lack of estate tax and its replacement, modified carryover basis. As the above discussion demonstrates, the key is flexibility and ensuring that clients' estate plans contain enough flexibility to accomplish their goals under changing circumstances.