JULY 5, 2011 VOLUME 18 NUMBER 24
Family members sometimes assume that an estate will be ready for distribution within days or weeks of a death. Those familiar with the probate process usually appreciate that it is more likely that distribution will be between six months to a year after death — and sometimes longer. When the decedent established a living trust, though, survivors often expect the final distribution to be faster. Everyone has gathered for the funeral, including out-of-town children and grandchildren — shouldn’t there be a check ready to hand out while the whole family is together?
The reality is that administration of an estate, even when a trust is involved, can take much longer. A good rule of thumb: it may still take six months to a year to prepare final income tax returns, gather trust assets, liquidate those which need to be sold (and not all will need to be sold in most cases), make calculations and actually complete the distribution. If there are more complicated issues, like estate tax liability, it may take even longer.
Delay in distribution of a trust estate was the issue involved in a recent Indiana Court of Appeals case. Harrison Eiteljorg’s will had provided a trust for his widow, Sonja Eiteljorg. When she died in 2003, the trust was to be divided into two shares — one each for Harrison’s sons Nick and Jack. Nick, a stepson and Harrison’s accountant were the co-trustees.
The trust was large — it held about $13 million of assets. That meant that an estate tax return had to be filed, and taxes totaling $6.2 million paid (remember that in 2003 tax was imposed on estates greater than $1 million). That was accomplished by late 2004, but the trustees were worried about closing out the estate and distributing the remaining assets. What would they do if the IRS disagreed with their calculations of values and imposed an additional tax liability.
At a heated meeting between the co-trustees and the two sons, Nick demanded a partial distribution of $2 million (half each to himself and Jack). The other trustees declined, saying that they worried that additional tax of up to $2 million might be imposed, and a distribution as large as Nick wanted would leave the trust with too little cash if that happened. They proposed instead to distribute $1 million to the two sons. Nick and Jack left the meeting without agreeing, and both sides hired new lawyers to battle out the timing and amount of a distribution.
A few months later Nick and Jack filed a petition with the Indiana probate court asking for removal of the co-trustees and entry of a judgment against them. Their argument: there was no reason not to distribute the requested $2 million when demanded, and failure to do so breached the trustees’ duty to the beneficiaries. The trustees answered, arguing that they needed to retain substantial liquidity until the IRS finally accepted the estate tax return (or imposed additional tax liability, if that was to be the outcome).
About a year after their original demand for partial distribution, Jack and Nick secured an order from the probate judge requiring that $1.5 million be divided between them. The co-trustees complied. The court proceedings then shifted gears to address a two-part question: did the delay in distribution amount to a breach of fiduciary duty, and (if it did) what were the damages due to Nick and Jack?
The probate judge found that the delay did amount to a breach of fiduciary duty. Nick testified that he would have put his distribution into two mutual funds, and that it would have grown significantly during the months he was deprived of its use. Jack testified that he had planned to purchase real estate in Texas, and that it would have appreciated. In addition, Nick and Jack had incurred attorneys fees totaling $403,612.81.
Based on the damages testimony, the probate judge awarded Nick $156,701 in “lost” profits from the funds he could not invest in. Jack was awarded $112,046.77 in missed real estate gains. The remaining co-trustees were ordered to pay those amounts from their own pockets, as well as all but $50,000 of the attorneys fees.
The Indiana Court of Appeals had a different take on the case, and significantly reduced the damages award. First, two of the three appellate judges agreed with the trial judge that failure to distribute the funds earlier was a breach of fiduciary duty. Rather than giving Nick and Jack the profits they said they would have earned, however, the two judges limited their damages to the interest that the $1.2 million would have earned during the nine months it was delayed — and even that damage award was to be reduced by the amount of interest the money actually earned in the trustees’ hands. The appellate court also reduced the attorneys fee award to a total of $150,000 — what they called “a more appropriate assessment.” In the Matter of Trust of Eiteljorg, June 27, 2011.
One appellate judge would not have gone even that far. According to the dissenting opinion he authored, there was no breach of fiduciary duty. After all, he reasoned, the co-trustees offered to distribute almost exactly what was ordered a few months later, and Nick and Jack rejected the partial distribution plan. Retaining at least $2 million in liquid assets until the estate tax return had been accepted was a reasonable and prudent course, according to the dissenting opinion.
What lessons can we draw from the Eiteljorg case? Several come to mind:
Even with a trust, it may take months or years after a death to complete the administration and make final distribution. That is not the usual circumstance, but it can happen.
Although avoidance of litigation is one common goal of trust planning, it is not always effective. And the cost of probate or trust litigation can be significant — note that Nick and Jack incurred legal fees of about one-third of the total amount they sought as distribution, and that the question was not whether they were entitled to the money, but only when.
In addition to increasing cost, litigation can slow down the process. Here, the co-trustees were ready to make a significant distribution at the first meeting, but the court-ordered distribution (of almost exactly the same amount) was delayed for nine months.
Acting as trustee can sometimes be costly. The co-trustees in this case will be liable for at least $150,000 out of their own pockets. We can anticipate that Nick and Jack will object to any attempt to pay the trustees’ own lawyers from trust assets, or to pay any fees to the co-trustees.
DECEMBER 20, 2010 VOLUME 17 NUMBER 39
The ink is not yet dry on Congress’s tax and unemployment insurance compromise. Signed just last week by President Obama, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 has now become law. It continues previous income tax breaks for everyone, regardless of wealth. It extends unemployment insurance coverage for an additional 13 months. It also rewrites the estate tax — it does not simply carry forward the estate tax rules adopted a decade ago.
Under the new law no estate tax will be due on estates of less than $5 million. Since there is no Arizona state estate tax, that means that only the wealthiest Arizonans (or those with significant assets in other states which do impose an estate tax) need to be concerned about estate tax rules at all. It should mean that estate planning just got easier, more predictable and lower-risk for nearly all of our clients.
It should mean that, but it may not. There are a number of details to watch out for, including:
If you are married and your estate plan was initially prepared a decade or more ago, you might well have a two-trust arrangement. Sometimes described by the shorthand “A/B trust” designation, such an arrangement can actually now increase the total tax paid by your heirs. How could that happen? If a separate trust is created and funded at the first spouse’s death, assets assigned to that trust will not get a stepped-up basis on the death of the second spouse. Under the new law you can get an equivalent estate tax result and still preserve the 100% step-up in income tax basis at the second spouse’s death.
If a loved one died during 2010, the heirs get to choose which tax regimen to adopt — either the no-tax choice originally in place for 2010 or the $5 million exemption now adopted. Since the $5 million option includes full stepped-up basis (the original 2010 structure limited the step-up to $1.3 million for unmarried decedents), it may actually be beneficial to opt for the new taxable-estate option. Hard to figure out? Yes. The good news: you have until September, 2011, to decide which option is better.
The $5 million exemption is now “portable.” That means that if your spouse dies without having planned to use the exemption, it is still available to you. In other words, a couple effectively gets $10 million in estate tax exemption without having to prepare any planning documents. One small caveat: if the surviving spouse remarries and their new spouse predeceases, they lose the original unused exemption amount (but still get to use any unused exemption from the second spouse). It looks like Congress has (perhaps unwittingly) created a new marriage-discouraging provision for seniors — or at least for wealthy seniors.
For a decade we have been saying that the most important estate tax principle would be certainty. If you are pretty sure you know what the estate tax will look like for the next five years or so, you can plan accordingly. Unfortunately, Congress and the Administration have given us only two years of certainty — and much of the certainty we have is that the issue will be politically charged and intensely debated for much of that two-year period. In fact, Vice President Biden told a national television audience Sunday morning (on NBC’s Meet the Press) that “scaling back … the estate tax for the very wealthy” would be a top priority for the Administration over the next two years.
The new law also increases the level at which both gift taxes and “generation-skipping” taxes are an issue. Both of those also set at the $5 million level for the next two years. If either or both returns to lower levels after 2012, that could mean an important planning issue for very wealthy individuals in the meantime. Should gifts be made now, just in case? Should gifts be made to grandchildren and later generations, just in case? Expect to see more about those issues in coming months.
Paradoxically, the new rules could mean that more people (at least more wealthy decedents) should be filing estate tax returns — even though no estate taxes are due. Penalties for failure to file are higher, the importance to surviving spouses has increased and the stakes involved have generally gone up.
Does all of that sound like the issues are resolved? No — but the plain fact remains that a tiny minority of Americans are wealthy enough to be worried about any of these issues. How do you know if you need to worry? Take this quick four-question quiz:
Is your entire estate (including life insurance, IRAs and retirement accounts) worth less than about $2 million? Whatever happens in the next two years, it is pretty unlikely that the estate tax level is going to return to a number below about $3.5 million (the favorite number kicked around by Democrats during debates over the past year).
Are you married? If so, you can double the estate value in the previous question.
Do you live in Arizona (or another state with no estate tax)? There are only about a dozen states where state estate tax is important — Arizona is not one of them.
Are you middle-aged or older? If so, are you comfortable assuming that your net worth will not dramatically increase in the next few years?
Depending on your answers, your estate planning choices are likely to be simplified. You should check to see whether you now have estate planning provisions that are no longer needed. You should also check whether your non-tax planning issues have been addressed. Do your documents name the right person to act as trustee, health care agent, personal representative and financial agent? Do they leave your assets to the people (and organizations) and in the proportions that you want? Do they refer to events, locations or items that are no longer relevant?
AUGUST 9, 2010 VOLUME 17 NUMBER 25
Want to read about the debate over estate tax reform/repeal/reinstatement? There is plenty of literature. You can easily learn about the history of the estate tax (going back to 1797 in the United States, or to the 7th century BCE elsewhere).
How about real-life stories? You already knew that George Steinbrenner saved his family $600 million by managing to die during 2010 (although it turns out that the actual savings is much murkier and, probably, not near that number). But you probably have not heard of Iowan Eugene Sukup, who at 81 is contemplating what will happen to his considerable estate — and the family business — when he dies.
Maybe you make your decisions on the basis of the positions of famous people. How about what Bill Gates, Sr. (not the software innovator, but his father, who has spoken and written extensively on this subject) says about the estate tax? How about Alan Greenspan, former Federal Reserve chairman? Turns out it’s easier to find wealthy people speaking out in favor of the estate tax (albeit a “reasonable” estate tax) than against the tax altogether, but perhaps that is just because it is such a surprise, at least at first blush.
You know what is missing from most of the debate — and reporting — on the estate tax? Real numbers. Except for that last reference (the Washington Post’s “PostPartisan” blog), there is almost no mention in any of the articles collected here about how many people actually pay — or would pay — an estate tax on death. Are you curious? You may be surprised by the answer.
The best reference we could find is a December 18, 2009, report from the Congressional Budget Office. The non-partisan CBO manages, in a dense but readable 12-page report, to explain the interrelationship of the estate tax with gift taxation and the generation-skipping tax, provide a history of the revenue generated through the estate tax (shown as a percentage of all federal receipts), and describe the effect of all of the major proposals being considered by Congress.
It turns out that in 2004, when the estate tax applied only to estates worth more than $1.5 million, there were 19,294 estate tax returns on which the decedent’s estate owed any money to the federal government. That amounts to .82% of all deaths in 2004. Compare that to 1.14% of deaths in 2003 and 1.17% in 2002; in both of those years the estate tax applied to estates worth more than $1 million. Those details, incidentally, come from the Internal Revenue Service’s Spring, 2009 Statistics of Income Bulletin (if you try to locate the figures yourself, you’ll want to scroll down to page 222 of that lengthy report). The IRS has updated the figures for 2005 and 2006 and, not surprisingly, the percentage of taxable estates has dropped further. In 2005 (with a taxable level of $1.5 million, the same as in 2004), the percentage of taxable estates was .95. In 2006, when the taxable estate level went to $2 million, the number of estates reaching that level dropped to .63%. That was the smallest percentage since at least 1934, when the current tax code was first adopted.
So what does this all mean? Basically, with an estate tax level at about $1 – 1.5 million, right around 1% of decedents will pay any tax at all. At the $2 million level, that percentage drops to about 2/3 of 1%. If Congress proves to be paralyzed, by partisanship or otherwise, and the estate tax drops back to the $1 million level in 2011, then about 1% of decedents’ estates will, presumably, have to pay estate taxes.
That is not the end of the story, of course. It is not, for instance, the same thing as saying that 1% of people are worth a million dollars, or slightly more. Why are they not the same thing? For a variety of reasons, including:
Decedents are, of course, older than the general population. It is likely that the decedents in a given year are somewhat wealthier than the population as a whole, but the statistics we have described here do not show that or even hint at how much difference we should expect. One thing the statistics DO take into account: the IRS removed deaths of children from the figures, so the percentage of ALL deaths paying estate taxes would be slightly smaller.
Decedents with estates of just over the taxable limit have a variety of estate planning options to avoid any estate taxes. Married couples can plan to preserve the exemption for each spouse, those with slightly larger estates can use lifetime gifting, and devices like family limited partnerships and limited liability companies can reduce the value of the estate for tax purposes. Money left to charities or surviving spouses escapes taxation altogether. It is likely that a significant percentage of decedents transferred an amount of property to heirs that would have been taxable but for such techniques.
Even if 99% of decedents avoid estate taxes completely, that does not mean that the estate tax system had no effect on any of them. Presumably another small but significant percentage (perhaps 1-5%) expended at least some funds on the estate planning necessary to avoid estate taxation. We know of no study indicating how many have done so, or at what cost.
Inflation (if there is any) and wealth concentration trends will have continued since the 2002/2003 figures were calculated. In those years the percentage of decedents’ estates paying any estate tax were 1.17 and 1.14, respectively; of course, with the significant reductions in net worth for many Americans since those years the figures might actually drop for 2011. Over time, however, the percentage should be expected to grow. As it did, for instance, between 1987 and 1999, when the estate tax level remained constant at $600,000. During those twelve years, the percentage of estates subject to any tax increased from .88% (in 1987) to 2.3% (in 1999).
Of course, the estate tax level increased to $3.5 million in 2009 (before being eliminated entirely in 2010). The result of that near-doubling of the taxable level in one year has not yet been calculated and published. It will be interesting to see.
One final thought about the statistics developed by the IRS and the CBO: in 2004, with a taxable level higher than ever before and with the smallest percentage of decedent’s estates paying any tax whatsoever in the history of the modern estate tax, the IRS brought in a total of $22.2 billion. That was the fourth-highest haul in the history of the tax, and was about $4.5 higher than the two previous years, with taxable levels at $1 million (rather than the $1.5 million of 2004).
This has been a tumultuous year for estate planning attorneys—and for their clients. The federal estate tax has been repealed, there are new rules in effect governing Roth IRAs, and heirs are facing higher capital gains liability. We don’t profess to have all the answers, but we think we have a pretty good handle on the questions.
You may agree with us when we say it would be productive to get together and review the current situation. In the next in our series of client education program, scheduled for Thursday, May 6, 2010, we hope to meet with as many of our clients as we are able, to review what is happening, what might change and what should be done.
As of January 1st, the federal estate tax has been eliminated – for this year only. What are the consequences of the repeal of the estate tax? What are the chances Congress will act this session to reinstate the estate tax? What does the tax look for 2011? What does the elimination of the “step-up in basis” mean for your heirs? Is it possible that your family could pay more in capital gains tax than they would have paid in estate tax?
We’ll talk about the (temporary) repeal of the estate tax and whether you should consider changes to your family trust or estate plan. We’ll talk about the competing proposals for changes to the estate tax exemption and the tax rate, and speculate about how likely it is that any one proposal will become law.
Recent rule changes make it easier for wealthier individuals to convert traditional Individual Retirement Accounts to Roth IRAs. Together, we’ll compare the ways in which IRAs and Roth IRAs are taxed, the distribution requirements for each, and the costs associated with making a conversion, so that you can decide what is right for you.
We know from talking to many of our clients that reducing the burden of probating your estate is a major concern. Beneficiary designations are an important tool for transferring assets to your family upon your death. Sadly, many people fail to take full advantage of this useful estate planning tool, or neglect to update their beneficiary designations when family situations (or estate plans) change.
We’ll take this opportunity to review the categories of assets that can be transferred via beneficiary designation, explain how the beneficiary designations work, and encourage you to review your existing designations to make sure that they are consistent with the rest of your estate plan.
This client education program is scheduled for Thursday, May 6th. The program is available to our clients (and family members and invitees) free of charge, but space is limited. To make reservations, telephone Yvette at (520) 622-0400. We look forward to seeing you there!
Last week Elder Law Issues predicted that the principal effect of the federal government’s estate tax repeal would be to make most people revisit their estate plans (and their attorney) more often. Because of the automatic “sunset” of the repeal measure in 2011, any plan addressing the changes in estate taxes must also deal with the real possibility that the tax will be reinstated in ten years. Even if the repeal becomes fully effective the imposition of a system of “carry-over basis” will mean that wealthy individuals still need to plan for taxes imposed on their heirs.
Not surprisingly, the new tax law is considerably more complicated than even those changes. A number of other provisions affect individual estate plans, and not all of those have been widely discussed or explained. Among the other changes in the new tax law:
•
The generation-skipping tax (usually referred to as the GST) will be reduced and, ultimately, eliminated. Current law imposes an additional tax on some property left to grandchildren and other younger beneficiaries. There is an exemption as to the first $1,060,000 left to later generations: that exemption will begin to increase with the estate tax exemption itself in 2004. Until that time the current maximum (adjusted annually for inflation) applies.
•
Current estate tax law allows some owner of family businesses to pass a larger amount to their heirs without incurring estate taxes. Although it can be difficult to qualify for the favorable treatment, at least some small business owners can take advantage of the so-called QFOBI (“Qualified Family Owned Business Interests”) rules to pass a total of up to $1.35 million without estate taxes. That special deduction for family business owners will end after 2003.
•
Limits on contributions to retirement accounts will increase in steps beginning in 2002. Not everyone can pay in to IRA and 401(k) plans. Those who can will find that maximum IRA contributions increase to $3,000 in 2002, to $4,000 in 2005 and to $5,000 in 2008. 401(k) limits (now set at $10,500) increase to $11,000 in 2002 and by an additional $1,000 each year until 2006 (when the limit will have reached $15,000). Contribution limits are raised for other, less-common retirement plans as well.
•
Gift taxes are not scheduled for repeal. Although the current transfer tax system treats lifetime gifts and transfers at death in a unified approach, that relationship diminishes next year and ends in 2010. After 2002, gifts of more than $1 million will be subject to the gift tax even though there might not be any estate tax if the property had been held until the owner’s death.
What do all the estate, gift and income tax changes mean? Most people will need to reconsider their current estate plan now, and at least once again as the 2011 deadline draws near.
On June 7, 2001, President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001. Despite extensive media coverage of tax reform, and especially of estate tax repeal, over the past six months, you may have been left wondering what it means. It turns out that it doesn’t mean much for most of us.
Estate tax repeal will have one of two effects for most people. For some, the change in tax laws will mean they must spend more on lawyer’s fees for changes to their estate plans—and may have to make more than one set of changes as the rules slowly shift over the next decade. For most people, however, the principal effect of estate tax repeal will be felt when government revenue must be raised from some other source—possibly including taxes on middle class citizens who wouldn’t have paid estate taxes under the old rules.
There are four elements of estate tax repeal that make it difficult to predict exactly what will happen over upcoming months and years:
•
Reductions in the estate tax will be phased in over a ten-year period, with relatively little change before full repeal. The current $675,000 exemption from federal estate tax liability is raised to $1 million next year and then increases slowly, but it only reaches $3.5 million before repeal.
•
The top tax rate drops slightly each year, from the current 55% to 45% in the year before the tax is finally eliminated.
•
Upon repeal of the estate tax, a new system of taxation is imposed—heirs will pay income taxes on capital gains when they sell inherited property. There will, however, be a substantial exclusion from this new tax—$1,300,000 of gain for every decedent’s estate, and another $3,000,000 of gain for surviving spouses.
•
Estate tax repeal is itself repealed in 2011.
That’s right: as currently written, the law ending the estate tax in 2010 ends (and the estate tax returns) in 2011. Authors of the tax repeal measure insist that they only included that provision in order to “balance” the budget for the next decade, but real estate tax repeal will require another Congress and President to sign another bill sometime in the next decade.
The new law eventually eliminates the “generation-skipping” tax, which penalized transfers to grandchildren (although a $1 million exemption makes the penalty less onerous). The gift tax, however, remains in effect—to keep taxpayers from giving their property to terminally ill family members expecting to get the property back within a few years.
Meanwhile, no one dares predict how federal estate tax “repeal” will affect state governments, where the estate tax has been a major source of revenue for decades. Arizona, for example, received about $80 million from the state estate tax last year. The federal credit for payment of state taxes will be phased out starting in 2002, so that the effect of estate tax reductions will be smaller—unless states follow the federal governments’ lead.
Last week Elder Law Issues reported on Arizona’s new “Beneficiary Deed” statute. A law passed by the Arizona legislature this year creates a new, simpler way to pass title to real property, without any requirement of probate and avoiding the cost of establishing a living trust.
A number of readers had questions about the new deed form. Questions included:
When can I sign a beneficiary deed?
Most laws take effect 90 days after the legislature adjourns. Adjournment is now scheduled for Thursday, May 10. If the legislature actually adjourns that day, the new law will be effective (and beneficiary deeds will become an available choice) on August 3, 2001.
Will the recipients under a beneficiary deed receive the benefit of stepped-up basis for income taxes?
Yes. To explain: when you inherit property from another, you usually do not have to pay income taxes on the increase in value of that property during the prior owner’s life. For purposes of calculating the income tax on capital gains, your “basis” in the property is said to have been “stepped up” to its value on the date of death of the person who left it to you. Beneficiary deeds will reach the same result.
How will beneficiary deeds affect ALTCS (Medicaid) recovery rights?
ALTCS is Arizona’s long-term care Medicaid program. When it provides benefits, the program has a claim against the recipient’s estate. Under current law that claim can only be collected in a probate proceeding. Since the beneficiary deed will avoid the probate process, ALTCS’ claim will not be levied against the property. This makes beneficiary deeds particularly attractive to ALTCS recipients and their families.
It is worth noting that a different law passed by the legislature this year may undo some of this benefit. “Non-probate transfers” (including beneficiary deeds, living trusts and joint tenancy bank accounts, but not real estate held as joint tenants) may now be challenged by creditors, including ALTCS.
Why would anyone want to create a living trust now?
Beneficiary deeds will be a valuable new estate planning tool, but will not replace other options. Perhaps most importantly, a beneficiary deed will not help a married couple take advantage of the maximum estate tax exemption if their combined estates exceed the taxable level (currently $675,000).
Trusts remain a more effective way to control property after death (for a disabled or spendthrift child, for example). Trusts can be used for real property outside Arizona. Another advantage for trusts: a single amendment can change your entire estate plan, rather than requiring new deeds and beneficiary designation changes on each individual asset.
For those who already have established living trusts, the beneficiary deed probably represents a step backward. For those now considering their options for the first time the beneficiary deed may be an attractive, low-cost choice for estate planning.
Discussions about repeal of the federal estate tax often focus on the notion that farms and businesses are threatened by taxing assets at the death of the family patriarch or matriarch. Opponents of repeal, on the other hand, argue that it is family and business dynamics that usually causes sale of farms and businesses. Katherine Pillot Lee Barnhart’s estate lends support to both arguments.
When Ms. Barnhart died in 1975 her estate was worth $12 million. Almost all of that value was tied up in two family ranches and several pieces of undeveloped land in Houston.
Ms. Barnhart had named her son Ronald E. Lee as executor of her estate and as trustee of two trusts she established for the benefit of her children and grandchildren. Mr. Lee began to administer the estate and the trusts shortly after his mother’s death, although there were few assets to permit payment of estate debts.
The first debt facing Mr. Lee was the federal and state estate tax liability. The IRS wanted $2.8 million in taxes, plus another $475,000 in interest by the time the tax liability was finalized. The State of Texas wanted $800,000.
Unfortunately there was no cash available to pay the tax bill. When Mr. Lee received an unsolicited offer on a 61-acre parcel of land in Houston, he sold it for a total of $19.5 million. After paying the tax bill he made the first distribution to his sister. Five years after her mother’s death, Susan Lee received $15,784 from her mother’s $12 million estate.
In all it took 13 years and two separate demands before Susan Lee decided her brother was not going to provide an accounting for his administration of the estate. She sued to remove him as trustee in late 1988.
She learned that Mr. Lee had charged fees totaling $2,836,000 to manage the trust property. He had failed to list any of the real estate for sale, and had refused several unsolicited offers as inadequate. He had spent over $700,000 in a failed effort to develop one of the parcels. He had continued to operate the family ranches at a loss rather than arrange their sale.
A jury decided Mr. Lee should be removed as trustee and reimburse the trusts $2.2 million in excessive fees, plus another $2 million in attorney’s fees, interest and other costs for the decade-long legal fight. Despite the jury’s award the trial judge reduced the judgment to less than $700,000 after finding that most of the excessive fees permitted substantial estate tax deductions, so that the estate was actually injured by a much smaller amount.
The Court of Appeals reinstated the jury award. It also added $300,000 for Susan Lee’s appellate costs, and ordered that the $1.5 million she had received for attorneys’ fees at trial should come from Mr. Lee’s own pocket. Lee v. Lee, February 8, 2001.
Was the estate tax liability of $4 million responsible for the break-up of Ms. Barnhart’s $12 million estate, or was it family infighting, greed and manipulation? Critics of the taxation of estates can point to the likelihood that Ms. Barnhart’s estate plan would likely have been more responsive to the family’s needs if estate taxes had not been an issue. Opponents of repeal can point to the fact that Ms. Barnhart’s estate was illiquid, and her chosen successor apparently unreliable, or at least unsuited to the task of managing the family’s considerable wealth.
Craig Fitzgerald was a successful accountant living in New Jersey; when he died he left three children and a wife. In the immediate aftermath of the unanticipated loss of her husband, Joan Fitzgerald did not realize that she had estate planning problems of her own to deal with.
Mr. and Mrs. Fitzgerald had originally hired their neighbor, attorney Francis Linnus, to prepare wills. Mr. Linnus had given them proposed drafts in 1988 but they had not actually signed their wills until 1995, just over a year before Mr. Fitzgerald’s death. Mr. Fitzgerald, who was not only an accountant but also held a law degree and an M.B.A., had instructed Mr. Linnus that the wills should not include tax planning considerations, as Mr. Fitzgerald intended to review the couple’s entire estate plan himself. As a consequence Mr. Fitzgerald’s will simply left his entire estate to his wife.
Mrs. Fitzgerald contacted lawyer Linnus immediately after her husband’s death. She retained him to represent her as executrix (personal representative) of her husband’s estate, and to help her collect life insurance proceeds from policies naming her as beneficiary.
Most of Craig Fitzgerald’s assets went to Joan automatically, so the probate process itself was quite simple. Although the couple’s assets totaled about $2 million, only $65,376 of that would ultimately go through probate. Another $2.2 million in life insurance would go directly to Mrs. Fitzgerald, and attorney Linnus completed and filed the applications for those benefits.
At first glance Mrs. Fitzgerald’s financial problems looked easy to solve. She would now have assets worth more than $4 million to take care of herself and her children. There is no estate tax due on money left to a spouse and life insurance proceeds are not subject to income taxes, so the tax liability as a result of Mr. Fitzgerald’s untimely death would be minimal.
Mrs. Fitzgerald’s tax problem will be apparent, however, to most estate planning professionals. Because no effort was made to preserve Mr. Fitzgerald’s estate tax exemption, Mrs. Fitzgerald’s estate will be subjected to much higher taxation on her death—assuming, of course, that the estate tax system remains unchanged.
Even with the failure to plan carefully all was not lost. Mrs. Fitzgerald could have disclaimed her right to receive life insurance proceeds and allowed those benefits to flow directly to her children. While she would not have benefited from the proceeds herself she could have reduced her own ultimate estate tax liability.
That, in fact, is exactly what lawyer and social friend Lisa Butler told Mrs. Fitzgerald a few weeks after she had received the life insurance proceeds. Disclaimers can usually be signed and delivered up to nine months after the death of the person from whom property would be received, and a disclaimer is not itself a gift of property. Unfortunately for Mrs. Fitzgerald there is one other requirement: a disclaimer must be executed and delivered before the proceeds have been received and used.
Mrs. Fitzgerald sued Mr. Linnus, her original lawyer, for failing to advise her about the availability and timing of disclaimers. Her children joined in the lawsuit, alleging that Mr. Linnus owed them a duty as well, and Mrs. Fitzgerald’s failure to know about and sign a timely disclaimer would ultimately cost them thousands of dollars in unnecessary estate taxes.
The Appellate Division of the New Jersey Superior Court decided that Mrs. Fitzgerald’s claim against Mr. Linnus could not stand. The problem, according to the appellate judges, was that Mrs. Fitzgerald was not actually injured by the lack of advice. In fact, she was several hundred thousand dollars better off for not having gotten—or taken—the disclaimer advice. Mr. Linnus owed no duty to the Fitzgerald children, according to the judges. In fact, the appellate judges were persuaded by the testimony of Mr. Linnus, corroborated by Mrs. Fitzgerald, that her primary concern when she first consulted with him was to get control of the estate and ensure her own financial security. The court dismissed all claims against the lawyer for failure to advise Mrs. Fitzgerald about a course of action she might have taken. Estate of Fitzgerald v. Linnus, January 22, 2001.
Gay and lesbian couples need to take special steps to make sure that their wishes are carried out at death. The law makes some assumptions about the intentions of married couples—that they usually intend to leave their property to one another, for example. There are also tax rules benefiting married couples that are not available to same-sex couples.
Mary Scott and Lucille Horstmeier lived together in Illinois for nearly twenty years. Ms. Horstmeier was a locally prominent businesswoman, while Ms. Scott managed the household, handled the couples’ finances and took care of housework and repairs. For some of the time they lived together, Ms. Scott worked at the school Ms. Horstmeier managed, but her earnings were considerably lower than her partner’s.
In 1975 the two women moved into a new home in Glenview, Illinois. Ms. Horstmeier made the down payment and all subsequent payments, and took the title in her name alone. While Ms. Scott contributed some of her earnings to the household over the ensuing years, she never contributed directly to the mortgage payment on the home.
Ms. Scott maintained that the two women agreed that they would own the home jointly, and that her name was left off the title only because she did not have a down payment or a steady income at the time they bought their home.
One problem that frequently arises in similar situations can occur when the couple separates, or one partner dies, and no arrangement has been formalized for division or transfer of the property. Ms. Horstmeier, however, had planned for her own death—she made a will leaving all her estate to Ms. Scott and naming Ms. Scott as her executor.
When Ms. Horstmeier died in 1993, however, there was still a problem. Because she had been successful her estate was large enough to incur an estate tax liability. If Ms. Scott could have been treated as a surviving spouse there would have been no problem, since estate tax law permits an unlimited amount of money and property to pass to a spouse without tax. But Ms. Scott’s problems with the IRS were even larger.
Since she believed that she was already a one-half owner of the couple’s home, Ms. Scott reported only half the value of the home (minus half the remaining mortgage) on Ms. Horstmeier’s estate tax return. The IRS disagreed, insisting that the entire home had belonged to Ms. Horstmeier. The distinction was important, since the IRS position produced an additional $157,404 in taxes.
The IRS position prevailed in the Tax Court, and Ms. Scott appealed. The appellate court agreed with the Tax Court, and ordered the tax paid. Scott v. Commissioner, September 8, 2000.
What could Ms. Horstmeier and Ms. Scott have done differently? They could have taken the title in their joint names and made joint payments on the mortgage, or even signed a written agreement in advance. The planning they did complete was good—without it the home might have gone to Ms. Horstmeier’s relatives instead of Ms. Scott. They should also have anticipated yet another problem facing same-sex couples in their effort to achieve the benefits routinely available to married partners.
