As a proponent of Family Limited Liability Companies (LLCs) for asset management, creditor protection, and ease of gifting, I was pleased to read about the U.S. Tax Court's decision in Mirowski v. Commissioner, T.C. Memo 2008-74. March 26, 2008.
Mrs. Mirowski, widow of the inventor of the heart defibrillator implant, created a trust for each of her three daughters in 1992, which were funded with portions of her interests in the patent licenses. Then, in 2001, she formed a single member LLC, transferring substantial assets to it. Shortly thereafter, Mrs. Mirowski gifted a 16% interest in the LLC to each of the trusts. A mere four days later, she died unexpectedly.
The IRS argued under Section 2036(a) of the Internal Revenue Code that Mrs. Mirowski retained the right to income or enjoyment of the gifted property, so that it was included in her taxable estate. The estate maintained that the Section 2038 "bona fide sale" exception applied, so that the transferred assets were not subject to estate tax.
The Tax Court agreed, holding that the LLC's activities do not have to be equivalent to those of a "business" for the bona fide sale exception to be applicable. The Court stated that Mrs. Mirowski had "legitimate and significant non-tax reasons" for establishing and funding the LLC, including 1) joint management of family assets, 2) combining family assets to maximize investment opportunities, and 3) enabling equal transfers to her daughters.
Some key points for Family LLCs to hold up for gift and estate tax purposes:
Strictly follow the terms of the Operating Agreement
State the reasons for the LLC in the Operating Agreement
Have the Agreement reviewed by separate counsel for all initial members
Leave enough assets outside the LLC to live on and pay taxes
Don't mingle LLC assets with personal assets
File the proper tax returns each year
File the necessary documents with the Secretary of State each year
Don't put your personal residence in a Family LLC
Make sure the senior generation does not have the power to allocate profits and losses
Require annual distributions
Have the junior family members (or their trusts) make initial contributions to the LLC to provide for the pooling of assets
Don't wait until the senior family member is near death
The bottom line is that Family LLCs remain a viable and attractive option for transfers of family wealth, while also providing asset protection and management advantages. Just make sure you use an attorney experienced in forming Family LLCs to assist you, and carefully follow all of his or her instructions.
Friday, July 25, 2008
Thursday, July 17, 2008
The New Jersey Civil Union Act: Tax Benefits?
On February 19, 2007, following the New Jersey Supreme Court’s decision in Lewis v. Harris, New Jersey effectuated the Civil Union Act (hereinafter, “the Act”). The Act grants couples in same sex civil unions equal protection and equal rights to couples in heterosexual marriages. In Lewis, the court unanimously held that although same-sex marriage is not a fundamental right, “committed same-sex couples must be afforded on equal terms the same rights and benefits enjoyed by married couples” and that the legislature amend or implement laws accordingly. New Jersey has decided to create a parallel civil union system rather than attempt to incorporate same-sex marriages within the existing marriage law framework. The Act provides that the legal benefits, protections and responsibilities afforded spouses in heterosexual marriages be granted to spouses involved in civil unions with respect to “laws relating to taxes imposed by the State or a municipality including but not limited to homestead rebate tax allowances, tax deductions based on marital status or exemptions from realty transfer tax based on marital status”.
This Act has vast tax implications affecting same sex couples’ property rights, estate transfer taxes, and income taxes.
Tax Advantages Under the New Jersey Civil Union Act
A. Property Rights
In New Jersey, civil union members can now own residential real estate as tenants by the entirety thereby avoiding probate and transferring full title to the surviving spouse by operation of the law in the event of the death of one of its members. Further, a civil union member can enjoy the tax-free realty transfer benefit afforded to those in a marriage.
Senior citizens and disabled persons in a civil union can now qualify for the Property Tax Reimbursement Program designed to reimburse these persons of property tax increases. Also if a civil union member is 65 years or older or permanently and totally disabled, they become eligible for a $250 local property tax deduction provided that the couple’s combined income is less than or equal to $10,000.
Under New Jersey law, veterans enjoy specialized tax exemptions based on their status as US war veterans. These exemptions are now applicable to the members in a civil union as well under the Act. In other words, a disabled war veteran in a civil union is entitled to a 100% tax exemption of real property taxes, as is his or her survivor in the couple in the event of death. Further, the member who is the survivor to the union of one who died during active duty in a war is entitled to a $250 local property tax deduction.
B. Estate Transfer
In New Jersey, property passing from a decedent to a beneficiary valued at $500 or
more is subject to a Transfer Inheritance Tax. However property passing to the decedents' spouse and child (among others) is exempt from this tax due to their classification as Class A Beneficiaries. Under the Act, members in a civil union will be applicable for this exemption. Further, under state estate tax, the survivor in a civil union can now qualify for the exemption of death taxes incurred on property valued under $675,000. However they are still accountable, as are other married couples, of the federal estate tax on property transferred valued over $2 million.
C. Income Taxes
On a state level, members of the civil union will be able to file either civil
union joint or separate tax returns. Therefore they will qualify for any and all exemptions and deductions provided at the state income tax level. This means that even though members of the civil union do not have to file separately at the state level, they still must do so at the federal level. In general, federal income tax rates are higher than state taxes and filing jointly provides many exemptions for income tax purposes.
The Inequalities That Remain in Taxes between Civil Union Members and Married Individuals
It is important to note that although the Act constitutes a great leap forward for the homosexual community, the advancements marked by this Act come with a large disclaimer. Specifically, federal laws still do not recognize same-sex marriages. As a result, members of civil unions are not qualified as a couple under the federal rules of tax, immigration, social security, bankruptcy and others. For example, members of a civil union do not qualify for the unlimited marital deduction of federal gift taxes between spouses subjecting them to federal gift tax of all transfers over $12,000 within a year.
The addition of New Jersey as the third state recognizing civil unions is an achievement for the homosexual community because a vast number of family issues such as health care, child custody and employment benefits are handled at the state level. However, federal law still treats members of civil unions unequally.
This Act has vast tax implications affecting same sex couples’ property rights, estate transfer taxes, and income taxes.
Tax Advantages Under the New Jersey Civil Union Act
A. Property Rights
In New Jersey, civil union members can now own residential real estate as tenants by the entirety thereby avoiding probate and transferring full title to the surviving spouse by operation of the law in the event of the death of one of its members. Further, a civil union member can enjoy the tax-free realty transfer benefit afforded to those in a marriage.
Senior citizens and disabled persons in a civil union can now qualify for the Property Tax Reimbursement Program designed to reimburse these persons of property tax increases. Also if a civil union member is 65 years or older or permanently and totally disabled, they become eligible for a $250 local property tax deduction provided that the couple’s combined income is less than or equal to $10,000.
Under New Jersey law, veterans enjoy specialized tax exemptions based on their status as US war veterans. These exemptions are now applicable to the members in a civil union as well under the Act. In other words, a disabled war veteran in a civil union is entitled to a 100% tax exemption of real property taxes, as is his or her survivor in the couple in the event of death. Further, the member who is the survivor to the union of one who died during active duty in a war is entitled to a $250 local property tax deduction.
B. Estate Transfer
In New Jersey, property passing from a decedent to a beneficiary valued at $500 or
more is subject to a Transfer Inheritance Tax. However property passing to the decedents' spouse and child (among others) is exempt from this tax due to their classification as Class A Beneficiaries. Under the Act, members in a civil union will be applicable for this exemption. Further, under state estate tax, the survivor in a civil union can now qualify for the exemption of death taxes incurred on property valued under $675,000. However they are still accountable, as are other married couples, of the federal estate tax on property transferred valued over $2 million.
C. Income Taxes
On a state level, members of the civil union will be able to file either civil
union joint or separate tax returns. Therefore they will qualify for any and all exemptions and deductions provided at the state income tax level. This means that even though members of the civil union do not have to file separately at the state level, they still must do so at the federal level. In general, federal income tax rates are higher than state taxes and filing jointly provides many exemptions for income tax purposes.
The Inequalities That Remain in Taxes between Civil Union Members and Married Individuals
It is important to note that although the Act constitutes a great leap forward for the homosexual community, the advancements marked by this Act come with a large disclaimer. Specifically, federal laws still do not recognize same-sex marriages. As a result, members of civil unions are not qualified as a couple under the federal rules of tax, immigration, social security, bankruptcy and others. For example, members of a civil union do not qualify for the unlimited marital deduction of federal gift taxes between spouses subjecting them to federal gift tax of all transfers over $12,000 within a year.
The addition of New Jersey as the third state recognizing civil unions is an achievement for the homosexual community because a vast number of family issues such as health care, child custody and employment benefits are handled at the state level. However, federal law still treats members of civil unions unequally.
Deferral is the Name of the Game: Funding a Trust With Retirement Assets
Many people today have a large concentration of their wealth in their IRA accounts and/or retirement plans, such as Pension, Profit Sharing and 401(K) plans. As a result, for married couples, it may be necessary to utilize these assets to fully fund the first spouse to die’s applicable exclusion amount. This article will highlight the income tax disadvantages associated with using such assets in this regard.
Under current law, the federal estate tax applicable exclusion permits taxpayers to transfer up to $2 million ($675K in NJ) at death to anyone other than a spouse without incurring a federal estate tax. The estate tax applicable exclusion is scheduled to increase to $3.5 million ($675K in NJ) in 2009. In 2010, the Federal estate tax is scheduled to be repealed, but only for one year. Starting in 2011, estates will once again be subject to estate tax at 2001 rates (top rate of 55%) with only a $1 million ($675K in NJ) exemption available.
Generally speaking, to maximize the applicable exclusion of the first spouse to die, Wills are drafted to provide that a trust is created automatically or via a disclaimer approach for the benefit of the surviving spouse and the decedent’s children and grandchildren and funded with the decedent’s then remaining applicable exclusion amount, taking into account any transfers the decedent may have made during his or her lifetime. These trusts are typically called bypass or disclaimer trusts. The balance of the decedent’s estate in most instances would pass to the surviving spouse.
If IRAs and/or retirement assets are used to fund the trusts as described above, there are significant income tax ramifications for the decedent and his or her family. If the surviving spouse is the beneficiary of the IRA and/or retirement assets, the surviving spouse has the ability to roll over these assets to his or her own IRA and treat it as a new IRA. Consequently, the surviving spouse is able to designate his or her own beneficiary. The new beneficiary designation means that at the surviving spouse’s death, the beneficiary can take required minimum distributions over that beneficiary’s life expectancy. In most circumstances, the beneficiaries of the surviving spouse’s IRA will be the next generation (i.e., children), so that the required pay out period will be based on the life expectancies of the children, which typically is a longer period of time.
While the surviving spouse is alive, required minimum distributions need to begin to be paid as of April 1 of the calendar year following the surviving spouse’s attainment of the age of 70 ½. After that date, in most cases, the required minimum distributions are based on IRS tables which factor in the life expectancy of the surviving spouse and a hypothetical beneficiary who is ten years younger than the surviving spouse.
The required minimum distributions are significantly accelerated if the beneficiary of the decedent’s IRA and/or retirement assets is the bypass or disclaimer trust under the decedent’s will, as opposed to the surviving spouse. First, during the surviving spouse’s life, assuming the surviving spouse is the oldest beneficiary of the trust, distributions during the spouse’s life must be taken over the spouse’s life expectancy, as opposed to the surviving spouse waiting until April 1 of the year following the attainment of age 70 1/2. In this event, the surviving spouse is not able to roll over the IRA and/or retirement assets and treat the IRA as his or her own IRA because he or she is not the beneficiary.
Second, at the surviving spouse’s death, while the beneficiaries are usually the younger generation, the required minimum distributions remain based on the surviving spouse’s life expectancy. The decedent’s family is not able to use the younger generation’s longer life expectancy to significantly delay distributions.
This is the major reason why IRAs and retirement assets should be the last resort to fund a bypass trust or a disclaimer trust to maximize the decedent’s applicable exclusion amount.
Generally speaking, the longer period of time a taxpayer can defer the payment of the income tax due from the IRA and retirement assets, the more the taxpayer will benefit. It is important to review your assets with your attorney to make sure your estate has the flexibility, to the greatest extent possible, to fund these trusts with non-retirement assets.
Under current law, the federal estate tax applicable exclusion permits taxpayers to transfer up to $2 million ($675K in NJ) at death to anyone other than a spouse without incurring a federal estate tax. The estate tax applicable exclusion is scheduled to increase to $3.5 million ($675K in NJ) in 2009. In 2010, the Federal estate tax is scheduled to be repealed, but only for one year. Starting in 2011, estates will once again be subject to estate tax at 2001 rates (top rate of 55%) with only a $1 million ($675K in NJ) exemption available.
Generally speaking, to maximize the applicable exclusion of the first spouse to die, Wills are drafted to provide that a trust is created automatically or via a disclaimer approach for the benefit of the surviving spouse and the decedent’s children and grandchildren and funded with the decedent’s then remaining applicable exclusion amount, taking into account any transfers the decedent may have made during his or her lifetime. These trusts are typically called bypass or disclaimer trusts. The balance of the decedent’s estate in most instances would pass to the surviving spouse.
If IRAs and/or retirement assets are used to fund the trusts as described above, there are significant income tax ramifications for the decedent and his or her family. If the surviving spouse is the beneficiary of the IRA and/or retirement assets, the surviving spouse has the ability to roll over these assets to his or her own IRA and treat it as a new IRA. Consequently, the surviving spouse is able to designate his or her own beneficiary. The new beneficiary designation means that at the surviving spouse’s death, the beneficiary can take required minimum distributions over that beneficiary’s life expectancy. In most circumstances, the beneficiaries of the surviving spouse’s IRA will be the next generation (i.e., children), so that the required pay out period will be based on the life expectancies of the children, which typically is a longer period of time.
While the surviving spouse is alive, required minimum distributions need to begin to be paid as of April 1 of the calendar year following the surviving spouse’s attainment of the age of 70 ½. After that date, in most cases, the required minimum distributions are based on IRS tables which factor in the life expectancy of the surviving spouse and a hypothetical beneficiary who is ten years younger than the surviving spouse.
The required minimum distributions are significantly accelerated if the beneficiary of the decedent’s IRA and/or retirement assets is the bypass or disclaimer trust under the decedent’s will, as opposed to the surviving spouse. First, during the surviving spouse’s life, assuming the surviving spouse is the oldest beneficiary of the trust, distributions during the spouse’s life must be taken over the spouse’s life expectancy, as opposed to the surviving spouse waiting until April 1 of the year following the attainment of age 70 1/2. In this event, the surviving spouse is not able to roll over the IRA and/or retirement assets and treat the IRA as his or her own IRA because he or she is not the beneficiary.
Second, at the surviving spouse’s death, while the beneficiaries are usually the younger generation, the required minimum distributions remain based on the surviving spouse’s life expectancy. The decedent’s family is not able to use the younger generation’s longer life expectancy to significantly delay distributions.
This is the major reason why IRAs and retirement assets should be the last resort to fund a bypass trust or a disclaimer trust to maximize the decedent’s applicable exclusion amount.
Generally speaking, the longer period of time a taxpayer can defer the payment of the income tax due from the IRA and retirement assets, the more the taxpayer will benefit. It is important to review your assets with your attorney to make sure your estate has the flexibility, to the greatest extent possible, to fund these trusts with non-retirement assets.
Wednesday, July 16, 2008
Summary of New Jersey Estate Taxes
New Jersey Estate Taxes
The New Jersey estate tax was revised on July 1, 2002, and made significant changes to the previous New Jersey estate tax scheme. The changes apply retroactively to decedents dying after December 31, 2001.
The New Jersey estate tax is imposed on resident decedents and is intended to absorb the maximum state death tax credit allowed under federal estate tax law. However, New Jersey has decoupled itself from current federal estate tax laws and no longer has a true "pickup" tax. Instead, the personal representative of the estate can elect to apply either the maximum state death tax credit in effect on December 31, 2001, or an amount determined by the Division of Taxation under the Simplified Tax System.
The New Jersey Domestic Partnership Act, which establishes domestic partnerships for same sex and opposite sex (age 62 and older) unrelated partners, made significant changes to the New Jersey transfer inheritance tax, applicable to decedents dying on or after July 10, 2004. Provided that a valid domestic partnership is established, the Act exempts all transfers made by will, survivorship, or contract to a surviving domestic partner.
However, the New Jersey estate tax is not affected by the Act. The estate tax is based upon the federal estate tax credit for state death taxes allowable under the provisions of the Internal Revenue Code, which does not provide an estate tax deduction for property passing to a domestic partner.
New Jersey also imposes a transfer inheritance tax, at graduated rates, on property having a total value of $500 or more which passes from a decedent to a beneficiary. Transfers of property to the surviving spouse of a decedent, and, applicable to estates of decedents dying on or after July 10, 2004, transfers of property to a decedent's domestic partner, are exempt from the New Jersey transfer inheritance tax. Also exempt from the tax are transfers of property to a father, mother, grandparent, child or children, adopted child or children, mutually acknowledged child, stepchild or issue of any child or adopted child of a decedent.
Deductions. The following items can be deducted from a decedent's estate when calculating New Jersey estate tax liability:
decedent's debts
funeral expenses (e.g., burial, funeral luncheon, minister/rabbi, monument, flowers)
ordinary administration expenses (including executors' and attorneys' fees)
state and local taxes up to the date of death
inheritance taxes paid to other states
mortgages (to show actual equity of mortgaged property)
Returns. A New Jersey transfer inheritance tax return (Form IT-R) is due within eight months after the decedent's death. Any taxes owed must be paid within the same eight-month period. A self-executing waiver (Form L-8) is available for surviving spouses and Class A beneficiaries exempt from the tax.
New Jersey estate taxes are due on the decedent's date of death and must be paid within nine months. There are two ways to file an estate tax return: the Form 706 method and the Simplified Tax System (Alternative) method.
The Form 706 method requires that a New Jersey Form IT-Estate is filed along with a 2001 federal Form 706 estate tax return completed according to the provisions of the Internal Revenue Code in effect on December 31, 2001. Using this method, the New Jersey return is due within nine months and 30 days of the decedent's date of death.
The Simplified Tax System method is not intended for use with all estates. It can only be used when federal income and estate tax returns need not be filed. Under this method, a New Jersey Form IT-Estate must be filed within nine months of the decedent's death.
Generation-skipping transfer tax. New Jersey does not impose this type of tax.
The New Jersey estate tax was revised on July 1, 2002, and made significant changes to the previous New Jersey estate tax scheme. The changes apply retroactively to decedents dying after December 31, 2001.
The New Jersey estate tax is imposed on resident decedents and is intended to absorb the maximum state death tax credit allowed under federal estate tax law. However, New Jersey has decoupled itself from current federal estate tax laws and no longer has a true "pickup" tax. Instead, the personal representative of the estate can elect to apply either the maximum state death tax credit in effect on December 31, 2001, or an amount determined by the Division of Taxation under the Simplified Tax System.
The New Jersey Domestic Partnership Act, which establishes domestic partnerships for same sex and opposite sex (age 62 and older) unrelated partners, made significant changes to the New Jersey transfer inheritance tax, applicable to decedents dying on or after July 10, 2004. Provided that a valid domestic partnership is established, the Act exempts all transfers made by will, survivorship, or contract to a surviving domestic partner.
However, the New Jersey estate tax is not affected by the Act. The estate tax is based upon the federal estate tax credit for state death taxes allowable under the provisions of the Internal Revenue Code, which does not provide an estate tax deduction for property passing to a domestic partner.
New Jersey also imposes a transfer inheritance tax, at graduated rates, on property having a total value of $500 or more which passes from a decedent to a beneficiary. Transfers of property to the surviving spouse of a decedent, and, applicable to estates of decedents dying on or after July 10, 2004, transfers of property to a decedent's domestic partner, are exempt from the New Jersey transfer inheritance tax. Also exempt from the tax are transfers of property to a father, mother, grandparent, child or children, adopted child or children, mutually acknowledged child, stepchild or issue of any child or adopted child of a decedent.
Deductions. The following items can be deducted from a decedent's estate when calculating New Jersey estate tax liability:
decedent's debts
funeral expenses (e.g., burial, funeral luncheon, minister/rabbi, monument, flowers)
ordinary administration expenses (including executors' and attorneys' fees)
state and local taxes up to the date of death
inheritance taxes paid to other states
mortgages (to show actual equity of mortgaged property)
Returns. A New Jersey transfer inheritance tax return (Form IT-R) is due within eight months after the decedent's death. Any taxes owed must be paid within the same eight-month period. A self-executing waiver (Form L-8) is available for surviving spouses and Class A beneficiaries exempt from the tax.
New Jersey estate taxes are due on the decedent's date of death and must be paid within nine months. There are two ways to file an estate tax return: the Form 706 method and the Simplified Tax System (Alternative) method.
The Form 706 method requires that a New Jersey Form IT-Estate is filed along with a 2001 federal Form 706 estate tax return completed according to the provisions of the Internal Revenue Code in effect on December 31, 2001. Using this method, the New Jersey return is due within nine months and 30 days of the decedent's date of death.
The Simplified Tax System method is not intended for use with all estates. It can only be used when federal income and estate tax returns need not be filed. Under this method, a New Jersey Form IT-Estate must be filed within nine months of the decedent's death.
Generation-skipping transfer tax. New Jersey does not impose this type of tax.
Monday, July 14, 2008
Knowing When an Estate is Required to File a Tax Return
In our previous issues, we have been following the Ashby family in order to address various issues that arise when a family member passes away.
When we last left Jillian Ashby, she was compiling a list of the estate’s assets (i.e. any assets that William owned individually, jointly, in trust, etc.), debts and expenses as of his date of death. This will determine if the estate is required to file any state or federal death tax returns.
A question that arises is, “How do I know if the estate is required to file a state or federal estate tax return?” For federal estate tax purposes, an estate is required to file an estate tax return if the decedent’s gross estate (plus adjusted taxable gifts) is worth $2,000,000 or more. In determining the value of the gross estate, Jillian should inventory every asset that William owned (either individually, jointly, in trust, etc.) as well as their values as of his date of death. This includes, but is not limited to, cash and securities, real estate, insurance, certain trust assets, annuities, retirement accounts, business interests, etc. An estate is required to file a New Jersey estate tax return, if the value of the decedent’s gross estate exceeds $675,000. In addition, New Jersey also imposes an inheritance tax on assets that pass to someone other than a spouse or a lineal ascendant or descendant. This will necessitate the filing of a New Jersey inheritance tax return.
When are these returns required to be filed and what happens if Jillian does not have all of the information ready by the due date? New Jersey and federal estate tax returns must be filed within nine months of William’s passing. If required, the New Jersey inheritance tax return is due eight months after the date of death. In addition, if William owned any real property in New York, a New York estate tax return must also be filed within nine months after the date of death. Extensions may be obtained for each of these returns; however, it should be noted that the extensions do not extend the time to pay any estate/inheritance tax due but only extends the time to file the returns.
Families always ask if there are any other tax filing requirements? William’s estate is now a separate income taxpaying entity and will be required to file annual federal fiduciary income tax returns, if income exceeding $600 each year is generated from estate assets. There may also be state fiduciary income tax return filing requirements depending upon the amount of estate income earned.
Once the death tax returns have been filed, how long can Jillian expect to wait before hearing from the Internal Revenue Service and the State of New Jersey? Generally, the taxing authorities have three years from the date the return is filed to examine it. Practically speaking, the taxing authorities will either accept the return as filed and issue a closing letter or select the estate for examination and this usually occurs approximately nine to twelve months after filing.
One predictable question asked is when can the estate assets be distributed? Generally, distributions should not be made until the estate has received clearance and tax waivers from all taxing authorities. In many circumstances; however, it may be appropriate for partial distributions to be made prior to receiving tax clearance. Special consideration must be given to the distribution of assets such as annuities, pension plans and other retirement assets as there may be adverse income tax consequences from delayed or premature distributions.
The administration of an estate raises many more issues than clients realize. There may be complex estate and income tax issues, distribution issues, valuation issues as well as complicated family dynamics that need to be addressed along with many other legal and non-legal issues that arise during estate administration. Jillian and those in her situation should enlist the aid of competent and experienced estate administration counsel in order to be guided through this process.
Tuesday, July 1, 2008
Businesses Owners Need To Plan for Their Exit: Companies should be prepared for the boss’s departure
By Scott Goldstein 6/2/2008 NJBIZ magazine
Owners of closely held companies—especially family businesses—have a lot on their minds, and it often doesn’t involve what happens if an owner or partner dies or leaves the company unexpectedly.
“To fail to plan is no plan. You are leaving things to chance,” says Parag P. Patel, a Woodbridge-based business and tax lawyer who helps companies create succession plans.
Experts say most small and mid-sized private companies don’t have succession plans—and that can lead to confusion and loss for the business.
The main questions for a succession plan are: Who will lead the company? Who will buy out the deceased partner? And in the case of a family business, will the successor come from within the company or from within the family?
“These are challenging questions. It’s better to have this conversation before a partner actually dies or pulls out, when the stakes and the emotions aren’t as high,” says Marguerite Mount, an accountant with The Mercadien Group in Princeton. “You can apply more intellect than emotion. That why it’s called succession planning.”
A succession plan addresses more than just death, she says. It can apply when a partner retires, gets divorced or becomes disabled.
“Do you have one partner sell to the others? Do you find another partner to sell to? Do you continue operating the business the same way? And who will take the leadership role?” Mount cites as questions that need to be explored.
And some of the answers help create a philosophy for the business as it currently exists, Mount says. Are you building the company to sell? To merge? Are you going to take the company public? Or will you let the company perpetuate in the same form?
When a partner is suddenly gone, the succession plan can designate whether the shares go to the departing shareholder’s estate or are sold to the surviving shareholders, says Patel.
“With a plan, you won’t have the remaining shareholders arguing and you won’t have an unexpected shareholder entering the business,” Patel says.
“Without a plan, you can have a bank become a shareholder in the case of a bankruptcy,” he adds. “And you can have a wife become a shareholder in the case of a divorce or death. There are many scenarios.”
Setting up a succession plan involves communication and time.
“First thing you need to do is set up a vision statement and if you can’t do that between yourselves, then you need to have that facilitated,” Mount says. “That can take the form of professional facilitators or you can use someone who has knowledge in your industry.”
When The Mercadien Group is hired as a facilitator, it sets up a meeting among company partners in a “retreat setting” for a day, Mount says. Then the firm follows up to implement the plan with a broker or an attorney if a legal document is created, says Mount.
“The idea is to have a game plan that covers the inevi-table but unexpected.”
A family business’ succession plan should include a “buy-sell agreement” that specifies terms of ownership am-ong partners and the value of their shar-es, Patel says. “Of course, the lower the specified sh-are price, the lower the estate- and gift-tax value of the shares,” Patel says. That “avoids valuation disputes with the IRS, which may otherwise value the business higher and seek more on taxes after it is sold.”
A way to reduce estate taxes is for a business owner to shift minority shares to family members before the owner retires, Patel says. The IRS taxes transfers of business shares among family at a lower rate than it does the inheritance of business shares, he notes.
© 2008 Journal Publications Inc. All information on this site are copyright of Journal Publications Inc. All images are the sole property of Journal Publications Inc. and no rights are granted for any use without the express written consent of Journal Publications Inc.
Owners of closely held companies—especially family businesses—have a lot on their minds, and it often doesn’t involve what happens if an owner or partner dies or leaves the company unexpectedly.
“To fail to plan is no plan. You are leaving things to chance,” says Parag P. Patel, a Woodbridge-based business and tax lawyer who helps companies create succession plans.
Experts say most small and mid-sized private companies don’t have succession plans—and that can lead to confusion and loss for the business.
The main questions for a succession plan are: Who will lead the company? Who will buy out the deceased partner? And in the case of a family business, will the successor come from within the company or from within the family?
“These are challenging questions. It’s better to have this conversation before a partner actually dies or pulls out, when the stakes and the emotions aren’t as high,” says Marguerite Mount, an accountant with The Mercadien Group in Princeton. “You can apply more intellect than emotion. That why it’s called succession planning.”
A succession plan addresses more than just death, she says. It can apply when a partner retires, gets divorced or becomes disabled.
“Do you have one partner sell to the others? Do you find another partner to sell to? Do you continue operating the business the same way? And who will take the leadership role?” Mount cites as questions that need to be explored.
And some of the answers help create a philosophy for the business as it currently exists, Mount says. Are you building the company to sell? To merge? Are you going to take the company public? Or will you let the company perpetuate in the same form?
When a partner is suddenly gone, the succession plan can designate whether the shares go to the departing shareholder’s estate or are sold to the surviving shareholders, says Patel.
“With a plan, you won’t have the remaining shareholders arguing and you won’t have an unexpected shareholder entering the business,” Patel says.
“Without a plan, you can have a bank become a shareholder in the case of a bankruptcy,” he adds. “And you can have a wife become a shareholder in the case of a divorce or death. There are many scenarios.”
Setting up a succession plan involves communication and time.
“First thing you need to do is set up a vision statement and if you can’t do that between yourselves, then you need to have that facilitated,” Mount says. “That can take the form of professional facilitators or you can use someone who has knowledge in your industry.”
When The Mercadien Group is hired as a facilitator, it sets up a meeting among company partners in a “retreat setting” for a day, Mount says. Then the firm follows up to implement the plan with a broker or an attorney if a legal document is created, says Mount.
“The idea is to have a game plan that covers the inevi-table but unexpected.”
A family business’ succession plan should include a “buy-sell agreement” that specifies terms of ownership am-ong partners and the value of their shar-es, Patel says. “Of course, the lower the specified sh-are price, the lower the estate- and gift-tax value of the shares,” Patel says. That “avoids valuation disputes with the IRS, which may otherwise value the business higher and seek more on taxes after it is sold.”
A way to reduce estate taxes is for a business owner to shift minority shares to family members before the owner retires, Patel says. The IRS taxes transfers of business shares among family at a lower rate than it does the inheritance of business shares, he notes.
© 2008 Journal Publications Inc. All information on this site are copyright of Journal Publications Inc. All images are the sole property of Journal Publications Inc. and no rights are granted for any use without the express written consent of Journal Publications Inc.
Wednesday, June 25, 2008
Leave Your IRA to a Special Needs Trust
In a private letter ruling recently, the IRS addressed the issue of transferring an inherited IRA into a Special Needs Trust. The law around taxation of inherited IRAs and the interaction with trusts has been unpredictable and fast-moving for several years now.
Fortunately, this private letter ruling indicates the direction the IRS is headed on two important questions:
First, the transfer to the SNT was not a taxable transfer for estate and gift tax purposes. That's great! It means that if a person with special needs inherits an IRA, we can still do some limited planning without immediate tax consequences.
Second, the trustee was able to stretch out the distributions from the IRA (and therefore stretch out the tax deferral benefits) over the life expectancy of the beneficiary. Another positive result.
Of course, the best result would have been achieved if the decedent had made the IRA payable to the SNT directly. That way, court costs, private letter ruling costs, anxiety, and a "pay back to the state" provision all could have been avoided.
Fortunately, this private letter ruling indicates the direction the IRS is headed on two important questions:
First, the transfer to the SNT was not a taxable transfer for estate and gift tax purposes. That's great! It means that if a person with special needs inherits an IRA, we can still do some limited planning without immediate tax consequences.
Second, the trustee was able to stretch out the distributions from the IRA (and therefore stretch out the tax deferral benefits) over the life expectancy of the beneficiary. Another positive result.
Of course, the best result would have been achieved if the decedent had made the IRA payable to the SNT directly. That way, court costs, private letter ruling costs, anxiety, and a "pay back to the state" provision all could have been avoided.
Monday, June 16, 2008
Contesting a Will: Protect Your Parents From Undue Influence
Contesting a Will: Protect Your Parents From Undue Influence
Ways to Avoid Will Contests and Estate Litigation
In our estate litigation practice, inquiries from persons seeking to contest a decedent’s last will and testament are on the rise. Often the inquiry comes as the result of a parent having made an unequal distribution among his or her children, favoring one child and excluding other children as beneficiaries.
There are two grounds for contesting a last will and testament: lack of capacity and undue influence. Lack of testamentary capacity means that the decedent was not of sound mind when he or she made the will. To have testamentary capacity, a person must know in general terms what s/he has and who the natural objects of his bounty are. This is not a high standard, and challenges to a will based on lack of testamentary capacity are usually difficult to win in the absence of good medical evidence that the decedent was mentally incompetent.
More and more, our estate litigation attorneys receive calls from people who claim that the person who made the will was coerced into doing so by someone else, often a child or relative who lived near or with the decedent. Medical advances have resulted in the populace becoming much older. The care and burden of the elderly tends to fall on the shoulders of a child. Even though we like to believe that our parents will always be a great strength and knowledge in our lives, there comes a time when the roles are reversed and the child must take on responsibility for his or her parent. Such responsibilities might include the child taking on the role of caretaker.
In some families one sibling takes on a greater burden of the care of the ill and dependent parent than the other siblings. We have seen many examples where the child who takes on these responsibilities during the parent’s final years, months or even days becomes the sole heir of the parent’s estate. Sometimes, this is the bona fide choice of the parent who feels indebted to the child as a result of the care, and all the siblings are made aware of this arrangement and are in agreement.
Sometimes the arrangement is kept secret, however, and this is when problems arise. When an aged parent suffers from mental or physical infirmity that makes him or her dependent on a child caretaker, the potential for undue influence is present. The phrase undue influence with respect to the making of a will means that a person exerted influence over another such that it destroyed the free agency of the person whose will it is. In cases that we have handled one sibling has had the burden of the care of the parent, while other siblings have had minimal communications with the parent.
There is no way to prevent a sibling from taking an elderly parent to an attorneys’ office and inducing the parent to execute a new will, but some preventive measures can be taken to assure that the elderly parent is not subject to undue influence by the caretaker child.
First, have a family meeting and come to some type of financial arrangement to assist the sibling who has taken on the care of the parent. Memorialize the arrangement in writing. Second, confirm that the parent has a will and discuss the will together as a family. Third, videotape the parent explaining his/her testamentary intent and make sure the parent understands the terms of the will. Fourth, keep the lines of communication with all the siblings and the parent open.
Unfortunately, if undue influence occurs it can be difficult to prove. Because the parent has died, it becomes a situation where the only evidence is circumstantial rather than direct. Some of the circumstantial evidence a Court would find relevant would include: (1) the health of the person at the time s/he signed the will; (2) the observations and factual commentary of the attorney who prepared the will; (3) did the favored child contact the attorney; (4) was this a sudden change in disposition of the estate of the parent; (5) was the favored child at the attorney’s office when the will was signed; (6) did the favored child keep possession of the will; and (7) did the favored child keep the will a secret from the other siblings.
If you have any questions about the last will and testament of someone you know, please do not hesitate to call us.
Ways to Avoid Will Contests and Estate Litigation
In our estate litigation practice, inquiries from persons seeking to contest a decedent’s last will and testament are on the rise. Often the inquiry comes as the result of a parent having made an unequal distribution among his or her children, favoring one child and excluding other children as beneficiaries.
There are two grounds for contesting a last will and testament: lack of capacity and undue influence. Lack of testamentary capacity means that the decedent was not of sound mind when he or she made the will. To have testamentary capacity, a person must know in general terms what s/he has and who the natural objects of his bounty are. This is not a high standard, and challenges to a will based on lack of testamentary capacity are usually difficult to win in the absence of good medical evidence that the decedent was mentally incompetent.
More and more, our estate litigation attorneys receive calls from people who claim that the person who made the will was coerced into doing so by someone else, often a child or relative who lived near or with the decedent. Medical advances have resulted in the populace becoming much older. The care and burden of the elderly tends to fall on the shoulders of a child. Even though we like to believe that our parents will always be a great strength and knowledge in our lives, there comes a time when the roles are reversed and the child must take on responsibility for his or her parent. Such responsibilities might include the child taking on the role of caretaker.
In some families one sibling takes on a greater burden of the care of the ill and dependent parent than the other siblings. We have seen many examples where the child who takes on these responsibilities during the parent’s final years, months or even days becomes the sole heir of the parent’s estate. Sometimes, this is the bona fide choice of the parent who feels indebted to the child as a result of the care, and all the siblings are made aware of this arrangement and are in agreement.
Sometimes the arrangement is kept secret, however, and this is when problems arise. When an aged parent suffers from mental or physical infirmity that makes him or her dependent on a child caretaker, the potential for undue influence is present. The phrase undue influence with respect to the making of a will means that a person exerted influence over another such that it destroyed the free agency of the person whose will it is. In cases that we have handled one sibling has had the burden of the care of the parent, while other siblings have had minimal communications with the parent.
There is no way to prevent a sibling from taking an elderly parent to an attorneys’ office and inducing the parent to execute a new will, but some preventive measures can be taken to assure that the elderly parent is not subject to undue influence by the caretaker child.
First, have a family meeting and come to some type of financial arrangement to assist the sibling who has taken on the care of the parent. Memorialize the arrangement in writing. Second, confirm that the parent has a will and discuss the will together as a family. Third, videotape the parent explaining his/her testamentary intent and make sure the parent understands the terms of the will. Fourth, keep the lines of communication with all the siblings and the parent open.
Unfortunately, if undue influence occurs it can be difficult to prove. Because the parent has died, it becomes a situation where the only evidence is circumstantial rather than direct. Some of the circumstantial evidence a Court would find relevant would include: (1) the health of the person at the time s/he signed the will; (2) the observations and factual commentary of the attorney who prepared the will; (3) did the favored child contact the attorney; (4) was this a sudden change in disposition of the estate of the parent; (5) was the favored child at the attorney’s office when the will was signed; (6) did the favored child keep possession of the will; and (7) did the favored child keep the will a secret from the other siblings.
If you have any questions about the last will and testament of someone you know, please do not hesitate to call us.
Thursday, June 5, 2008
Administrator of a Probate Estate: Duties and Responsibilities
The procedures in an estate administration may take from six months to several years, and a client’s patience may be sorely tried during this time. However, it has been our experience that clients who are forewarned have a much higher tolerance level for the slowly turning wheels of justice.
The following is a portion of the duties of an administrator:
Some of the Duties of the Administrator in Probate Estate Administration
Conduct a thorough search of the decedent’s personal papers and effects for any evidence that might point you in the direction of a potential creditor;
Carefully examine the decedent’s checkbook and check register for recurring payments, as these may indicate an existing debt;
Contact the issuer of each credit card that the decedent had in his or her possession at the time of his or her death;
Contact all parties who provided medical care, treatment, or assistance to the decedent prior to his or her death;
The attorney for the administrator will not be able to file any estate or inheritance tax return until it is clear as to the amounts of the medical bills. Medical expenses can be deducted in determining the amount of any inheritance tax.
In a Supreme Court case, Tulsa Professional Collection Services, Inc., v. Joanne Pope, Executrix of the Estate of H. Everett Pope, Jr., Deceased, the court held that the administrator/personal representative in every estate is personally responsible to provide actual notice to all known or “readily ascertainable” creditors of the decedent. This means that it is the administrator’s responsibility to diligently search for any “readily ascertainable” creditors.
Other Duties of the Administrator
In General
The administrator’s job is to (1) administer the estate—i.e., collect and manage assets, file tax returns and pay taxes and debts—and (2) distribute any assets or make any distributions of bequests, whether personal or charitable in nature, as the deceased directed (under the provisions of the will). Let’s take a look at some of the specific steps involved and what these responsibilities can mean. Chronological order of the various duties may vary.
Probate
The administrator must “probate” the will. Probate is a process by which a will is admitted. This means that the will is given legal effect by the court. The court’s decision that the will was validly executed under state law gives the administrator the power to perform his or her duties under the provisions of the will.
An employer identification number (EIN) must be obtained for the estate; this number must be included on all returns and other tax documents having to do with the estate. The administrator should also file a written notice with the IRS that he or she is serving as the fiduciary of the estate. This gives the administrator the authority to deal with the IRS on the estate’s behalf.
Pay the Debts
The claims of the estate’s creditors must be paid. Sometimes a claim must be litigated to determine if it is valid. All estate administration expenses, such as attorneys’, accountants’, and appraisers’ fees, must also be paid.
Manage the Estate
The administrator takes legal title to the assets in the probate estate. The probate court will sometimes require a public accounting of the estate assets. The assets of the estate must be found and may have to be collected. As part of the asset management function, the administrator may have to liquidate or run a business or manage a securities portfolio. To sell marketable securities or real estate, the administrator will have to obtain stock power, tax waivers, file affidavits, and so on as the case may be.
Take Care of Tax Matters
The administrator is legally responsible for filing necessary income and estate-tax returns (federal and state) and for paying all death taxes (i.e., estate and inheritance). The administrator can, in some cases, be held personally liable for unpaid taxes of the estate. Tax returns that will need to be filed can include the estate’s income tax return (both federal and state), the federal estate-tax return, the state death tax return (estate and inheritance), and the deceased’s final income tax return (federal and state). Taxes usually must be paid before other debts. In many instances, federal estate-tax returns are not needed as the size of the estate will be under the amount for which a federal estate-tax return is required.
Often it is necessary to hire an appraiser to value certain assets of the estate, such as a business, pension, or real estate, because estate taxes are based on the “fair market” value of the assets. After the filing of the returns and payment of taxes, the Internal Revenue Service will generally send some type of estate closing letter accepting the return. Occasionally, the return will be audited.
Distribute the Assets
After all debts and expenses have been paid, the administrator will distribute the assets. Frequently, beneficiaries can receive partial distributions of their inheritance without having to wait for the closing of the estate.
Under increasingly complex laws and rulings, particularly with respect to taxes, in larger estates an administrator can be in charge for two or three years before the estate administration is completed. If the job is to be done without unnecessary cost and without causing undue hardship and delay for the beneficiaries of the estate, the administrator should have an understanding of the many problems involved and an organization created for settling estates. In short, an administrator should have experience.
At some point in time, you may be asked to serve as the administrator of the estate of a relative or friend, or you may ask someone to serve as your administrator. An administrator’s job comes with many legal obligations. Under certain circumstances, an administrator can even be held personally liable for unpaid estate taxes. Review the major duties involved before you accept such a responsibility.
By Kenneth A. Vercammen
Kenneth A. Vercammen is a Middlesex County, New Jersey, trial attorney who has published 125 articles in national and New Jersey publications on probate and litigation topics. He is chair of the ABA General Practice, Solo & Small Firm Division's Estate Planning, Probate & Trust Committee.
The following is a portion of the duties of an administrator:
Some of the Duties of the Administrator in Probate Estate Administration
Conduct a thorough search of the decedent’s personal papers and effects for any evidence that might point you in the direction of a potential creditor;
Carefully examine the decedent’s checkbook and check register for recurring payments, as these may indicate an existing debt;
Contact the issuer of each credit card that the decedent had in his or her possession at the time of his or her death;
Contact all parties who provided medical care, treatment, or assistance to the decedent prior to his or her death;
The attorney for the administrator will not be able to file any estate or inheritance tax return until it is clear as to the amounts of the medical bills. Medical expenses can be deducted in determining the amount of any inheritance tax.
In a Supreme Court case, Tulsa Professional Collection Services, Inc., v. Joanne Pope, Executrix of the Estate of H. Everett Pope, Jr., Deceased, the court held that the administrator/personal representative in every estate is personally responsible to provide actual notice to all known or “readily ascertainable” creditors of the decedent. This means that it is the administrator’s responsibility to diligently search for any “readily ascertainable” creditors.
Other Duties of the Administrator
In General
The administrator’s job is to (1) administer the estate—i.e., collect and manage assets, file tax returns and pay taxes and debts—and (2) distribute any assets or make any distributions of bequests, whether personal or charitable in nature, as the deceased directed (under the provisions of the will). Let’s take a look at some of the specific steps involved and what these responsibilities can mean. Chronological order of the various duties may vary.
Probate
The administrator must “probate” the will. Probate is a process by which a will is admitted. This means that the will is given legal effect by the court. The court’s decision that the will was validly executed under state law gives the administrator the power to perform his or her duties under the provisions of the will.
An employer identification number (EIN) must be obtained for the estate; this number must be included on all returns and other tax documents having to do with the estate. The administrator should also file a written notice with the IRS that he or she is serving as the fiduciary of the estate. This gives the administrator the authority to deal with the IRS on the estate’s behalf.
Pay the Debts
The claims of the estate’s creditors must be paid. Sometimes a claim must be litigated to determine if it is valid. All estate administration expenses, such as attorneys’, accountants’, and appraisers’ fees, must also be paid.
Manage the Estate
The administrator takes legal title to the assets in the probate estate. The probate court will sometimes require a public accounting of the estate assets. The assets of the estate must be found and may have to be collected. As part of the asset management function, the administrator may have to liquidate or run a business or manage a securities portfolio. To sell marketable securities or real estate, the administrator will have to obtain stock power, tax waivers, file affidavits, and so on as the case may be.
Take Care of Tax Matters
The administrator is legally responsible for filing necessary income and estate-tax returns (federal and state) and for paying all death taxes (i.e., estate and inheritance). The administrator can, in some cases, be held personally liable for unpaid taxes of the estate. Tax returns that will need to be filed can include the estate’s income tax return (both federal and state), the federal estate-tax return, the state death tax return (estate and inheritance), and the deceased’s final income tax return (federal and state). Taxes usually must be paid before other debts. In many instances, federal estate-tax returns are not needed as the size of the estate will be under the amount for which a federal estate-tax return is required.
Often it is necessary to hire an appraiser to value certain assets of the estate, such as a business, pension, or real estate, because estate taxes are based on the “fair market” value of the assets. After the filing of the returns and payment of taxes, the Internal Revenue Service will generally send some type of estate closing letter accepting the return. Occasionally, the return will be audited.
Distribute the Assets
After all debts and expenses have been paid, the administrator will distribute the assets. Frequently, beneficiaries can receive partial distributions of their inheritance without having to wait for the closing of the estate.
Under increasingly complex laws and rulings, particularly with respect to taxes, in larger estates an administrator can be in charge for two or three years before the estate administration is completed. If the job is to be done without unnecessary cost and without causing undue hardship and delay for the beneficiaries of the estate, the administrator should have an understanding of the many problems involved and an organization created for settling estates. In short, an administrator should have experience.
At some point in time, you may be asked to serve as the administrator of the estate of a relative or friend, or you may ask someone to serve as your administrator. An administrator’s job comes with many legal obligations. Under certain circumstances, an administrator can even be held personally liable for unpaid estate taxes. Review the major duties involved before you accept such a responsibility.
By Kenneth A. Vercammen
Kenneth A. Vercammen is a Middlesex County, New Jersey, trial attorney who has published 125 articles in national and New Jersey publications on probate and litigation topics. He is chair of the ABA General Practice, Solo & Small Firm Division's Estate Planning, Probate & Trust Committee.
Subscribe to:
Posts (Atom)