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Year 2000 Estate Planning Considerations
s it safe to emerge from the bunkers? Assuming the fallout from the ballyhooed Y2K conflagration (and party) is swiftly sorted out and the world resumes business as usual, the post-modern estate planner may feel relatively comfortable. Estates are still planned with wills and trusts after all. But these times, they are a-changin'. Biotechnological changes, the Internet, and the potential repeal of transfer taxes all present challenges.
Mind-Boggling Biotechnology
Technology has presented us with novel circumstances that no court, family, or estate planner has ever had to contend with. In recent years, the situation of a surrogate mother who refuses to relinquish a child derived from her own egg presented a difficult conflict worthy of King Solomon's wisdom. Now, however, science has raised the stakes and it may take an Albert Einstein to assist us. The following situations are not science fiction or merely plausible; they are now reality:
Under an experimental procedure, one woman's genes were spliced into the egg of another woman, creating a hybrid egg that both gene donor and egg donor have a biological connection with.2 Oh yes, the father would be a third parent.3 The original couple's arrangements for a child involved two biological donors and a gestational surrogate mother who had a husband. However, they divorced before the child was born. Despite six potential parents, a trial judge in California ruled the child "parentless."4 As the result of a laboratory mix-up, a woman implanted with two embryos gives birth to two boys, one white and one black. The biological parents of one of the boys reach a settlement to gain custody of their son, but continue to battle the birth mother over the extent of visitation. Would the birth mother's testamentary bequest "to heirs of my body" include a child she bore but has no biological connection with? Another in vitro fertilization resulted in frozen embryos that a couple planned to use in the future. After the couple was divorced, the wife had the embryos implanted and subsequently gave birth to a girl. A custody battle ensued.
How many frozen embryos, eggs, DNA, and other genetic material are stored on ice, ready to be used in creating new life and affecting financial matters?5 A 28-year woman who died of cancer had left behind an embryo created with an anonymous donor. After the woman's death, her parents arranged to have a surrogate implanted with the embryo. Can the posthumous harvesting of reproductive materials take place without permission? A California woman had genetic materials taken from her husband 30 hours after his death; four years later, she had her late husband's child. A lawsuit compelled the Social Security Administration to provide death benefits for the child.6 Is the child produced in this example an heir to be included in the estate of the deceased husband? Suppose the samples harvested in this case were used to impregnate a surrogate parent rather than the decedent's spouse? What is to prevent a widow from creating a posthumous child just to create financial claims against an estate.7 Advertisements in college newspapers at Stanford, M.I.T., and Ivy League schools offered $50,000 for eggs donated by an athletic woman with good medical history who is 5 feet 10 inches tall and who scored at least a 1400 on her SAT exams. Medical ethicists already cringing at the coercive nature of small financial inducements to egg donors were appalled at the large sums being offered.8 Doesn't an individual have a right to not reproduce?
In England, the "Human Fertilisation and Embryology Authority" supervises fertilization techniques. Practices such as posthumous creation of heirs without the decedent's consent are prohibited. In the United States, the Uniform Anatomical Gift Act allows a surviving spouse or relative to donate organs, but does not specify how reproductive materials can be utilized.
Me and My Clone
Cloning of humans may never be legalized, but science has now brought us the successful cloning of highly developed mammals.9 What is the legal status of a cloned entity? Is a clone derived from someone's cells to be considered a biological offspring of that person, a twin sibling, a duplicate self, or merely a collection of spare parts? Does an unauthorized clone have lesser rights? What if posthumous clones arise? Do we own our own bodies, our very DNA? If someone gets possession of an individual's DNA, he or she could, potentially, use it to create heirs that would not otherwise exist. Naturally, a wealthy individual would be the most likely target.10
Beyond Cloning
Even more frightening developments are in store for society. Using cloning techniques or suspending life while replacement body parts are grown may extend life spans dramatically but also confronts us with the unfathomable.11 We already have artificial limbs and organs so the concept of a hybrid biomechanical being with microchip memory support is not unrealistic. And the prospect of computers manipulating the human genome and creating designer human beings without donors of any kind challenges our very role on earth.
The Whole E-World
Twenty years ago, before these new-fangled personal computers caught on, a "high-tech" estate was one that involved a videotaped portion of the will. Today, the cutting edge has gone far beyond that. As Internet commerce expands, the use of new forms of online wealth creates new possibilities. One could conceivably convert assets to e-wealth and then distribute them to heirs online in one group e-mail.
Everything "e" shall apply to estates. Executors can send group e-mails, estates can sell collectibles on E-Bay, and high-tech possessions such as a lucrative web site will be strategic interests to be divided among heirs. Legal notices will one day be posted on the Internet and interested parties will use automated search engines to scan for notices that apply.
Say Again, No Estate Tax?
And then there is the more orthodox arena of tax planning. Having crawled from the wreckage of radical tax proposals that concluded the last century, estate planners may be reassured to see a few familiar signs of civilization from the last millennium. There, for instance, is the tax code's unified estate and gift tax schedule. Yet this monumental tax structure now rests on shifting sands, silhouetted against a background of the changes on the horizon...the very same proposals we just left behind.12
If memory serves regarding the events of the last century, significant efforts to provide additional estate tax relief were made in both the House of Representatives and the Senate. In September, the President vetoed the Taxpayer Refund and Relief Bill of 1999 (H.R. 2488), yet by October, many of the same estate tax provisions were included in H.R. 3081, the Wage and Employment Growth Bill of 1999. Without estate or gift tax concerns, income tax and capital gains considerations will be paramount.
A Baseline: Estate Planning Basics for the Year 2000
Notwithstanding proposals to totally revise our tax code's approach to transfer taxation, the financial planning landscape looks remarkably unchanged. A number of new tax limits have taken effect due to cost-of-living adjustments, some of which can be found in Rev. Proc. 99-42, IRB 1999-46.
Estate Tax Rates
We begin the year 2000 with the same basic estate and gift tax rates in a progressive schedule that peaks at 55% for estates over $3 million but which continues to have a 5% surtax for estates in excess of $10 million and up to $17,184,000.
Unified Credit
The unified credit for 2000 and 2001 will be equal to an effective exemption of $675,000, up from $650,000 last year. By the year 2006, $1 million of an individual's estate will not be taxed.
Gift Tax
The annual gift tax exclusion will remain at $10,000 for 2000. The exclusion is scheduled to rise in increments of $1,000. It will reach $11,000 when there is sufficient cumulative inflation. Had the original $10,000 limit been indexed since 1982, the exclusion would now stand at $18,000.
GST Tax
The generation-skipping transfer tax Sec. 2642 exemption rises from $1,010,000 last year to $1,030,000 in year 2000.
Conservation Easement: The conservation easement exclusion limitation under Sec. 2031 rises to $300,000 (from $200,000) for qualified properties.
Retirement Distributions
Five-year averaging for eligible lump-sum distributions from qualified retirement plans is no longer available, leaving only 10-year averaging for those individuals who reached age 50 before 1986.
Special Use Valuation: The Sec. 2032A ceiling on special use valuation is indexed for inflation and rises in $10,000 increments. It rose from $750,000 for 1998 to $760,000 for 1999 and will be $770,000 for 2000.
Capital Gains
A top rate of 20% applies to assets held for at least one year. A principal residence for two of the five years prior to a sale will not be subject to capital gains tax up to $250,000--$500,000 for spouses filing jointly. This benefit can be used every two years. [Correction: This provision is not subject to a phaseout. The editor regrets the reference to such a requirement in the November, 1999 issue, p. 2.]
Administration Expense Deduction Denied
Most of an estate had been divided into a living trust and a QTIP trust. The living trust paid its share of estate tax. The QTIP trust, consisting of real estate, lacked the liquid assets to pay its share of estate tax. Three parcels of real estate were distributed to beneficiaries, who in turn placed the properties in their respective individual trusts. To pay the estate tax, the beneficiaries borrowed funds against the properties rather than sell the properties during an unfavorable real estate market. The estate described the interest incurred on the loan as an administrative expense under Sec. 2053. The estate moved to stay the proceedings for 20 years so that all of the interest could be deducted. Although bona fide interest expenses often qualify as deductible expenses of administration, the estate in question had already distributed the property. Once the property was in the hands of the beneficiaries and their trusts, those entities made the decision to borrow funds rather than sell the property. The estate was removed from this decision and did not directly incur the administrative expense, so no deduction was permitted. Estate of Lasarzig v. Comm'r, TC Memo. 1999-307.
Carry-Over Basis for Bronze Statue
Grandfather died in 1972, leaving his bronze statue to Father, who in turn gave the statute to Son in 1974. After a theft of the statue in 1994, Son claimed a $25,000 casualty loss and sought a deduction for income tax purposes under Sec. 165(h). However, before Sec. 165(h) can even be applied, the amount of the deduction must be ascertained by finding the lesser of Son's basis in the property or the fair market value immediately before the theft. Here, based on other sale prices, the Tax Court found the statue to have a fair market value of $4,000 at the time of Grandfather's death, which therefore became Father's basis under Sec. 1014. When Father transferred the property to Son as a gift, Son took on a carry-over basis under Sec. 1015. This basis consisted of the property's fair market value at the time of Grandfather's death plus any gift tax paid. Only a $4,000 loss could therefore be claimed. Vitale v. Comm'r, TC Memo. 1999-272.
Schism on Equitable Recoupment
The Tax Court allowed an estate to apply an income tax overpayment against an estate tax deficiency. The Court followed its own equitable recoupment position as stated in Bartels Estate, 106 TC 430 and B. Mueller Estate, 101 TC 551. Although Mueller had been reversed by the 6th Circuit Court of Appeals, the case at bar was within the appellate jurisdiction of the 9th Circuit. Here, a residuary legatee paid income tax on a long-term gain distribution. After the refund limitation period had expired, the stock was found to have been undervalued on the estate tax return. Under the circumstances, the requirements of equitable recoupment were met insofar as an income tax refund was time barred. The same asset was taxed for income tax purposes and estate tax purposes under inconsistent theories, the taxes were levied on the same transaction, and a sufficient identity existed between the residuary legatee and the decedent in that the estate taxes were paid from the residue of the estate. Branson v. Comm'r, TC Memo.1999-231.
Bequest to Cemetery Association
A cemetery association was organized under Missouri's nonprofit corporation statute. The association also had close ties to two churches in that each had two members on the association's six-member board of directors. Nevertheless, the association had no discernible nexus to a specific church or government body. A bequest of $50,000 to the association did not qualify for a charitable deduction because the estate could not demonstrate that the association was devoted exclusively to a charitable purpose. Estate of Alward v. Comm'r,TC Memo. 1999-262.
Deduction for Superfund Liability
Decedent transferred most of his assets, including a landfill that was later identified as a Superfund site, to a revocable trust. After a lawsuit was brought against the trust, a $750,000 settlement was reached with the Environmental Protection Agency (EPA). The estate deducted the entire $750,000 as a claim against the estate under Sec. 2053.The IRS argued that the deduction should be limited to the value of the "property subject to claims," i.e., the value of the probate estate. The Federal Court of Claims found that under Sec. 2053(c)(2), property subject to claims includes all property in the decedent's gross estate. The estate was entitled to a $750,000 deduction. Estate of Snyder v. U.S., Ct. Fed. Cl.(1999).
Standing to File Refund Suit
Only the estate or counsel for the estate has standing to file a civil action to recover estate taxes. Without a court order relieving the attorney as counsel for the estate, communications from others could not be accepted by the United States District Court under local civil rules. An individual donee of the estate who filed a 34-page pro se brief was therefore dismissed as a plaintiff. Rosanov. U.S., DC-NY, 6/24/1999.
Consistency Doctrine Bars Credit
Decedent sold property to his children and did not apply any portion of his unified credit to the transfer. In a subsequent year, Decedent made gifts to his children and did apply his unified credit. When the Internal Revenue Service (IRS) later recharacterized the first transfer to his children as a taxable gift, Decedent attempted to reallocate his unified credit to the earlier transfer. However, Decedent was stopped from reallocating unified credit based on the duty of consistency doctrine. Decedent's gift tax return (for the subsequent year) had represented that no prior taxable gifts had been made, the IRS relied upon that representation, and Decedent's estate was now making a contrary representation. TAM 1999 30002.
References
1 In re Baby M, 537 A2d 1227 (N.J. 1988); R.R. v. M.H., 689 NE2d 790 (Mass. 1998).
2 Human genes added to a fruit fly's motor neurons extended the insect's life by 40%. Hybrid cow cells with human nuclei have also been created at Advanced Cell Technology in Massachusetts. This raises the specter of the "chimera," a hybrid being.
3 Genetic donors may be considered the legal parents in some jurisdictions. Belsito v. Clark, 644 NE2d 760 (Ohio Misc.2d1994). However, the gestational surrogate laying claim to maternity can meet the "intent-to-procreate" test. McDonald v. McDonald, 608 NYS2d 477 (NY App. Div. 1994); Johnson v. Calvert,851 P2d 776 (Cal. 1993).
4 In re Marriage of Buzzanca, 72 Cal. Rptr.2d 280 (Cal. App. 4th 1998).
5 Other scenarios play out around the nation. In New Jersey, for example, a judge sided with a woman who wants her frozen embryos destroyed so that her ex-husband can't use them. In New York and Tennessee, women fight to be implanted by frozen embryos created with former husbands. By one estimate, several years ago, more than 20,000 frozen embryos are being held in "inventory." A 1997 survey identified 14 clinics in 12 states engaged in harvesting reproductive specimens from the deceased. The Center for Bioethics at the University of Pennsylvania indicated 45 cases of post-mortem harvesting from men.
6 Social Security benefits normally would apply only to replace the support the deceased father had provided during life, but benefits were granted in this unusual case anyway. The benefits were used by the surviving spouse/mother to attend law school and pursue a career in reproductive technology law.
7 Mr. K, a wealthy attorney, took his own life. He bequeathed genetic samples to his girl friend. Children from Mr. K.'s first marriage, not desiring after born siblings, contested the bequest, saying the disruption to existing families would cause emotional harm.
8 Human eggs have been auctioned on the Internet in a dubious publicity stunt. An infertility clinic in Manhattan began selling pedigreed embryos for $2,750 in 1997.
9 The arrival of Dolly the cloned sheep was announced in Scotland in 1997. In August, 1998, a couple donated $2.3 million to Texas A&M to sponsor the cloning of their pet dog Missy, a border collie/husky mix--see the project web site at missyplicity.com. By December, 1998, scientists in Hawaii, Massachusetts, France and Japan were cloning mice and cows, while rumors circulated about a human cloning from South Korea. As for Dolly the cloned sheep, she became a mother in 1999 by entirely natural techniques.
10 William Gates of Microsoft, has an estate that had reached $100 billion in value when he donated $15 billion to the charitable foundation that he and his wife established. Suppose an unscrupulous barber working on Mr. Gates gets hold of a hair follicle that contains Mr. Gates' DNA. If that DNA is used invitro, it could create an individual who is derived from the same genes as Mr. Gates' natural heirs. If DNA were used to clone Mr.Gates, would the clone have concurrent rights with Mr. Gates? Would it be an heir?
11 Cryolabs will be filled with stem cells and reproductive tissues to create replacement parts. Sci-fi disembodied heads that retain their identities ala Rosie Grier's cinematic role and Futurama have been demonstrated in lab experiments with rhesus monkeys.
12 In Planet of the Apes, the Statue of Liberty symbolically lying in ruins on the beach identified an alien world to be Mother Earth. It simultaneously revealed that Charleton Heston's home no longer existed as he knew it. The familiar unified credit and tax system that had been an unassailable fixture now stands in the shadow of the vote by both branches of Congress to abandon it. Like Mr. Heston, we see a familiar but fallen edifice.
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