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The Year In Review 2000: What Were We Thinking?
by Robert Moshman, JD
veryone held their breath, but when the clock struck midnight on December 31, 1999, and the new millennium finally arrived, the sound heard round the world was not of Y2K meltdown, but of billions of LCD readouts on clock radios and modems and computers, all quietly rolling over and marching on. Even the "I-love-you" virus later in 2000 wreaked more havoc. What were we thinking?
In 1998, international investor and philanthropist George Soros predicted the imminent collapse of the global capitalist system. True, investors have absorbed some blows this year, but for the most part, and for the future, the global economy is thriving, Soros retracted that prediction during 2000. "Basically, I got carried away in thinking that the system might actually collapse. I goofed." -George Soros, quoted in the New York Times (August 12, 2000).
As the current and future national surplus was evaluated, it became evident that our rivers of debt are now running backwards-an event with biblical overtones for those watching for signs of an apocalypse. The National Debt Clock was set up in 1989 on Fifth Avenue in New York by Seymour Durst to call attention to how rapidly the debt was rising. In June, the clock started running backwards, and in September, it was retired in a little ceremony. What were we worried about?
After being shocked that Congress had actually voted in favor of repealing the estate tax during 1999, the President's veto at that time was a dose of cold water. What were we thinking? Congress would never try anything that radical again, would it?
Tax Repeal Redux
As the year 2000 began, there was something depressingly déjà vu about having the Administration and Congress operating at cross purposes once again. The Clinton administration was concentrating on the total restriction of Crummey trusts and the
restoration of the 5% surtax on estates exceeding $10 million to offset the benefits of the unified credit. Congress, however, had little interest in repairing loopholes in a transfer tax system that it planned on eliminating entirely.
No sooner had the new year begun than a second transfer tax repeal was launched. Instead of being a quixotic suggestion, this proposal entered the legislative process with clear support in both the House and the Senate. Nevertheless, it never had a veto-proof majority backing it and the entire legislative exercise followed the same sequence for the second consecutive year. The Death Tax Elimination Act of 2000 was vetoed by the President and the attempted override fell short by 14 votes. The vetoed plan would have phased out the top estate and gift tax rates by 2010, yet it would have imposed a carryover basis on appreciated assets passing at death. A stepped-up basis would still apply to $3 million of assets transferred to a spouse and $1.3 million passed to other individuals. By comparison, the Democrats were proposing more immediate relief with a higher unified credit. The democratic plan would have reduced the top transfer tax rates to 44%. Other tax proposals were made during the year as well:
Marriage Penalty:
The Marriage Tax Relief Reconciliation Act would have provided certain married couples with $292 million of tax relief from the so-called "marriage-tax penalty" over the next 10 years. The President vetoed the bill and Congress failed to override the veto. A new version of the marriage penalty relief may arrive next year.
Retirement Plans
Elements from this year's vetoed retirement package are likely to see action during 2001. Key provisions would include an increase in contribution limits for traditional IRAs from $2,000 to $5,000 and on 401(k) plans from $10,500 to
$15,000. Roth IRA eligibility limits for conversions would increase from $100,000 of income to $200,000 for joint filers. Older workers would be able to make "catch-up" contributions to 401(k) plans. A new version of the 401(k) plan would feature
Roth-IRA-like tax benefits with taxes paid up front and tax-free distributions.
The Big Sunset
Congress also voted to sunset the 1986 Tax Code and establish a commission to design a new system by July 4, 2004. However, tax overhauls during the 1980s only enlarged the tax code and an ambitious review would require more bipartisan
cooperation than currently exists.
Cases and Rulings
A Tax Lien's Priority
Rohn Drye knew that his own $325,000 of outstanding federal tax debt would swiftly consume the entire value of his mother's $233,000 estate if, through inheritance, it ended up in his possession. Drye therefore executed a disclaimer so that his mother's estate could pass to Drye's children. The disclaimer was timely under Arkansas law, but another aspect of state law determined whether a federal lien takes priority. The U.S. Supreme Court concluded that if the disclaimer is executed in a "transfer" state such as Arkansas, the assets become vested in the beneficiary immediately at death, enabling a tax lien to attach to the assets. Had Mr. Drye lived in a jurisdiction such as Colorado that has an "acceptance-rejection" statutory scheme, the beneficiary's interests would not have become vested and could have been disclaimed before the tax liens were applied. Drye v. U.S. 120 Sup. Ct. 474 (Dec., 1999).
The Scrutinized CRAT
A charitable remainder annuity trust (CRAT) was not entitled to a charitable deduction because the lifetime distribution requirements of §664 were not met. The CRAT contained about $4 million of stock and was to pay the decedent an annuity of 5% until her death. Despite the fact that the CRAT was properly drafted, the distributions required by the terms of the trust were not carried out. Seven quarterly payments amounting to $350,000 were missed. This case raises serious questions. Will the IRS now subject every missed payment to this level of scrutiny? Will a late payment invalidate an otherwise well-planned estate? What substantial compliance arguments will the IRS entertain?
IRA and QTIP
Although the qualification of an IRA in a testamentary trust as qualified terminable interest property (QTIP) has been permitted in a series of Letter Rulings over the past decade, the arrival of Revenue Ruling 2000-2 (I.R.B. 2000-3, January, 2000) now provides a definitive position to rely upon. An IRA is left to a testamentary trust, the terms of which provide for income to be paid annually to the surviving spouse. No one has the power to appoint principal to any person other than B, and B has the power, exercisable annually, to compel the withdrawal of amounts from the IRA that are equal to the income earned by the IRA during the year. These terms satisfy QTIP requirements.
Redemption v. FLP
Compare two disparate results that followed once it was determined that two different mothers transferring interests in a family business were short changed. Mother #1 exchanged securities and ranch property for an interest in a
family limited partnership (FLP). Although the property given exceeded the property received in value, there was no gift because Mother had received a pro rata share of the partnership. Church v. U.S. DC-Tex. (Jan., 2000).
By contrast, Mother #2's stock in the family business was redeemed by the company for $3 million. When Mother #2 learned that the stock was actually worth $4.9 million at the time, she attempted to disinherit her son and rescind the transaction. Not only did Mother #2 have no success in rescinding the deal, her efforts may have backfired by triggering additional gift tax on the transaction. Here, the excess of the stock's value over the transfer prices constituted a taxable gift to the decedent's son, who was the remaining company shareholder. Maggos v. Comm'r, TC Memo. 2000-129.
Final Thoughts
Truthfully, 2000 was not a banner year for estate planning developments. Yet, estate planning may have reached its media zenith, with ongoing press coverage of the potential estate tax repeal and its ultimate veto. And there has been a wave of creative arrangements-split dollar, FLPs, guaranteed GRATs, NIMCRUTs, et al., which will generate numerous strategies to keep estate planners busy during 2001.
Trusts & Estates In Brief
Holocaust Settlement
"I do not say it is fair, because fairness is a relative term. No amount of money can possibly be fair under those circumstances. But I'm quite sure it is the very best that could be done by the groups that negotiated for the settlement." -Judge Edward R. Korman, quoting Holocaust survivor Ernest Lobet, who testified in a case resulting in a $1.25-billion settlement.
Estate Tax
"It's a cancer," said Representative Phil Gramm (R-Texas), referring to the estate tax. "It's wrong. We want to get rid of it totally." Representative Bill Archer (R-Texas) produced some of the year's most notable quotes in referring to the estate tax as a "wrecking ball of a life's worth of achievement and success." His most colorful quote on the subject: "The ancient Egyptians built elaborate fortresses and tunnels and even posted guards at tombs to stop grave robbers. In today's America, we call that estate planning."
Who Pays Estate Tax?
Of 42,901 taxable estates filed in 1997, 44% had assets of less than $1 million, while 85% had assets of less than $2.5 million. Between 1987 and 1998, the number of estate tax returns doubled to reach 47,482. Estate and gift tax revenues totaled $27.8 billion in the year ended Sept. 30, 1999, more than double the $12.6 billion collected in 1993.
Who Doesn't Pay Gift Tax?
The IRS audited 1,651 tax returns reporting gifts exceeding $1 million last year and 80% understated the value of the gifts by an average of $303,000 on which $167,000 of tax should have been paid. Last year, the IRS audited 75.3% of returns for gifts exceeding $1 million and 1.8% of returns for gifts valued between $600,000 and $1 million.
Most Novel Artument
Rather than sell assets, an estate borrowed funds to pay estate tax. The estate then moved to stay the proceedings for 20 years so that all of the interest could be deducted, but was, understandably, rejected. Estate of Lasarzig v. Comm'r, TC Memo. 1999-307.
Tax Outrage
A low point in IRS public relations arrived this past year when a chief counsel advisory noted that parents may not be able to claim a dependency exemption for a kidnapped child for whom they continue to keep a room and spend money searching for. Representative Jim Ramstad (R-Minn.) called the memo "anti-family, cruel, and heartless."
Security Idea
After a theft from the Los Alamos nuclear facility, it was suggested that, for improved security, the IRS should "rewrite our nuclear secrets in the style of the federal tax code, so that any enemy who tried to read them would be driven insane." -Humorist Dave Barry
Just Don't Call Him Shy Longtime publicity maven Abe Hershfeld showed reporters his will and revealed plans to disinherit his wife and children and use his wealth to create an Immigrant Hall of Fame featuring...Abe Hershfeld. Regrettably, the statement to the press came as Hershfeld was being led away to prison for attempted murder of his 73-year-old partner.
Robert Moshman, JD, can be reached at bmoshman@optonline or (800) 572-2468 with any questions, comments or suggestions. He authors the Estate Analyst.
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