Politics & The Estate Tax & Celebrity Estates

Reprinted from The Estate Analyst, August 2008

By Robert L. Moshman, Esq.

ow will the federal estate tax fare under the next president? How will small businesses without liquid assets fare under the next estate tax reform? Will there ever be an estate tax repeal? Are we really going to have a carry over basis like...Canada!

These questions may sound familiar; people have been asking them for the past seven years. We take no sides when it comes to politics but Presidential candidates have now indicated how they would approach estate taxation.

The Last Estate Tax?

The final estate tax exemption level clicks into place on January 1, 2009 at $3.5 million.

We are a scant few months from reaching the $3.5 million exemption level, which is a significant new level that will affect many estates exceeding the current $2-million exemption level. A married couple can divide up an estate of $7 million and pass half through each spouse's estate with no transfer tax, as compared with a $4 million estate being passed through a couple's estate under the 2008 exemption level of $2 million.

Will that $3.5-million exemption and the 45% top estate tax rate be the final estate tax of all time before the estate tax repeal is finalized in 2010? Or will Congress leave that tax intact, poised at the brink, taking action sometime in late December of 2009? Or will a new approach be crafted sometime in the next 16 months?

This is the uncertainty that has been the hallmark of this decade of "tax repeal." How very different from the staid simplicity of the days when the estate tax credit of $192,800 had an exemption equivalence of $600,000 and that's the way the exemption was calculated for many years.

Bold reforms had beefed the exemption level to $1 million prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 but the reforms of that age determined to extinguish the estate tax once and for all. Outright repeal became a reality. The law was passed.

But there were a few loose ends. For instance, $522 billion of lost tax revenue over the next decade. A terrorist attack on September 11, 2001 and subsequent military action that made discussion of estate tax repeal less politically correct in Congress. A potentially crippling blow to charitable giving. Problematic benefits to the most wealthy leading socio-economic class warfare. That kind of thing.

Estate Tax Platforms

But everyone has known this day would come. The logistics of a tax reform on a ten-year time delay where repeal takes years to arrive has always meant that the presidential election of 2008 would play a role in the final fate of the estate tax repeal.

Going into the final phase of the estate tax repeal, as things now stand, we have 2009 as the final year of estate tax, followed by no estate tax in 2010, and then, by a quirk of legislative rules, a reversion to 2001 tax rules in 2011 unless Congress takes action.

This is where our federal legislature set the gold standard for profoundly flawed planning. It would require Congresses made up of different representatives to ratify the same concept ten years apart. So far, that hasn't happened. Congress has lacked the votes to make the estate tax repeal permanent. And now, in the final presidential election before the estate tax repeal would take effect, the presidential candidates have staked out various positions on the estate tax as part of their platforms.

The Estate Tax Lives

Cutting right to the chase, candidates Barack Obama and John McCain have both indicated opposition to an outright repeal of the estate tax as well as other areas of agreement.

Both Senator Obama and Senator McCain also oppose the strange and unlikely scenario of the pre-2001 estate tax coming back into existence.

Both of the major party candidates favor plans in which the estate tax is accompanied by a fairly large estate tax exemption. Both favor indexing the exemption for inflation.

Several of the better known "third party" candidates such as Ralph Nader also favor retention of an estate tax of some kind.

Does this mean the estate tax repeal is dead? Not quite. The estate tax repeal continues on a seemingly inexorable march toward fruition under its own power. Only Congress can stop this process and Congress is experiencing its own shifting balance of power.

Small Business Impact

Based on figures from the Congressional Budget Office and reported in "The estate tax: McCain vs. Obama," by Meg Massey on CNNMoney.com, only a few of the 27 million small companies in the United States will remain affected by the estate tax.

In 2000, there were 485 estates with small business assets that owed estate tax based on an exemption of $1 million or less and of those, 164 estates lacked sufficient liquid assets to pay the tax. By comparison, with a $3.5 million estate tax exemption, only 95 such small business estates would owe estate tax and only 41 would lack sufficient liquid assets to pay the tax. Far more small business estates would be affected by a carryover basis that would accompany the estate tax repeal currently being phased in.

A Potpourri of Proposals

Democratic Candidate Obama indicates support for keeping the estate tax at the final level prior to the repeal, i.e., at a 45% top estate tax rate with a $3.5-million exemption which would then be indexed for inflation and available to both spouses of a married couple for a total of $7 million being exempt. (This is comparable to the position Hillary Clinton had taken.)

Republican candidate McCain supports a top estate tax rate of 15% (comparable to rates for capital gains) with an estate tax exemption of $5 million. Like his counterpart's proposal, this amount would be indexed for inflation and available to both spouses of a married couple for a total of $10 million being exempt.

Libertarian Candidate Bob Barr supports the elimination of death and capital gains taxes. Constitution Party nominee Chuck Baldwin supports the repeal of estate and income taxes.

Candidate Ralph Nader would impose a small estate tax on estates exceeding $500,000 with a progressive rate schedule that peaks at 35% for estates over $10 million. However, he would also impose a 1% "wealth tax" on the overall net wealth of individuals each year.

Capital Gains, Dividends

Candidate Obama indicates an increase of the top tax rate for capital gains and dividends to at least 20% but no more than 28% for high-income investors. He also proposes taxing "carried interest" of private equity and hedge fund managers as ordinary income. Candidate McCain would keep the top rate on capital gains, dividends, and "carried interest" at 15%.

ESTATE TAX BRIEFS

NEW EXPATRIATION RULES: Under the new Heroes Earnings Assistance and Relief Act, there is a new approach to taxation of expatriates. Effective for citizens who expatriate after June 16, 2008, Section 877A now imposes an "exit tax" on "Covered Expatriates" who have a net worth in excess of $2 million or an average annual income tax liability in excess of $139,000 over the five years preceding expatriation. Such expatriates will be deemed to have sold all their assets, with an exemption of $600,000. Covered Expatriates with an interest in non-grantor trusts will be subject to special 30% withholding and any direct or indirect gift or bequest to a U.S. person will be taxed at the highest applicable rate under new section 1208.

ANESTHESIOLOGISTS LEFT NUMB: The Tax Court ruled against a charitable deduction plan that five Oregon anesthesiologists were hoping would provide substantial charitable deductions. Oregon Health & Science University Hospital (OHSU), is a public teaching and research hospital that was being served by doctors from 30 different practice groups or companies. In the late 1990s, the hospital required all the groups to join its 501(c)(3) organization. But before the consolidation, the five anesthesiologists of University Anesthesiologists, P.C. created a new class of non-voting stock and donated it to the non-profit organization to gain a charitable deduction. Then, in theory, after the consolidation, the voting stock would be contributed and University Anesthesiologists P.C. would cease to exist.

If the non-voting stock were worth $401 per share as claimed, each of the physicians would have been able to claim a deduction of between $176,000 and $201,000. However, the IRS determined that the non-voting stock was only worth $35 per share and the Tax Court agreed with that analysis. The taxpayers' appraisal was more than 40% off from the government's appraisal and the court found that the doctors did not act in good faith. Therefore, penalties applied under section 6662(b)(1). Bergquist v. Commissioner, 131 T.C. No. 2 (July 22, 2008).

Celebrity Estates

The Helmsley Dog Trusts

More details about Leona Helmsley's estate, with a value between $5 and $8 billion, have been making news. When Helmsley passed away at age 87 in 2007, headlines focused on a large bequest to a small dog. The real estate heiress, also known as "The Queen of Mean," had left $8 million to her dog "Trouble" a five-pound Maltese.

One year later, other details of the will have been revealed. Two of Mrs. Helmsley's four grandchildren were disinherited. Other relatives were given bequests that are conditioned on their visiting her grave on a regular schedule and signing into a mausoleum guest book. Funds are provided for the perpetual care of the gravesite which is located on three quarters of an acre of Sleepy Hollow Cemetery in Westchester, New York and was constructed for $1.4 million.

As for Trouble, there has been some trouble. Mrs. Helmsley's will poured $12 million to a 2005 trust of which Trouble was the sole beneficiary. One year later, a New York Surrogate Court judge has cut Trouble's trust to $2 million and given $6 million settlements to the disinherited grandchildren. New York recognizes "honorary trusts" for pets but judges have the discretion to reduce the bequests if they substantially exceed the amount required for the intended use. There are now 39 states that provide for pet trusts.

Trouble, herself, was bequeathed to Mrs. Helmsley's brother, who disclaimed the bequest. Trouble now lives with a caretaker in Florida. The caretaker is paid $60,000 annually for this task and $100,000 is spent annually for full time security.

Writing for FindLaw, Joanna Grossman describes the problems of a trust with a pet as a beneficiary. Such trusts tend to violate the rule against perpetuities since the pet is property and cannot be a measuring life nor be qualified as an ascertainable beneficiary. A charitable trust for the care of dogs is needed to withstand legal scrutiny.

As for the rest of the estate, the final chapter may not yet have been written. The will leaves the bulk of the estate to a 1999 charitable trust that has vague terms. Leona Helmsley wrote a two-page mission statement for the trust in 2003 which indicates the trust is for the indigent and for the "care and welfare of dogs." However, "the indigent" were subsequently crossed out.

Did dogs of the world just receive a $5-billion trust? How will the trustees interpret the mission statement? How will New York's attorney general enforce this trust? And since the Surrogate Court's decision indicated that Mrs. Helmsley was not mentally competent when she executed the will, there may be additional skirmishing over the Helmsley estate.

Dannielynn is Sole Heir

Dannielynn, the daughter of Anna Nicole Smith, was declared the sole heir of her mother's estate. A Los Angeles judge established a trust for the child with her father Larry Birkhead and Smith's executor Howard K. Stern as co-trustees.

A will executed prior to Dannielynn's birth purported to disinherit future children other than Daniel Smith, who died at age 20. A Bahamian inquest concluded the cause of death was an accidental drug overdose.

The Smith estate continues to pursue a legal battle with the estate of Smith's second husband, billionaire J. Howard Marshall.